For many closely-held and family business owners, 2008 and 2009 was a stressful period. The volatile market followed by the Great Recession often produced
- a contraction of business revenue;
- the loss of profitability;
- the reduction in value of their companies;
- the aggressive and often not rapid enough implementation of business and personal cost-cutting measures;
- the layoffs of far more employees than these companies imagined might be necessary;
- the reduction of personal asset values;
- the reduction of owner pay and employee pay levels;
- the liquidating of owner personal assets to capitalize the business;
- the development of tenuous relations with their banks;
- a need to reinvent their business offerings in the marketplace; and,
- the concern about being able to meet their future financial goals.
Plus, the stress of all the previous mentioned events produced the most burdensome time of our business and personal lives. I, in fact, can say there were several occasions in 2009 when I called to reach a business owner client mid-workday to find that I reached them at home while they were nursing a stiff drink. To compound all this, while most baby boomers do not own businesses, most of our clients who own businesses are baby boomers, and the age in relation to retirement, personal savings, and lifestyle spend factors that make retirement a challenge for most baby boomers are often compounded for our business owners.
I had many a conversation with an owner who confided in me that they built their company, and would build its value again, but they were tired. Because the recession induced exhaustion, they felt that they only had the energy to build it one more time. As a result, they wanted to be very proactive and intentional about planning to maximize the business' value and minimize taxes upon their transition out of the business. It is in this regard that the development of a Business Transition Plan is of paramount importance. The development of a Business Transition Plan involves multiple steps:
- Identifying the owner's financial and timing objective for the transition out of the business.
- Assessing the business and personal resources available to help contribute to the owner's objectives.
- Developing and implementing strategies that will contribute to maximizing and protecting the value of the business.
- Evaluating the opportunities for ownership transition of the business to third parties.
- Evaluating the opportunities for ownership transition of the business to inside parties.
- Developing business continuity measures to protect the business and the owner's family from the loss of a key owner or employee.
- Developing a post-transition plan for the owner that aligns with their Legacy objectives, including lifestyle objectives, estate planning, philanthropy and family relationship enjoyment.
Let's look at each of these in greater detail.
Identifying the owner's financial and timing objectives for the transition out of the business: For most business owners, the transition out of their business will be the single, most significant, financial event of their life. Identifying when and how much the owner desires is the first step in the planning process.
Assessing the business and personal resources available to help contribute to the owner's objectives: In order to evaluate if the owner will be able to meet his or her financial objectives, we believe we must start by developing a personal financial plan for the owner(s). This plan takes into account the reality that both business value upon transition and personal wealth accumulated during the operation of the business, combined, will together finance the lifestyle of the retiring owner. The more efficiently a person manages their non-business wealth prior to exiting the business, the less pressure it places on the value obtained from the business upon exiting.
Developing and implementing strategies that will contribute to maximizing and protecting the value of the business: In my many discussions with business owners, I often conclude that the owner believes their business is worth more than it really is. One of the most beneficial things a business owner can do to maximize and protect business value is operate in a constant state of planning and operations as if their business is “For Sale.” By evaluating all of your company's planning and operations in alignment with this premise, an owner can proactively manage the investment in their business. These planning and operational strategies often include:
- Development of non-owner management.
- Implementation of Buy-Sell Arrangements between owners helps protect owners, and their heirs, from the termination of employment, death, disability, or divorce of an owner. Though not every risk in a business can be insured for, death and disability can and often should have insurance policies implemented to finance the buy-sell.
- Business Dashboard Metrics of sales and profitability.
- Task functionality planning within the business.
- Maintaining sufficient capitalization within the company for growth and banking purposes.
- Maintaining appropriate amounts of key-person insurance on valuable company personnel to protect the company from the loss of an owner, or key-employee, and the financial burden that can result. Examples of this burden can include loss of revenue, reduction in profitability, cost of hiring a replacement, or default of or risk to credit facilities. In the midst of a crisis, I don't believe it's possible to have too much cash.
- Formalizing appropriate compensation agreements with executive management, including golden-handcuff incentive compensation plans.
- Maintaining a certain level of outside audits of the company's financials.
- Recognizing when family should not be running the business and hiring professional outside management.
- Consistently reviewing customer contracts to maintain the most favorable terms for your company.
- Maximizing tax reduction planning opportunities on corporate profit, and at the time of a business ownership transition.
Evaluating the opportunities for ownership transition of the business to third parties: Many businesses are good candidates for a sale to a third party. These third parties often come in the form of a Strategic or Financial Buyer. The Strategic Buyer is often a competitor, or non-competitor that desires to enter your geographic market or industry, and sees your company as a lower cost or more rapid pathway to entry. The Financial Buyer typically comes in the form of a private equity group that owns another company that, when combined with some aspect of your company's offering or value, can acquire or joint venture with your company's offering to multiply the value of both companies within the private equity group's portfolio.
Either of these alternatives can produce an excellent financial transition windfall to a selling business owner, assuming the selling owner's company is clean. When an acquirer performs its due diligence, if it finds that the company hasn't been operationally managing itself in a professional manner as mentioned, hasn't applied consistent accounting principles, doesn't have a deep management bench, or depends upon the owners for ongoing revenue or profitability, the value it will pay in a transaction plummets.
Evaluating the opportunities for ownership transition of the business to inside parties: Whether your transition intentions are to transfer ownership to heirs, key employees, or the employees as a whole through an Employee Stock Ownership Plan (ESOP), assessing the skills and leadership capabilities of your successors is as important as the development of your ownership transition plan.
A successful transition plan requires the implementation of both Leadership Succession Planning and Ownership Transition Planning. One without the other greatly increases the potential for a failed transition. Once both have been designed, it is then important to evaluate what ongoing role the current owners will maintain through the transition, and the timetable of the transition.
Unlike a 3rd party sale, with an internal transition, the owner's gradual departure often helps facilitate the smoothest transition of Leadership Succession, while the owner can ease into retirement with the benefit of continuing to receive compensation during the transition, distributions of profits, implement gifting strategies, receive seller-financed note payments, or benefit from other strategies, thus lightening the burden on the owner's personal financial assets post departure.
Developing business continuity measures to protect the business and the owner's family from the loss of a key owner or employee: Despite the implementation of intentional planning, life can bring surprises. The premature death of an owner or key-employee, a disability or incapacity, the recruitment of a key employee by a competitor, can all derail the good planning, revenue stability, or corporate profitability.
Every good transition plan should address the need for Buy-Sell Agreements to protect owner personal finances, cash out the family of key-employee minority owners, permit the next generation to purchase the company from the previous owner at its current value before it grows further, reap the benefit of any Step-Up in Basis deceased owner's estates receive at the time of death, and benefit from the income and estate tax-free liquidity that properly designed and owned life insurance policies can provide the business and its family owners.
This planning can also present an excellent opportunity to utilize life insurance liquidity to fund the buyout of next generation family heirs who may not desire to stay in the family business, but otherwise the business might not have the funds to initiate these realignments of ownership.
Developing a post-transition plan for the owner that provides for their post exit Income and Wealth Management needs, and aligns with their Legacy objectives, including lifestyle objectives, estate planning, philanthropy and family relationship enjoyment: For many owners, their lifestyle, hobbies, net worth, and self-esteem is wrapped up in the business. The transition out of the business can be a stressful one.
Many of our clients find this transition to be an opportunity to develop a new personal life mission statement, having experienced great success in life, now focusing on what they desire their Legacy to be. This Legacy planning may involve an increased participation in philanthropy, spending more time with family, possibly even stepping into a new “missional” career. This change in life focus is only possible if post retirement Wealth Management provides for ongoing stable income, which we believe is more important in creating financial independence than a client's net worth.
However, the long-term potential threat of inflation, current low interest rates, increasing U.S. Federal debt, deficit spending and stimulus spending can present major obstacles for the retiree to generate sufficient income when developing a “traditional” post-retirement wealth portfolio. It is for this reason that we approach personal financial planning from a “non-traditional” perspective as we evaluate and recommend investment options beyond stocks, bonds, mutual funds and ETFs and also focus on the tax-efficiency of Wealth Management as it is not “how much you make,” as much as it is “how much you keep.”