Exit Planning Tools for Business Owners

John F. Dini

Owner Obstacles to an Exit Plan

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Owner obstacles to the implementation of an exit plan are often unconscious, but they can be dramatic.  Their attachment to the business can be difficult to break. An advisor spends a lot of time and energy developing the vision for life after ownership in the hopes that it is far more attractive to them than their current role in the business.

Yet no matter how well developed that vision is, or how well defined the action steps are, it isn’t unusual to find owners who behave in a way that ultimately sabotages the plan. Sometimes their actions are even intentional, but more often they aren’t. The problems arise in two ways.

 

“Death from Inattention”

We always ask exit planning clients for two target dates. The first is when they want to be relieved of day-to-day operational responsibilities. The second is when they want to be completely free of any connection to the company.

We tell a client that once we have achieved the first objective, the second may become more flexible. Freed on the task-based duties of running the business, an owner often becomes more strategic. He may start planning for new growth and value creation. She might go back to her role when the business first started when she was the best salesperson or the designer of novel product offerings.

Owners returning to their core skill set are usually a benefit to the business. The problem arises when they enjoy the lack of responsibility so much that they just become owners in absentia.

There is no strategy. The company drifts along on the backs of the operations managers, but doesn’t have a direction beyond “more of what we did yesterday.” There are no new initiatives.

Companies are organic. They are either growing or shrinking. The lack of direction may take a while to have an impact, but eventually, performance will suffer. Getting owners to re-engage after time away can be exceedingly difficult, but if they don’t, the transition is unlikely to accomplish their objectives.

“Death from Over-Attention”

The second obstacle to successfully implementing a transition occurs when owners have surrendered their task-based duties. In this case, they are unable to define their contribution in the absence of being “busy.” They begin looking for ways to contribute, often where their contribution isn’t needed.

It’s not uncommon to begin demanding more accountability and greater detail than is necessary. He or she pours over reports looking for errors, anomalies, or declining results to prove added value.

Another technique used to prove contribution is “seagull management”. An owner may look for opportunities to make decisions but does it without consulting the managers who are in charge of the function. Because they have always known best, they still know best. What isn’t as obvious is that they are now working in a vacuum, with little knowledge of what went before. The results are usually not ideal.

A third way owners might evidence over attention is with a “break the rules” mentality. They offer exemptions from policy or circumnavigate systems because they can. Exercising authority shows who is in charge, even if there is little apparent responsibility.

Preventing the Owner Obstacles

We call these “good” obstacles because they typically occur only after some level of initial success in the exit planning process. They are a direct result of relieving owners of the more mundane duties of management, and freeing them up for more effective leadership. Each is preventable with some preparation.

Either issue can be forestalled by including the owner’s next level of responsibility in the planning process. If the owner resists retained responsibilities, then the future becomes plain. Plans can then include the transfer of higher functions to the management team. If the owner insists on maintaining a level of day-to-day control, the coaching process should include defined parameters about what reporting is essential, and how often it will be presented.

owner obstaclesIn either case, owner obstacles occur when the owner is crossing the no man’s land between total focus on the business and the time when it isn’t a recipient of their attention at all. Like any no man’s land, it is unfamiliar territory, and some pathfinding is necessary. That is the exit planning coach’s job.

John F. Dini develops transition and succession strategies that allow business owners to exit their companies on their own schedule, with the proceeds they seek and complete control over the process. He takes a coaching approach to client engagements, focusing on helping owners of companies with $1M to $250M in revenue achieve both their desired lifestyles and legacies.

Entreprenuers Don’t Use Rearview Mirrors

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All business owners are goal oriented. From the day you founded or assumed control of your company, you set targets and achieved them. That is why you are successful. You know how to define a goal and make it happen.

If I asked you to tell me the best thing that you did in the business three years ago, you’d likely respond with, “I have no idea.” or “Why would I know that?” or “Who cares?” You are busy looking forward.

I’ve even had some owners get angry. They feel some obligation to know the answer, and that they are somehow failing a test if they don’t. The fact is, no entrepreneur has ever been able to give me a cogent answer about his or her accomplishments in the past.

If I ask, “What do you plan to do in the coming year?” you will share plans to increase sales, hire new employees, or enter into a new area of business. Whether or not you have a formal strategic planning process, you have a pretty good idea of the changes and improvements you want to implement in the future.

Looking Past the Rearview Mirrors

An entrepreneur’s vision of “What’s next?” is frequently the most neglected aspect of their exit planning. They may term their goals for exiting in measurable, concrete terms. “I want to retire in five years with ten million dollars in the bank,” is an archetypical example. Others will couch their vision in terms of people. “I want financial security for my family, and continuing employment for my staff.”

All too often, their vision for the future deemphasizes or completely neglects their own individual needs. When pressed to enunciate more personal goals, they’ll often respond with something like, “I guess I’ll just play a lot of golf.”

Playing a lot of golf isn’t a retirement plan.

In a recent survey from PwC, they reported that 75% of business owners have regrets a year after they leave the business. The Exit Planning Institute did a survey ten years ago with the same result. According to Riley Moines, author of The Ten Lessons: How You Too Can Squeeze All The “Juice” Out of Retirement, six months to a year is the typical initial “vacation” period when a retiree catches up on travel and recreational activities.

After that first year, the reason so many ex-owners are unhappy is because they didn’t have a clear vision for their life after the business. Their expectations simply did not take into account the reality of what would happen when they were no longer spending the majority of their time working.

Leaping into the Void

When I ask about their plans for next year, some owners are more specific than others. But none of them ever say, “I don’t know. We may make money, or we may lose money. We may grow, or we may shrink. Whatever happens, happens. It doesn’t matter.”

Why would anyone expect that an entrepreneur who has driven towards goals for their whole life will suddenly be happy without purpose, without identity, and without a plan? It isn’t surprising that so many owners are reluctant to discuss exit planning at all. Life without the daily challenges and decisions that come with running a business seems unattractive. Their vision of the future is unclear.

The success of an exit strategy depends less on the amount of money your transfer generates than it does on your personal satisfaction. Unless you can identify a vision for a “next act” that is more appealing than what you are doing now, business ownership will never be in your rearview mirrors.

John F. Dini develops transition and succession strategies that allow business owners to exit their companies on their own schedule, with the proceeds they seek and complete control over the process. He takes a coaching approach to client engagements, focusing on helping owners of companies with $1M to $250M in revenue achieve both their desired lifestyles and legacies.

Avoiding the “Exit” Word

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Owners don’t like the “Exit” word. They tell us regularly to change it, or that talking about it is uncomfortable. It’s the elephant in the room.

I understand. Anyone selling life insurance or funeral pre-planning knows that you don’t start with “So, let’s discuss what happens when you DIE.” For business owners, leaving the business is like a little bit of death. That’s why black humor in the exit planning world goes like this. “There are seven ways to exit your business. Six of those are head first.”

Your company has been the central focus of your life for twenty or thirty years, and perhaps more. It is so ingrained in your persona, your self-identification, that it’s frightening to think of that part of your identity disappearing.

Who is Bob?

When Bob leaves home every day to run Bob’s Widgets, he assumes the superhero cape of the owner. He walks in the door of the business as the head honcho, el hefe, the final word, the boss. That cape never comes off. The employees might go out for a beer after work, but he never becomes just one of the guys (especially when the table check comes.) The employees are careful about what they say around him, and he self-censures his conversations with them.

Just as importantly, that cape is always present in his personal life. He is Bob, the owner of Bob’s Widgets, everywhere he goes. At the kids’ sporting activities he is asked to sponsor (“It would be good for your business!”) In his church, at the Chamber of Commerce, and at parties he is introduced as “Bob, the owner of Bob’s Widgets.”

He overhears the identification at family gatherings. “Oh, that’s Sally’s cousin Bob. He owns his own business.” When his friends discuss their jobs, a bad boss, pending layoffs, or a reorganization they say “Of course you don’t have to worry about these things, Bob. You own the company.” (Ah, if they only knew…)

The “Exit” Word

So the word “exit” has a finality that jars a lot of clients. Advisors use lots of alternatives, like transition, succession or continuation – all of which imply an ongoing process, albeit one that doesn’t include you. Why would an advisor use the term “Exit” at all if it could be avoided?

We face up to it because it’s the elephant in the room. I am an Exit Planner. My companyex sells Exit Planning tools to advisors. We conduct the annual National Exit Planners Survey™. Our ExitMap® suite of coaching tools uses that word on virtually every page.

We use it because a coach is a trusted advisor, and a trusted advisor always speaks the truth. Not some of the time. Not just when it is agreeable. Not when it can’t be avoided. All of the time. The coaching relationship should be comfortable, but not too comfortable. Introducing a bit of unease to reinforce a point is part of the job.

I use the “exit” word to describe the final outcome of an implemented business plan. It usually involves a transaction, with legal documentation of a sale or other transfer mechanism. It can also include detailed succession planning for family members or a management team. We often discuss continuation – what happens if the plan is accelerated by unfortunate circumstances. Retirement might have a place in the conversation, or it might be about designing a “second act” or pursuing your life’s passion.

But all those terms, whether synonyms or euphemisms, are encompassed in the  “exit” word, We might as well get that on the table from the outset. If you start the advisory process by ducking anything that a client finds uncomfortable, you aren’t serving your purpose as a coach.

Let’s be Honest

Let’s agree to call a business transition what it is. Whether an owner wants to sell the business to a third party, create a family legacy through his or her children, finance a leveraged buy-out to employees, or just close down in an orderly manner, the ultimate objective is to exit.

 

John F. Dini develops transition and succession strategies that allow business owners to exit their companies on their own schedule, with the proceeds they seek and complete control over the process. He takes a coaching approach to client engagements, focusing on helping owners of companies with $1M to $250M in revenue achieve both their desired lifestyles and legacies.

Main Street Business and Middle-Market

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Main Street BusinessA common area of confusion among both business owners and advisors is the difference between a “Main Street” business, a “Middle Market” business, and a “Mom and Pop” business.

Main Street Businesses

The International Business Brokers’ Association and other professional intermediary organizations define “Main Street” as any company with a Fair Market Value of less than $3,000,000. That is about the upper limit of a business that can be purchased by an individual using “normal” 20% down financing. He or she is acquiring for the purpose of earning a living.

Main Street businesses typically calculate cash flow as Seller’s Discretionary Earnings (SDE). As discussed by Scott Gabehart, the creator of BizEquity valuation software, SDE is a better measure of a business’s return on owner labor, rather than return on investment.  SDE includes the benefits of ownership including salary, employer taxes, distributions, health insurance, vehicle, and other perks of ownership. It also includes non-cash tax deductions such as depreciation.

The average selling price for an owner-operated business in the United States is 2.3 times its SDE. That cash flow has to support any debt as well as provide a living for the principal operator.

If we extrapolate from the average multiple (which from my past experience as a business broker is accurate,) we would say that “Main Street” encompasses businesses that produce up to $1.3 million in cash flow. That number is actually pretty high and crosses the threshold of where Private Equity companies typically seek acquisitions. At that level, a buyer would have to have $600,000 for a down payment and about $25,000 a month for debt service.

In reality, companies that generate more than $500,000 a year in adjusted EBITDA cash flow (not counting owner compensation) are more commonly sold for multiples of EBITDA. At that size, a multiple of four times adjusted cash flow is pretty common, and would classify a company with up to about $750,000 in adjusted cash flow as “Main Street.”

Mom and Pop Businesses

There is no definition of what is too small to be considered “Main Street,” but I like the description used by Doug Tatum, author of No Man’s Land: Where Growing Companies Fail. Doug says that many entrepreneurs start a company to build wealth. They do all the jobs in the business and grow it by dint of their unflagging effort and willingness to work long hours. Eventually, they are earning an income that is three times what they could have made just holding down a job.

Unfortunately, they are earning that income by doing the work of three people. That is my definition of a “Mom and Pop” company. The owner is making a living, but the only way to improve that living is by further denigrating his or her lifestyle.

A local distribution business may have $10,000,000 in revenue, but operate with a half dozen employees and the owners. Their profit before taxes could be as little as $200,000 – putting this $10 million business squarely in the category of “Mom and Pop.”

Mom and Pop business owners are seldom candidates for exit planning. When they stop working, the business ceases to exist. Their best hope is usually to pass it to a family member or employee who is also willing to work really hard to earn a decent living. There is seldom enough free cash flow to support much in the way of debt for the purchase of the company.

Middle-Market Businesses

Middle-Market businesses are defined by investment bankers as having revenues between $100 million and $3 billion with less than 2,000 employees. The US Department of Commerce lists the parameters as between $10 million and $250 million in revenue. One accounting association says the “lower middle market” is classified as companies between $5 million and $100 million. Investopedia.com pegs it as $10 million to $1 billion. Divestopedia.com goes with $5 million to $500 million. TheStreet.com has the widest range at $5 million to $1 billion.

Of course, a $5 million revenue company could easily have less than $500,000 in pre-tax earnings, which would put it squarely in the Main Street category. On the other hand, a substantial number of software and Internet-based companies have become “unicorns” (over $1 billion in market valuation) with far less than $100 million in revenue.

This discussion illustrates two points. First, few people know exactly what they are referring to when they say “Main Street” or “Middle-Market.” They have their own idea and definition, which is fine. Unfortunately, it is unlikely that the person they are talking to has the same definition.

Second, inexperienced advisors may say they “don’t work with Main Street.” Many Main Street business owners are excellent candidates for exit planning. In fact, when the $3,000,000 fair market value yardstick is specified, two-thirds of exit planning professionals say that half or more of their clients are in that category(1).

The Business Owner’s Perspective

Why should any of this matter to a business owner? There are two areas where these definitions play an important role in your exit planning.

First, when you look for an intermediary to help you sell, understanding the market they serve is critical. Most business brokers will list a Mom and Pop business, and sell those to downsized corporate executives or others seeking to earn a living. They also handle Main Street listings, although those with over a million dollars in earnings are probably out of reach for 90% of their buyers. You should carefully look at their track record in selling businesses of that size.

Most business brokers will also say that they can handle lower middle-market companies. As we’ve seen, that covers an extremely wide range of revenues and earnings. Again, if you are in the range of profitability that would attract a corporate or financial acquirer, you are likely better off retaining an investment banking firm for the sale.

(1) 2022 National Exit Planners Survey – www.exitplannerssurvey.com

John F. Dini develops transition and succession strategies that allow business owners to exit their companies on their own schedule, with the proceeds they seek and complete control over the process. He takes a coaching approach to client engagements, focusing on helping owners of companies with $1M to $250M in revenue achieve both their desired lifestyles and legacies.

Contingency and Continuity Planning

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When business consultants talk about preparing for unforeseen problems, they frequently commingle the terms contingency and continuity. The terms are not synonymous, and there are important differences between them.

Contingency Planning

Contingency planning is generally accepted to mean how a business will respond in the event of a disaster. This could entail a building fire, severe weather, a strike of key service workers, civil unrest, or riots (depending on the audience.) Additionally, in the age of cybersecurity, ransomware or a denial of service attack, identity theft, and electronic fraud are all well qualified to be categorized as disasters.

Generally speaking, these are all insurable events. Contingency planning often recommends insurance as a major component of preparedness along with remote working capabilities or alternative production resources. In privately held businesses, however, contingency planning has one weakness.

It assumes that the owner of the company will be available to oversee the implementation of the plan.

What if the disaster is at the top of the pyramid? Most businesses need a continuity plan that addresses the sudden absence of the owner. We start the conversation with a simple scenario.

“What if you are hit by a bus on the way to work tomorrow? You are rushed to the hospital, and no one knows where you are. When they find out, it appears that you will be unable to respond to questions for weeks, if not months. How will the business operate for that time?

Continuity Planning

Exit Planning is presumably designed around a voluntary departure from the business, but what if it isn’t voluntary? Where contingency planning looks at a variety of financial risks, continuity planning is focused on the operational problems of an owner’s absence.

Continuity planning starts with the most elementary task-based assignments. We ask questions like, who opens the business? Who informs the employees, the customers, the vendors, and the bank? How are they told, (By email, phone call, personal meeting, or teleconference?) Who distributes funds, draws down the credit line, and signs contracts? Are there specific customers or vendors who will require special treatment?

Additionally, if employees are expected to step up to a higher level of responsibility, will they receive contingent compensation attached to their added duties? Many owners rightfully anticipate that employees will shoulder additional duties out of loyalty, but loyalty has a limit. What if they are in this position for months?

Are there limits on the employees’ decision-making authority? Can they decide on new capital investments, or enter into new vendor relationships? If there is a dollar limit, who has the authority to exceed it if necessary? Who are the key advisors they should consult if they have questions? Is there a compensation agreement with those advisors if they need to be closely involved or engaged for an extended time period?

Contingency and Continuity

These are just a few of the operational answers required on Day One. The owner’s extended or permanent absence will also involve decisions about credit facilities, family income, real estate, working capital, buy/sell agreements, licenses, cybersecurity, and the long-term disposition of the business.

We take a practical look at the issues of an owner’s absence from the business, whether it is planned or unplanned. Continuity planning is just one component of modeling “life after the business.” For the great majority of exit planning discussions, it is a useful but not urgent exercise. If a Continuity plan is needed, however, it may be the most important thing we’ve done for that client.

John F. Dini develops transition and succession strategies that allow business owners to exit their companies on their own schedule, with the proceeds they seek and complete control over the process. He takes a coaching approach to client engagements, focusing on helping owners of companies with $1M to $250M in revenue achieve both their desired lifestyles and legacies.