Why you must have an exit strategy for your business (part 2)

Last week we discussed one of two common mistakes made by business owners when planning to exit their business – not planning their intended exit in advance.

This week we’re going to look at their second common mistake – not planning for their unintended exit at all.

An unintended exit from your business results from an unforeseen event. Most common are the death, disability or traumatic illness (such as cancer, heart attack or stroke) of the business owner – you. These events can occur without warning so you need to identify how your business would be affected. You then need to put appropriate measures in place to shield your business from the impacts of these events.

The importance of this is best illustrated by an example:

Bill and Bob are partners in an engineering business. Bill’s role is to bring in new customers and Bob is involved with design and production. The business is doing well. It’s been growing steadily in recent times so after many years of hard work, Bill and Bob can now draw healthy salaries to support their families and lifestyles. However, the business still has an outstanding loan of $300,000 which was used to fund start-up costs five years ago. As the business is now generating reliable cashflow, Bill and Bob hope to have this loan paid off in a few years’ time. Bill and Bob have been so busy with the business that they haven’t planned for the consequences of death, disability or traumatic illness.

Without warning, Bill suffers a heart attack and passes away. Bill’s share of the business passes to his wife, Barb.

What does this mean for the business? Below is a list of scenarios that may result:

•  As Bill was responsible for new customers, sales and revenue begin to decline immediately. Because of this, the business is unable to afford to hire a replacement for Bill.

•  A reduction in revenue puts strain on the business because the $300,000 loan still needs to be serviced. Bob is forced to cut overheads and lay-off staff. Barb becomes responsible for Bill’s share of the loan but she doesn’t work. After exhausting savings she is forced to liquidate her share portfolio and sell her car to make the repayments and look after her family.

•  As the business declines, relationships with existing customers and suppliers become fragile and Bob begins to worry about his professional reputation.

•  Barb decides to sell her share of the business. Because Bill was the sole income earner, she needs to raise capital to support her family. Bob wants to buy Barb out, but he doesn’t have the funds to do so, nor does he qualify for a loan because he has already provided a personal guarantee for 50% of the $300,000 business loan. Barb needs funds quickly and wants to sell her share to another party but Bob doesn’t want a stranger to walk in and take 50% of his business. Bob is concerned that a) the business will suffer if the buyer is inexperienced, b) the buyer may have different ideas and vision for the business and, c) he and the buyer may not get along.

•  Barb sells her share to a third party, but the net sale price is not sufficient to repay Bill’s share of the business loan for which he provided a personal guarantee (i.e. Barb walks away from the business with nothing).

•  Barb sells her share to a third party but her net proceeds are much less than expected once she pays capital gains tax (CGT).

•  Barb sells her share but it takes 12 months to find a buyer. The business had been steadily declining over this time, and as a result the sale price is far less than Barb had hoped for.

•  Bob finds a way to raise the funds to buy Barb out, but Barb doesn’t the financial capacity to satisfy Bill’s personal guarantee.

•  Bob is able to buy Barb out, but they can’t agree on a sale price because there wasn’t a predetermined method for valuing the business.

•  Barb decides she wants to work in the business so she can draw a salary to support her family. This concerns Bob immensely as Barb has no experience in engineering sales. He is also concerned they won’t get along as he and Barb have never had a strong relationship, and the business could fail as a result.

As illustrated above, the consequences of an unforeseen event on your business are significant. Your business could fail if you aren’t prepared for the worst, so you need to identify the potential issues that could arise and put appropriate measures in place to ensure your business is protected.

In the event of death, disability or traumatic illness, your aim should be to achieve as little disruption as possible to your business.

 


This advice may not be suitable to you because it contains general advice that has not been tailored to your personal circumstances. Please seek personal financial and tax advice prior to acting on this information.Opinions constitute our judgement at the time of issue and are subject to change. Financial Planning Expert Pty Ltd does not give any warranty of accuracy, nor accept any responsibility for errors or omissions in this document.
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