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Change is an inevitable aspect of every life cycle. With business, the final evolution can take a variety of forms. You may be ready to retire and pass the business on to a family member. Perhaps your goal is to sell to outside investors and use the proceeds as a retirement nest egg. Or the business may have declined so much that the best exit is a legal dissolution of your company. These tools and resources will help you manage the big decisions ahead for a successful transition.
There is no one ideal method of exiting a small business. Unfortunately, most small business owners begin their retirement exit strategies by reviewing the legal and tax consequences of the alternatives. When this happens, they end up with a plan that is technically solid but will often not meet their personal goals and needs.
The best exit strategy is the one that meets the goals you have established for your exit strategy and is planned well in advance.
The following paragraphs summarize the most common exit strategies for an entrepreneur
When most people think about succession planning, they think about transferring the company to the owner’s children or other relatives.
One of the biggest challenges with this exit strategy is getting the business owner to share decision making with his successors before he or she is ready to retire. On many occasions we have seen children in their 40s or early 50s who are expected to take over the business, but have not been prepared for those decisions. They struggle making decisions because they do not have the training or experience to do so, lose the respect of employees and clients, and the company begins to faulter. Frankly, they have been setup to fail.
Another challenge for this exit strategy, is preparing the heirs financially to acquire the company. Heirs often will not have the ability to purchase the company in its entirety. Properly structuring the company will make the acquisition easier for the heir. An example of a technique that is often used to make the purchase more affordable is to separate the real estate from the business. This will reduce the purchase price for the heir and also provide rental income to business owner. This step can create a win-win situation for both parties.
This exit strategy often involves the transfer of ownership in steps, the owner financing the purchase over time, the owner gifting some of the stock over time, or transferring ownership of the company through the owner’s estate. The conflict in this situation is having the owner realize enough money to fund their retirement but still making the company affordable to their heirs.
Another strategy for this approach is to set up a Supplemental Executive Retirement Plan (SERP). This plan will pay the retiring owner a specific income for a specific number of years. These payments will be tax deductible to the business when paid, which makes the purchase more affordable. The disadvantage of a SERP is that the owner will be treated as an unsecured creditor of the business, if the company would fail in the future.
A common point of conflict happens when the owner has multiple children, some involved in the business and others not involved in the business. The owner needs to make clear the difference between ownership of the company and the management of the company. One strategy to protect those not involved in the day-to-day operation of the business, and reduce possible future conflicts amount the heirs, is to have a buy-sell agreement between the heirs which spells out the purchase price of shares for those who do not wish to be invested in the company. Another approach is for the non-managerial heirs to receive preferred stock rather than common stock. Preferred stock pays a pre-determined dividend, while giving the managing heirs complete control of the company’s management.
When there is more than one child involved in the business, you also have to make clear which will be the final decision maker. Again, this exit strategy requires planning and communication while the owner is available to make these decision clear to everyone.
This exit strategy requires years of preparation to be effective.
In professional service companies, it is common to have multiple owners that share decision making and income. The members of the professional service company often have buy-sell agreements in place with a predetermined formula for ownership transfers at retirement or an untimely death. This protects the members of the company by restricting ownership and protects the members heirs by negotiating an exit price in case of a sudden and untimely death. These buy-sell agreements are often funded by life insurance policies.
Another exit strategy that may work for an entrepreneur if he or she does not have family members who are interested in managing the company or partners or business associates who are willing to purchase the owner’s interest in the company is to sell the business to management. This approach is attractive if the business owner wants to see his or her legacy continue even after retirement and there is no heir interested in running the company. Individuals who are involved in the business today obviously are very familiar with the company’s strengths and weaknesses.
The biggest problem with this exit strategy is that it is rare that management has the ability to purchase the company. All of the problems and tactics discussed under 'Selling To The Family' will apply under this strategy as well.
To obtain adequate funds for the business owner’s retirement, it may be necessary to sell the company to an outside party. A sale of the company to a competitor, often allows the acquirer to eliminate duplicate overhead expenses that will enable them to pay a higher price for the company. Again, to implement this strategy properly takes time and planning.
An outside party looking to purchase a company wants to see steady growth and profitability. Profitability is the key driver in valuing a company. This is the company’s ability to repay the purchase price to the acquirer.
Research by BizBuySell.com has shown that this strategy is not as an easy as it may appear. This process takes a long time to complete. Most companies have not positioned their company for a sale, and only 20% of businesses listed for sale eventually get sold.
An exit strategy that most entrepreneurs do not want to think about is the liquidation of their company. Most would like to think their business is valuable and attractive to a potential buyer. At some point, they have no alternative but to liquate the company if a buyer cannot be found.
The primary disadvantage to this exit strategy is that you will generally not maximize the funds available for your retirement.
An approach that is often taken by small business owners is to continue to manage the company for the remainder of their life. This approach is a very acceptable approach under certain conditions. It also takes effective planning just as other approaches do.
With this exit strategy, the owner retains ownership of the company, along with supervisory decision making, but turns over much of the day to day supervision of the company to another person. This person must obviously be prepared for the position, trusted by the owner and accepted by the company’s employees and customers. The new management may be a relative or not a relative. If capable management can be identified, the owner will be in a position to cut back the number of hours spent working at the company significantly and enjoy a semi-retirement.
This approach works best when:
The primary disadvantage to this approach is the owner is assuming the risk of the continued success of the business and that they will be able to sell the business in the future. It also leaves responsibility for the future of the company in the hands of the entrepreneur’s executor and heirs.
To successfully develop an exit plan, you must start early (a minimum of five years before retirement) and often enlist the help of a professional such as a certified public accountant. This planning will provide the entrepreneur with the maximum value for the company and possibly multiple alternatives when the time comes. Unfortunately, most entrepreneurs do not plan for their exit from the business and are left with only one possible course of action – the liquidation of the business.
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