Exit Planning Tools for Business Owners

business ownership

Main Street Business: The Importance of a Written Exit Plan

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When planning for a vacation, do you typically jump in the car and just start driving without first determining where you are going?

No, of course not. You plan out where you want to go, when you want to leave, what activities you want to do on the trip, and so forth. You create a plan to make sure that you know where you are going and what you are going to be doing.

The same principle applies to business owners when transitioning from their Main Street and Mid-Market businesses. Without an exit plan in place, the odds of reaching your end goal are extremely low. Only by implementing a comprehensive plan with actionable steps do you stand a chance of making a successful exit from your business.

To quote baseball great, Yogi Berra, “If you don’t know where you are going, you’ll end up someplace else.” Without a detailed exit plan in place, you may find that your destination may not be where you want it to be.

While you may think you’re headed toward retirement and many years of well-earned relaxation, without a plan in place you could find that retirement is just out of reach or that you’ll have to work well past the age in which you thought you would. Many small business owners spend their entire lives working on their business, adding value to the bottom line, and developing strategies to build their customer base, only to find that it’s nearly impossible to sell the business when it comes time to retire.

If you don’t have a plan in place this can come as a real shock. What do you do then? You may get lucky and come across an “angel investor” who will buy you out at the right price, but the odds of that happening are slim to none. It’s more likely that you’ll end up caught between a bad option and an even worse choice.

Unfortunately, as many business owners near retirement, they find themselves in this precarious position because they never developed a real exit plan on how they will ultimately leave their business. This isn’t to say that business owners aren’t good planners. Most owners wouldn’t have a successful business if they hadn’t developed an in-depth plan long ago on how best to operate their company, so it’s profitable and set up for long-term growth.

The problem is that a business plan is not the same as an exit plan. While a business plan helps keep the company on track, it isn’t enough on its own because it only addresses the needs of the business, not the individual goals of Main Street Business owner.

A true exit plan involves the creation of foundational objectives and the execution of a strategy to implement those goals that are actionable and leads to the owner leaving on their terms. It typically involves support from a wide range of experts, such as an exit planning adviser, attorney, financial adviser, and certified valuation analyst, among others, so that all areas of the exit are considered.

This plan is an established process that lends itself to success. While no plan is foolproof, a plan that’s never implemented has no chance of success, which is why it’s so imperative to develop a thorough and actionable exit plan now and not wait until it’s too late.

Steven Douglas is a leader of Porte Brown’s Exit Planning practice group. Porte Brown offers one of the few exit planning programs specifically designed for small businesses, Exit RoadMAP Express, and hosts a free monthly webinar series that outlines various options specifically focused on the needs of main street business owners.

Non-Qualified Plans

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When I talk to business owners about “non-qualified plans,” their first reaction is often “Hold on there. I don’t want to get in trouble!”

The term “Non-qualified” merely refers to the Employee Retirement Income Security Act of 1974, more commonly known as ERISA. As the title indicates, it is the basic set of regulations for retirement plans. If your company offers a 401K or SEP IRA, it has a Qualified Plan. If you have an Employee Stock Ownership Plan (ESOP), that is also an ERISA plan.

Under the terms of ERISA, a plan must be made available to all employees. In return, the company can deduct contributions as benefit expenses, and the employee can contribute pretax income to the plan.

A non-qualified plan doesn’t comply with ERISA requirements.  It is discriminatory in nature, meaning it is not offered equally to all employees. The employee cannot make contributions, and the employer usually can’t deduct the costs of funding the plan (which is built around future benefits,) as of current expenses.

Most non-qualified plans are designed as Deferred Compensation, thus the common acronym NQDC. The concept is to offer key employees a carrot for long-term retention. It can be enhanced retirement funding, insurance, or one of many forms of synthetic equity in the business.

Non-qualified Plan Types

We can start with the simplest example of NQDC. If an employee remains with the company until retirement, he or she will receive an additional year’s salary upon retiring. This benefit is not sequestered in a secure account anywhere, it’s just a promise by the company. It’s known as an “unfunded” benefit. There is no annual statement, just a guaranty (typically in writing,) by the business.

Non-qualified plansOften, an NQDC is funded by an insurance policy with a death benefit and an increasing cash value. It is owned by the company, which pays the premiums. At retirement, the employee receives the paid-up policy. This approach has the added benefit of lending confidence to the process, as the employee can see the funding and growth of the future benefit.

Synthetic equity may be stock options, phantom stock, or Stock Appreciation Rights (SARs.) In most forms, it is the right to future compensation based on any increased value of the business. For example, if the business is valued at $2,000,000 today, the employee may be given a contractual right to 10% of the difference in value at the time of retirement. If the company is worth $3,000,000 then, the employee would receive $100,000. ($3,000,000 minus $2,000,000 times 10%.)

Valuation, Vesting, and Forfeiture

Non-qualified plans based on equity should have a formula for valuing the benefit. It may be any financial measure such as revenue, pre-tax profit, or EBITDA. The objective is to make it clear to both parties how the benefit will be measured.

Vesting is an opportunity to be creative. The benefit can vest gradually, or all at once at a specific point in the future. An employee may be able to collect once fully vested or, in the case of synthetic equity, may have the right to “let it ride” for future growth if other conditions are met.

Regardless of how attractive a benefit may be, no employment relationship lasts forever. Pay special attention to how you construct acceleration and forfeiture clauses. Of course, no one wants to pay out to an employee who has been terminated for cause, but the employee deserves some protection against being let go just because a promised benefit has gotten too expensive.

Similarly, provisions for accelerated valuation in the case of a change in ownership are common. You also may want to consider rolling the NQDC into a stay bonus agreement if you sell the business. If there are options on actual stock involved, you will need to determine the handling of them if they could pass into the hands of someone other than the employee. That would be triggered by bankruptcy, divorce, or death.

Benefits of Non-Qualified Plans

As I described in my book Hunting in a Farmer’s World, incentives for employees should match their level of responsibility. Production workers have incentives based on their production. Managers have incentives based on their ability to manage.

Your very best people, the ones you want to stay with you through their entire careers, should be able to participate in the long-term results of their efforts for the company. Non-qualified plans are a way to single them out and emphasize your interest in sharing what you are building together.

As always. check with your tax advisor. Setting a plan up incorrectly could result in unwanted or phantom taxation for the company or the employee.

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.

Are Remote Employees Value Killers?

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Remote workers, computers, businessesRemote employees can have a dramatic impact on the value of your business. If your exit strategy is to sell to a third party, take some time to think about the areas where offsite workers could have an impact.

Curb Appeal

One of the first things any good business broker will look at is your curb appeal. Your business needs to look good, just like a house that’s for sale. (OK, maybe right now a house doesn’t even need to look good, but you know what I mean.)

When I brokered Main Street businesses, I was always surprised at how much we had to tell owners. Clean up the piles of files in the office. Clean and sweep the parking area. Remove the pile of broken pallets next to the dumpster.

What message does your office space send?  Is it better to downsize, and just describe the employees who are no longer on the premises? Or would a buyer prefer to see a room full of empty desks, so that he knows he could bring them back if he so desired? (But he would also be calculating the wasted rent in his mental cash flow.)

Equating Dollar Value

What are your productivity measurements or KPIs for remote workers? Can you prove that they are worth what you are paying them? How? What level of confidence can a new owner have that he is acquiring a productive team? A recent survey in the U.K showed that almost 30% of remote employees were working a side gig on company time.

How is their remote presentation? Unless they are in a job that is strictly production-based, most will interact with customers, vendors or other employees. Do you have standards for their workspace and their appearance on video?

Can you give a buyer confidence in their compensation structure? New ownership can be a great time to ask for a raise. What assurances are there that it won’t happen? As I wrote a few weeks ago, how do you integrate them into your culture?

Confidentiality and Human Resources

Confidentiality about the transaction is more difficult. Does the buyer interview remote employees one by one? You can be sure they are talking to each other, whether on Teams or Slack or just texting each others’ cell phones.

On the other hand, a group video call raises new issues. A buyer could come out of it with a poor impression because one individual is obnoxious or inattentive. Someone might press for inappropriate information. (“Will all of us keep our jobs?”)

Remote Employees Increase  Risk

I am not campaigning against remote employees. They are a fact of life, now and likely for the foreseeable future. I’m just pointing out that handling their management, controlling the information flow to them, and anticipating their potential impact have all become part of exit planning.

The best surprise is no surprise. Part of your planning process when listing your company for sale should be how you will handle these questions.

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.

Wealth Management for Business Owners

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Wealth Management Considerations for Business Owners

Small business owners are at times neglected by the wealth management community as the business is commonly (not always) the owner’s largest asset rather than a portfolio of stocks, bonds, and mutual funds. You’d be well-advised as a business owner to engage a Financial Advisor who is proactive and experienced in factoring your future plans for the business, into your overall plan for managing your wealth.

 

Key Elements of Exit Planning

Impactful wealth management for you as a business owner would include at least these elements of exit planning:

  • Clarifying what “exit” means to you. For example, do you want to leave entirely at some point, or gradually over time?
  • Clarifying your financial, values-based, legacy goals, and what role the business needs to play in attaining your goals.
  • A financial needs and gap analysis with an accurate valuation (not back of the envelope – meaningful planning requires accurate data) of the business. How much $$$$ will you need to do everything you want to do after the business? Is there a financial gap? Will that gap need to be closed by increasing the value of the business?
  • Personal risk management including asset protection, insurance planning, tax planning.
  • A current estate plan — a business owner cannot do exit planning without doing estate planning.
  • A plan to preserve the value of the business (typically a small business owner’s largest asset), and a plan for it to survive during unexpected events of your permanent disability or death.
  • An appropriate plan for managing financial assets resulting from the successful sale or transfer of your business.

Exit planning is wealth management for business owners that requires assessing, preserving, and building the value of your largest and most complex asset…your business.

Invest 15 Minutes and take our FREE Exit Readiness Assessment. We do not request any confidential information.

Pat Ennis is the President of ENNIS Legacy Partners. The mission of ELP is to help business owners build value and exit on their own terms and conditions.

Are You Prepared for the Next Stage of Your Business?

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You’re a successful business owner who’s devoted all your time and effort to growing your company to be a best-in-class provider in the industry. With your head down so long, you’ve probably never thought about what you were going to do as you approached the next stage of life.

Planning for that next stage before you actually get there can help solve many of the problems today’s business owners often face following an exit transaction. It may sound great to play golf every day, or to sit at the lake and fish, but does that replace the daily rush you had while operating your business?

In the most recent State of Owner Readiness Survey conducted by the Exit Planning Institute, 75% of business owners were dissatisfied with the result of their exit transition, post-transaction.[1] While several factors can contribute to this dissatisfaction, developing a plan – and adjusting that plan based on what drives you emotionally – may help you from becoming one of the statistics. As Churchill once said, “Plans are of little importance, but planning is essential.”

Many owners think about what’s best for today but aren’t necessarily considering unforeseen situations. And planning for the unforeseen can be what helps transition a business successfully. No one wants to contemplate what might happen to the business if you’re suddenly incapable of running it, and you most likely have key man life insurance that can help cover certain things, but do you have someone in the house who can step in and keep the business afloat in your absence?. Having such a plan in place, and making sure everyone involved in the plan is on board, could help your business continue to be successful during a transition period.

Developing that type of plan also presents your company as more valuable, since it’s not viewed as being solely reliant on one person to run the operation.

After all those years of working to build a respected business, you want to be able to recoup the most value out of your efforts. With a little planning, you just may be able to set yourself up for a better than expected payday in the future.

[1] 2013 “State of Owner Readiness” Survey

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. Complete an Exit Readiness Assessment for yourself.