The Risks and Pitfalls of Not Planning a Business Exit

Fri, 03/04/2022 - 09:02

Running a business is more than just a full-time job. Business owners often find themselves wearing too many hats as they bear the weight of maintaining a successful and profitable business. The biggest risk of being so involved in the business is that they often are focused on the present, so the business lacks an Exit Plan for the future. At some point, every business owner will exit their business, whether by choice or through unexpected circumstances. When that time comes, they’ll want a smooth transition according to their terms and to leave with financial independence from the business. The problem they are unknowingly faced with is that because they aren’t taking the time to formalize those plans and properly prepare their businesses with exit planning, they are putting their dreams in jeopardy.

According to the 2019 BEI Business Owner Survey Report, 79% of owners lack a written plan for the future ownership of their business. This provides an opportunity for you as an Exit Planning Advisor to work in partnership with owners, instill urgency, and show them the importance of not only having a plan, but starting the process right away.

Let’s dive into some of the risks and pitfalls business owners might face when they fail to plan their exit.

Failure to Meet Financial Goals

A universal goal of all business owners is for the business to provide financial security for themselves and their families after they exit. Typically, owners make a lot of assumptions regarding their financial well-being that could put them in a position where they don’t realize their resources will fall short of what is needed until it’s too late.

First, they tend to underestimate the financial resources they will need to maintain their lifestyle after the transition of ownership. This is due to many factors such as underestimating the amount of taxes they will have to pay, not accounting for their business covering some of their current expenses, underestimating their life expectancy, and projecting a high withdrawal rate from their assets.

Secondly, owners overestimate the current value of their businesses. This assumption based on “gut feeling” is truly costly and they can do more harm than good if an attempt is made to sell the business before it’s ready. Getting a business valuation from an expert is eye-opening for many owners. Additionally, owners underestimate the time and planning needed to increase business value to the amount they need to exit on their terms.

Trusted Advisors can help owners overcome these assumptions and put plans in place to bridge the gap between current value and needed value.

Timing is Everything

Many owners believe that the time to plan is when they decide they are ready to exit. They don’t take the initiative to start the process because they believe they can leave the business successfully whenever they want or that the planning process is much simpler and faster than the reality.

Let’s look at an example. Most business owners that our BEI Members work with initially indicate a desire to transfer ownership to an insider. An “insider” can be a family member, employees, or partner. These successors typically don’t have the cash readily available to buy ownership of the business. Because of this, owners need a plan where they can maintain control of the business while the chosen successor grows the value and cash flow over time. This ensures that the owner’s financial needs are met, and the successor of their choice takes ownership of the business. However, the 5-8+ years needed to implement such a plan may not fit their timing goals if they don’t start planning early enough.

By sitting down with an owner and mapping out their goals, including financial, legacy, succession, and timing, you can help owners appreciate the time needed to properly execute a successful Exit Plan.

Sudden Exit Challenges

Business owners who don’t plan for their exit expose their business to greater risks, including their business dying with them. Owners often assume that a healthy life insurance policy and buy-sell agreement is all they need to protect their business and family’s financial future. Even when a business has a buy-sell agreement in place to cover an unexpected death or disability of an owner, they typically don’t factor in other lifetime events such as one co-owner buying out another.

The first obstacle to address is if the business will survive without the owner. Even with a life insurance policy, someone will need to know what to do with the money to keep the business running. By having an Exit Plan in place, the owner’s wishes will be documented, and an emergency plan can be put in place. Often owners will have already started grooming their successor to take over because of the conversations had during the Exit Planning Process.

A bulletproof Exit Plan has a succession plan long before ownership transfer occurs. An Exit Planning Advisor can help the owner confront the issues of their sudden departure in the event of a business owner’s death. In the end, the succession plan will protect the company from risks and give the family and employees peace of mind.

How to Address These Challenges with Exit Planning

The most effective way to prevent the challenges mentioned above is by starting an Exit Plan, years before the desired exit. Most business owners don’t have their exit top-of-mind at the start of their business. However, their exit is inevitable and the earlier they can start planning, the more options they will have. It is your job as an advisor to help mitigate these risks by starting the conversations early and having them on an ongoing basis to prioritize, re-evaluate and execute each step.

Business owners often don’t think about the pitfalls of not planning until it is too late. With your planning and preparation support, you can alleviate these stresses before they arise by making the necessary strides towards their personal and professional goals.