Critical Step Needed To Create An Exit Strategy! Part 1 

Some business owners think that selling their business is a matter of getting an appraisal and putting the business on the market hoping for a good offer.

Many business owners that I have worked with initially assumed they knew the value of their business and what they could sell it for.

Through our education process they realized there is much more to selling their business, then just the establishing a value and then going to market.     One of those factors or variables is whether the business owner needs the business value for their future retirement, most do!

Helping the owner figure out what they need for retirement is critical in establishing what they need to sell their business for, and what action is needed to increase the future value of the business (Value Drivers).  In this article I will cover two of the seven steps that  are the most critical when planning a future exit from the business.

Whether the sale is one year or ten years from now, these are the steps needed to sell  a business.

  1. Must identify the Exit Objectives (why, when, and in some cases who) 
  2. Identify Personal and business financial resources; (this is part of the future financial security of the business owner and their family).  
  3. Maximize and Protect Business Value
  4. Ownership Transfer to Third Parties
  5. Ownership Transfers to Insiders
  6. Business Continuity
  7. Personal Wealth and Estate planning

In this post I will cover steps 1-3, and cover steps 4-7 in the June issue.  

In comprehensive Exit planning, (when you break the process down it looks like this):

Your Exit Objectives

  • Building and preserving business value
  • Selling your company to a third party
  • Transferring your ownership to insiders

Your Business and Personal Financial Resources

  • Business Continuity
  • Personal wealth and estate planning

Owner’s goals and aspirations are

  • Financial Need
  • Overall Goals
  • Value based goals
  • Defining the owner’s goals and aspirations shows the client’s wants and needs and identifies what is  important to the business owner. By spending time collecting this information from the business owner we establish a strong relationship, while differentiating you, and allowing you to be the quarterback of the plan.

Accurate information from the owner is critical to planning.      Calculating what the GAP of resources the owner needs to have in order to supply their future retirement income is critical.  It is here where the measurement of their resources helps to decide what they need to sell their business for, to help fund the gap.    Continue reading “Critical Step Needed To Create An Exit Strategy! Part 1 “

Single Appraiser vs. Multiple Appraiser Choices

This month I wrote about multiple and single Appraiser choice.  My friend Ed Pratesi was nice enough to give me some of his thoughts, which I definitely respect due to his experience and training.   Ed, thank you for this contribution.

Ed Pratesi wrote:

I read with interest your comments on Single Appraiser vs. Multiple Appraiser choices that owners have for a BSA. I agree in part with your assessment that the single appraiser choice is preferred but I do have a number of caveats and suggest that before the number of appraisers needed is secondary to choices made before this decision. Let me explain my thoughts:

Firstly, the choice of number of appraisers almost always works, whether one, two or the three step approach – except when it doesn’t!

Prior to the determination of the number of appraisers needed is preceded by what I refer to as the education process that a business appraiser must take the owners through in order to develop an agreement and a process that will likely be triggered when an unanticipated or unfortunate event has occurred.

In never ceases to amaze me that owners will spend money on creating a business plan, invest in physical assets and talent and not spend enough time on one of the most important events that will occur in their lives – either their exit or a partners exit. My complaint is not pointed at the owners but at the appraiser called in to initially called in to assist in the valuation.

My point simply is the an appraiser needs to explain the valuation process, the valuation methods used to value a business, the applicability or not of the methods to the company, a discussion of the definition of value – (for example fair market value or fair value, more on this in a later discussion), a complete discussion of adjustments that appraiser consider in the valuation process, and what discounts could apply and the reasons for application of discounts.

This part of the valuation process is more consultative and sets the framework for the conduct of an initial appraisal and of the work product. Finally, once the appraisal is complete a meeting to discuss the results and the process is essential and should be prefeaced with scenario planning should a provision of the BSA be triggered.

The goal is to get buy-in on the process not just the number!

I hope I have addressed part of the discussion of the number of appraisers – more to follow if desired…

Ed Pratesi

Edward E. Pratesi, ASA, CM&AA, ABV, CVA

Managing Director | UHY Advisors N.E., LLC
6 Executive Drive, Farmington, CT  06032
D: 860 519 5648 | C: 860 558 0453 | F: 860 519 1982

epratesi@uhy-us.com |  www.uhyvaluation.com

www.linkedin.com/in/ed-pratesi-140b762

 

The Interplay Between the Funding Mechanism And the Valuation? 

What happens when life insurance proceeds are part of the funding vehicle of a buy and sell agreement (BSA).    

 Example 

 When a stockholder owner dies and life insurance payments are made, is the valuation of the stock being redeemed as part of the value of the company?   

The way life insurance benefits are treated in the buy and sell agreement (BSA), could lead to different estate treatment and income tax.    In both areas, the results can be dramatic.     

 Does the agreement tell the appraisers how to treat the life insurance benefits in their valuationDoes the agreement provide for the company to issue a promissory note to a deceased shareholder, and what are the terms? 

 Keep in mind, the agreement is no better than the ability of the parties and/or the company to fund any required purchases at the agreed upon price.    An agreement that is silent on this issue is like not having an agreement.  

 Life insurance  

 Generally, life insurance premiums are not deductible, and the pass through of non-deductibility can create pass-through income for the shareholders of S corporations, and the owners of partnerships and limited liability companies.  Knowing how to treat the life insurance premium for tax purposes would be important information for you.  We suggest you discuss this with your CPA.  

 Although the life insurance premium is not deductible, the death benefits generally are tax- free, notwithstanding the alternate minimum tax treatment for C corps.  

Keep in mind the funding mechanism is not actually necessary to define the engagement for valuation purposes and has nothing to do with appraisal standards or qualifications. It provides the funding for the company to afford the value, and to make sure the selling stockholder receives the value.  In essence, it’s the mechanism to fund the liability of the contract, or at least part of it.   

Wants and Needs of the Buyer and the Seller- The normal push and pull!  

The seller wants the highest price and the buyer wants the lowest price.   Without a doubt the best time to set the price would be prior to a triggering event, when both parties are in parity and neither is the subject of the trigger.  It is the best time when both parties will be the most reasonable in setting the rules of the agreements as they are both fair minded in the negotiations.   

 Funding Methods 

  1. Life InsuranceIn most cases life insurance will be the most inexpensive method for funding the death benefit part of the agreement, when comparing, self funding, and loans (including corporate promissory notes) to fund the liability, notwithstanding the ability to get a funding loan from a loaning institution.    In most of the comparisons I have done over the years, life insurance is the least expensive, most guaranteed, and the easiest method of funding for death benefit purposes. 
  1. Corporate Assets: They would have to be accumulated for this purpose, and would likely be included in the valuation, and also would be subjected to taxes during the accumulation stageWhat if the death of the stockholder occurred early after the agreement?  Would there be funds available to fund the liability of the agreement, as there would be a lack of time to accumulate the necessary net profits for the funding?   
  1. External borrowing: Depending on the company’s financial position, it may be possible to fund the purchase price by borrowing.  However, this should be negotiated in advance and before its needed.  Remember, the time to requests funds from an institution is when you don’t need them.  Also, on the other side of this funding element, is the possibility the loan covenant requesting the outstanding note balanced to be called in when there is a dramatic change in ownership and management.    The lending institution may be questioning the ability of the company’s future financial position and the ability to stay profitable.   
  1. Promissory Notes:  If this is going to be used, the terms of the notes should be in the agreement.  Although cash payments are preferable to the seller.   
  1. Combination of cash and promissory notes: Important to note:  Anytime capital is being used by the corporation, it is important not to unreasonably impair the capital of the business. Many state laws prohibit transactions that could impair capital and raise the question of insolvency.  

Without the mention of what funding mechanism is being used in the agreement to repurchase shares, lessens the value of the agreement.  Also, with stated funding, the economic or present value of the redemption price set by the agreement can significantly be reduced, because of inadequate interest or excessive risk leveled on the selling shareholder.   

  

Weak terms in the agreement of the funding mechanism diminishes the value of the agreement from the sellers prospective. However, terms that are too strong can taint the future transactions. What is clear is that it is essential for the parties to discuss the funding mechanism for the triggers of a BSA, keeping in mind both the sellers value position and the purchaser’s ability to fund the costs. 

Exiting Your Business- What You Need To Know and Do!

    In my last newsletter I discussed the three exit strategies business owners can use when they decide to sell their business.   As a review they are; outside sale, inside transition sale, and passive ownership.  Of course there is the liquidation sale which happens when there is no future planning. Liquidate and see what you can get, however I do not consider this an exit strategy.

So what does a blueprint for exiting your business look like?

First:  You must influence your personal company culture. Employees need to know the values and principles you have formed over the years of your business life so they understand the mission.  What needs to be communicated is how you started the company and how you built it up.  The values behind all that effort needs to be communicated to your employees, vendors, and anyone who will listen, especially potential purchasers of your business. By doing so you will gradually build a strong culture in your own organization that will remain in place whether you’re planning on being absent for a long period of time, or just a short period.     A healthy culture makes your company more attractive to buyers and sets the course for more options such as inside sale, or passive ownership.

Continue reading “Exiting Your Business- What You Need To Know and Do!”

The “What If’s”of a Business Owner’s Life!

The Four Life Changes Of A Business Owner

What is it that you think about the most as a business owner?   Chances are they are one of four things:

  • What if I don’t want to stay in business and I want to drop out?
  • What if I get sick, disabled, or die?
  • What if my key person (s) decides to leave me?
  • What if I can’t increase and improve my cash flow (life blood of the business)?

Besides running the day to day of the business, and the stress that goes with this, the four items listed above are probably the biggest stressful thoughts business owners have.   Let’s break them down.

Continue reading “The “What If’s”of a Business Owner’s Life!”

Your Business Worth

What is your business really worth?  If you don’t know this figure, don’t feel too bad, many business owners don’t know their real worth!

Why is knowing your worth important?  Think of it this way.

If you were to invest in the stock market, wouldn’t you want to know the current value of the company you are investing in, and the potential of it’s growth?

Business owners put time, money, and in most cases, most of their wealth in their business.  At some point you will want the wealth in your business.  It may because you want out of the business, you retire, you die, or a number of other triggers.

This blog is dedicated to sharing ideas about growing your business while putting you in the position of extracting your wealth…

Enjoy…

 

Tom Perrone