Many private business owners begin their business transition planning within a few years of when they plan to exit. While that works for some, for most this is too late to make changes that could lead to significant improvements in their after-tax gain from selling their business. Most business owners that we speak with have two standard mantras: "I don't want to pay a lot in taxes when I sell my business;" and "I do not intend to provide any seller financing to the buyer." Yet, without the proper planning in place well in advance of the sale, many sales of smaller businesses result in the owner paying more in taxes than they needed to; and in the owner providing financing to the buyer. Consequently, we recommend that business owners conduct a preliminary business transition planning exercise at least ten years prior to when the owners guess that they would be ready to exit. This business transition plan should be reviewed every two to three years to incorporate any significant changes in the business, industry, and tax laws into the plan.

What is a business transition plan?

A business transition plan should address the following questions:
1. What is my business worth? A value range for the business based on a realistic review of the business exit options. The diagram above gives one set of possible exit options.
2. What would be my total net worth after exit? An estimated range of available post-exit financial resources, including the after-tax ownership interest based on the range of values for the business, the estimated retirement funds available, and any other sources of financial assets or income, and an estimated range on annual income available.
3. What are the tax and legal ramifications of all this? A review of wills, business buy-sell agreements, corporate form (i.e. C vs. S or LLC), potential estate tax liability, and associated personal financial and estate planning implications.

After going through this process, there are likely to be a number of action items for the owner and his/her advisors to facilitate and implement the agreed-upon exit plan and related estate and financial plans.

Realistic Review of Business Exit Options

This is really the key starting point for a serious business transition plan. There are many successful businesses of substantial size that are unlikely to achieve a sale in the upper value quadrant of Selling to a Strategic Buyer or even Selling to a Financial Buyer.

Despite all the media hype about the current time being the best time to sell a business because there are strategic buyers and private equity firms competing for businesses, most private businesses do not have the characteristics that strategic buyers and private equity firms are looking for. Hence, this is a very challenging time to sell most private businesses.

It is important to note that there are typically no absolute answers to this review of business exit options. There have been business roll-up activities in the 1980s and 1990s where funeral homes, ambulance services, electrical contractors, and a variety of other types of firms have had strategic buyer opportunities. Since few of these roll-up activities were ultimately successful, the opportunities today for these firms are mostly in the lower value quadrant.

It is also important to note that while selling to employees and/or family members is generally done at lower value multiples than sales to financial buyers or strategic buyers, these internal deals can often be structured so that the after-tax gain over time to the seller is greater than selling to a strategic buyer. For example, an oft-quoted rule of thumb is that a steadily growing business can sell for between 3 to 7 times EBITDA. If the owner decides not to sell the business but rather to retire from active management and leave the management of the business to his/her key managers, the owner could get several more years of earnings distributions that could be worth more than selling to an external buyer.

There are two primary objectives of this realistic review of business exit options. First is to develop a range of possible values for the business for the owner's financial planning. If a business owner learns that he/she is unlikely to achieve their after-exit financial objectives from the sale of the business, then the owner should focus on using tax-deferred retirement options and other methods to increase the available after-exit funds.

Second, making explicit the end option or options for the owner(s) generally sets the future context for all important business decisions. Should an owner invest in continued expansion of his/her business, if there are no likely mid-level managers that could take over at some point? There is no single answer to that question, but in most situations, the value of a business increases when there is a management team that can continue to run the business after the departure of the owner(s)/founders(s).

It Takes a Team to Build an Effective Transition Plan

In the development of an effective business transition plan, there are tax, legal, financial planning, insurance, and business valuation issues that should be addressed by professional advisors, and any action steps should be carefully coordinated across the different disciplines. There are an increasing number of professional advisors that are focusing their practices on business transition planning; given the importance of this planning, owners may often need to augment their existing set of advisors with a specialist, who can function as the "general manager" of the process, reporting to the owner(s).

Experience in exit planning is also relevant for the valuation expert participating in the process. Most traditional valuation work is focused on valuing businesses consistent with the IRS fair market value standard. In the exit planning process, a key part of the value estimate analysis is to identify the buyers who would pay the most money for the business (in the top quadrants of the Value Matrix, in addition to an estimate of fair market value. Our Value Estimate and Strategic Value Estimate services are specifically designed to support the business transition planning process.

More on Business Transition Planning

This is the first in a series on the business transition planning process. In our next issue, we will consider the question of how the fair value of a business is decided in the U.S. legal system or arbitration if there is a dispute among the owners or a divorce or a death of an owner.

Stan Feldman, Axiom Valuation's chairman, and Mary Daugherty, Associate Professor of Finance, St. Thomas College, recently gave a presentation to family business owners and representatives on the key concepts of value for a family-owned business. A PDF version of the Powerpoint presentation is available at our web site. Click on the link below to view a copy.

Foley & Lardner, First Jensen Partners, and Axiom Valuation are jointly holding a free morning seminar on what CEOs and CFOs of early stage companies need to know about the new IRS 409A requirements and their impact on stock option plans of all types.