You plan for business success of course. But do you start off with governance documents in place that will facilitate orderly exit when that success is achieved? If your business is like most small businesses, the answer is no. A common assumption among owners of new ventures – if it achieves success, everyone will be happy enough to sort out the spoils in a friendly way. The reality is much more complicated.
Success will turn out to be defined differently by each owner. One is ready to exit, the others resist the proposed loss of talent, management or other vital input. Or perhaps some owners believe additional associates are needed to push the business forward, while others resist the proposed dilution of management rights and capital stake. Even when things are simple and all owners more or less agree that the business is at a point where an exit strategy should be pursued, valuation can become an impasse.
There are many more iterations of how a dispute among owners can arise. If success can create challenges, you can imagine the disagreement among owners in the face of failure. In those cases, you almost hope the failure is total – leaving no room for protracted disagreement in the absence of anything worth fighting over.
Many, many businesses find themselves somewhere between total success (where the owners feel like they won the lotto and everyone lives happily ever after) and total failure. At some point, exit is inevitable for one or more owners. Regardless of where the business finds itself on the spectrum of success, early planning can facilitate orderly and efficient exit of one or more owners. By doing so, businesses and their owners can avoid an outcome that too often occurs – business success is frittered away as the owners bicker over the spoils. Here are a few types of planning techniques:
Consents and restrictions: These focus on limiting transfer without necessarily providing a means of liquidity. Transfer restrictions can include absolute prohibitions or conditional limitations, usually involving prior consent of certain shareholders or management. The greater the restriction the higher the chance it may be held unenforceable by a court, if litigated.
Options: The most common of exit planning techniques, option provisions permit one or more parties the right, without conditional limitations, to surrender ownership interests, in the case of an exiting shareholder, or to acquire ownership interests, in the case of a remaining shareholder or succeeding corporation. At their most basic options involve merely the legal right to demand a transaction but do not necessarily provide the pricing mechanism or speak to other detail s, such as timing, of the transaction. Options that do not include any pricing mechanism can often prove useless. The price term is the most important, and differences of opinion between the sides can be significant and costly. For example, here is a story about LLC valuations differing by a factor of 25! An objective pricing mechanism spelled out prior to the exit can save the parties and the business tremendous time and expense.
Mandatory buy-sell agreements: As the name suggests, mandatory buy-sell provisions dictate the basic terms of the exit upon a preexisting trigger event. The decision to exit, the pricing, and other important terms are all agreed upon well in advance. Upon the occurrence of a triggering event, the parties execute the exit of one or more shareholders according to the terms of their buy-sell. The comprehensive nature of this technique makes them the most productive at the time of exit but also the most difficult to negotiate upfront.
The particular circumstances will dictate which technique is best for a given business. There are a number of considerations in play – too many to write about here – and we’re ready to listen and discuss practical solutions for interested small businesses.
Techniques to improve small-business owner-exits
You plan for business success of course. But do you start off with governance documents in place that will facilitate orderly exit when that success is achieved? If your business is like most small businesses, the answer is no. A common assumption among owners of new ventures – if it achieves success, everyone will be happy enough to sort out the spoils in a friendly way. The reality is much more complicated.
Success will turn out to be defined differently by each owner. One is ready to exit, the others resist the proposed loss of talent, management or other vital input. Or perhaps some owners believe additional associates are needed to push the business forward, while others resist the proposed dilution of management rights and capital stake. Even when things are simple and all owners more or less agree that the business is at a point where an exit strategy should be pursued, valuation can become an impasse.
There are many more iterations of how a dispute among owners can arise. If success can create challenges, you can imagine the disagreement among owners in the face of failure. In those cases, you almost hope the failure is total – leaving no room for protracted disagreement in the absence of anything worth fighting over.
Many, many businesses find themselves somewhere between total success (where the owners feel like they won the lotto and everyone lives happily ever after) and total failure. At some point, exit is inevitable for one or more owners. Regardless of where the business finds itself on the spectrum of success, early planning can facilitate orderly and efficient exit of one or more owners. By doing so, businesses and their owners can avoid an outcome that too often occurs – business success is frittered away as the owners bicker over the spoils. Here are a few types of planning techniques:
Consents and restrictions: These focus on limiting transfer without necessarily providing a means of liquidity. Transfer restrictions can include absolute prohibitions or conditional limitations, usually involving prior consent of certain shareholders or management. The greater the restriction the higher the chance it may be held unenforceable by a court, if litigated.
Options: The most common of exit planning techniques, option provisions permit one or more parties the right, without conditional limitations, to surrender ownership interests, in the case of an exiting shareholder, or to acquire ownership interests, in the case of a remaining shareholder or succeeding corporation. At their most basic options involve merely the legal right to demand a transaction but do not necessarily provide the pricing mechanism or speak to other detail s, such as timing, of the transaction. Options that do not include any pricing mechanism can often prove useless. The price term is the most important, and differences of opinion between the sides can be significant and costly. For example, here is a story about LLC valuations differing by a factor of 25! An objective pricing mechanism spelled out prior to the exit can save the parties and the business tremendous time and expense.
Mandatory buy-sell agreements: As the name suggests, mandatory buy-sell provisions dictate the basic terms of the exit upon a preexisting trigger event. The decision to exit, the pricing, and other important terms are all agreed upon well in advance. Upon the occurrence of a triggering event, the parties execute the exit of one or more shareholders according to the terms of their buy-sell. The comprehensive nature of this technique makes them the most productive at the time of exit but also the most difficult to negotiate upfront.
The particular circumstances will dictate which technique is best for a given business. There are a number of considerations in play – too many to write about here – and we’re ready to listen and discuss practical solutions for interested small businesses.