Exit Planning Tools for Business Owners

business ownership

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.

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.

Are You Financially Ready to Exit Your Business Even if it Happened Tomorrow?

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Does Your Current Situation Have You Financially Ready to Exit Your Business?

Setting the Scene: The Importance of Financial Preparedness for Exiting a Business

Exiting a business is a significant decision that requires careful consideration, particularly regarding financial readiness. Whether you’re considering retirement, pursuing new ventures, or simply ready to move on, being financially prepared is crucial for a smooth transition.

Understanding the Decision: Factors to Consider Before Exiting Your Business

Before making the leap, it’s essential to understand the various factors that influence your decision to exit your business. From personal goals to market conditions, several considerations can impact your readiness to move on from your business venture.

Assessing Your Financial Readiness:
Evaluating Your Current Financial Situation: Income, Expenses, and Assets

Start by taking stock of your current financial situation. Evaluate your income streams, including revenue from the business, personal investments, and other sources. Consider your monthly expenses and assess your assets, including both business and personal holdings.

Estimating Your Business’s Value: Determining Its Market Worth

Determining the value of your business is a critical step in assessing your financial readiness to exit. Consider consulting with a business valuation expert to get an accurate estimate based on various factors, including revenue, assets, market trends, and industry standards.

Analyzing Cash Flow: Ensuring Stability Post-Exit

Cash flow analysis is essential to ensure financial stability post-exit. Evaluate your business’s cash flow projections to understand how it will sustain your lifestyle and cover expenses after you’ve left the business. Consider factors such as ongoing revenue streams, debt obligations, and potential changes in expenses.

Understanding Exit Options:
Exploring Different Exit Strategies: Sale, Succession, or Closure

There are several exit strategies to consider, including selling the business, passing it on to family members or employees through succession, or simply closing the doors. Each option has its pros and cons, depending on your personal and financial goals, as well as the state of your business.

Pros and Cons of Each Option: Weighing the Benefits and Challenges

Take the time to weigh the advantages and disadvantages of each exit strategy. Selling the business may offer a significant financial windfall but requires finding the right buyer. Succession can preserve your legacy but may come with complexities in transition. Closure provides a clean break but may not maximize financial returns.

Considering Timing: Is Now the Right Time to Exit?

Timing is crucial when it comes to exiting your business. Consider factors such as market conditions, industry trends, personal readiness, and potential tax implications. Assess whether the current timing aligns with your financial goals and objectives.

Financial Planning for Exit:
Creating a Financial Exit Plan: Setting Clear Goals and Objectives

Develop a comprehensive financial exit plan that outlines your goals and objectives for exiting the business. Define what financial success looks like for you and establish clear milestones and timelines for achieving your objectives.

Building a Contingency Fund: Preparing for Unexpected Expenses

Prepare for unexpected expenses by building a contingency fund. Set aside a portion of your assets to cover unforeseen costs or emergencies that may arise during the exit process. Having a financial safety net in place can provide peace of mind and ensure a smoother transition.

Engaging Financial Advisors: Seeking Professional Guidance for Exit Planning

Consider seeking guidance from financial advisors who specialize in exit planning. An experienced advisor can help you navigate complex financial decisions, optimize tax strategies, and maximize the value of your business. Their expertise can provide valuable insights and support throughout the exit process.

Maximizing Business Value:
Increasing Profitability: Strategies to Boost Revenue and Reduce Costs

Take proactive steps to increase the profitability of your business before exiting. Implement strategies to boost revenue, such as expanding market reach, launching new products or services, or improving customer retention. Similarly, focus on reducing costs and improving operational efficiency to enhance overall profitability.

Enhancing Business Operations: Improving Efficiency and Productivity

Streamline business operations to maximize efficiency and productivity. Identify areas for improvement, such as workflow processes, technology integration, and resource allocation. By optimizing operations, you can increase the value of your business and make it more attractive to potential buyers or successors.

Investing in Growth Opportunities: Expanding Market Reach and Customer Base

Explore growth opportunities to expand your business’s market reach and customer base. Consider diversifying into new markets, partnering with complementary businesses, or investing in marketing and advertising efforts. By positioning your business for growth, you can enhance its value and appeal to potential buyers or successors.

Managing Debt and Liabilities:
Assessing Debt Obligations: Understanding Your Business’s Debt Structure

Assess your business’s debt obligations to understand its financial liabilities. Review outstanding loans, lines of credit, and other forms of debt, including repayment terms and interest rates. Understanding your debt structure is essential for developing a plan to manage or repay debts before exiting the business.

Developing a Debt Repayment Plan: Prioritizing Payments and Negotiating Terms

Develop a debt repayment plan to address outstanding obligations before exiting the business. Prioritize debt payments based on interest rates, maturity dates, and creditor requirements. Explore options for negotiating repayment terms or consolidating debts to improve your financial position.

Addressing Legal and Financial Liabilities: Mitigating Risks Before Exit

Identify and address any legal or financial liabilities that may pose risks to your business or personal assets. Review contracts, leases, and agreements to ensure compliance and mitigate potential liabilities. Seek legal advice to address any outstanding legal issues or liabilities before finalizing your exit plans.

Preparing Personal Finances:
Separating Personal and Business Finances: Organizing Accounts and Assets

Separate your personal and business finances to streamline your financial affairs. Organize accounts, assets, and expenses into distinct categories to simplify financial management and reporting. Establish clear boundaries between personal and business transactions to avoid confusion and potential legal or tax issues.

Building Personal Savings: Establishing a Safety Net for Post-Exit Life

Build personal savings to establish a financial safety net for post-exit life. Set aside funds in savings accounts, retirement plans, or investment portfolios to cover living expenses, healthcare costs, and other financial needs. Having a robust savings cushion can provide financial security and peace of mind during the transition period.

Planning for Retirement: Securing Financial Stability Beyond Business Ownership

Plan for retirement to ensure long-term financial stability beyond business ownership. Evaluate retirement savings options, such as IRAs, 401(k)s, or pensions, and consider how they fit into your overall financial plan. Develop a retirement income strategy that aligns with your lifestyle goals and objectives for retirement.

Tax Implications of Exit:
Understanding Tax Consequences: Capital Gains, Income Tax, and Other Considerations

Understand the tax implications of exiting your business, including capital gains tax, income tax, and other relevant taxes. Consult with tax professionals to assess your tax liability and explore strategies to minimize taxes legally. Consider timing your exit to optimize tax outcomes and maximize financial returns.

Utilizing Tax Strategies: Maximizing Deductions and Credits Before Exit

Explore tax strategies to maximize deductions and credits before exiting your business. Take advantage of available tax incentives, such as deductions for business expenses, retirement contributions, or capital investments. Implementing tax-efficient strategies can help reduce your overall tax burden and preserve more of your wealth.

Consulting Tax Professionals: Navigating Complex Tax Laws and Regulations

Seek guidance from tax professionals who specialize in business exits and transitions. A qualified tax advisor can help you navigate complex tax laws and regulations, interpret tax implications, and develop tax-efficient exit strategies. Their expertise can ensure compliance with tax requirements and optimize your financial outcomes.

Exiting with Confidence:
Finalizing Your Exit Plan: Documenting Agreements and Contracts

Finalize your exit plan by documenting agreements and contracts that outline the terms and conditions of your departure. Work with legal advisors to draft legally binding documents, such as sale agreements, succession plans, or dissolution agreements. Ensure all parties involved understand their rights and responsibilities.

Communicating with Stakeholders: Keeping Employees, Customers, and Partners Informed

Communicate openly and transparently with stakeholders about your exit plans. Keep employees, customers, suppliers, and partners informed about the transition process and how it may impact them. Address any concerns or questions promptly and reassure stakeholders of your commitment to a smooth transition.

Celebrating Achievements: Reflecting on Your Business Journey Before Moving On

Take time to reflect on your achievements and milestones before moving on from your business. Celebrate your successes and the hard work that went into building and growing your enterprise. Express gratitude to employees, customers, and supporters who contributed to your journey. Celebrating achievements can provide closure and pave the way for new beginnings.

Conclusion:
Taking the Leap: Are You Financially Ready to Exit Your Business?

Exiting a business is a significant decision that requires careful consideration and financial preparedness. By evaluating your financial readiness, understanding exit options, and planning strategically, you can confidently take the leap into the next chapter of your entrepreneurial journey.

Moving Forward with Confidence: Embracing the Next Chapter of Your Entrepreneurial Journey

As you embark on the journey of exiting your business, remember to move forward with confidence and optimism. Embrace the opportunities that lie ahead and leverage your experience and expertise to pursue new ventures or enjoy well-deserved retirement. With careful planning and preparation, you can navigate the transition successfully and embark on a new entrepreneurial adventure with confidence.

Reposted with permission of the author, Tara L. Groody, Executive Assistant/Operations Specialist for Brett Andrews and Fortress Business Advisory.

Brett Andrews, CWS, CExP, CEPA, is the President of Fortress Business Advisory. He has worked with individuals and businesses managing their assets since 1998. His mission is to help clients reach their goals while managing risk in their total financial situation. To accomplish this, Brett has combined modern financial planning techniques with technical, quantitative, and behavioral analysis to achieve a truly unique and dynamic approach to total wealth management.

Is your business too dependent on you?

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By definition, a small business depends on you, its owner. Especially if you are its original founder. After all, the business would never have existed without the leap you took to start it in the first place. It wouldn’t have survived it’s early years without the sweat, tears and sacrifices, financial and otherwise, that were made.

Likely it survived and went on to flourish because of some special knowledge, skills or traits you either already had when you began, or that you developed while building it into the successful enterprise it has become. The value that you brought to the table in the beginning was your company’s most precious asset, and is likely still valuable today.

However, if your company is too dependent you, then it’s probably not operating as efficiently as it could. Put another way, If you are your company’s greatest asset, then you could also very well be its biggest liability. Owner dependence can be an obstacle for growth and hurt a company’s value when the time comes to sell.

Degrees of owner dependence

Owner dependence comes in many different forms. Does the business rely on you for most or all of its sales? Are you the go-to person for a key skill or necessary knowledge? Are you required to review others’ work and sign-off because you hold the required license? Are you still doing the bookkeeping or payroll?

Even if not involved in the daily operations, there are other ways a business could be owner-centric. Are you the only one who brings new ideas for growth? What business decisions are you responsible for? In what areas does your management team need your approval before taking action?

There are various surveys available which can help identify how owner-centric a business is; we offer one that takes less than 15 minutes to complete. Here’s another way to get a basic idea of owner-centricity that takes only a few seconds. How much time did you spend ‘touching base’ with your company during your last vacation? If you’re not sure, I’ll bet your spouse knows.

Too much dependence = less value

A business too dependent on its owner can make it more difficult to sell and even reduce its value. If a potential external or internal buyer (if you plan on selling to key employees) can’t fill your shoes, then they must either hire talent to replace the lost skillset, or keep you on for an extended time to help with the transition. Adding headcount means less profit and therefore less value. An extended transition means more risk to the buyer, (what if the business can’t be as successful without you) which again makes it less valuable.

Even if you don’t plan on selling any time soon, getting the business less dependent on you can provide value in other ways. How much would it be worth to you if you could spend 10 less hours a week at work? What would it mean to those you cared about if you had more time to spend with them? How would it feel if you could take 3 months off comfortably knowing that your company is humming along fine without you?

Some owners who have had this concept presented to them have reasons why they can’t take their fingerprints off the business. The most common ones are, “I’d love for the business to be less dependent on me, but I’m too busy to train someone else.” Or, “I’m involved in these areas because a mistake would be too expensive.” There’s also the classic “No one can do this as well as me!” These or other reasons could be challenges for you as well. I didn’t say this would be easy. On the other hand, owners that have been able to overcome these obstacles have created more business value and a better quality of life for themselves. And some who initially thought they wanted to sell had a change of heart. Once they found that the business wasn’t running them, ownership became enjoyable again and it was worth keeping.

Taking the first step

If this sounds like a worthwhile exercise, the first step is to identify the aspects of your business that are dependent on you. Then start small and pick one area to tackle first. Can it be delegated? Can it be systematized? Outsourced? Maybe some additional training is needed. Maybe someone with experience in that area should be hired.

Once you have the first one checked off, you should have more time and energy to tackle the next. It’s a virtuous cycle. Accomplish enough of these and not only will your company’s value increase, so will your quality of life.

Michael Jones, CFP, CEPA spent several years in management and engineering roles for various Fortune 500 companies. He has a B.S. degree in Mechanical Engineering from Virginia Tech and an MBA from the Krannert School at Purdue University. He is the President of Ataraxia Advisory Services, LLC.

Why You Can’t Sell Your Business Overnight

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So why can’t you just sell your business in a couple of months?

Business owners are often told they need to get ready to sell their business, why can’t they just up and sell it? The short answer is that they are unlikely to sell it. Listing the business may be easy, getting someone to buy it, that’s the hard part. According to the Exit Planning Institute, only some 20-30% of businesses sell today.

You might be asking yourself, what actually makes a business part of this group who does sell?

Of course, there may be many answers to this question, but I think the biggest reason can be summed up in a single word: Risk. A business buyer is going to look at several factors when determining if they will buy. These factors lead them to conclude a risk level and they compare that with their tolerance for accepting risk. The higher the perceived risk, often there is a direct correlation with a lower multiple of EBITDA, and thus a lower selling price. In some cases, the risk perception may be so high that the buyer decides there is no price they would pay to accept that risk.

What are some of these perceived risks?

I think for a lot of small and lower middle market businesses, the challenges for a successful sale to an outside party are greater than for larger companies. Larger companies are larger because they sell more products – they need more inputs to sell a larger amount of their product. They need people, processes and management. Usually in a larger organization, the owner is not participating directly in the production or sales of the product, they have an organization that does this. Contrast this image with a smaller company where the owner is directly involved in the production of the product or sales – the greater this involvement, the greater the perceived reliance on the owner. We call this “owner centricity.” The higher the owner centricity, the riskier the proposition is to an outside buyer.

If the current owner is deeply active in production, sales or the management of the firm, then an outside buyer will have to replace those functions – they may conclude they will have to do these activities, and there is the rub. They may or may not want to do them, but perhaps more important, they may not perceive that they are able to do those functions. An owner who knows all his customers, an owner who is a gregarious personality and is responsible for attracting new business, an owner who has been at it for decades and knows the industry, the suppliers, the competition – those are all critical owner functions – the problem is that a new owner may not be able to see themselves doing those activities with the same success as someone who has done it for years. If the prospective buyer can’t see themselves as being able to do these functions as well, then they will question whether the business can repeat the sales and profits earned by the original owner. The degree to which this idea is challenged is risk.

A way to reduce this risk might be to reduce the level of owner centricity. To reduce the level of owner centricity, an owner would assess the critical functions of the business and measure the extent of their involvement. Once measured, the owner would undertake the process of implementing a management succession plan to develop written procedures, systems and policies, and begin the methodical process of handing over or delegating the owner’s responsibilities.

I like to think of a business as a mental model that fits inside of a shoebox. The box has systems, policies and procedures, that runs itself. It produces a repeatable process of making money. Imagine that one could reach inside that box and pulls the owner out! Now the owner owns the box that produces the repeatable product and earns a predictable profit. I recently met with a business owner client who shared that he had taken our advice and told his staff that he is no longer coming into the office. (His words were “only call me if someone dies”!) What he found was that the business ran without him, it produced recurring and repeatable revenue and profit streams. A new buyer might perceive that they can own that box, and they may then perceive it as less risky.

Exit, succession and continuity planning is about this process. Reducing owner centricity is one thing an owner can do to prepare for a sale or exit. This is not a quick fix, this takes time. Those who develop and implement an exit and succession plan over time may be able to reduce the perceived risks to a new buyer. You might say, those with a plan have a better chance of selling their business than those without a plan.

Mark Hegstrom is Certified Exit Planning Advisor and helps business owners to plan for what may be their single largest lifetime transaction: the transfer of their business. Get started by completing an exit readiness Assessment for yourself. Mark is Managing Partner at Business Owner Succession Strategies (BOSS). He currently serves as President of the Exit Planning Institute -Twin Cities Chapter.