Exit Planning

The Cost of Inaction

Many owners (if not most) wait until they’re ready to retire before they get serious about the planning of a transition. That timeframe is usually about 6 months before they want to sell the business. And while it’s true that most deals can be completed within 6 months, getting a deal done and getting the price and terms you want can be very different things.

There’s a cost to waiting until the last minute to plan an exit.

EXTERNAL SALES

Typically, when an owner plans to sell his or her company to an outside buyer, they’ve imagined a scenario where an advisor reviews their company, puts a value on it (which ends up being equal to what the owner feels it’s worth), and goes about finding a buyer. Once the buyer is found, they come in, look over the books and the operations, and write the owner a check for the value of the business in exchange for the keys.

But it rarely works like that…

More often, one or more issues related to price or terms surfaces and can even derail the plan.

Value Less Than Desired
When a formal valuation is done, sometimes the value is higher than expected, but often it is lower. Transition experts can help an owner increase the value of their company, but it takes time. Once changes are made and the improvements generate greater growth and profitability, that increased performance needs to be demonstrated for at least a year or more to properly boost the value of the business.

If an owner waits to address this, he or she will be forced to accept a lower value. There is a cost to inaction.

Actions to Take and The Benefits:
There are several steps an owner should take a year or more in advance of a sale to avoid surprises and to maximize value. A formal business valuation should be conducted to establish an unbiased value for the business. In addition, a preliminary Quality of Earnings evaluation and a Quality of Leadership assessment should be done to uncover any potential issues that could negatively impact value. Once the valuation, Quality of Earnings and Quality of Leadership are done, any shortcomings can then be addressed to mitigate problems and maximize value.

Price Less Than Desired
Generally, the price a buyer will pay for a company is close to the formal valuation figure. And that price is often a multiple of EBITDA. But as the wave of Boomer-owner retirements builds (it started in 2021), there will be a growing surplus of businesses on the market looking for a buyer. And with a growing surplus comes falling multiples. In other words, where the price might have been 6 times EBITDA, it may well drop to 4 times EBITDA.

If an owner waits too long to sell the company, he or she will be forced to accept a lower price due to the surplus of sellers on the market. There is a cost to inaction.

Actions to Take and The Benefits:
The Boomer owner retirement wave has begun (2021), the surplus of sellers over buyers will consistently increase over the next 3-4 years, and the surplus will persist for another 8-10 years after that. Given the dynamics of the marketplace, the best way to ensure a high multiple (and therefore a strong price), is to put an exit plan into action sooner than later.

Less Desirable Terms
Another consequence of a growing surplus of sellers, is that buyers can become more demanding and may require terms that an owner may find undesirable. They may demand a significant earn-out, where the owner must “earn” part of the purchase price based on the performance of the business following the acquisition. Or buyers may demand that the owner stay on for an extended period (1-3 years) to ensure performance. Or there may be any number of other demands that the owner may not like, which could be deal breakers.

If an owner waits too long to sell the company, he or she will be forced to accept additional terms because they’ve lost their leverage due to the surplus. There is a cost to inaction.

Actions to Take and The Benefits:
The same advice to maximize multiples holds true for deal terms. The sooner an owner acts, the more leverage he or she will have over the terms of the deal.

INTERNAL SALES

Just as with an external sale, an owner who plans on having a successor take over has also imagined a scenario. They imagine that when the time comes to retire, their chosen successor will be ready and willing to take the reins of the company and will successfully lead it into the future. The business will continue to grow, profits will continue to grow, employees will be happy, customers will be happy, and of course, all the buyout payments will be made.

But it doesn’t always happen like that…

Choosing the right person and properly preparing them to take over is essential to the success of an internal sale (succession). But many times, one or more issues exist and – if not addressed in advance – can cause major problems. There is a cost to inaction.

Lack of Preparedness
Preparing someone to take over the business is essential to the success of an internal sale. But grooming them in the mechanics of the business does not necessarily develop their ability to lead effectively, their ability of think strategically, nor their ability to make good decisions.

The result of an inadequately prepared successor can be employee turnover, loss of customers, declining revenues, diminishing profits, and missed buyout payments. There is a cost to inaction.

Actions to Take and The Benefits:
It’s very difficult for an owner to be objective about their successor. Therefore, it is essential to the success of a successor that an objective assessment be conducted and they get outside, objective coaching. It generally takes 6-12 months of coaching to develop the competencies needed for leadership and ownership success.

They’ll become a more effective leader, they’ll develop smarter strategies, and they’ll make better decisions.

Choosing the Wrong Person
Sometimes, no matter how much an owner and/or an executive coach grooms and mentors someone, they still won’t be effective at leading the company.

The problem, however, is that those shortcomings often are not evident until the successor takes over. And of course, by then it’s too late. In fact, often the shortcomings themselves aren’t apparent, but rather manifest themselves in declining business performance. Obviously, waiting until there’s no turning back is a mistake. There is a cost to inaction.

Actions to Take and The Benefits:
An objective assessment can reveal many of those shortcomings. But identifying a successor’s strengths and weaknesses is only part of what needs to happen. Having a successor work with an experienced executive coach can reveal lapses in judgment, gaps in interpersonal skills and blind spots. Usually these can be determined within about 3 months.

If it becomes apparent that the successor is the wrong person, a new successor can be recruited and groomed. The process of finding that right person can be completed in about 3-4 months. And at least another 9-12 months should be allowed to allow the successor to prove him or herself prior to the owner retiring.

Having to Choose Among Several People
When there are several potential successors, owners often put off choosing one as long as possible. They either can’t make the decision, hope that one will rise above the others, or fear the fallout that may come from one being chosen over the others.

But of course, procrastinating doesn’t resolve anything and more likely, will create even more problems and anxiety if done at the last minute. There is a cost to inaction.

Actions to Take and The Benefits:
The best way to make a decision that will be the least upsetting to people is one based on objective assessments. They will provide an unbiased picture of each person’s strengths and weaknesses. The results will allow an owner to either choose one over the others based on their strengths or split responsibilities based on their strengths. The objectivity removes a good deal of emotion from the decision process.

BOTTOM LINE

The bottom line is that, regardless of whether an owner plans to sell their company to an outside buyer or an internal buyer, waiting until months before the event usually produces less than desirable results. Taking action well in advance of a sale will either uncover issues that can be addressed (so the business is attractive to buyers), or will prove that everything is in order and will allow the owner to sleep at night, knowing their future is secure.

Contributed by Michael Beck

What to know before exploring a sale in 2021

By John Patnaude – Bernstein Private Wealth Management

The decision by a business owner to sell his or her company can be both emotionally challenging and financially complex. It has, however, become a growing consideration among local Puget Sound owners during the Covid-19 pandemic, as some companies struggle to continue their operations, or alternatively, become a more attractive acquisition target for potential buyers amid pandemic-related tailwinds.

The continued impact of Covid on the deal landscape, combined with the possibility of significant increases in the capital gains tax later this year, make sale preparation and planning for businesses and their owners, paramount.

For business owners potentially looking into a sale this year, there are a few key factors to consider:

Understand valuation. An owner should begin the process by connecting with an investment banker with expertise in their industry who can offer guidance on the likely value of the business and how deals are typically being structured. For example, should they expect to see all cash deals, having a portion paid out as an earn-out over the coming years, or perhaps having a portion rolled over into a newly created entity?

An investment banker can also prepare the business to be an attractive acquisition candidate both internally, ensuring the right management team is in place and the financials are in order, and also externally by evaluating the competitive landscape, branding of the company, as well as any concentration risk with their customer base.

Build an advisory team. Beyond the investment banker, business owners need to build a team with deep mergers and acquisitions expertise including a seasoned corporate lawyer, CPA and wealth adviser. Business owners tend to have relationships with these professionals already, but it’s key to ensure these individuals have experience with sizable, complex transactions.

Consider personal financial goals. Often the focus of the business owner is around maximizing the sales price of their business and completing the transaction. But sellers need to give equal attention to the impact the structure and sale will have on their personal financial goals, along with the effect on the next generation and philanthropic pursuits.

This is where the value of a qualified wealth adviser comes in. An adviser can explore a range of possibilities by simulating the sale of the business under several scenarios, after taxes, to determine:

The minimum amount needed from this sale to replace and secure lifetime spending
The amount of surplus capital beyond lifestyle spending available for generational and philanthropic goals
How accomplishing these needs might change based on different deal structures presented by potential buyers
How an earn-out or equity stake in a newly formed business might affect current goals
How a potential capital gains tax increase and reduction of the federal estate tax exemption, as proposed by the Biden administration, could impact financial goals
Tax-savings strategies, such as Qualified Small Business Stock (QSBS)

Create a pre-sale financial plan. Once the owner has defined their personal and family goals and objectives around the sale, it is important to understand the different investment options for their newfound liquidity. Interest rates are historically low and equity market valuations near all-time highs. Evaluating the broader range of investment choices beyond stocks and bonds to meet income needs, minimize volatility and accomplish growth objectives is critical.

It will also be necessary to explore different legal entities to create, in advance of the sale, to efficiently maximize wealth for the family and reduce taxes. These entities include generation skipping trusts, donor advised funds or private family foundations. Coupling these entities and certain planning techniques with the sale of the business can magnify the potential for the transaction well beyond the headline sales price.

Receiving an attractive multiple for the business is only one aspect to achieving a business owner’s financial goals, and a sole focus on the price may be to the owner’s detriment over time. Implementing wealth planning techniques before and after a sale will allow owners greater flexibility over how to deploy their wealth and ensure it lasts for generations to come.

John Patnaude is managing director at Bernstein Private Wealth Management in Seattle.

Contributed by James Bocinsky

Protecting Value with the Right Planning Partners

Your business is your most important asset, and you deserve advisors committed to delivering the right advice, the best solutions and the expertise to execute the planning to protect your business value.

The first step to protecting the value of your business is to understand what it is worth in relation to everything else you own (Left Pie Chart) and then what is at risk without good planning (Right Pie Chart). Knowing the value of your business helps you make better decisions. Start by getting a valuation of your business. Today’s technology allows for basic valuations to be completed with speed and accuracy at an affordable cost.

Once you know the value of your business you will need a team of advisors. No Business Value Protection Planning can be effective and completed without Financial Professionals, Attorneys and CPA’s working together for the benefit of you the business owner. Unfortunately, this job is not getting done for the majority of small and mid-sized businesses. This puts 60% to 80% of business value and income at risk.

70% of Small and Mid-Sized Businesses have an incomplete succession plan or none at all. How can this be?

Sole Proprietors can get by with a Single Advisor in most cases. Their business model simple and straightforward. Large Private and Public Companies have access to Full-Service Consulting Firms with the needed team members already in place. The majority of businesses fall in the middle and it is easy to understand why studies have revealed a majority of business owners are not sure about where to begin because there is not an existing team in place. You need a team of advisors. It important to identify those with the skills required and willing to work together rather than independently. Your existing trusted advisors should be able to help you get started.

So how will you know if you have the right team in place? There are three indicators to help you.

Clarity – Communication – Confidence

Clarity – When you have clarity about the value protection planning areas and the role each advisor plays then you are on the right track. The protection areas include Succession, Retirement, Estate and Key Stakeholder Planning. It is the responsibility of your advisors to bring clarity to you. If you are not clear, then they have not done their job.

Communication – Require your advisors to communicate effectively with you and with each other. It is their job to make this a priority and the only way the planning done will be coordinated and complete.

Confidence – When you look at the team assembled to do the work for you, and you have a sense of confidence then you are on the right track. Hoping it works out is not a strategy. Confidence comes when the team combines clarity and effective communication.

Benefits of Partnership Thinking

Your planning team working in partnership will hold each other accountable. This is a huge benefit to you. The planning solutions designed are vetted by your Attorney, CPA, Financial Advisor and others. In partnership they deliver complete solutions. Embrace the partnership approach to planning. Make it a requirement for your advisors to embrace working in partnership with each other. Advisors work best together when committed to a common goal or objective. Require them to focus on the objective of protecting the value of your business, your most important asset. It must be the central theme at all times. This saves you time, money and eliminates much of the frustration associated with planning.

If nothing else, remember the message from the pie charts to keep everyone focused on completing the protection planning process.

Contributed by Doug Marshall

Every Owner Has a Plan Until…

Mike Tyson, the heavyweight boxer, was quoted as saying, “Everyone has a plan until they get punched in the mouth.” Regardless of what you may think of him as a boxer or a person, it was a great observation.

It doesn’t matter whether we’re talking about boxing or business, the truth is that owners all have a plan for a transition until they get hit with a setback. Some will give up after being derailed, but others will take a step back, correct their course of action, and find a way to succeed. Giving up on a course of action is not the same as giving up on a goal.

Having a strong attachment to the process with which to achieve a goal often undermines our success.

Let’s look at the typical transition options, the potential setbacks, and how to recover from a setback.

Typical Transition Options:
Generally, owners have two practical options – an External Sale (Exit) or an Internal Sale (Succession). (The other option is to close the doors and sell the assets.) An Exit is generally a sale to an Individual Buyer or it’s some form of Strategic Acquisition (M&A/Investment Bank/Private Equity). In contrast, a Succession is a sale to a Family Member, a Key Executive, or via an ESOP (Employee Stock Ownership Plan). A number of these options can be the right path for an owner, depending on the nature of the business and the needs of the owner. The problem is that many times, things don’t go as planned.

Potential derailers for a planned External Sale
Circumstances that can derail an Exit include:

Can’t find a buyer or attract capital – This can be due to a surplus of businesses for sale or to the nature of the business. The greater the surplus of sellers, the more selective buyers can afford to be. Additionally, the more dependent on the owner and his/her relationships, the less attractive the business.
Price too low – This can also be due to a surplus of businesses for sale or it can be due to business valuation issues like customer concentration, weak leadership, market concentration, etc.
Unacceptable terms – Sometimes buyers require an owner to stay active in the business for an extended period of time and or defer payment of monies pending performance.
Health issues (yours or a family member) – Clearly, this situation is unexpected, and a sale would be undertaken under pressure, which would result in a loss of leverage.

Potential derailers for a planned Internal Sale
Circumstances that can derail a Succession include:

No qualified or interested successor – Either the person you had in mind to take over the business doesn’t want to, or you don’t have confidence in the person who wants to take over. Additionally, it’s not unusual for the person to lack the personal net worth that banks would deem adequate for funding the sale.
More than one interested family member or executive – You have more than one person who wants to be the successor and it creates conflict – sometimes significant conflict.
Too small for an ESOP – You like the idea of creating an employee-owned company, but the cost is too high and/or there aren’t enough savvy leaders to take charge.
Health issues (yours or a family member) – Clearly, this situation is unexpected, and a transition would be required before a successor is ready.

How to Reduce the Chance of Your Plans Getting Derailed:
The best approach to planning a transition is to be proactive, well in advance of your anticipated departure. Start by pulling together a team of professionals sooner than later. Their expertise can help you choose the best exit strategy for your situation, identify and resolve potential issues, and refer you to people with any additional expertise if needed.

• Wealth Manager
• Tax Planning Attorney
• Successor Recruiting
• Successor Development
• Succession Attorney
• Private Equity Firm
• M&A Advisor

• Investment Banker
• Exit Planner
• Executive Coach
• Estate Planning Attorney
• Commercial Banker
• Business Broker

If your goal is an external sale, consider having a preliminary Quality of Earnings Report done along with a Quality of Leadership Report. These two reports will highlight any shortcomings and/or impediments in advance of a sale so they can be addressed before going to market. Additionally, consider selling sooner than later to avoid the surplus of Boomer-owned businesses coming to market and/or to avoid being forced to retire due to health issues.

If your goal is an internal sale, ensure you’ve identified your successor well in advance and make sure they want the role. (If there is no one, then start the process of recruiting a potential successor as soon as you can.) Once that’s done, start working on developing that person. Develop their business savvy, their leadership effectiveness, their strategic thinking, and their owner mindset. If more than one successor will be involved, objectively assess them and decide how to split/share responsibilities.

How to Recover from a Setback on an External Sale:
Basically, there are two paths to recovering from a setback on an external sale. Start by attempting to make the business more attractive. If possible, address the issues that caused the business to be less attractive, caused it to be worth less than you hoped for, or caused the terms to be undesirable. If that can’t be accomplished, then switch to an internal sales solution by choosing or finding a suitable successor and grooming them to take over.

How to Recover from a Setback on an Internal Sale:
If your plan to have a particular person take over the business fails, re-evaluate and assess alternative successors and/or start the process to recruit a successor from outside the company. Once you’ve chosen someone, begin grooming them to take over.

By the way, if you want to accelerate the development of your successor, consider bringing in a professional executive coach. Having an objective, confidential sounding board can help them gain new perspective and develop the skills they need to succeed.

Contributed by Michael Beck

Planning on Selling Your Business? Think Again…

Everyone’s heard about how Baby Boomer business owners will be retiring and the wave of business successions/exits that will occur as a result of those retirements. But there’s a problem that almost no one is discussing. Our research clearly shows that there aren’t enough buyers for all those businesses. Here’s why and what you can do about it.

The SBA reports that there are roughly 6,000,000 small employers in the U.S. Of those 6 million businesses, approximately 3,600,000 are owned by Baby Boomers and about 2,400,000 are owned by GenX’ers. Based on the US Census population statistics, this means about 4.5% of Boomers own a business and about 3.0% of GenX’ers own a business. Human nature being what it is, we expect the percentage of GenX’ers who want to own a business to also rise to 4.5% as they get older. None of that is especially surprising – until you think about it a bit more. And then it becomes alarming. It becomes alarming because that rise in GenX owners from 3.0% to 4.5% represents only 1/3 of the Boomer businesses that will be for sale.

The result is that 2/3 of all Boomer businesses won’t find an individual buyer!

But what about strategic acquisition and private equity money? There’s lots of money looking for a home, right?

There are always companies looking to acquire or merge with businesses that complement or expand their core business. After all, the acquisition is considered “strategic” because it expands their market share, affords economies of scale, or adds products and services that dovetail with or complete their current offerings. But only the most profitable, highest regarded, or fastest growing businesses will be strong candidates for a strategic acquisition at full market value. The reality is (and always has been) that most companies will not be good candidates for strategic acquisition.

When it comes to private equity, pretty much all private equity investors are looking for opportunities with high profit growth potential. And as we know, most businesses are more about steady growth and consistent profits. They just don’t pencil out for that big, private equity payday.

Historically, between M&A deals and Private Equity deals, only about 15-25% actually close. Even if we’re optimistic and assume 25% of the available businesses can attract private equity money or a strategic buyer, it leaves a full 50% of Boomer businesses without a buyer or acquirer! (75% of the 2/3 noted above)

If owners REALLY want to sell their company to an outsider, they should work with an experienced M&A Advisor, Investment Banker, or Business Broker. It will maximize their chances of getting sold. In addition, they should get preliminary Quality of Earnings and Quality of Leadership reports done. These reports will highlight any weaknesses that need to be addressed before going to market, thereby increasing their chances of attracting a buyer and closing a deal.

So, where does that leave owners who can’t find a buyer or attract money?
Here are the five options open to them:

“FIRE SALE” ACQUISITION
Businesses whose profitability and growth are weak or who aren’t quite a perfect fit for an acquiring company may still be candidates for acquisition. The problem, however, is that they won’t be able to command their full market value. Because they’re not as attractive to a strategic buyer and because there will be so many businesses on the market, the only incentive to complete a deal will be to lower their asking price – sometime significantly.

FIND A SUCCESSOR
One of the better options for many businesses will be to recruit and develop a successor, and then sell the company to them at full price. Some banks may be willing to fund a portion of the buyout, but the majority of internal sales will be paid (in part or in full) out of future cash flow. Consequently, it is critical to find a successor as soon as possible and ensure they are well-prepared to be an effective leader and a successful owner. It generally requires one to two years of development to hone someone’s leadership capabilities, their strategic thinking, and their judgment. Without that development, you run the risk of the business not being able to make those buyout payments.

KEEP THE BUSINESS
A variation of selling to a successor is to bring on a successor to run the company but not sell the stock. This option allows the owner to draw out the business’ value from the company while still owning it, but without needing to run it on a day-to-day basis. It requires finding and developing a strong successor, and then rewarding him or her for good performance.

CREATE AN ESOP
In the absence of a strong successor, an option that will also yield full market value is to set up an Employee Stock Ownership Plan (ESOP). This approach can increase employee loyalty and productivity, ensure business continuity, and gain some tax advantages. An ESOP can be effective, but it requires one or two years of planning, along with the training and development of the people who will be directing the organization. But it can be expensive to establish an ESOP and is therefore not a practical option for most companies.

CLOSE THE BUSINESS
If a business can’t find an individual buyer, is not a candidate for acquisition, has no successor and isn’t able to structure an ESOP, the only course of action will be to close the business and sell off the assets. Obviously, this is the least desirable outcome. The owner will receive pennies on the dollar and the livelihood of all the employees and their families will come to an end.

We believe all too many businesses will be facing this stark reality if they don’t put plans in place at least two to three years in advance of retirement.

THE BOTTOM LINE
The bottom line is that if your businesses isn’t in high demand and you’d like to sell it for a reasonably strong price, the best course of action is generally going to be to recruit and develop a strong successor.

If you’d like help recruiting, assessing, and/or developing a successor for your business, please contact us. It’s what we specialize in. www.ElicitingExcellence.com

Contributed by Michael Beck