Exit strategy planning is so often associated with large scale businesses and multinationals; but, the conventional advice is that the ideal exit strategy is outlined during the early growth phases of your venture.
This advice illustrates that every entrepreneur can benefit from having an exit strategy from day one. So, how do they work, when should you plan one, and what do exit strategies for small businesses look like?
Do small businesses have to have an exit strategy?
Anything can happen in business. We can see this within the current UK business landscape, with one in four entrepreneurs having fast-tracked their business exit plans recently.
To understand why a small business needs an exit strategy, you need to grasp what an exit plan consists of. While many exit planners will discuss these strategies within the context of Initial Public Offerings (IPOs) and high-level mergers, exit plans can also consist of liquidation and bankruptcy.
Your exit strategy can maximise your gains, but it can also limit your losses, and within the context of a small business, this is highly relevant. For example, 60% of UK small businesses will fail within their first three years of life.
If your startup fails, how will you extricate yourself from it without losing everything you have worked for? That’s where a comprehensive exit plan comes to the fore. In short, responsible entrepreneurs will always have an exit plan that accounts for both the best-case and worst-case scenarios.
How do I know if my small business needs an exit strategy?
Choosing an exit strategy may not seem like an optimistic step for a brand-new venture, but it’s all part of good planning. After all, even an optimal small business can find itself in the doldrums if unexpected economic changes strike.
The right question is not how you know if your small business needs an exit strategy, but why it needs one. So, what are the primary benefits of possessing an exit strategy for your small business?
- It protects the value of the business you are building.
- You are creating a smooth transition for your leadership team and employees.
- Exit strategies can generate a potential income if you decide to retire.
- These plans can enhance your business’s overall worth.
- Exit plans contain tax planning strategies to minimise the impact on your estate and family.
- You can create a strategic direction for your firm that aids it on its journey.
These benefits impact your small business at different points in your journey. In other words, your small business benefits from an exit plan from the first day you open its doors.
How does a small business exit strategy work?
Despite the benefits of exit plans and the advice that you should have one as early as possible, few small business owners consider them.
According to one study, upward of two-thirds of companies with under 250 employees have no exit plan. Whether these firms suddenly receive interest from a major industry player or their leaders suffer a medical crisis that forces them into early retirement, they invite chaos and disruption.
Forward-thinking business owners know the value of exit plans, but determining how they work is more complex.
Without going into the complexities of individual business exit plans, an effective exit strategy includes various contingencies for every positive or negative scenario. It is your business’s plan A, B, C, etc., and applies regardless of the investment type or venture.
Let’s sum up the fundamentals of a business strategy:
- It details how you will liquidate your ownership/stake in the business.
- It outlines the step-by-step process of how you will achieve this.
- It contains vital information to decipher the true value of the organisation.
All exit plans are unemotional and aim to reduce risk, whichever aspect of your exit strategy is triggered.
Moreover, exit plans are designed to be fluid. While an entrepreneur may form an exit strategy within the initial few months of their venture, they will also update them as the business grows and the economic landscape shifts.
After all, you cannot expect a startup’s exit strategy to resemble a small business with a five-year history, as the nuts and bolts are fundamentally different.
When should small businesses plan their exit strategy?
The average UK small business is inherently weak because it has no plan if a founder leaves at short notice. Studies have already been performed into the resiliency of UK SMEs, and the overwhelming conclusion was that half of UK SMEs would fail within a month if a founder departed at short notice.
This contrasts larger corporations with colossal leadership teams because small businesses heavily rely on their founders.
With these figures in mind, forming an exit strategy with haste becomes crucial. While an exit strategy offers no guarantees, it will increase the odds of extracting the most for your hard work and ensuring your legacy lives on after you’re gone.
Exit strategies best for small businesses
Small business owners looking to formulate an exit plan must refrain from copying the exit plans of well-established companies. Household names have countless other considerations in their exit strategies that don’t apply to you.
This underlines the importance of enlisting the help of a small business exit planning consultant who can guide you through creating an exit plan relevant to you.
Likewise, exit plans differ depending on whether your small business is a startup within its first 18 months of operation, or one that has been in business for several years. Furthermore, there are also exit strategies for investors in a small business.Here’s a breakdown of what an exit strategy might look like for each group.
Startup exit strategies
In the case of startups, entrepreneurs creating a comprehensive exit strategy think less about overnight successes and more about extracting themselves from a startup not meeting its predetermined goals.
Your exit strategy will concentrate on what happens if you’re experiencing negative cash flow and attracting external investment is no longer enough to create a viable business. It will detail a planned tripwire for terminating operations and how to liquidate the startup in a way that limits losses.
On a side note, an exit plan in the startup phase is one of the first things external investors look for before they’re willing to commit any capital to the cause. Exit plans are essentially a stop-loss for investors and founders.
Ideally, your exit strategy will revolve around three key scenarios based on the likely trajectories of a UK startup, including:
- IPOs for lightning-fast success stories.
- Strategic acquisitions for mid-range successes.
- Liquidation/bankruptcies for startups that fail to make the cut.
For a positive startup exit strategy, your plans will revolve around relieving you of your responsibilities and creating a successful strategy. It will also calculate how to value your startup and the amount you’ll expect to leave your startup behind.
As part of a comprehensive business valuation, you must bring in an external valuation company. Startups are notoriously difficult to evaluate because they’re often sold based on their potential rather than current numbers.
Established business exit strategies
In contrast to startups, established small businesses have been in business for two to three years. They haven’t achieved the meteoric rise of a startup that moves from a one-man operation to IPO, but they’ve proved the model works and have managed to survive those initial growing pains.
Company directors in these situations are less likely to be planning for IPOs or imminent bankruptcy, but likelier to be thinking about some of the other exit strategies, such as:
- Mergers and acquisitions.
- Management buyouts
- Business sales
In particular, established businesses are prime targets for bigger competitors looking to increase their market shares, acquire top talent, eliminate a competitor, or take hold of intellectual property.
Exit strategies will also place tremendous value on calculating the actual value of the business and outlining an orderly merger or acquisition. Additionally, founders or stakeholders may want to sell due to the desire to retire.
Despite these priorities, established businesses must also plan for the worst-case scenarios of liquidation or bankruptcy. Due to the many different ways an established business owner may depart, exit planning for these SMEs often requires as much detail as giant multinationals.
Investor exit strategies
Are you an investor in a small business with limited input into day-to-day operations? Your priorities are different but overlap with busy entrepreneurs.
In this case, your exit strategy will factor in strategies to maximise your gains and minimise your losses. So, what are the contingencies a small business investor has to consider?
Selling an equity stake
Investors with shares in the company may decide to sell their equity to other investors or a member of the company. Remember, an investor doesn’t have to be a venture capitalist or an institutional investor. They can also be a founder themselves.
Typically, selling an equity stake will link closely with a defined succession plan. If this plan includes selling your stake to a family member or friend, there may be attached conditions to consider.
Leaving on the 1% rule
The 1% investment rule is a globally accepted standard many investors follow. It says that an investor will sell their stake in a small business if their total investment value decreases by 1% of their total liquid net worth.
For example, if you’ve invested £100,000 in a small business, and your total liquid net worth is £250,000, you would trigger your exit strategy if your small business investment declined by £25,000 or more.
While this is a systematic approach to protecting your capital, it’s not an approach you must rely on. Feel free to set your own loss limits based on your risk tolerance.
Percentage exit
A percentage exit is another exit plan contingency that investors can take from founders. Usually, founders will depart once their business reaches a particular value. Investors can do the same.
A percentage exit is a limit within your exit strategy that defines how much your investment will gain or lose before you decide to liquidate your stake.
For example, if you’re an investor, you may decide to liquidate if your investment reaches a 400% ROI, or you could trigger your exit plan if it loses 20% in value. Your percentage, again, depends on your goals and risk tolerance.
Time-based exit
Finally, there’s the time-based exit. Both founders and investors can include this contingency within their exit plans.
For example, if you want to retire in five or ten years, this could be a tripwire that triggers your exit plan.Whatever your specific contingencies and whether you are an involved investor or a venture capitalist, exit plans require careful thought. Hiring a professional from Hilton Smythe can protect your finances, cement your legacy and give you the peace of mind you require to move forward with your business.
