Asking the Right Question
What makes a business successful? In many small businesses, the owner is the principal driver, particularly from a technical and sales aspect. They are the ones running around, coordinating sales, staying late to ensure that products get made. They are the ones working the relationships with clients to ensure that the orders continue to come in.
With all that these individuals is doing, exit planners ask, “have they ever thought about what they want to do next?” Unfortunately, there is a good chance that one of the 5 D’s (Death, Divorce, Disability, Distress, and Disagreement) could affect their businesses. Let us hope that this does not happen. However, we all know what happens when we have hope on one hand and do something else on the other!
Consider this, a $10MM S-Corporation manufacturer, with a single owner. The owner’s best friend is diagnosed with cancer. Now the owner realizes that they want to sell their company because they want to spend more time with their kids and grandkids. Will this business be able to maximize value upon exit?
Three Areas of Focus
Most owners have the majority of their wealth tied into the business. One of the ways to get that wealth is to sell the company. A successful transition plan has three areas of focus:
1. Understanding and maximizing the value of the company
2. Understanding the owner’s future financial needs
3. Understanding what the owner wants to do after exit
The owner has an idea about one of those areas, but it is very vague. Working with owners to understand what they want to do upon exit helps with another area, the owner’s future financial needs. It is important to create a plan to understand how they want to spend their time with their grandkids. For example, the planner may ask, “Do you want to be able to pay for their future college needs, take them on nice vacations every year, or spend time skiing with them?”
Further understanding of what the owner wants to do next will help the financial planner develop an exit plan. They will be able to determine how much money that owner needs to achieve their desired lifestyle.
Once the future needs are determined, the owner can look at the current business value. The company should have a rough idea of business value. For example, it may be a function of EBITDA multiplied by a market multiple factors. While this seems simple, there are ways to improve the overall value of the company. Some of the factors may not be solely financially driven.
Succession Planning Starts With “What’s Next”
Developing a plan that addresses the owner’s exit ahead of time isn’t just good succession planning; it is good strategic business planning. By creating this plan, the owner can understand the context of what the company is worth. They will find ways to maximize business value and take into account their financial needs for the future. And finally, they can create a plan for how they will spend their time and lead to a successful exit from the company. As a result, the owner can enjoy their time instead of wondering, “Did I do something wrong? Could I have gotten more out of the sale? What am I going to do now?”
This article was first published on the Schneider Downs blog “Our Thoughts On.” John Kohler, CPA, CEPA has more than 15 years of experience in assisting clients in a variety of tax and accounting functions across numerous industries. He actively assists clients with business succession opportunities, helping them identify options for successful ownership transitions to families, third parties, and strategic partners.