An Exit Plan For Your Business
Creating An Exit Plan For Your Business
Succession Planning – Who Needs It?
It’s that time, isn’t it? Something is happening to make you aware of your need for an exit plan – changes in your personal life, perhaps. Maybe boredom, fatigue, illness, or some business downturn? Or, maybe a new opportunity is beckoning! The kind you really don’t want to pass up.
You Need Advice
You suddenly realize that you need to seek advice from a professional – your lawyer, accountant or business broker.
Even if you plan to transfer your business to a family member or an employee, it will still be a “sale” that must be handled skillfully. Sales to “insiders” are usually more complicated, in fact, than sales to “outsiders.” You need to get clear about what you will do.
How, exactly, will you eventually sell your business? An “Exit Plan” is simply your answer to that question.
If you expect your family to continue the business, the slightly more exalted name for
this process is “Succession Planning.” Ideally, your “Succession Plan” should be reviewed by your lawyer, approved by your accountant, sanctioned by your spouse or life partner, blessed by your children and supported by your employees.
Succession planning defines
- Various contingency plans for retirement, death or disability of the senior generation.
- How your family will be informed, included, involved, and compensated as well as be able to pay your estate taxes.
- How the new CEO will be found or chosen, and how they will own the business, be trained, involve remaining family members and finance the business purchase and operation.
- How your business will go on, fund itself, possibly fund your retirement or pay off your estate taxes and/or financing note.
Odds Favor Sales to “Outsiders”
Studies show that 70% of family businesses are sold to outsiders instead of remaining within the family. I believe that this percentage is even higher today. The study that originally generated the 70% figure is now quite dated, going back to the 1940’s. I would estimate the odds today to be even more favorable to an outside sale. There are more potential business buyers than at any time in history.
Today, for a stable or growing business, the odds of an “outsider” acquisition are probably 80% to 90%. The services of a business broker are needed to deal with the thousands of individuals, companies and investor groups now buying. The problem is not how to find prospects, but how to respond to them. Buyer inquiries can overwhelm a business owner. In our Portland office alone, we have over 2,000 registered buyer prospects and over 500 new inquiries per year!
Sorting and qualifying prospective business buyers, while protecting the business seller’s confidentiality, requires the skills of a seasoned business broker in any planned business sale.
Leaving A Legacy & Model
A planned business sale can serve as a legacy for its owner and as a model for the future. The senior generation gets a funded retirement and/or a second life. The next generation, or a synergistic outside acquirer, takes the business to new heights. The employees have jobs. The seller earns his/her place in the family’s entrepreneurial hall of fame.
Most business owners, of course, are completely in denial about the need for a plan. That’s understandable. Who wants to plan their own “exit?” Most owners of small businesses like to think of themselves as heroic and indestructible.
That kind of thinking (that a business owner is indestructible) can lead to an end that is not pretty. Instead of leaving a legacy and model, you run the serious risk of leaving yourself, your family and employees with overwhelming problems and debts. An unplanned family business sale can be a nightmare. The owner gets a low price. The business fails because it was sold to the wrong buyer. Jobless former employees have bitter memories. Sellers/heirs are often shocked when the tax bite is a lot larger than expected!
All of this can be avoided when a business owner decides to leave a legacy and model, seeks professional advice and takes it.
A Four Stage Process
There are several ways to view this process. After preparing for two “exit plan” seminars in which I am a speaker this year, I have concluded that it’s easiest to talk about it in four stages. At each stage, a plan of action is needed and the focus is narrowed.
Stage 1. Simple Retirement Plan – “How Much Is It Worth?”
In this first stage, the business owner simply decides how he/she is going to sell the business and retire. For the 70% of businesses that should be sold to outsiders, this is half the battle – no need to consider the dynamics of succession by family members. But, for family businesses, this is just the beginning of a long process.
Stage 1’s focus is usually around the questions of what the business is worth and how to sell it, or pass it on. For the simplest and least expensive answers to these questions, a good start is a no-charge consultation with a business broker. If, however, the business valuation is going to be part of an estate planning process, you will also need a full-blown appraisal by a business appraiser.
Selling your business will also get you into a lengthy discussion of seller financing and buy-sell agreements. If family is taking over, you’ll need professional advice to closely examine the world of various liquidity strategies, annuities and trusts.
Stage 2. The Tax & Finance Plan – “How Much Cash Is Needed?”
After a business valuation is completed, the need is to get specific about the details. The most important details are cash, cash, cash and cash.
How much cash do you need to retire? How much cash will a buyer of the business put down? How much cash will you need to pay the taxes on the business sale? How much cash will you, or your family, eventually need to pay estate and gift taxes?
Connected to those questions, of course, is how you expect the business to be financed as it goes forward. If it’s a third-party acquirer (an outsider), you don’t much care. But, if it’s family, the question needs to be given plenty of thought.
In family situations, it’s not unusual to buy life and/or disability insurance products to provide cash for second generation acquisition of your business.
Stage 3. Executive Replacement Plan – “Who Will Take Over?”
If an outside buyer is coming in, that’s easier. If there are family members continuing in the business, the process again becomes more complex.
The three major areas of consideration are how the new leadership will be chosen, how they will be compensated, and how trained? If there are multiple family members in a second or third generation scenario, then family politics are most important.
Remember that transfer of the business assets is only a technical process that calls for legal and financial advice. Transfer of power is, however, a family process that may call for counseling in family dynamics.
Stage 4. The Family Council Plan – “How Do We Set This Up?”
Family businesses, where family members are active in the business, must find a way to make unified business decisions. This is the most complicated stage. The entrepreneurial model followed by the single-owner CEO no longer works. Major issues for successor generations revolve around how much to invest in the continuing business growth vs. how much to take out as dividends and profits.
This is the battle of “planters” vs. “harvesters,” or more cynically, that of “parasites” vs. “plunderers.” Unfortunately, these are accurate descriptions in many cases, especially after the death of the business’ founder. Family councils do occasionally work, however, and there are many case studies available as examples.
What Works & What Doesn’t?
Get people you trust. Don’t rush. Don’t try to do it yourself. It’s important to take time to develop your plan. Get a multi-disciplinary team to work for you: lawyer, accountant, business broker, financial planner, insurance agent, appraiser and banker.
Review your financial options early. It doesn’t make sense to plan an exit if you can’t afford to exit. Get a business appraisal to see where you are. Review cash and liquidity issues closely. Make sure you understand the tax consequences of your actions. Know your options. This is a time for clear analysis.
Include your family in the process if they are involved in the business. It doesn’t work to leave them in the dark. You may also have key employees who, in this sense, are also “family.” Tutor family members on things they need to understand. It doesn’t work to assume they know what you do, or why.
Pay attention to ownership change and management succession as two separate issues. One is about the transfer of assets; the other is about the transfer of power. One has legal and tax consequences, requiring one set of advisors; the other requires a thorough understanding of family dynamics.
Finally, put it in writing. It doesn’t work to leave anything vaguely defined. Your family deserves answers. The IRS will demand them.
Consistent profitability. Well trained staff and a variety of e-commerce clients.
The cyclical nature of the economy can add uncertainty to the timing of an acquisition, or an exit from a business. However, unlike the clarity of an improving economy or the risks inherent in a downturn, buying or selling at a market high creates a unique set of challenges.