The $2 Million Mistake That Could Derail Your Exit

Insights

Business owners often dream of a smooth exit when the time comes to retire or move on to new ventures. But without careful planning, that dream can quickly turn into a financial headache. A recent situation involving a mid-sized company illustrates just how crucial strategic business planning and a well-thought-out exit strategy can be. Today, we’ll take a closer look at what went wrong in this case, what you can learn from it, and the steps you can take now to set your business up for a successful exit.

What Happened?

John and Lisa, co-owners of a rapidly growing software company, had always planned to retire in their 60s and pass the business on to their children. They set up a plan that allowed their kids to buy out their shares at market value when the time came. They also took steps to protect the value of the business, such as implementing employee stock ownership plans (ESOPs) and securing business life insurance. However, when John unexpectedly passed away, the situation became much more complicated.

The insurance payouts were used to cover John’s share of the business, and the ESOP was supposed to ensure a smooth transition to the next generation. But due to inconsistent valuation of the company’s worth and a poorly structured buyout agreement, the transition didn’t go as planned. Lisa, now the sole owner, was left with a tax bill of nearly $2 million—an amount that hadn’t been anticipated by her or their advisors. The buyout didn’t properly account for the business’s changing value over time, leading to significant estate and gift taxes.

What Does This Mean for You?

John and Lisa’s story highlights an important lesson: Business succession planning requires more than just a handshake agreement. Your plan needs to account for shifts in the business’s value, tax implications, and the goals of all involved parties.

In John and Lisa’s case, their buyout agreement, while well-intentioned, didn’t anticipate the potential for fluctuating company valuation and tax burdens that arose when John passed away. What seemed like a straightforward transition ended up causing financial strain and delays.

A properly structured exit plan is key to ensuring that your business’s value is preserved and that your tax liabilities don’t catch you off guard. Working with a professional team, including tax attorneys, business consultants, and financial advisors, can ensure that your exit strategy is tailored to your unique situation.

Steps to Prepare for a Successful Exit

1. Are Your Finances in Order?
Buyers will want a clear picture of your financial history, so keeping accurate, organized financial records is crucial. Prospective buyers will examine your profit and loss statements, tax returns, and cash flow documentation to assess your business’s value. Start preparing these documents early, even if your anticipated sale is years away.

2. Are Stakeholders Aligned?
Exiting a business involves many strategic decisions, from evaluating offers to the transition of ownership. Ensuring alignment among all stakeholders—whether they’re co-founders, board members, or key employees—can prevent misunderstandings or conflicts during the sale process. Determine key elements such as offer thresholds, gain distribution, and how the legacy of the business will be preserved post-sale.

3. Proactively Increase Your Business Value
Your business value is built over time, not overnight. Proactive measures can enhance your valuation when it’s time to sell. Streamlining processes, expanding into new markets, investing in innovation, and securing long-term contracts are some ways to boost your business’s worth.

4. Identify Your Ideal Buyer
Different buyers will bring different visions for your business’s future. Do you prefer a buyer that will maintain your legacy or one that may integrate your business into their operations? Create an ideal buyer profile to align your preparation efforts and target potential buyers that match your goals.

Build Your Business for Future Financial Success

Scaling any business for an exit poses challenges in every scenario. However, doing so with the right systems, processes, and preparation will streamline your exit path, helping you gain maximum value and satisfaction from selling your business.

At Tomoro, we specialize in creating comprehensive business financial plans and strategies that guide you through the exit process. Whether you’re just starting to think about an exit or are actively preparing for one, our WealthMaps™ help ensure your financial journey aligns with your ideal outcome. Reach out to learn more about our tailored business exit solutions and how we can help you achieve your long-term goals.