Exit Planning Tools for Business Owners

exit strategies

Your Transition Advisor Team

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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.

 

 

Selling Your Business – the Buyer’s Eyes

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Selling your business is much like selling a house. In order to realize the highest price possible, you want it to look its best.

The other day I passed an independent gas station/convenience store. The marquee at the curb advertised  their price for “unlead” gas. Really? Unleaded fuel has been required for new cars since 1975. Lead was completely banned as an additive 22 years ago. That means anyone who has bought a new car in the last 40-plus years, and every driver under 40 years old, has never purchased anything but unleaded gas.

What does that indicate about the maintenance of the business? If it has been decades since they updated their sign, what have they done with their refrigeration, roof, and other, more costly items of the infrastructure? Their P&L and cash flow are suspect, and due diligence will be more extensive. All because the first thing you see is an outdated sign.

First Impressions Count

In Steve Martin’s “LA Story” his girlfriend (Marilu Henner) checks her wardrobe by closing her eyes, spinning around in front of the mirror, opening her eyes, and removing the first thing she notices.

Very early in my working career I was in retail. My training manager taught me the same technique. Each day I walked out to the edge of the street in front of the business. I stood with my back to the business and my eyes closed. “Pretend you’ve never done business with us before,” he told me, “Then turn around, open your eyes, and see how our business looks to a new customer.”

I’ve used that exercise ever since. When I was actively brokering businesses, I remained acutely aware of first impressions. A parking lot with weeds in all the cracks or sidewalk seams. A front office with stacks of unfiled invoices on top of the cabinets. A conference room with six month old notes on the whiteboard. An owner’s office that doubled as storage for samples.

My favorite is the “Employee of the Month” board that was last updated years ago.

Staging for a Sale

Most small business owners seeking to sell ask “What can I do to get the best price?” Surprisingly, many pushed back on my staging suggestions. “I’m selling a profitable business, not a parking lot.” “Those invoices show that we are busy shipping product instead of filing.” “If a new owner wants to reinstate the employee of the month, the board is there and ready.”

Selling your business isn’t a joking matter. I want to do the best job I can for the client. If the first suggestions I make are shrugged off, what will happen when the client has to execute the more difficult tasks like preparing due diligence information?

Fortunately there were other brokers who would gladly list any business, in any condition. I was happy to let these brokers put in the effort. My time was too valuable to invest in a client who refused to see his business through the eyes of a buyer.

Subordinated Debt in an Exit Plan

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Subordinated debt can be a key consideration in any sale transaction. Whether you are contemplating a sale to a third party or an internal transfer to employees, the topic of taking second place to a lender will likely come up.

If an outside buyer is financing the purchase, seller notes can be considered as part of a down payment, but any bank will require it to hold second priority to their loan. If the Small Business Administration is involved, they will usually demand that the seller assume some of the risk with a secondary loan. In an internal sale, that will be a requirement.

Risk vs. Reward

As a business owner, you make decisions about good risk and bad risk every day. You extend credit to customers, and spend money on marketing or expansion based on your projection of a future payoff. Subordinated debt is just another risk/reward consideration.

It may allow you to get a higher price (eventually) than demanding an all-cash deal. It can also be the deciding factor in qualifying a buyer for outside financing for the majority of the purchase.

In an internal sale, subordinated debt is frequently a trade-off for time. An exit date may be your choice, or driven by outside factors such as health, family needs or increased competition.

When your target departure date is close, especially if it is two years or less, it is difficult to transfer enough equity to employees for them to qualify for 100% outside financing. The percentage of  the risk that you are willing to bear has a direct impact on what another lender will do.

If you need to leave in less than a year, financing the entire transaction might be your only choice.

Qualifying Subordinated Debt

Some brokers tout the tax advantages of installment sales with 100% seller financing as the best way to sell a business. In my experience, it is more likely to attract unqualified buyers. No reduction in tax rates comes close to the advantages of cash in your pocket.

It’s true that unsecured loans usually carry a higher interest rate due to the lack of security. That might be tempting, but no interest rate is attractive if you don’t get paid.

As a lender, you have the same interest in choosing a qualified buyer as the bank. Using subordinated debt to serve your purposes is a valid tactic. Using it simply because you are the lender of last recourse is probably not.

 

Business Buyers and Disintermediation

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In the last post, we discussed the reluctance of many prospective business buyers to deal with the regulatory burden of being an employer or service provider. You may be among the lucky few whose profession doesn’t require licensing. Even better, you may have qualified employees who are able to run the business without you.

There are other issues that concern younger buyers, however. One of these is the threat of disintermediation. That’s a trendy word for what we used to call “bypassing the middle man,” but it applies to many businesses that are being made obsolete by technology.

Disintermediated Businesses

How many business people still rent cars to attend a couple of meetings in a city? With Lyft and Uber, it is frequently easier to call a ride than leave a car in the (expensive) hotel parking for 90% of a visit. I’d be very skeptical of buying a car rental business today.

What happens when (not if) autonomous vehicles become part of daily life? Long-haul trucking will move to non-peak traffic hours, reducing the need for drivers, training schools, highway expansion, truck stops, and perhaps the number of trucks themselves.

Service businesses where the middleman lends expertise (easily duplicated by Internet research) or access to vendors are feeling the crunch already. The warning bell is sounding for mortgage companies, real estate agents, insurance and benefit brokers, employment agencies, printers, publishers, and travel agents.

These businesses won’t go away, but there will be fewer of them, and their margins are eroding.

The rise of robotics and artificial intelligence threatens even the most skilled professions. Legal databases, automated interpretation of medical imaging and free online tax filing are a few examples.

This quote is from a  February 21 essay by Rob Kaplan, President of the Federal Reserve Bank of Dallas.

As I have been discussing for the past two years, technology-enabled disruption means workers increasingly being replaced by technology. It also means that existing business models are being supplanted by new models, often technology-enabled, for more efficiently selling or distributing goods and services. In addition, consumers are increasingly being able to use technology to shop for goods and services at lower prices with greater convenience—having the impact of reducing the pricing power of businesses which has, in turn, caused them to further intensify their focus on creating greater operational efficiencies. These trends appear to be accelerating.

The Impact on Sellers

The overview of the business seller’s marketplace is straightforward. As I’ve been proselytizing for over a decade in my “Boomer Bust” presentations and books, selling a business will be more challenging, but that doesn’t mean any particular business is unsellable.

As with any other competition, the response is to create differentiation from the rest of the pack. There are a few key factors that top the list of appealing differentiators for business buyers.

  1. Build a business that can run without you. The more you work in your business, the less it is worth.
  2. Train effective management. Employees who understand how to run a profitable business are highly appealing to any prospective buyer. In addition, they can provide you with an alternative to a third-party sale.
  3. Upgrade the value-added component of your offering. If the only benefit you offer to a customer is time and place utility, you are probably toast.

There is another factor that may sound counterintuitive. Design your business so that it requires more expensive employees. If low wage workers are the backbone of what you do, you risk losing the technology arms race with larger competitors. I’ll expand on this in my next post.

The population of business buyers is younger, more technologically savvy, and less inclined to long hours than the generation that is selling. Winning in a competitive marketplace demands that you offer what business buyers want.

 

What’s Wrong with the Buyer Generations?

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Many of the upcoming buyer generations can’t or won’t run Baby Boomer businesses. This is (or should be) of concern to sellers everywhere.

“The children now love luxury; they have bad manners, contempt for authority; they show disrespect for elders and love chatter in place of exercise. Children are now tyrants, not the servants of their households.” Attributed to Socrates by Plato.

Elders have been complaining about their offspring for 2,500 years. The complaints change only in the activity bemoaned. “Chatter in place of exercise” is replaced by those damn radios, or automobiles, or television, or rock’n’roll, or cell phones or texting. It’s amazing when you realize that we’ve somehow managed to thrive through eons of generational deterioration.

The Buyer Generations

But one thing is true. Generation X and the Millennials are not attracted, as a group, to many of the businesses run by Baby Boomers. We’ve discussed the macroeconomic trends, demographics, sociographics and psychographics, at length in this column and in my latest book Your ExitMap: Navigating the Boomer Bust.

For the next few columns, we’ll talk about other forces that deplete the number of available and interested buyers, and what you as a seller can do about them. Note that I said “deplete” the number. An attendee at one of my presentations a few weeks ago raised his hand during Q&A and said “There will always be someone willing to buy a profitable business.”

That is probably true, but in any competitive sales situation the challenge is to find and attract a qualified buyer. Most of us do that by targeting our offerings to the buyers we seek, then making certain they are aware of what we are selling. The buyers we seek are those who are willing and able to pay the price we ask. In other words, we play the odds. What we are discussing here is finding willing buyers who are able to pay your asking price.

Regulatory Obstacles

One issue in selling your business is the regulatory environment. Since the 1970’s, Americans have come to accept that basic business qualifications should be legislated. Some 30% of all products and services now require some form of government permission (licenses or certifications) to operate.

When the owner of a business is the sole qualified practitioner for its offerings, he or she has a problem. Selling the business requires either continuing to work in it personally until a new owner is legally qualified, or providing licensed employees with some insurance for the new owner of their retention. (See our column on Stay Bonuses.)

This issue drives many owners’ decision to sell the business to qualified employees. You can include a few licensed practitioners in an ownership group, frequently combining them with non-licensed managers or executives who are more suited to running operations. With a few years of advance planning, an owner can exit with the sale price in hand on the day he or she gives up control.

To be blunt, if you are the only person legally capable of creating, presenting or approving the work of your company, you have a job more than a business. The first step in preparing a saleable enterprise is to make sure it can operate without you.