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Legal Exit Strategies for Business Owners: A Guide for Business Owners

Legal Exit Strategies for Business Owners: A Guide for Business Owners

A business exit strategy is a carefully designed plan that allows an entrepreneur to sell their stake in a company to investors or another firm. This strategy provides a pathway for a business owner to either reduce or entirely divest their ownership, potentially yielding a significant profit if the business thrives. Conversely, if the business underperforms, an exit strategy, also known as an “exit plan,” helps the entrepreneur mitigate losses. Investors, such as venture capitalists, also utilize exit strategies to outline their plan for cashing out their investments.

It is important to distinguish business exit strategies from trading exit strategies employed in securities markets.

Business Exit Strategy: Which Is Best?

The optimal exit strategy varies based on the business’s type and size. For example, a partner in a medical office might find it advantageous to sell to another existing partner, while a sole proprietor might aim to maximize profits before closing down the business. When a company has multiple founders or substantial shareholders, their interests must also be considered in the decision-making process for an exit strategy.

Selecting the Right Exit Strategy for Your Business

Choosing the appropriate exit strategy is a complex process influenced by numerous factors. Obtaining an independent business valuation and legal advice can help identify the most suitable strategy for your situation.

At Seven Legal, we specialize in providing start-ups, founders, and entrepreneurs with tailored legal advice at every stage. Our objective during your exit is to secure the best terms while considering the interests of your employees and key stakeholders. We offer guidance on common exit strategies such as mergers and acquisitions (M&A), management buyouts (MBO), and buy-ins. Additionally, we assist with reorganizations, restructures, and due diligence for both buyers and sellers. Discover more about our business exit services and packages.

7 Types of Exit Strategies

Here are the seven most common exit strategies, along with their strengths and weaknesses:

  • Initial Public Offering (IPO)
  • Mergers and Acquisitions (M&As)
  • Management and Employee Buyouts (MBO)
  • Selling to a Partner or Known Investor (Including Family Succession)
  • Acquihires
  • Liquidation
  • Bankruptcy

Understanding Business Exit Strategy

Ideally, an entrepreneur should incorporate an exit strategy into their initial business plan before launching their venture. The chosen exit plan can significantly influence the business’s development trajectory. Common exit strategies include initial public offerings (IPOs), strategic acquisitions, and management buyouts (MBOs). The selection of an exit strategy depends on various factors, such as the level of control or involvement the entrepreneur wishes to maintain, whether they prefer the company to continue operating in the same manner after their departure, or if they are open to changes in exchange for a substantial payout.

For instance, a strategic acquisition allows the founder to relinquish ownership responsibilities but also means forfeiting control of the business. IPOs are often regarded as the pinnacle of exit strategies due to the prestige and significant financial rewards they offer. Conversely, bankruptcy is considered the least desirable exit method.

A crucial element of an exit strategy is business valuation. Specialists can assist business owners and potential buyers in evaluating a company’s financials to establish a fair market value. Additionally, transition managers play a vital role in guiding sellers through the process of implementing their business exit strategies.

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Initial Public Offering (IPO)

An IPO exit occurs when a private business “goes public” by offering shares in the company to the general public. This transition shifts ownership from primarily being investor and founder-backed to including public shareholders. Following an IPO, founders and original investors can decide to either sell their shares in the company or remain involved. Even if owners opt to cash out, it’s common for founders and the management team to stay on board during a transition period.

Strengths:

Capital Infusion: An IPO can generate substantial capital, fueling business growth and expansion.

Cash Out Option: Founders and investors have the opportunity to monetize their stake in the company.

Weaknesses:

Complex Process: IPO exits can be protracted, expensive, and intricate to negotiate.

Regulatory Burden: The process entails significant regulatory costs and demanding reporting obligations.

Stock Performance Risk: Founders and investors may face disappointment if the stock fails to perform as expected.

Increased Scrutiny: Post-IPO, the company faces heightened scrutiny from shareholders, regulatory bodies, and the public.

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Mergers and Acquisitions (M&As)

Mergers and acquisitions occur when a business is either bought out or merged with another existing business. There are several motivations behind why a larger business might seek to acquire a smaller one, including:

  • Competitor Elimination: Eliminating a competitor from the market.
  • Market Expansion: Expanding into new geographical areas or markets.
  • Asset Acquisition: Acquiring valuable assets such as skilled workforce, infrastructure, or desired products.

In a merger, it’s typical for business owners to continue playing a role within the merged entity, often retaining management positions. However, in an acquisition scenario, founders and owners of the smaller business typically surrender control and ownership as their business becomes part of the acquiring company.

Strengths:

Profitable Exits: M&A transactions can lead to highly profitable exits, especially if there’s competitive bidding involved.

Control Retention: Founders and investors maintain a high degree of control over the exit, including negotiating the price and terms of the sale.

Weaknesses:

Resource-Intensive: M&A processes can be lengthy, expensive, and not always successfully completed, potentially resulting in wasted resources.

Employee Uncertainty: M&A deals may create uncertainty among employees regarding their roles and job security.

Non-compete Agreements: Some acquisition exits may require founders and owners to agree not to work for or start a competing business post-sale.

Management and Employee Buyouts (MBO)

Management and employee buyouts involve selling the business to the current management team or employees.

Strengths:

Speed of Execution: MBOs are often quicker to accomplish compared to other exit strategies.

Owner Retention: The business owner may retain a stake in the company.

Minimal Disruption: As the management team knows the business well, this can minimize disruption for both the business and employees.

Weaknesses:

Dependent on Interest and Funds: Success relies on sufficient interest and personal funds within the management team or employees to facilitate the sale.

Selling to a Partner or Known Investor (Including Family Succession)

This exit entails selling to someone already familiar to the seller, often referred to as a “friendly buyer.” The buyer could be an existing partner, investor, family member, friend, customer, or colleague.

Strengths:

Minimal Disruption: The buyer’s familiarity with the business can ensure minimal disruption and continued success.

Weaknesses:

Dependent on Willing Buyer: Success hinges on finding a willing buyer.

Potential Undervaluation: There’s a risk of accepting a below-market price, especially if there’s a personal relationship with the buyer.

Personal Relationships at Risk: There’s a potential for personal conflicts or compromised negotiations.

Family Succession:

Family succession involves passing down ownership in a successful family business to a relative, such as a sibling, child, or other family member.

Pros and cons mirror those of selling to friendly buyers, with heightened implications:

Extensive Understanding: The family member likely has a deep understanding of the business and can transition into the role of owner with careful preparation.

Risk of Underselling: There’s a risk of underselling the stake in the business.

Personal Relationships at Risk: Personal relationships may be strained, especially if business dealings affect family dynamics.

Lack of Suitable Successor: There may not be a suitable or willing family member to take over the business.

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Acquihires

Acquihires involve acquisitions based on the value of a company’s employees. This exit strategy is particularly effective in sectors with highly skilled and talented workforce.

Strengths:

Lucrative Opportunity: Acquihires can be financially rewarding as skilled employees are highly valued.

Job Protection: The acquihire model often safeguards jobs within the business, leading to high employee retention.

Weaknesses:

Difficulty in Finding Buyers: Acquihire exits can be challenging to secure buyers for.

Costly Execution: Like other acquisition strategies, acquihires can be expensive to set up and execute.

Liquidation

In cases where a business is struggling or failing to generate profits, liquidation becomes necessary. It involves selling off assets to settle debts and repay shareholders. Liquidation is typically considered after exploring more favorable exit strategies.

Strengths:

Quick Resolution: Liquidation offers a relatively swift end to the business without the lengthy processes involved in mergers or acquisitions.

Finality: Despite being an undesirable outcome, liquidation provides a definitive resolution.

Weaknesses:

Low-Value Exit: Liquidation usually results in a lower value compared to other exit strategies.

Impact on Stakeholders: Ending the venture affects employees, partners, and customers, potentially leading to reputational damage for founders and investors.

7. Bankruptcy

Bankruptcy is the least desirable form of exit, often considered as a last resort for founders.

Strengths:

Debt Relief: Following bankruptcy declaration, the business owner is relieved of debts, although assets may be seized to settle debts.

Weaknesses:

Incomplete Debt Settlement: It’s possible that not all debts will be settled through asset seizure.

Negative Impacts: Bankruptcy carries implications for employees, partners, and customers, along with potential reputational damage for founders and investors.

Credit Rating Impact: Business owners’ credit ratings are likely to suffer as a consequence of bankruptcy declaration.

Business Exit Strategy and Liquidity

Different business exit strategies provide varying levels of liquidity for business owners. For instance, selling ownership through a strategic acquisition can deliver substantial liquidity quickly, depending on the acquisition’s structure. The attractiveness of a particular exit strategy also hinges on market conditions. For example, an IPO might not be ideal during a recession, while a management buyout could be less appealing to a buyer when interest rates are high.

While an IPO is typically a lucrative opportunity for company founders and seed investors, the shares can be highly volatile and risky for ordinary investors who purchase them from early investors.

3 Quick Tips on Preparing for Exit

Plan for Exit Early: Incorporate exit planning from the outset of your venture. Regularly review your ability to exit at each stage to avoid being tied into situations where selling becomes challenging. Early exit planning enhances flexibility and ensures readiness when the time comes.

Define Exit Criteria Clearly: Determine your exit goals, including financial objectives and desired level of post-exit involvement in the business. Having clear exit criteria helps guide decision-making and identifies trigger points for initiating the exit process.

Stay Prepared with Due Diligence: Anticipate potential acquisitions and exits by staying ahead on due diligence. Manage internal operations efficiently by utilizing due diligence questionnaires or checklists. Establish a due diligence room, an online repository for pertinent documents, to streamline the process. Access our comprehensive data room guide for startups to ensure thorough preparation.

By proactively planning for exit, clarifying your exit criteria, and maintaining readiness with due diligence, you can optimize your business’s transition process for a successful exit.

Get legal support on exit strategies from Batuc Law Firm

By providing stage-specific legal advice, we assist founders and start-ups throughout every phase of their business growth, including exits. If you have any legal inquiries regarding exit strategies, please don’t hesitate to contact our lawyers today.

You can also discover more information on exits on the client journey or specialisms pages of our website.

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