Exit Planning Tools for Business Owners

Baby Boomers

What the Heck is Exit Planning?

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The wave of Baby Boomer retirements is beginning. I’ve been writing and speaking about exit planning nationally for the last ten years, (you can download my free eBook on the subject here), but the inevitability of the demographics is gaining momentum.

Today, Boomers in their late 60s are starting to sell the businesses they’ve built over the last 30 years or so. They are just the tip of the iceberg. Millions more are steadily approaching their career finish lines at a rate of hundreds every day.

Exit Planning is a new discipline, developed to meet a massive market need. Unfortunately, like any new service offering, there are a lot of people who use the term without fully understanding it, or in hopes that it will associate them with a growing field of professional practice.

Accountants say they do exit planning when they help clients structure their business and personal holdings to minimize the bite of the IRS.

Estate attorneys say they do exit planning when they protect assets and document transfers of inheritances.

Wealth managers say they do exit planning when they provide retirement projections and validate lifestyle assumptions.

Consultants say they do exit planning when they recommend ways to increase the value of the business, presumably maximizing the proceeds from a sale.

Business brokers say they do exit planning when they value and list a company for acquisition.

Insurance brokers say they do exit planning when they write policies to protect owners, their families  and their companies against premature departures, or the absence of key employees.

Which of these professionals really do exit planning? There are two answers:

  1. All of them
  2. None of them

Exit Planning Map MazeExit planning is the process of developing a business owner’s strategy for what may be the biggest financial transaction of his or her life…the transfer of the business. That strategy may be a succession to the next generation of family. It could be a sale to employees. It may be a sale to another entrepreneur, or acquisition by a larger company. In some cases, it could require an orderly dissolution.

In every case, it involves tax, legal, financial, operational and risk management expertise. No one practitioner (including me) has all the knowledge required for every aspect of the plan. Exit planning, in the true sense of the word, is coordinating all those skills so that they work together for a single objective.

Let’s say, for example, you run a warehouse with delivery services. You decide to make it as efficient as possible.

  • You tell the purchasing manager to only order product when pricing and inbound freight are the least expensive.
  • You tell the warehouse manager to develop a system for picking orders with methods that require the least amount of labor.
  • You tell the shipping department to pack up orders using the least possible amount of material.
  • You tell the dispatcher to plan routes for times with the least traffic and the lowest fuel use.
  • You tell the sales department to promise the customer anything that will close the sale.

Now, without letting any of these people talk to each other, you announce that tomorrow you are implementing all their results simultaneously. You go home dreaming about how amazingly profitable your business is about to become.

You don’t have to be a distribution expert to know what is going to happen. The uncoordinated plans are going to explode when combined. You’ve just come up with a great way to go out of business.

Now, what if you told one manager that your overall goal is to sell more product and give excellent service, so customers would become loyal buyers and the company will increase revenues and profits?  Then you had the other managers report to him, so that all of their plans would compliment the overall objective.

That’s what an exit planner does.

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What is the Right Price?

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Of all the misconceptions by business owners, the ones surrounding their company’s value are both the most common and often wildly inaccurate.

I’ve been working for the last couple of months on the training videos for advisors in our new product, The ExitMap®. (You can take the assessment for free at www.myexitmap.com). In one session, we role-play a vignette about a financial planner discussing the value of a business with a client planning retirement. Part of it goes something like this.

Q: “So Bob, how much do you expect to realize from your business when you sell it?”

A: “I’ve heard from my accountant that most small businesses sell for about five times earnings.”

Q: “And how much would that be?”

A: “Well, I made about $150,000 in salary last year, and another $200,000 in profit. Add in my insurance policies and my car, my wife’s car and a few trips that combined business and pleasure. Say around $500,000 in total benefits. So I’d expect to get somewhere around $2,500,000 for the business.

Q: “What would that be after taxes?”

A: “I’d have to pay capital gains, so I’ll net in the area of $2 million.”

Simple, right? Let’s look at the reality.

abacusBob is calculating what the brokerage industry calls “Seller’s Discretionary Benefits” or SDE. While it is a legitimate way to look at the full value of business ownership, ball park valuations of 4-5 times pre-tax earnings don’t apply to that calculation. Cash flow expensed for benefits (rather than dropping to a taxable bottom line), isn’t included in those earnings multiples. The traditional multiple for a small business sale averages 2.5 time SDE, or half of what Bob is estimating. We are immediately reducing the likely price to something like $1,250,000.

Next, about 90% of small business sales are asset transactions. Only about 10% close as a transfer of stock ownership. Double that tax estimate from 20% capital gains to a 40% ordinary income rate.

Businesses transfer debt-free. So if Bob owes another $300,000 on his credit line, that comes off the top from the proceeds, but the tax is still payable on that $300,000.

So Bob’s $1,250,000 drops to $750,000 after taxes, and to $450,000 after debt repayment. He has lost three quarters of the amount he was planning on for retirement.

The problem is exacerbated when the planner dutifully enters $2,000,000 in his retirement software, assuming that the owner certainly knows the value of his business. That happens more often than I care to discuss.

These misunderstandings are just the tip of the iceberg. There are another half-dozen common mistakes when owners look at their value. In many cases it results in owners being highly insulted by legitimate offers from qualified buyers. I’ve also seen them renege on accepted offers when they finally have a CPA model the tax impact.

(NOTE: I do not perform valuations, give tax advice, or broker businesses. My recommendations here will not generate revenue for me.)

If you are like 85% of all owners and plan to sell your business to a third party, the first thing to do is engage a valuation professional. The second thing is to take that valuation to your accountant for tax modeling. Start your exit planning by embracing reality. You’ll be a lot happier in the long run.

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Not Just Workers…Qualified Workers

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A few weeks ago I attended one of Trinity University’s Policy Maker breakfasts. Although living in a large city has its drawbacks, it is great for access to events such as these. It takes substantial ticket sales to justify top-rank speakers, and Trinity’s series brings the best.

The speaker was Richard W. Fisher, immediate past President and CEO of the Federal Reserve Bank of Dallas, as well as almost 11 years on the Federal Open Market Committee, where he voted on monetary policy under Alan Greenspan, Ben Bernanke and Janet Yellen.

In Q&A time, I had the opportunity to ask how he could project robust growth over the next 20 years with the large number of Baby Boomers leaving the workforce and scaling back their consumerism.

Mr. Fisher had already warned the audience that he had no intention of making controversial or otherwise newsworthy statements, so his answer surprised me a bit.

He said that he remained confident that productivity gains through technology could offset much of the drop in workforce growth. The real problem, he said, was the failure of our educational system to prepare a generation of workers with the skills they need to succeed.

I’ve written previously about how small businesses are being saddled with the job of teaching young workers basic job skills. Just getting them to understand that cutting class doesn’t carry over into cutting work, that there are no unlimited extra credit assignments to make up for lack of effort, and that everyone doesn’t always get a passing grade, can be a real challenge.

Some years ago I employed a young Dutch woman who had come to the USA as a student in a top university. She also apparently had sufficient financial support that dropping out and taking a part-time job with me wasn’t a hardship. Eventually, more out of boredom than need, she enrolled again in the local state university.

She came to me one day to coordinate her class schedule with work for the semester. (I think it was her second half of sophomore year.) These were her courses:

  • Great Women in Architecture
  • Diversity in Art
  • The Sociology of Class Distinction
  • World Geography

I asked why she bothered going back to college if she wasn’t going to study anything that prepared her for a career. She laughed, and informed me that she was just catching up on the core courses required before she could declare any liberal arts major.

I’m sure each of those topics were interesting, and contributed to a well-rounded world view. What they contributed as far as preparation for the workplace, however, remains a mystery to me.

A recent survey of college students found 21% believe that the First Amendment to the Constitution should be modified to exclude free speech that is offensive.

A widely circulated essay on Vox.com expresses a liberal professor’s fear of violating the “safe place” of university learning by teaching offensive literature such as the writings of Mark Twain.

bright studentUniversities now publish their 6-year graduation rates (fewer than half graduate a majority of students in 4 years.) Students with failing grades receive almost daily emails as final exams loom, reminding them that they can drop classes without penalty (except, of course to their parents’ wallets — refunds aren’t offered.)

It may be helicopter parents, politically correct coursework or just a general corruption in the education system driven by billions in student loans that require no accountability. Whatever the cause or causes, a college education no longer seems to carry with it an assumption of career-readiness.

There are certainly many good colleges, and an excellent education is still a great beginning for a successful career. As an employer, however, I’ve long since stopped assuming that a six-figure degree is, by itself, any sort of qualification for a job.

Is Your Business in the “Neutral Zone?”

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As Baby Boomers business owners approach retirement (the youngest of them turned 50 this year) they face a unique challenge. The market for small businesses is increasingly a buyer’s smorgasbord A shrinking middle-aged population, corporate competition for talent and less interest in the long hours associated with many traditional small businesses combine to make selling many Boomer enterprises a more difficult proposition.

The best-of-class companies on both the smaller and larger end of the spectrum will still stand out as appealing propositions to buyers. On the main street side (companies selling for less than $3 million or so) there are still plenty of aspiring entrepreneurs who seek a lucrative opportunity.

The mid-market (companies with over $1 million of pre-tax income) has more money chasing fewer target prospects. Current estimates calculate over $1.6 trillion (about the GDP of Japan) allocated by Private Equity Groups and corporate M&A departments for purchasing those businesses.

stuck in betweenWhat about the companies in the middle? As in the Star Trek “Neutral Zone,” the place where neither the Federation nor the Romulans travel, these businesses have a special challenge when their owners seek to transition, and especially when they want to exit with the value of what they’ve built.

A generic history of these Neutral Zone companies applies to thousands of them. A Boomer entrepreneur bootstrapped a business thirty years ago. Badly undercapitalized, he or she struggled for years to make a decent living. As time passed, a four decade long expanding economy, driven by the influx of workers and consumers from the same generation, helped to grow the business until it provided a comfortable living.

Now in their 50s or 60s, those owners have achieved their life goals. Their labors have resulted in an enterprise that employs between 15 and 50 people, and puts between 300,000 and a million dollars to the bottom line above and beyond their own salaries. Compared to 95% of Americans, they are “rich.”

But they are too big to sell easily in the small business (main street) markets, and too small to attract mid-market buyers. They are in the Neutral Zone.

In main street sales (as I’ve explained here before) solid companies sell for an upper limit of around three times the pre-tax profit combined with the owner’s salary and benefits. As that pricing exceeds $3 million, and certainly above $4 million, it becomes difficult to find an individual entrepreneur who can leverage that purchase price.

In the mid-market, where the cost of a transaction limits targets to those with $1 million and more in EBITDA, many Neutral Zone owners would have to grow the business by 30% to 70% just to make the entry level numbers.

A Boomer entrepreneur who is in the “harvesting” phase of business ownership; enjoying the benefits that come from decades of dedication to the business, is often not interested in another big push. It may require more investment, more risk, and probably a lot more effort.

He or she built the company with a belief that it would fund a certain post-business lifestyle upon sale. Now they are finding out that a well run organization with solid and sustained profitability may not be enough.

I typically work with between 15 and 25 of these owners at any given time. For many, the solution can be to “hire a buyer.” Their companies are financially capable of recruiting top management talent. That talent should first be capable of taking the day-to-day management duties from the owner, but in addition, be entrepreneurial enough to eventually assume ownership in turn.

The secret to realizing the full value of a Neutral Zone company may not lie in bringing it up to another level (or, perish the thought, down to a lower level) of prospective buyers. Instead, consider using the organizational strength and profitability you’ve created to engineer an internal sale on your own terms, in your own time, and under your control.

 

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Boomers and the Lost Generation

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Those who read this column regularly are well aware of the huge shifts underway as a result of the Baby Boomers’ coming exodus from the workplace. Those who aren’t familiar with the issue are invited to download my free, 45-page eBook Beating the Boomer Bust.

Almost four years ago I mused about the chances of Generation X, smaller in numbers and less accustomed to competition than the generations immediately before (Boomers) or following (Millennials) becoming another Lost Generation, much like that of the F. Scott Fitzgerald era.

Now, I’m seeing and hearing more evidence that such may be the case. A friend who works closely with the large corporations in the oil and gas industry noted a different trend in the layoffs that are accompanying the fall in prices. The Great Recession, like previous downturns, saw buyouts of many workers who were approaching retirement. This time around, companies are getting leaner by cutting less experienced workers, and keeping their more experienced core regardless of age.

older workerI see a similar trend in smaller businesses as well. Owners who traditionally filled lower and mid-level positions by seeking younger workers are now much more inclined to hire people in their 50s and 60s. What is causing this shift?

First, there is a new expectation about employee retention. It’s well documented that workers from GenX and the Millennials are far less likely to take a job for life. Regardless of how well they are treated, younger workers take a position with the expectation that they will be moving on when they find a better opportunity, or simply when the job interferes with their chosen lifestyle.

The majority of small businesses are still owned by Boomers, and they are often more comfortable with employees who share their experience and attitudes. If a young employee has an employment life expectancy of, say, five years, why not have that position filled by someone who understands that paid time off is something that has to be accrued before it’s taken?

If you have to accomplish more work with fewer people, employers naturally want people who will stretch to get things done. Most Boomer workers accept the need to work late on occasion, and are accustomed to planning personal activities around the job. Younger people often see that as being too docile, or foolishly loyal when “It’s only a job.” Employers, on the other hand, cherish such dedication.

Boomers are generally healthier than preceding generations. They haven’t been great savers, and most plan to work longer than their predecessors. As the pace of change accelerates in almost every industry, a worker who needs little ramping up and can be expected to produce for another ten years looks better and better, regardless of any gray hair.

Not all Boomers have the skills necessary to function in today’s workplace. If you are looking for technical abilities, however, someone in their 30s (a Millennial) is likely to be faster and more savvy than someone in their mid-40s. That’s why Generation X is getting squeezed in the middle.

Of course, as another friend says, “A Millennial will figure out how to use technology to accomplish in a single day what would take a Boomer three. Of course, then he wants the other two days off.”