Exit Planning Tools for Business Owners

Exit Planning

Private Equity Leverage

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red coin purse full of golden coins surrounded by a silver toothed bear trapPrivate equity leverage can dramatically increase ROI, but it can also be a trap. In our previous article, we discussed the general structure of Private Equity, how it works, and the types of Private Equity Groups (PEGs). They have grown rapidly as an alternative investment that produces far better returns than Treasury Bills or publicly traded equities.

The Power of OPM (Other People’s Money)


How do they provide these enviable 18% to 25% returns on an investment? The simple answer is leverage. An example most business owners can easily comprehend is a real estate mortgage. You put down $100,000 on a $500,000 building. The mortgage, especially in the first few years, is largely interest expense. You lease the building for a rental rate that covers your mortgage payment and expenses. Two years later you sell the building for $700,000. How much did you make?

The obvious answer is $200,000, but what is your Return on Investment (ROI)? If you said 40% you’d technically be correct. You made a $200,000 profit on a $500,000 investment. But what was your cash-on-cash return?

That is 200%. You actually invested $100,000 of your own money and used the building to secure a loan for the rest. Your profit was $200,000 on a $100,000 investment.

Private Equity Leverage(Other People’s Money)


Extend this example to buying a business. The business makes about $2,000,000 a year. (For the sake of simplicity, we won’t discuss here the differences between cash flow and profit.) The agreed-upon acquisition price is $10,000,000, or five times the profits. The PEG contributes $2,000,000 as a downpayment and finances the remaining $8,000,000. The cash flow of the business must cover the loan payments and leave enough working capital for operations.

A 5% loan amortized over 20 years requires a payment of about $53,000 a month or $636,000 a year. The remaining cash flow ($1,364,000) produces a return of 68% annually on the purchase.

Of course, the Limited Partner investors don’t get all 68%. Some must be kept as working capital for expanding operations. The PEG receives substantial fees for creating the deal and overseeing the investment.

In fact, the 25% return to the investors is only part of the story. If the PEG can double the company to a $4,000,000 profit level, even the exact same 5x multiple on exit could produce a $20,000,000 sale, or an $18,000,000 return on the original $2,000,000 cash outlay. That’s a 900% ROI.

Leveraging the Leverage


Buying a middle-market business with the structure outlined above would be lucrative enough, but of course, as professionals, the PEG would like to maximize their return. They frequently cut expenses dramatically upon acquisition (more on this in the next article.)

Often, they will line up a secondary loan, using the company’s cash flow to reduce or eliminate their downpayment exposure.

Private equity leverageDuring the low-interest environment of the last decade, PEGs could negotiate even more favorable terms. If you replace the 5% loan with a 2.5% loan, the annual cost is reduced to $509,000 annually, leaving a 75% return to work with.

Traditionally, most of the loan terms in private equity purchases reset after a few years. Refinancing at 9% raises the loan cost to about $865,000. Still, a 57% ROI is acceptable, if the business is thriving and the other expenses are kept under control. If the cash flow is covering a secondary loan at an even higher rate to replace the downpayment, or it’s been pledged to cover other debt outside the business, the picture might not be as rosy.

 

 
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.

Private Equity and Privately Held Businesses

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Depending on who you are talking to, Private Equity is either the Great Satan or the savior of small and mid-market companies in the United States. The stories depend a lot on the personal experience of the speakers.

Once a vehicle for high-risk investment plays in corporate takeovers (see Bryan Burrough’s Barbarians at the Gate,) Private Equity has morphed into tranches where specialists seek opportunities in everything from a Main Street entrepreneurship to multi-billion-dollar entities.

What is Private Equity?

The term itself is relatively generic. According to Pitchbook, there are currently 17,000 Private Equity Groups (or PEGs) operating in the US. The accepted business model for our purposes is a limited partnership that raises money to invest in closely held companies. The purpose is plain. Well-run private businesses typically produce a better return on investment than publicly traded entities.

The current Price to Earnings (or PE – just to be a little more confusing) ratio of the S&P 500 is about 27.5. This is after a long bull market has raised stock prices considerably. The ratio is up 11.5% in the last year. That means the average stock currently returns 3.6% profit on its price. Of course, the profits are not usually distributed to the shareholders in their entirety.

Compare that to the 18% to 25% return many PEGs promise their investors. It’s easy to see why they are a favorite of high net worth individuals, hedge funds and family offices. As the Private Equity industry has matured and diversified, they have even drawn investment from the usually more conservative government and union pension funds.

Private Equity Types

Among those 17,000 PEGs the types range from those who have billions in “dry powder” (investable capital,) to some who claim to know of investors who would probably put money into a good deal if asked. Of course, which type of PEG you are dealing with is important information for an owner considering an offer.

private equity moneyThe “typical” PEG as most people know it has a fund for acquisitions. It may be their first, or it may be the latest of many funds they’ve raised. This fund invests in privately held businesses. Traditionally PEGs in the middle market space would only consider companies with a free cash flow of $1,000,000 or greater. That left a plethora of smaller businesses out of the game.

For a dozen years I’ve been writing about the pending flood of exiting Boomers faced with a lack of willing and able buyers. I should have known better. Business abhors a vacuum.

Searchfunders

Faced with an overabundance of sellers and a dearth of capable buyers, Private Equity spawned a new model to take advantage of the market, the Searchfunders. These are typically younger individuals, many of whom graduated from one of the “EBA” (Entrepreneurship By Acquisition) programs now offered by almost two dozen business schools.

These programs teach would-be entrepreneurs how to seek out capital, structure deals, and conduct due diligence. Some Searchfunders are “funded”, meaning they have investors putting up a stipend for their expenses. Others are “self-funded.” They find a deal, and then negotiate with investment funds to back them financially.

Both PEGs and Searchfunders seek “platform” companies, those that have experienced management or sufficiently strong operational systems to absorb “add-on” or “tuck-in” acquisitions. The costs of a transaction have bumped many seasoned PEGs into $2,000,000 and up as a cash flow requirement. Searchfunders have happily moved into the $500,000 to $2,000,000 market.

In the next article we’ll discuss how PEGs can promise returns that are far beyond the profitability of the businesses they buy.

 

 
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.

It’s Fall, or as Some Say, “Football Season” – How Succession and Exit Planning Mirror Winning the Big Game

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CEPA Info Graphic

Fall brings crisp air, colorful leaves, and the undeniable excitement of football season. And much like football, where great individual players exist, the game’s heart and soul lie in teamwork. No matter how talented a quarterback or running back is, they can’t win the game alone. Victory requires everyone—linemen, defense, special teams, and coaches—working together toward a shared goal.

Succession and exit planning for business owners are strikingly similar. Just as a quarterback can’t win without a strong team, an owner can’t craft a successful exit strategy solo. Many owners are so wrapped up in running their day-to-day operations that they never stop to think about their “end game.” And like a team without a playbook, they often delay these crucial conversations until it’s too late.

According to the first-ever “2024 State of Succession and Exit Planning in the Horticulture Industry” survey by PivotPoint Business Solutions, we’re seeing too many businesses fumble the ball. The data shows an alarming trend of closures and liquidations—avoidable with proper planning. Succession planning, like football, is a team sport, and many businesses are unprepared for the big win.

Ideally, business owners start with the end in mind. But the survey reveals that our readiness score as an industry is a mere 3 out of 10. Even worse, 32% of respondents don’t have an exit plan at all, and of those wanting to exit within two years, 55% haven’t started preparing. The message is clear: You can’t do it alone.

Building Your Winning Team

In football, every successful team needs coaches and players making the right moves to cross the goal line. For a business owner, your trusted advisors are your coaching staff, and they play an equally pivotal role in guiding you to a successful exit. Creating a well-structured exit plan that maximizes your business’s value can take 3-5 years, but with the right team, you’ll be prepared for anything—from an unexpected third-party offer to a forced exit due to unforeseen events like death, disability, divorce, business disagreements between owners, or business distress.

So, who are the key players on your exit planning team, and how do they help you score the winning touchdown?

Your Trusted Advisors: The Coaching Staff

Just like in football, you need a variety of coaches or experts working in harmony to achieve success. Here’s a breakdown of the key advisors every owner should have:

The Accountant (CPA):

Often the most trusted advisor, your accountant knows your financial history inside out. They ensure clean financials, which are crucial for any exit plan. Survey results show that 25% of respondents rely on their accountant the most.

The Attorney:

Your legal coach is critical in drafting key agreements like Shareholder and Buy-Sell for example, and reviewing any Letters of Intent or offers. With 17% of respondents citing their attorney as a top advisor, their role in securing the “game-winning” contracts and estate planning is indispensable.

The Financial Planner:

Only 12% of business owners look to their financial planner for guidance, but they should. Financial readiness is a key factor in your transition. In fact, 70% of owners are unsure of their after-tax income needs post-transition. Many owners face financial uncertainty, rating their financial readiness 58 out of 100, well below our target of 80. A financial planner helps you plan for retirement, ensuring you have enough resources to live comfortably once you exit.

Certified Exit Plan Advisor (CEPA):

Your CEPA is your quarterback who calls the plays in your business transition. This advisor coordinates all the moving parts, bringing together your personal, business, and financial goals to ensure a smooth exit. Shockingly, only 7% of survey respondents have a CEPA, but they are key to keeping your exit strategy on track.

Your CEPA leads the team through three critical phases:

  1. Discovery-Understanding your personal goals, business goals, and financial situation, including a business valuation.
  2. Preparation-Building value, mitigating risks, and setting up your financial future.
  3. Decision-Guiding you to confidently choose between growing or selling, with everything in place for a smooth transition.

Your Spouse is Not Your Trusted Exit Advisor

The survey found that many owners consider their spouse their most trusted advisor. While it’s wonderful to have that partnership in life, exit planning requires external, specialized guidance. Just as in football, where you likely wouldn’t ask a family member to coach the Super Bowl, you need objective advisors to give you the best shot at success. They will help manage the complex legal, financial, and operational components of your exit.

Your Internal Team: The Key Players

In football, even the best coaches need skilled players to execute the game plan. The same goes for your business. Your internal management team plays a critical role in driving the business forward. Luckily, 80% of survey respondents have already shared their plans with key team members. Regular communication with your team—whether family, employees, or potential successors—is essential to prevent misunderstandings and to align everyone on business goals and timelines.

Just as football teams develop a strategy for each play, you need a plan to retain these key players and keep your business running smoothly as you move toward your transition. Next month we’ll talk more about how to ensure you have the right people on your team and what it takes to retain these key players as you move down your path to victory.

Teamwork Makes the Dream Work

Only 33% of business owners are currently working with advisors to prepare for their exit. But just as no football team can win the Super Bowl with only one star player, you can’t craft an effective exit strategy alone. Exit planning is a team effort that requires insights from multiple stakeholders—advisors, management, and family members. Each brings expertise in a specific area, helping you navigate the transition successfully.

Ultimately, winning in business transition is like winning the big game—it takes teamwork, strategy, and preparation. With the right trusted advisors and players by your side, you’ll be well on your way to securing your business’s legacy and crossing that finish line victoriously.


Chris Cimaglio, CEPA®, Certified Value Builder™, Accredited Value Guide, PEMA® is the Managing Director at PivotPoint Business Solutions. Contact Chris at chris@pivotpointbizsolutions.com.

A Cash Balance Plan May be a Great Tax- Reducing Benefit to A Business Owner

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Like most business owners, you’re likely exploring ways to strategically grow your revenue, increase profits, and minimize taxes. This is a common goal. As your cash flows increase, you may find yourself seeking ways to reduce your growing tax burden. Often, we explore sensible capital expenditures or business reinvestments that align with your strategic goals, which is a healthy exercise.

Growing the Business, Graph on top if ipad with eyeglassesBut sometimes, business owners could benefit from strategies to accumulate personal assets and reduce taxes. Depending on specific criteria, a Cash Balance Plan could be a powerful tool to achieve this objective and significantly reduce your tax burden.

What is a Cash Balance Plan? It’s an ERISA-based hybrid plan, a unique blend of a Defined Benefit Plan and a Money Purchase Plan. To plan participants, it resembles a Defined Contribution Plan, like a 401(k), but the IRS treats it as a Defined Benefit Plan. This plan operates alongside your 401(k)/ Profit Sharing Plan, offering an additional tax-deferral strategy for accumulating retirement assets.

Cash Balance Plans are effective tax-qualified retirement funding vehicles designed to help business owners aggressively accumulate retirement assets. They are beneficial if they have fallen behind in their retirement savings goals.

Like a Money Purchase Plan, a Cash Balance Plan has fixed contributions for each participant each year. Additionally, plan participants receive interest credits based on the established interest rate defined in the plan. Often viewed as a feature of flexibility, an increase or a decrease in the value of the investments within the plan does not affect the benefits promised to the participants. Gains and losses from the plan’s investments reduce or increase the plan sponsors contributions. The employer oversees the risk/reward design of the investments with the assistance of a professional investment advisor. A portfolio is designed for reasonable and relatively stable long-term growth.

Here are some itemized potential benefits for the business owner:

  1. Significant tax savings. The funds contributed to the plan in the first year of implementation are tax-deductible and considered an ” above-the-line” deduction. Also, employees with high earnings may be able to accelerate their savings. Administration fees may be tax-deductible.
     
  2. Protection of assets from creditors. The Cash Balance Plan is a tax-qualified ERISA plan, so it is protected from creditors.
     
  3. The plan can help attract and retain valued employees. Many younger employees may find an employer-funded retirement plan attractive.
     
  4. Cash Balance Plans can help business owners accelerate their retirement savings. In 2024, the potential contribution to a Cash balance plan can be $376,000 (for participants aged 66 -70 and in a top income bracket). See the table below for contribution limits and potential tax savings.
     

Below is a table that illustrates the maximum contribution for a 401(k) based on age, along with the profit sharing and potential contribution of the Cash Balance Plan. The CB contribution is based on age and income.
Source: Cash Balance 101: FuturePlan by Ascensus

Assets in the plan are not allocated into separate accounts for the participants, and the participants cannot direct the investments within the plan. The investments and contributions are in a pooled fund managed by the Trustees.

One of the unique features of a Cash Balance Plan is its age-discriminatory aspect. The older the business owner, the more income they can allocate to the plan pre-tax. Conversely, the younger the other plan participants (employees), the lower the contribution requirements are to the sponsor (owner). This makes it ideal for a company where the owner is considerably older than the other plan participants, especially if the owner is in their 50s or older.

Another ideal scenario for a Cash Balance Plan is when the owner’s or potential income is significantly higher than the other employees. This income disparity is a key factor in the plan’s effectiveness and should be considered when evaluating its suitability for your business. Some requirements must be met. The CB plan can be implemented if the annual non-discrimination requirements are satisfied. At a minimum, a CB plan is required to cover 40% of employees or 50 employees, whichever is less.

Some owners look for ways to increase their cash flow to help fund a Cash Balance Plan, such as R&D Tax Credits, Employee Retention Credits, etc. However, these need to be vetted by a tax credit specialist, and current laws and eligibility must be followed carefully. But suppose the conditions are suitable for the owner. In that case, they are interested in saving on taxes and accelerating retirement savings, and it helps retain employees; it might make sense to perform an employee census-based analysis.

Steven Zeller is a Certified Business Exit Planner, Certified Financial Planner, Accredited Investment Fiduciary, and Co-Founder and President of Zeller Kern Wealth Advisors. He advises business owners with developing exit plans, increasing business value, employee retention, executive bonus plans, etc. He can be reached at szeller@zellerkern.com

Owning Change: Continuity Planning for Businesses in Ownership Transitions

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Ownership changes are critical moments in the life of any business. Whether due to the untimely death of an owner, the departure of a sole owner, or the exit of a co-owner in a multi-owner business, these transitions present unique challenges that require thoughtful planning. Effective continuity planning can help ensure that a business not only survives but thrives through these transitions.

Continuity Planning Following the Death of an Owner

The sudden death of an owner can be a devastating event for any business, particularly for small to medium-sized enterprises (SMEs). Without a well-thought-out continuity plan, the business may face significant disruption, which could lead to operational paralysis, loss of key clients, and eventual closure. A few key considerations for this scenario include:

Succession Planning: One of the most critical components of a continuity plan in this scenario is a detailed succession plan. This plan should identify who will take over the owner’s responsibilities and how the transition will occur.

Business Continuity Instructions (BCI): BCIs provide the deceased owner’s family and key employees with a roadmap for managing the business in the immediate aftermath of the owner’s death. These instructions should include contact information for trusted advisors, detailed plans for continuing operations, and clear guidance on the eventual transfer of ownership.

Financial Considerations: Life insurance policies can provide the necessary funds to maintain operations, pay off debts, and support the transition to new ownership. These funds can also be used to finance a Stay Bonus Plan to retain key employees during the transition.

Continuity Planning for Owner Departure in a Sole Proprietorship

In sole proprietorships, the departure of the owner, whether due to retirement, sale of the business, or other reasons, poses a significant challenge. Unlike multi-owner businesses, there is no one to automatically take over, making advance planning crucial. Important steps in this scenario include:

Identifying a Successor: For sole proprietors, it’s vital to identify and prepare a successor well before departure. This could be a family member, a key employee, or an external buyer. The process of grooming a successor should involve training and gradually increasing their responsibilities to ensure they are ready to take over when the time comes.

Business Valuation: Regular business valuation is essential to ensure that the owner receives fair compensation upon exiting the business. An accurate valuation also helps potential successors or buyers understand the financial health of the business and its growth prospects.

Transition Planning: A comprehensive transition plan should outline the steps for transferring ownership, including legal and financial considerations. This plan should be shared with all stakeholders to ensure a smooth handover and to minimize disruption to business operations.

Continuity Planning for Departure of One Owner in a Co-Owned Business

In businesses with multiple owners, the departure of one owner can create tension and uncertainty, particularly if the remaining owners are unprepared. A well-drafted Buy-Sell Agreement is essential in these situations to govern the transition and ensure fairness to all parties.

Buy-Sell Agreement: This agreement should clearly define the terms under which an owner can exit the business, including how their share will be valued and purchased by the remaining owners. The agreement should also outline the payment terms and any financing arrangements necessary to complete the buyout.

Valuation Methods: The Buy-Sell Agreement should specify an independent and fair valuation method for the departing owner’s share of the business. This helps prevent disputes and ensures that the process is transparent and equitable.

Impact on Business Operations: The departure of a co-owner may require a reassessment of the business’s strategic direction, particularly if the departing owner played a significant role in decision-making. It’s important for the remaining owners to communicate clearly with employees, clients, and other stakeholders to maintain confidence and stability during the transition.

Common Considerations

While each ownership transition scenario presents unique challenges, several common themes emerge:

Proactive Planning: Whether dealing with the death of an owner, the departure of a sole proprietor, or the exit of a co-owner, proactive planning is crucial. Waiting until a crisis occurs can lead to hasty decisions that may jeopardize the future of the business.

Legal and Financial Preparedness: In all scenarios, having the right legal and financial structures in place—such as succession plans, Buy-Sell Agreements, and life insurance policies—can mitigate risks and ensure a smoother transition.

Communication: Clear and consistent communication with all stakeholders is vital. Whether it’s sharing Business Continuity Instructions with family members or discussing the terms of a Buy-Sell Agreement with co-owners, transparency helps prevent misunderstandings and builds trust.

Ownership transitions are inevitable, but with the right continuity planning, businesses can navigate these changes successfully. By understanding the unique challenges of each scenario and taking proactive steps to address them, business owners and financial managers can ensure that their companies remain resilient and poised for continued success. Contact an exit planning consultant to develop a continuity plan that works for your individual business needs.

 

David Jean is the Director of Altus Exit Strategies and a Principal at Albin, Randall & Bennett, where he is also the Practice Leader of the Succession Planning, Business Advisory, and Construction & Real Estate Services Teams. David works with business owners who want to improve their business’s value before they sell through the Seven-Step Exit Planning Preparation™ process. He has worked with companies from $5 million to $50 million in revenue across a range of industries. He can be reached at djean@arbcpa.com.