Including the exit strategy from your small business in your Estate Planning strategy is critical, but most business owners do it horribly wrong. You need to get this right, because most of your wealth, and perhaps your family legacy, are tied up in the business. Your net worth can drop substantially when the planning and execution fall short.
Preparations for a transition of business ownership or management must begin years in advance. If you want to maximize value, start working at least five to 10 years before you might leave or scale back your role in the firm. The nice thing about planning the small business exit is you don’t have to leave when the target time in the plan is reached. But to generate value you must prepare for the potential sale or transition and have things set before you decide to make the move. Keep in mind that many people retire before they weren’t planning. Health problems and other life events often intervene before their planned retirement date.
Another reason to plan early is the value of a small business fluctuates greatly with the economy and interest rates. You need to be ready to go to market when conditions are favorable or you’ll leave a lot of money on the table for others.
Here are steps to maximize the value of a small business when the ownership changes.
Tighten the systems. Accounting and other systems usually are weak in a small business. You and your finance person or people might know what’s going on, at least well enough to suit your needs. But a new owner wants to function without relying on you. The new owner also might be interested in data that’s different or more comprehensive. In addition to professionalizing the financial system, it’s a good idea to begin having annual audits performed. It costs some money, but it also builds confidence in potential buyers and allows you to increase the asking price.
The same applies to your other systems and processes. As many tasks as possible should be documented and standardized. Your business needs systems, not knowledge in someone’s head, for conducting daily operations.
Build a team. A small business that depends on the owner isn’t worth much to others. You need to build a team and delegate. Customers and clients need to be comfortable working with others at the firm instead of insisting on working with the owner. Other employees need to be generating sales and revenues and handling key tasks. Your work force also needs to have low turnover and high quality if you want to maximize the sale price.
Separate the family support. Many small businesses also serve as charities for the owners’ families. To the extent possible, expenses are run through the business. Family members are given jobs for which they aren’t ideally qualified. You need to be able to show buyers that the business is being run as a business. Family members who are involved or receive payments from the business should be qualified for their roles. Otherwise, you won’t be able to sell to an outsider for a decent price.
Diversify the revenue base. Buyers will be hesitant when the business is dependent on a small number of clients or customers. The risk that one or more will leave when you do is high, so they’ll bid less to buy the business.
Show growth. Many business owners reach a point where they’re comfortable with the size of the business and its income. They stop aggressive growth efforts. A buyer, however, isn’t going to pay much for a stagnant business, even one that’s profitable.
Determine a reasonable value. Business owners rarely are objective about what their businesses are worth. Have one or two business valuation experts study your business and estimate the value. They also should be able to explain how they reached their values and actions you can take to increase the value.
Build your experts. At a minimum you want a lawyer who’s focused on small business transfers. There are nuances in both the tax and non-tax aspects of small business transfers that aren’t in the knowledge base of lawyers who spend their time elsewhere. When you prepare years ahead of time, you can interview several prospective lawyers, get a feel for their expertise and philosophy, and learn how they work. When you’re closer to transferring ownership, you’ll be able to move quickly and profitably
Plan taxes early. A classic small business mistake is to negotiate a sale price and terms, and then bring the tax expert in and ask how taxes can be minimized. By then it’s too late to maximize savings. Taxes potentially will take a hefty share of the sale proceeds of a small business. Review options with a tax expert early. You might be able to make changes in the years before the sale, such as giving shares to family members, that save quite a bit of money.
Consider an inside sale. Current employees or family members often are the best buyers for a business. I’ve long believed that an employee stock ownership plan (ESOP) is the most neglected business sale vehicle. The ESOP provides substantial tax benefits in addition to flexibility. It allows you to spread the sale over time or prepare for it and trigger the sale when you’re ready to exit. I discussed the ESOP option in detail in our March 2007 visit, which is on the web site.
An ESOP or any inside sale also makes it easier for the owner to make a gradual transition out of the business instead of an abrupt shift from running the business to being complete uninvolved.
Most small business owners don’t know the values of their businesses to others and are unfamiliar how to maximize that value to an outside buyer. They need to prepare for a transition well ahead of time, because preparing for a sale is the best way to attract buyers and maximize the sale price.
RW June 2012.