Exit Planning Tools for Business Owners

exitmap

What is “Holistic” Planning?

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Financial planners use the term “holistic planning” frequently. It’s meant to indicate that they consider the client’s short- and long-term life goals and the future they visualize. According to Fidelity Investments Holistic Wealth Planning is continuous and considers two dozen aspects of client wealth objectives.

The Valuation Reality Gap

Only one of those aspects is ownership of a business. This raises the question “If a typical business owner has 50% of their net worth in a business, is it really just 1/24 of their planning?”

Of course not. I’m exaggerating for effect, but there is an uncomfortable truth about financial planning for business owners.

When we ask financial planners about their assumptions regarding business value, the great majority (almost all) reply that they use a value provided to them by the client. Unfortunately, most business advisors estimate that the average owner’s impression of their company’s value is at least 35% too high.

An owner is planning on a $3,000,000 nest egg in retirement. He estimates that $1,500,000 will come from the net proceeds (after paying capital gains tax) of selling his business for $2,000,000.

But 90% of businesses that size are sold on an asset basis. That could bump the tax rate from under 25% to something closer to 40%. If he has overvalued by the “average” of 35%, a $1,300,000 sale would net $780,000.

Holistic Planning Man

Impact on Retirement Goals

Now his nest egg is $720,000 short of goal. Retiring on $2.3 million isn’t exactly poverty, but it would require substantial changes to the anticipated goals.

That is why financial planning for business owners can’t be holistic if it doesn’t include the value of their business. That value should be confirmed by a third party.

Exit planning is the critical final component of a business owner’s wealth strategy. A business requires different tax strategies, risk management and timing assumptions from simply calculating around a pension. Even an appraised value can range widely between different transition strategies.

Holistic Planning in Exit Considerations

How is estate planning affected by the disposal of the business? Does it employ one or more children? Just as importantly, does it not employ one or more children? How can the business value in the estate be balanced between fair and equal? In the most extreme case, will the business be passed down as part of the estate? In that case its value may not be included as part of the owner’s wealth at all.

Will the business be sold to a third party, or as part of a management buyout or ESOP? The proceeds may be realized all at once, or over a long period of time. Is there value for any real estate involved? (A new owner may or may not wish to purchase the real property.)

Holistic planning for a business owner is far more complex than for an employed individual. It’s almost like having a second client in the room. If the planning doesn’t consider the myriad of complexities surrounding monetization of an illiquid asset (the company), it may not be considering the biggest single factor in the client’s financial future.

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.

What is an Exit Plan?

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“What is an Exit Plan” is an article I wrote ten years ago. It was just brought to my attention and I realized I never posted it to Awake for some reason. Here, with some updating, we celebrate its 10th anniversary.

Exit planning is the buzzword for those who consult to Baby Boomer business owners. Business brokers, wealth managers and other professionals are adding “exit planning” to their marketing messages. It’s a logical reaction when over 5,000,000 Baby Boomers (about 3,000,000 in 2024) are preparing to leave their businesses.

Not surprisingly, when a business broker creates an “exit plan,” it usually involves listing the business for sale to a third party. An attorney’s planning focuses on the legal documents that allow the transition of the assets of a company to new ownership. An accountant or financial planner will look closely at tax and inheritance issues, and an insurance broker offers products that reduce the risk of interruption or disaster.

All these are important to the successful implementation of a plan, but each professional focuses on his or her specific skill set. If your shoulder hurts, you could go to an orthopedic surgeon, a neurologist, a general internist, a chiropractor, or a physical therapist. Each will have a treatment approach for a painful shoulder. Each will be different, based on his or her specialty. Each will reduce the pain at least somewhat, although some of them may or may not address the underlying cause.

Similarly, there are many professionals who claim competence in exit planning. Each has a different area of expertise, and what they term exit planning tends to focus on those areas. A comprehensive exit strategy encompasses legal, tax, and risk management issues, but it also examines the operational issues of the company whose value is the underlying driver for everything else.

Why do an Exit Plan?

Before drafting the first document or embarking on a plan to spend the money from a sale, the business must first realize the proceeds of a transaction. That means it must find a buyer who will pay for it. That buyer could be a third party, but it might also be an employee, an employee group, or family members.

Any third party considering the purchase of a business will do extensive due diligence. Their willingness to pay a premium for a company will depend on its track record of revenue growth, the stability of its margins, and how well-established its systems and customers are. If the company is larger than about twenty employees, they will look for supervisory and management talent who will stay after the sale.

Regardless of size, a business that is highly dependent on the owner for revenue or making all key decisions will be deeply discounted or even impossible to sell. An exit plan should look at these factors and help to make the adjustments needed to realize full value.

Selling to employees or family is often an attractive option because it allows the owner to choose a retirement date, and price is less of an issue than financing terms. Unless you are willing to accept a promissory note for most of the price and feel secure that your successors can maintain payments over a long period, a plan for this kind of exit should begin at least three, and preferably five to eight years before the planned transfer date.

What is an Exit Planner?

An exit plan needs legal, tax, risk and wealth management expertise to be successful, but it also requires a practical examination of the operational strengths of your business. Selecting one professional to manage the efforts of everyone, and to help keep you on track, is a wise investment.

In America, the average small business owner has nearly 75% of his or her net worth in the company (still true in 2024). The single biggest financial transaction of your life deserves special attention.

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.