The terms ‘succession’ and ‘exit plan’ in business carry two different meanings or perceptions, says Joanna Oakey, Managing Partner of Aspect Legal, and author of Buy Grow Exit: The ultimate guide to using business as a wealth-creation vehicle.
Succession implies handing or selling a business down through family generations or through internal staff holdings. Exit plans refer to business sales to third parties.
This is important to understand, Oakey says.
“When you’re building a business to ultimately pass down to your family or your employees, you actually need a different mindset than if you’re building it to extract value out of it,” she says.
That is the first thing to keep in mind when developing any form of exit plan – what is the end goal?
“The majority of successions these days actually are no longer to the family, because kids find their own path,” Oakey says.
“Over the last 20 years, the landscape has been changing. Now, if you’re looking to exit your business, to properly extract value and attract a buyer, you’re going to have to build it in a way that allows the value to be transferred.”
Why is an exit plan important?
Whether you’re currently looking to sell or not, putting an exit plan in place will make it a better business overall, Oakey says.
“In building a business that is not full of the sorts of issues that would put off a third-party buyer, you’re creating a business with better processes, more safeguards, less chances of disputes and less risk,” she says.
A business designed to be attractive at sale is one that does not rely on the presence, experience or knowledge of one person, she explains. It empowers and trains its staff, is consistent in its dealings with customers and clients and shows steady and reliable growth.
Exit strategy: start at the end
The very first step for a business owner, Oakey says, is to develop a clear idea of what they desire when it comes time for them to step away.
“There are a few different options, including staying on with the business and keeping it as an investment, but having it run by someone else,” she says.
“You might want to pass it on to family. Or you might want a third-party sale, in which case you’re looking at maximising the value.”
If the business owner is clear on the end game, it will help them prioritise issues and know exactly what order to approach matters.
“No matter which of these you choose, you’re still trying to create a business that has prevented risks that can undermine its longevity and value,” Oakey says. “If you’re looking at a third-party exit, you certainly need to be having a mind to what a buyer will see in the business.”
Next up: Evaluate your current position
Where does the business stand right now? Where does its value lie? Where are the risks? How might a buyer consider the business today, as opposed to a few years down the track?
When conducting an analysis of the current shape of the business, all key areas must be considered. The most important, Oakey says, is staff.
“How have you dealt with staff opportunity and risk?” she says. “Quite often, staff are a key component of value in a business. The way you approach risk protection, and retention, is critical to both the value and the risk level in the business.”
Another key area is clients, including how the business deals with them, whether they carry any risk, how “sticky” they are, and how transferable they are likely to be in the event of a change of ownership.
“This is all about relationships,” Oakey says. “Are the client relationships with you, or are they more broadly with the business as a whole? And how have you dealt with risks in your client base by ensuring there are no disputes in the future?”
A similar assessment should be run against other areas such as systems and processes, suppliers, key contracting parties, other stakeholders, and the protection of intellectual property (IP).
Finally, Oakey says, the business structure should be assessed in consultation with a relevant professional, to ensure appropriate levels of flexibility and tax effectiveness for whatever is planned for the change of ownership.
The strategy to reach the end goal should only be designed once these analyses have been conducted, and should be reviewed no less than annually, to ensure progress toward the desired goal.
Business exit: When the time comes
When the exit point arrives, Oakey says, the business should be in a form that ticks all boxes in terms of value from the point of view of a buyer.
Now, it is important to understand what might influence the multiples in the valuation.
“The value of a business is profit times a multiple,” she says. “Most people don’t understand that profit is not the most important thing. It is important, but the multiple is more important.”
“We work with businesses that sell anywhere from 0.5 times profit to 10 times profit. For a business with $500,000 profit, that’s the difference between a sale for $250,000 and a sale for $5 million.”
The multiple can be influenced by a range of factors, including all the things that were designed into the business itself during the build process, such as staff, systems, processes, risk, IP protection, stickiness and therefore transferability of customers and clients, or lack of owner dependency.
“Buyers are seeing a lot of risk in non-compliance with employment laws at the moment,” Oakey says. “So, that’s an area that causes transactions to fall over, or at least reduces the value of a business and decreases the pool of buyers.”
“If you’re on top of legislation, if you’re on top of what’s changing in workplace law and where the risks are, and if you’re building your business with protections in place, then you’re going to have access to a larger buyer pool, and a buyer pool that will pay a higher multiple. And your business will be better off for it, whether you sell or not.”
