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How Do I Plan My Exit Strategy?

John Harrington's headshotIn this three-part series, First Bank’s John Harrington, Western Region Senior Credit Analyst, goes through exit strategy scenarios. The first, outlined below, follows the premise that the business has a key employee that could take over the business. The second and third (coming soon) explore options if there is not a clear internal succession option.

You had an idea. You saw a need. You built a business. Time has gone by, and now you are ready to retire. You have no children willing or able to take over the company, but you don’t want to simply shut down the business or let down the employees who depend on you and who have helped make you successful.

Many business owners face these problems as they enter their later years. It’s not as if they can simply have a retirement party and clean out the office. There are equity concerns, among other things, that needs to be dealt with before involvement in the business ends.

The Key Employee

Ideally, you have had a key employee for some time now. They have worked multiple jobs within the business, understands exactly how the company functions, is well respected by other employees, and has aspirations to continue the business after you are gone. You trust them to responsibly manage the business in your absence. You believe the best thing for your company and its employees is to sell the business to your key employee.

Say this hypothetical company is worth $2,000,000. While you have showed how much you value them with their compensation, you have not paid your prospective successor well enough to be able to have that much liquidity. How can you sell a business to someone who can’t afford it?

Seller Financing

Acquisition financing can be done one of two ways: seller financing or with third-party debt.

Seller financing is simple. You already trust your successor with the business, so you also trust them to pay you for the company over time. As a result, you are willing to accept payment for the business in installments.

This set up can be a benefit both for the business and the new business owner, and in some ways can be beneficial to you, the seller, too. Instead of getting a lump sum of cash, you get consistent payments into retirement, like an annuity.

Seller financing is also typically less formal, lower maintenance, and more lenient because you avoid dealing with financial reporting requirements and loan covenants from a bank. This is “friendly debt” as it’s called in the industry.

Additionally, seller financing gives you the freedom to tailor loan terms to what you know the company can afford. Some do not charge interest. Many charge token amounts; 1% or 2%. In many cases, the rate is far cheaper than what third-party debt could provide.

Terms too could be longer. Many bank policies prohibit acquisition debt from having a term longer than 5 years. A 65-year-old business owner may prefer having consistent monthly income from payments over the next 10 years. Expanding the term could be a tremendous cash flow benefit for the company as the loan payment would be much smaller per month.

Another Option: Third-Party Financing

Alternatively, some companies are strong enough for third-party financing of the ownership transition. The next article (coming soon) will discuss the factors banks look for to get comfortable with lending money to businesses that are being sold to a new owner.

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