Don’t Let Key Employees Hijack Your Exit Strategy

/in , /by Jim Leonhard

In building a successful company, owners usually invest in hiring and developing managers and key contributors that become vital to the company’s effective operations. These people are considered “key employees”. When the time comes for the owner to exit his or her business, these key employees are usually valuable “assets” in the eyes of potential buyers.  Unfortunately, if a business owner has failed to take certain steps, key employees can derail a successful sale or ownership transfer.

Here are some observations and suggestions with respect to key employees that can help enable a successful exit:

  • Ask all employees to sign a multi-year non-compete and non-solicitation agreement. While not always enforceable, they make employees pause and potential buyers more comfortable.
  • Ensure your key employees are sufficiently incentivized to facilitate rather than undermine your exit. For example, grant minority shares, stock options or stock appreciation rights, or offer them stay bonuses so they would profit from a sale.
  • Cross-train your key people to reduce reliance on single individuals. And if your business can afford it, develop a bench of qualified staff beneath key employees so someone can step up should an unexpected vacancy occur.
  • Carefully decide when and how much of your plans to divulge to key employees. Employees often react negatively to the prospect of a company being sold and may start seeking employment elsewhere. Assuming you’re planning to sell to a third party, most owners wait as long as possible to inform key employees of your plans, and, when you do, give them only the information they need. If possible, assure them they will be valued and wanted by the new owners. If the terms of the intended sale don’t allow you to do that, be ready to offer key employees a stay bonus that extends beyond the sale closing.
  • Involve an exit planning advisor who can help you position your company for a successful management transition. He or she can help you build transferable enterprise value, minimize key person risks and discounts, and avoid many common pitfalls along the way.

Click on this link to read a tragic key employee sabotage story:  When Key Employees Stall Your Exit

Could this happen to you? Don’t take chances with your retirement!

For further information on incentivizing key employees or for help with an exit strategy, M&A or business valuation, feel free to contact Jim Leonhard at 916-800-2716 or jhleonhard@exitstrategiesgroup.com.

Is Your Company an Employee Stock Ownership Plan (ESOP) Candidate?

/in , /by Al Statz

Employee Stock Ownership Plans (ESOPs) have compelling competitive, financial and legacy benefits. For business owners weighing their exit options, a leveraged ESOP may be feasible if the owner, company and employees possess certain attributes:

Owner Attributes

  1. Owns 30% or more of corporate stock
  2. Has a low basis in the stock
  3. Looking to reduce involvement in the company long term (5+ years) or shorter term if successor(s) are in place to take over
  4. Concerned with employee welfare and wants to reward them by transferring an interest in company stock to them
  5. Wants to sell shares on a tax-deferred basis
  6. Willing to sell for fair market value and forgo the possibility of obtaining a price premium through an M&A sale process

Company / Employee Attributes

  1. Mature, non-cyclical business with strong operating performance (revenue and net margins), past and projected
  2. A balance sheet strong enough to absorb ESOP acquisition debt
  3. Adequate cash flow from operations to cover capital spending needs and debt service for ESOP acquisition and other borrowings
  4. Adequate payroll, say $1,000,000 or more per year
  5. 20+ employees
  6. A participatory management culture, and open and effective communications between employees and management
  7. Strong executive leadership and management bench to succeed long term

ESOPs are costly to set up and comply with IRS and DOL regulations. They are not for everyone. ESOP is a complex area that is not well understood by most CFO’s, attorneys, CPAs and M&A advisors. Be sure to work with specialists.

Use these rules of thumb if you are considering transferring ownership of your company through an Employee Stock Ownership Plan. To find help determining the feasibility of an ESOP for your California company, feel free to contact Al Statz at 707-781-8580 or alstatz@exitstrategiesgroup.com.

Does My Buy-Sell Agreement Establish Value for Estate Purposes?

/in , , /by Al Statz

Al StatzBuy-sell agreements that contain a clause that values stock at less than fair market value can be disregarded for tax purposes. It is important to consider the requirements of Internal Revenue Code (IRC) Section 2703 when developing an estate plan involving business interests in which 50% or more of the stock is family owned.

Section 2703(a) states that a shareholder agreement (entered into after October 8, 1990) that allows for the acquisition or transfer of property at a price that is less than fair market value will be ignored for estate and gift tax purposes. With respect to buy-sell agreements, Section 2703 provides that such agreements will set the value of shares for estate tax purposes if the agreement is binding in life as well as at death and results in the shares being transferred at fair market value.

Also, the buy-sell agreement must meet these requirements:

  1. It is a bona fide business arrangement.
  2. It is not a device to transfer property to members of the decedent’s family for less than full and adequate consideration.
  3. Its terms are comparable to similar arrangements entered into by persons in an arms­-length transaction.

A buy-sell agreement is deemed to meet the three requirements if more than 50% of the business enterprise is owned by individuals who are not members of the transferor’s family.

 A business owner’s estate plan and succession plan can be interrelated in other ways as well.  Exit Strategies does not provide tax counsel, but we connect owners with competent tax professionals.  Our accredited business valuation experts appraise privately held businesses and fractional interests for buy-sell, tax, exit planning and many other purposes.  Contact Al Statz at 707-781-8580 with any questions or to discuss a current need. 

How Would Your Company Survive Without You?

/in , /by Exit Strategies

If you are like many business owners, you tend to get caught up in the daily demands of your business: managing sales and production, costs, and the bottom line. What about preservation and protection? Perish the thought, but what would happen to your company if it was unable to carry on due to your death or disability?

These concerns may seem like, and may in fact be, remote possibilities. However, by putting them off, you may be placing the future of your business, and its shareholders and their families, at risk. Once death or disability strikes, it will be too late to plan. Your company’s continuing operations could be severely damaged, permanently affecting your family, partners, employees, and others who may depend on it for their livelihood. If you’re like many business owners, you may assume that, if disaster struck, your family could simply sell the company. But, to whom would they sell and at what price? And what if otherwise capable buyers did not have sufficient cash for the purchase? A buy-sell agreement helps provide answers to these and many more questions.

What is a Buy-Sell Agreement?

Briefly, a buy-sell is a legal contract that guarantees a buyer for your business, and provides a means of funding the purchase. You typically negotiate a buy-sell with partners, shareholders, the management team, or key employees. The agreement commits them to buy out your share of the business if you die or become disabled. The process for valuing the company is agreed upon up-front, when the deal is struck. Life insurance and disability insurance are often used to provide the necessary funding.
Your family benefits by automatically having a cash buyer for the business. Your buyer benefits by being able to continue operations without fear of interference from outsiders who are unfamiliar with the business.

The Basics of Setting One Up

An insurance professional usually plays a key role in structuring a buy-sell. Ideally, your representative should have extensive experience in business succession planning. You may also require legal, tax, and accounting assistance, depending on the complexity of the agreement.
In many cases, funding a buy-sell agreement with both life and disability insurance may be the best way to proceed. The life insurance policy can either be term or have a cash value component. A term policy provides the largest death benefit for the least cost; however, it will only cover the buy-sell itself. If you want the insurance to provide other benefits, such as supplementing your pension or providing funds to buy out a partner, you will need a cash value policy. Disability insurance is particularly important, since the chances of becoming disabled are statistically greater than the chances of dying before age 65. However, insurability will depend on your occupation, health, and age.

One Company’s Approach

Consider the benefits of a buy-sell agreement, in the following hypothetical example. Barbara Smith, Mary Jones, and Tom Altuve are partners in a computer services company. Barbara owns the majority interest, while Mary and Tom are minority shareholders. Recognizing the importance of guaranteeing the company’s long-term survival, they consult an insurance professional, who, over the course of several months and with assistance from the company’s lawyers and accountants, develops a buy-sell agreement.

Twelve insurance policies are written to fund the buy-sell agreement, two life and two disability insurance policies per partner. Both life insurance policies are payable to the business. One policy will provide funds to buy out a deceased partner’s interest, while the other will pay the costs of recruiting a replacement. Of the two life policies, one is a term policy, while the other is a cash value policy. The cash value policy can be used to provide supplemental pension income in the event the partner retires. Of the two disability policies per partner, one is payable to the partner, while the other is payable to the company. The partner’s policy will provide him or her with income in the event of disability; the company’s policy will provide funds that can be used to buy out a disabled partner’s share.

Clearly, a buy-sell agreement can be complex and does not come cheaply, since it needs to be tailored to your company and your shareholders. However, it may help you sleep more easily at night, knowing that your family, and others who depend on your business, will continue to benefit from the company you worked so hard to build.

When is the Right Time to Sell My Business?

/in , /by Al Statz

BOOK REVIEW —

I don’t recall the last time I recommended a book, but today I feel compelled to tell business owners about an excellent new book titled, “When is the Right Time to Sell My Business?”

This book not only helps you decide when to sell your business, but will also help you understand its value from the perspective of willing buyers, increase its value and marketability, and choose and plan your best exit option. If you are a private business owner; following the recommendations in this book will help you sell for more money, on your terms and time-frame, without regrets.

Expect a great return on the time you’ll invest in reading this book. Mr. Mowrey presents a sensible and proven approach to selling a business. It’s a quick read that covers a lot of important ground at just the right depth for busy business owners, and it’s one that I suspect you’ll take notes in and refer back to as you approach your exit. Mr. Mowrey pours a tremendous amount of valuable insights and sound recommendations into 188 pages. I can’t say that for most of the books on this subject authored by other so-called experts.

CPA’s, transaction attorneys, wealth managers, M&A intermediaries and business appraisers would also do well to read this one.

Purchase this Book on Amazon

Full Disclosure — Not only is Rich Mowrey a four-time business owner and seasoned valuation expert and transaction intermediary, he’s also a colleague of ours who we met through our national business valuation and M&A trade associations.

The process outlined in Rich’s book closely mirrors what Exit Strategies does for our clients. Feel free to contact one of our California-based advisors with any business valuation or M&A brokerage questions or needs.

Forbes Article: Which Is Better, A Financial Buyer Or A Strategic Buyer?

/in , /by Al Statz

Image result for forbes logoI thought would share this brief Forbes article that came across my transom early this morning. I generally agree with author John Warrillow’s comments on Strategic versus Financial buyers. If your goal is to maximize value and liquidity today, and you’re not looking for an equity partner to help you build longer term enterprise value, a strategic buyer generally produces the best outcome. Having multiple strategic buyers at the negotiating table as a result of a structured M&A sale process produces even better results!

The article …

If you decide to sell your business to an outside acquirer, you’re going to have to decide between a financial and a strategic buyer. Understanding the different motivations of these two buyers can be the key to getting a good price for your business.

A financial buyer is acquiring your future profit stream, so they will evaluate your business based on how much profit it is likely to make in the future and how reliable that profit stream is likely to be. The more profit you can convince them your company will produce, the more they will pay for your business.

But there is a limit to how much they will pay, … READ THE FULL ARTICLE ON FORBES.COM

Exit Planning: Meaning and purpose drives sustainable business growth

/in , /by Al Statz

Several years ago I had the opportunity to work on an acquisition assignment for Mitsubishi Electric, one of the multinational business units of the Mitsubishi group of companies. While doing research to better understand my client’s organization, I found an inspiring article that quoted Tachi Kiuchi, Mitsubishi Electric’s managing director at that time…

“Are the needs of the corporation and the world in conflict? In the long run, they can’t be. Today, 600 million of the Earth’s inhabitants enjoy the material benefits of industrialism. Soon, 2.5 billion more–China, India, the former Soviet republics–will join us. The final 3 billion people will follow. To accommodate all those people in terms of resources today, we would need three planets.

So how can the needs of the world be met in the future? The truth is, we can’t build a sustainable economy. We can only grow one. That’s a lesson I learned from the rain forest. The vitality of nature comes from its capacity to cultivate more advanced forms of life and then support them for billions of years on finite resources and a fixed flow of energy from the sun. That happens through a constant process of feedback and adaptation. In the global economy, the problem is, we are blocking feedback. As companies extend their reach, they become less tied to the communities they serve. Ecological and social costs and benefits never appear on our balance sheets. Feedback only exists in the form of direct financial returns. If there is not adequate feedback, there’s no adaptation. No adaptation, no innovation. It becomes hard to respond effectively to change. We become vulnerable.

People talk about businesses needing to be responsible as if it’s something new we need to do on top of everything else. But the whole essence of business should be responsibility. My philosophy is, we don’t run companies to earn profits. We earn profits to run companies. Our companies need meaning and purpose if they’re to fit into the world, or why should they live at all?”

Tachi Kiuchi went on to serve as CEO and Chairman of Mitsubishi Electric America and is currently Chairman of Future 500. As Managing Director of Mitsubishi Electric, he broke with Japanese corporate norms to champion a “living systems” approach to business that included rapid adaptation, financial transparency, openness, cultural diversity, executive positions for women, and environmental sustainability. Read the January 2004 article in Fast Company.

Every CEO and business owner looking to create a valuable and marketable enterprise would do well to contemplate its fundamental meaning and purpose within the communities it serves, and decide how well positioned the company is to deliver sustainable long-term growth.

Al Statz is an M&A advisor and the founder of California-based Exit Strategies Group, which is celebrating its 15th year in business. Contact Al at 707-781-8580, via Email, or connect with Al on LinkedIn.

Preparing to sell? Why clean financial records are important.

/in /by Exit Strategies

Most business owners don’t like to spend any more time on financial statements than they have to. Trust me, I was one of them!  But, when it comes time to prepare a business for a potential sale, owners need to get serious because having clean financial records is one of the most important factors in concluding a successful business sale or merger.

What do I mean by clean financial statements?

First, all relevant business transactions are recorded in a well organized chart of accounts. You should be able to present an accurate P&L and Balance Sheet for each accounting period. Most buyers will want to look back three to five years. Of course you should have followed accepted accounting methods and have applied those practices consistently over several years. Not doing so makes it harder to compare your company to its industry peers. Also, the recorded transactions should clearly reflect what is going on in your business because prospective buyers use financial statements to study how a business is managed and spot opportunities to improve operations under their ownership.

Another part of what makes financials “clean” is not having an excessive amount of commingled personal expenses, assets and liabilities on the books. When preparing your business for sale, an M&A Advisor will review your financials with you and help identify expenses, such as personal auto expenses or other owner benefits, that might be adjusted back into the net profit of the business when it is presented to potential buyers.

Think of your financial records as a window into the quality of your business overall. Presenting clear, well organized financials to buyers makes a good impression of your business. Financials that are disorganized or hard to follow give buyers the impression that there are other problems in the business, which detracts from receiving maximum value, or, even worse, causes them to walk away.

While potential buyers may be attracted to your business initially based on its top line, industry or business model, they quickly move to the important task of evaluating the details. And more often than not, that process starts with analyzing the past several years of financial statements.

You will have more buyers and can make the process of selling your business much easier by having clean financial records. If you are considering selling in the next 3-5 years and are not certain that your financials qualify as “clean”, give us a call. Or, ask your CPA to give you their objective feedback, from a buyer, buyer’s CPA, investor and lender perspective.

Mark Soeth is an M&A Advisor with Exit Strategies Group’s Roseville California office.

Is Private Equity the Right Solution for Your Exit?

/in , /by Al Statz

Is Private Equity the Right Solution for Your Exit? Private Equity Groups (PEGs) are disciplined buyers of lower middle-market companies. Most have cash funds and lender relationships in place for the right acquisition opportunities. PEGs often recapitalize a company, where they purchase a majority or minority interest. They bring growth capital and business acumen to […]

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Six Reasons NOT to Skim

/in , , /by Don Ross

Pulling unreported cash receipts out of a business is indefensible and unwise under any circumstances, but particularly if the owner expects to exit in the next 3-5 years.

All of us during our childhood were offered the parental edict: “Don’t do it, you are only hurting yourself.” So “why”, you may ask . . . now that you are a grown adult, “should I not skim?”

Many reasons immediately come to mind and I am certain that we could all come up with many more, but in the interests of brevity, I’ll keep it to six reasons.

  1. Skimming is against the law. Tax evasion is a felony.
  2. Management of your business becomes more challenging. Skimming requires you to underreport revenues which means your cost of sales percentage rises. Cost containment and inventory control are more difficult to assess.
  3. Loss of Employee, Partner and Spousal Trust. You set a bad example and create a fertile ground for others to steal. Worse yet, a disgruntled employee or retaliatory ex-spouse or partner could report you.
  4. Bank Loans are difficult to secure, for you and potential buyers.
  5. The value of your business declines.
  6. The marketabilty of your Business is severely compromised. You cannot expect potential buyers to trust you, let alone make a “leap of faith” and pay a premium for your business on the merits of unreported, unverifiable income.

Hopefully this doesn’t apply to you. But, if it does, what’s the solution? I refer you back to your childhood: Don’t Do It.

  1. Stop Skimming
  2. Clean up your books.
  3. Effectively manage your business, using reliable financial records.
  4. Redeem your credibility with your staff, your partners and your bank.
  5. Add value to your business as an ongoing entity or as a potential sale. The amount you no longer skim can easily be worth 2 – 5 times its selling value, or more, depending on the degree of skimming and the size and nature of your business.

In summary, each of us at some point makes a life defining decision … “Do I want to eat better or sleep better?”  You make the call.  As it relates to preparing a business to sell, you can do both.

Don Ross is a seasoned business broker with Exit Strategies Group. He can be reached at 707-778-0210 or donross@exitstrategiesgroup.com.