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January 2014 Tip of the Month

IT'S NOT JUST EXIT PLANNING...IT'S ALL ABOUT PLANNING

Unlike people whose investment portfolios are diversified in many different stocks and bonds, business owners tend to have invested the majority of their funds in one thing -- their own businesses. This makes cashing out when they are ready to retire much more difficult. If you are facing retirement and own a business, now is the time to begin creating an exit strategy. The same amount of energy you have devoted to building the business now needs to be spent planning your exit so that you can fully realize the value that has taken a lifetime to build.

Before we get into the actual topic and as we mentioned in a prior email alert, Marty Abo likes to "practice what we preach" and was asked to "step up to the plate" as a director for The Exit Planning Exchange of Philadelphia (XPX). XPX is dedicated to helping entrepreneurs prepare for an informed, organized and financially rewarding exit from their company. XPX's members are seasoned advisors who understand the value to an owner of having a team of advisors to support the exit process. Member specialties include law, banking, accounting, wealth management, investment bankers and business brokers, merger and acquisition professionals, insurance, business valuation, and business consultation. XPX's purpose is to help advisors gain thought leader training about the exit process, learn about the role of other disciplines and come together to form exit teams to better support their owner clients to achieve a successful exit from their businesses. Anyone interested in the organization should feel free to reach out to Marty.   

Read on....

An exit strategy involves developing a plan for passing on responsibility for running the company, transferring ownership and extracting the owner's money. Because a stable business is worth more than an unstable one, creating a seamless transition is essential to maximize the owner's investment.

Developing an effective exit strategy involves planning on several levels. These include consideration of corporate changes, personal lifestyle changes, family issues, and income and estate taxes.

Selecting your business successor is a fundamental objective of planning an exit strategy and requires a careful assessment of what you want from the sale of your business and who can best give it to you. For business owners who have spent their lives building a business, retiring may not be an easy prospect. Many lack company-sponsored pension plans and most of their money is tied up in the business.

We at Abo and Company have seen but four ways to leave your business:

  • transfer ownership to family members;
  • Employee Stock Option Plan (ESOP);
  • sale to a third party, and
  • liquidation.

We think the more you understand about each one, the better the chance is that you will leave your business on your terms and under the conditions you want. Of course, a logical question is how much the business is worth. You wouldn't think of buying or selling a home without knowing its value and that logic certainly extends to buying and selling a business. To ensure you receive a well-performed and well-reasoned valuation, you need to understand key valuation elements and then carefully select a skilled valuator but that is the subject of a different Abo and Company article or inquiry.

So.....here's what Abo and Company thinks you need to know about each one of the four alternatives above.

1. Transfer Ownership to Your Children

Transferring a business within the family fulfills many people's personal goals of keeping their business and family together, but while most business owners want to transfer their business to their children, few end up doing so for various reasons. As such, it's necessary to develop a contingency plan to convey your business to another type of buyer.

Transferring your business to your children 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.

It also affords you the luxury of selling the business for whatever amount of money you need to live on, even if the value of the business does not justify that sum of money.

On the other hand, this option also holds the potential to increase family friction, discord, and feelings of unequal treatment among siblings. Parents often feel the need to treat all of their children equally. In reality, this is difficult to achieve. In most cases, one child will probably run or own the business at the perceived expense of the others.

At the same time, financial security also may be 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, family dynamics in general, may also significantly diminish your control over the business and its operations.

2. Employee Stock Option Plans (ESOP)

If your children have no interest or are unable to take over your business, there is another option to ensure the continued success of your business: the Employee Stock Ownership Plan (ESOP).

ESOPs are qualified retirement plans subject to the regulatory requirements of the Employee Retirement Income Security Act of 1974 (ERISA). There's one important difference however; the majority (more than half) of their investment must be derived from their own company stock.

Whether it's due to lack of interest from your children, an economic downturn or a high asking price that no one is willing to pay, what an ESOP does is create a third-party buyer (your employees) where none previously existed. After all, who more than your employees has a vested interest in your company?

ESOPs are set up as a trust (complete with trustees) into which either cash to buy company stock or newly issued stock is placed. Contributions the company makes to the trust are generally tax deductible, subject to certain limitations and because transactions are considered stock sales, the owner who is selling (you) can avoid paying capital gains. Shares are then distributed to employees (typically based on compensation levels) and grow tax free until distribution.

If your company is a stable, well-established one with steady, consistent earnings, then an ESOP might be just the ticket to creating a winning exit plan from your business.

As an aside, because of the many technical issues surrounding the implementation and annual valuation mandated for an ESOP, Abo and Company refers out to credible appraiser colleagues and attorneys seasoned in this arena. If you have any questions about setting up an ESOP for your business, give Marty Abo a call today for a name or two.

3. Sale to a Third Party

When planning a private sale, consider the logical buyer: current management, a customer, a competitor or a private investor. Determine if the sale is likely to be outright, a leveraged buyout or an installment sale. If you already have other partners, you may be able to structure your buy-sell agreement so that the company or other shareholders buy back your shares when you are ready to retire.

Plan now to ensure you have the liquidity you need when you are ready to retire.

In a retirement situation, a sale to a third party too often becomes a bargain sale--and 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, most or all of your money should come 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.

If you do not receive the bulk of the purchase price in cash, at closing, however, your risk can 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."  This is an area where we at Abo and Company want to make sure an attorney, seasoned in structuring and crafting credible documents for such transactions, is made an integral part of "our team".  Once again, if you need a name or two of experienced attorneys, just give Marty Abo a call. 

A variation of an outright sale and if you still have some time before retirement, bringing in a  strategic partner -- either through a merger or a joint venture project -- may provide you with the liquidity to diversify your investments now. It may also provide you with a future successor.

Of course, if your company has enough size and growth to warrant it, a public offering can raise capital and gain liquidity. Your company will receive the added benefit of the exposure and prestige of being a public company. But an initial public offering is costly, as is complying with the ongoing reporting requirements. And because the market will expect you to stay on as a significant shareholder for some time after the public offering, this is a long-term exit strategy.  Here again, while Abo and Company does not practice in this space, we have many a credible expert "on our rolodex" if you need such a referral.

4. Liquidation

If there is no one to buy your business, you shut it down. In liquidation the owners sell off their assets, collect outstanding accounts receivable, pay off their bills, and keep what's left, if anything, for themselves.

The primary reason liquidation is considered as an exit plan 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 assets.

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.

If you need assistance figuring out which exit strategy is best for you and your business, please don't hesitate to contact us. The sooner you start planning, the easier it will be.

If you are facing retirement and own a business, now is the time to begin creating an exit strategy. The same amount of energy you have devoted to building the business now needs to be spent planning your exit so that you can fully realize the value that has taken a lifetime to build.