4 Exit Strategies For Small Businesses + Deal Structures & Expert Tips

4 Exit Strategies For Small Businesses + Deal Structures & Expert Tips

By: Corey Philip
Updated: February 17, 2021

In 2012 I started a local home service business.  Over the next several years it grew pretty quickly to over 60 employees.  

There was never an exit strategy or a plan, simply just grow as fast as I could while maximizing profitability.  I'm not one of those 'grow at any cost' kind of guys.  I believe in business fundamentals and that a business needs to produce cash... but that's a whole 'nother topic.

After about 6 years I was ready for exit.  It was that time.  I felt that I had grown it as far as I could.  I no longer had the motivation to grow it.  I wanted a little break.  I wanted to get into a different industry (actually I was already moving into other businesses).

The business was listed for sale and after about a year, in early 2020 it sold!  The business was profitable and well established generating a cash out sale.  

Through my career I have been involved in other business transactions as an investor and advisor.

👉 Here I cover some of the small business exit strategies that I have seen, the deal structures, and my 'expert tips'.

Asset Liquidation

In some cases, your individual assets may be worth more than the business in whole.

Consider this, a business that is losing money might be worthless.   In the context of systems one could say that the sum of all the systems produces a negative return.  However within those systems could be components that have a higher value individually than they do as part of the system.  

Asset liquidation is simply the process of selling all the business assets, repaying creditors (if applicable) and closing up shop.  

Who is this for?  An asset liquidation exit is typically going to be for businesses where the business as a whole has no valuation.  These cases might be where the business is losing money, or a business that is highly 'owner/operator' dependent.

What assets might be valuable?  Most people think in terms of fixed assets such as machinery for liquidation, or inventory, but you might have other valuable assets.  

For example, your customer list might be valuable to a competitor or business looking to enter the market.  You could sell the customer list for a fixed price, or a deal based on the revenue earned from that customers list.

Other examples could be marketing content such as your website, your phone number or even promotional videos.  

Expert Tips:  Think about what you've created that is valuable to your business, then come up with a plan to package or present it in a way that it is valuable to other businesses in the same industry.  I once sold a Youtube channel from a business that I liquidated by directly (cold) contacting competitors.  Most brokers or advisors won't do this, it's something you'll need to do yourself.

Generational Transfer

While many start businesses with goal of 'cashing out', for some a small business was created to be kept in the family.  And there's nothing wrong with that.

Passing the business on to the family can ensure wealth and preserve the family name (I call this social capital).

Who is this for: business owners with close family or cases where the business employs family.  

Deal Structures: These deals typically are done with a small down payment that comes out of the pocket of the acquiring generation (read the expert tip below), and then some seller financing.  

Expert Tips:  Never just 'give' equity.  We'll often see situations where the older generation basically gives the younger generation the equity, as it is easier and well the younger generation 'worked for it'.  This often fails as the younger generation doesn't want the business.  To be successful, there must be skin in the game and the equity must be purchased.  It could be at a significantly discount price, but a transaction must happen.  

Sell To An Employee

Some times the best purchaser for your business is already in-house.  Employees know the business and enjoy it, making them ideal candidates to continue operating the business

Often the most difficult part of selling to an employee is the funding -- they typically don't have the capital on hand or access to capital (lending) that other buyers have access to.  To make this work, you'll typically need to make some type of owner financing

Who is this for: This is generally a recommend options for businesses in locations that are not 'prime areas for relocation' or businesses that have not had much luck on the market.

Deal structure:  Selling to an employee typically requires significant owner financing.  What can be done is a structure that has higher payments up front so you receive cash for your equity as soon as possible, but then reduce the payment to where the new owner enjoys the cash flow.

Alternatively you could only sell a percentage of the business allowing you to enjoy a portion of the future cashflow and capital appreciation.

Expert Tips: Never sell a business to an employee with $0 out of pocket or in other words never finance 100% of the deal.  No matter how confident you are in their ability to run the business at the same profitability, this will be a recipe for failure.   The employee needs to have skin in the game so require a deposit that is within reach of the employee.  If they make $60,000 / yr, require $20,000 down payment.  This amount may be difficult for them to come up with, but if they want to take advantage of the opportunity, they will make it happen.

Sell Business Outright

Small businesses get bought and sold everyday.  It actually happens more frequently than you realize.  According to a friend of mine that is a business broker, an estimated 3% of businesses doing over $1,000,000/yr in revenue change ownership.  

For a profitable and established business, this is often the 'right' method of exit.

Let's take a look at who the buyers are.

Buyers

Individuals.  For businesses selling at $5,000,000 and below, individuals are common buyers.  Here's why; the SBA 7A loan program makes acquisition loans up to the $5 million point with 10-15% down, putting small business ownership within reach of many.  In 2020, with the Covid stimulus, the SBA sweetened the deal even more and actually made 6 months of payments (with no repayment) for SBA loan holders effectively meaning a 5% discount on 10 year note.

You'll typically find, people who want to leave the corporate world, career small business owners/investors, and even managers from other small businesses that want to leave and get into the ownership role.  I find this a lot in the HVAC world where a general manager could be making 200k per year, can save 100k each year for a few years, and then wants to leave to and buy a business to grow.

Competitors.  While competitors often talk a big game, I find they actually rarely acquire, instead they just talk, and poke numbers.  Occasionally though the deals do happen.

I recently observed a deal where an HVAC company doing about $10 million per year in revenue acquired a smaller company doing $1.3 million.  In this case they felt that they would acquire some good employees and if they didn't buy them, someone else would.  

The transaction happened privately, before the business was publicly marketed, at a valuation multiple of about 2.5, which is on the low side.  Quite frankly I believe it would've been in the 3-3.5 range had it gone to market... so I guess that just drives home the bigger point, competitors rarely acquire and even less so at a fair market price.  

Private Equity.  Larger businesses require more capital then individual investors have access to.  Fortunately in the private equity world cash is flowing freely.

In 2020, despite the Covid economic climate, PE investment activity totaled 708.4 billion.

As private equity firms don't want to be involved in the day to day of running a business, they typically look for established management before making the offer, so if you operate business that you're planning to sell for a juicy price, work on stepping back and establishing management.

As a rule of thumb it is always best to establish systems and processes that allow you to step back, but when selling to individuals, they realize that businesses of that size will require an owner operator.

Mergers & Rollups.  These types of deals are similar to private equity, but it in this case, rather than buying purely for ongoing profits, they're buying to 'merge & rollup' just as the name implies. 

Typically these are done by large established brands looking to acquire more territory and customer base FAST. 


Frequently Asked Questions on Small Business Exits

Should you use a business broker?  Typically yes.  Here's the deal, without a broker you'll find buyers typically try to beat you up to where you feel like your business isn't worth much so you'll sell for a lower price.  This clearly isn't good.  In the example I mentioned above with the the 'competitors' section, that seller probably would've gotten at least another 100k even after broker fees.

On top of that, without a broker your business will get a lot of tire kickers that just want to probe the financials, make low ball bullshit offers 'Shark Tank Style', and then once an offer is accepted, drag things out and negotiate lower. 

Should you seller finance?  That depends... on the necessity to close the deal.  In hot market, you could turn a cold shoulder to any seller financing.  Financing 5-20% is acceptable over 1-2 years is acceptable, but I would draw a hard line at 20% and certainly NEVER agree to anything no money out of pocket.

How much will buyers be able to finance through SBA 7(a)?  Typically up to $5,000,000.  There are ways that it can go higher.  And I've seen many with 10% down.  Damn near easier to buy a business than a house.

Corey Philip
February 17, 2021
Corey Philip

Founder of a home service / specialty trade contracting company (think patio's and deck) with a focus on customer experience. Quantitative investor. Data driven marketer. Runner.