Exit Planning Tools for Business Owners

Building Value

Non-Qualified Plans

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When I talk to business owners about “non-qualified plans,” their first reaction is often “Hold on there. I don’t want to get in trouble!”

The term “Non-qualified” merely refers to the Employee Retirement Income Security Act of 1974, more commonly known as ERISA. As the title indicates, it is the basic set of regulations for retirement plans. If your company offers a 401K or SEP IRA, it has a Qualified Plan. If you have an Employee Stock Ownership Plan (ESOP), that is also an ERISA plan.

Under the terms of ERISA, a plan must be made available to all employees. In return, the company can deduct contributions as benefit expenses, and the employee can contribute pretax income to the plan.

A non-qualified plan doesn’t comply with ERISA requirements.  It is discriminatory in nature, meaning it is not offered equally to all employees. The employee cannot make contributions, and the employer usually can’t deduct the costs of funding the plan (which is built around future benefits,) as of current expenses.

Most non-qualified plans are designed as Deferred Compensation, thus the common acronym NQDC. The concept is to offer key employees a carrot for long-term retention. It can be enhanced retirement funding, insurance, or one of many forms of synthetic equity in the business.

Non-qualified Plan Types

We can start with the simplest example of NQDC. If an employee remains with the company until retirement, he or she will receive an additional year’s salary upon retiring. This benefit is not sequestered in a secure account anywhere, it’s just a promise by the company. It’s known as an “unfunded” benefit. There is no annual statement, just a guaranty (typically in writing,) by the business.

Non-qualified plansOften, an NQDC is funded by an insurance policy with a death benefit and an increasing cash value. It is owned by the company, which pays the premiums. At retirement, the employee receives the paid-up policy. This approach has the added benefit of lending confidence to the process, as the employee can see the funding and growth of the future benefit.

Synthetic equity may be stock options, phantom stock, or Stock Appreciation Rights (SARs.) In most forms, it is the right to future compensation based on any increased value of the business. For example, if the business is valued at $2,000,000 today, the employee may be given a contractual right to 10% of the difference in value at the time of retirement. If the company is worth $3,000,000 then, the employee would receive $100,000. ($3,000,000 minus $2,000,000 times 10%.)

Valuation, Vesting, and Forfeiture

Non-qualified plans based on equity should have a formula for valuing the benefit. It may be any financial measure such as revenue, pre-tax profit, or EBITDA. The objective is to make it clear to both parties how the benefit will be measured.

Vesting is an opportunity to be creative. The benefit can vest gradually, or all at once at a specific point in the future. An employee may be able to collect once fully vested or, in the case of synthetic equity, may have the right to “let it ride” for future growth if other conditions are met.

Regardless of how attractive a benefit may be, no employment relationship lasts forever. Pay special attention to how you construct acceleration and forfeiture clauses. Of course, no one wants to pay out to an employee who has been terminated for cause, but the employee deserves some protection against being let go just because a promised benefit has gotten too expensive.

Similarly, provisions for accelerated valuation in the case of a change in ownership are common. You also may want to consider rolling the NQDC into a stay bonus agreement if you sell the business. If there are options on actual stock involved, you will need to determine the handling of them if they could pass into the hands of someone other than the employee. That would be triggered by bankruptcy, divorce, or death.

Benefits of Non-Qualified Plans

As I described in my book Hunting in a Farmer’s World, incentives for employees should match their level of responsibility. Production workers have incentives based on their production. Managers have incentives based on their ability to manage.

Your very best people, the ones you want to stay with you through their entire careers, should be able to participate in the long-term results of their efforts for the company. Non-qualified plans are a way to single them out and emphasize your interest in sharing what you are building together.

As always. check with your tax advisor. Setting a plan up incorrectly could result in unwanted or phantom taxation for the company or the employee.

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.

Internal Leaders Affect the Value of Your Business

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Internal leaders may not be obvious. They may not even have a “leadership” title. Make no mistake, however; internal leaders are critical to value and attractiveness when it comes to selling your business.

In Super Bowl 55 we saw the impact of an internal leader. Tom Brady has the highest winning percentage of any single athlete in major professional sports. The Tampa Bay Buccaneers have (or at least did up until this season,) the worst win/loss record over their entire existence of any major professional sports team. Yet one man changed the culture of the organization almost overnight.

Remember, for all the accolades being heaped on Brady, he is an employee. He doesn’t own the Buccaneer enterprise or negotiates any contracts other than his own. He didn’t choose the team’s logo, uniforms, location, or coaches.

Tom Brady is paid to fill only one of 53 player positions in the organization. There are also 31 coaches on the team, whose jobs are to teach and give direction to those 53 players. Although every player will acknowledge that winning is a team effort, none will argue the impact of one strong internal leader on his 83 coworkers.

Internal leaders can be good or bad

When I was a very young business owner, I hired an experienced salesman. He was an alcoholic and began inviting other employees to his house for a cocktail after work. It took me some time (too long) to realize that he was plying his coworkers with free booze while he ranted daily about how poorly the company was being run.

I couldn’t understand why there was so much resentment among my team. They seemed to resist any direction I gave them. Finally, one person was kind enough to explain to me what was happening. Because this salesman was my top producer, I was afraid of the impact on revenues if I fired him.

He didn’t want my job. In fact, he didn’t want any of the responsibility that should go with leading. He had merely discovered one of the biggest truths about leadership. It’s easier to tear something down than build it up. People love to hear that things could be better. It’s making them better that is the tough part.

Tom Brady made the Tampa Bay Buccaneers better. Like any good internal leader, he didn’t limit his contribution to his job description as Quarterback. He helped recruit and train the people around him to build a better team.

Identify your internal leaders

An army dispatches its troops under the leadership of its lieutenants, but it succeeds on the ability of its sergeants. As a business owner, you can inspire with core values and set great goals. Whether you reach them, however, will be determined by your internal leaders.

When it comes time for your transition, they are more important than ever. If you are selling to family or employees, they may not expect to be included in equity, but they will determine the acceptance of those who are.

If you are selling to a third party, his or her achievements following the sale are conditional on the support of your internal leaders. They can prop up an inexperienced owner, or sink him without a trace.

If any part of your proceeds from exiting depend on the continued success of the business, you would be wise to identify your internal leaders and make some provision for their continued loyalty after you are gone. If they don’t buy-in, you could see the value of your enterprise (and your payout) decline substantially.

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.

Exit Planning and Marathon Runners

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“Eat well and exercise!”

Just about everyone over 30 has heard this advice from someone interested in our health, usually a doctor. We all know that we should begin by doing SOMETHING, yet we wind up not really doing anything. We know deep inside that if we want to live long and prosper, taking a few painful steps will have long-term pay-offs, but all too often those first few steps never happen.

What has this got to do with Exit planning?

Business owners know they should be taking steps to plan for the future, but all too often they don’t seem to get around to it. With each passing year comes the thought, “I’ll get to that.” But, like the good intentions for diet and exercise, the longer one waits, the harder it gets.

Exit Planners Help Businesses Get In Shape

Exit planners are a bit like personal trainers. What personal trainers do for fitness, exit planners do for businesses. They take a look at the shape a business is currently in, and develop plans to improve that business until it is in optimal condition, usually so that the business can be transferred or sold in such a way that the owner remains in control of the sale. A business in less than optimal condition often means that the owner will lose some of control of the sale to the whims of the buyer.

Dream Big

A middle-aged person who develops a dream to run a marathon soon finds that just reading about marathons is not enough to get in the race. Still, if they never dream the marathon dream the race has no chance of being run at all.

Business owners who intend to sell also should not hesitate to dream big, even if they do not plan to sell for five or ten years. Big dreams mean big accomplishments. Every business owner should dream big about two things:

1. The ultimate objectives (financial, personal, family, and/or philanthropic goals) for leaving the business.

2. The “transferable value,” of that business, which should ensure that the owner does not have to go with the business when it is sold.

Set Small, Achievable Goals

Like someday wanting to run a marathon, dreams are easy to write down, but need diligent daily work to achieve. They will not happen on their own. Whether you a baby boomer nearing retirement, in the middle of your career enjoying the excitement, or just at the very start of a venture, taking these simple steps will prepare you for the future:

1. Get help to develop a “workout plan.” Just as it can be helpful to get a personal trainer involved when you begin to exercise, the same is true for business planning. It’s a complex process that requires specific knowledge in certain areas (legal, financial, estate planning, human resources, etc.) to ensure your business gets in optimum shape.

2. Set simple goals – Simple goals when one begins exercising help to prevent accidental injury, and the same is true for exit planning. Three simple, easily achievable goals are:

     a. Determine how much money you need, or want, for retirement

     b. Decide when you want to leave your business

     c. Identify the person, or persons, to whom you want to transfer the business

3. Start slowly – you can’t rush getting into great physical conditioning, and you can’t rush the business planning process. Set realistic goals and act on them one by one.

4. Stay steady and consistent – sticking with the plan and taking small, consistent steps will pay off. Make time in your busy schedule to do the essential steps.

5. Measure progress – in order to ensure you’re making progress toward your goal you’ve got to measure it. Setting 90-day goals allows manageable progress and the ability to celebrate the small wins.

As you work hard in the business day-to-day, take the necessary time to prepare for tomorrow – starting your exit planning program now will maximize your quality of life in the future.

Invest 15 Minutes and take our FREE Exit Readiness Assessment. We do not request any confidential information.

Corby Megorden is a Principal at ENNIS Legacy Partners. The mission of ELP is to help business owners build value and exit on their own terms and conditions.

Wealth Management for Business Owners

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Wealth Management Considerations for Business Owners

Small business owners are at times neglected by the wealth management community as the business is commonly (not always) the owner’s largest asset rather than a portfolio of stocks, bonds, and mutual funds. You’d be well-advised as a business owner to engage a Financial Advisor who is proactive and experienced in factoring your future plans for the business, into your overall plan for managing your wealth.

 

Key Elements of Exit Planning

Impactful wealth management for you as a business owner would include at least these elements of exit planning:

  • Clarifying what “exit” means to you. For example, do you want to leave entirely at some point, or gradually over time?
  • Clarifying your financial, values-based, legacy goals, and what role the business needs to play in attaining your goals.
  • A financial needs and gap analysis with an accurate valuation (not back of the envelope – meaningful planning requires accurate data) of the business. How much $$$$ will you need to do everything you want to do after the business? Is there a financial gap? Will that gap need to be closed by increasing the value of the business?
  • Personal risk management including asset protection, insurance planning, tax planning.
  • A current estate plan — a business owner cannot do exit planning without doing estate planning.
  • A plan to preserve the value of the business (typically a small business owner’s largest asset), and a plan for it to survive during unexpected events of your permanent disability or death.
  • An appropriate plan for managing financial assets resulting from the successful sale or transfer of your business.

Exit planning is wealth management for business owners that requires assessing, preserving, and building the value of your largest and most complex asset…your business.

Invest 15 Minutes and take our FREE Exit Readiness Assessment. We do not request any confidential information.

Pat Ennis is the President of ENNIS Legacy Partners. The mission of ELP is to help business owners build value and exit on their own terms and conditions.

The Dismal Ds and Exit Planning

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The “Dismal Ds” is an inside joke in exit planning. Every industry and profession has them. In some, it’s “You can have it done well, done fast, or done cheaply. Pick any two.” In planning it’s “Sooner or later, every owner exits his or her business… 100% guaranteed.”

Clearly, that refers to the unplanned but inevitable departure from the biggest D – Death. That isn’t the only D, however. There are others, NONE of which lead to a controlled, lucrative, or enjoyable transition. Most start with dis- defined as “dis– 1. a Latin prefix meaning “apart,” “asunder,” “away,” “utterly,” or having a privative, negative, or reversing force.”

The other Dismal Ds include:

  • Disease – the critical illness of the owner or an irreplaceable employee.
  • Dissension – between partners, shareholders, or family members
  • Disaster – Fire, flood, storm, or accident
  • Disability – An owner’s inability to oversee operations
  • Disinterest – of the founder or next-generation ownership
  • Distraction – When an owner’s focus is elsewhere. (frequently love or bar ownership)
  • Disarray – More simply, bad management
  • Dishonor – financial fraud or other skulduggery
  • Disenchantment – A fancy word for burnout
  • Divorce – a bitter fight over the business asset or its value
  • Debt – Leverage taken on in good times but no longer sustainable
  • Depression – Economic malaise (think hospitality in 2020.)
  • Defection– The poaching or bolting of a key employee, frequently in sales
  • Defenestration – Getting thrown from a window

(Okay, I may have gone too far with that last one, but I couldn’t resist.)

Planning – The Cure for the Dismal Ds

The point is, there are many ways of a forced exit from your business due to circumstances. Some might be beyond your control, but most can be avoided.

  • Disease – Have solid business continuity instructions in place
  • Dissension – Start with a good buy/sell or shareholders’ agreement that makes it plain how disagreements will be handled
  • Disaster – Fire, flood, storm, or accidents can be insured, including for loss of revenue.
  • Disability – Business continuity instructions again
  • Disinterest – Start implementing an exit plan before your business shows the effect. For example, in brokerage, we used to say “Show me an owner who says he is burned out, and I’ll show you financial statements that evidenced the problem three years ago.”
  • Distraction – Don’t buy a bar. Don’t buy another business. Don’t have an affair.
  • Disarray – Get help. Consulting, coaching and peer groups all work.
  • Dishonor – Have an outside party check your systems and security.
  • Disenchantment – See Disinterest
  • Divorce – Settle the value of the business first, preferably before the lawyers do it for you.
  • Debt – Limit your debt to half what your current cash flow can service.
  • Depression – If you have to cut expenses, do so deeply and quickly.
  • Defection– Two words- employment agreements
  • Defenestration – Stay away from the Departed, or Irish, Italian, and Jewish mobsters in general. Alternatively, live where there are only low-rise buildings.

Dismal DsI obviously have my tongue firmly planted in cheek for this column, but my point should be clear. Your business is probably the most valuable asset in your life. Losing it to unplanned events hurts. So even if you are no longer in the picture, you have some responsibility to your family, employees and customers.

A good exit plan, whether it’s for implementation now or years down the road, should take many, if not all of the Dismal Ds into account. All entrepreneurs want control over their future. That is why they are entrepreneurs. Planning isn’t merely an intellectual exercise. It’s all about control.

John F. Dini, CExP, CEPA is an exit planning coach and the President of MPN Incorporated in San Antonio Texas. He is the author of Your Exit Map: Navigating the Boomer Bust, and two other books on business ownership. If you want to see how prepared you are for transition, take the 15-minute Assessment at MPNInc.com/ExitMap.