The majority of business writing focuses on the challenges, opportunities and lessons of starting a business, but the way you leave is just as important. Every business needs an ‘exit strategy’ – a plan that determines how you will eventually leave your business as it will significantly impact the financial return you achieve.
Whether you're thinking of selling to a third party, passing the business on to your management team, or handing it over to a family member, there are several important factors to consider. Here, Haines Watts Chester Associate Director Matt Davenport explains how business owners can take the right steps to maximise your returns while minimising tax liabilities when it’s time to move on.
What is an exit strategy?
All good things have to come to an end and in business it helps to plan ahead. Your exit strategy is a plan for what will happen when you want to leave your business, either retiring or passing it on to another party.
It outlines how you will sell your stake in the business, who will take over, and how you will get paid. It can be an uncomfortable topic for some who don’t want to imagine the end of their story, or who think of it as a far-off event, less important than building value in the here and now. But if you want to leave on your terms, it’s an essential step to prepare for a smooth transition and ensure you can extract the maximum value as you leave.
Deciding what to do with your business
The first consideration in any exit strategy is identifying who you will sell to. The options typically include:
- Third Party: Selling your business to an external buyer.
- Management Team/Buyout: Selling the business to your existing management team.
- Family Member: Passing the business on to a family member.
Each option comes with its own set of considerations, particularly regarding the method of sale, the tax implications, and the overall financial outcome. In many circumstances, the choice will be heavily influenced by the environment around you. For example, selling to a management team requires a strong team to be in place already for some time, and for those there to have the necessary skills and desire to carry on the business.
Selling to a Third Party
When selling to a third party, you will likely aim for a straightforward sale, where you receive payment in full or over a defined period. This option is often the most straightforward but also the most impacted by tax considerations.
Capital Gains Tax (CGT) is the main financial risk hanging over you when selling your business. Fortunately, Business Asset Disposal Relief (BADR) (formerly Entrepreneurs' Relief) can reduce the tax on the first £1 million of gains to 10%, with the remaining gains taxed at the standard CGT rate of 20%. This relief can significantly affect how much money you ultimately take home, but the ongoing availability of BADR is not necessarily assured.
Management Buyout
If you are considering a management buyout (MBO), it's worth remembering that the management team may not have the funds for an outright purchase. In this scenario, the sale might be structured in a few ways:
- Leveraged Buyout: The team borrows the necessary funds to purchase the business.
- Deferred Payment: The buyout is paid out of future profits generated by the business.
An Employee Ownership Trust (EOT) is another option, where the business is transferred to a trust for the benefit of the employees. This can be an attractive option as it allows for the business to be sold without incurring CGT. However, setting up an EOT can incur significant legal fees, typically ranging from £40,000 to £90,000. This expense can offset the tax savings, so it’s crucial to weigh the benefits against the costs.
Building your strategy
When planning your exit, there are a range of factors to shape your strategy:
- How much value do you need to extract: Start with a professional business valuation. This valuation considers your business’s assets, revenue, profitability, market position, and growth potential. For instance, if you own a retail business, the valuation might consider your inventory value, location, customer base, and financial performance over the past few years.
- What are the tax consequences of the sale, and how can you minimise them? The amount and timing of any value you extract can significantly impact the net proceeds from your sale.
- Timing of Payment: When do you need the cash? Will you receive it upfront or over a more extended period? Receiving cash upfront is generally safer but may result in a lower total amount. Deferred payments can offer higher returns but come with risks.
- Trust in Buyers: If you’re receiving payments over time, do you trust the team or buyer to fulfil their obligations? Assess the buyer’s track record, market conditions and financial health, as well as their plans for your business.
- Due Diligence: The more robust and complete your business records, the easier the due diligence process will be. This includes examining your financial statements, legal records, customer contracts, and other critical documents.
- Contingency Plans: Develop contingency plans in case the sale does not go as expected. This might involve identifying backup buyers, understanding your options if the buyer defaults on payments, or planning for market downturns.
Short term versus long term considerations
One crucial decision is whether to take cash upfront or agree to a deferred payment plan. Cash upfront provides immediate liquidity but might come at a lower overall price, especially if interest rates or market demand is not in your favour. Deferred payments can potentially offer a higher total payout but come with the risk that future payments might not be made if the business underperforms.
It’s also worth noting that external buyers often prefer to retain the existing management team for a transition period, which can also affect the payment structure and your ongoing involvement. For instance, they might offer a deferred payment plan contingent on hitting specific performance targets that ties you to the business for several years post sale. If you’re looking forward to wiping your hands clean of the day to day, make sure the offer you accept doesn’t include you as part of the deal.
Timing Your Exit
Planning an exit strategy should start well in advance of your intended departure. The more time you allow, the better prepared you will be to secure the best deal. Typically, the entire process—from initial planning through to completing the sale—can take three to five years.
From a tax perspective, selling as quickly as possible after deciding to exit is often beneficial. Tax laws can change, and what is advantageous today might not be in the future. For instance, Business Asset Disposal Relief rules could be altered, affecting the tax payable on the sale of your business.
- Start Early: Begin planning your exit several years in advance to allow time for finding the right buyer and structuring the sale optimally.
- Evaluate Your Business: Get a professional valuation to understand what your business is worth.
- Identify Potential Buyers: Determine who your potential buyers are and how they might finance the purchase.
- Consider Tax Implications: Work with a tax advisor to explore ways to minimise your tax liability.
- Prepare Financials: Ensure your financial records are in order, as potential buyers will scrutinise these.
- Seek Advice: Engage an accountant and solicitors experienced in business sales to navigate the legal complexities.
- Plan for Transition: Consider your role post-sale, particularly if the buyer wants you to stay on for a transition period.
Leaving on your terms with Haines Watts
An exit strategy is not just about how and when you will leave your business but also about ensuring you get the best possible return for your hard work. Having the right expertise to guide your strategy can make all the difference, when it matters most. Haines Watts advisors have helped thousands of entrepreneurs take their dreams from idea, to operations and a successful exit. Our network of experts can support you with scenario planning, understanding tax implications and structural optimisation, as well as connecting you to reputable other services such as legal and sales advisors.
