Planning Your Exit

By: Tom Lindahl, CABI President

Transferring your business to the control of someone else is the single most important financial event in every business owner’s life.  Transferring it to whom you wish on terms that are favorable is a huge challenge and one that business owners need help with.  Think of planning for your exit as planning for the succession in ownership and leadership of the company.  The best way for you to exit is with a competent, motivated leadership team executing a proven, documented business model and continuing the tradition of service and value you established to your customers.

This is a short overview of exit planning.  The topics are topics that regularly turn up in exit planning.  They are not meant to be a complete checklist of things to consider; they are meant to stimulate your thinking.  Every situation is unique and every business owner should get outside, objective, Third Party assistance in developing a personal exit strategy that converts the illiquid value of a closely held company into liquid wealth and lifetime security for the owner and his or her family.

I. Plan Your Personal Affairs.  Business owners generally underplan and they underplan their personal affairs even more egregiously than their business affairs.  Planning your exit starts with planning for your personal needs right now and during the time you own and run your business.

• Conduct A Financial Needs Analysis.  How much do you spend to support your current lifestyle?  You need to understand and accommodate your current and near future financial needs.  If you have a child headed to college, you may have significantly higher income needs over the next few years.  Current financial needs analysis looks at assets and liabilities as well as income and spending and should consider a range of ‘what-if’ scenarios. How much will you need to support your lifestyle after you sell your business?  (In some cases, the answer is more than you currently spend because you will have more time for travel and other expensive pursuits.) This will give you a good sense of how much you need to realize from the sale of the business to support your desired lifestyle and future spending.  This gives you a value target.

• Plan For Your Estate.  How would you like your assets distributed if you were to pass away prematurely?  Would you want the courts to make those decisions for you?  It is never too early to begin planning.  In many cases, estate planning is an important part of financial needs analysis because you have to look at the needs of your family if you are not able to execute your business plan and meet your family’s financial needs in the manner you expected to.  Early in an owner’s life, a will may be adequate.  As you mature and your business increases in value, other tax efficient strategies may become more important in your planning.

• Plan Your Taxes (Personal And Business).  We all have an obligation to pay taxes.  None of us has an obligation to overpay taxes.  Tax planning involves looking at your potential personal and business taxes and minimizing them.  If your tax situation is straightforward, your regular CPA can probably handle your taxes.  As businesses get larger and more and more complex, it is often useful to engage a tax expert to deal with complicated tax scenarios and avoid mistakes and penalties.

• Analyze Your Assets (Personal And Business).  Even if you plan to run your business for another 20 years, knowing where you stand financially (both personally and in your business) is an important part of deciding how to move forward.  For most owners, the value of their business is 80 – 95% of their personal net worth and without being able to capture that value; their families would suffer a significant loss of lifestyle.  Although you may plan to work another 20 years, health, and accidents can occur at any time.  Business owners should arrange their finances and do contingency planning based on the possibility of not being able to run their business as long as they planned.

• Consider Hiring A Personal Coach.  If you are planning to run your business for a long time, you may consider this premature but most owners who grow their businesses effectively find they have to evolve personally, as the business evolves.  Most owners start with a great product or service idea and work hard to implement that product or service and to look for other products and services that their customers need.  Once the business is established, owners need to begin building a management team with the same zeal that they displayed when they built products and services.  That’s a difficult leap for many owners and a personal coach can help with that leap.  At the same time, the business is growing, family demands are growing too.  A personal coach can help through these stressful periods and can allow you not to become the victim of the tyranny of the urgent – your business.

II. Plan To Build And Protect Your Business.  Your primary goal right now is to run your business the way you want for as long as you want until its worth what you want.  This won’t happen by accident.  You will need to consciously evolve with your markets and bring your employees along with you as you evolve your company.  A company that isn’t evolving is slowly dying.

• Identify And Build Value Drivers.  What makes your company successful?  What creates value and how can you best grow that value?  If you think you know the answer to those questions, think again.  What made your company successful and profitable last year isn’t what will make it successful and profitable next year.  Successful businesses are always experimenting and innovating, usually on a small scale, but they are constantly evolving.

• Write Your Business Plan.  Most businesses survive without a business plan; that doesn’t mean they survive well.  Too many owners view a business plan as an exercise they must endure to justify a loan or line of credit from a bank.  A simple business plan can be a powerful tool for change.  I generally advocate a “bullet point” business plan that is a living document.  Start with an outline that is appropriate for your industry and put a few top level bullet points in each section.  In some sections, the topic will determine what you start with but in most sections, the appropriate top level entries are WHAT you want to accomplish.  About a week later, go back to your outline and add a second layer of bullet points that define HOW you are going to achieve your goal.  Use this as a basis for discussions with employees and for measuring progress during the year.  Also, as situations change, most owners find it easier to change a bullet point plan than to change a large written document.

• Drive Cash Flow.  Driving cash flow drives business value.  Investment companies that consistently outperform their competitors do so by recognizing changes in the investment marketplace before other investment companies.  They also are constantly trying to eliminate the investments with the worst outlook and replace them with new investments with a better outlook.  Successful business owners should always be looking at their markets with an eye toward beating their competitors to new ways to meet new customer needs.  In addition, they should be weeding out the least profitable of their products and services and replacing them with more profitable products and services – products and services their customer need and will pay a premium for.

• Grow Your Growth Platform.  Constantly working to create a growth platform positions your company for growth but it also forces development of a strong management team and clean financials.  Doing the things that position a company for growth also position a company for sale.  You should try to keep your company in a state where you can choose to grow, not grow, or sell.  The best way to do that is to keep the company poised for growth.

• Develop Your Management Team.  Developing the management team is the single most important thing for an entrepreneur to do if he wants to create a strong enduring company.  When you ask private equity groups what they look for in a company, they generally respond: management, management, and management.  The two things that indicate a management team is strong are strong delegation, where mistakes are learning opportunities rather than firing opportunities, and incentive compensation.  If a management team isn’t rewarded for success, they will generally become more (or too) cautious.  And that will erode company performance.  When Private Equity Groups are asked what are the top three things they look for in an acquisition, they usually answer Management, Management, and Management.

• Document Your Systems.  Selling your business is like selling a franchise of one unit.  Look at the types of systems and documentation a franchisor provides to each franchisee.  You probably don’t need quite as complete a “cookbook” as your local franchise sandwich shop but most business owners are not even close.  An investment in documenting and following systems usually has a major effect on the multiple you receive for your business.  An intelligent buyer will look at what your business is worth and what it’s going to take to make it manageable for the new owner.  The most compelling selling proposition for most businesses is a competent motivated management team executing a proven documented business system.

• Manage Value Detractors.  The mirror image of value drivers are your value detractors.  To build a business that buyers will truly want, you need to eliminate or at least minimize your value detractors.  The absence of any of value drivers can also be detractors but here are a few others.

• Reduce Customer Concentration.  This is often a problem in smaller businesses.  Customer concentration tells prospective buyer two things.  First, the business is at risk if they lose the customer.  Second, if the single customer has been the main source of business for many years, a smart buyer will infer that the sales organization is stagnant and not capable of bringing in new customers.

• Resolve Conflicts (Employees, Clients, Suppliers).  Persistent conflicts are a problem that should never occur but sometimes do.  Conflicts with anyone indicate an organization that isn’t dealing with conflicting interests in a mature and productive manner.  Conflicts are bound to occur; how a business deals with those conflicts can affect the value of the company.  An intelligent buyer generally picks up signs of conflict early in discussions/negotiations and will confirm those suspicions during due diligence.  Getting open issues resolved before engaging buyers will improve the value of your company.

• Protect Your Assets.  Having built a valuable organization, you need to protect the value of what you have built.  Every business is different but here are two areas where I consistently see issues.

• Insure Against risk.  Most owners understand that their business needs property and casualty insurance.  In some industries, law requires some basic levels of insurance.  Work with an experienced insurance professional to determine what insurance is required in your industry in your state and then look at what insurance would make sense.  The purpose of insurance is to protect against losses your business cannot afford so you should consider that you are self-insuring against small losses and using an insurer to protect against large losses.  Don’t limit yourself to property and casualty; those are the most common business insurance types but you should consider others, such as key man insurance and insurance to support buy-sell agreements.

• Plan For Contingencies And Business Continuity.  What would happen to your business if you lost a key employee?  What if your business flooded and ruined inventory and data systems?  Every business has events that could happen.  Thinking about the unthinkable when the pressure is off, puts you in better position to deal with unplanned events when they do occur.  The most common type of contingency for businesses with multiple owners is a buy-sell agreement that can be executed if the partnership breaks up but good business continuity planning usually includes many more contingencies. 

III. Transfer Planning.  The goal of every business owner is to transfer the business to whom he or she wants on terms he or she wants.  Pulling that off can be tricky.  Seventy percent of business owners want to transfer the company to someone they know and trust.  Only thirty percent accomplish that and half of those transfers are through buy-sell agreements rather than conscious transition planning.  In many cases you can transfer your business to someone you know and trust as long as they are competent and you give yourself plenty of time.

• Choose Your Transfer Team.  Choosing a team of transition advisors to assist in the transfer of your business will help you to get the best possible price for your business and to limit the post closing risk.  In most cases, the team that helps you run your business is not the right team to help you transfer your business.  If you work with a large advisor firm (Attorneys, CPAs, etc.) you may be able to work with someone else in the same firm.  If you work with a sole practitioner, there is a good chance (almost a certainty in my opinion) that the person who is on top of your day to day business issues has not spent enough time doing business transfers.  I like to use a medical analogy.  The advisors that have helped you deal with the problems of running your business are like your family practice doctors.  Transferring your business requires business transfer specialists just like your health requires medical specialist; you should rely on your business team to recommend those specialists but you wouldn’t expect your family practice doctor to perform open heart surgery.

• Build Your Company’s Financial Fitness.  Before attempting to sell your business, make sure you understand how financially fit your business is.  Cleaning up financials is a critical part of getting top dollar for your business and sometimes cleaning up your books can take a couple years if you have personal assets and expenses flowing through your business.  Smart buyers will only pay for provable, sustainable profits and most lenders will only lend based on the same.  Regardless of the lender or investor, they will look at how much is available after their risk adjustments to service debt and that will become the upper limit for what they are prepared to lend for a buyer to leverage his own equity.  Lots of variability in earnings and books that are difficult to decipher will both increase the perceived risk and lower the amount a lender will lend on a deal.  That will most likely lead to a lower price and in many cases may require the owner to carry back a significant portion of the purchase price.

• Know Your Valuation Range.  Get a formal valuation from someone not associated with your business or the transaction before starting the selling process.  Make sure you understand the overall value and the elements of value.  In addition to a most likely estimate of value, get a likely value range from your valuation professional.  That way, you have a good sense of what is in play.  Also, if you have built your company well and have a strong management team executing a proven business model, you should expect to be in the upper half of the range of values.  If you have a particularly strong brand name in your market or have patents or other long term elements of value, you may command an even higher price for your business.

• Plan Early To Transfer To An Insider.  Transferring your business to an insider (key employee or family member) would seem like the easiest solution and it is often the desirable solution for the succession of your businesses leadership.  But transfer to an insider can be difficult in some ways.  First, the insider may not have much capital to put into the deal so you may have to come up with creative ways to get an initial ownership interest.  Second the transfer of authority generally has to occur before you leave the company rather than after.  This is because the insider will need to be operating as the CEO and have an ownership interest to have a credible picture to paint for a lender when he or she applies for a loan to complete the transaction.  An insider transfer also often involves complicated financial maneuvers to make the business affordable.  For example, a Non-Qualified Deferred Compensation Plan with you as the beneficiary creates a liability that reduces the equity of the business and increases the percentage of equity that can be purchased with a given amount of funds.  The NQDC becomes a de facto part of your purchase consideration that is dependent on the future performance of the company after you have left active leadership.  There are too many permutations and combinations to go into in detail here but an insider transfer requires a lot of expert advice very early as it can easily take five years to complete a transfer.

• Plan Your Transfer To A Third Party.  Most owners transfer their business to a Third party.  Third party transfers are less complicated than most Insider transfers but still require a long time to execute depending on how well prepared your company is when you start.  The active selling phase can take two years but there is usually a preparation phase as well.  You will need a full complement of advisors to execute a Third Party sale.  In addition to your business lawyer and CPA, you will need an intermediary to get better access to the market and an experienced transaction attorney who can ensure that the transaction is enforceable and limit your post closing risk.  You may need other specialists, such as a tax attorney, as well.  The result of the sale should be the best risk adjusted net present value after taxes.

• Develop Your Negotiating Baseline.  Developing a negotiating baseline prepares you to negotiate.  No two offers are alike and a negotiating baseline allows you to compare one offer to another and to correct issues in an offer that keep it from being acceptable.  Financially, most offers are evaluated for Net Present Value After Taxes to establish a financial baseline but other terms and conditions may increase your risk and make a lower NPVAT offer the most acceptable.  There are a myriad of issues in negotiating a deal for your business so you will need help sorting through all the variables and assessing offers.  In developing a negotiating baseline, remember that the deal has to be a win for the buyer as well as for you.  Pricing the business too high or dictating terms and conditions that place all the risk on the buyer will usually result in the deal falling through.

• Develop Your Marketing Plan.  To get top dollar, you need a plan to reach the most buyers and generate the most interest in your business while maintaining the confidentiality of the deal.  This is where your intermediary (investment banker or M&A advisor) earns his fees.  If your business has patents that give it a sustainable competitive advantage or you have a well recognized brand that customers trust, an auction may be the way to find the buyer who values your business the most.  For most other businesses, an auction may shrink the available buyer pool significantly and lead to less competition than a negotiated deal.  Either way, your intermediary should be able to develop a list of target buyers for the business that have the financial strength to do a deal and to push the company on to new levels of performance.

IV. Personal Planning.  After selling your business, you will need to revisit many of your personal planning decisions.  You should already have your team of experts in place.  Entrepreneurs characteristically have a difficult time going from working 24/7 to not working so a life coach that can help you develop new interests is often a very important part of your transition plan.

• Rethink Your Financial Needs.  You should revisit your needs analysis and adjust it as necessary.  Most owners will need more income in retirement than they needed when working because of travel and other deferred spending.  The old rule of thumb of 70-80% of working income will get you by but won’t (in most cases) support the lifestyle you want.

• Understand Your Financial Resources.  Post closing, your resources will be fixed (more or less) and you will need to live within your means.  Knowing what your resource base is will allow you to support your lifestyle and know how much cushion you have.  For example, a large number of entrepreneurs want to stay active in business and become angel investors.  You need to know what you have to support your lifestyle and what remains for other pursuits.

• Rethink Your Estate Planning.  Selling a business converts illiquid value into liquid wealth and is often a good time to review estate plans.  Depending on the size of the nest egg you have, it may be wise to start looking at wealth transfer strategies and charitable giving strategies that maximize the return you get on your portfolio.

• Rethink Your Tax Planning.  Your tax situation has probably changed and reviewing your tax situation with your new wealth will help you minimize the taxes both on the transfer of the business.  Tour tax professional can recommend suitable tax deferral and avoidance strategies for your situation.