Business Owners Develop Exit Strategy to Ensure Smooth Company Transition

Developing a comprehensive exit strategy allows business owners to retire with peace of mind and their company intact.
Business Owners Develop Exit Strategy to Ensure Smooth Company Transition
Thomas E. Houck is a CPA, speaker, consultant and author of The Top 10 Mistakes Business Owners Make (and how to fix them). Visit his website, www.heritagebusiness solutions.com.

There’s a common question on the minds of business owners 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 you retire, and simply execute it.

Take the case of Chuck, a 65-year-old, life-of-the-party type of guy. Although he joked with everyone, he was plagued by a gnawing problem: “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. How do I pull this off?”

IDENTIFY GOALS

Chuck started his business from scratch 20 years ago. He 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. So Chuck needed to develop a plan that would make the buyout process affordable for Carlos, while assuring that his daughter would get a fair value if anything happened to Chuck.

To develop a quality “exit strategy,” business owners like Chuck need to follow some important steps:

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.

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 for his employees. 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.

Step three: Determine the company’s worth. Instead of hiring a valuation analyst to compute his company’s worth, Chuck and his financial advisors came up with an approximate value by determining the amount of net cash from the business to Chuck in the previous year. A good rule of thumb to use: three to five times the amount of net cash equals the value.

Step four: 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 get a loan to buy 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 receive 5 percent of the company’s stock at the end of each year until he reached 49 percent ownership in the 10th year. At that point, a bank would likely be willing to loan him half of the business’s value to complete the buyout of Chuck’s interest.

Step five: 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 particulars, including performance incentives, and the requirement that Carlos would buy out Chuck at the end of the 10-year period. The attorney also created a trust, laying out the transfer of Chuck’s assets to his daughter, in case he died.

PLAN AHEAD

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 a business owner plans for exiting his business, the greater his chance of success. 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 creating an exit plan.

Another key element in making an exit strategy succeed is to work with advisors who have extensive experience with this type of planning. Many quality certified public accountants and attorneys don’t fall into this category, yet they’re smart enough to bring in an outside advisor who does.

Chuck’s plan was enacted five years ago, and all has gone exactly as planned. He’s still the life of the party and loves seeing his vision turned into reality. And now he can enjoy retirement because he has financial peace of mind.



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