Exiting and Transferring the Business to Family, Friend or Foe
1. Preparing Yourself
Believe it or not, the business can survive without you with the proper succession planning. Without the proper succession, many a business has gone out of business once the founder dies because he did not delegate authority to those under him or her to groom their replacement.
You need to start identifying other interests and ways to fulfill your life. It might be starting up another company, working with a non-profit organization or your favorite charity. You may choose to focus on a hobby once you turn the reins over to your successor. The main point is that you need something else to occupy your interest and time once you start easing out of your day-to-day position of the company or else you never will leave voluntarily and then the company you have grown will suffer…possibly to the point of its own death.
There are other ways to identify yourself besides “president of the company” and there are others that can run and grow the company equally or better than you. The main problem is that you have to agree to give someone the chance and understand that there are various ways to complete and solve the same problem. Coming to terms with these issues are the most critical to creating a company that can thrive long after you have left this earth.
You also need to determine how much income or savings you will need to meet your annual life style. Other questions to consider will concern covering your health insurance needs when you no longer work with the company. There are certainly other more minor questions to cover, but these are at the top when preparing yourself for exiting the business.
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Board of Directors – Many owners have found it very useful to develop a Board of Directors. These positions can be filled by others in similar positions and they do not necessarily have to be paid. However, this depends on how often you meet and what you are requiring of them. They can be a great sounding board and help you face what sometimes you would rather not. Try not to put on the board just your risk taking friends who will always answer yes to what you suggest. You want a balanced board, one that will hold you accountable.
Advisor Board – Create an Advisor Board made up of a tax advisor, financial planner, intermediary and appraisers. These roles are critical to a sound foundation for your company.
Using your Advisor Board, first determine if you have created a job or a business. You want to have a business and you want your goodwill to be that of the business and not just your personal goodwill. You will not be able to transfer the business to other management until you transfer most of your personal goodwill over to the company. You want your customers to follow the business, not you. A good indicator of this will be if you can take a month long vacation without the business revenue disappearing. This will insure that the company can succeed after your exit. Remember, you will exit one day, one way, whether you like it or not, dead or alive…it is your choice.
Management Team – Create a management team that can take your company to the next level. Surround yourself with people smarter than you. If you have family involved, make sure that they meet the same standards as the market, and that they are paid the same as the market.
Business Value Drivers – For your business to have the best chance of survival when you are gone, you want to have the following in place to assure that the value of the business stays intact with your exit:
• Make sure that all your key employees have signed non-compete agreements – one year in duration, limited geographical area, and pay special signing bonus. Make sure to work with a legal advisor on developing this agreement.
• Do your best not to have any one customer or client represent more than 10% of your total revenue unless you sell to someone like the U.S. Defense Department.
• Make sure that you are not overly reliant on any one vendor.
• Strive to keep accounts receivable as current as possible.
• Reduce excessive inventory and sell off obsolete inventory.
• Sell off any company assets that are non-income producing.
• Replace personal assets used by the company with non-personal assets.
• Have an employee handbook in place that covers the company’s policies, procedures and benefit plans.
• If you have any employee contracts, make sure that they are transferable to a new owner.
• It is paramount that you have an operating agreement, buy/sell agreement, stockholder agreement if there are any partners or stockholders in the business other than yourself, and that these documents are up to date.
• Work to remove any personal guarantees that you may have with your vendors. The company should stand on its own collateral.
• If you rent the building and land to the company, at least charge market rent. Generally, place all your real estate used by the company in another entity (other than a C Corp).
• Resolve all known environmental issues and have a well documented environmental track record.
• Any restrictive contracts in place should be limited when possible and created to be transferable under predetermined guidelines.
• Consider key man insurance and life insurance funding of any buy/sell agreements.
• Discontinue any practices of material “discretionary” expenses that the company is being burdened with by the stockholders.
• Resolve any pending or ongoing lawsuits.
• Accurately represent, at market value, any transaction with a third party or related entity that is not at arms length.
• Develop accounting practices that materially represent true accrual reports and statements. Have monthly financials that are at least compiled by an outside accounting firm at year end; reviewed financials are much better, audited financials are ideal – and generally required if selling to a public company.
• Have internal documents that can clearly show divisional earnings and costs.
• Have at least a 3 to 5 year record of stable earnings and have annual growth of at least 4 to 6 percent if possible.
• Always look to transfer on an up cycle in your industry.
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Transferring Personal Goodwill – Schedule a time period that allows you to transfer the balance of your personal goodwill over to your successor. The time period will vary depending upon who the successor is, the season the transfer occurs, and the level of personal goodwill still left in your hands when the time comes to say goodbye.
Understand that personal goodwill is made up of:
• Relationships with employees
• Relations with Vendors
• Relationships with customers/clients
• Historical trends of the company on a monthly basis
• History of how the business developed into what it is today
• Tricks of the Trade.
• An explanation of the company’s mission statement and purpose
• A description of where the growth trends are for the company in the near future, and
• An explanation of the path that you were leading the company down.
Successor Qualities – Make sure that your successor is adequately financially capitalized to handle the transaction and the future growth. Choose the right personality type to take the company to the next level. The MBTI (Myers-Briggs Type Indicator) personality test is one option. In selecting a successor, realize that two or three are not always better than one when making the final management decisions.
If you are selling to the family; it is best if they work outside of your company for the first five years, allow ten years for grooming if possible, and only put family members in place if they are equal to or are the best in the known job market and their gifts and talents will allow them to excel in the position of ownership.
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Overcoming Tax Issues – If you are a sole proprietor, your family can lose as much as 60% of the business value, so meet with your tax advisor. If your company is a partnership or closely held corporation, make sure that the company can afford enough life insurance to fund the buy/sell agreement or operating agreement and that all parties have agreed to the buy out structure if the life insurance does not cover the entire value of the company. If you are gifting shares of the company, you need to remember the annual limits and the life time limits. Also with trusts, you need to review testamentary or living trusts.
Buy-Sell Agreements – When creating a buy-sell agreement, make sure to consider both cross-purchase agreements and repurchase agreements. Always understand how the business will continue after you and who will the owners be. Make sure you have made the decision and not the government or the spouse of a partner.
What’s the Value of the Business – You need to have the company appraised whether you have a buy sell agreement or not. In growing your business, you need to know where you have been and where you are going. The business appraisal will help you in developing your personal financial plans for when you eventually exit. You should always know the value of your largest asset – generally your business.
Structuring a Deal – Here you have to make decisions such as stock vs. asset, developing trusts vs. just paying the tax now; all cash transaction vs. seller financing; and recapitalization where you can take some of your money off the table now, grow the business with others, and get a second bite of the apple in 3 to 5 years.
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If you decide to ignore all the above information and suggestions, your family and friends will lose. You may say to your self, “Who Cares – I’m Dead!” The answer to this question is simple – you do. The company is your baby or your bride. You have spent a life time building a legacy. You want to see it succeed. If it does, it can even then be turned into a gift to your church or family.
If you do not plan, the only entity that will win is the IRS and the competition. Haven’t you been fighting them all these years?
Your Next Calling
What picture represents your next step?