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Morning Column
The Great Escape: Developing an Exit Strategy
By Thomas E. Houck
There's a common question on the minds of entrepreneurs when they think
about retirement: "How can I eventually get out of my business and not lose
my shirt?" The answer is simple: Develop an exit strategy a few years
before your desired retirement, and simply execute it.
Take the case of Chuck, a 65-year-old-going-on-21 life-of-the-party type of
guy. He sported a big smile, and joked with everyone. But he was plagued
by a gnawing question: "In 10 years, I want to exit my business, take care
of my employees, have enough money to live out my retirement dreams, and
guarantee that my daughter inherits everything if something happens to me.
Some people may want to get every dime they can when they sell; but these
are the most important things to me. How do I pull this off?"
Chuck had been an entrepreneur for his entire life, and about 20 years
before, started his current business from scratch. Due to his insatiable
appetite for nonstop improvement, his business blossomed into one of the
largest in Southeast Florida.
Chuck felt a great deal of loyalty to his employees, and wanted to develop a
plan to sell the business to his General Manager, Carlos. Since Carlos was
a young guy with a family, he didn't have many financial assets. Chuck
needed to develop a plan that would make the buyout process affordable for
Carlos, while simultaneously assuring that his daughter would get a fair
value if anything happened to him.
To develop a quality exit strategy, business owners like Chuck need to
follow some important steps. They are:
Step One: Create a financial plan.
In Chuck's case, the plan helped
identify how much income he would need after retirement to fulfill his
dreams. This number determined how much money Chuck would need in his
retirement savings, and from the sale of the business on the day that he
retires.
Step Two: Maximize retirement savings now.
Over the next several months,
Chuck consulted with his financial advisors and developed a comprehensive
financial plan. A thorough analysis revealed that Chuck needed to put
$5,000 per month into a retirement savings plan. Since IRAs and 401(k)s
allow limited funding, a defined benefit pension plan was a good choice for
the company. These plans work best with an older owner who has younger
employees-in Chuck's case, a perfect match. This plan allowed Chuck to put
$60,000 a year into savings, all of which was tax deductible. The tax
savings alone helped fund a portion of the plan. A true win-win!
Step 3: Determine the company's worth.
Chuck didn't want the expense of
hiring a valuation analyst to compute his company's worth. To come up with
an approximate value, Chuck and his financial advisors went through an
exercise to determine the amount of net cash from the business to Chuck in
the previous year. A good rule of thumb to use is three to five times that
number equals the value.
Step 4: Establish a transfer strategy for the business to the buyer.
Because Carlos didn't have much money or assets, he wasn't going to be able
to simply go to the bank and get a loan to pay for the business. To solve
this challenge, annual performance incentives were created for the company.
If the business met those performance incentives, Carlos, as General
Manager, would be gifted 5 percent of the stock of the company at the end of
each year until he reached 49 percent ownership in year 10. At that point,
Carlos would be a 49 percent owner with a 10-year track record, and a bank
would likely be willing to loan him half of the business' value to complete
the buyout of Chuck's interest.
Step 5: Get it in writing.
Now Chuck needed to sit down with an attorney
and get all this in writing. Since his advisors had done most of the
legwork already, they were able to specifically tell the attorney what was
needed, which saved a considerable sum in legal fees. The attorney drafted
a stock purchase agreement for Chuck and Carlos. The agreement laid out the
performance incentives, where the stock would be held, stipulated that the
shares would be non?voting, and required Carlos to buy Chuck out at the end
of the 10-year period. The attorney also created a trust, which laid out
the transfer of Chuck's assets to his daughter, in case he died.
This type of buyout strategy is useful when the owner wants to sell to an
employee or family member. The key element that allows these plans to
succeed is TIME. The greater the amount of time the business owner plans
for the exit of his business, the greater his chance of success. If Chuck
simply woke up one day and said, "I can't take it anymore," there's no way
that Carlos could buy him out. Everyone knows a business owner who's had
health problems, or unexpectedly passed away, causing the business and all
its value to go down the tubes. This could have been avoided in almost
every case by taking the time to create an exit plan.
Another key element in making your exit strategy succeed is to work with
advisors who have extensive experience with this type of planning. Many
quality CPAs and attorneys don't fall into this category, yet they're smart
enough to bring in an outside advisor who does. Also, it's important that
the advisors work as a team, so that everyone is on the same page, working
toward the business owner's goals.
Chuck's plan was enacted five years ago, and all has gone exactly as
planned. Chuck's still the life of the party, and loves seeing his vision
turned into reality. Financial peace of mind hasn't changed him one
bit-when his friends get together, they all smile, shake their heads and
marvel at the character everyone knows as Chuck.
About the Author:
Thomas E. Houck, CPA, CFP®, is a speaker, author and consultant who's
program, "Your CFO Advantage™" has helped numerous business owners grow
their businesses, reduce their taxes and lower their stress level. His
book, "The Top 10 Mistakes Business Owners Make (and how to fix them)" helps
business owners develop strategies to lead a better life by running a better
business. For more information you can visit Tom's website at
www.heritagebusinesssolutions.com
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