Exit Planning Tools for Business Owners

exit strategies

The Unplanned Exit

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One of the least-heralded benefits of exit planning is preparation for an unplanned exit. In the brokerage business, the reasons driving the listing of a company are known collectively as the Dismal D’s.

Some of “Da D’s” are just typical reasons behind putting a business up for sale. They include Dissension among partners, Declining sales, Divorce, Disinterest by, or Distraction of the owner and Debt.

Others are the driving force for an emergency sale, usually far below the fair market value. Those are Disaster, Disease, Disability and Death. As we’ve said many times before in this space, sooner or later every owner leaves his or her business. If you wait long enough, one of these four horsemen of business apocalypse will claim your transition.

Business Continuity Instructions

In every exit plan we do there are Business Continuity Instructions. As I instruct our Affiliates around the country, BCIs should be part of every engagement. Only a small percentage of our clients will need them, but for those who do they will be the most important and valuable part of our services.

There are two types of planning tools that often go by the name BCI, but fall short in my opinion. One is risk planning, usually associated with insurance. These are questionnaires that focus on financial risk management. Do you have sufficient policy benefits to take care of the business and your family?

The other is business interruption planning, usually in anticipation of a natural disaster.  Do you have backup records, a place to establish phone answering, and communications with your employees?

BCIs versus Disaster Planning

Both financial risk assessment and disaster scenarios are useful, but neither takes the approach we do. Our BCI starts with one simple question. “What happens if you are suddenly and unexpectedly absent from your business for an indefinite time?”

We begin from day one, hour one. How does the business open and function? Who is responsible for telling the employees? The vendors? The customers? Who has access to the bank accounts? Where are spare keys and security codes? Most importantly, who has the authority to make immediate decisions regarding operations, finance. personnel and administration?

Who are your key advisors? Who should be contacted regarding legal, accounting, insurance, leasehold or benefit issues? Are there other trusted advisors who should be included on major decisions? What authority do they have?

Is your Board of Directors capable of guiding the company? We find many small corporations where the owner is the only officer and Director. That means in his or her absence the company is incapable of functioning. Who names replacement officers?

New directors musty be elected by shareholders. In the event of an owner’s death, ownership of the business may go into probate, crippling its ability to function.

For each level of decision making, is there a dollar limit? Perhaps your operations manager and controller can handle most of the day-to-day between them. Does their authority extend to selling the company?

Are key employees a flight risk? If they have to step up to a level beyond their normal responsibilities, will their compensation reflect their new authority? Who decides what they are worth?

Insurance

One area where I see frequent issues involves life insurance on the owner. If it is intended to purchase the stock from family members, who is the buyer? A company cannot buy itself. There has to be at least one other owner to execute the purchase.

If the proceeds of insurance are intended to provide working capital, are they also pledged to the bank for a credit line? Do the policies have restrictions on their distribution?

One particularly ugly scenario is when an owner has a buy/sell agreement funded by life insurance. In order to make the premiums tax deductible, he chooses to have the company pay for it. The benefit is paid to the company with the intention being to buy out the surviving family. However, the company is already in dire straits without its majority owner, and the remaining shareholder(s) hold onto the cash, leaving the deceased owner’s family without income.

Unplanned Exits

Exit planning is really about how you want to leave the business. It is a process of examining your choices, and deciding which you prefer. From that day forward you can make business decisions based on the outcome you seek.

A side benefit, however, is deciding how to handle an unplanned exit. Hopefully it is never used, but when it’s needed it is invaluable.

If you would like a fillable PDF form to draft your own BCI, just send me an email at BCI@ExitMap.com.

Time Frames for Exit Planning

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Time frames are one of the most critical, challenging and frightening factors in planning your exit. At the same time, they are one of the most flexible factors in your plan. How can something be this important and still be fungible?

When we interview an owner, one of our first questions is about time frames. Note that they are plural. The first is when you want to step away from daily management of the business. The second is when you want to leave entirely.

Those questions  also lead off our exit preparedness Assessment, the ExitMap®, and impact the scoring on many of the other responses. When it comes to actually implementing a plan, however, their importance is often the opposite of what you might expect.

Owners frequently are most concerned about the second question. Setting a date for leaving the business is scary. That is when their lives will change substantially. That is why good exit planners focus so much on the owner’s personal vision of life after the company.

The First Time Frame

It’s the other question about time frames that is more important. Stepping away from daily operations is hard. Letting other people make decisions is hard. Seeing people get excited about initiatives that aren’t yours is hard.

In my book Hunting in a Farmer’s World I discuss “taking off the Superman cape,” or the challenge of letting your employees go to someone else for answers. Once you get beyond that, running the business can be a lot more enjoyable.

So part of an owner’s fear regarding time frames is the fear of the unknown, the void that looms if you don’t have a post-exit plan. The other part is a fear of leaving the business just as it becomes a lot more fun.

In fact, I’ve seen a number of owners who, once relieved of the daily burden of being the answer man or woman, want to postpone their final exit date. That’s not surprising. You didn’t become a business owner because you thought you would hate it. In fact, owner burnout isn’t usually caused by the creative or innovative parts of an owner’s role. It’s caused by the tasks and workload of running things day in and day out.

Leave  on Your Own Terms

That is why we design many exit plans with a kind of escape clause. Once the owner has transitioned his or her duties, most of the requirement for the second time frame have been met. At that point, the remaining criteria may be the accumulation of retirement funds, or accomplishment of a non-financial life goal (such as training for a new role.)

The final time frame is only met when the owner is ready. In an internal transition to family or employees that may involve selling a last bit of controlling equity.

Even if you are planning a third party sale, having your employee team spun up for an easy transition to a new owner will add considerable value to your company.

The goal in exit planning isn’t to set a departure date in concrete. It is to understand the time frame required to put you in a position to exit. The last move is up to you.

Exit Planning: Controlling Your Choices

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Many owners are reluctant to plan for their departure from the business. In some cases it’s because they are too comfortable with ambiguity (see my previous post.) For others it is because they fear losing control. They believe that setting a final date for their departure, even tentatively, starts a process that will take on a life of its own.

The tag line of this column is “Control the most important financial event of your life.” Control is the key. Refusing to deal with the realities of an eventual transition from the business is surrendering control. Sooner or later, something will happen that requires a transfer of the business. Then it is too late to exercise the options you have now.

Exit planning three, five or ten years before your anticipated transition gives you a clearer picture of the direction your company needs to take if it is going to serve your personal objectives.

All business owners want to grow their companies, make more money and work a bit less, but few things are more disappointing than finding out that the work you put in won’t result in the outcome you expected.

What if you work yourself to the point of exhaustion, only to find that you are too critical to the company’s success for anyone else to buy it without tying you into a long term employment agreement? What if you rapidly grow your revenues, but discover that your margins are too thin to attract a decent acquirer? What if you build a great management team, but they leave to start a competing business? What if you invest in new equipment  that looks great, but doesn’t add to the value of your company?

Understanding Your Choices

All these things would be addressed in a comprehensive exit plan. It’s not only about your life after the business, it’s about the life of the business after you. Exit planning requires that you look at your company through both the eyes of both a seller and of a buyer.

As a seller, you have certain goals for what you would accept as a successful exit. Usually those are financial, but other factors sometimes count for even more than the sale price. What future do you envision for your employees and customers following the sale? Is the company’s reputation, or it’s contribution to the community important to you? Answering these questions could have an impact on the type of buyer you will consider.

What are the intangible assets of your business? Are your employees able to make good business decisions without your oversight? Do they dependably execute their roles according to documented processes with consistently high levels of quality? The ability to duplicate your success is the single most important factor in a buyer’s calculation of value.

How sticky would your company’s relationship with key employees be in your absence? Are they committed to the company because of a sense of ownership, actual ownership, or long-term incentives? If their only tie is personal loyalty to you, the value proposition to a buyer is a lot riskier.

Controlling Your Choices

All these questions should be part of your planning. Yet most owners don’t ask them until they are on the brink of retiring. That is a mistake. Knowing what you want to accomplish, or in other words – where your finish line is, is critical to building your business in the right way, in the right direction.

Having an exit plan doesn’t mean that you have to implement it on a specific date. You can choose “wait and watch” from the options outlined in this short video on the Five Roads to a Business Exit.

If you know your destination, your choice of a pathway becomes much easier.

Ambiguity Kills Value

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Ambiguity kills value. That was a key point in a white paper from Orange Kiwi that I read over the holidays. Taken from the PhD thesis of Dr. Allie Taylor, the paper describes the psychological profile of  entrepreneurs, and their historical reluctance to begin an exit planning process.

According to Dr. Taylor, entrepreneurs have five major behavioral traits; Risk Taking, Innovativeness, Need for Achievement, tolerance for Ambiguity and a locus for Control. This follows closely my description of the mind of an entrepreneur in Hunting in a Farmer’s World. In that book I discuss the traits of tenacious problem solving and the ability to navigate in the fog.

Ambiguity and Dopamine

That ability to choose a path where others don’t see a way forward is key to a business owner’s ability to stomach risk. What Dr. Taylor points out, however, is that some owners fall in love with their own tolerance for ambiguity. As Simon Sinek points out in Leaders Eat Last (and I also discuss in Hunting,) problem solving provides an owner with a little shot of Dopamine dozens, or even scores of times daily.

Dopamine is the same neurotransmitter that drives substance abuse. In very real terms, an owner’s need for regular dopamine titillations can make decision making addictive. Anticipating a life without the business can subconsciously create a fear of life without the business.  

That’s why owners are reluctant to discuss exit planning. Despite the obvious wisdom of controlling the most important financial event of a lifetime, the personal void that lies beyond ownership is scary. As with many other potentially unpleasant things, from going to the dentist to funeral prearrangements, it’s easy to deal with it…later.

Ambiguity Kills Value

The problem with embracing ambiguity too much is that it can damage your business. Management by firefighting is costly. As Abraham Lincoln said, “If I had eight hours to cut down a tree, I’d spend seven of those sharpening my saw,” Fixing problems almost always costs more than preventing them. Dealing with distractions reduces the time you have available for selling, creating or teaching.

Avoiding the uncomfortable task of exit planning leaves you much more likely to deal with it in response to one of the Dismal D’s. (Death, Disease, Disability, Divorce, Declining sales, Dissention among owners, Debt, Distraction, Disaster or Disinterest.) That’s when the value of your most important asset, a thriving business, starts to plummet.

We all like a bit of ambiguity. Our decision making abilities are what makes us successful owners. Exit planning should be a process of gathering information about your possible decisions, not a ticking clock controlling your future.

Embracing Your Options

Whether you plan to eventually sell your business to a third party, pass it on to family or create a transfer to employees, you still want to assess your financial performance compared to industry standards. Your management team needs to be able to run the company without you. Your processes should be well documented. Most importantly, you should be thinking about what you will do when those hits of decision-making dopamine stop coming.

Once you have the components in place, you can control the timing, proceeds and method of your transition. Until then, you are just waiting for ambiguity to bite you in the butt.

How prepared are you? Take the ExitMap® preparedness Assessment at www.YourExitMap.com

Four Basics of Exit Planning 3: Know Your Buyer

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Know your buyer? Your initial reaction to this title may be “How can I know my buyer? I haven’t even decided to sell yet!”

Nonetheless, understanding the type of buyer that your company will attract is vital. More importantly, gaining that understanding long before you go to market will impact many decisions about how to run your business between now and when you start to actively market the company for sale.

The classes of buyers are not interchangeable. I once worked with the owner of a subcontracting company. He told me “I want to find a strategic buyer. I know they pay higher multiples than anyone else.”

That’s nice in concept, but Strategic Buyers make strategic acquisitions. His business was only as good as its next bid. He had no proprietary systems, no products, no long-term customers and no contracts besides the current jobs. Strategic buyers pay for strategic differentiation. He was unhappy that I didn’t classify his self-defined “great reputation in town” as a differentiator.

Other Classes of Buyers

Your business will determine what types of buyers you should seek, how your earnings will be viewed, and the multiple of earnings you can expect.

Main Street is the generally accepted term for businesses that sell for less than $3,000,000. Entrepreneurial Buyers are most commonly an individual or partnership. Downsized executives and entrepreneurs who have sold a previous business make up a large percentage of the buyer population for these companies. These transactions are usually handled privately, or through a business broker who advertises them on the Internet.

Cash flow for these businesses is called Seller’s Discretionary Earnings (SDE), and includes all the perks of ownership (wife’s car, no-show child employment and the like.) Anything that could be applied to a debt payment qualifies. For most Main Street buyers, their ability to service loans for the purchase usually tops out around 3 times SDE.

Mid-market companies sell for between $3,000,000 and $100,000,000. Financial Buyers include private equity firms and family offices. These buyers usually seek acquisitions where the cash flow is in excess of $1,000,000 a year.

Many lower Mid-market sellers are confused by the cash flow calculations. Financial Buyers’ cash flow measure is EBITDA (Earnings Before Interest Taxes Depreciation and Amortization.) Some sellers try to include the side benefits their company pays for in EBITDA. Financial Buyers assume that any benefits you have, a replacement manager will have as well, and they will ignore many of the SDE inclusions.

Private equity and Family Offices purchase businesses that are likely to produce a predictable return. Because they have investors (or wealthy family members) to please, their purchase prices are usually in the range of 4 to 5 times EBITDA, although the recent financial markets have driven that into the 6x territory for acquisitions over $20,000,000.

The Mid-market is also where sales are made to customers, vendors or competitors. Handling these transactions requires special care with confidential information. Since buyer and seller usually know each other, a broker-type intermediary is less necessary. Many times a transaction attorney or accounting firm can handle the negotiations.

The Neutral Zone

Exit Planners provide special value to companies in the “Neutral Zone.” I define that as too small to be big, and too big to be small. Their EBITDA is healthy (usually $500,000 or more after owner compensation) but below the $1,000,000+ that the Financial Buyers seek. Yet at that level, few Entrepreneurial Buyers can handle the purchase price.

There are many options still available to a Neutral Zone company. You can choose a growth strategy to enter the realm of Financial Buyers. A Leveraged Buy Out (LBO) by experienced employees is likely to attract the interest of a lender. An Employee Stock Ownership Plan (ESOP) is a very attractive alternative in the right circumstances.

In all cases, a good planning runway will help you to know your buyer. Then you can position the business with control over the outcome you seek.

A short video on classes of buyers and the multiples they pay, along with a free calculator to determine your SDE or EBITDA are both available on our website of free tools for owners, Your Exit Map.