When I was about to set up one of my first limited companies, back in 2002, a good friend said to me “Andy, always have a business exit plan!”. I had no idea what he was talking about and brushed the whole idea under the carpet for a while. Little did I know at the time, this was the best single piece of business advice I’ve ever been given.
What is a business exit plan?
Traditionally in the world of business an exit plan mostly revolves around selling a business. However I’m going to be talking about an exit plan in a much broader sense. Most businesses don’t get sold but many people want to shut a business down to do something else. On top of this, and I realise this is a bit morbid, but everyone dies… including you! An exit plan is all about extracting yourself from the business in a controlled manner. Points to consider:
- What happens if you want to do something else?
- What happens when you die?
- What happens if you want to sell the business?
- What if your business partner dies?
- What if you want to bring someone new in to the business?
The implications of not having an exit plan
In order to better explain the importance of having a business exit plan let me explain a story to you. This is a true story with some of the key facts changed to protect the identity of those involved. Other than the business type and the names involved, this all actually happened to a good friend of mine.
In the beginning
My friend, James, had always been passionate about setting up his own business. We was an amazing drummer and loved helping others get involved in playing. Eventually, after a few late night conversations and minimal planning, he decided to open his own drum shop.
It was hard work but after many sleepless nights over around three years he eventually started making some money. He had some basic premises and the business was paying for itself. James wasn’t actually taking a wage for himself, everything he made he invested back in the business. Luckily he had a very supportive wife and they made things work.
Time to expand
Eventually James decided it was time to expand. He was sick of low-margin sales and people coming in to try out a drum kit only to buy it on Amazon for £10 cheaper. He needed a better quality of customer and this entailed moving in to a more professional market.
This was tricky since James was already working 10 hours a day with minimal time off. Luckily a friend of his was looking for a change of scenery and he was a perfect fit for the business. Paul joined the operation and things really took off.
They did everything by the book. They set up a brand new limited company. Invested even more money in the business and even signed a new business lease for more professional premises. The stage was set and new customers started arriving. A more professional class of customer, interested in a more personal experience from technically knowledgeable people.
The partnership worked great. Paul handled the early shift, preparing new stock and getting customer orders ready for collection. James handled the late shift, sales and general business management. It was a great team and the business grew as a result. It quickly became profitable and not too long afterwards they were able to pay themselves a small wage. Things were VERY busy but they were happy. The business was finally going in the right direction.
The unthinkable happened
One morning James arrived at work to find no sign of Paul. This was really unusual. Paul was an early riser and was never late for work. James checked his voicemails – nothing. He tried calling Paul – no answer. He got distracted by a customer coming in the shop but he was still slightly confused as to what was going on.
Then, at 11am, his phone finally rang. It was Paul’s wife, Jane. This was unusual. Paul’s marriage wasn’t in a great state – they were on the verge of divorce and James really didn’t get on with Jane. So for her to call it was strange and awkward to say the least.
Jane wasn’t in a good way. She was sobbing and could barely get her words out. Paul had been out for his usual early morning run when he was hit by a car. He was rushed to hospital but he passed away a couple of hours after arrival. Jane was silent. James was silent.
Life went on
James was utterly distraught but immersed himself in the business. It reminded him of Paul and he did his utmost to keep going. Stiff upper lip and all that. It was a challenge though. Even when they were working together they barely had time to stop. Now James was working 12 hour days, every day. He hadn’t had a single day off for months.
Meanwhile things weren’t going well with Jane. Family members would randomly turn up at the shop taking notes. Asking weird questions about how much stock he had and how busy it was. James tried speaking to Jane to discuss Paul’s shares in the business, but she would never return his calls.
The penny dropped
Paul and James were 50/50 shareholders in their limited company. When Paul died his share in the business became part of his estate and as such. He didn’t leave a will so Jane inherited everything… including 50% of James’ business.
Although Jane had no interest in the day-to-day running of the shop, she knew fine well that 50% of everything was hers. She was quite happy to watch from the sidelines as James worked his fingers to the bone. He tried and tried to come up with an amicable agreement to buy her out, but she wasn’t having any of it.
The demise of a successful business
In the end it was all too much for James and he was left with no other option but to shut the business down. Jane was unwilling to negotiate and James couldn’t spend his entire life building up a business for a person he didn’t even like.
He sold his stock to a competitor and used that money to buy himself out of the business lease. It took about six months but eventually he closed the door to his shop for the last time. He was broke and the dream was over.
It’ll never happen to me!
This may sound like an extreme scenario but it happens all the time. People die. Business partners fall out. Circumstances change. Everything ends… one day. The frustrating thing is this could have all been avoided.
Preparing a business exit plan
There are several methods that could have been used to avoid the situation James encountered. They’d been so busy they simply hadn’t stopped to think “what if” and what was left was a mess. All they needed to have done was sit down with their accountant (or legal professional) to discuss an exit plan. Typically this may be documented in 5 ways:
- An informal arrangement
- Articles of Association
- A cross-option agreement
- A shareholders agreement
- Shareholders Will
IMPORTANT: You MUST engage the assistance of a professional to help you with this. A good starting point is your accountant, who will almost certainly have encountered this for other businesses. You can also try a legal professional who specialises in this side of things.
An informal business exit plan
I wouldn’t really recommend the informal route since sometimes it can be more confusing than no exit plan at all. But in some circumstances it can work. At least sit down with your business partner and discuss the whole situation. If possible document your decisions, both sign acceptance and make sure your family knows what’s going on. If you don’t have a business partner just sit down with a family member for an hour or so and explain what should happen in the event of your death or serious illness. However this is no substitute for the more formal route.
Articles of Association
If you have a limited company you may already be covered by your Articles of Association (we’ll just call them Articles). The Articles are the rules of engagement of how your business works. They’re normally based on standard model articles but your company formation agent may have used special Articles that cater for these sort of scenarios. If you don’t have your Articles to hand you can download them from Companies House.
The two main disadvantages of including this sort of information as part of your Articles is:
- They’re public
- They’re slightly more complicated to change
Check with your accountant or legal professional to see if your Articles already include clauses to cover what should happen in the event of the death of a shareholder etc. Make sure you understand this and don’t be frightened to ask questions!
A cross-option agreement is generally a simple a contract between shareholders that gives surviving shareholders priority to buy back the shares of the person who died. They’re normally implemented along with an insurance policy to cover the costs of buying these shares at a fair market value.
A shareholders agreement is more broad reaching. It will normally include some form of cross-option agreement along with additional details, such as what happens if a shareholder wants to leave the business.
Whilst you wouldn’t necessarily include detail such as a shareholders agreement within a person’s will, it is important that the wills of shareholders are reviewed throughout this whole process. The rules of intestacy or the provisions of a will will apply in the event of a shareholder’s death. While a company specific agreement (such as a Shareholders Agreement) would generally take precedence, it’s important that the provisions of the will don’t contradict the provisions of these agreements. As such it’s normal to review all shareholders’ wills in parallel with putting these agreements in place.
Don’t panic! But do take a business exit plan seriously
By the very fact that you’re reading this, you’re already ahead of the curve. Most businesses only consider these options when it’s too late. Start off by having an informal chat with all parties involved. Briefly document your decisions and at the earliest opportunity sit down with a legal professional to get things formalised. A few careful hours now could prevent months or years of stress later down the line.
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Last Updated on 28 July 2023 by Andy Mac