Maximize Your Wealth With A Winning Exit Plan
| How To Get What You Want When You Leave Your Business
||Few things are certain in business life, but there is one
universal truth: Be it a carefully planned decision or the result of fate’s
swift hand, someday you will leave your business.
Your exit is going to take place in one of two ways:
- You will transfer ownership of the business during your
lifetime because you’ve decided you want out. Without planning, this will
probably mean that you have to liquidate. With planning you will be able to
sell the business to a third party, to key employees or co-workers, or to
family members – all at minimal tax rates.
- You will die or become totally disabled, and the
business will have to be liquidated unless some type of business continuity
arrangements have been planned and documented.
Most owners measure their satisfaction with their business
in terms of the income, wealth, identity, challenge, stimulation, satisfaction
and pride that it provides to them. Consider another definition of success that
measures a business – not only by how well it operates under your ownership and
by the benefits it provides -- but also by the rewards it will bestow when you
leave it. Because in the end, what you really want and need from your business
is the ability to leave it – under the most favorable conditions. The only way
you as an owner can do this successfully is to create an exit plan as early as
possible and stick to that plan as long as you maintain your business.
Developing Your Exit Plan
||What exactly is an Exit Plan that will allow you to leave
your business in style and how do you create it? Despite the almost infinite
variety of businesses and business owners almost all exit plans contain common
elements or goals. Generally these goals fall into three broad categories:
- To create and preserve the value of the company;
- To provide a means to exchange that value for money
with the least tax consequence possible;
- To meet personal and family needs by providing security
and continuity to your business and for your family either upon your planned
departure or if disaster strikes – upon your death or disability.
| Creating and Preserving Value In Your Business
||Most entrepreneurs are so dedicated to the worthy purpose
of making money that they have little or no time to spend on creating and
preserving value for their business. You must find the time because…
First, to exit the business in style, you will need cash.
That source of cash is the business. To determine the amount of cash you will
receive, we must know the value of the business.
Second, if you intend to give the business to children,
the business must be valued and that value must be used for gift tax purposes.
Third, the business typically comprises the great majority
of an owner’s total wealth. The IRS knows this just as surely as you do.
Determining the value now, allows you the opportunity to design an Exit Plan
taking your business into account with the goal of minimizing the IRS’s take.
Fourth, well-designed key employee incentive compensation
planning is central to increasing business value. Business value is often used
as a measuring rod for such plans.
Fifth, if an owner goes through this exercise well before
the business is sold or transferred, he or she will be able to pinpoint the
factors that are crucial to measuring and increasing (or decreasing) the worth
of the business.
How Much Is Your Business Worth? Determining The Value
||Valuation of your business is likely to be performed by
your CPA or a business appraiser using a methodology consistent with the
approaches sanctioned by the IRS. This valuation will determine a range of fair
market values for your business for purposes of gifting, estate taxation, and
general planning. Note that this fair market value is not the same as the sales
price for your business. To determine the sales price, the fair market value is
used as a hypothetical starting point and adjusted to accommodate factors like
timing of the sale and industry cycles, current condition of the merger and
acquisition market, interest rates, and geographic location among others.
The technical details of business valuation are beyond the
scope of this report. But one aspect worth noting is that estimating the value
of your business will be critically dependent on who the business will be
transferred to. If you are selling the business to an outside third party, you
will seek the highest possible value for your ownership interest. If you are
transferring ownership to your children, you must make every effort to develop
the lowest defensible value for your ownership interest. This counter intuitive
strategy is due to the huge role the IRS plays in the transfer of your business.
If you decide to sell to an outside third party, it will
be for cash and you’ll want all you can get via a high value. But your children,
your employees, your co-owner don’t have much of that green stuff. Their source
of money, or cash flow, is the same as yours – the business. They will need to
earn money on the business and pay income tax on it (tax #1) then pay the
balance to you to buy the business – at which time you will pay a second tax on
the gain (tax #2). The higher the business value, the greater the purchase
price. The greater the purchase price, the greater the double tax bite.
For example, if company earnings are distributed to the
purchaser (let’s say a key employee), it will be taxed to her as compensation –
salary or bonus money. She will then pay the after tax money to you (say 65
cents of the original dollar of earnings). You in turn pay a capital gains tax
on the 65 cents received (assume little or no basis on your ownership interest,
therefore a tax of about 25 percent). The net is less than 50 cents on each
dollar earned and paid out by the company.
In other words, all purchasers, other than outside third
parties, need to look to the earnings of the company for money to pay to you
because they have no money of their own. This results in a double tax paid on
the money received by you (taxed once as the employee/purchaser earns it and
once when you receive it for your stock). The higher the business value, the
higher the tax, the more difficult it is to accomplish a successful transfer…
the less likely you will leave your business in style. Methods for avoiding this
double taxation are rather complex for our discussion here, but keep in mind
that determining the value of your business will require you to decide early on
how you wish to transfer it.
How To Motivate And Retain Key Employees Through Ownership
||The one indispensable component of a valuable business is
its top employees. Think about it: your top employees are even more valuable
than you are for the purpose of creating value for your ownership interest. The
more valuable you are to the business, the less valuable the business will be
when you leave it. What you need to do is leave behind key employees who add
significant value to the business for several important reasons:
- Properly motivated by a profit-based incentive plan,
key employees do increase the value of your business.
- Key employees often become potential owners when you
decide to retire or move on to another venture.
- If you decide to sell to a third party, the continued
existence of a stable, motivated management team will increase the purchase
Key employees are not necessarily employees in key
positions. Key employees think and act a lot like you, they are eager to be
given responsibilities and challenges. Like you, they want to see the business
grow and prosper, and they want to grow and prosper along with it. They take
pride in being identified with, and contributing to, a successful business. In
short, they act like owners. Their continued presence in the business is
necessary if the business is to thrive.
There are several incentive packages you can implement to
retain and motivate key employees. These incentive packages help your key
employees reach their financial and psychological goals – if they stay with you.
As your key employees attain their goals, the design of these incentive packages
should also help you to achieve your ownership goal of building business value
(and eventually converting that value into money). Take a hard look at your
current employee benefit programs, especially those aimed at your key employees.
Elements of your incentive program should include:
- Financially attractive awards that create a potential
bonus of at least 10 percent of the key employee’s annual compensation.
Anything less than this will not be sufficiently attractive to motivate the
key employee to modify his or her performance to make the company more
- Specifics; that is, determinable performance standards,
such as the company reaching a certain net income or revenue level.
- Structure to increase the company’s value such that, as
the key employee reaches measurable objective standards, the net income of the
- Incentive reward vesting or “golden handcuffs” that
link payment to tenure thus encouraging the employee to remain on the job in
order to receive the reward.
- Face-to-face meetings with your key employees to
discuss the plan and make sure the incentive arrangements are thoroughly
understood and all questions answered.
Four Ways To Leave Your Business – Which One Is Right For You?
||Selecting your successor is a fundamental objective that
is decided early in the Exit Planning process. Almost all owners want to
transfer the business to other family members, an employee or a co-owner; only
about 5 percent want to sell to an outside third party. Interestingly, however,
most persons first identified as successors do not usually end up as the
Choosing your successor involves a careful assessment of
what you want from the sale of your business and who can best give it to you.
There are only four ways to leave your business. If you know these methods and
decide in advance which one you prefer, then you have a better chance of leaving
your business under terms and conditions you choose. Without planning you are
more likely to settle for terms and conditions beyond your control.
| 1. Transfer of Ownership to Your Children
||50 percent of typical business owners want to transfer
their business to their children. Fewer than one in three of these owners end up
doing so. Because this is the riskiest way to leave your business, you must
prepare for failure by developing a contingency plan to convey your business to
another type of buyer.
Transferring a business within the family fulfills many
people’s personal goals of keeping their business and family together. It can
provide financial well-being for younger family members unable to earn
comparable income from outside employment, as well as allow you to stay actively
involved in the business with your children until you choose your departure
date. Transferring your business to your children will also afford you the
luxury of selling the business for what you need to live on, even if the value
of the business does not justify that sum of money. You will determine how much
you need or want, rather than be told how much you will get.
On the other hand this option also holds great potential
to increase family friction, discord, and feelings of unequal treatment among
siblings. The normal objective of treating all children equally is difficult to
achieve because one child will probably run or own the business at the perceived
expense of the others. At the same time financial security is normally
diminished rather than enhanced and the very existence of the business is at
risk if it’s transferred to a family member who can’t or won’t run it properly.
In addition the vagaries of family dynamics may also significantly diminish your
control over the business and its operations.
2. Sale to Other Owners or Employees
||One of the great advantages of having other owners in your
business is that they can be your means to retirement. Especially with smaller
businesses, a common retirement planning technique is to have a younger
individual buy into your business while you are still active. Upon your
retirement, the younger owner will purchase your remaining stock.
This plan can be advantageous because the younger person
learns the business – its structure, employees, customers, operation, and
management – under your tutelage. More important for you, the younger person’s
capabilities (as well as his weaknesses) are known to you, so you have a pretty
good idea of how your business will be run after you leave. And most important
of all, the business can be sold to a market you create and control. You
structure the deal ahead of time to suit your particular needs and objectives.
Disadvantages in this plan are that there is no cash up
front, unless you as the owner have pre-funded the sale, but even then, you have
probably pre-funded with money that was yours anyway. A great risk also exists
in the fact that the buyout money comes from the future earnings of the business
after you leave it. Employees are often employees because they don’t have an
owner “mindset.” They’re not entrepreneurs and they don’t respond well to the
challenges and pressures of ownership. These disadvantages apply especially to
businesses worth more than $2 million. The owner simply has too much money and
financial independence at risk, and the price will be too high for an employee
| 3. Sell It To A Third Party
||In a retirement situation, a sale to a third party too
often becomes a bargain sale – the only alternative to liquidation. But if the
business is well prepared for sale this option just might be your best way to
cash out. In fact you may find that this so called “last resort” strategy just
happens to land you at the resort of your choice.
Although many owners don’t realize it, you should get most
or all of your money from the business at closing. Therefore, the fundamental
advantage of a third party sale is immediate cash or at least a substantial up
front portion of the selling price. This ensures that you obtain your
fundamental objectives of financial security and, perhaps, avoid risk as well. A
second unanticipated advantage in selling to a third party is the ability to
frequently receive substantially more cash than your CPA or other business
appraiser anticipated because the market place is “hot.” Finally, this may be
the best option for a business that is to valuable to be purchased by anyone
other than someone who has access to a considerable source of money.
If you do not receive the bulk of the purchase price in
cash, at closing, however, your risk will suddenly become immense. You will
place a substantial amount of the money you counted on receiving in the
unpredictable hands of fate. The best way to avoid this risk is to get all of
the money you are going to need at closing. This way any outstanding balance
payable to you is “icing on the cake.”
| 4. Liquidate It
||If there is no one to buy your business, you shut it down.
In a liquidation the owners sell off their assets, collect outstanding accounts
receivable, pay off their bills, and keep what’s left, if anything, for
The primary reason liquidation is considered is that a
business lacks sufficient income-producing capacity apart from the owner’s
direct efforts and apart from the value of the assets themselves. For example if
the business can produce only $75,000 per year and the assets themselves are
worth $1 million, no one would pay more for the business than the value of the
Service businesses in particular are thought to have
little value when the owner leaves the business. Since most service businesses
have little “hard value” other than accounts receivable, liquidation produces
the smallest return for the owner’s lifelong commitment to the business. Smart
owners guard against this. They plan ahead to ensure that they do not have to
rely on this last ditch method to fund their retirement.
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