Exit Planning Tools for Business Owners

exit planning

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.

If you know a business owner who would benefit from “Awake at 2 o’clock,” please share!

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Selling Your Business: Money isn’t Everything

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When I was a kid my mother said “Money isn’t everything” in response to every envious glance at another kid’s stuff. As I became successful enough to afford things for my children, I reversed the meaning. “Money isn’t everything” became my reminder that their possessions didn’t make them better or happier than others.

The same holds true for companies. An entrepreneur who is struggling to generate sufficient working capital is an unlikely prospect for a lender, let alone an investor.

I regularly receive approaches from business owners who have a great ideas, but have run out of capital without generating cash flow.  They usually have trouble understanding why I don’t want to represent them in their investment search (for a fee contingent on only my success, of course.)

“But everyone says there is plenty of money looking for deals,” they say. It is true. There is always more money available than good investments. That’s why so many investments lose money.

Once your business approaches $1 million in annual earnings, the whole capital landscape changes dramatically. If you are scalable (meaning you likely have around 100 employees or more) your deal is attractive to financial investors such as private equity groups. There are currently about 7,000 such buyers in the US, pursuing the 17,000 or so companies who meet their criteria.

These buyers range from Search Groups (who have investors lined up if they find a company), to investment funds with a billion dollars or more in “dry powder” (cash in the bank).

If you are smart, and clever, and tenacious, and lucky, you can reach the point where there is plenty of money to buy you out. In fact, money is probably chasing you. Most sellers, however, come to realize that money isn’t everything.

shark with dollarThe M&A world abounds with horror stories of financial buyers who stripped the employee benefits from a company and drove off its key personnel. Others pulled their capital as soon as they had control (to leverage it in another deal) and left the business staggering under the debt replacing it. Still more inserted a Hired Gun executive from another industry whose inexperience quickly ran the business on the rocks.

That might not be your concern if you walk away with a terrific multiple, but if the deal (like many) requires you to leave a substantial amount on the table for a few years, it’s critical.

I work with business owners in their exit planning. Although I haven’t brokered in years (meaning list and market businesses for sale), I regularly advise owners who are dealing with an approach from financial buyers. Here’s my mental checklist for vetting a financial buyer:

  1. Do you trust them? Can you see working side by side with them as your partners?
  2. Do they understand your business and your customers, or are they just looking at your financial statements?
  3. How important to you is the future of your employees and your reputation?

Notice that the questions don’t include “How much money do they have?” If you are attractive to one financial buyer, you are probably attractive to a lot more.

Many of my clients, when they examine the non-financial aspects of selling, choose alternative exits. They arrange for the employees to buy the business, or merge with a friendly competitor. They may not make quite as much, but money isn’t everything.

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What’s in YOUR Nondisclosure Agreement?

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A Nondisclosure Agreement (NDA) has become one of the basic standard documents in every company’s wallet. Between the rising swell of Baby Boomer owners entertaining exit planning, and greater caution surrounding the legal issues of strategic partnering, an NDA is now the standard next step following many initial exploratory conversations.

What should you protect in an NDA? (Note: I am not an attorney, and I don’t create Nondisclosure Agreements for clients.)

Secret informationFirst, there is the question of who is covered by the agreement. Most allow for advisors to each party to see the agreement. That can encompass accountants, attorneys, consultants, bankers and employees. I think employees present the greatest risk, since they are the most likely to personally benefit from information about customers, vendors and pricing.

Some attorneys include language requiring every person who shares the information to sign and return a separate copy. That is cumbersome, and opens the question of enforcement. If you talk to someone on the other side of the transaction, and don’t have a signed copy of the agreement first, have you voided that condition yourself?

Try to keep the responsibility for protecting information with the other side. One mechanism is to have each person who sees information add their signature to the agreement, with language that makes it the other party’s responsibility to only share with signatories. At a minimum, the other party should be required to make certain everyone on their side is informed of the confidential nature of the information. Electronically stamping everything “Confidential” and converting it into pdf is also a basic caution.

Then there are decisions about what information to share. Most potential acquirers are concerned about customer concentration in sales. They will ask for customer purchasing history as one of the first items in preliminary examination of your company.

That is a legitimate concern, but it doesn’t mean they need the names of the customers until much later in the process. We provide redacted reports, identifying customers by letters or numbers.

The same type of common sense applies to vendors, employee compensation and margins by product line. You can provide sufficient information for valuing the business without the details. No matter how honest or well intentioned the other party may be, he or she will remember that you are making 10% more on a specific product, or are selling substantial amounts to a customer they thought was all theirs.

Finally, we recommend that the Nondisclosure Agreement go beyond just keeping information confidential. It should always include a non-employment clause regarding your employees. Non-solicitation is okay, but it’s hard to prove if the company claims the employee approached them. Just make it simple; they can’t hire any employee for two years following your discussions. You may be surprised at how many potential partners balk at this condition.

Always have a qualified attorney draft any Nondisclosure Agreement, but there is no need to go wild. One page is typically insufficient, but more than two pages and you are usually loading it up with conditions that are either irrelevant or unenforceable.

No NDA will stop someone from being dishonest. It is intended to make plain what you consider yours, and how you expect it to be handled. As in any other business transaction, what’s written on the paper doesn’t replace trust.

 

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What the Heck is Exit Planning?

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The wave of Baby Boomer retirements is beginning. I’ve been writing and speaking about exit planning nationally for the last ten years, (you can download my free eBook on the subject here), but the inevitability of the demographics is gaining momentum.

Today, Boomers in their late 60s are starting to sell the businesses they’ve built over the last 30 years or so. They are just the tip of the iceberg. Millions more are steadily approaching their career finish lines at a rate of hundreds every day.

Exit Planning is a new discipline, developed to meet a massive market need. Unfortunately, like any new service offering, there are a lot of people who use the term without fully understanding it, or in hopes that it will associate them with a growing field of professional practice.

Accountants say they do exit planning when they help clients structure their business and personal holdings to minimize the bite of the IRS.

Estate attorneys say they do exit planning when they protect assets and document transfers of inheritances.

Wealth managers say they do exit planning when they provide retirement projections and validate lifestyle assumptions.

Consultants say they do exit planning when they recommend ways to increase the value of the business, presumably maximizing the proceeds from a sale.

Business brokers say they do exit planning when they value and list a company for acquisition.

Insurance brokers say they do exit planning when they write policies to protect owners, their families  and their companies against premature departures, or the absence of key employees.

Which of these professionals really do exit planning? There are two answers:

  1. All of them
  2. None of them

Exit Planning Map MazeExit planning is the process of developing a business owner’s strategy for what may be the biggest financial transaction of his or her life…the transfer of the business. That strategy may be a succession to the next generation of family. It could be a sale to employees. It may be a sale to another entrepreneur, or acquisition by a larger company. In some cases, it could require an orderly dissolution.

In every case, it involves tax, legal, financial, operational and risk management expertise. No one practitioner (including me) has all the knowledge required for every aspect of the plan. Exit planning, in the true sense of the word, is coordinating all those skills so that they work together for a single objective.

Let’s say, for example, you run a warehouse with delivery services. You decide to make it as efficient as possible.

  • You tell the purchasing manager to only order product when pricing and inbound freight are the least expensive.
  • You tell the warehouse manager to develop a system for picking orders with methods that require the least amount of labor.
  • You tell the shipping department to pack up orders using the least possible amount of material.
  • You tell the dispatcher to plan routes for times with the least traffic and the lowest fuel use.
  • You tell the sales department to promise the customer anything that will close the sale.

Now, without letting any of these people talk to each other, you announce that tomorrow you are implementing all their results simultaneously. You go home dreaming about how amazingly profitable your business is about to become.

You don’t have to be a distribution expert to know what is going to happen. The uncoordinated plans are going to explode when combined. You’ve just come up with a great way to go out of business.

Now, what if you told one manager that your overall goal is to sell more product and give excellent service, so customers would become loyal buyers and the company will increase revenues and profits?  Then you had the other managers report to him, so that all of their plans would compliment the overall objective.

That’s what an exit planner does.

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What is the Right Price?

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Of all the misconceptions by business owners, the ones surrounding their company’s value are both the most common and often wildly inaccurate.

I’ve been working for the last couple of months on the training videos for advisors in our new product, The ExitMap®. (You can take the assessment for free at www.myexitmap.com). In one session, we role-play a vignette about a financial planner discussing the value of a business with a client planning retirement. Part of it goes something like this.

Q: “So Bob, how much do you expect to realize from your business when you sell it?”

A: “I’ve heard from my accountant that most small businesses sell for about five times earnings.”

Q: “And how much would that be?”

A: “Well, I made about $150,000 in salary last year, and another $200,000 in profit. Add in my insurance policies and my car, my wife’s car and a few trips that combined business and pleasure. Say around $500,000 in total benefits. So I’d expect to get somewhere around $2,500,000 for the business.

Q: “What would that be after taxes?”

A: “I’d have to pay capital gains, so I’ll net in the area of $2 million.”

Simple, right? Let’s look at the reality.

abacusBob is calculating what the brokerage industry calls “Seller’s Discretionary Benefits” or SDE. While it is a legitimate way to look at the full value of business ownership, ball park valuations of 4-5 times pre-tax earnings don’t apply to that calculation. Cash flow expensed for benefits (rather than dropping to a taxable bottom line), isn’t included in those earnings multiples. The traditional multiple for a small business sale averages 2.5 time SDE, or half of what Bob is estimating. We are immediately reducing the likely price to something like $1,250,000.

Next, about 90% of small business sales are asset transactions. Only about 10% close as a transfer of stock ownership. Double that tax estimate from 20% capital gains to a 40% ordinary income rate.

Businesses transfer debt-free. So if Bob owes another $300,000 on his credit line, that comes off the top from the proceeds, but the tax is still payable on that $300,000.

So Bob’s $1,250,000 drops to $750,000 after taxes, and to $450,000 after debt repayment. He has lost three quarters of the amount he was planning on for retirement.

The problem is exacerbated when the planner dutifully enters $2,000,000 in his retirement software, assuming that the owner certainly knows the value of his business. That happens more often than I care to discuss.

These misunderstandings are just the tip of the iceberg. There are another half-dozen common mistakes when owners look at their value. In many cases it results in owners being highly insulted by legitimate offers from qualified buyers. I’ve also seen them renege on accepted offers when they finally have a CPA model the tax impact.

(NOTE: I do not perform valuations, give tax advice, or broker businesses. My recommendations here will not generate revenue for me.)

If you are like 85% of all owners and plan to sell your business to a third party, the first thing to do is engage a valuation professional. The second thing is to take that valuation to your accountant for tax modeling. Start your exit planning by embracing reality. You’ll be a lot happier in the long run.

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