Even in the best of times, disposing of a business is a multifaceted process fraught with danger. With the current state of the economy, what you don’t know can be fatal. Even so, there are techniques that can be used to avoid many of the dangers. For many small and medium-sized business owners, today’s economy can provide an unprecedented opportunity to shore up their exit strategies and receive maximum value for their most important asset. Here are some noteworthy numbers:
- Recent estimates show that 63% of business owners do not have a formal exit plan.
- Over 90% of North American businesses are privately owned.
- According to the US Census Bureau in 2004, there were more than 25 million businesses in the US, most of which were sole proprietorships, partnerships, or limited liability companies.
This means that almost 16 million companies have no formal exit plan.
AICPA – Estate Planning Studthere 35% of multi-owner businesses and 9% of sole proprietors (sole proprietorships and sole professionals) had a written succession plan in 2008, compared to just 25% of multi-owner businesses and 8% of sole proprietors in 2004. *
Current State of Succession Planning Multi-Owner Businesses Sole Proprietors
They have started the plan and will soon complete it. 35% 7%
Will start the process in the next year or two 32% 43%
The process will begin in about 5 years 10% 23%
The process will begin in about 10 years 3% 3%
They have a plan written, but it has not been formally approved 9% 3%
*2008 PCPS Succession Survey conducted by AICPA
These undeniable numbers are compelling arguments for the aggressive pursuit of state-of-the-art strategies and state-of-the-art techniques for planning and implementing 21st century exit strategies, asset/heritage preservation plans, and strategic plans.
As a business owner in today’s economy, growing the business (or lack thereof) and trying to manage day-to-day operations dictate how you will spend most of your time. However, there is no more compelling reason than the current economic situation for you, as a business owner, to take steps to take advantage of trends and opportunities that will result in better valuation, lower tax consequences, and smoother transitions when your event takes place. of liquidity comes to fruition. His future after his departure is also cause for concern. The sooner you plan for all eventualities, the better.
What are your options?
Traditionally, there are two main paths you can choose: Sell to an external third party or Transfer to insiders like your employees or family members. Essentially, there are two paths business owners can take when they decide it’s time to move on to the next phase of life: sell the business to an outside party or transfer the business to “insiders” such as family members or employees. Of course it could also be liquidated, but this is not usually the chosen path, but rather a forced or difficult path when a buyer does not appear or other circumstances intervene.
Today, when selling to third parties, some options that need to be carefully considered include transferring 100% ownership or retaining some equity. While it may be tempting to try to walk away with a large amount of cash, it may not be practical or in the best interest of the seller in the current state of our economy.
In light of the current economic climate, it might not be the smartest strategy for owners of industries where valuations are negatively affected by the economy to sell 100% of their stake when market value is at an all-time low.
Some examples are real estate related businesses, construction companies, automobile manufacturing/sale, and retail stores. Instead of cashing out, a second option is to sell only part of the capital and retain part. The retained capital can be a majority or minority interest. In certain cases, a partial sale may be desirable as it allows the selling shareholder to withdraw a portion of their net worth from the business so that they can diversify a portion of their assets, while retaining some capital for possible future appreciation. .
In uncertain economic times, the ability to free up a portion of your equity can help the business grow, thereby increasing the valuation of the retained interest in the business. More specifically, selling a partial interest in your business allows you to share future business risks and opportunities with a partner.
Acme Corporation was valued at $10 million and owned by a single shareholder. However, in light of the current economic climate, the sole shareholder decides to sell 70% of his property to a third party. The result is a liquidity event where the selling shareholder obtains $7 million of tied up capital. The seller negotiates an agreement to continue to participate in the management of the business, with a new owner who introduces a new perspective in the operational and management structure of the company. By retaining a significant minority equity position and combining forces with the outside buyer, the stage is set for the selling shareholder to participate in future growth as the economy recovers. This scenario also gives the buyer reassurance that the seller still has “in-game skins”. This vested interest in the company is beneficial to both the buyer and the seller. With a carefully designed plan, the seller is positioned such that the 30% equity stake could be worth significantly more than it was at the time of the initial transaction.
Another approach is to implement a plan to transfer insiders, such as family members, managers, or employees. In family succession cases, the internal transfer can be used to reduce certain tax consequences. This is because, in the current environment, the tax liability is likely to be reduced as a result of lower valuations. We have seen that company valuations are generally lower than they were a year or two ago. Factors causing this range from depressed earnings, lower profits, tight credit, and lower appraisal multiples.
The resulting lower valuations present exceptional options for transferring ownership rights to family members through a variety of techniques that protect or defer tax events and achieve various other estate plan benefits. Because interest rates are still relatively low, these techniques are further improved. Also, if your goal is to prepare the business for another sale to a third party at a future date, the current climate is conducive to recapitalization and intra-family transactions to change ownership and save taxes when the business is sold to a third party in the future. . future. A cautionary note; Because there is a very real probability that hyperinflation could devalue our currency, you should carefully consider where to invest the funds you receive upon transfer, protecting yourself against the eventuality. In addition, such inflationary conditions could lessen or erase any gain you may enjoy from the retained equity interest.
The current depressed state of the economy may also encourage a sale to your employees. You may want to sell through a management buyout to select key managers, or by using an employee stock ownership plan (ESOP). Again, lower valuations equate to better economics for buyers and potential tax savings for sellers.
How should you proceed?
Planning an orderly succession and obtaining maximum liquidity from the final disposal of your business requires a team approach. By bringing together the combined experience of distinguished tax, legal, insurance and financial professionals, you will gain an integrated strategy that addresses the many facets of your exit plan.
Case study #1
John Smith, 70% owner of ABC Manufacturing, LLC, wanted to plan his exit strategy. The value of his ownership interest in the company was $4 million and he wanted to retire in 5 years, but the question was how? Using state-of-the-art techniques, ABC Manufacturing, LLC agreed to borrow $4 million over 5 years to finance the premiums for an indexed universal life insurance policy on John’s life. John could then start receiving distributions from the life insurance policy after leaving the company. The bottom line: This approach exceeded John’s expectations and provided more than 249% of what John expected to receive for the value of his property.
Outgoing owner: Male, age 46 Expected value of owner’s business interest: $2,500,000 Retirement distributions to begin at age 55 Annual retirement distributions: $263,611 for 30 years Net death benefit: $659,700 Total benefits resulting from this approach: $8,568,037 Share of expected value of the owner obtained with this solution: 343%
Outgoing owner: Male, age 43 Expected value of owner’s business interest: $8,000,000 Retirement distributions to begin at age 50 Annual retirement distributions: $760,125 for 20 years Net death benefit: $13,758,412 Total benefits resulting from this approach: $28,960,918 Share of Owner expected value obtained by this solution: 362%
For these business owners, using our recommended techniques, the business owners were able to meet their business succession planning needs and enabled funding for a smooth transition of ownership while providing a potential tax-free retirement income.
For yet another example of a strategy that reflects current methods, check out this Wall Street Journal article: Wall Street Journal Article
What is your exit plan?
If you’ve put off planning or implementing your exit strategies, now would be a good time to stop procrastinating and put your plan into action. The current atmosphere is presenting opportunities that we may not see again for many years, if ever. Now is the time for you to take action. Just like death and taxes, you will eventually go out of business. Will your departure be on your terms or someone else’s?
Stop rationalizing, stop managing. Get up from your chair and get to work! denis waitley