How to craft a winning business exit strategy in 2024
Half of UK business owners have no exit strategy. That was the discovery of a recent survey, which also found that more than one in 10 (or 13 per cent) had not even considered the need for an exit plan.
In recent years, business owners have (understandably) been quite short-sighted, focusing more on riding out the successive waves of pandemic, supply chain disruptions, high inflation and interest rates than on any long-term plans.
However, as investor confidence returns and the threat of capital gains tax increases looms, there has never been a more optimal time to think about how you’ll exit your business in the most profitable and tax-efficient way.
Firstly…
“Why do I need an exit strategy?”
Fourteen per cent of business owners with no exit strategy do not believe that they need one – a surprising statistic given the widespread recognition of the need for wills and retirement plans.
Like a will, a business exit strategy is an important part of risk management, even if you’re still riding high on your firm’s runaway success. Of course, business sales often occur due to retirement, but life is fickle: unforeseen circumstances such as illness, shareholder/family disputes, or simply falling out of love with your venture can raise the spectre of a business sale.
In these circumstances, business owners are often reactive rather than proactive, leading to suboptimal outcomes.
Even for high-growth startups, a haphazard approach to exit strategies can spell the writing on the wall. “In my own experience as a founder,” Touraj Parang writes in the Harvard Business Review, “the lack of advance exit planning led to the demise and fire sale of my first startup Jaxtr, a promising communications solution founded in 2005 with top-tier VC backing and a large user base.”
And…
“When should I start crafting my exit strategy?”
In Charles Stanley’s survey, another twenty four percent of business owners with no exit strategy said that it was “too early” to think about an exit plan. But what is “too early” when it comes to your exit strategy?
12-months to three years in advance is oft bandied about as a guideline for when you should start thinking about your exit plan, especially given the qualification criteria for Business Asset Disposal Relief (BADR). However, business owners would do well to think like private equity managers: start thinking about your exit before you’re even out of the starting gate.
“Business owners would do well to think like private equity managers: start thinking about your exit before you’re even out of the starting gate.” – Hilton Smythe Business & Finance Brokers
Why? Every business decision that you take will have repercussions on your company’s growth potential, profitability, and ultimately, its value and appeal to eventual investors or buyers. Value drivers like low revenue concentration, high MRR or ARR, scalable tech, cash flow, and an experienced and loyal workforce will drive up the multiple you can command upon exit – and they are all things that can be cultivated from day one.
The macroeconomic and political environment will also impact the timing of your exit strategy. 2024, for example, has seen more UK business owners applying the accelerator to their exit plans – activity that has been linked with Labour’s anticipated hike in Capital Gains Tax (CGT).
More accessible financing and lower interest rates also create a more conducive seller’s market, encouraging business owners to get the ball rolling on their exit strategies sooner.
Hilton Smythe’s exit planning service helps you assess your exit readiness
Contact us todayFinally…
“What are the main elements of a successful exit strategy?”
1. Setting your objectives
Your exit strategy’s objectives will be both financial and non-financial. Financial considerations include liquidity, valuation, and tax/estate planning. Do you want to retain a financial stake post-sale? What are your objectives in terms of wealth planning and retirement income?
Non-financial factors include succession, employee and stakeholder concerns, and family dynamics. Are there any employees who you want to protect or reward? Is an EOT or an MBO on the cards? Does your business have the managerial expertise required to be successful in the future?
And do you care who buys the company – a private equity buyer, trade buyer, or even just an ambitious individual? Maybe vertical integration is an option and one of your suppliers, distributors or customers would be interested in acquiring your business to strengthen their own market position.
“Business owners must objectively assess all their options when planning the company’s next strategic phase. These may include third-party transactions (private equity or strategic buyers), winding up operations, an EOT, or a management buyout (MBO). Prudent vendors should consider all available liquidity options.”
Hilton Smythe Business & Finance Brokers
2. Early tax planning
“In this world nothing can be said to be certain, except death and taxes.” So said Benjamin Franklin. And preparing for the latter is key.
Minimising ordinary income tax treatment in favour of long-term capital gain taxation is one of the main goals of business sale tax planning due to the significant rate differential of a top rate of 45% for ordinary income as compared to 20% for long-term capital gains. For example, sellers will favour a share sale over an asset sale to avoid the double tax charge often associated with the latter.
You may also wish to consider the plausibility of an Employee Ownership Trust (EOT) – one of the most tax-efficient ways to exit because it does not incur any capital gains or inheritance tax (IHT) liabilities.
If you’re planning on family succession, you may be able to transfer business assets to younger generations now, taking advantage of the rules that mean gifts made at least seven years before the donor’s death are free of IHT. You may also be eligible for Gift Hold-Over Relief, meaning that your successor will pay it when they sell the business.
Too often, a sale process has already reached the letter-of-intent stage before tax advisers are consulted. At that point, many areas have already been negotiated and expectations set, and tax-efficient alternatives may no longer be on the table. The key takeaway? Think about the tax implications of any exit strategy, and if necessary, consult an adviser early on.
3. Identifying and maximising value drivers
As well as minimising tax burdens, the primary objectives of most business exit strategies are to maximise valuation and secure the most favourable deal structure.
Achieving this will be contingent on your financials, but also your key “value drivers”. Business valuation typically employs a range concept due to the broader spectrum of possible values compared to other investments. For example, a business might be valued within a 4.0 to 6.0 EBITDA multiple range. Where in this range your company’s falls, however, will depend on its value drivers which generally fall within one of two categories – earnings growth and resilience.
Under the “earnings growth” banner, you’ll have things like historic growth, future scalability, low CapEx requirements, and high free cash flow (FCF) conversion ratio. Under resilience, you’ll have things like quality of earnings, customer stickiness, IP and barriers to entry, and human capital.
Identifying these and maximising them in the run-up to your exit will help position your business as a more competitive target.
4. Aligning your business objectives with your sale objectives
The buyer’s identity will significantly influence transactional value. Understanding their investment philosophy will allow you to align your business with their criteria and craft a compelling growth narrative that can be set out in your marketing materials and Information Memorandum.
For private equity investors, you’ll want to focus on solid cash flows, strong management, market growth, and low capital expenditure needs.
For strategic or “pure-play” buyers, you’ll want to emphasise integration benefits: potential opportunities, sales and distribution synergies, increased purchasing power, operational efficiencies, and working capital improvements.
“The key to maximising your business’s value lies in strategic alignment. By understanding potential buyers’ investment philosophies, whether they’re private equity firms seeking robust financials and growth potential, or strategic buyers looking for synergies and integration opportunities, you can tailor your business narrative accordingly.”
Hilton Smythe Business & Finance Brokers
5. Managing exit-related risks
Identifying and managing exit-related risks is an oft-neglected part of a successful exit strategy. Potential risks may include loss of key personnel, customers, and suppliers, or inadequate protection of intellectual property.
Employees are often the most valuable asset that a business has – and never more so given the UK’s growing labour crisis. And for a buyer, business continuity is key to realising the benefits of an acquisition, with large financial implications associated with hiring new employees, the loss of intellectual capital, and the loss of client relationships.
For this reason, managing human capital-related risks is crucial. Possible issues include the executive team’s capabilities, their alignment with new ownership plans, key employees exiting, and the financial impact of existing compensation and benefits structures.
Ask yourself: will the business survive without you? Even if you employ staff, if you are what Americans call the “rainmaker” —the one who attracts clients and revenue, and the person around whom the goodwill has been built — the business may flounder without you. Ensure you train up your senior members of staff to take over the key strategic work.
Managing IP-related risks is also crucial in exit planning. You’ll want to ensure that protection measures (e.g., nondisclosure agreements, trade secret agreements, and possibly post-employment restrictive covenants) have been implemented, and in more complex cases, consult an intellectual property lawyer.
6. Determining the timing of your exit
In an ideal world, your exit should be timed to coincide with peak financial performance – when there is consistent growth, strong profitability and a stable market position.
However, there are other “push” factors, such as industry consolidation, tax policy changes, high investor activity, or increasing industry challenges. Indeed, in the face of industry disruption, there is much to be said for joining forces with a competitor and pooling resources to tackle it head on.
In recent months, business owners looking to sell their businesses have also been attempting to push through transactions ahead of possible capital gains tax changes.
“Internal” reasons such as retirement, health issues, or a desire to pursue new ventures may also come into play.
The key takeaway? Look at the question of timing through a wide-angle lens, taking into account personal motivations, the business’ financial trajectory, and wider industry and macroeconomics conditions.
“In the most successful exits, the company should be delivering its peak performance for the months leading up to the final price negotiations and closing.”
Basil Peters, Early Exits: Exit Strategies for Entrepreneurs and Angel Investors
7. Picking your advisers well
Given the limited bandwidth of a typical SME’s resources, experienced external advisers—such as brokers, lawyers, and accountants – will be critical for a successful outcome.
They’ll be able to advise on deal structuring, assess business value, tell the business’ story through marketing materials, handle buyer solicitation, provide negotiation support and accounting expertise, and bring objectivity to emotionally charged decisions.
When selecting advisers, chemistry and trust are paramount, considering the significant time spent working together. To effectively use advisers, an owner must engage them early enough in the process to enable them to help influence the outcome.
