Do You Have an Exit Plan?
February 9 2009 by John M. Leonetti
As a CEO, and most likely owner or part-owner of your enterprise, you are responsible for grasping the big picture of how the company is performing; you make critical decisions in order to succeed and direct the future of the company. With that said, how well prepared for your company’s future do you think you are? Have you taken the time to outline your ultimate goal of how you plan to exit the business? If so, how confident are you that this move is the most profitable option, and, at the same time, the best strategic move for the company?
Creating an exit plan for your company should be considered standard practice, a regular component of your business planning. An exit plan does not, and should not, imply that you are currently considering selling the business or looking to retire in the near future. On the contrary, well thought out exit plans occur over many years and often times selling the business is only one of the many options considered in the plan. What your exit plan should do is analyze the possibilities for the ultimate succession of the business’s ownership and control, the tax and business implications of each option, taking into account the wants and needs of the company’s ownership. What then will creating an exit plan give you if you do not believe your company’s ownership is nearing an exit? The answer, it will give you confidence that the decisions you make today are supporting your ultimate exit plan as well as providing you with the maximum exit value when the time is right.
If you have an Exit Plan, you will have the confidence that the decisions you make today are not only good operating decisions but they are keeping the company in line with where you know it is headed upon your eventual departure. Without knowing the ultimate goal for the company itself, it would be impossible to know with confidence that you are making the best strategic decisions for the future. Are you willing to take a look down the road towards the exit and see what your ultimate goal is and to align your decision making to suit it? Good, let’s begin.
Let’s start with a few illustrations. A business owner who plans to sell to an outsider wants to show the highest level of profits as well as a demonstrated consistency in achieving those results, year in and year out. By contrast, the CEO who plans on transferring business ownership to family members can benefit in this recessionary period due to lower values that may afford a more tax efficient transfer. More specifically, the shares of a private company can be valued lower (and potentially further discounted for minority shares) to allow for a greater amount of wealth to transfer with fewer transfer taxes. Further, the owner who wants to eventually shift control to a management team, or perhaps install an employee stock ownership plan (ESOP), may decide today to include the key managers in both strategic and tactical conversations and meetings. These simple examples illustrate the larger importance of the managers aligning their thoughts and interests with the owner’s exit plan. Within these basic illustrations run thousands of decisions within the company that will be made toward the ultimate exit. So how do we determine which is the optimal path for your company? We offer three steps that pull this planning together.
First step: Assessing ownership’s readiness
The first step in creating an Exit Plan is to look at the current ownership of the company and determine how prepared they are for an exit. If you are owner as well as the CEO, you will need to accurately assess how much money you will need to maintain your lifestyle. This entails understanding your dependency on the business not only for income, but for benefits such as car payments, health insurance, and other lifestyle expenses. Determining what you need versus what you have will help you choose an exit option that can bridge that financial gap. In addition, you will need to assess how mentally prepared for an exit you are. Exiting a business that has been built by years of hard work and dedication can be a difficult emotional hurdle. How involved are you in the day to day operations of the business? What will you do with your time when you are no longer running the business?
In one owner’s case we had him design what his days were going to look like after his exit in his new, part-time consulting business. We went to the office where he would sit, discussed who would handle the administrative work, and helped him envision the type of work he would be doing and what it would feel like to have the flexibility (and continued income) that he had always dreamed of. If you view your business as more of a ‘job’ than an ‘investment’ and you are integrally involved in the day-to-day operations, this would be a wise thing to do as well in setting a vision for your post-exit lifestyle.
These answers and visions will become vital to prepare you for the next step of looking at the company’s exit options and trying to find the optimal exit path.
Second step: Know your exit options
The most obvious exit solution is the sale of the business to another buyer, perhaps someone in your industry. It is helpful to know that only a small percentage of businesses, less than 20%, successfully sell to an outside buyer. The less obvious, and much more frequent, exit strategies include transfers to family members, to management teams, to private equity groups, or to employee stock ownership plans (ESOPs) as well as gifting programs. Each option offers benefits as well as consequences and some may be better suited to your company’s exit plan better than others. It is your responsibility to learn about the pros and cons of these different options and how they will affect the company.
For example, one very useful, but poorly understood exit option is an employee stock ownership plan. An ESOP provides great flexibility for an owner or CEO to monetize any portion of their illiquid stock. And, it is still an internal transfer where the owner or CEO decides whether and / or how they want to give up control. So, if the attributes of an ESOP look like a good exit option, you will want to begin to align your management and business decisions to accommodate that exit path. One simple example is to begin to transition independent (1099) workers into full-time (W-2) status because a [leveraged] ESOP will account for payroll census as a major portion of the structuring. The higher the payroll, the greater the deductions, and the more a CEO can increase the cash flow of their business.
By contrast, an owner of a software company who wants to sell for top dollar will be largely indifferent as to how the product is distributed because, in all likelihood, the buyer of this business will be most interested in the intellectual property. In this case, an investment in engineering better solutions and better legal protection of that intellectual property is one of the key decisions to be made while looking ahead towards the sale transaction.
A properly constructed exit plan has you building your company towards the type of exit that you envision, aligning the resources of your firm towards that ultimate goal. This leads to the third and final step in this initial process - execution.
Third Step: Executing your plan and protecting the company’s wealth
The process of exiting a business is almost always a multi-layered complex engagement. When it comes time to execute the plan, it will be vital that you gain the support of advisors who will help you in protecting the wealth of the company while minimizing taxes. How a transaction is characterized for tax purposes determines how it is taxed. Tax characterizations are tied to how transactions are structured. It is then critical that you determine the actual financial outcome of your exit plan. Remember, it is not ‘what you get’ when exiting your business, but rather ‘what you keep’ that counts.
This is not the only step to protecting your wealth. You will also want to consider the estate tax consequences of your total business wealth as a part of this planning. By not including the business in your larger estate planning objectives, you may compromise the company’s succession and survival. In addition, you may end up placing a burden on your family after a lifetime of successfully running a profitable business. To help you navigate this part of the journey you should construct an advisory team that may include an; attorney, accountant, financial advisor, insurance advisor, mergers and acquisitions advisor, as well as a valuation advisor.
Ben Franklin was quoted as saying “By failing to prepare you are preparing to fail.” As a CEO, you can look at creating an exit plan simply as being prepared. Prepared for the future, prepared by knowing the direction the ownership wants to take the company, and prepared in case the need for an exit comes sooner rather than later.
John M. Leonetti, Esq., CFPÂ®, CM&AA, is the founder and managing director of Pinnacle Equity Solutions, an exit strategy planning firm that offers planning services to business owners as well as education and training programs for professional advisors. He is the author of the book, “Exiting Your Business, Protecting Your Wealth” (Wiley/October 2008). www.exitingyourbusiness.com.