Exit Planning Tools for Business Owners

Boomer Bust

Employee Retention Before and After Your Exit

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In most businesses, employee retention is a material factor in valuation and transferability.

The ability of a buyer to assume control of a fully-functional organization has substantial influence on his or her perception of a company’s value. Any need to pay the seller for an extended period of training adds a redundant executive salary to the projected operating costs. Concern that key personnel may resign or be recruited away by a competitor adds a level of uncertainty to the transfer.

Of course, the basic premise of “The more you work in the business, the less it is worth.” always applies. Even if you’ve effectively delegated most of your operational responsibilities, however,  there remains the threat of an exodus of corporate knowledge.

Many exiting owners don’t believe that the problem is theirs. “These people work for me because I treat them well.” they say. “A new owner should have no problem if he or she does the same.”

True enough, but every buyer’s confidence level is greatly increased by a mechanism to support employee retention through the transfer process.

Stay Bonuses

Stay bonuses are so named (quite logically) because their purpose is to get key employees to stick around after a transfer of leadership. They can take a number of forms, but one of the most common is to escrow a portion of the sale proceeds for later payment if certain conditions are met.

The amount of the bonus can vary, but a general rule of thumb is about six months’ salary for two years of continued employment. Depending on the deal and the number of employees involved, this could be substantial. We suggest allocating about 5% of the sale price when planning such bonuses, but it could vary widely. Here are a few examples.

You sell your company for $5,000,000. Your four top executives each earn $200,000 a year. Six months of their salaries would be $200,000, or 4% of the sale.

On the other hand, if you have seven top executives at that level, $350,000 is 7% of your sale proceeds. That might be too rich a commission for your taste. The 5% guideline would make their bonuses about $35,000 or about 18% of salary.

Only you can decide whether the amount is motivational. Differing amounts based on position are normal. There is no requirement (such as in ERISA) that you apportion the funds by longevity or salary level.

Conditions of Payment

If you choose to make the bonus available, it only enhances the buyer’s confidence. Because the bonus is the seller’s liability, the new employer has no added financial motivation to keep or terminate any particular individual.

Bonuses are customarily forfeited upon resignation or termination for cause. Unlike other non-qualified deferred compensation plans, bonuses are typically not paid out in the event of the employee’s death or disability. This isn’t synthetic equity or a reward for general tenure. Qualification for payment is dependent on a specific condition being met at a specific time.

Also, unlike most NQDC plans, there is no buildup or gradual vesting of value. An employee who stays for 18 months isn’t eligible for three-quarters of a bonus. That should make stay bonuses free of claims in the event of an employee’s bankruptcy or divorce.

Employee Retention Alternatives

Employee retention is an issue in the transfer of any business with skilled personnel.  Only you can determine whether it is worth the investment of offering stay bonuses.

If you are confident in employees’ loyalty to the company, one alternative is to place some of the sale price into an escrow account, to be released if turnover remains below a certain percentage for a specific time. This still allows you to retain the entire proceeds, but transfers some of the financial risk of turnover (even for non employment-related causes) to you.

The other approach is to rely on inertia and security to maintain your workforce in place. Those are strong motivations, and are sufficient in most cases.

Regardless of a buyer’s demands, remember that no one gave you financial guarantees of loyalty. You earned it, and it isn’t unreasonable to expect a buyer to do the same.

Celebrating Mr. Fezziwig

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To celebrate the holiday, I’m reprinting a post from 2013 about the underappreciated boss of A Christmas Carol, Mr. Fezziwig. I hope that you enjoy it. Merry Christmas!

Last week was the 170th anniversary of the publication of Charles Dickens’ A Christmas Carol (December 17, 1843). The immortal words of Ebenezer Scrooge are ingrained in the memory of the entire English speaking world. I’d venture to guess that “Bah, Humbug!” can be correctly identified as to source and speaker by over 99% of those reading this.

The novella, serialized in five parts, was not a commercial success. Unhappy with the sales of his previous novel (Martin Chuzzlewit– no wonder!), he refused his normal fee from the publisher in favor of royalties on the proceeds, which proved disappointing. Critical reception was favorable, although it didn’t catch on in America until much later. The New York Times first published a review in 1863, 20 years after its publication in England.

Like most of Dickens’ work, A Christmas Carol clearly includes an indictment of the social inequalities of the Industrial Age; child labor, workhouses, and debtors’ prisons. It stands out, however, because of the lessons taught by its memorable ghosts, and the redemption of its main character in only 113 pages.

During the Protestant Reformation in England and Scotland, Christmas had become a period of penance and reflection. A Christmas Carol is credited by many for leading the return to a celebratory holiday, focused on appreciation and thanks for family and friends.

Modern Ebenezers

Modern filmmakers have returned to the straight-ahead plot and uplifting story line (not to mention the recurring revenues available year after year) with a frequency that helps stamp the legend in our psyche. Starting with the 1938 Reginald Owen version (originally released as “Scrooge”) and the 1951 Alistair Sim classic, the character of Ebenezer has been tackled by actors ranging from George C. Scott to Michael Caine (with the Muppets). Patrick Stewart, Kelsey Grammar and Rich Little (in various celebrity impersonations) have taken a shot, as have Mickey Mouse, Mr. Magoo, the Smurfs, Barbie, Dora the Explorer and the Flintstones.

Let’s not forget the variants; Bill Murray in “Scrooged”, or Boris Karloff and Jim Carrey in versions of “How the Grinch Stole Christmas.” In all, IMDB lists almost 200 filmed variants of the story.

Unfortunately, the characterization of Scrooge has become ingrained in the minds of many as a stereotype of all bosses who dare to focus on margins and profit. How many employees identify their bosses with Fezziwig, who took pride in making his employees a happy group, even though Scrooge dismissed it as “only a little thing?”

FezziwigInstead of focusing on  the things that allow Fezziwig to spend lavishly on his employees (a motivated workforce, honesty, doing what’s right, profitability), we prefer to fantasize about a boss who expresses sudden enlightenment by unexpectedly bestowing gifts and extra days off. Fezziwig is relegated to an afterthought, an overweight doting uncle with no visible reason for his success.

Most of us are far more Fezziwigs than Scrooges. Oddly, if we celebrated the season of giving by handing our employees a list of all the extra things we’ve done for them during the year, we’d be considered more akin to Ebenezer. We bow to the popular myth, give even more at the holidays, and hope it has some carryover of appreciation into the New Year.

Just remember to remind your employees when you are being Fezziwig the rest of the year. A Christmas turkey for Tiny Tim isn’t as important as being a good boss.

Life After Exit — Time is of the Essence

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From time to time, we share real stories about life after exit from owners who have sold their businesses. Some are great and some… not so much. The have agreed to share their experiences to help other owners prepare for both the process of transferring their companies and what comes after.

The Business

BVA Scientific, a distributor of laboratory supplies and equipment, started in Bob and Nancy Davison’s bedroom with the garage serving as the “warehouse.” Both had a background in laboratory supply sales, and they focused on building deeper customer relationships than the multi-billion dollar vendors who dominate the industry.

That approach helped the company grow with a balanced customer base. BVA has a presence in food testing laboratories, water and wastewater plants and the Texas oil fields, rather than the typical dominance of doctors and hospitals for their type of business.

Not surprisingly, BVA had attracted multiple inquiries from private equity groups. None of those came with management, however, and all wanted the Davisons to remain as employees for a long time after the acquisition. While they weren’t in a rush to get out the door, Bob and Nancy wanted a clear path to retirement

Here is how they describe the transaction

“First, let’s kill all the lawyers…”

Nancy: “We knew that the business had grown beyond what a couple of salespeople could handle well. Supply sources were moving to Asia, and I felt a bit out of step. I think the real impetus was when a general manager to whom we planned to sell the business left for, of all things, his own sign shop franchise. We hired a replacement, but we could see that he wasn’t our exit plan.”

Bob: “I’ve always been very active in our trade association. A colleague with a much larger operation had asked me several times to let him know if we would consider selling. When he repeated the offer at a conference, we decided to start talking seriously.”

Nancy: “The due diligence almost killed me. The buyer’s attorneys kept asking for more information. Halfway through the deal their lead attorney went on maternity leave, and her replacement wanted to restart the whole process from the beginning!”

Bob: “Our legal bills wound up being so much more than we anticipated. I think my biggest surprise was finding out how many adjectives could be used to modify the word lawyers.”

Nancy: “The closing date was delayed multiple times. Then our biggest customer told us privately that they were planning to shift their purchasing for high-volume items to China. It was a gut check, but we shared the information with the buyer. We had to restructure the deal with a portion tied to an earn-out, based on the level of business we maintained for a year after closing.”

Life After Exit

Bob: “Nancy stepped back pretty quickly. I wasn’t quite ready to retire, and now I have the added motivation of watching our earn-out. My role is technically sales-related, but it is just as much about keeping the employees happy through the change.”

(Note: As we approach the end of the earn-out agreement, BVA Scientific has easily reached all the goals required for full contingency payment. Nancy and Bob continue to enjoy life after exit.)

 

This story and others are in my latest book Your Exit Map: Navigating the Boomer Bust.

Exit Planning – Maintaining Control

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For many owners, their biggest concern in an exit plan is maintaining control.  Whether they seek to sell to employees, family or a third-party, there is a fear that, once started, the process will have its own rules and momentum.

My colleague John Warrillow, author of Built to Sell and The Automatic Customer, has written an excellent white paper on the types of people who own businesses. John previously owned a data-driven marketing company, and always backs up his opinions with solid research.

I’ll leave the indicators of the entrepreneurial types to John, since it is his material. His conclusion, however, is that 2% of owners are Mountain Climbers. They are focused entirely on the next goal (usually growing the business.) Another 24% are Freedom Fighters; those who are in business for themselves as a way to control their lives. The remaining 74% are Craftspeople. They run their own business as a job, focusing on doing much of the work themselves to maintain the best quality.

Craftspeople aren’t prime candidates for exit planning. Their owner-centric approach to the business leaves them little value to sell to another entrepreneur. Mountain Climbers are almost certainly planning an exit, but their objective is probably to reach a level that attracts financial and strategic acquirers.

That leaves Freedom Fighters as about 92% of the owners who will benefit from a planned transition. Maintaining control is their very reason for owning a business. They have no intention of surrendering the outcome to someone else.

Sharing Control with a Buyer

Ironically, the majority of these owners say that they plan to sell their companies to a third party. By definition, they will be sharing the timing, price and transfer mechanisms with a stranger. The buyer will have his or her own ideas about the process and how much the company is worth.

Combining Warrillow’s  work with my own research on the number of Boomer employers (5 or more employees) in the U.S., and we can estimate that somewhere between 750,000 and 1,500,000 of these businesses are owned by Freedom Fighters over 55 years old. If you’ve read my latest book or visit this column regularly, you already know that the intermediary community (brokers and investment bankers), accounts for about 10,000 third-party sales annually.

These owners don’t have a century or more to stand on line waiting for a buyer. That’s why so many are choosing to sell their businesses to employees.

“But my employees have no money!” That first objection is usually true, but if they have the skills to run the business, the financial mechanisms can often be arranged. A Leveraged Buyout (LBO) or an Employee Stock Ownership Plan (ESOP) can be structured over a few years so that the owner remains in control of the business until he or she leaves with the full value of the company in his or her pocket.

Of course, you can always finance the transaction yourself, and sell to employees for a note. That, however, is the antithesis of maintaining control.

 

 

Choosing Your Timeframe to Exit

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“My timeframe? Talk to me in about five years.”

When business owners are asked about exit planning, that answer is almost ubiquitous. In fact, a much-quoted 2008 survey of owners by Price Waterhouse Coopers (now PwC – not clear why Mr. Waterhouse warranted lower case) found that 85% of private business owners said they expected to sell in five years.

Clearly, that didn’t happen, since it would have required some  1,500 businesses to be sold daily during that period. (The brokerage industry claims about 9,000 sales a year.)

In fact, when the survey results were broken down, they discovered that 85% of 60 year old owners expected to sell in five years. Among 65 year olds, 85% expected to sell in five years. Among 70 year olds, you guessed it, 85% expected to sell in five years.

Clearly, “five years” is most owners’ shorthand for “I haven’t really thought about it.”

Realistic Timeframes

Exit planning and more importantly, implementing a plan, can easily take five years. That doesn’t include the time thinking about it, talking about it, or waiting for someone to call you up and make an offer.

If you are an owner-centric business (for example, a specialty craft where either you do the work or it is all done under your personal supervision,) you exit plan may be to close down. Even so, respect for your customers and employees suggests that discontinuing the business should take about a year.

Main Street businesses are those where another individual could step into your shoes and make a living. Such companies generally sell for less than $2 million. This is the market where business brokers excel. Expect the listing and sale process to take anywhere from nine months to two years. That is after you’ve done any needed clean-up of your records, contracts and procedure documentation.

If you plan to sell to employees without taking on all of the financing risk personally, allow at least three years to bring them into an equity position and document their ability to run the business without you. For most companies, five to eight years is a more realistic timeframe to accomplish this.

Selling to family members who are already capable of running the business is also time sensitive. A family transition can offer unique tax benefits, but the transfer mechanisms usually need at least five years for maximum benefit.

Selling to a family member who is not yet involved in the business is a much more lengthy proposition. I meet regularly with owners in their 60s who claim that a son or daughter in high school will be their successor. That timeframe requires the owner’s presence until well into his or her 70s or beyond.

Planning Isn’t Implementing

It makes little sense to embark on the biggest financial event of a lifetime without planning. However, plans can be made without rushing right into them.

Too many owners start to plan, only to find that the assumptions they’ve held for years aren’t true. Their estimate of value for the business is way off, or the key employee they assumed would take over has little interest in ownership.

Testing a plan for its practicality helps focus you in a specific direction. Does the business need to grow, improve profitability or take on new lines? Who are the buyers for a business of your size, or in your industry?

Investments in new hires and equipment are weighed for their long-term impact more than immediate need. Even if your target date is a decade away, you’ll start making strategic and tactical decisions based on your ultimate goal.

“Read” my latest book in 12 minutes!

Your Exit Map, Navigating the Boomer Bust is now available on Amazon, Barnes & Noble and wherever books are sold. It was ranked the #1 new release in its category on Amazon, and is supplemented by free tools and educational materials at www.YourExitMap.com.

Now, we have a really cool 12 minute animated video from our friends at readitfor.me that summarizes the book, and helps you understand why it is so different from “how to” exit planning tomes. Take some time to check it out here. Thanks!