Exit Planning For Small Business Owners Part 2

Part 2: The interim plan and planning development process

by Allen Duck COO, Northstar Financial Companies, Inc.

In part one of this series, we discussed the importance of helping business owners recognize and acknowledge the need for an exit plan. After all, according to a Wells Fargo/Gallup Small Business Index poll conducted in 2010, 47% of small business owners plan to never retire! Is that out of a desire to work or a perceived need to? It’s our job as the advisor to bring to light that we will not be able to work forever, and the businesses we’ve worked so hard to build can play a critical role in creating the retirement we want and deserve. In order to succeed in retiring profitably, as in business, we have to plan. Choosing the appropriate time to sell and maximize the value of the business as an asset is not as simple as listing it and waiting for the phone to ring – careful thought and preparation is imperative.

So what happens when the opportunity comes to have the conversation? What steps should you take to encourage a client to start developing an exit plan? This will be an iterative process and may take time to evolve, but your role as the advisor and mentor is crucial. To help, we can boil the basic outline down to four specific steps. By following this outline, you can guide your business owner clients (and yourself) into making sound decisions that generate the best possible outcome for every party involved.


Initially, a very traditional approach of gathering data has to be undertaken, which can subsequently be used in creating a plan. First you must develop a comprehensive understanding of a client’s overall stated net worth in all asset classes. The business will emerge as a line item on his or her personal balance sheet with a question mark against the value. You’ll need to discuss how much he or she has set aside for retirement in a 401(k), SIMPLE or SEP IRA, or other savings vehicles, as well as what the client anticipates his or her retirement lifestyle to be. Often times, a "Lifestyle Gap" will become evident. You might be surprised at how many clients have very little put away for retirement and simply assume that their businesses are their retirement futures. For many, this is a difficult conversation to have and you may have your work cut out for you. Secondary considerations related to age and state of health must also be explored. If health is an issue, selling more quickly would make sense.


Once the "Personal Balance Sheet" has been established, it’s necessary to lay out the landscape to accurately determine the asset gap the business value needs to fill. Knowing what the business "needs" to be worth as well as its dependency on the founder, the client’s succession and continuity plans can start taking shape, as you engage him or her in a view toward retirement and income planning. If retirement is the point of lift off, the concern is with the length of the runway and how to build enough value (speed) in the asset base to launch clients into their golden years. Now, you can determine if the potential value of the business as an asset is adequate to fill the void, and qualify the timeline to a monetization event.

If the analysis of the business highlights a disconnect between the owner’s expectations and available assets, your role as planner and life coach can save the day. Ask the tough questions: Should the client get out early and go work someplace else to secure necessary employee benefits, stay in the business and try to grow it to fill the identified gap, or lengthen the runway and simply take more out before retiring a year or two later than planned? The right decision for a client at this point is now academic in nature and based on quantitative information, rather than the subjective approach many business owners tend to want to follow.


In addition to all of the personal information you gather about the client, you need to help him or her recognize any environmental issues that could impact the situation. You may not have all the answers but you can ask the questions! Depending on the industry sector and business type, you’ll want to consider everything from technology and staff to operations, inventory and intellectual property. Does the market support a "push hard" approach, or is an earlier exit more appropriate? The information you collect will affect a business owner’s outlook and impact the decision to look at an external sale versus an internal one.

In example one, the dry cleaners is worth $1 million; it was worth the same last year and will be worth same next year. The owner is responsible for all liabilities, stress and HR concerns. If he is simply along for the ride, it is quite likely he would be better off selling and investing the proceeds – and relieving himself of the burden. The value of the business is terminal. On the other hand, in example two, a small engineering company that’s been in business for 12 years with flat revenues could fall into the same mold as the dry cleaner. However, this owner has developed a new widget and is pushing for a patent. The patent and widget together could move the value needle immediately, and therefore a delay in sale for a year or two makes great sense.

Example 1


Now comes the time for that critical strategic decision: Should a client position for an internal or external sale? As far as internal sales go, some of your clients may still be clinging to the notion that their kids will take over the family business upon their retirement, but few have proactively prepared. According to the Family Business Institute, only 30% of second generation successions work out as planned. Many other clients believe they have a great manager in the firm who would make an ideal successor. The requirement for providing the necessary level of training – teaching roles, responsibilities and practicalities of management – is an enormous challenge and often under estimated. Most importantly, it’s extremely difficult to impart a particular management "style," and, subsequently, the failure rate is high. In either situation, failure of the succession is likely to affect the seller’s ability to collect the money!

In order to understand if an external sale is appropriate, help the business owner do the math and determine what would be left after taxes. It may be appropriate to change the company registration to limit the tax consequence, or set aside much of the value to goodwill. Help the owner identify where money is being spent in the business cycle and suggest efficiencies to minimize expenses. When those efficiencies start to produce results and the profit trajectory steepens, it is likely a good time to actively seek out a buyer. This, too, needs to be approached diligently. Keep in mind that a good broker can make a huge difference, and an amenable buyer makes the transition cleaner. Additionally, the client might also consider creating employment agreements and incentives to protect current employees when an external ownership transfer is planned. This gives the employee’s security and confidence and protects the seller’s interests post-sale.

Regardless of which avenue your clients (or you) choose, keep in mind that businesses that would net less than $1 million in profit are roughly 10 times more difficult to sell. From asset valuation to planning and structuring the contract, to determining the need to monetize and finally having the money change hands, planning is essential for every business owner. Although the effort you expend with these clients is potentially greater, the rewards can be extraordinary. Setting yourself apart from others is a challenge, but addressing a significant issue pragmatically and with professionalism creates an indelible impression.


This material has been prepared for informational and educational purposes only. It is not intended to provide, and should not be relied upon for, accounting, legal, tax or investment advice.

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