Exit Planning Tools for Business Owners

entrepreneurship

Four Basics of Exit Planning 1: Valuation

by

There are four basics an owner should address before beginning any exit, succession, or transition plan. They are Valuation, Distance to Goal, Prospective Buyers, and Professional Team.

First, my apologies for missing a tri-weekly post. Between trips to Denver for BEI’s National Exit Planning Conference, Dallas for a client, San Antonio for our own XPX Exit Planning Summit, Nashville for the national EPI Exit Planning Summit, and St. Louis for Archford’s Metro Business Owner Summit, I kind of lost track of my posting schedule.

Here is the first of the four basic requirements. I promise not to dally in posting the rest of the full set.

Understanding Valuation

Value is the starting point for all transition planning. Any decision, any business plan, and every retirement projection (either for time frames or finances) must start with the value of your business today.

Knowing the value of your business is different from thinking you know it. I talk to many owners who say “I met a guy at a trade show, and he told me that he knows a guy with a business just like mine who sold his company for five million dollars. I think I’m a little bigger than he was, so I know my business is worth at least six million.”

Sounds foolish? How about “My accountant says that all small business sells for about five times earnings.” Or “Everyone in my industry knows that all companies like ours sell for one and a half times revenue.”

Any valuation estimate that is in the same sentence as “all,” or “everyone” is a crock. Multiples may serve as guidelines, but the value of a specific business is always unique to that business.

How much is a manufacturer of disposable paper products worth? What if they specialize in paper straws? How much does that value change every time McDonald’s or Southwest Airlines announces that they are switching to paper straws? How much is it worth if it is the last paper straw manufacturer in the USA (like Aardvark® Straws?) If you understand the value, your mental estimate should have changed with each sentence.

Every change in the above paragraph described an intangible. Events and market conditions are as important, or in some cases more important, than last year’s numbers. Valuation starts with profitability and cash flow, but the real price that someone will pay for a business lies in the intangibles.

Intangibles

There are scores of intangible factors affecting business value. Most are related to customers, employees, or systems. Ask yourself these questions (although there are many more.)

  • Customers:
    • Do you get more than 20% of your sales from one customer?
    • Is your revenue recurring (by contract) or a series of one-time transactions?
    • Is your value proposition more than just “good service?”
    • Are steady or repeat customers increasing their purchases?
    • Can you forecast their purchasing accurately?
  • Employees:
    • Do you have managers that can run the day to day operations without you?
    • Are your key employees too close to retirement age?
    • Is turnover too high, or nonexistent?
    • Are important positions cross-trained via a formal process?
    • Do you have non-competes and/or long term retention incentives?
  • Systems
    • How accurate is your budgeting when compared to historical reality?
    • Are all processes documented and followed?
    • Is equipment carefully maintained?
    • Our proprietary systems and knowledge protected?
    • Do you track the effectiveness of sales and advertising expenses?

All valuations begin with profitability and cash flow. Most business appraisals take at least a cursory look at a few of the intangibles listed above. Buyers, however, will look at all of these factors and more.

Understanding the four basics of exit planning starts with valuation. If you don’t know where you are, it’s tough to plan where you are going.

For over twenty years, business owners have asked me “What can I do to increase the value of my company?” My answer is always the same.

“Exactly what you should be doing to improve it every day.”

Do you think you know the value of your business? Try the “Sellers Sanity Check,” a free tool at YourExitMap.com

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

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

Exit Planning: Ripples and Ripples.

by

Every stone thrown into a pond creates ripples. Every advance in technology does the same.

The late Stephen Hawking said that we were progressing too quickly. Along with other technology and science notables, he argued for a slowing down of development in Artificial Intelligence (AI).

Most current “AI” is actually machine learning. As computing speed increases exponentially, the ability of a computer to calculate, test hypotheses and weigh varying outcomes increases as well. Computers can now beat the best humans at every game ever invented. From Chess to Go, and from Texas Hold ‘Em to Ms. Pac Man, binary geniuses are sorting through billions of possibilities, and even being credited with rudimentary “intuition.”

But Machine Learning isn’t intelligence. A computer can sort through every chess move possible, but has trouble deciding what to do when a person with a bicycle steps out between two cars.  What if the correct answer is to swerve into oncoming traffic? A computer can’t make that call.

Robots on the Roads

That doesn’t mean you can be smug about what is coming. Take autonomous trucks. Clearly they aren’t smart enough (yet) to negotiate narrow city streets, bumper to bumper traffic jams or unload oddly-shaped cargo. That would require some real intelligence. But they don’t have to. They can just take care of the 80% of the easy stuff, long haul driving. Automatically driving great distances on relatively clear roads is completely feasible right now.

What if autonomous trucks were limited to driving from 8:00 PM to 6:00 AM? A few lanes on interstate highways could easily be electronically tagged for higher speed,  and robot-truck only use. They can follow more closely, having both quicker reaction times and the connected ability to “see” what is happening further ahead. A truck that doesn’t have to stop for food or sleep could cover a lot of ground in ten hours of high speed driving. Daytimes would be reserved for human-operated local delivery.

Ripples in the Pond.

How much would that affect trucking and other industries?

There would be far fewer driver jobs, although most drivers would likely be closer to home.

Traffic would be greatly lessened during the day. Good, you say? Tell that to the paving contractors, sign companies, crane operators, orange cone manufacturers, lighting and signal electricians or bridge builders. It could be decades before we have to expand highway capacity again. With the speed of technological advancement, decades could translate into “never.”

Is this good news for truck stops, all night diners, and budget motels? Heavy equipment manufacturers? Civil engineering companies? Public sector spending on highway construction is almost $100 billion every year. For comparison, that’s about the size of the whole digital/streaming TV and video industry.

Returning to the trucking industry itself, I doubt that trucks will remain as “one size fits all.”  Current testing is on models than can be autonomous, but also accommodate a human driver. The latter will go away. Robotic models can greatly reduce size, be more aerodynamic, and weigh less. They would also be more fuel efficient, and could be electric.

Uh oh. Trucks consume almost a quarter of all the petroleum products used in the U.S. That starts the conversation about the impact on oil companies, the fuel distribution network, gas dispenser manufacturers, drillers, pipeline construction, tank fabrication and installation…the ripples continue.

As an Exit Planner, I’m predisposed to look down the road, and to consider the risk in every transfer. Not all scenarios are doom and gloom, and many new industries will be born, most of which I can’t imagine.

I guess my message is that none of us should be smug about the future. If the financial community sees a threat on the horizon, expect lenders and investors to run the other way, fast. We watch the stones. They watch the ripples.

 

 

Succession Planning – Ownership Lessons

by

When selling your business to employees or family, ownership lessons rise to a special level of importance. Regardless of the financial, inheritance, estate or valuation aspects of the plan, the real question is how to prepare your successors to run the company.

I’ve written before about the Luxury of No Resources. When you started out, making mistakes was part of your business education. The company was small, so the mistakes were small. Now you’ve built a substantial enterprise, and your successors can’t afford to learn by trial and error. (Especially if you are depending on them to be successful enough to pay you for the business!)

Experience is what you get when you don’t get what you want. We  learn very little from our successes. (“Hey, it worked! I guess I’m just brilliant.”) We learn a lot more from our failures. (“I sure as hell won’t let THAT happen again.”)

Trial by Fire

For many founders, business started off well because they had customers lined up and some reputation in their field. Their real learning experience came when a large customer defected to a competitor, or there was a recession, or a key employee quit. That’s when we learn fast how to pay attention to the numbers and solve problems on the cheap.

So how do you prepare new ownership without having them go through the same trials by fire? Here are a few suggestions.

  • Segregate a department or division as a profit center. Make the manager in charge prepare a budget, generate independent financial statements and take on all of the HR responsibilities.
  • Use history to teach. Take a past bid, order, customer or product for which you already know that there was a bad outcome. Have the employee make the decision again, and use the historical experience to discuss together whether it would turn out better or worse with the employee’s decisions.
  • Tie one hand behind their back. Task them to train a group of new people, but without your training manager’s help. Have them open a new territory without your marketing department. Help them to understand that the resources you provide may not always be there.

Of course, you will still be there to head off mission-critical errors. Letting them fail with limits on the damage, however, will render ownership lessons that prepare them for when you aren’t there.

 

Transition Tribulations

by

This article in Financier Worldwide of the United Kingdom quotes me extensively. I thought you might like to see it. (My spellings were changed to British standard.)

Transition tribulations: exiting a family-owned business

by Fraser Tennant

When the owner of a family business decides to call it a day in order to enjoy the fruits of his or her labour, the transfer of ownership can be a challenging process. What is more, in the US in particular, transitions of this nature are becoming ever more common.

Indeed, as highlighted in JC Jones and Associates LLC’s white paper, ‘Exit Planning for the Family Owned Business Owner’, more than 70 percent of privately owned businesses in the US will change hands in the next 20 years. At an estimated $10 trillion, it is the largest intergenerational transfer of wealth in history.

In terms of today’s retirement-minded family business owners, what is required is a well-conceived exit plan, one that sets clear and realistic objectives. “An exit plan is a strategic process detailing the financial, operational, management and ownership changes that will take place as leadership is transitioned,” states the report. “A well-thought-out plan is required to meet the personal goals and timeframes of owners and to monetise their business.”

Myriad issues

When the decision to depart a business is taken, there are myriad exit or succession planning (the primary emphasis of which is family) strategies to be considered and a multitude of questions to be answered. What will happen to the business when the owner moves on? Should the business be sold? Will the owner’s children want to carry on with the business, and, if so, is there a successor ready to assume the leadership? How can a maximum return from the business be ensured? These are just some of the key issues.

In many instances, a family business owner may have no choice but to pursue exit rather than succession, as there is no next-generation family member ready, willing or able to take the helm. That said, for those owners who do have the option of transferring ownership elsewhere in the family, statistics are not encouraging.

Stephen Pascarella, owner of Pascarella and Gill, PC, notes that less than one-third of family-owned businesses survive the transition from first generation ownership to second. According to Mr Pascarella, three main challenges are likely to arise. First, transferring when parents are not financially ready. This is a premature move which could be devastating to retirement planning and financial security, as retirement funding may draw from the business, impeding possible growth. Second, transferring to children who do not know how to run a business. Many business owners forget that new owners, most often their children, must possess the skills to run a business. Finally, attempting to give everyone equal shares. When multiple family members are involved, dividing a business equally may not be in the owner’s best interests. For business owners, it is crucial to remember that management and ownership are two separate issues.

Exit and succession strategies

When a business owner decides to make an exit and there are children employed in the business, a layer of complexity is added to the planning process. According to John Dini, president of MPN Inc, in this scenario there are three relationships between family members at work.

First, there is the blood relationship between parent and child. Second, there is the management relationship, not only where a child reports to a parent but when a child is, at least nominally, in charge of siblings or even the children of siblings. Third, there are the ownership relationships. Does ownership pass according to the blood relationship or in proportion to the management responsibility? Are children who are not working in the business included in ownership? What rights do they have to determine the course of the business? In today’s extended families, where these questions frequently encompass step-children and in-laws, it is a complicated business.

“A family successor should be ready, willing and able to run the company,” says Mr Dini. “However, if he or she is not, all may not be lost. There are a number of succession plans where employees who are key to successful operations are included in ownership or otherwise financially motivated to spend a lifetime within the business. There are numerous incentive plans, including stock appreciation rights, phantom equity or other forms of deferred remuneration that can compensate a critical employee based on company value, without actually issuing ownership.”

For Nadine Kammerlander, professor of family business at WHU – Otto Beisheim School of Management, the main challenge is to find the ‘right’ next owner and at the right time. “Family business owners often start thinking about their exit at too late a juncture and often have unrealistic expectations,” she suggests. “Moreover, they often underestimate the difficulties of finding an individual to take over a firm, overestimate the future potential of the firm as well as its value due to emotional attachment, neglect legal, regulatory or tax issues that might impede the sale, and can be reluctant to cede control.”

Whether it is a matter of unrealistic expectation, misplaced emotion or wasteful procrastination, the likely outcome is that the sale will not proceed as smoothly as intended, with the business owner forced to restart the process more than once. “When considering suitable strategies, family business owners first need to decide whether they want to pass on ownership and management to the same individuals or split them, for instance by giving the ownership shares to the children and hiring an external chief executive.”

In terms of selling the business, a family owner has several choices, such as bequeathing to a family member, an employee via management-buy-out (MBO), another individual previously unconnected with the firm, via management-buy-in (MBI), or a competitor. “These strategies vary across the dimensions of sales price, professional management and continuance of firm tradition,” adds Ms Kammerlander.

Valuation

When it comes to assessing the value of a business there are a number of options to ensure valuation reflects both current worth and future potential. How this valuation is determined very much depends on the type of exit strategy the owner has chosen to pursue.

“While selling a business to a competitor will probably generate the highest value, it may lead to a loss of more than 25 percent of the business proceeds due to taxes and advisory fees,” says Mr Pascarella. “External transfers, such as a sale to a competitor or private equity group recapitalisation, use synergy value and investment value. In contrast, internal transfers, such as an employee stock ownership plan (ESOP) or gift or sale to family, use fair market value where discounts may apply.”

Choosing the exit option most conducive to maximising value is, therefore, critical, as is obtaining well-qualified and experienced assistance. “A qualified valuation professional will consider both historical and projected value,” affirms Mr Dini. “But in a family transfer other considerations often take precedence over fair market pricing. What are the retirement needs of the parents? Is the estate being ‘balanced’ between children active in the business and those who are not? Is stock being transferred via a more arms-length sale process? And is the focus more on tax-reduction strategies, such as gifting or trusts?”

The worth of a valuation expert is clear, but caution should be exercised when securing a specialist. “Given the importance and complexity of the process, experience and support is required,” agrees Ms Kammerlander. “However, there are a large number of so-called advisers that may lack the required competencies, experience and attitude. A careful selection is needed.”

Another issue is that owner-managed firms often lack proper documentation. “Such a lack of transparency makes it difficult for outsiders to recognise the real value of a firm and might lead to a lower-than-desired sale price,” adds Ms Kammerlander.

Reaping rewards

With the sale of a family business often the culmination of a lifetime’s work, departing owners want to make the right choices, avoid missteps, keep regret to a minimum, and reap the rewards of years of endeavour.

“Sometimes a business has served its purpose,” says Mr Dini. “If all the children have moved on and are successful in other pursuits, then the company should be sold to a third party. “Few owners are more unhappy than those forced to return to a family business out of a sense of obligation to their parents, regardless of any related financial success. Their misery might be exceeded only by those who spent a lifetime in the company, only to see it sold to strangers because parents thought it was the only way to monetise the fruits of their labour.”

It is important for owners to consider both financial and non-financial issues. As regards the former, owners need to start thinking about the manner of their exit sooner rather than later. The more time dedicated to the search for the ‘perfect’ successor, the more likely that search will be successful.

In terms of non-financial considerations, the owner needs to reflect upon his or her goals before entering the exit process. What is most important? Is it the sale price? Is it the continuation of the businesses’ name? “A clear answer to such questions helps the exiting owner to achieve a satisfactory solution,” believes Ms Kammerlander. “Communication with family and other stakeholders is also crucial. If a family business owner sells, unaware that his or her children were interested in taking over, there is a high potential for ongoing family conflicts.”

To make the transition from business owner to retiree as smooth as possible, Mr Pascarella’s advice is to follow a five-step process: (i) establish exit goals; (ii) measure financial and mental readiness; (iii) learn and choose the optimal exit option; (iv) understand the business value of the option chosen; and (v) execute the exit strategy plan to achieve exit goals.

Complex and emotional

Exiting a family business is clearly a complex and emotional undertaking – a process requiring careful advance planning and much resolve, especially when the business is the largest single asset in an estate.

Moreover, once the decision to depart has been taken, there should be no procrastination. “This can lead to disaster with a great deal of vicious, internecine squabbling,” warns Mr Dini. “If an owner wants his or her children to remain on speaking terms, they owe it to them to discuss and define what will happen as the business passes, or not, to the next generation.”

Ultimately though, family business owners want to harbour no regrets over the decisions they make when the time comes for them to pass over the reins and transition to the next stage of their lives.

© Financier Worldwide

Your Transition Advisor Team

by

Nothing impacts the success of your business transition more than the advisor team. Let’s say you receive a free pass to play in the Super Bowl. You will be playing against the New England Patriots, but you can choose any NFL player not on their roster for your team. Who would you pick?

There are a multitude of opinions about who is the best quarterback, wide receiver or free safety. One thing is pretty certain. You wouldn’t choose the guys you grew up playing touch football with. At least, not if you wanted to win.

Owners feel loyalty to the trusted advisors they already have relationships with. “He’s the attorney who handles all my legal problems,” is a bit like saying “He’s the doctor I always go to when I feel sick.” That is fine, but what if you needed a heart transplant?

Professionals are Specialists

All physicians went to medical school. In residency, they took rotations in surgery, obstetrics, pediatrics and infectious diseases. That doesn’t mean that twenty years down the road you want someone delivering your newborn child unless he’s practiced it a lot.

Just as there are many physicians, there are many attorneys and CPAs. They all have some training in all aspects of law or accounting. It is required to pass the bar or to get certified. But if your attorney spent the last twenty years doing real estate closings, or your CPA spends most of his time preparing tax returns, he or she may not be the right advisor for the biggest financial transaction of your life.

Business transitions aren’t simple. Even the asset sale of a small business has tax pitfalls that can easily trap those who don’t know what to look for. I recently heard a story about an owner who sold the stock of his company. He was ecstatic about getting the lower capital gains tax rate, and put that money aside for when he filed his return.

Unfortunately, neither his attorney nor his CPA thought to include a prohibition against the buyer declaring a Section 338 (h) 10 election. While not common, it allows a buyer to recast the transaction as an asset purchase. The seller has little say in the matter. Over a year after the closing the seller saw his capital gains turned largely into ordinary income. At that time, it meant a tax bite for about 20% more of his proceeds.

Choosing an Advisor Team isn’t Disloyal

Your traditional CPA can continue to do your tax returns. Your traditional attorney can still take care of your normal business and personal legal needs. For a transaction, however, you want someone who deals with the sale and transfer of companies on a very regular basis.

Unfortunately, some practitioners are insecure. They are afraid if another  professional is called in they will lose a long-time client. Their usual claim is something like “I haven’t done many (or any) of those, but they are pretty straightforward. I’m sure I can handle it.”

Those who are more confident in your relationship, or more successful in their specialty, will say “I don’t do enough of those to be fully confident of doing the best job for you. Let me recommend someone who has more expertise than me.”

The other issue is often cost. I’m regularly dismayed when I ask why someone uses a particular professional, and the owner answers “Because he’s cheap.”  Would you pick a physician using that criteria? Good help costs money.

Selling your company is your financial Super Bowl. You want to put together the best advisor team possible for that one game. Afterwards, you can go have a beer with your buddy from the sandlot. You’ll still be friends, and he will (or should) understand.