Planning an Exit

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The last thing most people think about when they start a business is how they are going to get out of it. In fact, the biggest mistake they make is starting without any plan at all, says business succession and estate planning advisor Vaughn Henry, of Henry & Associates in Springfield, Illinois. This especially applies to horse operations.

“Many people get into the horse business for the lifestyle,” Henry says. “So you’re dealing with emotions, not facts and logic.” When he asks horse business owners how they got started, they realize that they just sort of backed into it. Many horse breeding operations start with one or two mares, and are soon growing more like hobbies on steroids rather than as profit-oriented businesses.

Yes, service businesses like horse farms may often start as a source of personal income based on the owners’ lifestyle decisions, rather than as decisions about investing time and capital. But when it’s time to retire or leave the business, the owners abruptly learn that getting into business is much easier than getting out.

“Whenever” vs. planning

When people just drift into business without a plan, their exit strategy is often just a vague idea that they’ll die with their boots on. “That’s the worst way of [planning],” says Peter Engel, author of “What’s Your Exit Strategy: Seven Ways to Maximize the Value of the Business You’ve Built” (Prima Publishing). “They wake up one morning, say, ‘Screw it. I can’t do it any more.’ They start looking for an exit and take whatever they can get, which will probably be a great deal less than if they had planned while they were still enthusiastic about the business.”

The sale of a business is often triggered by a major life change, such as marriage, divorce, ill health, retirement or death—an eventuality, Henry points out, that nobody likes to talk about. Each of these life changes also requires major financial decisions. If you do nothing, death ensures that you will eventually get out of business whether you plan to or not.

Getting out of business is going to mean one or more of the following:

  • selling off any assets and dissolving the business;
  • turning the business over to a partner;
  • turning the business over to a family member;
  • turning the business over to an insider or “key employee”;
  • selling the business to an outside buyer; or
  • merging the business into another existing business.

Leaving this decision to chance is the riskiest strategy of all. At best, failure to plan will limit the cash or other value that an owner is able to take out of the business (see sidebar, Putting a Value on Your Business). At worst, it will ensure that hard assets must be liquidated quickly, below their real value, and that the value of intangible assets such as a client list is lost completely.

The longer an owner puts off developing an exit strategy, the more difficult it can become. For example, take the case of a stable owner who starts up on the fringes of an urban area, puts her farm land into a corporation, then proceeds to work for 35 years. She plans to retire, in part, on proceeds from the sale of her now highly appreciated suburban real estate. But she may be in for a rude awakening after the land’s sale is taxed twice—first when the corporation pays its capital gains taxes, and again when she pays income tax on it. Proper planning at the right time could have protected her retirement nest egg from this enormous tax bite.

The more time you have to plan, the better off you are going to be. The best time to plan how to get out of your business is when you first get into it. If you didn’t plan it then, there’s no time like the present. With a five- to 10-year time line, you will have more options. Here are some of the issues you need to address:

What form of ownership will be easiest to transfer?

Attorney Julie Fershtman of Farmington Hills, Michigan, author of “Equine Law and Horse Sense” and “More Equine Law and Horse Sense” (Horses and the Law Publishing), notes that a significant percentage of equine businesses are sole proprietorships. From a legal standpoint, a sole proprietorship or general partnership agreement is the easiest form of business to create or dissolve. All you may need is to file a name form with your county or draw up a partnership agreement.

Depending on your business goals and exit strategy, however, your business may have more value to a future buyer if you have incorporated or established a limited liability company (LLC). These more formal business structures mean less likelihood of co-mingling business and personal funds, making it easier for a potential buyer to see just how your business functions. There are also more rigorous recordkeeping requirements. And, since a corporation can issue shares, a corporate business structure may make it easier to gradually shift ownership by gifting shares to a family member or paying a key employee with stock.

Has a business successor been identified?

Do you have a partner who will take over if you retire, become disabled or die? What kind of written agreements do you need? If your share of a partnership will pass to a spouse on your death, there can be both management and financial complications, Henry cautions. If your partner and spouse don’t plan to manage the business together, a carefully structured buy-sell agreement, funded with insurance and prepared before any triggering event, can ensure a smooth transition.

What about family?

Are there any family members interested in continuing the business? Will you gift shares in a family corporation in your lifetime, let the family member earn shares in the corporation, or pass ownership on death? A well structured estate plan, possibly funded with insurance, can ensure that the family business stays in the family after the owner’s death. If you plan to turn control of the business over to a son or daughter while funding your retirement by drawing a salary as a part-time consultant, can the business generate enough income to support your successor while buying you out?

If there is no family member interested in the business, you may have a key employee who is interested in continuing it. Just as with a partnership or handoff to a family member, you will need to decide when and how both the business assets and control of the business will pass.

When will you give up control? Can you?

Business succession involves a transfer of both assets and power. When to pass control can be an emotional issue and can create a great deal of conflict, especially when the baton is passed in family businesses. How do you plan to turn over control of the business, and how much control are you willing to give up? What tools will you use? A family limited partnership is a tool, for example, that can be used to pass minority interest in the business to a family member while the owner retains control. If you have decided to stay on as a salaried consultant while the business gradually buys you out, will you be able to sit back and allow someone else to inject their ideas into the business you built?

Is the business based on one personality?

Did the business earn its own reputation or is it built on the personal reputation of its owner? It can be a challenge to transfer the reputation and “goodwill” generated by a star owner to a new one. Is there enough time for a staged transfer of ownership while client goodwill, employee loyalty and other intangibles are shifted to an heir apparent?

Does the business have any likely buyers?

Maybe you don’t have a family member or key employee interested in your business. Is there a competitor, supplier or other closely allied business that might benefit by buying your business and merging it into theirs? For example, a retiring riding instructor might partner with a nearby teacher, bringing her students into her competitor’s barn and working there for a period of time as she stages her exit. This can be an excellent way to maximize the value you take out of your business. Identifying and courting businesses that might absorb yours takes time, but the more “bidders” you can encourage, the more likely you are to take as much value as possible out of your business.

Can you improve the financial picture?

Before you sell your business, notes Fershtman, you want several years that show a steady stream of revenue to potential buyers. In past years, have you emphasized tax savings to the detriment of earnings? Talk to your accountant about how to trim expenses in order to boost profits. This might be a good time to reduce owner perks, like vehicle leases or travel expenses, which show up as expenses on the business’s balance sheet and reduce profits.

Can you sell unused assets to pay down debt and improve the business’s debt-to-asset ratio? Think about thinning the broodmare band, finding a buyer for a surplus stallion, or selling that extra truck and trailer.

Has a large, one-time expense kept earnings low in one of the past three or four years—the period a potential buyer is likely to scrutinize most closely? If a recent one-time expense, such as installing mats in 50 stalls, caused a dip in last year’s earnings, says Fershtman, your sales proposal might include a calculation of the long-term savings in bedding and show what that year’s earnings would have been without the large expense.

How fast do you need the cash?

Your timetable for exiting is critical, because the longer you wait, the fewer options you may have. Business owners desperate for cash have the fewest choices. They will have to liquidate their tangible assets, such as horses, tack, equipment and real estate, through private sales or an auction. They are likely to lose the value of intangible assets such as business goodwill or their client list. Even if they find a willing buyer, they will be in a tough negotiating position. If you are dealing with outside buyers, the more time you have to court them, the less the likelihood you will have to settle for whatever deal they put on the table.

If you’ve planned ahead, you may be able to provide financing to an outside buyer. Financing small businesses can often be difficult, so owner-financed businesses can attract potential buyers more easily. You know the profitability of your business. The ability of the buyer to run the business profitably while paying off the loan, however, is a wild card. You will have to do your homework and research their abilities thoroughly before depending on loan payments as a guaranteed stream of future income.

If you plan to turn your business over to a family member or key employee, the sooner you start planning the necessary financial steps to make this possible, the more likely it is that you will succeed. There are going to be retirement and estate planning issues to sort through.

Speaking of timing, business advisors caution about talking too openly about leaving your business to clients, employees or competitors. Boarders and employees may become nervous about their futures. Students and training clients may decide to leave you before you leave them. Suppliers may wonder whether bills will be paid. Keep your exit strategy confidential until you are ready to execute it. Even then, think carefully about who needs to know what, and when.

No simple sales formula

View selling your business as a process rather than as an event. This is especially true if you are planning for business succession rather than business liquidation. There is no ideal situation that fits all businesses. For example, a charitable remainder trust could allow you to extract cash out of hard assets such as land or livestock while still using them during your lifetime. But it would not be the best solution if your goal is to pass your business on to your daughter.

The first step in developing an exit strategy is to define your goals as specifically as possible. Those goals may (or may not) include maximizing the value you extract from your business, turning the business over to a family member, funding your retirement or passing assets to heirs.

Developing an exit strategy can involve complicated legal and financial instruments. Get all the advice you can find. For starters, talk to your accountant and attorney. They already know both you and your business and can suggest likely scenarios. Financial advisors can help you analyze the big picture, especially when it comes to retirement or estate planning. Business brokers can help you put together a sales prospectus, identify and qualify potential buyers, negotiate sale terms, and maintain confidentiality.

Be aware that every professional you consult will see your situation from his or her unique perspective. It is up to you to keep everyone aware of your goals and to make sure they put those goals ahead of their own. The final decision, and its consequences, are entirely yours.

Planning for the Unplanned

While you’re thinking about your final exit from business, says Vaughn Henry or Henry & Associates in Springfield, Ill., you should also consider the possibility that life circumstances can force you to temporarily leave your business.

If illness, injury, a family crisis or some other unplanned event took you away from the day-to-day operation of your business for an extended period of time, is anyone else authorized to deposit checks, pay bills, make sure employees are paid, order feed, approve veterinary care and carry on other ordinary business transactions? These are critical issues, especially for a sole proprietorship where the owner wears all the hats.

A “durable power of attorney” gives another person authority (within limits) to conduct your financial and business affairs to keep your business running. Talk to your legal advisor about how to structure one so that your business can run temporarily, and safely, without you. —BK

For More Information

These websites are among many that offer more information about succession planning and business valuation:

sbdcnet.utsa.edu

www.bankrate.com

www.bizplanit.com

www.businesscentre.net

www.buysellbiz.com

www.entrepreneur.com

www.ext.colostate.edu (click on “Consumer/Family” button, then on “Tending to Business”)

www.gift-estate.com

www.inc.com/services

www.toolkit.cch.com

www.usabusinessbroker.com