Exit Planning Tools for Business Owners

leadership

Selling to Employees: Is Your Exit Strategy Right in Front of You?

by

When I interview a prospective client for exit planning assistance, we usually explore selling to employees. The first reaction is always “That won’t work. They don’t have any money.”

If you have a company with reasonable cash flow, a talented management team and sufficient time, selling to employees is not only a realistic option; it may be the best way to get value from your business. I’ll define those parameters for you in a minute.

If you haven’t read my eBook Beating the Boomer Bust, follow the link for the free download. My research shows that the hard numbers will inevitably translate into a hard market. There are 3,000,000 Baby Boomers (over 50) who own businesses with employees. Over the next 20 years, that’s an average of 150,000 owner retirements per year. Intermediaries (brokers, private equity and M&A) account for about 9,000 transactions a year.

That leaves a lot of folks looking for a way to cash out. Selling to employees is a process that lets you keep control until retirement. By structuring the sale correctly, you can leave with the proceeds in the bank, not in a promissory note.

How does that work? It requires a bit of mental gymnastics. First, any owner has to accept that the only source of funding for any transaction is the cash flow of his or her company. If a buyer pays cash, he expects that cash flow to pay him back. If a bank finances the acquisition, they expect the cash flow to service the debt. If you finance it, you are the essentially the bank.

Selling to employees is the same. You use the current cash flow to help employees buy stock. In return, they qualify by working to increase the value of the business until your final return is equal to (or more than) what it was when you started.

Think of it as taking a note for 30% of the purchase price while you are still in control, so that you can get a 70% cash down payment when you leave.

Now, let’s discuss the parameters.

Cash Flow: Your company has to be earning more than just your paycheck. My rule of thumb is that around $500,000 a year after owner’s compensation gives enough to work with. More than that doesn’t change much, since then we are usually looking at a higher purchase price. Less than that is doable in a longer time frame, or if the owner is willing to subordinate some debt to the bank.

Management Team: You need at least one decision maker who does more than just go through the operational motions. Any third-party lender wants to be comfortable with company leadership when you’re gone. A large portion of our planning surrounds transfer and documentation of management capability sufficient to satisfy a lender.

Time Frame: Many business owners tell me “I’ll think about exiting in five years.” That’s fine, if your plan is to retire in fifteen years. Generally speaking, the longer you have, the more lucrative an internal sale can be. I’ve done three year plans, but five is much more comfortable, eight years is even better, and we regularly work on transitions of ten years and longer.

all for one one for allSelling to employees requires legal agreements, specialized compensation plans and a willingness to run the company transparently. The return is a team that is committed to the long term, highly motivated, and all on the same page when it comes to growing the business.

Why should you consider selling to employees?  Because your company lives on with the culture you created. Because you can choose the value, not negotiate it. Because your employees aren’t comparing your company with other investments. Because you control the timing of your exit.

Because it is probably the biggest financial transaction of your life.

Do you know an owner who would benefit from reading Awake at 2 o’clock? Please share!

What’s in YOUR Nondisclosure Agreement?

by

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.

 

Over 1,000 business people subscribe to Awake at 2 o’clock. Please share it with others who are part of the 3% of Americans who provide 60% of all new jobs! Thanks.

What the Heck is Exit Planning?

by

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.

If you enjoy Awake at 2 o’clock, please share it with other business owners.

The 7 Deadly Sins of an Entrepreneur — Reprise

by

I make no claim that using the Seven Deadly Sins as a metaphor for business behavior is original. Of course, the original concept is a codifying of “undesirable” human behaviors, or sins. The work probably comes from the Latin word sons (guilty). Various sources attribute it to Old English and Hebrew, but since Latin was the language of the church, this seems most likely.

The concept of personifying the seven sins for popular consumption, as I mentioned in the first column in this series, goes back at least to Dante in the early 1300’s. It’s been used regularly in popular fiction including Roald Dahl’s Charlie and the Chocolate Factory (the five golden ticket winners each represent a sin, with Grandpa as Envy and Willie Wonka as Wrath); and in “Sponge Bob Squarepants” (I’ll assume that most readers don’t know the characters well enough to make identification worthwhile.)

gilligans-titlePerhaps the most amusing application was in “Gilligan’s Island.” The seven castaways fill their assignments well. There’s Gilligan (Sloth), the Skipper too (Wrath).  The millionaire (Thurston Howell — Greed) and his wife (Gluttony). The movie star (Ginger — Lust, of course); The professor (Pride) and Mary Ann (Envy), here on Gilligan’s Isle (Hell?)

My apologies if I just stuck that tune in your head for the rest of the day.

When I present “The 7 Sins of an Entrepreneur” to business audiences, they take special delight in identifying their own behaviors. Maybe it’s because they are relieved (“Gee, I only have four.”) or because they are naturally competitive (“Hey, I hit on all seven!”)

What ever the reason, it’s an easy way to organize negative behaviors. Perhaps that’s why it has remained so dominant a concept. Regardless of your failings, they can probably be categorized as one of the seven sins.

Here is a synopsis in order, with the corresponding “virtues” that counteract each.

  • The Operational Sins: Those which reduce your personal effectiveness as an owner and leader.
    • Lust: Allowing whim du jour to drag the company in differing directions. (Counteracting behavior: A Personal Vision.)
    • Gluttony: Hoarding all authority and decision-making for yourself. (Delegation)
  • The Tactical Sins: Those which denigrate the effectiveness of your organization.
    • Sloth: Settling for “good enough.” (Metrics and Benchmarking)
    • Wrath: Using adrenaline to drive performance. (Planning)
    • Greed: Addressing any problem with more effort or more intensity. (Budgeting)
  • The Strategic Sins: Those that prevent long term vision and improvement.
    • Envy: Thinking that no one else has your problems. (Outside advice and knowledge)
    • Pride: Believing that you are the single most important factor in your company. (Exit Strategy)

The sins are addressed in order. Dealing with the Operational Sins allows you to tackle the Tactical problems. Strategic improvement is only possible if you’ve first dealt with Tactical issues.

The Seven Deadly Sins of an Entrepreneur are an excellent mnemonic for considering your own behavior and those of your company.  Keep them in mind as you run your business day-to-day.

If you enjoy “Awake at 2 o’clock,” please share it with other business owners. Thanks for reading!

The Seventh Entrepreneurial Sin — Pride

by

Every business owner should be proud of his or her business. If you are the founder, you built every system, and probably landed the biggest customers. If you bought the business, you took what was in place and made it fit your vision and style.

But there is a dividing line between pride in what you’ve created and thinking that you are the business. Taking pleasure in seeing people add value and produce wealth is justifiable pride. Thinking that it exists only because of you is “sinful” pride.

(This is the eighth in a series on The Seven Deadly Sins of an Entrepreneur. It starts here.)

pawn to kingPride has characteristics that are easily recognizable in some owners. In meetings, do you do all the talking? Do you complain that you are the only one who has new ideas? Does everyone come to you for the solutions to any and every problem? Worse yet, do you insist on it? Do you reprimand employees for making decisions that, while they might work, aren’t exactly the way you would have done it?

My friend Kevin Armstrong in Vancouver says “The more you work in your business, the less it is worth.” Building an organization that is dependent on you to operate it has one drawback.

You can’t leave…ever. If you are the business, then it is worth nothing without you.

In the worst cases, you can’t take a vacation. Even getting away for a few days requires that you be tethered to electronic communications. Perhaps you’ve built sufficient managerial capacity to keep things going for a few weeks, but upon your return you have to jump-start activity again.

Here’s another axiom, this one from John Brown of the Business Enterprise Institute in Golden, Colorado. “Sooner or later, every business owner leaves his or her business.” In stark terms, you can think about how you want to exit, or you can let it be a surprise.

The virtue that counteracts Pride is Exit Planning. An exit plan differs greatly with the owner’s age, his or her personal goals and the size of the business. In every case, it requires consideration of finances, career objectives, lifestyle ambitions, management development and self-maintaining systems.

Ah, but you are still young. You are still healthy. You still enjoy running the business. Why would you want to think about leaving?

Because thinking about how the business will function without you leads to greater profitability, a higher value for your company, and more personal flexibility in your life. Aren’t those reason enough?

Professional investors craft an exit strategy before they buy into a company. For most entrepreneurs, especially in their first five years, leaving is the furthest thing from their minds. If you are beyond your fifth anniversary as an owner, you should have one eye on the door, even if it’s still a long way off.

Thinking about the business as a separate entity, something that will survive after you’ve moved on, will help make you think in longer, more strategic terms about things like new products, target markets, and developing other decision makers in your organization. It brings up questions many owners ignore, especially “What does my company look like to a buyer?”

Long, long ago I was a manager for a national chain restaurant. They taught me a trick that I still use today. Once a week or so I’d walk out in front of my restaurant and stand with my back to it. I’d close my eyes and think “I am a new customer, who has never been to this establishment before. I’ve never even driven past. I am seeing it for the very first time.”

Then I’d turn around and look at my business for the very first time. I always saw something that could have been better.

Selling a business is a bit like selling a house. You spruce things up so that it looks good. In a business you make sure your financial statements are up to date and easily understood. You tighten up on expenses. You refresh operating procedures.

If you start seriously thinking about your exit now, you’ll naturally regard your business through your buyer’s eyes. To quote one of my own favorite axioms, “The things you should do to get the best price for your business are the same things you should do every day that you own it.”

Thanks for reading “Awake at 2 o’clock”. Please share it with other business owners.