Dipping a Toe in the Exit Planning Pool

Here we attempt to dismantle the most common objections owners have to undertaking the planning to exit their companies successfully. Excuses to avoid exit planning include the following:

1. The business isn’t worth enough to meet my financial needs. When it is, I’ll think about leaving.
2. I will be required to work for a new owner for years.
3. I don’t need to plan. When the business is ready, a buyer will find me.
4. I can’t imagine my life without it!

Assuming we are successful in persuading you that exit planning helps your business while you are in it and is the best way to leave the company to the successor you choose, on the date you choose, and for the amount of cash you want; you might ask: “How do I, as an owner, jump into exit planning?”

Let us suggest that one of the best places to jump in is to take some measurements.

First, owners should retain a valuation expert to perform an estimate of the company’s value to find out what it is actually worth. (If you plan to sell to a family member, co-owner or employee, retain a certified business appraiser. If you foresee a sale to a third party, ask a business broker or investment banker for a “sale-price estimate.”) The transaction advisor – an investment banker if the company’s likely value is at least $5 million and a business broker for smaller businesses – should be able to give the owner a range of values for the business in today’s mergers and acquisitions (M&A) marketplace. Regardless of the M&A market, they are weak foundations for exit planning.

Second, owners should sit down with their financial advisors to figure out how much cash they will need to meet their financial goals. Tapping into this expertise to objectively analyze an owner’s future needs and make realistic, risk-sensitive assumptions about investment rates of return is paramount.

To illustrate how assumptions, rather than objective measurements, can lead owners astray, let’s look at a hypothetical business owner who went into a transaction armed only with assumptions:

When Sam Reed began thinking about selling his business, he started paying close attention to what competitors were getting for their companies. He applied his industry’s rule of thumb to his company, compared his company to others and figured that his company was worth about $20 million. He calculated that he’d take home about 75 percent of that after taxes. Since he needed $6 million to pay off business debt, he thought he could cash out for $9 million.

He hadn’t put a lot of thought into what income he’d need for a comfortable post-exit life, but figured that at his age (50), $9 million, yielding 8 percent per year ($700,000+ annually), would be an adequate replacement for the $850,000 salary and distributions he currently took from the business.

With the stars seemingly aligned, Reed put his company on the market. Unfortunately, his telescope was out of focus: His idea of business value was unrealistically high, given the flatness of his company’s cash flow and the state of the M&A market. The best offer on the table was $14 million, of which $11 million was in cash, leaving him with about $2 million net at closing (after taxes and debt payoff), and another $3 million in future payments.

When Reed learned from his financial advisor that the realistic return on the net proceeds ($2 million to 5 million depending on whether he actually received the $3 million in future payments) was 4 percent to 5 perncet, he had no alternative but to back out of the sale process.

This fictious character made two critical mistakes:

1. He miscalculated the proceeds he’d receive at closing and unrealistically overestimated the rate of future investment return.
2. He would have saved time, effort and money if he had (a.) gotten a sale-price estimate that allowed him to realistically estimate how much he would net from the sale and (b.) forecasted a realistic, risk-sensitive rate of investment return (as part of a financial needs analysis).

With these two pieces of information in hand, Sam could have made a more informed decision.

Many owners don’t have the luxury of time. We suggest that you at least stick your toe in the exit planning pool by obtaining these two simple measurements. Test your assumptions: You may be surprised by the results.

The information contained in this article is general in nature and is not legal, tax or financial advice. For information regarding your particular situation, contact an attorney or a tax or financial advisor. The information in this newsletter is provided with the understanding that it does not render legal, accounting, tax or financial advice. In specific cases, clients should consult their legal, accounting, tax or financial advisor. This article is not intended to give advice or to represent our firm as being qualified to give advice in all areas of professional services. Exit Planning is a discipline that typically requires the collaboration of multiple professional advisors. To the extent that our firm does not have the expertise required on a particular matter, we will always work closely with you to help you gain access to the resources and professional advice that you need.

Article presented by Karen Jessey, ChFC®, CLU®, CFP®, RCIP®, CExP™, [email protected], a Member of BEI’s International Network of Exit Planning Professionals™. ©2018 BEI

Registered Representative and Financial Advisor of Park Avenue Securities LLC (PAS). OSJ: 6455 South Yosemite Street Suite 300, Greenwood Village, CO 80111, 303-770-9020. Securities products and advisory services offered through PAS, member FINRA, SIPC. Financial Representative of The Guardian Life Insurance Company of America® (Guardian), New York, NY. PAS is an indirect, wholly-owned subsidiary of Guardian. Strategic Wealth Partners is not an affiliate or subsidiary of PAS or Guardian. 2018-65628 Exp. 8/20 2) This material contains the current opinions of the author but not necessarily those of Guardian or its subsidiaries and such opinions are subject to change without notice.

PAS is a member FINRA, SIPC