This article originally appeared in the October 2010 issue of Smart Business Philadelphia magazine.
Whether an owner is near retirement or not, he or she should have a plan for how and when to exit from the business and incorporate it into the broader financial and management plan of the company.
“You can’t ignore it, particularly with a private business,” says Mario Vicari, CPA, CVA, a business advisor and a director in the Audit and Accounting group at Kreischer Miller. “Most business owners have the bulk of their wealth tied up in their companies. Owning 100 shares of your private company is not like owning 100 shares of IBM, where you can just call your broker and sell tomorrow. Exiting a private business is far more complicated.”
Smart Business spoke with Vicari about the four areas of readiness to consider for a successful and profitable exit.
What areas of readiness must a business owner consider when planning an exit?
One is owner readiness. Many people are unwilling to confront the fact that they’re getting older and that they have to address what they’re going to do with themselves and their business. This involves the psychological aspect of coming to grips with the fact that you’re probably not going to be doing what you’re doing forever and giving some thought to what that transition looks like. Owners who refuse to plan for this issue can create a bad situation that can do a lot of harm to the value of the company.
The other thing owners have to evaluate is their personal financial readiness. What does retirement look like, financially speaking? Have they saved enough money to maintain their lifestyle? If they decide to get out of the business, is it necessary to create liquidity by selling it? The owner’s estate planning should be incorporated into this analysis. The owner’s financial situation often dictates the exit plan for the business.
What other areas should an owner consider?
The second area of readiness is financial readiness of the company. In order to consider any kind of transaction, it is important to understand the company’s financial situation.
This typically involves the company’s earnings and cash flows, as well as its overall financial position. How well capitalized is the company? Is the company leveraged? Are the balance sheet and the cash flow of the company healthy so that there are a lot of exit options?
Suppose an owner is 53 years old and he wants to retire at 60 and sell his business. During those seven years, the company has to make decisions every year about how to allocate its capital — whether to buy new equipment, take on debt to buy a new building and expand the business. The financial condition of the company is a critical consideration because it dictates a lot of what you can do. If nothing else, a strong company, from a financial standpoint, will maximize the price if an owner decides to sell the business.
The third area of readiness is the performance of the company. How well does it perform in its industry and peer group? Is it being run in a way that is maximizing returns on capital and returns on assets? How well is it performing from a profit standpoint? If the company performs poorly, it makes any transition harder, and it makes the value of the business less.
The last area of readiness we focus on is management readiness. If an owner has been in that business for 20 or 30 years and wants to leave or take a lesser role, he needs to look at the next level of executives to ensure there are no weak links. It’s critical to make an honest assessment of the management team and make changes if necessary so that there is a clear succession plan.
A good executive team is probably the most critical piece of any exit because it allows an owner to exit knowing that the business is in good hands. A great management team is a critical cog if the owner sells the business outright or if he decides to do an internal transfer to family or the management team.
How does this relate to the owner’s ultimate exit plan?
In private companies, whether an owner plans to transfer the business to children or sell it to a third party, if these areas of readiness — financial, performance and management — are all functioning at a high level, it doesn’t matter which of those choices the owner makes because he or she will have a lot of flexibility in planning the exit. If it’s an internal transfer, the transition will be smoother if you have a good management team and balance sheet. If you decide to sell, you’ll get a higher price with a good management team and financials. There’s a lot of congruence in these areas, and they’re important no matter what the owner’s exit choices are.
What if an owner’s exit is more sudden?
Aside from the all-important planned exit, there should also be a plan for an emergency exit. If something were to happen to the owner of a private business, the company should have a strategy or a document in place for the management team, as well as the spouse.
The owner should take a close look at the buy-sell agreement, and his or her life and disability insurance. Especially in cases of a single-owner business, the owner should leave instructions on who does what tomorrow if something happens to them unexpectedly.
A basic set of instructions could include which advisors to use to help sell the company, or how to hire a new president until the company can be sold. These factors are often left unsaid, and the managers jump in to help, but it creates chaos if you’re not sure who’s in charge. Another way to address this is to form a board to oversee this process. When the business is so concentrated on one person, and something happens, the company can be at risk and place undue pressure on the spouse.
All owners will have to exit their businesses at some point. We feel it’s best to be prepared, because the consequences of not planning properly could be severe both personally and financially for the owner.●
- Valuable Planning: Mentally Preparing for a Successful Business Exit
- Planning Your Exit: How to Plan Ahead for Your Departure From Your Business
- A Tax-Free Alternative to Transfer Control of a Closely-Held Business