Finding The Exit

Dec. 21, 2004
Transferring ownership in a growing company requires analysis of the business -- and a look in the mirror.

Looking to exit your firm or reduce your role? Wondering about business valuations and tax strategies and whether your children will talk to you again if you pass on passing the business to them? How you wrap things up can ensure a great beginning at that other company you've been itching to launch or guarantee smooth sailing as you venture into retirement. How to exit "is a very important topic," says Robert Myers, president, Myers & Co. Architectural Metals, a closely held firm in Basalt, Colo., that fabricates ornamental and structural products used in building. "You work your whole life to hopefully build up a business that works and has some value. You think, 'Hey, you built all this value into the business, how do you free some of it up?' " Myers, one of four shareholders in the firm that opened its doors in 1975, has been considering his and the company's options for about five years. By trying to lay the groundwork for a successful transition and taking care of details before that day comes, he says, the firm hopes to maximize both shareholder value and the value of the firm on the open market. Studying your options is just plain common sense, Myers points out. People involved in the business might have different plans for the second half of their lives, he notes, so it's important that the exit strategy address that fact. "What if someone wants to retire before you?" he asks. "How do you pay for those shares?" And, he observes, the business has to be solid enough to sustain the payouts and continue to grow. "You don't want to leverage so much you can't [compete]." Owners and entrepreneurs can do a number of things to make sure the ownership transfer of their growing company goes smoothly. One of the first is "to give some thought to whom your targeted buyer will be," says Washington-based attorney, author, and consultant Andrew J. Sherman. Different buyers have different motivations, Sherman notes. A "strategic buyer," he says, looks for synergies, whereas a "financial buyer" seeks profitability and is not necessarily concerned with creating a dynamic marriage. It's also important to "get inside the heads" of potential buyers and try to determine what they may consider to be transaction turnoffs or outright deal breakers, Sherman says. These could range from problem equipment to problem employees. "Are there five sexual-harassment complaints pending?" he asks, arguing that owners should do what they can upfront to take issues off the table and minimize headaches for both parties in the transaction. Author and planning expert Quentin J. Fleming of Marina del Rey, Calif., agrees. It's critical, he says, to analyze the various facets of the business and to make improvements where necessary before putting the firm on the market. This will help maximize value and put more money in your pocket. "Invest in the right infrastructure and ask the right questions," Fleming says. "How does the supply chain look? How are your inventory, distribution, and logistics systems? It may cost you a little more to update systems and processes, but that investment may lead to a sale at a premium." Think modernization, stresses Fleming. "Some companies are still being run with paper and carbon paper," he says. "For those that are, a little investment in a low-level ERP (enterprise resource planning) system can be attractive." Preparing a business-plan memorandum -- a document given to prospective suitors that describes the firm, its assets, and operations -- serves the dual function of shortening due diligence and making sure you're not wasting time with buyers who aren't serious or aren't a good match for the firm and its employees. "It prevents you from kissing a lot of frogs," Sherman says. What it's worth Among the stumbling blocks that may delay your dream of opening a new business or embarking on a permanent cruise are valuation issues concerning the firm that's for sale. Owners must seek guidance to establish the "real worth" of the firm, Sherman says. How financing will be arranged and tax strategies also must be discussed in detail. Sherman warns against taking the first offer that comes along, saying it may come before potential suitors have a chance to enter the picture. "A vendor or customer might be interested in buying the business," he notes, adding that both often are overlooked as potential buyers. While there is no substitute for a full business valuation performed by a financial expert, a growing number of firms are performing electronic valuations online as a preliminary step. Malon Wilkus, chairman and CEO of, a Web site where sources of capital and financial services compete for business, spent five years developing processes to do the task and provides the service free at the firm's Web site. One need not be a computer guru or electronics genius to use the service. "An owner or CFO of a private company can input the necessary data and conduct a discounted cash-flow valuation and a comparable public-company valuation that are merged to produce a valuation within minutes of [inputting the data,]" Wilkus says. Noting that companies with annual sales from $10 million to $50 million normally pay from $10,000 to $25,000 for a valuation that needs to be updated regularly, Wilkus says, "Many CFOs return [to the Web site] monthly or quarterly to conduct valuations for presentation purposes to their boards of directors." In a family way One of the most personal challenges in planning an exit is "letting go of your baby," says Jerry Murphy, a consultant and certified public accountant in Fort Bragg, Calif. "The biggest problem [of which] to convince the owner, who probably started from scratch, is to let go of some of the decision-making authority." And other problems surface, particularly if the business is family-run. Among the biggest is finding a way to overcome the guilt that you may heap upon yourself or that others may pile at your door. Author Fleming, who wrote Keep the Family Baggage out of the Family Business (2000, Simon & Schuster) and hosts the Web site, says to get beyond the guilt. Indeed, he says, one of an owner's greatest obstacles to exiting a business is dealing with his or her own psyche, which may be under attack from all quarters. "Family members will view you as a traitor to the family," he cautions. "You have to let them know that it's not a family decision; it's a business decision. You'll hear that you're killing off your grandfather, who started the business, and you're killing off your father, who built it up to where it is today," he continues. "But a business is just an asset. You're not betraying the family; you're wanting to maximize the asset." Among the key things to consider when planning your exit is whether a family member or someone in the chain of command is prepared to take over the business. It's important to ask if the successor you designate has the seasoning, training, financial savvy, and flexibility to respond to changing conditions. Bad decision-making can be catastrophic. Warns Murphy, the CPA: "What the owner has grown over the years could become worthless in a relatively short period of time through mismanagement." But deciding on a successor can be a minefield. Fleming nevertheless urges leaders to move forward. "Many times the decision [on who will take over] has been left vague on purpose because the people who don't get picked will be angry," Fleming says. He recommends a three-part succession test: Do successors have the skills, ability, and competence? Do they have the full authority or can they get it? Do they want to do the job? A "no" answer to any of those questions should disqualify the candidate, he says. "If you can't get a 'yes' answer to all three questions, you're better off selling outside the family." When considering skill, Fleming says, it's a good idea to be forward-thinking. "You're not looking for [it] with respect to where the business is today," he says. "You're looking for skill with respect to where the business will be moving over the years. "A status-quo successor is not good because the business will constantly change," he contends. "A status-quo successor will do the same thing that was done in 1980, which may not be what is needed now." If a number of family members with the skill to run the business are identified, the other questions will help break the tie. Chief among these is whether the person can gain the authority needed to operate the business productively and profitably. Establishing authority often is no mean feat because of jealousies or outright enmities, Fleming says, noting that sometimes authority has to be seized. "You hope it doesn't happen, but if angry rustlers are in town, you may need Clint Eastwood to clean up Dodge City. They'll have to be willing to fight to take authority." Fleming says it must be clear that the successor has command presence and the desire to be in the business at the top of the heap. "You need someone who has the belief they need to be in the family business and has the desire to persevere." Easing out Flexibility and adaptability are crucial elements of an exit strategy. Owners seeking to sell also must confront the "what-now" phenomenon -- what's next after retirement -- and be able to "redefine where life begins," Fleming says. Owners often devote too little thought to the transition and discover their move has resulted in nothing meaningful, he observes. Some leaders should consider starting a new business. Others should arrange to consult for the firm or be employed by it for a "specific purpose doing very specific projects," Fleming says. Still others may wish to cash out entirely and become leaders in their professional fields or philanthropists. Regardless of an owner's plans, he or she must exercise caution and think clearly when considering options. "What I've seen sometimes is that a big accounting firm will try to get you to become a publicly traded company, singing a song about all these riches that will flow to the family," Fleming says. "But filing fees, regulatory fees, and accounting fees easily could total half a million dollars a year." His bottom line: Be careful. Make sure those you consult in the sale of the business aren't lining their pockets at the expense of your future. Unscrupulous consultants "will start playing games with financial products [they sell] instead of considering what's best for the business," Fleming says. Tax consequences are broad and depend on the type of transaction being considered. The firm can be sold in installments to a new owner, through shareholder plans, through an Employee Stock Ownership Plan, or through other means. Family members may be able to take advantage of "minority discounts" to save taxes for both buyer and seller, and "marketability discounts" also can be considered if the business if not easy to sell, says consultant Murphy. Owners also may wish to set up a buy-sell arrangement that gives the firm the right of first refusal on the outgoing owner's shares of stock as a means of providing the needed cash to the owner, he notes. Owners should plan on giving themselves a minimum of a 10-year window to get out of the business in tip-top shape. Accounting functions must be carried out religiously. "In order to work on a transition from one owner to the next, the first thing you need is good records-sound financials, general ledger, and tax returns," Murphy says. Myers, who says he's been thinking long and hard on the subject of exiting properly, says owners should not relax too soon because doing so sends the wrong signal to employees. "As owners get older, they tend to relax and maybe not work as hard," he says. "That can be a death knell if employees see [your interest is waning] and jump ship because you've stopped growing. The people who are the first rats off the ship are usually the best employees." One final thing to consider when daydreaming about your future is whether now is a good time to put the firm up for sale. "Not paying attention to market conditions is a big mistake," Sherman declares, adding that inattention and unchecked exuberance have created disaster after disaster. "I've seen so many that it's hard to keep track of them," he says. Problems likely will crop up no matter what you do. Fleming notes that often it's hard to sell a firm to a family member "and get your money out of it without killing the business. You can burden it with long-term debt, and family financing is tricky and difficult." And there are other concerns. If you have to wait for your money because the bank gets paid first, for example, you may have a tendency to try to micromanage something that no longer is yours. "That 'meddling' factor is disruptive to the business," Fleming says.

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