Exit Planning Tools for Business Owners

Private Equity Reputation

 
We began this series by saying that Private Equity reputation is as the Great Satan to some, and a savior to others, depending on the personal experience of the speakers. In fact, both reputations are well deserved, but neither can be universally applied.

The “Great Satan” Private Equity Reputation


Man with a net chasing a gold coin walking on legsPEGs buy companies for the express purpose of improving their performance. That often comes with considerable pain for employees. A Searchfunder I know said recently “I’m looking at this acquisition because the owner thinks he is running an efficient company, where I see at least ten points that could be dropping to the bottom line.”

Efficiency is good, but too often it flies in the face of what made a company successful. In one example I recall, the PEG principals spoke to the assembled employees the day after closing on the business. They said “We bought this company for its culture and its people. Those are the most important assets to us.”

The cuts started coming the following Monday. Thanksgiving turkeys were “outdated.” Gone. All bonuses would be performance-based, so extra bonuses at Christmas would be discontinued. Season seats for the local sports franchise – gone. (Most of those went to customers.) Weekend overtime – gone. Schedules would be rearranged so that weekend workers were now scheduled for Saturdays and Sundays and got fewer hours during the week to make up for it.

Employee discounts on the company’s products – gone. Partial subsidies for family health insurance, well by now you are getting the gist. The flood of cuts was shocking and seemed unending. The flood of resignations started soon after.

By the way, the PEG missed its planned flip date (when they were supposed to sell to a bigger PEG) because of poor results and eventually took the company into Chapter 11.
I wish I could say that this type of result was unique, but it happens in far too many cases.

The “Savior” Private Equity Reputation


There is another reality. About 50% of all the privately held employers in the United States are Baby Boomers. The youngest of these are now turning 60. Many have built substantial enterprises whose value is far beyond what a younger entrepreneur can afford.

Private Equity has morphed into a many-headed creature, capable of acquiring almost any size business with value. It will never be for the mom-and-pop businesses that merely earn a living for the owner. As Doug Tatum says in No Man’s Land, they have grown to a level where they provide “wealth” to the owner equivalent to three salaries. Unfortunately, the owner must hold down three jobs for it to work.

But businesses with real cash flow, from a few hundred thousand dollars to a few hundred million, can find a tranche of PEGs who will consider their acquisition. Some specialize in minority ownership, or in funding the transition to a new generation of owners. Like it or not, these will be the saving of an entire generation who became successful by building a illiquid asset.

The latest estimate (from the Exit Planning Institute) is that these owners have $14 trillion dollars locked up in these illiquid assets – their companies. It that was an economy, it would be third in the world behind only the USA and China.

Reputation Counts


Many business owners are dazzled by the money a PEG has. With 17,000 of them out there, “We have money” is no longer as impressive as it once was. If a PEG comes calling, sellers (and their advisors) should carefully research their track record. If they lead with a guy “just like you” who owned a previous acquisition, be cautious. In most cases, he or she is compensated for adding to their portfolio.

Instead, talk to other owners who were acquired previously and are no longer active in the business. Look carefully into the acquirer’s experience in your industry. Unfortunately, “We have money” sometimes dazzles the PEG too. They begin to think financial manipulation is the only thing needed to make any business more successful.

Private Equity reputation is important. It will help you decide whether you should be discussing “show me the money” or “show me the future.”

 

 
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 Leverage

 
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

 
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

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

 

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