Small business owners should have an exit strategy – a plan for the time when they’re either unwilling or unable to keep running their company. That plan should include both a current business continuity plan for relatively young business owners and a future long-term succession plan for a smooth path to retirement.
An exit strategy to cover your worst case scenario
No matter how young or how healthy you are, you’re not immune to tragedy. Therefore, business owners should have a continuity plan. Such a plan can protect you or your family in case of death or disability.
To understand why such a plan is vital, consider what might happen in its absence:
Example: John Smith, age 45, is the sole shareholder of the successful John Smith Co. After a fatal auto accident, his widow Jane inherits John’s shares. At such a time, Jane will have to find a buyer and negotiate the terms of the sale. Jane may have a difficult time getting full value for this profitable business.
Alternatively, John might suffer a stroke and lose his ability to work full-time. In the absence of a business continuity plan, John (or someone representing him) will have to relinquish control of the company and find some way to realize the value of the business he has built.
Benefits of having a Buy-Sell Agreement
To provide protection against such possible disasters, business owners and co-owners of all ages should have a buy-sell agreement in place. Such an agreement should identify the buyer and specified events that will trigger the buyout, in case a sale becomes necessary. The agreement should also spell out how the price will be determined—it could be a multiple of cash flow or revenue, for instance.
If a company has two or more co-owners, a mutual buy-sell can be effective. For sole shareholders, such as John Smith in our example, finding a buyer may require some creativity. A key employee might be named, or even a competitor. Funding for a possible buyout might be provided through life and disability insurance.
An exit strategy to cover your future retirement
If all goes well, our hypothetical John Smith will remain healthy and active throughout his 40s and 50s. At some time, though, John will start to think about stepping down—or at least slowing down. In anticipation of this, John should have a long-term succession plan for his retirement or semi-retirement.
Note that John should not ignore the chance of a catastrophe, at any age. Therefore, his long-term succession plan should still include a business continuity plan. For the long-term plan, John may prefer to have a different buyer than the buyer for the continuity plan. (The initial continuity plan can contain language allowing for cancellation of the agreement with written notice from the buyer or seller.)
In addition to continuity coverage, the long-term succession plan might have a schedule for John’s future participation in the company. Will John leave altogether, as of a certain date? Will he continue to work at the company for a certain or an indefinite time period? If he stays on, what responsibilities will he have? In some cases, the purchase price might be reduced if John leaves the company altogether. A higher price might be agreed upon if John agrees to stay for a while, helping the company make the transition to new ownership.
The Bottom Line
Business owners of all ages need an exit strategy. This strategy may evolve as the owners age and the business grows and matures. And any plan should be coordinated with the business owner’s personal estate plan. (See our article “Why you need a will [1]” for more information.) You should consult your attorney and tax adviser to discuss your business continuity and succession plan.