Exit Planning Tools for Business Owners

Exit Options

Exit Planning: Controlling Your Choices

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Many owners are reluctant to plan for their departure from the business. In some cases it’s because they are too comfortable with ambiguity (see my previous post.) For others it is because they fear losing control. They believe that setting a final date for their departure, even tentatively, starts a process that will take on a life of its own.

The tag line of this column is “Control the most important financial event of your life.” Control is the key. Refusing to deal with the realities of an eventual transition from the business is surrendering control. Sooner or later, something will happen that requires a transfer of the business. Then it is too late to exercise the options you have now.

Exit planning three, five or ten years before your anticipated transition gives you a clearer picture of the direction your company needs to take if it is going to serve your personal objectives.

All business owners want to grow their companies, make more money and work a bit less, but few things are more disappointing than finding out that the work you put in won’t result in the outcome you expected.

What if you work yourself to the point of exhaustion, only to find that you are too critical to the company’s success for anyone else to buy it without tying you into a long term employment agreement? What if you rapidly grow your revenues, but discover that your margins are too thin to attract a decent acquirer? What if you build a great management team, but they leave to start a competing business? What if you invest in new equipment  that looks great, but doesn’t add to the value of your company?

Understanding Your Choices

All these things would be addressed in a comprehensive exit plan. It’s not only about your life after the business, it’s about the life of the business after you. Exit planning requires that you look at your company through both the eyes of both a seller and of a buyer.

As a seller, you have certain goals for what you would accept as a successful exit. Usually those are financial, but other factors sometimes count for even more than the sale price. What future do you envision for your employees and customers following the sale? Is the company’s reputation, or it’s contribution to the community important to you? Answering these questions could have an impact on the type of buyer you will consider.

What are the intangible assets of your business? Are your employees able to make good business decisions without your oversight? Do they dependably execute their roles according to documented processes with consistently high levels of quality? The ability to duplicate your success is the single most important factor in a buyer’s calculation of value.

How sticky would your company’s relationship with key employees be in your absence? Are they committed to the company because of a sense of ownership, actual ownership, or long-term incentives? If their only tie is personal loyalty to you, the value proposition to a buyer is a lot riskier.

Controlling Your Choices

All these questions should be part of your planning. Yet most owners don’t ask them until they are on the brink of retiring. That is a mistake. Knowing what you want to accomplish, or in other words – where your finish line is, is critical to building your business in the right way, in the right direction.

Having an exit plan doesn’t mean that you have to implement it on a specific date. You can choose “wait and watch” from the options outlined in this short video on the Five Roads to a Business Exit.

If you know your destination, your choice of a pathway becomes much easier.

Ambiguity Kills Value

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Ambiguity kills value. That was a key point in a white paper from Orange Kiwi that I read over the holidays. Taken from the PhD thesis of Dr. Allie Taylor, the paper describes the psychological profile of  entrepreneurs, and their historical reluctance to begin an exit planning process.

According to Dr. Taylor, entrepreneurs have five major behavioral traits; Risk Taking, Innovativeness, Need for Achievement, tolerance for Ambiguity and a locus for Control. This follows closely my description of the mind of an entrepreneur in Hunting in a Farmer’s World. In that book I discuss the traits of tenacious problem solving and the ability to navigate in the fog.

Ambiguity and Dopamine

That ability to choose a path where others don’t see a way forward is key to a business owner’s ability to stomach risk. What Dr. Taylor points out, however, is that some owners fall in love with their own tolerance for ambiguity. As Simon Sinek points out in Leaders Eat Last (and I also discuss in Hunting,) problem solving provides an owner with a little shot of Dopamine dozens, or even scores of times daily.

Dopamine is the same neurotransmitter that drives substance abuse. In very real terms, an owner’s need for regular dopamine titillations can make decision making addictive. Anticipating a life without the business can subconsciously create a fear of life without the business.  

That’s why owners are reluctant to discuss exit planning. Despite the obvious wisdom of controlling the most important financial event of a lifetime, the personal void that lies beyond ownership is scary. As with many other potentially unpleasant things, from going to the dentist to funeral prearrangements, it’s easy to deal with it…later.

Ambiguity Kills Value

The problem with embracing ambiguity too much is that it can damage your business. Management by firefighting is costly. As Abraham Lincoln said, “If I had eight hours to cut down a tree, I’d spend seven of those sharpening my saw,” Fixing problems almost always costs more than preventing them. Dealing with distractions reduces the time you have available for selling, creating or teaching.

Avoiding the uncomfortable task of exit planning leaves you much more likely to deal with it in response to one of the Dismal D’s. (Death, Disease, Disability, Divorce, Declining sales, Dissention among owners, Debt, Distraction, Disaster or Disinterest.) That’s when the value of your most important asset, a thriving business, starts to plummet.

We all like a bit of ambiguity. Our decision making abilities are what makes us successful owners. Exit planning should be a process of gathering information about your possible decisions, not a ticking clock controlling your future.

Embracing Your Options

Whether you plan to eventually sell your business to a third party, pass it on to family or create a transfer to employees, you still want to assess your financial performance compared to industry standards. Your management team needs to be able to run the company without you. Your processes should be well documented. Most importantly, you should be thinking about what you will do when those hits of decision-making dopamine stop coming.

Once you have the components in place, you can control the timing, proceeds and method of your transition. Until then, you are just waiting for ambiguity to bite you in the butt.

How prepared are you? Take the ExitMap® preparedness Assessment at www.YourExitMap.com

Succession Planning – Ownership Lessons

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When selling your business to employees or family, ownership lessons rise to a special level of importance. Regardless of the financial, inheritance, estate or valuation aspects of the plan, the real question is how to prepare your successors to run the company.

I’ve written before about the Luxury of No Resources. When you started out, making mistakes was part of your business education. The company was small, so the mistakes were small. Now you’ve built a substantial enterprise, and your successors can’t afford to learn by trial and error. (Especially if you are depending on them to be successful enough to pay you for the business!)

Experience is what you get when you don’t get what you want. We  learn very little from our successes. (“Hey, it worked! I guess I’m just brilliant.”) We learn a lot more from our failures. (“I sure as hell won’t let THAT happen again.”)

Trial by Fire

For many founders, business started off well because they had customers lined up and some reputation in their field. Their real learning experience came when a large customer defected to a competitor, or there was a recession, or a key employee quit. That’s when we learn fast how to pay attention to the numbers and solve problems on the cheap.

So how do you prepare new ownership without having them go through the same trials by fire? Here are a few suggestions.

  • Segregate a department or division as a profit center. Make the manager in charge prepare a budget, generate independent financial statements and take on all of the HR responsibilities.
  • Use history to teach. Take a past bid, order, customer or product for which you already know that there was a bad outcome. Have the employee make the decision again, and use the historical experience to discuss together whether it would turn out better or worse with the employee’s decisions.
  • Tie one hand behind their back. Task them to train a group of new people, but without your training manager’s help. Have them open a new territory without your marketing department. Help them to understand that the resources you provide may not always be there.

Of course, you will still be there to head off mission-critical errors. Letting them fail with limits on the damage, however, will render ownership lessons that prepare them for when you aren’t there.

 

Transition Tribulations

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This article in Financier Worldwide of the United Kingdom quotes me extensively. I thought you might like to see it. (My spellings were changed to British standard.)

Transition tribulations: exiting a family-owned business

by Fraser Tennant

When the owner of a family business decides to call it a day in order to enjoy the fruits of his or her labour, the transfer of ownership can be a challenging process. What is more, in the US in particular, transitions of this nature are becoming ever more common.

Indeed, as highlighted in JC Jones and Associates LLC’s white paper, ‘Exit Planning for the Family Owned Business Owner’, more than 70 percent of privately owned businesses in the US will change hands in the next 20 years. At an estimated $10 trillion, it is the largest intergenerational transfer of wealth in history.

In terms of today’s retirement-minded family business owners, what is required is a well-conceived exit plan, one that sets clear and realistic objectives. “An exit plan is a strategic process detailing the financial, operational, management and ownership changes that will take place as leadership is transitioned,” states the report. “A well-thought-out plan is required to meet the personal goals and timeframes of owners and to monetise their business.”

Myriad issues

When the decision to depart a business is taken, there are myriad exit or succession planning (the primary emphasis of which is family) strategies to be considered and a multitude of questions to be answered. What will happen to the business when the owner moves on? Should the business be sold? Will the owner’s children want to carry on with the business, and, if so, is there a successor ready to assume the leadership? How can a maximum return from the business be ensured? These are just some of the key issues.

In many instances, a family business owner may have no choice but to pursue exit rather than succession, as there is no next-generation family member ready, willing or able to take the helm. That said, for those owners who do have the option of transferring ownership elsewhere in the family, statistics are not encouraging.

Stephen Pascarella, owner of Pascarella and Gill, PC, notes that less than one-third of family-owned businesses survive the transition from first generation ownership to second. According to Mr Pascarella, three main challenges are likely to arise. First, transferring when parents are not financially ready. This is a premature move which could be devastating to retirement planning and financial security, as retirement funding may draw from the business, impeding possible growth. Second, transferring to children who do not know how to run a business. Many business owners forget that new owners, most often their children, must possess the skills to run a business. Finally, attempting to give everyone equal shares. When multiple family members are involved, dividing a business equally may not be in the owner’s best interests. For business owners, it is crucial to remember that management and ownership are two separate issues.

Exit and succession strategies

When a business owner decides to make an exit and there are children employed in the business, a layer of complexity is added to the planning process. According to John Dini, president of MPN Inc, in this scenario there are three relationships between family members at work.

First, there is the blood relationship between parent and child. Second, there is the management relationship, not only where a child reports to a parent but when a child is, at least nominally, in charge of siblings or even the children of siblings. Third, there are the ownership relationships. Does ownership pass according to the blood relationship or in proportion to the management responsibility? Are children who are not working in the business included in ownership? What rights do they have to determine the course of the business? In today’s extended families, where these questions frequently encompass step-children and in-laws, it is a complicated business.

“A family successor should be ready, willing and able to run the company,” says Mr Dini. “However, if he or she is not, all may not be lost. There are a number of succession plans where employees who are key to successful operations are included in ownership or otherwise financially motivated to spend a lifetime within the business. There are numerous incentive plans, including stock appreciation rights, phantom equity or other forms of deferred remuneration that can compensate a critical employee based on company value, without actually issuing ownership.”

For Nadine Kammerlander, professor of family business at WHU – Otto Beisheim School of Management, the main challenge is to find the ‘right’ next owner and at the right time. “Family business owners often start thinking about their exit at too late a juncture and often have unrealistic expectations,” she suggests. “Moreover, they often underestimate the difficulties of finding an individual to take over a firm, overestimate the future potential of the firm as well as its value due to emotional attachment, neglect legal, regulatory or tax issues that might impede the sale, and can be reluctant to cede control.”

Whether it is a matter of unrealistic expectation, misplaced emotion or wasteful procrastination, the likely outcome is that the sale will not proceed as smoothly as intended, with the business owner forced to restart the process more than once. “When considering suitable strategies, family business owners first need to decide whether they want to pass on ownership and management to the same individuals or split them, for instance by giving the ownership shares to the children and hiring an external chief executive.”

In terms of selling the business, a family owner has several choices, such as bequeathing to a family member, an employee via management-buy-out (MBO), another individual previously unconnected with the firm, via management-buy-in (MBI), or a competitor. “These strategies vary across the dimensions of sales price, professional management and continuance of firm tradition,” adds Ms Kammerlander.

Valuation

When it comes to assessing the value of a business there are a number of options to ensure valuation reflects both current worth and future potential. How this valuation is determined very much depends on the type of exit strategy the owner has chosen to pursue.

“While selling a business to a competitor will probably generate the highest value, it may lead to a loss of more than 25 percent of the business proceeds due to taxes and advisory fees,” says Mr Pascarella. “External transfers, such as a sale to a competitor or private equity group recapitalisation, use synergy value and investment value. In contrast, internal transfers, such as an employee stock ownership plan (ESOP) or gift or sale to family, use fair market value where discounts may apply.”

Choosing the exit option most conducive to maximising value is, therefore, critical, as is obtaining well-qualified and experienced assistance. “A qualified valuation professional will consider both historical and projected value,” affirms Mr Dini. “But in a family transfer other considerations often take precedence over fair market pricing. What are the retirement needs of the parents? Is the estate being ‘balanced’ between children active in the business and those who are not? Is stock being transferred via a more arms-length sale process? And is the focus more on tax-reduction strategies, such as gifting or trusts?”

The worth of a valuation expert is clear, but caution should be exercised when securing a specialist. “Given the importance and complexity of the process, experience and support is required,” agrees Ms Kammerlander. “However, there are a large number of so-called advisers that may lack the required competencies, experience and attitude. A careful selection is needed.”

Another issue is that owner-managed firms often lack proper documentation. “Such a lack of transparency makes it difficult for outsiders to recognise the real value of a firm and might lead to a lower-than-desired sale price,” adds Ms Kammerlander.

Reaping rewards

With the sale of a family business often the culmination of a lifetime’s work, departing owners want to make the right choices, avoid missteps, keep regret to a minimum, and reap the rewards of years of endeavour.

“Sometimes a business has served its purpose,” says Mr Dini. “If all the children have moved on and are successful in other pursuits, then the company should be sold to a third party. “Few owners are more unhappy than those forced to return to a family business out of a sense of obligation to their parents, regardless of any related financial success. Their misery might be exceeded only by those who spent a lifetime in the company, only to see it sold to strangers because parents thought it was the only way to monetise the fruits of their labour.”

It is important for owners to consider both financial and non-financial issues. As regards the former, owners need to start thinking about the manner of their exit sooner rather than later. The more time dedicated to the search for the ‘perfect’ successor, the more likely that search will be successful.

In terms of non-financial considerations, the owner needs to reflect upon his or her goals before entering the exit process. What is most important? Is it the sale price? Is it the continuation of the businesses’ name? “A clear answer to such questions helps the exiting owner to achieve a satisfactory solution,” believes Ms Kammerlander. “Communication with family and other stakeholders is also crucial. If a family business owner sells, unaware that his or her children were interested in taking over, there is a high potential for ongoing family conflicts.”

To make the transition from business owner to retiree as smooth as possible, Mr Pascarella’s advice is to follow a five-step process: (i) establish exit goals; (ii) measure financial and mental readiness; (iii) learn and choose the optimal exit option; (iv) understand the business value of the option chosen; and (v) execute the exit strategy plan to achieve exit goals.

Complex and emotional

Exiting a family business is clearly a complex and emotional undertaking – a process requiring careful advance planning and much resolve, especially when the business is the largest single asset in an estate.

Moreover, once the decision to depart has been taken, there should be no procrastination. “This can lead to disaster with a great deal of vicious, internecine squabbling,” warns Mr Dini. “If an owner wants his or her children to remain on speaking terms, they owe it to them to discuss and define what will happen as the business passes, or not, to the next generation.”

Ultimately though, family business owners want to harbour no regrets over the decisions they make when the time comes for them to pass over the reins and transition to the next stage of their lives.

© Financier Worldwide

Your Transition Advisor Team

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Nothing impacts the success of your business transition more than the advisor team. Let’s say you receive a free pass to play in the Super Bowl. You will be playing against the New England Patriots, but you can choose any NFL player not on their roster for your team. Who would you pick?

There are a multitude of opinions about who is the best quarterback, wide receiver or free safety. One thing is pretty certain. You wouldn’t choose the guys you grew up playing touch football with. At least, not if you wanted to win.

Owners feel loyalty to the trusted advisors they already have relationships with. “He’s the attorney who handles all my legal problems,” is a bit like saying “He’s the doctor I always go to when I feel sick.” That is fine, but what if you needed a heart transplant?

Professionals are Specialists

All physicians went to medical school. In residency, they took rotations in surgery, obstetrics, pediatrics and infectious diseases. That doesn’t mean that twenty years down the road you want someone delivering your newborn child unless he’s practiced it a lot.

Just as there are many physicians, there are many attorneys and CPAs. They all have some training in all aspects of law or accounting. It is required to pass the bar or to get certified. But if your attorney spent the last twenty years doing real estate closings, or your CPA spends most of his time preparing tax returns, he or she may not be the right advisor for the biggest financial transaction of your life.

Business transitions aren’t simple. Even the asset sale of a small business has tax pitfalls that can easily trap those who don’t know what to look for. I recently heard a story about an owner who sold the stock of his company. He was ecstatic about getting the lower capital gains tax rate, and put that money aside for when he filed his return.

Unfortunately, neither his attorney nor his CPA thought to include a prohibition against the buyer declaring a Section 338 (h) 10 election. While not common, it allows a buyer to recast the transaction as an asset purchase. The seller has little say in the matter. Over a year after the closing the seller saw his capital gains turned largely into ordinary income. At that time, it meant a tax bite for about 20% more of his proceeds.

Choosing an Advisor Team isn’t Disloyal

Your traditional CPA can continue to do your tax returns. Your traditional attorney can still take care of your normal business and personal legal needs. For a transaction, however, you want someone who deals with the sale and transfer of companies on a very regular basis.

Unfortunately, some practitioners are insecure. They are afraid if another  professional is called in they will lose a long-time client. Their usual claim is something like “I haven’t done many (or any) of those, but they are pretty straightforward. I’m sure I can handle it.”

Those who are more confident in your relationship, or more successful in their specialty, will say “I don’t do enough of those to be fully confident of doing the best job for you. Let me recommend someone who has more expertise than me.”

The other issue is often cost. I’m regularly dismayed when I ask why someone uses a particular professional, and the owner answers “Because he’s cheap.”  Would you pick a physician using that criteria? Good help costs money.

Selling your company is your financial Super Bowl. You want to put together the best advisor team possible for that one game. Afterwards, you can go have a beer with your buddy from the sandlot. You’ll still be friends, and he will (or should) understand.