“My investment advisor suggested that I sell my company to an ESOP. Is that a good idea?”
“My estate planning attorney recommended that I begin giving my business to my children. What do you think?”
“I’m getting tired of running my business every day. My accountant thinks a sale to a third party is a good idea. What’s your opinion?”
Sales to key employees, Employee Stock Ownership Plans, transfers to children and sales to third parties can all be excellent exit strategies. But if questions like these are the foundation for your Exit Plan, you may be like the car buyer who asks if the Mercedes, BMW or Lexus is the best vehicle. We admit to owners who ask which particular exit path is best for them that, “We have no idea.”
While owners may not be keen on paying us for this response (or non-response), it is the only honest advice to give an owner whose Exit Plan is obviously adrift. When an owner asks questions out of the blue like the ones above it can indicate that his advisors lack experience as well as a coordinated approach to helping their business owner clients. They have not asked the questions necessary to start the owner on the path to a successful business exit.
As advisors, unless and until we know more about an owner’s company and what goals he or she wants his Exit Plan to achieve, we cannot possibly know which route is best. It is the job of your Exit Planning advisor to help you plan and implement your exit strategies by asking the questions that help you to clarify your goals. Experienced Exit Planning advisors ask the right questions so that you know where you are going, who is going to help you get there and the route you are going to take.
We recommend that you begin your Exit Planning journey with two things: 1) a road map and 2) an experienced guide. The road map describing an Exit Planning process is simple and relatively easy to create. Finding and using experienced advisors may not be as easy. Of course, if an advisor has provided you with a copy of this article, you already know one advisor who can help you with Exit Planning.
Who should be on your Advisory Team?
An Advisory Team should consist of the following professionals:
Financial/Insurance Professional
Business/Estate Planning Attorney(s)
CPA, and
Business Consultant (as needed).
If a third party sale is likely, you should also have a:
Transaction Intermediary (Business Broker or Investment Banker) and
Transaction Attorney.
Why should I have all of these Advisors?
First, no one professional has all of the answers. The issues you face in exiting your company are complex and will require input from professionals in a number of disciplines. For example, an accountant skilled in Exit Planning brings a host of skills (especially tax minimizing techniques) to the process that your attorney may not possess and vice versa. In addition to being skilled in a particular practice area, each advisor should also be familiar with, and better yet, experienced in Exit Planning and should know how to work for you as a member of an Advisory Team.
Lawyers and CPAs are expensive. Won’t this Team cost me more money?
Assembling and meeting with your Advisory Team not only facilitates the exchange of information and ideas but it can reduce your costs by increasing the efficiency of each advisor. Instead of your advisors proceeding in a disjointed and inefficient manner, have a single meeting with all advisors present to coordinate everyone’s efforts.
How do I find Team members?
Many business owners are familiar with many of these professionals and have worked with them individually in the past. What you may not have done is assembled them as a team charged with a common goal: helping you to leave your business in style. No one advisor can guide you through this process.
Get started today on planning for the single, most critically important financial event of your life – the transition out of your business because the reality is – you only have one chance to get it right!
Value Drivers – the intrinsic characteristics of a company that buyers look for when deciding what company to buy and how much to pay. Value Drivers are an important aspect in a successful sale of a business and consequently it is the work of the owner (not employees) to create and to nurture them. Value drivers include:
A stable and motivated management team.
Operating systems that improve sustainability of cash flows.
A solid, diversified customer base.
A realistic growth strategy.
Effective financial controls.
Stable and improving cash flow.
In a strong Merger & Acquisition (M&A) market, buyers compare the relative strength of your company’s value drivers to those of your competitors. In today’s M&A market, however, buyers want companies that possess all of the characteristics of a well-run business. Additionally, tighter credit forces buyers to use more of their own capital to buy businesses, so they look for acquisitions that carry minimal business risk. Companies with strong value drivers in place carry less risk. Companies lacking one or more value driver(s) simply will not attract interested buyers. This harsh reality means most owners have a lot of work ahead.
Luckily, the economic forecast – at least for the foreseeable future – gives owners exactly that: time to install and energize the value drivers in their companies. It also gives them time to demonstrate, over several years, the sustainability of the value drivers they create. Buyers want to know that the success or growth charted in one year can be sustained over a number of years. They bank on (and pay for) your company’s potential to grow under their ownership so they look very carefully at how long your company’s value drivers have yielded positive results. More
“I haven’t decided what I ultimately want to do with my business, or when I want to exit, or how much money I’ll need, or whom to sell to, so how can I plan my exit? Besides, I don’t want to exit right now.” If you’ve said this, or thought it, you are not alone. Many business owners are either overwhelmed with the thought of exiting or are so busy fighting daily business fires that they think they cannot plan their exits.
Know that in your indecision, you are making a decision. As Winston Churchill observed, “I never worry about action, but only about inaction.” When you take a passive attitude toward the irrefutable fact that you will–one way or another–leave your business, you are deciding to settle for a least profitable exit for yourself and for your family.
If you are an owner who isn’t sure about what you want, or when you want to leave, why is it so important to decide to act today? Why can’t you wait?
Preparing and transferring a company for top dollar takes time—on average about 5 years. Most of those years will be spent preparing the business for the transfer. If you decide to sell to employees or children (two groups who rarely have any money), they’ll need that time to earn the money to pay you for your interest.
More time often equals greater reductions in risk. Time can be used to design and implement income tax-saving strategies, build value, strengthen your management team, begin a gradual transfer of ownership (not control) to key employees or children. If you wait too long, you probably won’t have time to implement these strategies and you’ll likely end up transferring your business on less-than-ideal terms.
The market does not operate on your schedule and may not be paying peak prices when you are ready to sell to an outside party. Witness the state of the Mergers & Acquisitions (M&A) market in 2008 through 1011: activity is almost non-existent in many business sectors and down in almost all.
If leaving a company you’ve worked so hard to build and having little or nothing to show for it, is unacceptable to you, let’s look at a few of your options.
Wait for a buyer. According to Deloitte’s Entrepreneurship UK: 2008 survey, 35 percent of business owners said they will wait for a third-party offer for their businesses. Owners in this group believe that one day a buyer will contact them, negotiate a sale, and that will be that. Well, this is a decision of sorts—but one that flies in the face of reality. While few businesses are being sold today, there will likely be a significant number of Baby Boomer business owners vying with you to sell their businesses when the M&A market recovers.
In a competitive buyer’s market, only the best-prepared businesses sell for top dollar. And the owners of those well-prepared businesses will be those who made the decision to act to prepare their company years ahead of the actual sale.
Liquidate. Liquidation is a common exit path for owners of companies whose cash flow is flat and has little probability of improving—absent the design and execution of a business/exit plan. If you find yourself in this group, we recommend that you meet with your tax and other advisors to do the planning necessary to create the most tax-efficient liquidation possible.
Decide to exit and plan accordingly. Start today and take the following steps:
Fix a departure date.
Determine your after-tax financial needs.
Decide whom you want to succeed you.
Have your business valued to see if: a) should you sell today; and/or b) it has the value necessary to meet your financial and other exit objectives.
Based on your objectives and the realities of your business, use a skilled Exit Planning Professional to forge a plan with accountability/decision deadlines.
Deciding to do something now to create the best possible exit path is not difficult. The failure to act, however, can potentially be fatal to a successful exit. The success of your business exit is simply too important to you (your family and your employees) to leave to chance. Why wait? Why decide not to decide?
A successful business ExitPlan achieves three important owner goals:
Financial Security. (The business sale or transfer provides the amount of income the owner, and owner’s family, needs after the owner’s exit.)
The Right Person. The owner chooses his or her successor (children, key employees, co-owners or a third party).
Income Tax Minimization maximizes the amount of cash in the departing owner’s pocket.
A successful Estate Plan achieves three important personal goals:
Financial Security (for the decedent’s heirs).
The Right Person. The decedent (rather than the State) chooses who receives his or her estate.
Estate Tax Minimization reduces the Government’s bite leaving more funds for one’s heirs.
Once owners see that the two processes share the same goals, they can appreciate how to leverage the time and money they spend developing their Exit Plans into the design of their estate plans.
For example, when you engage in Exit Planning you most likely determine your objectives and secure an estimate of value on your business before you start working to create more business value. In securing an estimate of value, you possess a piece of information that’s critical to both your business continuity and estate plans.
Thinking of exit and estate planning in tandem brings the owner’s entire picture into focus:
If you don’t make it to your business exit date, how will you provide your family with the same income stream they would have enjoyed if you had?
How will you make sure that your business retains its previously determined value?
If your exit strategy involves transferring part of the business to the children, or if it does not, does your estate plan reflect and implement your wishes if you don’t survive?
If you die before you exit the business, are you certain your family will still receive the full value of the business? (This question is especially important to answer if you are the sole owner. Sole owners are unlikely to have a buy-sell agreement because there are no remaining co-owners to purchase and/or continue the business.) More
“To will is to select a goal, determine a course of action that will bring one to that goal, and then hold to that action till the goal is reached. The key is action.” Michael Hanson
If the thought, “Why exit plan when I can’t sell my business now or anytime soon?” has crossed your mind, consider the case of fictional owner Rudolfo LeMonde.
Rudolfo LeMonde’s hospitality services business had grown steadily until the last few years. Although revenues had flattened, Rudolfo maintained profitability by reducing overhead and working more hours.
This was Rudolfo’s situation when a would-be buyer approached. At age 55, Rudolfo hadn’t actively considered selling his business, but was beginning to think that life after work might have something to offer. His business wasn’t providing as much fun as his other activities, especially since business growth (and more importantly, profitability) had been slowing for the last two years.
Rudolfo scheduled an hour to talk to that interested buyer and, in 60 minutes, his eyes were opened and his priorities turned upside-down.
The buyer, a large national company seeking to establish a presence in Rudolfo’s community wanted, like most buyers, to acquire a business that could grow with little other than financial support and the synergies it brought to all of its acquisitions.
This meant it sought companies with a number of characteristics that we call Value Drivers. Some important ones are:
Capable management apart from the owner. Rudolfo’s buyer (again, like most) did not have its own management team to insert into the business. Rudolfo had not attracted or retained solid management (nor had he created a plan to do so).
Strong and increasing cash flow. Unfortunately, Rudolfo’s company had been experiencing declining cash flow.
Sustainable and comprehensive systems throughout the organization (from human resources to marketing and sales to work flow). At best, Rudolfo’s business was a hodgepodge of stand-alone, as-needed systems created over time to respond to particular emergencies, and positioned Rudolfo at all decision points.
A plan to grow the business focused on enhancing a company’s unique position in the marketplace. Rudolfo had never created a written plan, let alone identified or clarified his company’s competitive advantage. More
“In preparing for battle, I have always found that plans are useless but planning is indispensable.” Dwight D. Eisenhower (as quoted in Six Crises by Nixon, Richard (1962), “Krushchev” – Doubleday).
General Eisenhower’s point was that the process of creating a plan provides value because it forces the planner to consider (and make provision for) “What if events don’t proceed as planned?” A plan not only provides context and the basis for adapting to new and unanticipated events, it also provides alternatives based on assumptions about goals, objectives and resources that may need revision.
As advisors, we know that business owners who create business plans are able to react more quickly to new events—events of the past few years in this economy and this world come to mind—than can those without plans.
Unfortunately, even owners who have business plans will fly without Exit Plans, co-pilots, or maps to help them when storms force them to alter course toward their business exits. If an unanticipated event arises (such as a deterioration in the economy), they shelve their exit planning thinking (and thinking is all they have since they haven’t created a written plan) because their only option is to wait for conditions to improve. These successful owners would never consider a similar passive response to be acceptable in a business plan.
If the value of an Exit Plan isn’t obvious yet, let’s look at a few hard, cold facts. More
Aesop is famous for his stories that teach important lessons but are fictional-and often fantastic. Our topic today, ESOPs (Employee Stock Ownership Plans) is similar. Fictional and often fantastic claims are made about what ESOPs can and cannot do. ESOPs can help business owners to achieve a number of important Exit Planning goals-namely, selling a business tax-free to employees for full market value. But as with a fable, readers must take care to separate the important lesson from the fiction. What can or should you believe about ESOPs? Read on.
Business owners use ESOPs (Employee Stock Ownership Plans) as a tool to achieve three common Exit Objectives:
To leave the business soon;
To leave the business with cash adequate for financial stability; and
To leave the business to employees.
An ESOP is a tax deductible retirement plan – like a 401k; however, it is a form of a Profit Sharing Plan.
Three Key Differences from a regular Profit Sharing Plan:
Can borrow money.
Can engage in transactions with “parties in interest.”
Invests primarily in stock of sponsoring employer.
Armed with that basic information, let’s look at how an ESOP helped one ficticious owner to achieve his Exit Objectives.
Steve Victoria was the sole owner of VECI, a 35-person firm with annual revenues of $5 million and cash flow of $500,000. After exploring a sale to a third party, Steve’s business broker suggested that a cash sale was unlikely. A sale to employees was also problematic given their inability to obtain meaningful financing.Until Steve came across an article about ESOPs, he thought that his only exit option was to gradually diminish his involvement in the hope that VECI could continue to distribute earnings to him. The article outlined a far different exit option. It said that Steve could cash out for fair value, his employees could own his company and, best of all, Steve would pay no taxes on the sale.
ESOP Advantages
The biggest advantage in the minds of many owners is the fact that the funding of a purchase by an ESOP is accomplished via pre-tax instead of post-tax dollars.
Running a close second is that if, after an ESOP purchases the owner’s C corporation stock, the ESOP holds at least 30 percent of the corporation’s outstanding stock, the shareholder’s proceeds are tax-free so long as they are invested in U.S. stocks and bonds.
Finally, national surveys indicate that a company’s productivity improves after an ESOP is instituted. More
In my opinion, for a company to be run successfully, it must contain four essential ingredients:
Leadership
Financial Acumen
Sales/Marketing, and
Operations.
Leadership, a critical management skill, is the ability to motivate a group of people toward a common goal. Leadership boils down to having vision (of the end result desired), integrity (keeping your word), ability to plan, creating a positive working environment, and the ability to communicate to help the team “catch the vision.”
The Financial side of running a business is very complex. It should start with the development of a strategic plan. What products or services should we produce? How should we produce them? What is the most efficient way to bring them to market? How should we price them? I believe every company should develop a strategic plan, and most owners don’t know how to go about it. If they don’t know how to do it themselves, there are many business consultants that can help them develop that plan. The good consultants will get everyone on the leadership team of the company involved in the development of the strategic plan because then everyone on the company’s leadership team “owns the plan.” My suggestion is to develop at least a 3 year and at most a 5 year strategic plan. Will you execute every aspect of that plan? Probably not – because market conditions can sometimes change dramatically, as they did so recently in 2008 with the “economic meltdown.” The key is not so much the plan itself, but the planning process, especially with everyone on the company’s leadership team involved in that process.
The Financial side also involves understanding completely the major aspects of your financial picture that contribute the most to your company’s profitability. For example, if inventory is higher than what is needed to operate efficiently, then you have too much capital tied into the inventory, which restricts using that capital elsewhere, such as in more employees or machines or equipment that will allow you to produce more products or more services more efficiently. When you correct each item of your financial picture that is “out of balance,” it can have a multiplier effect on your earnings, which means for every $1 of “savings” in one area can mean $2 to $3 to $4 of increased profitability. It can be that dramatic!
Sales/Marketing is how you bring your products to market. Marketing involves 4 aspects:
Generating demand – direct mail, e-mailing, website, trade shows
Selling involves asking the customer for the order! That can be accomplished by inside sales reps, outside sales reps, distributors or any combination thereof. It is important to teach sales reps that they are the face of the company with the customer.
Operations means how efficiently does your company produce and price the product or service? Industry metrics can be used to assist the owner in determining the efficiency of your own operation. In the manufacturing sector that can mean anything from ISO qualification to LEAN to 6 Sigma to Just in Time, using ERP and other industry measurements.
It has been my professional experience that most companies do 1, maybe 2 of the 4 ingredients successfully. That is where adding a “professional management team” can really add a multiplier effect on a company’s profitability. More
Franklin Taft was understandably a bit neurotic. He was increasingly anxious to begin planning for his eventual departure from his business but his concerns prevented him from proceeding. “I’m too busy working in my business to think about how to leave it. Besides, I don’t know what to do – and neither do my advisors.”
Sound familiar? In our experience, the primary reasons owners hesitate to begin the planning process are:
1. You may be so busy fighting alligators that you don’t have time to drain the swamp. Daily demands mean all of your time and energy are spent working in the business. You have little left to work on the business of leaving your business.
A solution: spend a few hours learning what you need to know by reading “The Completely Revised How to Run Your Business So You Can Leave It In Style” and the provider of this blog can offer you additional material discussing Exit Planning.
2. Owners may be unaware that there is a defined Exit Planning process that provides a template showing them the steps they can take in order to help them “leave their businesses in style.”
3. Some lawyers, CPAs, insurance professionals and investment advisors – your professional advisors — may not know how to effectively work together to help you leave your business in style.
4. Finally, (and this wasn’t a problem for Franklin) many owners have a fear of the unknown – what will they do after they exit their businesses?
At the risk of sounding like the dentist you feared as a child, “Trust me, it won’t hurt.” As a successful, smart business owner, you can both discover and create a new and fulfilling life apart from your business.
The last step in your Exit Plan is Personal Wealth & Estate Planning. But that doesn’t mean you should wait until you are out of the business to begin actively preserving your wealth. In fact, if you wait until the value of your business is converted to cash, it may be too late to realize all of the benefits of wealth preservation. The most significant and powerful claimant to your wealth is the IRS — especially in the estate tax arena.
These are the benefits to owners of planning ahead of time:
Financial security for spouse and children – this is the most important reason for planning.
Treat children equitably, not equally – some of the greatest disasters I’ve seen have been those situations where parents pass stock equally to all their children, even though only one is active in the business. From that point on, children are at cross purposes with each other. The active child wants to plow profits back into the company, and the inactive children want cash flow today. The solution is to use non-business assets and/or life insurance for the non active children and stock in the business for the active child.
Address estate taxes – are they “voluntary?” Of course they’re not voluntary, but it is possible to plan around the significant adverse impact they can have on a large estate, especially one that is not liquid.
Complete new estate plan to go with exit plan – we encourage owners to allow us to give them a second opinion on their existing estate plan so they can revise and update their plan in conjunction with their Exit Plan.
Consider charitable bequests – remember, the object of your bounty can only go to 3 places: your heirs, your favorite charities, or the I.R.S through estate and inheritance taxes. Most of the people we work with prefer their heirs and favorite charities.
