Transitions Digest

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

Posted on June 15th, 2009 under Exit Planning Digest. Tags: business for sale, business planning, Exit Planning, process of selling a business, selling business. Comments: 5

The Exit Planning Review™ Bi-Monthly Newsletter

In the previous issue of this newsletter, we talked briefly about how owners can and do build the value of their companies — even during a recession. Some owners will take that approach, but all owners should be, at a minimum, protecting the existing value of their companies.

This issue is devoted to explaining a few of the ways you can do exactly that by concentrating on specific items taken from a fiscal year agenda that we use with many business owners. (Meeting annually with your advisors before your fiscal year-end is a great way for all of you to keep your planning on track.) If you would like a copy of the entire outline, please contact us.

Minimizing Tax Exposure

You and your advisors should begin any discussion about minimizing your tax exposure with a review of your current business income tax status. From there, your CPA or CFO should be able to prepare an initial estimate of the company’s and your income tax liability.

You should then review what you are currently doing to reduce income tax liability. One of the purposes of ongoing tax planning is to avoid extreme peaks or valleys in corporate taxable income. By anticipating increased taxable income, through proper tax planning there is much you can do to minimize the actual tax costs. These methods include:

• Shifting income taxation from one year to the next.
• Implementing tax reduction devices, such as qualified retirement plans, medical expense reimbursement plans and the payment of large bonuses.
• Increasing deductible payments to shareholders, such as renters for equipment or buildings that may be owned individually by the business owner and leased to the business.

After reviewing what you are doing to minimize taxes, turn your attention to your advisors’ suggestions of new ways to reduce tax liability. For example, you might consider (with the input and counsel of your advisors) the new tax credits and incentives for “small businesses” promised by the new Obama administration.

Business Contraction

During a period of contraction, most business owners dig themselves into a deeper hole, not by cutting expenses too rapidly, but by hanging on too long to the existing operation, primarily because of pride or a deep aversion to laying off loyal employees. Business owners also don’t like to admit they are cutting back; the American Way is to grow, grow, grow. Yet we’ve all seen businesses that spend themselves into bankruptcy.

One of your most important goals must be to preserve value for the business in difficult times. Your advisory team demonstrates its greatest value when it helps you face hard facts and then helps you translate your decisions into action.

As you weigh the choices you face, use your advisors’ expertise to make decisions and to execute them in a manner that is legally correct and minimizes the affect on the remaining employees’ morale. For example, it may be better to reduce staff and overhead as you would remove a bandage: quickly. Moving slowly through all-but-inevitable cutbacks just prolongs the “Am I next?” period for employees.

Other Corporate Considerations

If you haven’t made an annual pre-fiscal year-end review part of your standard operating procedure, there are a few more items on that agenda that you might want to review.

• Business Continuity. Does your existing buy-sell agreement take into account a decrease in current value?
• Employee Considerations. Are your key employees contractually bound to restrict competition and protect trade secrets? Are their compensation structures defined in writing?
• Business Contracts. Are your existing contracts and forms up to the challenges of a tougher economic environment? When did you last review your property, casualty and liability policies to determine not only if there are ways to save money, but also if you and your company are adequately protected?

Individual Planning Considerations

You should also be talking with your advisors about your own income tax status. Is this the time to leave income in the company or take it out? If you take it out, there are a number of techniques you can use to reduce taxation at the individual level.

Finally, meet with your advisors to see how increased taxation, business contraction or a reduction in business value will affect your financial planning and estate planning goals.

While there are few silver linings in a recession, one is that a recession tests the mettle of your advisors. While they aren’t magicians who can make a recession disappear in a poof of smoke, they should bring you ideas and strategies to help you protect, if not build, value during difficult times.

Subsequent issues of The Exit Planning Digest discuss all aspects of Exit Planning. The provider of this Newsletter (Holly 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.

Posted on December 17th, 2008 under Exit Planning, Exit Planning Digest. Tags: build business value, business for sale, business planning, buy-sell agreement, exit objectives, Exit Planning, Exit Planning Digest, fair market value, individual planning considerations, merger & acquisition market, minimizing tax exposure, retire, Strategic Exit Planning, tax reduction. Comments: None

The Exit Planning Review™ Bi-Monthly Newsletter

Faced with a barrage of bad economic news, business owners wonder first how they will survive in what promises to be a tough environment and then, if they’ll be able to leave their companies when they planned. Before we can help owners to answer that question, let’s look at their three options: (1) hunker down until the market recovers; (2) actively work to build business value; or (3) sell now for whatever you can get.

Before we look at the pros and cons of each option, remember that there is no “right” or “one-size-fits-all” answer. You and your advisors need to sit down and look at your particular circumstances before choosing the path that is right for you.

Option One: Batten Down the Hatches

• How old are you and how long do you want to work?
• To whom did you plan to transfer your company: a third party? children? key employees?
• Exactly how much money do you need from the sale of your company to support a comfortable retirement?

These are the questions that you and your advisors must answer as you analyze whether this strategy is the right one for you.

We find that owners who have time on their side (they are nowhere near retirement age) are looking at this option as their best one. Before you join them, we hope you’ll finish reading this newsletter.

How long do you want to work?

If your original exit plan was to transfer your company to your children and they are approaching transfer age, you may wish to move your exit date forward. As the value of your company falls (on paper) it is a perfect time to consider beginning a gifting program and to transfer the company to your children while still reaching your financial and other objectives. A lower business value reduces gift tax complications and income taxes if you decide to sell part of the business to children. Additionally, simply transferring part of the business to children need not ultimately reduce the amount of money you receive from the business.

To whom do you plan to transfer your company?

If your original goal was to transfer your company to your employees, this is an optimal time to begin that transfer. For example, a lower stock value means lower overall taxes in a well-designed transfer because more of the company’s cash flow can be paid directly to you rather than being used by the employee to buy your stock.

This number varies from owner to owner depending on the type of retirement one chooses (annual world cruises or a simpler lifestyle) and on the value of the owner’s other assets (real estate, retirement plan accounts, stock portfolios, etc.). Another variable among owners is the type of assumptions they made about growth and income in their investment portfolios. If your original assumptions need to be a little more conservative, remember that you will need more money/capital from the sale of your company.

How much money do you need from the sale of your company to retire?

Option Two: Build Business Value

In boom times, building the value of a company drives every business owner. What many owners don’t recognize, however, is that tough times provide no reason to abandon that goal in favor of riding out the storm. In its recent study of 400 companies, Diamond Management & Technology Consultants looked at what led to success or failure during the last recession (1998-2004).

Diamond found that just over half improved their gross profit margins because they:

1) made targeted rather than blanket cost-cuts; 2) were smart about automation, customer relationships and investments; 3) managed vendors to reduce and variabilize their costs; and 4) focused on core strengths. (“Don’t Waste A Crisis: Emerge a Winner by Applying Lessons From the Last Recession,” Diamond Management and Technology Consultants, Chicago, IL, October 13, 2008).

• Is this the time for you to cut back or to commit additional resources to marketing?
• Could your company benefit from hiring the top-notch talent that is becoming increasingly available as your competitors downsize?
• Is this the time to acquire smaller, less adaptable, less capitalized or less well-managed competitors? In this buyer’s market we see not only lower purchase prices, but also much more attractive seller-based financing and earn-outs.
• Have you designed incentive plans for your management team that reward long-term employment and provide short-term incentive to increase your bottom line? There are many ways to structure incentive standards so that they support your goals in a changing business environment.

These are the questions you and your advisors must ask and answer as you decide how to proceed.

Option Three: Sell Now

There are several types of owners who are choosing to sell their companies today rather than hunker down or actively build value. These include:

• Owners who just don’t have the fire in the belly to go to work each day ready to fight another battle.
• Owners who have “sale-able” companies that if sold at today’s less exuberant multiples, will support a comfortable retirement.

If you recognize yourself in either of these two categories, you will want to read the last issue of this newsletter series, “Should You Sell Your Company Now?” In it, we will look at what makes your company valuable to buyers in today’s Merger & Acquisition market.

Subsequent issues of The Exit Planning Digest discuss all aspects of Exit Planning. The provider of this Newsletter (Holly 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.

Posted on December 1st, 2008 under Building Value, Economy, Exit Planning, Exit Planning Digest. Tags: build business value, business brokers, business for sale, changing economy, exit objectives, exit planners, Exit Planning, Exit Planning Digest, retirement goals, should you sell your company now, Strategic Exit Planning, valuation, valuation methods. Comments: None

The Exit Planning Review™ Bi-Monthly Newsletter

With this issue of The Exit Planning Review™ we begin a discussion of how owners of mid-sized business are making decisions about their futures in a quickly changing economy.As exit planners, we consistently urge business owners to take the initiative when planning their exits. Today, we apply that perspective to encourage business owners to go beyond panicked headlines and take a clear-eyed look at their options in light of their: (1) exit objectives, (2) companies and (3) current M&A conditions in their marketplaces before they decide if their exits must be moved forward or delayed.

Each owner is different: some are so close to retiring that they can taste it, while others have years to work before they can even think about leaving the limelight. Some owners have a sense that hidden in this recession there just might be opportunities to be grabbed. Others are looking to protect what they’ve built and want nothing more than to survive. Some owners have invested outside of their companies, while for others their companies are, by far, their largest asset.No matter your situation, you and your advisors have some serious work ahead of you. This series of newsletters will examine three components of your decision-making process: your exit objectives (especially your target exit date and how that might need to change), your company (how you can help protect or build its value and its sale-ability) and, should you decide to sell, what you can expect.

Your Exit Objectives

If you suspect that the current economic downturn means that the departure you planned in the next five to ten years will be delayed, you’ve got a lot of company. According to a 2005 PricewaterhouseCoopers’ survey of 364 CEOs of privately held, fast-growing companies, “nearly two-thirds … plan to move on within a decade or less: 42 percent within five years, and 23 percent in five to ten years.” (“Wide Majority of Fast-Growth CEOs Likely to Move On Within Ten Years, PwC Finds.” January 31, 2005.)The question is: What do you do about your target departure date? If you leave it as is, do you spend your energy protecting what you’ve got or actively working to build value?

If you decide to move your departure date forward by selling now, how does that affect your other retirement goals (transferring for the amount of money you want and transferring to the party of your choice)? Is your company attractive to buyers? Are there buyers active in the marketplace? And, how can you get top dollar for your company?

We’ll look at each of these options in upcoming issues of The Exit Planning Review™.

Your Company

As operations become leaner and meaner, is your company more vulnerable than ever before? Specifically, are there things that you can do to protect the value of your most valuable asset, your company? What can you do to help minimize your company’s tax exposure? Is there a way to prevent the departure of your key employees? We will examine how you can help protect value, minimize taxation and protect trade secrets, vendor relationships and referral sources.

After looking at protecting business value, our next issue will look at how owners can build business value during a recession through acquisition. Before you dismiss this strategy as unrealistic for your company, please read about owners who are taking advantage of lower purchase prices (by using seller financing and earn outs) to acquire specific assets (like customer lists and equipment) of smaller, less adaptable, less capitalized or less well-managed competitors.

Current M&A Conditions

In the last issue of this series of newsletters on adapting your exit plan during a recession, we’ll take a look at what is going on in today’s Merger & Acquisition market for mid-sized businesses ($5 million to $250 million of value). We’ll look at which companies are selling, who is buying and what credit is available to finance deals of this size.

As a business owner, you have a number of arrows in your quiver and need not stand impassively on the sidelines during a time of economic volatility. Unlike the “average” investor, you aren’t limited to the single strategy of pulling dwindling assets out of the market. Even if the general economy suffers, your business profitability need not.

Subsequent issues of The Exit Planning Digest discuss all aspects of Exit Planning. The provider of this Newsletter (Holly 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.

Posted on November 24th, 2008 under Economy, Exit Planning, Exit Planning Digest, Mergers and Acquisitions. Tags: business appraisal, business appraiser, business brokers, business changes, business for sale, business planning, buy-sell agreement, buy-sell agreements, buy-sell transfer, buyout, changing economy, companies change, exit objectives, exit planners, Exit Planning, Exit Planning Digest, Exit Planning Review: Valuation in Buy-Sell Agreements, fair market value, m&A conditions, mid-size business, protecting business value, retire, retirement, retirement goals, Strategic Exit Plan, Strategic Exit Planning, target departure date, valuation, valuation methods. Comments: None

The Exit Planning Review™ Bi-Monthly Newsletter

In this series of articles about buy-sell agreements, we’ve talked about what those agreements are, what transfer events they cover, why these agreements should be updated as shareholders and companies grow and change, and why the choices you’ve made about whether buyouts are mandatory or optional may change over time. In this article, we’ll discuss the all-important issue of valuation: the pros and cons of using three common valuation methods.

Before we talk about three common valuation methods, there’s one critical ground rule that you should know: The valuation method used should be consistent with IRS rulings and guidelines. If the IRS disputes the value used, you or the other co-owner may end up paying more taxes, although that value still governs the price paid for the stock. As you might imagine, that is generally not a result that favors the taxpayer.A second issue is not so much a ground rule as it is a lesson from experience. As difficult as it may be to decide the valuation method your agreement will use in all transfer events, think how difficult it would be to agree after that event has occurred—the buyer will naturally want the lowest value and the seller the highest value. This conflict can all too easily result in anger, legal expense, valuation expense, etc.In the world of buy-sell agreements there are three common valuation methods: an arbitrarily agreed upon value, a formula and a fair market valuation (to be performed at the time of the transfer).

SET VALUE

Some companies (especially in the early years when the prospect of hiring a business appraiser is financially daunting) decide to estimate a value for the company. For example, two shareholders may estimate that the company will be valued at $100,000 should any transfer event occur. This methodology is simple and inexpensive; it works when the estimated amount agreed upon is one the remaining shareholder(s) could raise, if necessary, to buy out a departing owner. Seldom is this method fair to all parties when the business ownership interest is valuable; nor is it one the IRS is likely to embrace! It is typically used when: 1) business value is minimal; and 2) the triggering event is a) funded by life insurance or b) small enough that the ownership interest payout can easily be funded through future business cash flow (for example, a minority owner with only a 10 percent share cashes out). This valuation approach may be “better than nothing” in the early years of a business, but a successful business is likely to soon outgrow it.

FORMULA

The second common valuation method is using a pre-established formula to determine the value of the company should a transfer event occur. Formulas are as varied as the companies that create them, but they generally fall into three categories: book value at the time of transfer, some multiple of cash flow (or EBITDA) or a combination of the two.

The formula approach is relatively straightforward and inexpensive to use — as opposed to one requiring a business appraisal. A primary disadvantage can be that the IRS may not be bound to accept the value — even if pre-stated in the buy-sell agreement. In addition, rapidly changing circumstances, in or outside of the business, which dramatically affect value are not “built in” to the formula. As a result, depending on the circumstance, either the buyer or the seller can be disadvantaged (one paying too much or one receiving too little) if a trigger event occurs requiring a purchase and sale.

FAIR MARKET VALUE

The last common valuation method is to require the use of a certified business appraiser, at the time a transfer occurs, to establish a Fair Value for the company using valuation standards and procedures stated in the buy-sell agreement.

Many business owners prefer this method over the others because it is fair both to the seller and to the buyer of the stock. By capturing the value of the company at the time of the transfer, buyers don’t overpay and sellers get what they deserve.

TERMS

No matter the type of valuation method you choose for your company, you will also have to decide the terms of payment. You and your co-owners will decide how much time the buyer will have to purchase stock and what down payment will be necessary. You may decide that buyers will have to personally guarantee unpaid amounts. Will those unpaid amounts carry a minimal interest rate, the prime rate or the rate the company is charged by its bank? What penalties will be imposed for late or non-payment? All of these terms should be clearly stated on a sample promissory note attached as an exhibit to the buy-sell agreement.

In the beginning of a business’s life, few think of leaving; things are simple and your buy-sell reflects that simplicity. As the business becomes valuable, shareholders broaden their interests beyond the business (working less or even leaving it) and ownership becomes complex, your buy-sell agreement should reflect these new and quickly changing realities. Don’t ignore your buy-sell agreement until the day you need it. If you do, the headaches, the heartache and, very possibly, the legal fees, may be more than you could ever have imagined.

Subsequent issues of The Exit Planning Digest discuss all aspects of Exit Planning. The provider of this Newsletter (Holly 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.

Posted on November 5th, 2008 under Exit Planning, Exit Planning Digest. Tags: business appraisal, business appraiser, business brokers, business for sale, business planning, buy-sell agreement, buy-sell agreements, buy-sell transfer, companies change, Enterprise Transitions, Exit Panning Review, Exit Planning, Exit Planning Review: Valuation in Buy-Sell Agreements, fair market value, industries change, retire, retirement, set value, shareholder, shareholders, Strategic Exit Plan, Strategic Exit Planning, valuation, valuation methods. Comments: None

The 30,000 Mile Checklist

In the prior two issues of this newsletter, we’ve looked at several key elements of your buy-sell agreement and the transfer events that can trigger a buyout. Today, we look at all the types of changes (in you, your partners, your company, your finances and your industry) that can transform that vigorous buy-sell you created years ago into a lumbering, but potentially dangerous, dinosaur. In this issue you’ll also find a checklist that will help you assess the viability of your buy-sell agreement.

PEOPLE CHANGE

Shareholders are living, breathing creatures. In addition to all the “bad things” (or transfer events) that we discussed in previous issues, shareholders will age. As they do, they may adjust how much they want to work or what goals they want to work toward. If shareholders are all of a common age, they may share these changes or they may not. If one shareholder is older than one or more of the others, the commitment to work long hours or the long-term ownership goals of the older and younger shareholder can diverge. Should that happen, the only effective recourse may well lie in the provisions of a well drafted, comprehensive and current buy-sell agreement.

COMPANIES CHANGE

The most common change in the life of a successful business is its increase in value. When the company isn’t worth much, shareholders may be able to buy each other out if certain events occur. As the company becomes more valuable, however, shareholders cannot put together the resources necessary to cash each other out.Also, over time, the ownership of companies changes as new owners buy in and older ones sell out and retire. As these changes occur, the ownership proportions can change in ways not intended or planned by the majority shareholders. The buy-sell agreement can respond by allowing ownership, but not voting control, to shift to the younger, incoming generation of owners.

INDUSTRIES CHANGE

Like it or not, the industries we are in affect the value of our companies. If we’re in a niche or “hot” industry, buyers will pay more for our companies and values reflect that demand. If there is a great deal of industry consolidation going on, the value of your company will reflect that. Similarly, industries go through boom and bust cycles and if the company is enduring the bust part of the cycle, its value reflects that downward pressure as well. Buy-sell agreements can be drafted to reflect not only rapid changes in value, but also corresponding changes in the terms (length of buyout, amount of down payment, mandatory vs. optional purchase, etc.) of any purchase. This tends to prevent one owner from “gaming” the buy-sell agreement by selling out when value peaks.

BUYOUT REQUIREMENTS CHANGE

When you created your buy-sell agreement, you made decisions about whether particular events would trigger an optional or a mandatory buy out. You made those decisions based on then current factors. As the foundation for those decisions may have changed so too do your preferences. For example, you now may prefer that a child or a key employee acquires your ownership when you retire or die, rather than the other co-owner.

THE ABILITY TO SELL OUT CHANGES

When your company was worth very little, it would have been highly unlikely for an unrelated third party to approach you with a lucrative offer to buy. Now that your company may be more valuable, however, the possibility that a third party would make an offer is a real possibility. Does your buy-sell agreement adequately address this? What if one owner wants to sell and the other doesn’t? Does it make a difference whether you are the owner who wants to sell or the owner who doesn’t want to sell? Given all the moving parts, it makes sense to review your buy-sell agreement at least every year. The following checklist is designed to give you and your advisors a snapshot of your buy-sell agreement. The purpose is to help you identify those areas that should be updated for all the reasons discussed here.

Buy-Sell Transfer Event Checklist

Subsequent issues of The Exit Planning Digest discuss all aspects of Exit Planning. The provider of this Newsletter (Holly 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.

Posted on October 15th, 2008 under Exit Planning, Exit Planning Digest. Tags: 30000 mile checklist, bi-monthly newsletter, business brokers, business changes, business for sale, business planning, buy-sell agreement, buy-sell agreements, buy-sell transfer, buyout, companies change, Enterprise Transitions, Entrepreneur, Entrepreneurs, Entreprenuer, Entreprenuers, Exit Panning Review, Exit Planning, Exit Planning Review: “Should I Sell My Business Now?, industries change, part two, retire, retirement, shareholder, shareholders, Strategic Exit Plan, Strategic Exit Planning, update. Comments: None

 The Exit Planning Review™ Bi-Monthly Newsletter

In the previous issue of The Exit Planning Review™, we discussed what a buy-sell agreement is and why you should dust it off, take a second look at it, and call your advisors to update it.If you just aren’t convinced that setting up that meeting is all that important, in this issue, we’ll look at the events that can (and do) crop up in the life of a business and that can be handled by a carefully designed, frequently updated buy-sell agreement. Once you see how one agreement can impartially and fairly treat all parties when bad things happen, we think you’ll make that call.

TRANSFER EVENTS

Buy-sell agreements can be designed to handle the unhappiness that can arise when any of the following events happen to the shareholders of a closely held company:

• Death of a shareholder
• Disability of a shareholder
• Divorce of a shareholder
• Bankruptcy of a shareholder
• Sale of part or all of the company to a third party
• Retirement of a shareholder
• Involuntary termination of a shareholder
• Business dispute among shareholders

You probably have no trouble imagining how most of these events (the death or disability of a shareholder, for example) could cripple your company or your family if left unaddressed. But some events, like the involuntary termination of a shareholder, are harder to grasp.

Rarely do owners anticipate that one day they might have to terminate the services of another shareholder. If they can imagine that scenario, it is rarer still that they can imagine the thorny problems that will arise. Is the terminated shareholder required to sell back his stock? Is the remaining shareholder or the company required to purchase it? In a divorce scenario (especially in a community property state) do you run the risk of ending up with your co-owner’s ex-spouse as a new co-owner?

Let’s look at a few all-too-common problems that well-written buy-sell agreement can solve.

Sale of Part or All of Company to a Third Party

You receive a call from a legitimate representative of a deep-pocketed Private Equity Group who has identified your company as an acquisition candidate. He makes an initial offer that would guarantee your family’s financial security for life. Imagine your surprise as your 25 percent co-owner responds to your announcement, “Thanks, but no thanks. I’m just getting started and think we can take this company to the next level ourselves!” You call the PEG back to offer your stock for sale, but the PEG (like almost every third party owner) isn’t interested in buying a part of your company. It is an all or nothing offer. Since your buy-sell agreement doesn’t address this issue, you hang up and return to work.

A well-crafted buy-sell agreement can stipulate that when a third party makes an offer to buy a company’s stock, the other shareholders must match that offer or must sell their shares to that third party.

Firing a Shareholder

Twenty years ago Ned, Kathy and Jim left a common employer and started their company. The three equal shareholders knew exactly what they’d do differently and agreed on how hard they’d all work to reach their common goals. During the last five years however, Jim’s behavior was becoming unpredictable. He missed important customer meetings, ignored his department’s performance and finally, was arrested for soliciting an undercover policewoman in a well-publicized sting. In an attempt to calm vendors and customers and to restore employee morale, Ned and Kathy asked Jim to resign. He refused. They reluctantly told Jim that he’d have to leave and that they’d purchase his stock at the value agreed upon in the buy-sell agreement. Jim pointed out to his co-owners that their buy-sell agreement did not mention the involuntary “retirement” of a shareholder and refused to sell his shares.

A carefully considered buy-sell agreement can stipulate not only that a fired shareholder must sell his or her shares for the agreed upon value, but also that the remaining shareholders must pay for that stock.

Divorce of a Shareholder

When Mike and Patrick went into business 15 years ago, they agreed on everything — except women. Neither could imagine what the other one saw in the other’s wife, but had managed the situation by maintaining a polite distance.

One Saturday night, Mike called Patrick to ask if he could stay at Patrick’s house because his wife had kicked him out. The following week, Mike was served with divorce papers and within days, Mike’s attorney scheduled a meeting with both men. Patrick’s initial curiosity about why he was involved turned to anger when the attorney told them that Mike’s wife wanted, and, in their community property state had a right to, half of Mike’s share of the company. If the three of them couldn’t run the company together, Patrick would have to buy both of them out and Mike’s wife had an especially unrealistic idea of what her share was worth.

Mike and Patrick turned to their buy-sell agreement hoping they’d thought to plan for this event. They had not. Their agreement did not include a divorce provision.

We are happy to send you information about any transfer events that your buy-sell should cover. In the next issue, we’ll talk about how changes in your company can turn the buy-sell decisions you made in the past into less-than desirable solutions today.

Subsequent issues of The Exit Planning Digest discuss all aspects of Exit Planning. The provider of this Newsletter (Holly 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.

Posted on October 6th, 2008 under Exit Planning, Exit Planning Digest, Uncategorized. Tags: "Does Your Buy-Sell Cover Everything it Should?", bi-monthly newsletter, business brokers, business for sale, business planning, buy-sell agreements, Enterprise Transitions, Entrepreneur, Entrepreneurs, Entreprenuer, Entreprenuers, Exit Panning Review, Exit Planning, Exit Planning Review: “Should I Sell My Business Now?, part two, retire, retirement, shareholder, Strategic Exit Plan, Strategic Exit Planning. Comments: 2

The Exit Planning Review™ Bi-Monthly Newsletter

The business continuity agreement is the single most important document that the owners of a closely held business will ever sign. This agreement (also known as a buy-and-sell or buy-sell agreement) controls the transfer of ownership when certain events occur. These events include: the death or disability of a shareholder, an involuntary termination or retirement of a shareholder and even (yes they do happen) disputes among owners.

In this four-part series of articles about buy-sell agreements, we assume that, like most successful co-owned companies, your company has, in place, a buy-sell agreement. In our experience, however, many, if not most, of these agreements do not reflect either the current circumstances of the business or the owners’ current wishes regarding business continuity. When that is the case, an outdated buy-sell agreement may cause more problems than having no agreement at all! Let’s examine why.Your first buy-sell agreement (and maybe the one you still have) was likely created when your business was in its infancy, had little value and even less complexity.

The most significant continuity issue contemplated was the death of a shareholder. If one owner wanted to leave, the buyout, if any, would cost little. In fact, the most reasonable response might have been to liquidate the business. A comprehensive buy-sell agreement addressing all possible events that can trigger a sale and purchase of ownership was not only unnecessary, the legal fees to create such an agreement may have exceeded the value of your company!

But you, your business, and your co-owner(s) have likely changed mightily since those early days. Has your buy-sell agreement kept up?This series of articles explores the reasons to review and to revise the buy-sell agreement, what events a buy-sell can and should cover and finally, how valuation can and should work in these agreements.So, take a look at a copy of your buy-sell agreement (it’s probably where you keep those other “important” documents — in the bottom drawer of your desk), and ask yourself a few questions:

1.  When was this document last reviewed? If the answer is never or more than two years ago, it needs to be reviewed now. In the early years of the business it probably wasn’t vital to review the buy-sell every year or so because business conditions and value and shareholder aspirations (both personal and business) didn’t change significantly. But today, change is the norm:

• business value may increase or decrease more in one year than the total business value of your company in its start up years;
• owners inch closer to retirement or a desire to sell the company;
• or young co-owners who worked as a group during the early years now have different outlooks, different work ethics, and perhaps different health situations.

In short, your buy-sell agreement now needs to address all of the issues that could trigger a transfer of ownership. The next issue of this newsletter discusses seven trigger events successful owners should consider including in their buy-sell agreements.

2. Would I rather make decisions about how to cash out a departing shareholder now or when tempers are flaring? Decisions about how to put out a fire before there’s even a whiff of smoke in the air are hard enough to make. Attempting to find solutions that are fair to all parties when emotions run high is nearly impossible. In the company’s formative years, it wasn’t critical to consider how a lifetime buyout would be structured and valued because the value was minimal. Today it is and unless your buy-sell agreement fully addresses how to cash out departing shareholders, it becomes a ticking time bomb.

To help you prepare for your meeting with your advisors, let’s review a few key items in your buy-sell agreement:

1. Who is included in the Agreement? Who has voting control? Are there any changes in either who is included or in the proportions of ownership since you last reviewed the document?
2. What events are covered in the Agreement? (Look for a comprehensive list in the next issue of The Exit Planning Review™ )
3. Transfer events (death, disability, business disputes, etc.) trigger either mandatory or optional buyouts. The choices you made about what event triggers mandatory buyouts vs. which trigger optional buyouts may no longer be the best choices. As companies grow in value (and have more cash on hand) shareholders more often choose the mandatory buyout option.
4. How does your buy-sell agreement determine how the amount of future buyouts will be calculated? In the third part of this series, we’ll look at several ways to establish value and which methods work best.
5. Finally, look at how you’ve decided to fund particular types of buyouts. If, for example, there is a life insurance funding a buyout of a deceased shareholder, is it in a sufficient amount? Is the policy owned by the proper party? Are the beneficiary designations correct? If a lifetime buyout of an owner is expected, how can that buyout best be (at least partially) pre-funded and designed to minimize overall taxes?

This quick list should give you plenty to discuss at your next meeting with your advisors. If you aren’t convinced you should schedule that meeting, our next issue will summarize some of the events that can and do occur in the life of any business. If your buy-sell agreement does not cover these events, you and your company may be more vulnerable than you ever imagined.

Subsequent issues of The Exit Planning Digest discuss all aspects of Exit Planning. The provider of this Newsletter (Holly 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.

Posted on September 15th, 2008 under Exit Planning, Exit Planning Digest. Tags: "Is Your Buy-Sell Agreement Current?", bi-monthly newsletter, business brokers, business for sale, business planning, Enterprise Transitions, Entrepreneur, Entrepreneurs, Entreprenuer, Entreprenuers, Exit Panning Review, Exit Planning, Exit Planning Review: "Is Your Buy-Sell Agreement Curr, part two, retire, retirement, Strategic Exit Plan, Strategic Exit Planning. Comments: None

The Exit Planning Review™ Bi-Monthly Newsletter

Overcoming Common Objections: Part Two
 
As we introduced to you in the last The Exit Planning Review™ newsletter, the common objections that tend to hold back owners from selling their businesses are usually based upon some combination of the following:

• The business isn’t worth enough to meet my financial needs.
• The employees (or customers) will leave when they discover I’m trying to sell.
• I will be required to work years for a new owner.
• The sale process will take too long and cost too much.
• Given the tax bite on sale proceeds, it makes more sense to stay, enjoy the cash flow and get paid over time.
• What will I do after I sell and leave the business? This business is my life!

We previously looked at the first two common objections that can influence your timing on selling your business — determining business value and losing employees or customers before you sell. We will follow up on this discussion by looking at the remaining common objections that can affect your decision to cash out of your business and move on to the next stage of your life.

I Will Be Required To Work Years For A New Owner

If one of your Exit Objectives is to leave the business as soon as possible, it is important to make that objective known to your Exit Planning Professional and it will be a prerequisite of any sale. That objective will determine which type of buyer you should seek. There are categories of buyers who typically do not require the former owner to remain with the company beyond a short transition time period — usually no more than a few months — provided your management team is strong.

The Sale Process Will Take Too Long And Cost Too Much

Cost, of course, is a matter of perspective. But the only way for you to make the determination whether the sale process is too expensive or not is to discuss costs and expenses with your advisors before you hire them. It usually takes from six to eighteen months to sell your business. The more you know, the better prepared your company can be for sale. Better preparation on your part can mean less time and expense on the part of your advisors.

Given The Tax Bite On Sale Proceeds, It Makes More Sense To Stay, Enjoy The Cash Flow And Get Paid Over Time

With proper tax planning, Uncle Sam’s cut of the sale proceeds can be minimized so that you are in a better position to meet your financial and personal objectives upon your exit from your business. But planning — and implementation — can take years to be fully effective. Delays in beginning to plan works to reduce time available and can increase taxes.

What Will I Do After I Sell And Leave The Business? This Business Is My Life!

For many business owners, the old “fire in the belly” is gone, but there is nothing to replace it. So many hang on to their businesses, willing to accept what they know because they fear that the unknown may be even worse. Yet, many owners don’t know what they will do when they exit. In the words of a real-life business owner who faced this dilemma; however, exiting a business can end up uncovering new and exciting opportunities for owners to pursue after the sale.

“Doing the same thing every day was getting old. I wanted to do something new and different and the buyer I chose (one of six) presented that new and different opportunity,” said Wayne Berger, former business owner whose story of cashing out of his business is shared in the new book Cash Out Move On, by John H. Brown, published January 2008.

Final Thoughts

Certainly, the decision to sell the business you created and nurtured is an intensely personal decision. No one is more qualified to tell you what to do with the rest of your life than yourself, especially when it comes to the decision to sell your business. The fear of the unknown is natural, but you do not have to venture on this journey alone. Our office is available to help guide you through the process of preparing for the biggest financial event of your life. We can help you review all of the factors associated with exiting your business and work to help remove the common roadblocks you may be facing, while addressing all of your personal and business objectives.

Subsequent issues of The Exit Planning Digest discuss all aspects of Exit Planning. The provider of this Newsletter (Holly 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.

Posted on September 2nd, 2008 under Exit Planning, Exit Planning Digest. Tags: bi-monthly newsletter, business brokers, business for sale, business planning, Enterprise Transitions, Entrepreneur, Entrepreneurs, Entreprenuer, Entreprenuers, Exit Panning Review, Exit Planning, Exit Planning Review: "Should I Sell My Business Now?", part two, retire, retirement, Strategic Exit Plan, Strategic Exit Planning. Comments: None