It’s standard business advice that entrepreneurs often don’t consider: The best time to begin preparing your exit from any business venture is the day you open its doors. Decisions you make then could significantly alter how much you actually profit from the enterprise. But even if you haven’t planned your endgame when you launched your business, it’s not too late to think about it now.
“Many business founders begin with ideas about their company’s life cycle,” says Steven Faulkner, head of private business advisory for J.P. Morgan Private Bank. “They may be serial entrepreneurs who want to sell quickly and move on.” In other cases, founders have a much longer trajectory in mind; they think of the business as their lifestyle and maybe even their legacy.
Whatever stage your business is in, says Faulkner, it’s important to look in the mirror, and ask questions about who you are and what you want your life to be—both now and in the years ahead. At the very least, make sure you regularly answer four crucial questions to ensure that your business keeps working toward your life goals.
WHAT KIND OF BUSINESS DO YOU HAVE?
One of the early, essential choices is determining what legal structure your company will have. Are you going to organize as a C corporation, S corporation or limited liability company (LLC)? The decision has both immediate and long-term consequences.
“If you haven’t thought about this question, you may end up with whatever structure your attorney prefers,” Faulkner says.
Legal entity determines how and when you and the company will be taxed. As pass-through entities, S corps and LLCs typically don’t pay taxes directly; instead, they pass profits along to owners, who report earnings on their personal returns. A C corp, in contrast, is subject to double taxation. First, company earnings are taxed at corporate rates, and then shareholder-owners owe taxes on any distributed dividends.
But, entrepreneurs take note: The C corp may make sense if you expect the business to be minimally or not profitable until it’s sold; especially now that the tax act of 2017 materially lowered tax rates on C corps. Faulkner tells of one founder whose company was built around a proprietary technology that made the business an attractive acquisition for larger tech companies. Because he’d organized his firm as a C corp, he was able to enjoy a significant portion of his business sale proceeds tax-free, thanks to rules for qualified small-business stock.
Concerned you may have chosen the wrong entity for your company? Ask your advisors to do a cost-benefit analysis of a potential reorg. It’s never too late to consider a different legal and tax structure as your business evolves and your outcomes change. But be sure to consult with professionals as the rules are complex and unforgiving.
DO YOU HAVE THE RIGHT ADVISORS?
At every stage of an operating business’s lifecycle, it’s important to think about how businesses are governed and operated, says Faulkner, particularly if the company is growing. “You need a kitchen cabinet—the smartest, best people who can advise you about finances, taxes, and legal and audit questions,” he says. “They can help you with crucial questions related to the company’s growth—when it’s time to move from an external bookkeeper to a more rigorous controller and then from a controller to a seasoned CFO.”
Those kinds of changes also can put your business on solid footing for a transition—whether a sale to an outsider or a transfer to a family member. “If you professionalize your company at every stage of its growth, that can provide flexibility for whatever comes next,” Faulkner says.
WHAT ROLE MIGHT YOU WANT AFTER A (POTENTIAL) SALE?
Even if you currently have no plans to sell the business, you still should understand the options. The long-term plans you have for your life should affect the kind of buyer you pursue and the deal you negotiate for your business, Faulkner says. “Is this your last business? Or are you already planning your next one? You need to ask yourself what success in a transaction looks like for you.”
Suppose you’re considering a strategic buyer, a company in your industry that may have its eye on integrating operations and eliminating redundancies. “A strategic buyer will almost certainly want to purchase 100% of your business,” Faulkner says. “You’ll probably also have to agree to a non-compete, non-solicitation provision.” If you don’t want to keep working, at least in the current industry, such an agreement may not matter; but it could be vitally important if you’re thinking of starting another business in the same field.
Other factors may come into play if, for example, you sell to a private-equity firm. “In that case, you’re probably going to be required to roll forward some percentage of your sale proceeds into the new deal,” Faulkner says. “And your future involvement may depend on how the firm views this transaction.” The firm may see you and your management team as integral to the company’s future—or it may see your business as a “tuck in” and be primarily interested in your assets, customers, and sales. Understanding the buyer’s motivations often yields the best outcomes for sellers.
WHAT WOULD YOU DO WITH THE MONEY?
Look ahead and imagine your future: How you’d invest and manage the proceeds from the sale of your business ultimately revolve around what you see ahead of you. “A serial entrepreneur may need to retain a significant amount of liquidity to finance the next business,” Faulkner says.
On the other hand, those who expect to use the proceeds to support their lifestyles may need to learn how to become effective long-term investors. “Founders of businesses tend to be 100% comfortable living at risk when it comes to their companies,” Faulkner says. “Yet if they sell the business and have liquid proceeds to invest, they’re often so unfamiliar with the investment environment that they want to put all of the money in Treasury bills.”
Such a hyper-conservative approach isn’t likely to fund the kind of future most sellers hope to enjoy. Instead, Faulkner says, expect to have in-depth conversations with your advisors about wealth planning and investments that truly work toward your life’s goals.
These discussions need to happen long before the cash hits your account. “What comes next in a business owner’s life is the elephant in the room that many people are afraid to think about,” Faulkner says. “Who and what are you if you’re not your company? What are your passions? What do you really want from the rest of your life? We have advised business owners on traditional and non-traditional exits, helping them to find the path that would best satisfy their objectives for their combined lifestyle, legacy, and wealth.
“There’s the corporate balance sheet and the personal balance sheet,” Faulkner adds. Be sure to think about and integrate both—every step of the way—to prepare for the future you want.