Optimize & Protect Your Business with an Exit Plan
by Edward B. Lasak, CPA, MS – part of our series The “_______” Journey.
Throughout his 35-year career as a CFO, COO, Ed collaboratively consults with and empowers business owners by developing high-potential exit strategies, succession plans, and company valuations integrated with a comprehensive strategic vision.
Optimize & Protect Your Business with an Exit Plan
The Business Value Opportunity
Riverside, CA – One of the largest assets on a business owner’s balance sheet is the value of the family business. Many times, the business is an asset that is not fully optimized by the benefit of a strategic plan and capable management, and it is at risk of losing its going concern status due to the untimely loss of the business owner. When the business is not optimized for value and/or prepared for succession, the unaware owner is operating with major risks of future significant financial losses to his/her company’s stakeholders, which include: customers, vendors, employees, business partners, and family. Unfortunately, many times an owner’s other assets such as Social Security benefits, pension plan annuities, stock market investments, and real estate holdings seem to take a higher priority and level of awareness even though the family business may have the highest potential value by offering financial security through tax incentives, benefit plans, and an ongoing annuity payments or a significant cash payout.
One may wonder why some companies are not optimized and protected?
Let’s face it, this planning is a long-term, arduous process that can take up to three years to perfect to realize optimal value, and the plan can be challenging to execute with many moving parts, often requiring outside guidance and expertise. There are only so many hours in the day, and it can be challenging for a business owner to find planning time when he/she is flooded with so many daily responsibilities all needing
immediate attention without the necessary management structure in place for running the business. Many times the business owner is wearing several hats such as the CEO, CFO, and CRO requiring he/she to be an expert in so many subjects and every decision needs their analysis and involvement. Likewise, every discipline requires special skills, experience, and knowledge and it is not possible for one person to be an expert in all areas of a business. Consequently, many robust and high potential business opportunities are neglected and not realized due to the over reliance on the business owner.
Also, some business owners may not be receiving the necessary advice from their trusted advisors because advisors typically do not have the hands-on experience of running a business. The focus remains to close the books, prepare tax returns, and update estate plans, not to plan for optimizing the business and incorporating appropriate exit strategies in line with the owner’s expectations and desires. This skill set is normally provided by former CEOs and CFOs as outside consultants who are not normally part of the trusted advisor team.
Finally, and perhaps most importantly, most business owners think that they will have tomorrow to do this necessary planning, but as we all know, no one is promised tomorrow, only today.
Although all of these excuses are completely understandable in today’s business environment, there are no plans in place to guarantee optimal value and assured business continuity. Likewise, there should be no excuse for not having the necessary planning process in place to optimize value, reduce future risk, and secure future success with an optimal exit strategy.
Without planning, business owners are placing their families in a vulnerable position.
Without this planning, business owners are placing their families in a vulnerable and precarious position of expecting them to run a complex business without the necessary institutional knowledge, education, entrepreneurial spirit, and experience required. It is a stressful position to place family members in the later stages of their lives who suddenly have inherited the responsibility of running the family business. In addition to risking business equity, family members may be risking other personal assets by assuming personal guarantees on business lines-of-credit and long-term leases, all of which are necessary for running a family business.
Furthermore, these unplanned transitions may cause irreparable damage to long term family dynamics and relationships by placing them in a stressful position where they are unprepared to achieve. Adding to this stress is the fact that some family members may want their cash now, and many times, their internally calculated business valuation are usually much higher than justified by future cash flows and professional business appraisals. This family dynamic may place undue hardships on the family business by reducing necessary working capital for unanticipated payouts. It is important to recall the lessons of Accounting 101 that just because there is a positive book value does not assure one that there is available cash in the business to make these distributions.
All these risks become exaggerated in the future because the business owner will not be available to manage the business and control family dynamics and expectations. To be most effective, exit planning needs to happen while the business owner is still functioning in the business. His/her leadership is the special ingredient that is needed to drive this planning and then to communicated the plan to key stakeholders and trusted advisors.
Business transition risks may extend beyond the business owner’s family.
Some business owners may have grown their companies through trusted partnerships with other like-minded partners. Together, as a team and over time, these partnerships have created a valuable business asset by leveraging complementary skill sets and experiences of the group. Likewise, this begs the question, what happens to the company when one partner of the partnership is no longer able to work and contribute as he/she once did? Who is prepared to fill that role and how is financial interest transitioned to remaining partners?
Since a partnership have been effective in managing and growing the business, one may feel confident that the remaining partners would agree upon a fair settlement to the business owner’s family. Of course, there is nothing further from the truth mainly because the business owner’s voice of reason and influence will not be heard as part of this process. Consequently, the family may face the risk of not receiving fair market value and reasonable payment terms placing their retirements at risk.
On the other side of the coin, the surviving business partners may face an even greater risk of not being able to acquire the necessary ownership of the business at fair market value, and perhaps even more importantly, at workable payment terms consistent with the cash flows of the business. Without a thoughtfully prepared Buy/Sell Agreement, this transition will have to be negotiated by family members and remaining business partners in a crisis’s mode without the benefit and influence of the former partner. Consequently, there may be no protection in place for either side of the transaction causing major delays and expensive legal action and arbitration. Moreover, family members may have a different assessment of value as well as different opinions on the way the business in being managed. It is a situation fraught with potential legal disputes, and in the meantime, someone with the appropriate skill sets needs to continue running the company without the benefit of complete ownership and control of the company.
It is almost certain that transition settlements will not proceed in the manner that would have been decided upon with all business owners at the table. In all likelihood, there will be significant disputes over how the company’s valuation as well as payment terms. These negotiations can be further complicated by similar valuation disputes over related real estate holdings. These disputes can be extremely challenging and could drag on for many years causing significant hardships to all parties especially the going concern status of the business. Worst of all, some family members may prefer liquidation, the lowest valuation option, so that they can get their money now.
In order avoid these risks, a comprehensive plan needs to be developed now while all partners are participating in the business, and it should be tested and refined annually. Likewise, family members and service providers need to be briefed on the plan so that everyone is on the same page when it is time to execute.
Read Part 3
- Going concern, business as usual
- Going concern, optimized business
- 3 to 5-year strategic plan
- Succession plans
- Exit strategies
Part 3 – Exit Options
- Owners transition from management to Board
- Admit new strategic partners
- Sell to employees (ESOP)
- Sell to management team
The Value of Business Appraisals
- Know the value of the company
- Measure progress to strategic plan
- Provide an objective management incentive awards
- Measure future decisions on creating value
Header Image Credit – provided by Ed Lasak