Exiting a business, and exit strategy alternatives
Harry S. Dennis III, For SBT
My thanks this month to TEC member and great TEC speaker Kraig Kramers for his thoughts on these two most important subjects for business owners. They are subject to radical postponement rationalization, but they shouldn’t be.
There are six steps, Kramer maintains, to building a strong foundation for preparing to exit your business:
1. Establish a price for the business. True, a price is but a number, and most such numbers are subject to negotiation. But you should have an "I won’t go below" price. Remember that a cash deal and a price for payments over time can be significantly different. Also, a stock deal differs from an asset purchase. And finally a "strategic" buyer most always pays more than a financial buyer.
2. Know the market value of your firm. Ask your banker for a current "RMA Guide." You can look up your industry and compare your ratios against those published. If you are in the upper quartiles, your business will be more marketable. Professional appraisals can also establish market values based upon industry comparables.
3. Have a current business plan. The plan should provide a written and numerical picture of what a prospective buyer would see while touring or doing due diligence at your facility. Have a confidentiality agreement signed before any information is released. Then:
a) Have three years of clean financials, with built-up valuation bases.
b) Have detailed current asset listings and loan documents already copied.
c) Have a current employee manual that spells out your benefits and policies.
4. Seek professional advice. This is one place it does not pay to cut costs. Among those pros to consider are: a deal attorney, a specialty deal accountant, and possibly an expert negotiator. The handling of real estate can be very tricky, for example, and a pro can really help here.
5. Build in the "timing" factor. Unfortunately, timing is everything, and it is not easily predicted. But clearly, economic cycles, wars, 9/11 events, and market behavior all can affect a buyer’s willingness to contract more risk, which the purchase of most businesses entails.
6. If you can’t find a buyer, the surest way is through a top-notch broker. We recommend that you interview three candidates, and especially candidates who know and have worked in your industry.
Now let’s talk about 10 different alternative exit strategies that Kramers recommends you consider:
1. Give your money away. You and your spouse can give $11,000 each to each child with no taxes on the transfer. This applies to grandchildren and others. as well. There are also new tax-deductible tuition opportunities.
2. Form a family limited partnership. I won’t risk abusing the details, but if your firm is worth $1MM and you are the general partner, you can give 99% of the ownership to your children, keep 1%, and set it up so that neither the company nor their ownership can be marketed. There are significant reduced-tax opportunities here (reduced transfer values of up to 30-40%). Consult with your tax pro.
3. Consider a private annuity. If your company is worth $1mm, and your 60-year-old mom owns the business, you can buy it from her for an annuity. Maybe, depending upon rates, it’s $80/$90K a year for her life. If she dies with no pre-existing health condition, you would pay hardly any taxes on that portion of the business transferred. The longer she lives, the deal can potentially be better for you.
4. Give to charity. If you bought stock that has appreciated to $1mm, and it’s placed in a charitable remainder trust, the trust can sell the stock with no capital gain. The trust can then pay you about taxable $50K a year for life. Maybe much more money than if you sold the business now. Also, you’ll get a nice tax deduction in the year you do it.
5. For sale by owner. As discussed earlier, sell to a strategic buyer, customer, supplier, friend, or family member.
6. Sell through a broker or investment banker. The advantages are a wider range of potential buyer contacts, better "dressed up" prep for the sale, and the "auction process" utilized may yield the highest price with you in control of the timing.
7. Sell to your management team (either LBO or MBO as the buy-out fund). Both are leveraged, usually highly so, transactions. This is not for the faint-hearted. Usually the buyout fund owns 80% of the business, the balance sheet works on thin ice, and there is not much room for management error.
8. Private placement. While the outside investor will want to know everything about you, there are benefits to this alternative. Often you can option a private placement into a sale to the investor. You will attract quality lenders with private placement in your business.
9. Leveraged or management buy-out. Basically they are the same thing. Whether a financial or strategic buyer, you can generally get a high price; however, you usually end up running the company for the lenders to pay off the debt. See item No. 7 above regarding the risks involved.
10. Remotely run the company. Share some of the ownership with a promising group of key managers whom you can trust. Work out a deal through which they buy you out over time, and build into the deal performance incentives for them.
You take off into the sunset and still enjoy a good income. The deal can have penalties if you have to come back and start putting in 80-hour weeks to fix things!
Running a tad long this month, so I’ll simply close by saying "good exiting via the best exit route for you"!
Harry S. Dennis III is the president of TEC (The Executive Committee) in Wisconsin and Michigan. TEC is a professional development group for CEOs, presidents and business owners. He can be reached at 262-821-3340.
June 7, 2002 Small Business Times, Milwaukee
