Episode 8 Transcript: Seven Steps to Take Before Exiting Your Business

BRETT: Welcome to The Charleston Entrepreneur Podcast.

BRETT: My radical idea is that personal finance should be…personal.

BRETT: Ultimately, the human element in each of us is what makes up personal finance. We are all business owners doing the best we can to make the right decisions about our personal lives with the information we have.

BRETT: In this podcast it is my goal to give you everything I have to make you successful. I want you to live your most fulfilled life, and I know you can.

BRETT: In Episode #5, I introduced the topic that there is a 100% reality that we’ll all, as business owners, have to leave our business at some point in the future.

BRETT: Now, you are not in the minority if you haven’t thought much about this yet. Most of us don’t. The only time we’ll really begin to contemplate leaving our business, is when we’re feeling that we want to be doing something else with our life or believe that we’re close to our Financial Independence (whatever that means to us), and so we want to be sure we get over that finish line.

BRETT: Exiting from our business takes a lot of time. And the farther in advance you start planning for your exit, the more options you have and the better the outcome is likely to be.

BRETT: So in Episode 5, I introduced you to the Seven different ways you can leave your business. But they were very brief, I simply listed them.

BRETT: For today’s episode I’d like to go deeper into those steps, specifically the most common ways business owners of today are exiting from their business.

BRETT: A note on these Seven Exit Paths; each one aims to increase business value both in the short and long term. And the most successful of these Exit Paths, put their Plan into writing.

BRETT: Step One of Seven: Set You Exit Goals. Many owners do not set Exit Goals, because it’s too emotionally wrenching for them to think about separating themselves from a business they have created.

BRETT: Frankly, it’s almost impossible to successfully leave your business until you are emotionally prepared to do so.

BRETT: There are three straightforward Exit Goals that, once established, will really help you through the muddled thinking that otherwise would act as a barrier for you.

BRETT: One: Know how much longer you want to work in your business before retiring or moving on.

BRETT: Two: Determine the after-tax net income you want during retirement (in today’s dollars).

BRETT: And Three: To whom do you want to transfer the business? Family? Key Employees? Co-owner(s)? Outside third party?

BRETT: We can’t effectively begin planning to leave our business without answering each of those Goals. Because it is these Goals that will direct all subsequent planning and decision making. We are the person primarily responsible for this step.

BRETT: Step Two: Quantify Your Available Resources. Ideally, we all want to secure the income stream needed to fully support our families’ future lifestyle.

BRETT: And these are the three resources we all have as business owners; 1.) The Value of our Business. 2.) The projected Cash Flow of our Business. 3.) The non-business assets or income we have.

BRETT: A word about Business Value. For many of us, our business is our most valuable asset. So to successfully exit our business, knowing its value is critical to our planning. (Pause) Make sense?

BRETT: Once we know the current value of our business, we can then determine whether our financial Goals can be met given the present value of our business, through its conversion to cash?

BRETT: If not, how much does the business’ value have to grow in order to reach our Goal?

BRETT: Step Three: Focus on Business Value. There are three parts to focusing on business value:

1.) Increasing the value of your business. 2.) Protecting its existing value. 3.) Minimize current tax liability and personal liability when you transfer ownership.

BRETT: Let me explain these a little further. Increase Business Value, an inevitable byproduct of a consistently well-run business, is a consistent increase in value. And there are many ways as owners we can maximize our company’s value.

BRETT: Such as maintaining and consistently increasing cash flow. Creating and using efficient systems. Documenting the sustainability of earnings. And motivating and keeping key employees.

BRETT: If you can do this, you’re at the heart of a successful business and to the essence of your role within the business: to enhance its value.

BRETT: Minimizing Risk, what do I mean by that? A future buyer may not even consider purchasing your company if there’s a risk that its value will decrease.

And the biggest risk, frankly, to a buyer, is whether or not your key employees will stay with the buyer after you exit?

BRETT: And Minimize Tax Liability. There are a number of tax-minimizing techniques business owners employ as they work towards their exits.

Charitable remainder trusts, Defined Benefit Plans, and lowest defensible value are tools we use to minimize taxes.

At best, it takes years to reap the benefits from most tax-planning strategies. Assuming both income- and business-tax rates are likely to increase, can you afford to wait to investigate various tax-saving strategies?

BRETT: Step Four: Sale to a Third Party. There are many ways to market your business for sale, but if your company is worth at least $10 million, one of the best ways to reap top dollar is to have an investment-banking firm orchestrate a competitive auction of your business.

BRETT: This way, multiple qualified buyers come to the negotiating table at the same time, all with the same information and all prepared to make an offer for the company.

This process maximizes your leverage as the seller and enables you to select the sale price, deal structure, and ongoing operating philosophy that is most attractive to you.

BRETT: If your company is worth less than $10 million, you may be able to attain the services of an investment banker, but more realistically you will use the services of a business broker and engage in a negotiated sale.

BRETT: Step Five: Transfer to Insiders (co-owners, family members, or key employees).

Now, if you’re a business owner who wishes to do this, to transfer your business to family, co-owners, or key employees, you must:

  • One, minimize the income-tax consequences of the transfer to both yourself as seller and the buyer.
  • Two, minimize your risk as departing owner of not being paid the entire purchase price, by staying in control of the company until you receive every dime of the purchase price.

The reason I emphasize these two conditions is simple: The buyers (children, co-owners, or key employees) have no money!

BRETT: The only way you (as the owner/seller) will receive your purchase price is to receive installment or other payments directly from the company over an extended period of time.

All of the money you receive will come from the business’ future cash flow (the income the business earns after you depart).

Therefore, it is imperative that your Exit Plan works to minimize the tax consequences to the business and to the buyer in order to preserve a greater part of the company’s cash flow for you, the departing owner.

In other words, for you to receive money for your ownership interest, the company must first earn the cash that the buyer pays tax on when he or she receives it.

The buyer then pays that after-tax amount to you the seller as partial payment for the ownership interest, and you the seller pays a capital gains tax upon receiving the money.

So there is a double tax on each dollar of cash flow earned by the business that is used to pay for your interest in the company.

BRETT: Now there are ways to protect the business’ cash flow from the double tax and that is by creating unfunded obligations to you the owner, from the business, long before the actual transfer. Examples of these are:

  • Non-qualified deferred compensation for you (the owner).
  • Leasing obligations between you and the business, such as a building.
  • Licensing and royalty fees.
  • Subchapter S dividends.

BRETT: All of these work if the business operates as we think it should. But what if it doesn’t? How do you make sure it will continue to produce the cash it needs to buy you out?

The best way to minimize a departing owner’s risk of not receiving the full purchase price is to keep that owner in control until he or she receives every dollar.

To accomplish this, your Exit Plan might include one or more of the following techniques:

  • Securing personal guarantees from the buyer, including business and personal assets.
  • Holding a controlling interest in your company until financial security is  assured. A great technique here is to use a two-phase process in which the insiders only purchase a minority interest in the business originally.

BRETT: Transferring a business to children, co-owners, or key employees is a high-risk venture. Your best bet is usually to sell to an outside party if the insiders/buyers are unable to fulfill their obligations.

BRETT: STEP Six: Develop a Contingency Plan for the Business. One of the benefits of developing an overall exit strategy is that you’ll quickly appreciate how contingency planning is an integral part of it.

Taking measures so that your business survives if you don’t is a natural part of the Exit Planning Process.

BRETT: In an ideal situation, business-continuity needs upon the death or disability of an owner can be met by a business-continuity agreement with a co-owner. The problem is most businesses are solely owned.

If the sole owner does nothing else, they have a duty to their families and businesses to create written plans that answer these questions:

  • In my absence, who can be given the responsibility to continue and supervise:
    • Business Operations?
    • Financial Decisions?
    • Internal Administration?
  • How will these people be compensated for their time and, most importantly, their commitment to continue working until the company is transferred or liquidated?
  • What should happen to the business upon my death or permanent disability?

BRETT: When owners make the decision to begin transferring their businesses, the last thing they are likely to consider is the need for adequate planning to protect the business if they should suddenly die or become disabled.

Yet, this is precisely the point at which the business is most vulnerable: It has peaked in value, but the sale of the business is likely still years away.

The remedy to this is usually straightforward: adequate legal documentation in the form of a buy-sell agreement or stay-bonus program that includes adequate funding for important employees.

BRETT: And finally, the last step, STEP SEVEN: Develop a Contingency Plan for the Owner’s Family.

I bet you heard me just repeat myself from the last step. But I didn’t, we need a contingency plan for the business, and we need one for your family.

And with this final step, your Exit Planning Process comes full circle.

BRETT: If you don’t survive until your business exit, which financial resources will your family need and where will they come from?

As a business owner, your Estate Plan is another part of your overall Exit Plan. Unlike some of your lifetime goals (like financial security), Estate Planning objectives and business-continuity objectives  are relatively easy to meet upon your death or disability.

To acquire the liquidity sufficient to meet your financial goals, consider the purchase of life insurance and disability insurance. You may be surprised by how easy it is to meet after-death objectives using insurance.

BRETT: To wrap up here – all of the techniques that have produced your business success to date (learning from your mistakes, developing business strategy based on your experience, and trial and error) do not guarantee you will successfully exit your business.

Sadly, the valuable experience you’ve developed over the years does not quip you to leave your business successfully. Experience, learning, and trial and error all require time, a luxury most business owners do not enjoy as they approach the end of their ownership lives.

BRETT: Now I know this planning sounds complex and time consuming, but it does not have to be.

With the right team of trusted advisors, you can create a written and comprehensive Exit Plan that gets you the money you need, achieves all of your other objectives in a time-and cost-efficient manner.

Do this ideally several years before your exit, and you can optimize your ability to leave your business in style.

BRETT: Thanks for tuning in today everybody. As always, visit our website oakcapitaladvisor.com for more information, and request a Free Retirement Assessment to get started on your retirement planning journey. And check out the show notes for more resources that can help you succeed. Until next time.

BRETT: Have a great day!

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