Exit Planning Tools for Business Owners

employees

Protecting Your Best Asset

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If you are planning your exit from the business, what is the best asset that you have to sell? Unless you have patented product, exclusive rights, or long-term customer contracts, you answer was likely “Our people.”

employees-in-officeEven if you have strategic differentiation like the ones above, “our people” was still likely a top-three answer. Proponents of Human Resource Accounting correctly point out that few businesses have a bigger investment. Hiring, training and developing talent is at the center of most successful organizations.

But people aren’t chattels. How can someone rationally consider paying top dollar for your successful business when its best asset might disappear the day after closing the sale?

Securing a great price for your company means paying attention to its value drivers. Those include documentation of reproducible processes and quality controls. Customer diversity, long term relationships and a clear marketing strategy are also important. All those pale, however, against the ability to assure a transition of your key people.

The Last Minute Bonus

There are numerous stories in the planning world about owners who neglected to protect their best asset. Some are certainly apocryphal, but they all go something liked this.

Bob was straightening up his desk in preparation to move to his smaller, temporary office. He kept pulling out his phone to check if his bank balance reflected the proceeds from the closing wire transfer. He wasn’t thrilled about spending a few months as an employee, but it was well worth it.

There was a quick knock on the door and Jack, the Director of Sales walked right in. Bob thought of how much that irked him, but he wouldn’t have to deal with it much longer. As usual, Jack got right to the point.

“Congratulations Boss. I know that you put many years into building this company, and from what the buyers just told me, you received a great price. I’ll miss working with you.”

Jack didn’t wait for a response. “That new owner, Carl, seems like a nice enough guy. You know, he told me that I was one of the main reasons they bought this business, and they have big plans for me in the future.”

Bob knew the other shoe was about to drop. “So I was thinking. Considering how important I am to a successful transition, how much of that big check were you planning to share with me?”

Bob thought of the escrow fund in the agreement, and how it required transfer of the company without major changes in personnel. He took a deep breath, wondering how much of it he should use for an opening offer.

Sooner Rather than Later

The time to negotiate a stay bonus is before you start the sale process, not after there is money on the table. Securing your best asset adds value to the business, and greatly lessens the chance that an employee will derail any deal.

Many owners hesitate because they fear telling key employees that the business may be sold. That is a rational concern, but the sooner you bring it up, the more inertia will be  on your side. When things don’t change right away, people tend to go back to what they were doing.

Explain that transitioning is a logical step for every business, and that once you start the process, it could take years. You want to recognize the employee’s contribution, but you also want to make sure that he or she gives any new owners a fair chance.

Stay bonuses very widely, but an additional half-year’s salary is reasonable in return for two years of post-transition service. In some cases, the bonus can involve a percentage of the sale proceeds placed in escrow and paid after the transition period. The benefit can also vest over time, strengthening your short-term retention.

One thing is certain. Protecting your best asset before starting an exit process will be cheaper than being forced to do it afterwards.

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Business Buyers: The “Buy Now, Pay Later” Generation

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If you are preparing to sell your business, your buyers will likely be members of the “buy now, pay later” generation. Generation X is the first demographic group to be raised in a culture that put little emphasis on savings.

Diner’s Club was introduced as the first “charge card” in 1960. By the end of that decade competition from member cards (American Express and Carte Blanche) and bank-owned revolving finance cards (MasterCard and Visa) began placing millions of cards in consumers’ hands.

credit-cardIn a competitive credit environment, advertising for the revolving charge cards was directed to the pleasures of paying for something after you already enjoyed the use of it. The struggle of saving for a long time before purchasing was portrayed as foolish and unnecessary. In the 1980s and ’90s Baby Boomers on the quest for material success embraced the concept wholeheartedly.

This is the environment that today’s prime business buyers between the ages of 35 and 50 grew up in. Americans reached the height of “buy now, pay later” just after the turn of the century. In the early 2000s, when Generation Xers were between 28 and 45 (the prime consumption age range) Americans spent about 2% more than they earned annually.

That was a great formula for boosting an economy, but a lousy way to amass capital for investment. That credit-fueled boom died a gruesome death in 2008, and many debt-laden Xers haven’t yet recovered.

These are the buyers for your business. Many have grown up believing that personal financial management consists of parsing a paycheck to allow enough for food after their installment payments. The US savings rate has since recovered to a more normal 5%; much of it fueled by Boomers belatedly preparing for retirement.

If you’ve spent the last 30 years or more building a business worth a million dollars, you need to find one of these folks who has put aside at least $300,000 or so to buy it outright (a down payment to qualify for financing plus initial working capital.) There are such buyers, including escapees from corporate life with substantial retirement plans and those who will be inheriting their parents’ savings.

Most buyers, however, don’t have that kind of money. If you want to realize full value for your business, you may want to think about how to accommodate a “buy now, pay later” approach. A buyer who writes a check is more appealing, but good business logic seldom results in complete dependence on a long-shot strategy.

There are four ways to sell a successful business to folks who have no money. The more time you have to implement a plan, the better its chances of success. In order of my preference they are:

  • Best – Sell to Employees. A five to ten year period is usually sufficient to get a “down payment” (25-35%) into employees’ hands via stock incentives. The best scenario is earning the awards by growing the value of the business. In a strong company, the owner can leave with the full proceeds in his or her pocket, and remain in control until retirement.
  • Better – Hire Your Buyer. This is similar to a sale to employees, but you use the equity plan to recruit a more highly qualified individual than you could otherwise attract. It is better in the sense that the buyer may be stronger, but the time up front to make sure he/she is a good fit represents a risk.
  • Good – Finance the Down Payment. For many lenders, including the SBA, stock sold via a subordinated note can qualify as a down payment. It means you walk away with 65-75% of your money, and leave the rest in the business until the first-position lender is comfortable with the stability of their risk.
  • Worst – Finance the Purchase. This is often the scenario for an owner who waits too long to consider the options. Whether the buyer is an employee or a third-party, you sell the company for a promissory note and hope for the best.

You have options, but they disappear one by one as you get closer to your exit. That’s why we encourage planning. Having a plan in place doesn’t require immediate implementation, but it does help when evaluating opportunities.

For more on Boomers and Buyers, you can download my free eBook Beating the Boomer Bust.

Following my own advice, I am leaving on my biannual sabbatical. Awake at 2 o’clock will resume on November 6th. In the meantime, please share it with another business owner. Thank you.

Is Your Business Built on Individual Heroics?

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Great employees are a wonderful gift, but individual heroics aren’t healthy for your business.

Someday, you will start thinking about leaving the business. Perhaps you already do. When you begin planning for your transition, what will your company systems sound like when you describe them to a critical buyer?

“Yes, we have a process for that. It hasn’t been updated, but Martha knows it like the back of her hand.”

“We really don’t have anyone cross-trained on that machine. Bucky likes to work alone, but it’s okay because he hasn’t taken a vacation in three years.”

“We always use Andy on that route. There are lots of traffic snarls, and he’s the only one who seems to be able to finish on schedule.”

You are getting the point. When an employee is especially productive or reliable, it’s easy to become dependent on his or her individual heroics. It’s one fewer function of the business that you have to watch.

heroic workersIt is ironic that the very behaviors that make your life easier appear to be threats in the eyes of a prospective buyer. You know that they could pose a problem, but they haven’t so far. Why fiddle with what’s working?

The answer is because individual heroics discount the value of your business. A buyer worries that key workers might not like his or her management style. As a new owner, he might be immediately approached for pay increases. Worst of all, if one of your heroes’ performance heads south, he may not be able to fix it, or even know what is happening.

For just a moment, look at your best employees as threats. Do you have a contingency plan for each? Can Martha’s process be documented so anyone can do it? Is Bucky just a loner, or is he trying to make himself irreplaceable? Can Andy’s mental map be duplicated by routing software?

And in case you didn’t realize it, “I can do any of those jobs myself. ” is the worst of all possible answers. Those kind of individual heroics will send the buyer towards the exit instead of you.

Dependable high performers are invaluable, but they are frequently protective of their status. Recognize them, but make it plain that that their work needs to be duplicable. (Although, “Of course, not at the level you perform.”)

If you don’t, start looking at them as liabilities rather than assets.

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The Immortal Business Goes on Forever

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Do you run an immortal business? I hope so. If you answered “no,” or even hesitated to be sure of your response, then you don’t think of your business as immortal.

So when do you plan to shut it down?

Most owners react viscerally to that question. They’ve invested too much time and too much sweat to watch their companies become a memory. They care too much about employees and customers to entertain the idea of  abandoning them.

ForeverFor many, the business is a part of them. Shutting it down would be like having a piece of you die.

Ironically, we play mental gymnastics in our heads every day. We think we have an immortal business. We know we aren’t immortal (on this plane of existence, at least.) Yet, I talk to owners every day who want to pretend that either they will run the business forever, or that it will find some magic way to continue without them.

Anyone who works in exit planning knows the standard answers to the question “What is your exit plan?”

  • “I intend to look for a buyer in about 5 years.”
  • “I still enjoy my business. Talk to me after I get tired of it.”
  • “I’ll sell anything for the right price if someone offers it.”

Each of those answers is a version of “I haven’t thought much about it, and I really don’t want to.” I wouldn’t be much of a consultant (or at least I’d be an impoverished one), if I didn’t have some counter arguments ready.

  • “I intend to look for a buyer in about 5 years.” That’s fine, but five years is about the minimum time you should allow for any serious tax planning. If you are going to take a subchapter S election, create a new entity, or change your  depreciation methods, it will take some time to have the desired effect. Of course, the Internal Revenue Service already has a plan for how they would handle the proceeds, so you could just go with theirs.
  • “I still enjoy my business. Talk to me after I get tired of it.” That is clearly too late. Whether you are selling to employees or family, or marketing the company to third parties,  the business needs to be running well to survive a transition to new ownership. Once you start losing interest, it gets much tougher.
  • “I’ll sell anything for the right price if someone offers it.” Sure but what is the “right” price? Is it based on industry metrics? Is it some multiple that a guy from a vendor told you a competitor sold for? Is it a number you need for retirement that has little to do with market value? If you received an offer tomorrow, how would you know if it was the best offer you might ever see?

The most important thing to remember is this: Planning is only planning. Implementation is a different activity in the management cycle. Just because you have a plan doesn’t mean you will use it today or tomorrow, but it will still be there when you choose to put it into action.

If you own an immortal business, you have an obligation to the folks who depend on it. Part of that is to know how they will be able to continue depending on it when you aren’t there.

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Selling to Employees: Is Your Exit Strategy Right in Front of You?

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When I interview a prospective client for exit planning assistance, we usually explore selling to employees. The first reaction is always “That won’t work. They don’t have any money.”

If you have a company with reasonable cash flow, a talented management team and sufficient time, selling to employees is not only a realistic option; it may be the best way to get value from your business. I’ll define those parameters for you in a minute.

If you haven’t read my eBook Beating the Boomer Bust, follow the link for the free download. My research shows that the hard numbers will inevitably translate into a hard market. There are 3,000,000 Baby Boomers (over 50) who own businesses with employees. Over the next 20 years, that’s an average of 150,000 owner retirements per year. Intermediaries (brokers, private equity and M&A) account for about 9,000 transactions a year.

That leaves a lot of folks looking for a way to cash out. Selling to employees is a process that lets you keep control until retirement. By structuring the sale correctly, you can leave with the proceeds in the bank, not in a promissory note.

How does that work? It requires a bit of mental gymnastics. First, any owner has to accept that the only source of funding for any transaction is the cash flow of his or her company. If a buyer pays cash, he expects that cash flow to pay him back. If a bank finances the acquisition, they expect the cash flow to service the debt. If you finance it, you are the essentially the bank.

Selling to employees is the same. You use the current cash flow to help employees buy stock. In return, they qualify by working to increase the value of the business until your final return is equal to (or more than) what it was when you started.

Think of it as taking a note for 30% of the purchase price while you are still in control, so that you can get a 70% cash down payment when you leave.

Now, let’s discuss the parameters.

Cash Flow: Your company has to be earning more than just your paycheck. My rule of thumb is that around $500,000 a year after owner’s compensation gives enough to work with. More than that doesn’t change much, since then we are usually looking at a higher purchase price. Less than that is doable in a longer time frame, or if the owner is willing to subordinate some debt to the bank.

Management Team: You need at least one decision maker who does more than just go through the operational motions. Any third-party lender wants to be comfortable with company leadership when you’re gone. A large portion of our planning surrounds transfer and documentation of management capability sufficient to satisfy a lender.

Time Frame: Many business owners tell me “I’ll think about exiting in five years.” That’s fine, if your plan is to retire in fifteen years. Generally speaking, the longer you have, the more lucrative an internal sale can be. I’ve done three year plans, but five is much more comfortable, eight years is even better, and we regularly work on transitions of ten years and longer.

all for one one for allSelling to employees requires legal agreements, specialized compensation plans and a willingness to run the company transparently. The return is a team that is committed to the long term, highly motivated, and all on the same page when it comes to growing the business.

Why should you consider selling to employees?  Because your company lives on with the culture you created. Because you can choose the value, not negotiate it. Because your employees aren’t comparing your company with other investments. Because you control the timing of your exit.

Because it is probably the biggest financial transaction of your life.

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