P.T. Barnum used “This way to the Egress!” signs in his traveling circus in the late 1800’s to keep crowds moving.  Apparently most people did not know that “egress” meant “exit.”  Barnum is reputed to have noted, “People can’t get to where they want to be if they don’t know where they are going.”  That statement also holds true for business owners.  If they want to realize the financial rewards of the equity they have built up in their business it is necessary to know how to exit the business.

Some people will ask, “Why should I have to exit when I have a successful business?  There is no absolute answer to this question and for some business owners, exiting may not fit their personal goals.  Consider, however, that if you have a typical small business you are “working for yourself,” in other words you have a job to go to each day.  Presumably you are earning a higher wage and have a better benefit package than if you were working for somebody else, but you still have a job.  If you stay away from the business too long the sales will fall and your income will drop.  In essence, your investment in the business has bought yourself a job.

The real value of a business is the equity that it builds up.  This is shown on your balance sheet, and is the key to achieving financial freedom as a business owner.  If you were to sell your business it would sell for a multiple of sales and assets.  While the “rules of thumb” for business valuation vary from business to business we can still consider a generic example.  Let’s assume that”

• You started your business a number of years ago with an investment of $150,000
• Your sales are now $400,000 a year
• Your net profit is 20%, or $80,000 a year, of which you draw $50,000 as a dividend, and reinvest the balance of $30,000 in the business.
• You also draw a salary of $30,000 which is in your operating expenses (deducted from the $400,000 in sales along with all other expenses, leaving the $80,000 net profit as the “bottom line”).
• You can sell the business for 1.5 times sales plus equipment and inventory.

In the event that you sell you will receive $600,000 (1.5 times sales) plus the value of inventory at cost and the depreciated value of equipment.  Simplistically stated, you have received $600,000 for your initial $150,000 investment and have recouped the cost of your inventory and equipment. 

Further assuming that you are too young to retire and have an interest in remaining an entrepreneur, you can start another similar business, subject to any geographical limitations in the non-compete portion of your sales agreement, or you can start a different business.  If we assume that due to inflation it now takes $200,000 to start a new business and you deduct that from the $600,000 there is still $400,000 left.  That $400,000 represents five years of income at your $80,000 level.  By exiting and realizing the gain on the equity in your business you have realized five years worth of income in one year and still have the capital (the $200,000) to start another business.

There are many serial entrepreneurs who start, grow, and sell businesses one after another.  The analogy may be that of buying, fixing, and “flipping” houses.  I know of several successful entrepreneurs who developed a model of starting and growing Italian Deli’s.  Every three to five years they sell, realize their equity, and then start another deli in a neighboring town (in order to comply with the non-compete clause which stipulates a mileage radius).

Ok, so much for the concept… how should you plan to exit?  The first step is to determine what the assets in your type of business are.  They could be equipment, recipes, customer lists, repeat customers, on-going contracts, and so on.  This will vary by the type of business.  I had a client who ran a burglar and fire alarm installation company.  In his case the assets were the number of customers he charged a monthly fee to for monitoring their system.  Their value was significant as presumably the monthly fees would continue forever, either with the current customer or the new homeowner if they sold the house.  My client decided to sell his systems at cost, covering his operating expenses, his installation expenses, and a modest salary for himself.  By having a lower initial cost and the same monthly fee as other companies, he outsold his competition. 

He was able to sell his business after about eight years, started another business that did the same thing in the commercial market (his non-compete only barred him from the residential alarm business), sold that business after six years and retired to become a passive investor.

Bakeries, pizzerias and restaurants may have unique recipes that are assets, those will add value to the business and increase the selling price above that for traditional fixed assets and a multiple of sales.  As in the alarm business, companies with service contracts have an asset in those contracts.  Retailers with rights to be the exclusive distributor in a geographic area for manufacturers have assets in those rights.  You will need to identify both assets that you have in your business and assets you can add to the business.  If you do that you will be able to increase the sales value of your company, realize the equity if you choose to exit, and then repeat the process as often as you wish.