Exit Planning Tools for Business Owners

Building Value

“Work From Anywhere” Comes Full Circle

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Work from anywhere has been a necessity, an epithet, an obstacle, and an opportunity over the last 3 years. To paraphrase Aristotle’s axiom about Nature (“Horror Vacui”), business abhors a vacuum. Where one occurs, it is quickly filled.

Work from anywhere started as a COVID-induced necessity. During the lockdowns of 2020-2021 (and longer in some places) we all had a crash course in video calling, VPNs, and virtual meetings.

Employees quickly expanded the definition of anywhere. They tired of shunting the children off to a bedroom during conference calls, or using office-like backdrops to hide their kitchen cabinets. Soon they began changing their backgrounds to something more aspirational, like a mountain cabin or a scenic lake.

From there it wasn’t much of a leap to make the mental shift from a make-believe environment to a physical one. Pretty soon employees were calling in from real mountain cabins. In many cases, they shifted to someplace where the cost of living was much lower than in their former metropolitan workspace.

Work from Anywhere as an epithet and an obstacle

As employees moved further afield from their office environment, bosses began to sound off. “We aren’t going to pay Los Angeles wages to someone who has a Boise cost of living,” was a commonly heard complaint.  Most put up with it because qualified help was getting harder to find. Hiring remotely was too hard a new skill to master.

The complaints of employers grew louder as they began to ask employees to return to their former location of working activity. They made arguments about deteriorating corporate culture or a lack of mentoring opportunities.

At the same time, stories surfaced about workers who were getting full-time paychecks from multiple employers, or who were “quiet quitting” by doing as little as possible. The “Great Resignation” forced many organizations to put up with it. If you wanted to keep employees, you needed to accommodate their demands.

Then the work-from-anywhere poaching started. If an employee could do the job from a thousand miles away, why not just hire people from a thousand miles away? Now recruiters could dangle Los Angeles wages at candidates from Boise. Many employers saw work from anywhere as a curse costing them their best talent.

Work from Anywhere as an Opportunity

But as I said at the outset, business abhors a vacuum. Every action has a reaction. When the job can be done from anywhere, does that mean anywhere?

work from anywhereIf the higher cost of living centers can fill their needs by hiring people who are accustomed to earning less, why shouldn’t employers look at those candidates before the local talent? The Internet allows almost-instant communication across countries, what about across oceans?

In the last few months, I’ve worked with employers who are hiring accountants in India, staffing recruiters in the Philippines, programmers in Argentina, support techs in Colombia, and screening nurses in Nicaragua.  None of these employers are multinationals. Each one fits the SBA’s definition of a small business.

Their new employees are educated, English speaking, have the same hours as the employer, and are thrilled for the opportunity. Some are hired directly through a local placement agency. Others work for an organization in their home country that makes them exclusive to the client and promises to replace them if needed.

Most of the wages appear to be about 50% more than the same job would pay in the country of residence, and roughly half of what the position in the U.S. would cost.

Business has once again filled a vacuum. I wonder what is next?
 
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.

Key Employees: Build and Protect Business Value

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Businessman and business Woman Holding key

Key Employees

You may have people working in key roles who are instrumental in growing and building the value of your business. These key people can be identified as having the following characteristics:

  • Makes a substantial business contribution
  • Possesses critical information or knowledge
  • Maintains and nourishes key contacts and relationships

Sellable Business

In helping clients plan to build a sellable business, and then eventually exit on their terms and conditions, we emphasize that “key people are a key value driver” in realizing success in both of those strategic goals. And, we find it helpful for owners to have two categories in mind when considering key employees:

  • Building business value
  • Protecting business value

Key people help owners build value and exit successfully as their roles serve in removing the owner(s) from the day-to-day management of the business, and by accomplishing objectives and key results for growing the business, that is aligned with the exit goals of the owner(s). An important planning focus for the owner(s) in building value, as it pertains to key employees, would include alignment of the employee’s performance goals with the exit goals of the owner(s), and a well-defined key employee incentive plan that provides impactful awards for goal attainment and retention.

Owners Beware

Owners need to be aware, that there is also inherent risk related to key employees. Risks involving departure and competition, solicitation of customers and/or employees, and disclosure of confidential information. There is also the risk of losing a key employee due to unexpected death or disability. It can be costly to recruit, train, and compensate for a replacement in such a situation, as well as make up for any loss in corporate earnings. Important planning areas in protecting business value, as it pertains to key employees, would include: Well-written and regularly reviewed employee documents (i.e., Employment Agreement; (listen to ExitReadiness® PODCAST Episode 43 w/attorney Marc Engel) and adequate life insurance coverage on the key employee (listen to ExitReadiness® PODCAST 54 w/Bill Betz of Betz Financial Advisory).

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.

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.