Business Exit Planning – How to Convert Your Business into Cash
by Jane M. Myers, Esq.
Fact of life: if you’re a business owner, one day, one way or another, you will leave your business. The question is – how do you want to exit? There are only a few scenarios. You can keep working until you “pass on to greener pastures”; or you can one day simply shut the lights, lock the doors and call it quits. You can transfer the business to your children or other relatives; or you can sell the business to key employees, co-owners, or an employee stock ownership plan. You can sell the business to a third party.
How will you exit your business? What’s the best way to do that? Why should you think about it?
The benefit of business exit planning is that it allows you to control what happens to you, your loved ones, and your business so that you can exit under the most favorable circumstances rather than leaving it to chance. If structured properly, an exit plan can create a cash flow stream that will continue for your benefit while you move on to the next phase of your life.
While you have developed and nurtured a business that has provided you with the means to support yourself and loved ones comfortably over the years, if you die or become disabled without a succession plan or simply lock the doors and walk away, you (or your estate) will have lost the opportunity to convert to cash the equity that you’ve built up in your business. Why would anyone throw that money away?
More often than not, business owners do throw that money away and they do so for a variety of reasons. Many are just “too busy” to think about an exit plan, or they just don’t know where to begin, or they have given it some thought, but don’t see an heir apparent within the business and don’t understand how to sell to a third party. Many are in the dark about the process and convince themselves that it’s just too complicated. Most commonly, all of this is thickly layered with a fear of letting go and moving on to the next phase of one’s life. However, once a solid exit plan is in place, typically the fear of transition evaporates.
The first step in business exit planning is to create the overall vision of your exit plan. This is developed with the assistance of a team of advisors usually consisting of an accountant, attorney, financial planner, and a business valuation expert. Depending on the circumstances, a business broker may be part of the team as well.
The essential elements of a successful exit plan are:
1. Establish fundamental planning objectives:
a. What is your anticipated departure date?
b. How much income will you need after you leave the business to have financial security?
c. Who will you leave the business to?
2. Determine the value of your business.
3. Between now and the time you transfer the business, identify and take the steps necessary to increase the value of your business including implementing a key employee retention plan and systems documentation.
4. Identify the best way to sell your business, minimize tax liability and reduce selling risks.
5. Establish a plan for the business to continue to provide revenue for your family if you should die or become permanently disabled.
While you are still the owner, care must be taken to retain your “key employees”, i.e. those individuals who add value to the company and without whom the value of the business would be severely diminished. The presence of key employees can make the business that much more attractive to a potential buyer who will see the business as a “turn key” operation because there are “insiders” there who know how to effectively run it. Additionally, key employees are oftentimes themselves the future purchasers of the business which is why you want them to stay.
Most people can be motivated to stay at their jobs through financial incentives. This can take the form of either granting an ownership interest in the business or paying the key employee a meaningful amount of cash through the use of a cash bonus plan set up by the business owner. Usually, the business owner will want to avoid granting an ownership interest to a key employee until there is certainty that the employee will, in fact, be the one to ultimately take over the business. For that reason, the cash bonus plan can prove to be an excellent way to retain an employee while evaluating whether they are appropriate to take the business reins.
Other considerations to be addressed are structuring the sale to gain the most advantageous tax treatment and for that, a knowledgeable tax advisor is an essential member of the team. Also important to the transaction is an attorney experienced in these matters which typically includes estate planning, and a business valuation expert since favorable tax treatment is very closely tied to a “defensible” valuation of the business, should the valuation ever be reviewed by the IRS.
While there are several intertwined aspects to developing a complete business exit plan, it is something that every business owner should address and can accomplish.
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Please note that this article is intended only as a general discussion of issues pertaining to exit planning and that it should not be taken as creating an attorney-client relationship or as legal advice with respect to any particular person, business or situation. Circumstances and the applicable legal principles vary and you should consult with an attorney and/or other professionals in order to develop an exit plan appropriate for you and your business.