Maureen M. Rutecki CPA/ABV/CFF, ASA | Partner
Ah! The dog days of summer are upon us, the time of year when you might find yourself on a beach, reading a good book and catching a few rays of sun. You are thinking about where to go for dinner and whether to take a dip in the ocean to cool off. As you walk toward the water, the realization hits you – “If a rogue wave takes me out, what happens to my business?”
Business owners who plan for their exit know the answer to this question and others that relate to succession planning. While succession plans vary, depending on the goals of the owner and the size, industry and health of a business, there are several key considerations to address.
You will exit your business someday. Read that sentence again. You will exit your business someday. You may intend to work until the day you die, but you will eventually die. By not taking action or formulating a plan, you have decided that chaos or uncertainty will be the outcome. If this is not the outcome you have in mind, then you should consider these questions:
- What do you see happening when you exit?
- Do you plan to retire from your business?
- Do you have the management team in place to run the business in your absence?
- Do you need the cash from the sale of the business for your retirement?
- When you retire, do you plan to stay with the business during the transition to a new owner?
- Would you like to sell your business to one or two individuals, an ESOP (Employee Stock Ownership Plan) or another company?
- Would you prefer to maximize your sale proceeds and sell to a strategic buyer?
- Do you have family members in the business?
- Do employees factor into your succession plan goals?
- Do you have bank loans outstanding? How will they be paid off?
- Is your succession plan written down?
This list is not intended to be exhaustive, but a starting point for further discussions with your advisers. Keep in mind that by not having a plan, that is the plan. Think of this scenario – an individual owns 100% of a business, with $50 million in annual revenues from selling a type of commodity. The owner suddenly dies and the spouse, who has no business experience, becomes the 100% owner. If you are thinking that this will likely not end well, you are correct. I will spare you the details, but keep in mind that inaction can result in unintended consequences.
You know what type of entity you have for tax purposes and whether you pay taxes at the corporate level or individually, in the case of pass-through entities, but can you answer the following questions?
- Do you know where the corporate documents are?
- Have you read your by-laws, operating agreement or buy-sell agreement lately?
- Are the terms of those agreements that you established 5, 10 or 20 years ago still appropriate for your current business?
- Do you meet with your attorney at least annually to discuss your business and your plans?
If you own a business with others, then it is critically important that your corporate documents be in order and reflect the objectives of the owners. You may feel that these questions do not pertain to you if you are a 25-year-old and working with your buddy to get that start-up business to profitability. Think again, as litigation is not dependent on age, friendship or profitability. Besides, you may get along with that friend, but what about their spouse/partner/future widow? Without well-written corporate documents, that person may be your future co-owner.
If you have a successful business, then you are undoubtedly focused on managing the day-to-day operations. Perhaps you even have a current year budget and are tracking your quarterly financials against the budget. You can talk about the current backlog, production efficiencies and meeting the quality standards for customer products. These activities are good for managing a business, but have you thought about managing the business for your ultimate goal of exiting? You may be thinking, well, how does that goal differ from meeting budget and keeping customers happy? The answer is that those short-term goals may be part of managing your business for your exit, but they are not the entire answer.
In a broader sense, managing your business for your exit can mean increasing the value of your business over time, so that the value is maximized upon your exit. To increase the value of the business, you first need to have a baseline understanding of your business, including answers to the following questions:
- Do you know what your business is worth?
- You may think you know what your business is worth, but have you had an appraisal performed by an accredited business appraiser who practices full-time in this area?
- Do you know the factors that are driving the value of your business?
- Is your buy-sell agreement properly funded?
- If you are going to sell the business, how will you determine the sales price?
Once you know the factors that drive the value of your business, then you can work to improve those factors and increase the value over time.
Maximizing business value is one key financial consideration. Others financial considerations include:
- Cash flow impact of a transaction on the business cash flows.
- Impact of taxes on a transaction.
- Structure of a transaction.
- Impact of due diligence on sales price.
- Excess/deficiency in working capital.
- Holding a note versus cash sale.
- Bank financing of a transaction.
- Plan for cash proceeds and consultation with a financial planner.
If you have that “Rogue Wave” moment, then it is time to visit/revisit your succession plan. With one-half to two-thirds of your personal net worth invested in your closely-held business, you are wise to have your “investment advisers” (attorney, business appraiser, accountant and banker) help guide you toward achieving your succession planning goals, so that you will be able to convert that illiquid investment into liquid investments that will finance your retirement. Your management team will also be grateful that you have a plan, so that they are not left with uncertainty, in the unlikely event the rogue wave takes you out. With your succession plan in place, enjoy the beach and go for a swim.
Questions? Contact us today!
About Maureen Rutecki, CPA/ABV/CFF, ASA, MBA: Maureen is a Partner in StoneBridge Business Partners, an EFPR Group Company. She specializes in valuation, litigation and consulting services. Her valuation experience encompasses a broad range of companies, complex business arrangements and intangible assets for purposes such as succession planning, taxation, corporate planning, transactions and financial reporting. Maureen’s litigation experience includes disputes related to diminution in value, shareholder oppression, lost profits and marital dissolution matters.