© Dr. William Hendricks 2007 Overland Park, KS 66210 (913) 451-2938 Page 1 ıla nninı ninı By Dr. William Hendricks The following information is intended to provide education and information for small business owners. It is not intended to provide legal or business advice. Seek professional assistance in developing your exit plan. Are you tired of fighting the alligators? Looking for a new or different challenge? Are you thinking about getting out of your business? Is a successor prepared to step up? Are you confused and a little overwhelmed about what to do next? ew people have the courage to launch out and start a business; most cannot manage their time and resources well enough to keep the doors of a small business open. You did it! But you have one more hurdle… getting out of that business. If done well an exit plan helps you leave in style; with the right person in position, the business sold for the right price and in a manner that allows you to put as much of your hard earned money in your pocket and not the pocket of the IRS. Getting Started Seeing the big picture is the first step to developing a successful exit plan. Whole books with hundreds of pages have been written on this subject, so we will not rewrite them. Instead, we will provide an overview of the five basic disciplines of a successful exit plan. 1. Time Management. It typically takes 3-5 years to properly structure an exit plan for maximum value. 2. Business Valuation. Do you know how much your business is worth today, in cash? Do you sell outright? Create an ESOP? Finance a transition to a friend or family member? 3. Personal Goal Setting. How will you fund your retirement, exactly what are your retirement objectives and what will it take to reach them? Are you prepared to transfer your business to another party while paying the least possible taxes and enjoying maximum financial security? 4. Performance Management. The value of your business is built on sustainable customer engagement. Do you know, and can you share, the best way to maximize the income generated in your business? 5. Build Your Business Advisory Team. Where do you turn for guidance and direction? One thing is guaranteed… There is no lack of opinions on what you should do. Discipline1: Time Management Prudent business management recommends showing the lowest allowable revenue, while reducing tax liabilities. F © Dr. William Hendricks 2007 Overland Park, KS 66210 (913) 451-2938 Page 2 Many of those business “loop holes” must now be closed to show the “real” value of your business. Years of deductions and well paid CPAs must now be redirected. If you are going to get the maximum for your business, you need to have a declared value that represents what you are actually making. This is usually a much higher number. This cannot be done in a year. Business valuation is set on past performance and future projections. A huge gap between past and future will set off warning signs and red flags, making it harder to get an accurate valuation. You should dedicate a 3-5 year window for your exit plan if you expect to draw the maximum value from your business. A rush to sell out will reflect poorly on the sales price. In some cases this could mean a reduction in discretionary income, and you will spend significantly more time documenting processes, cleaning up inventory and backfilling plans. Small business owners often avoid these activities forces to deal with the myriad of day-to-day problems and business concerns. You must use your time carefully in the next 3 years. Discipline 2: Business Valuation Identifying the value of your business must be done at the inception of the Exit Planning Process. The way you invest your time over the next three years is defined by the value you place on your business and the strategy you select for transferring it to someone else. Every aspect of your short-term goal setting is re-defined by your business valuation, and every customer now is connected to your exit strategy because they do impact the valuation of your business. For example, do you plan to sell your business to a third party who has cash, or to an internal source (either family member or employee) who will count on the on-going revenue from the business? Think of business valuation as three stages. Stage One, the initial stage, provides a framework for decisionmakking Your responsibility in this stage is to get a good estimate to determine the viability of selling, and the implications that surround your decisions. Often this is done informally, and unprofessionally, leading to frustration and disappointment. Folk lore and the Internet offer a host of ways to determine the value of your business, and people being people will likely gravitate to those that over estimate. In Stage One, do your research, and develop an estimate that reflects your industry and a business your size. One rule of thumb in this phase… once you determine what you think your business is worth, reduce the number by ¼ and then ½ . How much does this affect your thinking? Is there a point when you can’t make a deal? Stage Two adds a level of clarification and expertise to the valuation process. Usually this is done by an individual who knows the market and has bought and sold businesses like yours. They will help you identify market trends, interests and expectations. You’ll also gain a much better idea of whether your Phase One estimate is accurate. Stage Three actually begins the selling process and provides the vehicle that will create the selling process, and usually initiate the sale. If Stage One and Two are well done, there are few surprises. Done poorly and you will feel as if your life’s work has slipped through your fingers. In each Stage of your business valuation you obtain greater detail and understanding. A poorly developed or rushed exit plan is a formula for disappointment. © Dr. William Hendricks 2007 Overland Park, KS 66210 (913) 451-2938 Page 3 Without knowing the value of your business or the after-tax cash you will receive it’s impossible to determine if your objectives can be met, or possibly how much your company must grow before you can exit. Discipline 3: Personal Goal Setting Selling your business starts with a definition of what the business means to you and determines what you want and need from the business. You must make the time to weigh options and set clear objectives. The definition of a successful Exit Plan varies from owner to owner. To establish your goals, we suggest that you know the answer to six questions: 1. When do I want to sell my business? 2. What is the after-tax Value income I want from the sale of my business? 3. To whom do I want to transfer the business? 4. What are the basic processes that must be understood and transferred. 5. How do I secure key customer accounts and ensure a smooth transition? 6. How will I address and communicate the transition to key employees? At some point, you will leave your business — voluntarily or otherwise. Failing to answer the questions above can cause delay and confusion for everyone involved. An exit strategy, with well developed goals and objectives should be mapped to ensure reality is maintained and a course of action defined. Discipline 4: Performance Management The teeter totter provides an exceptional analogy of performance management during an exit plan. Positioned on opposite ends of the teeter totter are your financial expectations and customer expectations. Over a three to five year time frame, you must find the balance between making money and pleasing customers. Too heavy an emphasis on either end can significantly influence your exit plan. Can a very heavy person teeter with a very light person? Sure, but you must move the fulcrum to establish balance. Consider the fulcrum of your exit plan your core business processes. If you get these correct, you can manage the shift caused by high customer demands and the need to show increasing financial performance. The two legs that support the fulcrum are your people and the technology you use to deliver results. These five perspectives (Finance, Customer, Process, Technology and People) form your exit plan balanced scorecard. By developing clear objectives and defining your desired measures you can have great tool for communicating business needs. These are often referred to as Critical Success Factors. (CSFs) CSFs are characteristics that either reduce the risk associated with owning the business or enhance the prospects that the business will grow significantly in the future. Discipline 5: Build Your Team The ability to navigate your business through the intricacies of an Exit Plan is more than any one person can provide, and errors in judgment can be very costly. If your have the slightest inkling that you might face tax issues and sales problems when you exit your business, then you © Dr. William Hendricks 2007 Overland Park, KS 66210 (913) 451-2938 Page 4 should create a team of advisors to help you through the process. These advisors are asked to manage four “soft” business areas and three “hard” business areas inherent in the “Exit.” Soft Areas include: • Concentration of Sales • Strength of Management • Strength of Systems • Transition Planning Hard Areas include: • Legal issues, contracts and documents • Business valuation and fee structuring • Financial performance and projections. The following people should be considered as potential team members when building your Exit Plan Team Roster… A Business Advisor -Keeping a business going while planning for the future can be a real juggling act. The alligators don’t go away because you are leaving! The role of your business advisor is to keep you on course, focused, and moving toward your exit. They should help you manage the five disciplines and build your Exit Plan Scorecard. An Investment Banker or an Attorney will help you proceed with the sale. They ensure the “Ts” are crossed. In some cases you will need both as team members. They also will prepare many of the documents you need to prove business performance and set up the sale. A CPA will help you avoid (or at least minimize) the unpleasant experiences with the IRS. In many cases your business valuation is better accomplished by a CPA than an attorney. Look for a CPA that knows business and not just accounting. In some cases a Benefits Specialist can help you direct retirement funds and benefit administration for key employees. If you opt to execute an ESOP a benefits expert can structure incentives and create appropriate employee incentives. Conclusion Owners who ignore the five disciplines of Exit Planning can become poster children of the IRS. When managed well, the transfer of millions of dollars occurs as you wish, but only if you have done your job before the business is converted to cash. I encourage you to use this brief white paper as a call for action. Since this white paper is written by a Business Advisor, it should come as no surprise that I recommend that the first step in exit planning is to select a business advisor; someone who knows their limitations and is well aware of the need for a highly skilled team as you approach your target date for exit. A skilled Business Advisor will get in the trenches and fight the alligators one day and work with attorneys the next. They have the proven ability to keep one eye on the present and the other clearly fixed on your exit date... Your Business Advisor will manage your Exit Plan with you, without “Nickel and Diming” you every step of the way. As the author of this article, I offer a comprehensive exit planning assessment and the opportunity to talk about next steps. Please feel free to call so we can talk.