Planning

WITH ECONOMISTS and forecasters predicting a near-term recession in the U.S., business owners may be asking if now is the right time to plan their exit strategy?

Similar to other questions we hear from clients, including “How early is too early to plan for retirement” or “When is the ideal time to plan for business continuity” or “When should I implement an Employee Retention Plan,” the answer to all is the same … yesterday!

Or, at the very least, today.

Why? Because the likelihood of surviving an exit, retirement, continuity challenge, or key employee’s unexpected departure, is having a plan in place well before the triggering event occurs. And the earlier an owner establishes that plan and communicates it, the more likely they and their companies will successfully navigate the accompanying financial challenges.

Exit planning is a process, not an event

In fact, the longer an owner waits, the more limited their exit options may become. Independent of what the economy is doing, owners need to begin planning for their inevitable departure, sooner rather than later.

So where should they begin? The first step in developing an intentional plan for ownership transition starts with the owner’s objectives. These form the foundation of exploring options, evaluating realistic strategies and, most importantly, offering direction to his or her advisory team. That team, by the way, is essential to the development of a comprehensive plan. No one adviser has all the answers and even those already on the team may not have the exit planning expertise needed to complete the project.

Owner objectives requiring clarification include when they want to depart or reduce involvement in the company, whether they have an idea of whom they would like to transfer the business to and, finally, what amount of capital is required to offer the owner financial independence upon departure.

The next step involves identifying financial resources available to the departing owner, including the business value. Since it is estimated that as much as 85 percent of a typical business owner’s net worth is tied up in their business, gaining accurate value is critical to exploring exit options. While the owner likely has an opinion on the company’s value, an accurate valuation typically comes from a qualified valuation expert. It is at this juncture that analysis of whether financial independence needs and financial resources available are a match. Less than 20 percent of business owners are in the enviable position of not needing a dime from their business in order to reach independence. The vast majority must either maintain business value or enhance value in order to reach their financial independence goals.

As such, attention to business value drivers is a perpetual endeavor for most owners and a necessary step in the development of their exit plan.

There are many: developing operating systems, documenting sustained earnings, focus on before tax earnings (EBITDA), growth strategy, paying down debt, managing inventory, updating facilities, equipment and systems, audited or reviewed financial statements, solid diversified customer base, and finally developing, incentivizing and retaining a key management group, to name a few.

While a CPA or business consultant can measure many of these value drivers, the hardest one to measure, in my opinion, is the last.

As a litmus test to determine if the business would survive without an owner’s day-to-day involvement (translated: motivated/loyal/capable management team), ask when was the last time he or she took a six-week vacation without checking in and the business survived or even thrived? If the answer is “no way,” then an owner’s task should be to begin working their way into operational insignificance. By doing so, that owner increases the transferability of the business and, indeed, enterprise value.

Next, if the owner’s objective is to build the business and eventually sell to an outside party, such as a financial or strategic buyer, focus on the aforementioned value drivers should be early and often.

They should add a transaction intermediary to their adviser team, ideally two to three years before an anticipated sale. A qualified expert can help navigate the process and help fight against dismal statistics indicating that only 30 percent of sales culminate in a closing transaction.

If an owner’s objective is to transfer the business to an “inside” buyer, such as a co-owner, family member or a key employee group, they will need to reconcile the fact that those buyers are likely going to be supported via some sort of seller financing.

When coordinated with a properly designed key employee incentive plan, seller financing can be cash flowed via increased profits. That in turn, is synonymous with increased enterprise value. A win-win for the selling owner. An internal transition is going to require an owner’s continued involvement with the business to ensure payment. It typically requires a minimum of a five-year runway to facilitate and finance.

A final step in the development of an owner’s exit plan involves establishing and/or updating a definitive business continuity plan. Unplanned “triggering” events do occur, often without warning.

They often initiate the need for stock transfer. While not all-inclusive, in the event of a death, disability, disagreement, divorce, etc. provision for stock transfer should be identified in a well drafted shareholders agreement. An updated contingency plan can make the difference between receiving or paying fair market price and/or adjusting to an unintended business partner.

Market cycles go up and they go down. That’s not a prediction, it’s a certainty.

Another certainty is that 100 percent of business owners will one day leave their businesses, voluntarily or involuntarily. The question is will it be on their terms, at their desired price and to their chosen successors? Odds are significantly improved with an intentional exit plan, developed well in advance of a triggering event, regardless of what’s happening in the economy.