exit strategy planning educational linkedin

Copyright © 2012

EXIT STRATEGY PLANNING “Achieving optimum value for your business”

3/18/13 1 ABRAXAS BUSINESS SERVICES

Presented by: Denis M. Brown Abraxas Business Services 5279 Glenridge Drive NE Atlanta, GA 30342 (404) 843-8618 [email protected]

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EXIT STRATEGY PLANNING

3/18/13 ABRAXAS BUSINESS SERVICES 2

“You’ve gotta to be careful if you don’t know where you are going because you might not get there” Yogi Berra.

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Business Planning

Exit Strategy Planning

Estate Planning

“Exit Strategy Planning coordinates and integrates Business Planning and Estate Planning based on the

Business Owner’s objectives”

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MARKET NEED

•  Based on a 2005 survey by PriceWaterhouseCoopers’:

–  More than 4.5 million business owners are 50 years old or older.

–  67% of business owners of firms with revenues from $5 million to $150 million plan to leave the business within the 10 years.

–  More than 75% of the owners have not done much planning for what will probably be the single most significant financial event of their lives.

•  M&A Marketplace:

―  Success rate is 1 in 4 actually sells(1)

―  Success rate for businesses with sales of $10 million – 1 in 3(1)

―  Success rate for businesses with sales above $10 million – 50-50(1)

(1) 2005 Business Reference Guide by Tom West


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EXIT ALTERNATIVES

•  Sell to a Strategic Buyer – 100% liquidity.

•  Sell to a Financial Buyer – up to 100% liquidity.

•  Sell to Management/Family– up to 100% liquidity.

•  Recap – harvest a majority of your net worth and retain minority ownership “for a second bite of the apple” but still maintain operational control of the business.

•  ESOP – up to 100% liquidity selling the business to the employees.

•  IPO – initial public offering.

•  Liquidate.

Is your company positioned to consider multiple exit alternatives or are your alternatives limited?


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ISSUES LIMITING EXIT ALTERNATIVES AND VALUE

•  Is there an heir apparent or a management team capable of taking the business to the next level or run the business in the owner’s absence?

•  Do you have a relatively consistent cash flow performance trend?

•  Does your largest customer account for less than 20% of sales?

•  Do you have multiple suppliers for product or raw materials?

•  Do you have systems and processes to properly manage the business in the future and provide the level of service expected from your customer base?

•  Does the business have opportunities for growth through geographic expansion, product line extensions or new channels of distribution?

•  Do you have excess capacity to support future growth?

A “NO” to any of these questions may limit your alternatives and depress the value of your business. Proper Exit Strategy Planning addressing these and other issues will produce the desired results positioning the business as an attractive investment from multiple sources.


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INGREDIENTS OF A SUCCESSFUL EXIT

•  A written Exit Strategy Plan based on an owner’s objectives.

•  Designed and implemented by an experienced team of advisors.

•  Cash flow, maximizing value

•  Management Team capable of running the business.

•  Time.


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EXIT PLAN COMPONENTS


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EXIT PLAN COMPONENTS


Define Owner Objectives

Quantify Business and Personal

Resources

Maximize and Protect Business Value

Ownership Transfer to Third Parties

Ownership Transfer to Insiders

Business Continuity Planning

Personal Wealth and Estate Planning

COMPREHENSIVE EXIT PLAN

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SEVEN STEP PROCESS

•  Step 1 – Identify Exit Objectives

•  Step 2 – Quantify Business and Personal Financial Resources

•  Step 3 – Maximizing and Protecting Business Value

•  Step 4 – Ownership Transfer - Selling to Third Parties

•  Step 5 – Ownership Transfer - Selling to Insiders

•  Step 6 – Business Continuity

•  Step 7 – Personal Wealth and Estate Planning


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1. IDENTIFY EXIT OBJECTIVES

The process begins with answering three questions:

•  How much longer does an owner want to work in the business before retiring or moving on?

•  What annual after-tax income does the owner want during retirement?

•  To whom does the owner want to sell the business?

Benefits to the Owner:

•  Clarifies priorities.

•  Facilitates progress by identifying a desired outcome.

•  Controls and defines the Exit Strategy Planning process.


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Additional Objectives:

•  Shift wealth to children.

•  Provide charitable gifts or transfers.

•  Reward employees.

•  Receive full value for the business.

•  Take business to the next level.


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Advisory Team:

•  Who is the advisory team? –  Attorney – Estate, Tax, Corporate –  Wealth Management Advisor, Financial Planner –  CPA –  Insurance Advisor –  Valuation Specialist –  Exit Strategy Planning Specialist

•  No one professional has all the answers.

•  Diverse skills and talents are necessary.

•  Team approach minimizes time and cost.


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2. QUANTIFY BUSINESS AND PERSONAL FINANCIAL RESOURCES

•  Perform a third party valuation of the business.

•  Perform a “needs assessment” to determine the amount of after-tax dollars needed to lead the desired lifestyle after exiting the business.

•  Do the combined business and personal financial resources meet your objectives?


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3. MAXIMIZING AND PROTECTING BUSINESS VALUE


•  Increase enterprise value by creating and enhancing the value drivers of the business.

•  Tax strategy -reduce income taxes upon sale of business.

•  Protect assets from potential business and personal creditors.

•  Motivate and keep key employees.

•  Create ability to sell the business.


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Value Drivers:

•  Proven management team.

•  Consistent financial performance; upper quartile relative to peers.

•  Realistic growth strategy.

•  Market defensibility.

•  Reliable operating systems, processes and financial controls.

•  Product differentiation.

•  Proprietary technology.

•  Established and diversified customer base.

•  Established and diversified vendor base.


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Process:

•  Assess industry structure, the balance of power of your business (Supplier Power, Buyer Power, Competitive Rivalry, Threat of Substitution and Threat of New Entry).

•  Perform a SWOT (Strengths, Weaknesses, Opportunities and Threats) analysis of the business.

•  Analyze competitive position, advantages and value drivers of the business.

•  Review operating systems and processes.

•  Assess human resources, asset and capital requirements.

•  Assess value creation alternatives.

•  Develop a strategic plan to enhance the value drivers of the business and address weaknesses and threats; positioning the business to achieve optimum value on an after tax basis.


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FIVE FORCES – BALANCE OF POWER

Threat of New Entry: Competitive Rivalry: Cost advantages Number of Competitors Economies of scale Quality differences Time and cost of entry Customer loyalty Barriers to entry Switching costs

Supply Power:

Number of suppliers Buyer Power: Size Number of customers Cost of Changing Price sensitivity

Ability to substitute Threat of Substitute: Cost of Change Performance


Competitive Rivalry

Supplier Power Buyer Power

Threat of New Entry

Threat of Substitute

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SWOT ANALYSIS

Strengths: Weaknesses:

What do others see as your strengths? What factors lose you sales?

What do you do well? What could you improve?

What advantages do you have? Where do you have fewer resources?

What unique resources do you have? What do others see as weaknesses?

Opportunities: Threats:

What opportunities are open to you? What trends can harm you?

Take advantage of current trends? What is your competition doing?

Can you turn your strengths into opportunities?

What threats do your weaknesses expose you to?


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Possible recommendations:

•  Management Team Development Plan.

•  Profit margin improvements (outsourcing processes, procurement costs, pricing, production improvements, cost reductions, acquisitions).

•  Key Employee Incentive Compensation Plan (stock bonus, stock appreciation rights, non-qualified compensation plan, cash bonus).

•  Separation of business assets from business operations.

•  Non- solicitation, Non-compete agreements.

•  Wealth transfer to children during owner’s lifetime.


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4. OWNERSHIP TRANSFER – SELLING TO THIRD PARTIES

Benefits to Owner:

•  Cash at closing.

•  Eliminate or reduce financial risk.

•  No family succession issues.

•  Speed of exit.


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4. OWNERSHIP TRANSFER – SELLING TO THIRD PARTIES

Considerations:

•  Ability to sell and business value determined by: ―  Intrinsic Value: the value drivers ―  Extrinsic Value: the value the market places on the business ―  Effectiveness of the sale process

•  M&A Marketplace: ―  Success rate is one out of four actually sells(1)

―  Success rate for businesses with sales of $10 million – one out of three(1)

―  Success rate for businesses with sales above $10 million – 50-50(1)

•  Positioning the business for sale, pre-sale due diligence and tax planning.

(1) 2005 Business Reference Guide by Tom West


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5. OWNERSHIP TRANSFER - SELLING TO INSIDERS


•  Achieves exit objective of: ―  Selling to key employee group ―  Transferring to a relative

•  Motivates and retains key employees.

•  Planning reduces risk and increases amount of cash received by minimizing the tax consequences for both the seller and buyer.


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The 5 Rules of Engagement for Insider Transfers

•  Do not take an inordinate amount of risk on the front end.

•  Do not give up control until receiving the last dollar.

•  Shorten the timeline as much as possible.

•  Minimize taxes for both parties.

•  Utilize the cash flow of the business as efficiently as possible since that is the resource paying for the transfer.


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Sale to a Third Party for Cash:


Fair Market Value = $10,000,000 Cash Flow = $2,500,000

Buyer Cash for purchase

Owner $8,000,000 Net of Tax

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Sale to Employee for Installment Note:


Fair Market Value = $10,000,000 Cash Flow = $2,500,000

Employee Cash flow from business $2,500,000 - $1,500,000 (net of taxes) Cash to Owner $1,200,000 (net of taxes)


Timing: 7 – 9 years

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Transfer to Employee Phase 1:


Fair Market Value = $5,000,000 - $10,000,000 Cash Flow = $2,500,000

Employee Purchased 40% for $2,000,000 ($1,000,000 of cash flow per year to employee)

Owner $480,000 Net of Tax $1,440,000 After 3 Years

Owner Cash flow from business $1,500,000

Owner $900,000 Net of Tax $2,700,000 After 3 Years

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Transfer to Employee Phase 2:


Fair Market Value = $5,000,000 - $10,000,000 Cash Flow = $2,500,000

Employee Purchased 60% for $6,000,000


Timing: 3 years

Owner $8,940,000 After 3 Years

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Possible recommendations:

•  Sale of ownership interest (cash, note or bank financing).

•  Bonus or gift of ownership interest.

•  Grantor Retained Annuity Trust (GRAT).

•  Non-qualified deferred compensation plan (409a).

•  Buy back agreement for minority owner.


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FAMILY SUCCESSION ISSUES

•  Only one third of family businesses are passed to the second generation

•  Only 10% are passed to the third generation

•  Less than 4% are passed to the fourth generation

Reasons:

•  Children may not get along

•  Different career goals

•  Inability for parents to achieve financial goals

•  Unable to run the business


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INGREDIENTS OF SUCCESSFUL FAMILY TRANSFER

•  A written plan –  Defines financial independence –  Defines fairness in distribution –  Timeline

•  Only one child becomes sole successor or at least control

•  Business transition plan is fair to all

•  Parents achieve financial security independent of the business

•  Business active child demonstrates the ability and willingness to run the business

•  There is a backup Plan B


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INGREDIENTS OF SUCCESSFUL TRANSFER

Reasons for backup Plan B:

•  Value increases to a point a buyout is financially too difficult

•  Increase in value exceeds value of other assets – “fairness”

•  Business becomes too complex or sophisticated for one child

•  Child loses interest or becomes ill


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6. BUSINESS CONTINUITY PLANNING


•  Objectives can still be achieved if you do not survive your exit.

•  Retains ownership and control of business if co-owners depart.

•  Can force non-contributing owners to leave the business.

•  Provides consistency between lifetime and death objectives.

•  Ensures survival of the business for the benefit of others by: –  Addressing continuity of ownership –  Addressing the potential loss of financial resources –  Addressing loss of key talent, customers and vendors


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6. BUSINESS CONTINUITY PLANNING

Possible Recommendations:

•  Review and update continuity guidelines.

•  Review and update Buy-Sell (Shareholder) Agreement –  Valuation –  Funding mechanism –  Address voluntary and involuntary termination

•  Insurance for continuity planning.

•  Stay bonus plan.

•  Plan for financial independence of the business.


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7. PERSONAL WEALTH AND ESTATE PLANNING


•  Preserve wealth, minimize taxes using both lifetime and death planning tools.

•  Coordinates and integrates lifetime exit objectives with the estate plan.

•  In effect, estate planning becomes part of the business planning.


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7. PERSONAL WEALTH AND ESTATE PLANNING

Possible Recommendations:

•  Personal asset protection planning.

•  Personal and family insurance.

•  Transferring of specific non-business assets.

•  Personal wealth management plan.


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REALITY

Eventually every owner will exit their business voluntarily or otherwise. Proper Exit Strategy Planning will enable you to have an element of CONTROL:

•  transition under your time frame

•  maximize the after-tax value of your business

•  ensure continuity in case of an unexpected event

•  assure financial security for you and your family


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CASE STUDY (1) – ASSET PROTECTION, WEALTH TRANSFER

FACTS: •  Retained to position the Company for a third party transaction (strategic).

•  Profitable growing business (20+% EBITDA, 10+% growth).

•  38 vehicles, recently 7 wrecks over a 45 day period.

•  Purchase 5 to 6 new vehicles each year.

•  Owner has considerable wealth outside the business.

KEY ISSUES:

•  Asset Protection – high risk assets, ambulance chasers dream.

•  Wealth Transfer - continued asset accumulation within the estate.


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CASE STUDY (1) - SOLUTIONS

Asset Protection – High Risk Assets •  Made trusted advisors aware of the issue.

•  Addressed tax issues relating to possible transfer.

•  Separated vehicles and drivers in to a new legal entity, leased back to operating company.

Wealth Transfer – Asset Accumulation •  Setup a FLP to purchase new vehicles, leaseback to new entity.


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CASE STUDY (2) – CREATE ABILITY TO SELL

FACTS: •  Profitable business run by son of the founder and brother-in-law.

•  C Corp. owned equally by son and daughter of founder.

•  Brother-in-law set up an LLC to perform complementary services.

•  Tried to sell the business 4 years ago, no takers, children not interested .

•  Retained to position the business for a third party transition.

KEY ISSUES: •  Tax problem – C Corp. asset sale.

•  No management team succession plan.

•  Customer concentration issue.


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CASE STUDY (2) SOLUTION

TAX PROBLEM: •  Old Co/New Co – the LLC is leasing the assets from the C Corp, all ongoing

purchases and billings are through LLC.

•  Overtime diminishes the value of the C Corp and increases value of LLC minimizing the double taxation from an asset sale.

MANAGEMENT TEAM: •  Hired an heir apparent.

•  If proven capable over time need to implement an incentive retention program (SAR, phantom stock, stock options, stock bonus or stock purchase).

CUSTOMER CONCENTRATION: •  In process of developing a marketing strategy to broaden customer base in

served industries, previously non-existent.


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CASE STUDY (3) – TRANSFER TO MANAGEMENT

FACTS: •  Profitable C Corp with a management team.

•  Owner wants to retire in 3 to 5 years.

•  Considerable net worth outside of business.

•  No family in the business.

•  Considering transferring to management, management running day to day.

KEY ISSUES: •  Tax issue, C Corp (FICA).

•  Tax issue, $200,000 cash on the balance sheet.

•  Legacy, make it sustainable.


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CASE STUDY (3) SOLUTION

TAX ISSUES: •  Remember the 5 Rules of Engagement

•  Owner 20 years older than management, 412 Defined Benefit Plan - $200,000 cash off the balance as an expense to prefund owner’s retirement plan.

•  Trademark the company brand in a separate entity owned by the owner and leased back to the company.

•  Increased real estate lease to market rate.

•  The above actions reduced stock value (lowest defensible value).

•  Next year initial transfer of ownership via installment sale (40%).

LEGACY: •  Reviewing and updating systems and processes.

•  Reviewing potential growth strategies.


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CASE STUDY (4) – OUTDATED BUY-SELL

FACTS: •  Retained to position the Company for a third party transaction (strategic).

•  Profitable growing business start 12 years ago.

KEY ISSUES: •  Outdated Buy-Sell – 12 years since last review.

–  Only addressed death and not disability, divorce or retirement. –  Funding mechanism issue – one partner and wife not insurable but has

accumulated wealth outside the business. –  Other partner spends every nickel that comes through the door.


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SOLUTION (4) – OUTDATED BUY-SELL

Buy-Sell Funding Mechanism •  Group Term Life – limited.

•  Captive Insurance Company (pending). –  $1.2 million tax free. –  Help with the funding of Buy-Sell over time. –  Forced retirement savings for the other partner.


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CASE STUDY (5) – TRANSFER TO FAMILY MEMBERS

FACTS: •  Profitable construction business with two sons and a daughter active.

•  Oldest son is heir apparent, capable and has support of siblings.

•  Each child owned 10%, 30% in aggregate; non-family manager owned 10% and the parents owned 60%.

•  Father/Founder wanted to retire in three years and wanted each child to have equal share (with as much gifting as possible).

KEY ISSUES: •  Determine after tax life style spending.

•  Determine after tax dollars needed from the business.

•  Develop a tax efficient transfer structure.

•  Update an appropriate Buy-Sell Agreement.

•  Never considered the control issue.


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SOLUTION (5) – TRANSFER TO FAMILY MEMBERS

•  Quantified annual spending and after tax dollars needed from the business.

•  Developed tax efficient structure: –  Recapitalized into 13.5% voting and 86.5% non-voting (67% of voting

held by parents and the remaining voting held by oldest son, his original 10%).

–  Parents remaining interest in non-voting stock, approximately 51% interest was gift equally to each child; leaving 9% ownership interest but voting control.

–  On retirement in 3 years the children will buy the remaining shares at fair market value in an installment sale leaving oldest son with voting control.

–  Setup a SERP payable over five years starting at retirement. –  Structure was cleared with bonding agent with parents still on the bond

until retirement.

•  Updated the Buy-sell Agreement, valuation standard Rev Ruling 59-60, addressed funding and triggering events.


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CASE (6) – BUSINESS CONTINUITY PLAN

FACTS: •  Owner, mid 40s, of a successful business who likes flying his plane.

•  Capable management team and wife were concerned with the unexpected event.

•  Wife is involved in the business but no desire to run. ISSUES: •  No formalized Continuity Plan outlining his wishes.

•  Outdated estate plan and under insured.

•  No incentive plan locking down management team.

•  No Non-Competes.


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SOLUTION (6) - BUSINESS CONTINUITY PLAN

Formalized a Business Continuity Plan (discussed with key employees, the bank and key relationships) •  Designated who will run the company •  Realigned key positions •  Sell to a strategic player when practical (designated 3 IBs with experience in

the industry to interview) •  Implemented a policy all key relationships (customers and vendors) had two

points of contact

Updated estate plan including establishing trusts for the children and sizeable increase in insurance coverage.

Implemented a Stay Bonus Program payable over time based on a percentage of base salary and a percentage of net proceeds so long as the employee remained in good standing over the designated time period. Agreement included Non-Competes.


exit strategy planning educational linkedin

Documents

business continuitystep

business valuestep

business beforeretiring

business owners of firms

business reference guide

exit objectivesstep

successful exit

exit alternativessell