Exit Planning Tools for Business Owners

small business

Private Equity and Privately Held Businesses

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Depending on who you are talking to, Private Equity is either the Great Satan or the savior of small and mid-market companies in the United States. The stories depend a lot on the personal experience of the speakers.

Once a vehicle for high-risk investment plays in corporate takeovers (see Bryan Burrough’s Barbarians at the Gate,) Private Equity has morphed into tranches where specialists seek opportunities in everything from a Main Street entrepreneurship to multi-billion-dollar entities.

What is Private Equity?

The term itself is relatively generic. According to Pitchbook, there are currently 17,000 Private Equity Groups (or PEGs) operating in the US. The accepted business model for our purposes is a limited partnership that raises money to invest in closely held companies. The purpose is plain. Well-run private businesses typically produce a better return on investment than publicly traded entities.

The current Price to Earnings (or PE – just to be a little more confusing) ratio of the S&P 500 is about 27.5. This is after a long bull market has raised stock prices considerably. The ratio is up 11.5% in the last year. That means the average stock currently returns 3.6% profit on its price. Of course, the profits are not usually distributed to the shareholders in their entirety.

Compare that to the 18% to 25% return many PEGs promise their investors. It’s easy to see why they are a favorite of high net worth individuals, hedge funds and family offices. As the Private Equity industry has matured and diversified, they have even drawn investment from the usually more conservative government and union pension funds.

Private Equity Types

Among those 17,000 PEGs the types range from those who have billions in “dry powder” (investable capital,) to some who claim to know of investors who would probably put money into a good deal if asked. Of course, which type of PEG you are dealing with is important information for an owner considering an offer.

private equity moneyThe “typical” PEG as most people know it has a fund for acquisitions. It may be their first, or it may be the latest of many funds they’ve raised. This fund invests in privately held businesses. Traditionally PEGs in the middle market space would only consider companies with a free cash flow of $1,000,000 or greater. That left a plethora of smaller businesses out of the game.

For a dozen years I’ve been writing about the pending flood of exiting Boomers faced with a lack of willing and able buyers. I should have known better. Business abhors a vacuum.

Searchfunders

Faced with an overabundance of sellers and a dearth of capable buyers, Private Equity spawned a new model to take advantage of the market, the Searchfunders. These are typically younger individuals, many of whom graduated from one of the “EBA” (Entrepreneurship By Acquisition) programs now offered by almost two dozen business schools.

These programs teach would-be entrepreneurs how to seek out capital, structure deals, and conduct due diligence. Some Searchfunders are “funded”, meaning they have investors putting up a stipend for their expenses. Others are “self-funded.” They find a deal, and then negotiate with investment funds to back them financially.

Both PEGs and Searchfunders seek “platform” companies, those that have experienced management or sufficiently strong operational systems to absorb “add-on” or “tuck-in” acquisitions. The costs of a transaction have bumped many seasoned PEGs into $2,000,000 and up as a cash flow requirement. Searchfunders have happily moved into the $500,000 to $2,000,000 market.

In the next article we’ll discuss how PEGs can promise returns that are far beyond the profitability of the businesses they buy.

 

 
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.

Business Continuity Planning

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A number of years ago, I worked for a financial advisory firm that was affiliated with a broker-dealer (b-d) network of a few hundred businesses throughout the country. Each year, the b-d would take it’s best firm owner customers and their spouses on a fully paid trip. This particular year, it was to Hawaii. Unfortunately, during a scuba diving excursion, one of the owners suffered a heart attack and died.

On top of the shock his family and employees were experiencing, it quickly came to light that he did not have a continuity plan in place. As a result, his family, during their time of mourning, had to scramble to not only keep the firm going day-to-day, but also decide on a longer term solution. As emotionally difficult as the situation was, it also had serious financial implications. Most small business owners have anywhere from 40% to 80% of their family wealth tied up in their business, and this situation was no different.

Luckily for the family, the b-d was a huge help. They provided additional services and technical support to help keep the business operating and even assisted with finding a buyer. While the company wound up being sold at a discount, it was a much better outcome than a fire sale, or worse yet, having the business dissolve.

In this case, the firm had a great relationship with a critical supplier, who was willing and able to step in and help during a crisis. Unfortunately, most small businesses who haven’t adequately planned aren’t so lucky.

What is a Business Continuity Plan?

As the name implies, a business continuity plan is a document that contains everything needed to successfully preserve the company’s value in the event of an owner’s death or incapacitation. There are 2 parts of a good plan. The first is the information that the family and employees need to keep the business going over the short term. The other is a longer-term strategy for the company in the event that the owner will be permanently absent.

A solid plan requires time and effort but is definitely something owners can do on their own. However, if you’d like assistance, there are business and exit planning consultants available to help. Let’s look at what’s included in a plan.

The Emergency Kit

This is where your family and key employees will find the critically important information that’s needed for running daily business operations over the short term. It would include such items as:

  • Bank account information
  • Insurance policy information
  • Points of contact for key business advisors – CPA, Banker, Attorney, Insurance Agent, etc
  • Lists of key suppliers and customers
  • Passwords
  • Information about trade secrets, patents, and other intellectual property
  • Who has short-term decision making authority

This is just a start. Every business is unique and the emergency kit should include everything needed to run the business as efficiently as possible in the days and weeks immediately following your absence. If the document is complete, your family and key employees should be able to find the answers to the following questions:

1. What do you, as the owner, do on a daily basis in the company?
2. What information do you have that others would need to know about in order to perform these tasks?

Once you think you have everything covered, have your spouse and key employees to review it. They will probably come up with some additional items that need to be addressed.

Long-Term Strategy

This is the portion of the plan that spells out your intentions for the company if you are expected to be incapacitated indefinitely or have died. This may or may not be the exit plan you currently have in mind. For example, if your current goal is to one day pass the business along to your children, but they are still in high school or college, an alternate plan is needed.

In some cases, this strategy could be similar to what you had envisioned if nothing had ever happened. However, additional contingencies may need to be put in place to help ensure its success. Let’s say your plan was to sell the business to your key employees several years from now. If the timetable was accelerated would this plan still work? If not, why not? Could these obstacles be overcome? If so, how?

A common reason I hear from owners planning an employee sale is their lieutenants aren’t quite ready to take over. One solution to this could be to have a ‘just in case’ arrangement with an outside advisor you have already vetted. That way, your employess will know who you want to come in to help manage the business and finish their training.

If you already have a contingency plan in place, congratulations, you’re ahead of the game. Now, when was the last time it was reviewed and updated? If it includes a buy-sell agreement, that should be reviewed on a regular basis as well. For instance, does the buyout amount reflect the company’s current market value? If the buyout is to be financed, is the financing still adequate? A large percentage of buy-sell agreements use life insurance to provide at least part of the buyout funds. If yours does, when was the policy last reviewed by an insurance professional?

If you died yesterday…

What would be going on at your company today? Do your loved ones and key employees have a good answer to this question? If not, then putting a business continuity plan in place will be time well spent.

“Work From Anywhere” Comes Full Circle

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Work from anywhere has been a necessity, an epithet, an obstacle, and an opportunity over the last 3 years. To paraphrase Aristotle’s axiom about Nature (“Horror Vacui”), business abhors a vacuum. Where one occurs, it is quickly filled.

Work from anywhere started as a COVID-induced necessity. During the lockdowns of 2020-2021 (and longer in some places) we all had a crash course in video calling, VPNs, and virtual meetings.

Employees quickly expanded the definition of anywhere. They tired of shunting the children off to a bedroom during conference calls, or using office-like backdrops to hide their kitchen cabinets. Soon they began changing their backgrounds to something more aspirational, like a mountain cabin or a scenic lake.

From there it wasn’t much of a leap to make the mental shift from a make-believe environment to a physical one. Pretty soon employees were calling in from real mountain cabins. In many cases, they shifted to someplace where the cost of living was much lower than in their former metropolitan workspace.

Work from Anywhere as an epithet and an obstacle

As employees moved further afield from their office environment, bosses began to sound off. “We aren’t going to pay Los Angeles wages to someone who has a Boise cost of living,” was a commonly heard complaint.  Most put up with it because qualified help was getting harder to find. Hiring remotely was too hard a new skill to master.

The complaints of employers grew louder as they began to ask employees to return to their former location of working activity. They made arguments about deteriorating corporate culture or a lack of mentoring opportunities.

At the same time, stories surfaced about workers who were getting full-time paychecks from multiple employers, or who were “quiet quitting” by doing as little as possible. The “Great Resignation” forced many organizations to put up with it. If you wanted to keep employees, you needed to accommodate their demands.

Then the work-from-anywhere poaching started. If an employee could do the job from a thousand miles away, why not just hire people from a thousand miles away? Now recruiters could dangle Los Angeles wages at candidates from Boise. Many employers saw work from anywhere as a curse costing them their best talent.

Work from Anywhere as an Opportunity

But as I said at the outset, business abhors a vacuum. Every action has a reaction. When the job can be done from anywhere, does that mean anywhere?

work from anywhereIf the higher cost of living centers can fill their needs by hiring people who are accustomed to earning less, why shouldn’t employers look at those candidates before the local talent? The Internet allows almost-instant communication across countries, what about across oceans?

In the last few months, I’ve worked with employers who are hiring accountants in India, staffing recruiters in the Philippines, programmers in Argentina, support techs in Colombia, and screening nurses in Nicaragua.  None of these employers are multinationals. Each one fits the SBA’s definition of a small business.

Their new employees are educated, English speaking, have the same hours as the employer, and are thrilled for the opportunity. Some are hired directly through a local placement agency. Others work for an organization in their home country that makes them exclusive to the client and promises to replace them if needed.

Most of the wages appear to be about 50% more than the same job would pay in the country of residence, and roughly half of what the position in the U.S. would cost.

Business has once again filled a vacuum. I wonder what is next?
 
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.

Main Street Business: The Importance of a Written Exit Plan

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When planning for a vacation, do you typically jump in the car and just start driving without first determining where you are going?

No, of course not. You plan out where you want to go, when you want to leave, what activities you want to do on the trip, and so forth. You create a plan to make sure that you know where you are going and what you are going to be doing.

The same principle applies to business owners when transitioning from their Main Street and Mid-Market businesses. Without an exit plan in place, the odds of reaching your end goal are extremely low. Only by implementing a comprehensive plan with actionable steps do you stand a chance of making a successful exit from your business.

To quote baseball great, Yogi Berra, “If you don’t know where you are going, you’ll end up someplace else.” Without a detailed exit plan in place, you may find that your destination may not be where you want it to be.

While you may think you’re headed toward retirement and many years of well-earned relaxation, without a plan in place you could find that retirement is just out of reach or that you’ll have to work well past the age in which you thought you would. Many small business owners spend their entire lives working on their business, adding value to the bottom line, and developing strategies to build their customer base, only to find that it’s nearly impossible to sell the business when it comes time to retire.

If you don’t have a plan in place this can come as a real shock. What do you do then? You may get lucky and come across an “angel investor” who will buy you out at the right price, but the odds of that happening are slim to none. It’s more likely that you’ll end up caught between a bad option and an even worse choice.

Unfortunately, as many business owners near retirement, they find themselves in this precarious position because they never developed a real exit plan on how they will ultimately leave their business. This isn’t to say that business owners aren’t good planners. Most owners wouldn’t have a successful business if they hadn’t developed an in-depth plan long ago on how best to operate their company, so it’s profitable and set up for long-term growth.

The problem is that a business plan is not the same as an exit plan. While a business plan helps keep the company on track, it isn’t enough on its own because it only addresses the needs of the business, not the individual goals of Main Street Business owner.

A true exit plan involves the creation of foundational objectives and the execution of a strategy to implement those goals that are actionable and leads to the owner leaving on their terms. It typically involves support from a wide range of experts, such as an exit planning adviser, attorney, financial adviser, and certified valuation analyst, among others, so that all areas of the exit are considered.

This plan is an established process that lends itself to success. While no plan is foolproof, a plan that’s never implemented has no chance of success, which is why it’s so imperative to develop a thorough and actionable exit plan now and not wait until it’s too late.

Steven Douglas is a leader of Porte Brown’s Exit Planning practice group. Porte Brown offers one of the few exit planning programs specifically designed for small businesses, Exit RoadMAP Express, and hosts a free monthly webinar series that outlines various options specifically focused on the needs of main street business owners.

Thinking About the Future: What’s Your Plan?

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Thinking About the FutureWe’ve all heard the saying, “Fail to plan, plan to fail.” This is extremely pertinent if you’re thinking about the future of your business. Many owners focus solely on the exit transaction itself without spending the time to properly prepare for it. Transitioning your business can take many forms, from passing to a family member to selling to a strategic partner. Here are some things to think about before you transition.

Are you ready to leave?

Many business owners fail to consider what they’ll do after a transaction. Do you plan to continue to work in the business? For how long? To whom will you report? If you’re no longer the owner, then you will NOT be in charge. If you’re not present, is existing management prepared to run the business? What will you do?

Have you mapped out your financial plan?

Before any transaction, you should evaluate your finances and create a personal balance sheet with a lifetime spending plan. How much wealth does it take to retire? What kind of lifestyle do you plan to have? Have you considered medical costs? Don’t forget to update your estate plan to take into account personal and charitable bequests.

What’s your business worth?

Sure, you may have an idea of the value of the business. How can you best position the business for maximum value extraction? What’s your best option? What about non-financial considerations?

The decision to turn over your business to someone else is a difficult one. Think about your goals before you proceed, then “Plan your work and work your plan!”

Invest 15 Minutes and take our FREE Exit Readiness Assessment. We do not request any confidential information.

Mary D. Richter is a tax shareholder who has been serving tax clients for more than 25 years. She has worked in both public accounting and private industry. Mary has a diverse tax background with experience in federal, state, and international tax and business issues and has provided dedicated client service to multinational manufacturing and service entities in all phases of the business cycle, from start-up to exit strategy.