Transitions Digest

By Chuck Chrissis, The Growth Coach®

Equally important to thinking and acting like a CEO is the opportunity to become a sculptor of your business. Make time to craft and mold your business so it will run more effectively and deliver more consistent results. Actively shape and re-shape it to make operations smoother and more efficient. Turn chaos and confusion into order and discipline. Rising customer satisfaction and more predictable profits will follow. It’s time to standardize and document your business.

Challenge old beliefs about how your business should work. It’s never too early or too late to shape or re-shape your business. It doesn’t matter if your business is 20 years old, 2 years old, or still on the drawing board. Begin to mold the company to run without you being woven into its very fabric. Design it to run without you supplying all the energy and effort. You can’t control everything and everyone, nor should you. In short, behave like a strategic business owner. Let go!

Do this by creating more than simply a job for yourself. The ultimate goal of starting a business is to sell it one day at the highest possible premium to your employees, family members, or an outside buyer. You deserve an acceptable return on your time, talent, and capital.

No matter the size, age, or industry, every business should be prepared to be sold. Yours is no different. This “start with the end in mind” strategy should help focus you on building an effective business model that doesn’t have you at the center of its universe and doesn’t rely on your presence, personality, and perspiration for its success. In other words, you should not be the business and the business should not be you. This work-in-reverse approach not only maximizes your selling price, but minimizes the challenges and headaches while you own and run the business.

As mentioned earlier, your goal is to design and re-design your business to work without you. Your business model should be sculpted in such a way that it can be replicated easily and often in cities across the country and around the world. All that’s necessary is your vision, not your physical presence and exertion. Whether you intend to expand or not, such a goal will help focus you on building a systems-dependent, not owner dependent business that will generate repeatable performance and consistent results.  And you must get others to help. Without them you don’t run a business – you work a job.

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What is an effective business system? It is simply an integrated web of separate processes, procedures, and policies. A business system is your documented instruction manual for “this is what we do, and how we do it” at our company. A business system allows you to get consistent results through other people. What tremendous leverage and freedom that can give you!

Some typical operating processes are:

• Selling
• Marketing
• Manufacturing
• Inventory Management
• Order Processing and Fulfillment
• Customer Service
• Billing and Accounts Receivable
• Procurement and Accounts Payable
• Facilities Management
• Accounting and Finance
• Human Resources
• Information Systems

With such processes fully identified and explained, your employees will deliver amazing consistency by minimizing employee discretion. Such a system will also free you from having to touch every transaction, make every decision, answer every question, and solve every problem. You can manage by exception! Such a carefully crafted approach affords you breathing room to think and behave like a strategic business owner. You will also have time for the personal activities that matter most to you.

Without a business system in place, it’s unlikely you will be able to obtain a premium price for your business. A potential buyer may be unwilling to invest in an enterprise that is dependent solely on you for its day-to-day operations and survival. If it’s obvious that you are held hostage to your business, you may not realistically expect to achieve a sale price you find acceptable. If it’s obvious the business is systems-deficient, then it’s unlikely an objective third party will offer you a price that reflects the time and effort you have put into your business. Rather, emotion, not reason will come to rule the transaction and may very well derail it.

To maximize your company’s eventual selling price, realize that buyers want to acquire a smoothly-running, money-generating machine. They want to purchase a business system that runs on near autopilot. They want to buy a fully documented and organized business system that gets predictable results. They desire an asset with a proven track record, predictable revenue stream, and growth potential. Give them this by first taking the opportunity to step back, let go, and become a sculptor of your business.

 Let us know your insights by commenting on our blog post below.  

By Chuck Chrissis
The Growth Coach®

Subsequent issues of The Exit Planning Digest discuss all aspects of Exit Planning. The provider of this Newsletter (Holly A. Magister, CPA, CFP®) offers you unbiased information about what you may need to know. Subscribe to our free Exit Planning educational newsletter to learn more about how to grow and/or plan for your business exit.

October 29th, 2009 | Tags: business processes, coaching, Exit Planning, exit strategies, process of selling a business | Category: Building Value, Business Growth, Entrepreneurship, Exit Planning Digest | Leave a comment

By Holly A. Magister, CPA, CFP®

Without a single doubt, there is only one obstacle or “deal breaker” that I have come across over the years that is insurmountable.  And it always surprises the Seller.  “What could that be?” you are wondering.
 
Well, before we get to that, let’s talk a bit about what makes a business valuable after the Seller departs for his/her golden years in retirement. 
 
A Buyer wants a business that will sustain itself in good times and in bad times.  Recently, we all have learned what those “bad times” feel like in more ways that most of us can count.  Those bad times have brought havoc to virtually every industry across every nation.  Long term sustainability requires a business cash flow to have a “quality” about it.  Positive cash flow is not sufficient; instead it must be cash flow that will endure.  (Cash flow quality will be covered in a subsequent article.) 
 
A Buyer wants a business that is not riddled with conflicts, lawsuits, and the like.  Essentially a poor reputation in the marketplace and local business community is very unattractive.  Nonetheless, it is typically not a deal breaker.  Many Buyers will take on such a challenge hoping their own ethically sound business practices will repair and rejuvenate the business and its future prospect for success.
 
A Buyer wants the Seller to be truthful about its past operations and future opportunities.  This is why we recommend you hire the best accounting firm you can afford to assist you in preparation of your financial statements if you intend to sell your business in the next three-to-five years.

A Buyer wants to know that the day the founding Entrepreneur receives his/her equivalent to the corporate “golden parachute”, that the business will continue to operate without a misstep.  Indeed, this is where deals break down.

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In all my years working closely with founding Entrepreneurs, I still find it highly unusual to find one truly preparing their business for that day.  Most Entrepreneurs are very good at doing many tasks.  You know them too…Jack of all trades!   It is their innate ability to do many things well that gave them the courage and energy to start their business in the first place.   No one is better suited to succeed in a business endeavor than someone who can handle many tasks coupled with endless stamina.  And for most founding Entrepreneurs, delegating anything to others is difficult at best!

Regardless of the stress that delegation to others may cause the Entrepreneur, it is wise and necessary to begin the process of delegation sooner than later.  When a buyer looks seriously at a business for its long term financial opportunity, they want a business that operates without the founder.  And they want to know that it has been operating without the direct contribution of effort from the Entrepreneur for a reasonable period of time. 

When the situation is not one where the business operates through the efforts of key management and other employees, many Buyers lose interest and walk away.  If they are willing to take on the challenge to replace the efforts and talents of the Entrepreneur post sale, the price paid is either reduced or contingent on future success of the business.  Neither consequence is a good one! 

Unfortunately, when the Entrepreneur receives negative feedback from a potential Buyer regarding the need to “replace” the CEO, they often say “I wish I knew the importance of this issue years ago”.   Don’t underestimate this matter and be one of those disappointed Entrepreneurs.

 Let us know your insights by commenting on our blog post below.  

Holly A. Magister, CPA, CFP
Enterprise Transitions, LLP

Subsequent issues of The Exit Planning Digest discuss all aspects of Exit Planning. The provider of this Newsletter (Holly A. Magister, CPA, CFP®) offers you unbiased information about what you may need to know. Subscribe to our free Exit Planning educational newsletter to learn more about how to grow and/or plan for your business exit.

October 29th, 2009 | Tags: business planning, Exit Planning, exit strategy, planning for retirement, process of selling a business, sell a business, sell businesses, sell my business, selling a family business | Category: Building Value, Entrepreneurship, Exit Planning, Exit Planning Digest | Leave a comment

Part 4

Recently I took my nine year old daughter and a carload of her friends to our town’s Volunteer Fireman’s Carnival for an evening of ferris wheels, funnel cakes, and laughter–of course!  It was a Friday night after a long week.  Truly, I would have benefited from a simple dinner at home to unwind from the week.  Sound familiar?  However, I intuitively knew that the laughter of those children was most important and desperately needed…so off we went.
 
As the girls were getting out of the car, they caught sight of the ferris wheel in the distance and the excitement erupted into chaotic squeals, giggles and laughter.  I found myself feeling a bit nervous for their safety as the other cars were moving in and out of the parking spaces nearby.  I regained their attention and reminded them that they promised me to apply the buddy system to keep safe.  All was well…
 
In typical fashion, the Fireman’s Carnival delivered all that was anticipated.  It rained all week, so the grounds were like a mud filled sponge and no amount of hay can fix that.  It always rains during the week the carnival comes to our town.  The children never take notice of the condition of their shoes.  It is all about the laughter. 
 
When I was nine, I loved carnival rides too.  Another mother and I were lamenting the fact that somewhere between the age of 21 and childbirth the ferris wheel went from thrilling to terrifying.  How does that happen?  I think it is just about the same time that we adults forget how to laugh. 
 
Among my successful Entrepreneur clients, I observe that they know how to keep all of their troubles in perspective.  Simply put, they have not forgotten how to laugh!  And given the times we live in, they have been laughing a lot!  Don’t get me wrong, they do not disregard reality or not take their business or life seriously. They keep perspective and know the value of childlike laughter! 
 
After an evening of laughter, it was time to return home with our funnel cakes “to go”.  Dad and big brother were waiting for them.  As we returned to our car, we found ourselves “in trouble”.  No, I am not kidding.  As we approached my car, a Policeman asked me if I was Holly Magister and if that was my car?  Never a good question when posed by a Police Officer!  His cruiser cornered me and my car in and his spotlight was squarely on me!  “Yes, officer.  What is wrong?”  I replied.  My panic-struck heart was pounding and my nine year old began to cry.
 
Truly, my first thought was that someone died and they were trying to find me to deliver the news.  What else could it be?  My daughter thought I was going away in handcuffs forever because that is what she sees on TV.  She never saw a Police Officer that close before–one that knew my name.  They were looking for my mom!
 
The Officer told me that “the white SUV next to me suffered a “door ding” and he was there to investigate the accident.”  “Is this truly necessary?”  I asked the young man who was standing next to his prized mode of transportation.  (Okay, if you have read my earlier blogs, you know that I ask this question a lot!) With no reply to my question, I asked it another way… “Did you have to call the Police?”
 
It turns out that the nine year old’s chorus of squeals, giggles and laughter muffled the sound of the “door ding” that the neighboring SUV suffered several hours earlier.  And the young man felt that he needed the protection of the Police to make certain that justice would be done.  This young man discovered his “door ding” and decided to wait for me to return to my car.  He waited more than two and one half hours! 
 
The Police Officer informed me that it was his “job to determine if the door ding was inflicted with malicious intent or by accident.”  I replied, “I do not know any nine year old that would have malicious intent of any kind and I am grateful for that!”  He was not pleased with my reply and further informed me that he “did not want this to get ugly”.  Regardless of the absurd situation, I decided to save my sharp tongue and sarcastic sense of humor so the Officer did not feel compelled to take me away!  Besides, the funnel cakes were getting cold.
 
Today, I learned that the body shop did not consider the SUV’s injury to be a “door ding”, instead it was a “paint transfer”.  And it would take only $554.73 to make it go away!
 
The white paint from the SUV that was “transferred” onto my blue car was undetectable after a $6.00 wishy wash at the gas station.  What a bargain!  But here is the best part…after my car was washed, the shine revealed no less than 11 “door dings”.  Real ones! 
 
As I share this story with you, and more recently my family, I am reminded of the numerous “door dings” we endure as Entrepreneurs, parents, and humans for that matter!   And I believe that it is the endurance and perspective gained along the way, not the removal of the door dings, that make the difference!  To know that the door ding the white SUV suffered was because of a child’s excitement and laughter put a smile on my face.  Are you smiling?
 
As for my door dings, all eleven of them, they are not going away!  They serve to remind me daily what really matters… endure, keep perspective and remember to laugh every chance you have!
 
Let us know your insights by commenting on our blog post below.  

Holly A. Magister, CPA, CFP
Enterprise Transitions, LLP

Read Previous Articles in the Series:

Part1:Troubled Waters Part 1
Part2: Troubled Waters Part 2
Part3: Truly Necessary in Troubled Waters

September 15th, 2009 | Tags: Entrepreneur, Entrepreneurship, successfull entrepreneur | Category: Building Value, Business Growth, Economy, Entrepreneurship, Exit Planning | Comments (3)

Are you like many business owners?

• A majority of closely held and family owned businesses will change hands within the next five years¹; but
• Many Business Owners may not have taken active steps to transition out of ownership.

Again, if you are like many of our readers, the reasons for failing to plan
may be:

• You may have simply been too busy working in your business to be working on it — at least until now.
• You may be unsure of how to begin Exit Planning, who to use or even where to begin. Those uncertainties can be addressed today.

This issue of The Exit Planning Review™ and every subsequent issue will encourage you to work on — not in — your business. Your education about the Exit Planning process begins now. Proper knowledge and preparation can possibly mean millions of dollars to you when you ultimately leave your company. Start Exit Planning today and you can help to avoid the sad (but too common) fate of the hypothetical business owners of T J Construction.

Years ago, I met with Jim and Tim McCoy, two owners of a thriving construction company. What I assumed would be a business planning meeting, turned out to be a “We’re getting out of business, how do we do it?” meeting. As successful as they were, they were tired of the government regulations, changing tax codes and day-to-day grind of running a multi-million dollar company.

A sale to a third party was not an option because Tim and Jim were not willing to stay on after a sale — and they had failed to develop a strong management team, which any savvy purchaser would require as a condition of purchasing the company. Transferring ownership to a group of key employees was also out of the question. None had been groomed to take on this type of responsibility and nothing had been done to fund this type of buy out.

Both owners were too young to have business active children so their only option was to liquidate.

Jim and Tim’s highly profitable company had little worth beyond the value of its tangible assets. After the sale of those assets, dozens of the employees lost jobs, the business disappeared, and Jim and Tim left millions of dollars on the table.

How can you help to avoid Jim and Tim’s fate? By engaging in an Exit Planning process that you control. An Exit Planning process begins by asking yourself the questions that follow. Your Exit Plan will begin to be created as you answer each of the following questions affirmatively:

1. Do you know your retirement goals and what it will take — in cash — to reach them?
2. Do you know how much your business is worth today, in cash?
3. Do you know the best way to increase the income stream generated by your ownership interest?
4. Do you know how to sell your business to a third party and possibly lower your taxes?
5. Do you know how to transfer your business to family members, co-owners, or employees while lowering taxes and potentially enjoying financial gain?
6. Do you have a continuity plan for your business if the unexpected happens to you?
7. Do you have a plan to help secure finances for your family if the unexpected happens to you?

These questions are almost misleadingly simple to ask, but to answer them affirmatively requires thought and action on your part.

Creating and implementing your Exit Plan may be the most important business and financial event of your life.

Subsequent issues of The Exit Planning Digest discuss all aspects of Exit Planning. The provider of this Newsletter (Holly A. Magister, CPA, CFP®) offers you unbiased information about what you may need to know. Subscribe to our free Exit Planning educational newsletter to learn more about how to grow and/or plan for your business exit.

1Winsby, Roger. Axiom Valuation, 2003.

August 15th, 2009 | Tags: Economic Downturn, mergers and acquisitions, Pay Equity Groups, Value Drivers | Category: Economy, Exit Planning, Exit Planning Digest, Mergers and Acquisitions | Leave a comment

Step 7

 The last step in your Exit Plan is Wealth Preservation Planning. But that doesn’t mean you should wait until you are out of the business to begin actively preserving your wealth. In fact, if you wait until the value of your business is converted to cash, it may be too late to realize all of the benefits of wealth preservation. The most significant and powerful claimant to your wealth is the IRS — especially in the estate tax arena.

George opened our meeting almost apologetically. “I knew I’d waited too long to begin gifting part of the company to my kids when I met with my CPA. She told me that, based on the company’s pre-tax cash flow of $2 million per year, the company could be worth as much as $12 million to a third party. I had no idea! Since I don’t need that much, I want to transfer at least half the value — at a lower valuation of course — before any possible sale. I’m looking at millions in gift taxes.”

George hired a Certified Valuation Analyst (CVA) who valued the business at $9 million, a conservative but supportable valuation. The company’s stock was recapitalized into voting and non-voting stock. Based on current tax case law, the CVA knew that she could justify discounting the value of non-voting stock (or a gift of a minority interest of the voting stock). In her opinion, the minority discount was 35 percent of the full fair market value of the stock. Even with the 35 percent discount, however, a gift of half of the company (now reduced to a gift of approximately $3 million) would cause the payment of a gift tax of approximately $500,000.

Like you, George was not particularly keen on paying a tax of $500,000. So he didn’t. And he still gave away 50 percent of the company to his children. He did so by using the biggest lever in the Wealth Preservation Transfer Game: a “GRAT” — a Grantor Retained Annuity Trust.

A GRAT is an irrevocable trust into which the business owner (and the Trustee of the GRAT) transfers some of his stock.

The GRAT must make a fixed payment (annuity) to the owner each year for a pre-determined number of years (in George’s case, four years). At the end of this period, any stock remaining is transferred to the owner’s children.

Stock transferred into a GRAT is treated as a gift — the amount of which is the value of the asset transferred minus the present value of the annuity which the owner will continue to receive. (George’s advisors made sure that the present value of the annuity paid out over four years equaled the value of the stock transferred into the GRAT — therefore no gift was made by George.)

Another key to a GRAT’s success is the transfer of an asset that appreciates in value and/or produces income in excess of 120 percent of the federal mid-term interest rate. This rate fluctuates monthly; for examplpe, the rate varied from 7.5% to 2% in the period 2003-2009.

Let’s summarize what George did:

1. He transferred one-half of a business with a fair market value of $9-$12 million to his children in four years using none of his lifetime exemption.
2. He continued to receive all of the income from the company during that four-year period, because the annuity payment to George was designed to equal the amount of income expected from the stock transferred into the GRAT.
3. At the termination of the trust (four years) the trust asset, consisting of one-half of the company, was transferred to trusts for George’s children, free of any gift tax.

These trusts were in turn established by George when the GRAT was created and contained his wishes regarding when, and if, the children were to receive money from those trusts.

This is huge leverage. And best of all, planning techniques such as GRAT’s and the careful use of minority discounts, as well as a variety of other estate tax avoidance techniques, are likely available to you and your family.

Your financial, legal and tax advisors can provide you with more information about this aspect of the planning.

Subsequent issues of The Exit Planning Digest discuss all aspects of Exit Planning. The provider of this Newsletter (Holly A. Magister, CPA, CFP®) offers you unbiased information about what you may need to know.  Subscribe to our free Exit Planning educational newsletter to learn more about how to grow and/or plan for your business exit.

Complete Series

Step One: Setting Exit Objectives
Step Two: What is My Business Worth
Step Three: Working On - Not In - Your Business
Step Four: Getting Top Dollar for Your Business
Step Five: Transferring the Business to Children or Employees
Step Six: Planning for a Rainy Day
Step Seven: Preserve Wealth: Give it Away!

July 15th, 2009 | Tags: Exit Planning, Grantor Retained Annuity Trust, GRAT, retirement, sell a business, sell businesses, selling a family business, wealth preservation transfer | Category: Building Value, Exit Planning Digest | Leave a comment

Part 6

There may be nothing worse for a business than to have its owner suddenly die. . . especially if it’s your business.

Let’s look at what can happen when an owner dies.

Joe Carpenter was the 55-year-old sole owner of a successful construction company. Joe hoped to sell his company to a third party in the next 18 months.

What Joe needed was a way to ensure that his company would survive if he died or became disabled during that period. Before he could put any plan into place, Joe was killed in a traffic accident. Soon after his death, key employees left his company for jobs with more certain futures. They feared that the company might not continue without Joe’s leadership and personal financial backing.

Their departures caused a decrease in revenues, as well as the default on a number of contracts, which exposed the company to significant liabilities. Long-time customers grew uneasy with what they perceived to be a rudderless ship and took their business to Joe’s competitors. Joe’s bank grew uneasy as well and decided to call in his company’s debt — debt Joe personally guaranteed.

Within weeks of Joe’s death, his key managers were gone, his company defaulted on a number of contracts, revenues plummeted, customers jumped ship and any prospects of securing replacement financing quickly disappeared.

As you can see, business continuity planning is vitally important to your company. Without a well thought out “survival plan,” the consequences to employees, customers and most importantly, your family and estate are dire. (Don’t think that your estate will escape the notice of your business creditors.)

Fortunately, there are a number of methods sole owners can implement today to help avoid the type of business collapse that Joe Carpenter’s business experienced.

First, to keep key employees on board after your demise, offer ownership — perhaps via a buy and sell agreement, or offer additional compensation if key employees continue to run the company. The amount of compensation can be directly tied to company profitability and continued success. As an additional incentive, offer these employees a substantial bonus (called a “Stay Bonus”) for staying with the company — one that can be funded with insurance and that can be accessed in case of your death.

Second, alert your bank to your succession plans. Meet with your banker to discuss the arrangements you have made and show him or her that insurance to affect these plans is in place. Make sure your creditors are comfortable with your succession plan. Ask them what arrangements they would like to see in place.

Third, create a written plan that states: 1) who should take on the responsibility of running the business; 2) whether the business should be sold (if so, to whom) continued or liquidated; and 3) who your heirs should consult regarding the sale, continuation or liquidation of the company.

Finally, work closely with a capable insurance professional to make certain the necessary insurance (such as funding the Stay Bonus) is purchased by the proper entity, (you, your trust or the business) for the right reason and for the right amount.

Subsequent issues of The Exit Planning Digest discuss all aspects of Exit Planning. The provider of this Newsletter (Holly A. Magister, CPA, CFP®) offers you unbiased information about what you may need to know. Subscribe to our free Exit Planning educational newsletter to learn more about how to grow and/or plan for your business exit.

Complete Series

June 15th, 2009 | Tags: business for sale, business planning, Exit Planning, process of selling a business, selling business | Category: Exit Planning Digest | Comments (5)

By Holly A. Magister, CPA, CFP®

Do you know what is truly necessary?
 
With the multiple changes in the marketplace over the past six months or so, many Entrepreneurs find themselves overwhelmed.  They are reacting to client demands, changing vendor and employee relationships, increasing costs, and dwindling resources–financial, human and even their own energy.  They go home at the end of the day not truly knowing if they made any progress.  And that day was likely a 12-to-15 hour day! 
 
Does this sound familiar?  If so, know that you are in good company!
 
As you endure the chaos, it is impossible to have the insight to recognize what is truly necessary and what is distracting you from your best work and opportunities.  Unless, you stop and make a point of asking yourself “is this truly necessary?”
 
In many cases, Entrepreneurs spend inordinate amounts of time dealing with the matters that really mean the least to their future success.  And by doing this, they are expediting their failure.  Do you fear failure?
 
To ensure success, you must take time to reflect on matters that are critical and clearly understand and focus on the matters that are truly necessary every day.  As far as those matters that are not truly necessary, stop addressing them now! 
 
When you recognize how distracting those unnecessary matters are, you will quickly recognize the numerous expenses you will be able to eliminate when you let go of the unnecessary.  That is the good part!   When you eliminate the unnecessary, your life is simplified, some (maybe many) of your expenses are eliminated and your profit increases!  In my experience, “eliminating the unnecessary” has the potential to transform your business, your outlook as an Entrepreneur, and you.
 
Over the past few weeks, I have been sharing my insights through this blog series about how successful entrepreneurs are navigating the troubled waters we all share.  Successful Entrepreneurs are courageous as they consider their numerous options, they utilize their resources and eliminate the unnecessary.  And without exception, they understand the importance of the last principle…they find the humor in the situation.  In very simple terms, they laugh.  They apply this principle often!
 
I will share more about humor in my next blog posting.  In the meantime, stop and ask yourself “what am I doing today that is not truly necessary?”  Let us know your insights by commenting here.

Read the Previous Articles in this Series

Troubled Waters Part 1
Troubled Waters Part 2

May 20th, 2009 | Tags: Entrepreneur, Increasing Costs, Profit, Profitability, Simplify, Successful Entrepreneur | Category: Building Value, Business Growth, Economy, Exit Planning | Comments (1)

Step 5

How do you successfully transfer your business to a child, key employee or co-owner? The most successful method is to follow a recipe that mixes, in equal measure, three key ingredients:

• One part: the ability, experience and dedication of the prospective new owners;
• One part: a company with strong, consistent cash flow and little debt; and
• One part: a transaction designed to prevent income taxes from eroding the cash flow available to you, the seller.

It should be obvious that a business cannot be successfully transferred unless the new ownership is capable. Furthermore, we cannot expect the transfer to be successful if the business itself lacks the ability to provide an ongoing stream of income with which to pay for the business acquisition. What may not be so obvious; however, is the corrosive affect of income taxation upon the transfer of a business to “insiders” — children, key employees or co-owners. Let’s look at two key facts associated with transferring business to an insider.

First, your children or key employees may not have cash to buy you out. Therefore, any sale may take many years to complete — a potentially risky prospect. Further, all of the cash used to purchase your ownership may come from one source: the future cash flow of the business after you have left it.

Second, without planning, the cash flow can be taxed twice. It is this double tax, (sometimes totaling more than 50 percent) that can spell disaster for many internal transfers. Through effective tax planning, however, much of this tax burden can be legally avoided. Witness what Karl Clark did.

Karl Clark agreed to sell his company to a key employee, Sharon Smith, for $1 million. This value was based on the company’s annual $250,000 cash flow, which Karl historically took in the form of salary. While Karl understood that Sharon could not pay $1 million (nor could she secure financing), he did think that she could buy out the company over a five- or six-year period, using the available cash flow of the company.

Karl’s calculations were way off the mark. The time needed for a buy out was at least 10 years. But why were his calculations so off base? In a word, taxes — actually in two words, double taxation. Without proper planning, this is what happens if Sharon buys the company (and what can happen to you when you attempt to sell your business to your children or employees):

1. Sharon receives the cash flow ($250,000 per year) and is taxed on it at an estimated 35 percent federal and 5 percent state income tax rate(These rates may vary depending on total income and your state’s tax rate).
2. Sharon pays $100,000 in taxes (40 percent of $250,000). This is the first tax on the business’s cash flow.
3. Sharon pays the remaining $150,000 (net after tax) to Karl.
4. Karl pays an estimated 15 percent federal and 5 percent capital gains tax on the $150,000 he has received for the sale of his ownership interest, or $30,000 in taxes. This is the second tax on the original stream of income from the business. The result?
5. The company distributed $250,000 of its cash flow, but Karl was only able to put $120,000 in his pocket.

Without proper tax planning, you too, may experience an effective tax rate that could be in excess of 50 percent on the company’s available cash flow used to fund your buyout. This is likely to prevent, as it did for Karl and Sharon, a consummation of the sale of the business.

How might you design your sale to lower taxes and maximize the opportunity for success?

1. Plan. Like Karl, you should have a plan that yields you a greater after-tax amount for the sale of your company. Since the cash flow of the company may increase, the key is to provide Uncle Sam a smaller slice of the available cash flow.
2. Use an experienced advisory team, usually consisting of a business attorney, CPA and insurance or financial professional. They should understand the importance of tax sensitivity to both seller and buyer in order to make more money available to you.
3. In addition, you and your advisors should use a modest, but defensible valuation for the company. Because a lower value is used for the purchase price, the size of the tax bite is correspondingly reduced. The difference between what you will receive from the sale of your business, at a lower price, and what you want to be paid to you after you leave the business is “made good” through a number of different techniques to extract cash from the company after you leave it.

Tax planning for the transfer of your company to an insider takes time, planning and knowledge. But it can possibly save a tremendous amount of money. Take time now to begin the planning process.

• Learn as much as you can about how to best accomplish the transfer of your business.
• Seek the advice of your advisory team. Taking action sooner rather than later may help your business transfer recipe provide a tastier result. Bon appetit!

Subsequent issues of The Exit Planning Digest discuss all aspects of Exit Planning. The provider of this Newsletter (Holly A. Magister, CPA, CFP®) offers you unbiased information about what you may need to know. Subscribe to our free Exit Planning educational newsletter to learn more about how to grow and/or plan for your business exit.

 Complete Series

May 15th, 2009 | Tags: acquisition, Add new tag, buy-sell transfer, buyout, companies change, Exit Planning | Category: Exit Planning, Exit Planning Digest, Mergers and Acquisitions | Comments (4)

By Holly A. Magister, CPA, CFP®

As you navigate these troubled waters, what resources do you draw upon?

Many good-intentioned entrepreneurs confuse being courageous (the subject of my last blog) with the notion that during difficult times they must become Lone Rangers in order to survive.  What I have observed is the truly successful entrepreneurs do the exact opposite.  They instinctively recognize the value of their resources and know exactly when to draw upon them for help.  Instead of retreating to their early days of entrepreneurship, where they were “rugged individualists” by necessity, they call upon the people, companies, and other resources from the past that have consistently provided them with “best of their breed” performances.  And if for some reason, they do not have access to such a resource in their time of need, they find them.  Someway, somehow they find them.
 
As your business is occupying its position in the marketplace today, the world is changing.  Really, really changing.  Stop for a minute and ask yourself the following question: “What is different today in my marketplace than one year ago?”  If you cannot list at least three differences, your head is buried in the sand.  And if that is the case, you have permission to stop reading this now.
 
With your list of three (or more) differences, you have the place from which you should start to work.  You must deal with these differences NOW to survive today AND thrive in the future.  This is where those valuable resources (old and new) become critical.
 
So how do you know if the resources you have drawn upon in the past, or are considering for your current and future needs, are truly “resourceful”?  Or do they simply go through the motions?  I recommend asking yourself if those resources have delivered, kept promises, or maybe even exceeded your expectations. Are they creative and capable of providing a point of view that may not be popular?  Is their advice, service and attitude one that makes you feel as if they truly are concerned about YOU?  The truly valuable resources in your world should not be afraid to make changes to the way they deliver their products and services to you.  They should be flexible, open-minded and capable of adapting to the troubled waters we are all sharing.  Technology and the knowledge base is changing and growing rapidly.   Your resources should be adopting these advances and excited to share with you the benefits from doing so.
 
One of my favorite quotes of Warren Buffett is “You never are hit by the bus that you are looking at.”  How so true, on so many levels!
 
The successful entrepreneurs that I work with have been run over by more than a few busses.  The difference between the successful ones and the rest is the attitude they carry as they react to the situation and the resources they have to draw from to help them.
 
Before you pull out your PDA to call upon your resources, we need to make certain you are applying them to the things that really matter.  And that leads me to the subject of my next blog–principal number three–Eliminate the Unnecessary.  In the meantime, think about your resources…Are they resourceful?
 
Read Trouble Waters Part 1

May 8th, 2009 | Tags: Building Valuable Businesses, Business Growth, Business Resources, Economy, Entrepreneur, Growth Resources, Successful Entrepreneur, Warren Buffett | Category: Building Value, Business Growth, Economy | Comments (1)