Developing An “Exit Strategy”

by Charles H. Van Gorder and Bill Thorogood

Every year, hundreds of businesses open up in the outdoor recreation industry, ranging from product designers and manufacturers to wholesalers and retail outlets, instruction centers and commercial outfitters and guides serving the end users. Reasons for entering the outdoor recreation industry vary greatly from one enterprise to another, but seldom is there an expectation of losing money through the business. Most often, businesses need to make money, or at least to break even, to continue in existence. The entrepreneur must usually bring in enough revenue to pay the expenses of the business and have enough left over to sustain their own life style. A further reality is that seldom is any single individual's involvement in a specific business permanent.

For a variety of reasons, people move on in their lives and need to end their involvement in the business. These reasons may include boredom or burn out, insufficient capital resources or revenue, change in product availability or market demand, or simply a need to accommodate life's other priorities. When the time comes to get out of your business, you need to have formulated an "exit strategy" to enable you to do so . This article is intended to help you formulate such a strategy now. If you are able to successfully formulate such a strategy, when the time comes, you will be able to exit your business without sacrificing your financial and emotional investment.   

The initial and perhaps most fundamental consideration in formulating an exit strategy is to understand why you entered the outdoor recreation industry in the first place. What was it that you were looking for: a particular lifestyle, an ability to spend significant portions of your life in the outdoors with folks having similar interests, an income sufficient to support your desired lifestyle, or a pot of gold to finance your retirement? Only by understanding what it is that you want from your business can you determine what may be necessary for a successful exit. After spending years of long, six or seven day work weeks with a minimal level of personal income, the last thing you want to find yourself with is an albatross of a business around your neck, one from which you can't afford to get away once its initial allure has faded into oblivion.

A second fundamental consideration is to understand what might lead to a decision to get out of your outdoor recreation business. It is often difficult to anticipate why you might want to leave your business, but many times an entrepreneur will start a new business venture with specific end goals or time frame in mind. By recognizing your desired or most likely scenarios that could lead to terminate your involvement in your business, you stand a better chance of finding a exit ramp that will suit your needs.

The formulation of an exit strategy will be different for every business. However there are numerous areas of concern that will affect most businesses. Following is a listing of some of those areas that can be considered in developing your exist strategy:

Business Entity and Structure
Perhaps the most important aspect of an exit strategy is determining how an "exit" decision can be made an implemented. The type of business entity selected by an entrepreneur will have a significant effect on the execution of an exit strategy. A sole proprietorship will usually permit a quick exit decision as there is only one owner to make that decision. However, sole proprietorships have other limitations, including limited access to capital funding.

Most entrepreneurs select the corporate form of a business entity, primarily because of the protection of personal assets by the "corporate veil" and the ability to raise capital through the sale of stock. If an entrepreneur chooses to form a corporation, it is critical that he or she do everything possible to maintain at least 51% of the voting stock. A majority shareholder has the ability to control the decisions of the corporation. The articles of incorporation should specify the shareholder vote necessary to sell or dissolve the corporation. Minority shareholders may have certain "dissenters' rights" that may have to be accommodated. Shareholder agreements are often used to limit the sale of stock to new shareholders.

If a partnership form of business entity is selected, partnership voting rights may control the sale of a company. However, partners may agree to a dissolution that differs somewhat from that envisioned in the partnership agreement. While it may be difficult to force the dissolution of a corporation, a partnership is a voluntary association, and courts may be reluctant to keep partners in business together when one of them no longer desires to get out. However, with two partners with equal voting rights, the controlled sale of a company is difficult without the agreement of both partners.

It is always best for an entrepreneur to maintain legal control of the business. Proceed carefully with the type of entity selected for your business so not to compromise your exit strategy. Satisfy and document the steps that must be taken to maintain the legal structure of your chosen entity, including annual meetings or special meetings effecting changes in ownership. Always ensure annual tax and statutory compliance filings are completed in a timely manner. Failure to satisfy such mundane procedural requirements may throw unexpected roadblocks in the sale of a business when the prospective buyer conducts their "due diligence" review.

Method of Capital Funding
The manner in which an entrepreneur raises the initial or secondary capital necessary to fund the operation and growth of the business will have a serious effect on the manner in which the business can be sold or closed. Financing agreements with venture capitalists are often structured so as to trigger additional returns to the investor (at a significant cost to the owner/ entrepreneur) if the business is sold before a specified holding period or financial return is satisfied. An early "prepayment" of debt may also trigger penalties where a debt is retired prior to its scheduled payoff. Is it possible for your financing to be assumed by a new owner, and if so, what requirements must be satisfied? The entrepreneur needs to be aware of these and similar restrictions on their ability to sell of close their business.

All entrepreneurs incur those horrible moments when one is ready to "sell their soul" in order to obtain additional critical capital funding. However, at such times, they need to carefully step through the minefield of any unacceptable financing terms to defuse the triggers that could otherwise fire a round during an exit from the business.
Timing of Exit

While the art of exiting a business has a long way to go before it can be "textbooked," certain recognized components are critical to the process. A foremost consideration is that the process of exiting a business always takes longer than expected. Therefore, start the exit effort well before any critical event or date to ensure the process is completed without someone's back getting up against the veritable wall. The "2X" factor works well in planning an exit strategy. Always double the time the exit process is expected to take to reach a culmination. In may be possible to delay the exiting process, but it is seldom possible to accelerate it.

Every business has a cycle, especially in the outdoor recreation industry, and every product has a shelf life. It is important to do everything possible to understand where are your business and its products in such cycles. Selling too late in the seasonal cycle or product shelf life may bring less value to the owners than had the sale occurred three or six months earlier. It is important to be aware of the near term economic and industry segment conditions in which the business operates. It is difficult to sell a business at a good price when the general economy or industry segment is in a down swing.

Within the industry segment cycle, identify the window of opportunity in which to exit. Then, develop a time line to a planned closing of the sale of the business. When implementing an exit strategy, do everything possible to stay ahead of this schedule. It is always possible that a planned exit window will slam shut due to external conditions or other uncontrollable events. In anticipation of such an eventuality, be sure you have sufficient working capital available to allow the exit process to be put on hold while you wait for improved conditions. Above all, don't panic and close the sale on unfavorable terms. Simply gracefully withdraw from the sale negotiations, leaving an opportunity to re-enter discussions at a later date when conditions improve.

Paying the Price
There are many accepted methods of valuing a company. Current or projected future annual earnings, past revenue and current cash flow are the cornerstones for all valuation models. Depending on the nature of the company's business, the selling price is normally some "multiple" of current or future annual earnings or cash flow. This multiple may then be adjusted for certain expenses such as interest and depreciation. For most lines of business, there is a range of generally acceptable valuation methods. Normally, the results of a commonly accepted valuation method is used as a starting point for any sale negotiations.

The initial valuation formula could be as simple as 2.1 times annual revenue or 5 times annual cash flow, less owner's compensation, interest and depreciation. Hot products or services have "sizzle," and if properly packaged they can obtain higher valuation multiples than the typical product or service, thereby yielding a higher price to the seller. Good recent examples of such business include roller blades and snowboard products with patent protected technology.

In order to maximize the sales price, have the future products/services pipeline full of new ideas in various stages of development or implementation. If a business has additional products or services "in the development hopper" which can be included in the purchase, the seller can enhance the valuation multiplier without incurring additional development risks or costs. While the value of these "drag-alongs" normally do not approach the value of a single successful product or service, they can be significant negotiating chips to be used for reaching agreement of the final pricing or terms of sale.

Another crucial factor is the value a potential buyer can bring to the business. Most small business are cash poor; well-funded buyer can rapidly expand product market penetration. Appreciating the current limitations of your business which may make it attractive to a potential buyer will enable you to take advantage of the buyer's strengths. If a buyer has the ability to take your business to new heights, your recognition of that fact will enable you to argue for a higher sale price.

Packaging the business in a concise, focused manner will assist in generating interest in its purchase. The dollars spent with public relations or marketing specialists with a strong history in your service or product line could significantly enhance the purchase price. Such packaging should include financial projections without capital limitations, good descriptions of products or services included in the sale, details of how growth could be accomplished. Methods of improving staff productivity and potential reductions in the cost goods. This information go a long way to answering the questions of prospective buyers before they can even be asked.

Tax Considerations
The tax consequences of the sale of a business can have a significant impact on both the seller and the buyer. Many of these consequences can be anticipated and dealt with to minimize the tax impact on all parties. Some sale transactions may be structured to allow the seller to defer any tax liability until a future date when his or her tax bracket is smaller. On the other hand, a seller may want to deal with the tax liability all at once at the time of closing. While perhaps more costly, such an arrangement usually results in total closure, permitting the seller to move on in life without worrying about the buyer being able to make future payments and incurring additional taxes.

The manner in which the purchase price is allocated among the assets being sold can have significant tax impacts for the buyer. Some assets can be depreciated over time, and the buyer may want to increase the value of these assets. Good will cannot be depreciated, but it is often a significant portion of the value of the business. Attention should be focused on this area of concern at the beginning of negotiations. Any delay in resolving these points could end up costing either the buyer or the seller dearly as the transaction nears its closing and negotiations become increasingly tense.

Future Personal Involvement
To what degree will your exit from the business be total and absolute? The importance of the individual owner(s) varies greatly depending upon the nature of your business. Will you need to be involved in the business to help clients make the transition to the new owner? If so, you need to agree on the nature of your continued involvement, including compensation, decision making and liability. Do you have a stake in the financial success of the new owner, such as when the purchase price is being paid over time? Do you need to be protected from unknown claims against the company, such as through an indemnification agreement or "extended tail" endorsement on your insurance policy?

Even if you are successfully severed from your former business, you still need to be concerned about what you will be doing next. The sale of many businesses involve non-competition agreements whereby the former owner(s) is barred from entering any new business that will compete with their former business. What information (such as customer lists, trade secrets or patents and trademarks) will the former owners take with them or be able to use. Non-compete agreements are enforceable in most states, but must be reasonable in time and geographic scope. You need to be clear exactly what resources from the business, if any, you may still be able to use. These are essential elements of a buy/sell agreement but are often overlooked until there is a problem. 
 
Conclusion
Most people in the outdoor recreation industry will be in and out of numerous businesses in the course of their career. When the time comes and you have walk away from the endeavor that has taken your working life for a considerable length of time, you want to be able to answer "Yes" when someone comments to you "Congratulations, I hope you have done well." You want to have maximized the return on your personal and business investment. By looking at and developing an exit strategy well in advance of your exit, you will considerably enhance your ability to do so. The formulation of an exit strategy at the beginning of your business allows the entrepreneur to keep in mind the factors set forth above, and to maximize opportunities to enhance the potential value of the business. It is critical to seek out competent legal and accounting advice so that you can anticipate the factors affecting a successful exit and plan to satisfy them. Once an exit strategy is in place, be sure review it periodically to ensure that it meets any changed conditions. In this way, you will hopefully avoid being caught in a situation where a graceful, financially-secure exist becomes a spectacular crash and burn.