“An exit strategy is a process that begins with a vision of what the owner would like,” says Royce Stutzman, chairman of Vicenti, Lloyd & Stutzman LLP and president of Exit Transition Strategies LLC. “It’s setting goals and then checking out the reality of the vision and goals.”
Smart Business spoke with Stutzman about the importance of implementing an exit strategy, key aspects to consider when determining the value of a business, and what tax considerations should be taken into account before finalizing a deal.
Why is it important to have a written exit strategy in place?
Everyone will eventually exit their business either voluntarily or involuntarily. Without considering and planning for an exit transition, the risk to family, customers, employees and others connected to the business can be significant. Most owners would like to leave in style, and a well thought-through strategy will help make it happen.
When determining the value of a business, what are key considerations?
If the owner wants to sell or gift to a family member, there may be a very different approach than if the goal is to sell to management or an outsider. Family and management many times will not have the cash, so the exit will frequently result in the owner carrying back a note over a period of time. In the case of a gift to a family, or even a sale, the owner wants to minimize the value so the deal can be done. A goal to sell to an outsider might be very different.
In any exit scenario, knowing the value of the business as determined by an independent qualified business valuation expert is the basis for developing the rest of the process. It is a reality check for the owner’s financial goals and development of the tactics that will help assure realizing the vision and goals.
How can business owners best preserve the value of their businesses?
During the whole process, especially the valuation, there will be the opportunity to see how the business performs related to peers. Many times, we see businesses where some performance measure is below peer groups. That may be a sign of weakness. It’s much better for the owner to know that and fix it before soliciting a potential buyer. It’s critical to clean up the balance sheet before going to the market. There is no greater turn-off to a prospective buyer than to find under-performance and sloppy management. Anything and everything that can be done to clean up the financial performance should be done prior to putting the business up for sale.
What information should be included in the financial documents that are shared with prospective buyers?
The best approach when selling to an outsider is to develop what I refer to as an executive summary on the business. It’s an overview of the business, financial statements, customers, industry trends, employees and more, which will tell prospective buyers about the business.
How should the selling process work?
Marketing the business becomes a plan to create a sort of silent auction [with] multiple prospective buyers. The goal is to create multiple interests in which several will hopefully bid the offer higher. The process will usually result in a letter of intent in which the buyer will set forth the price, terms, etc. all subject to doing (his or her) own due diligence. Then, if everything is as presented, a definitive legal agreement is developed and negotiated. Prior to this process, the business will have already done its own due diligence and will be assured that all the books and records are complete and in order.
What tax considerations should be taken into account?
The structure of the deal can make a significant difference in the ultimate amount of cash in the bank. Tax structure of a corporation can make a difference in excess of 35 percent of the price. A ‘C’ corporation pays a tax, and then upon its liquidation the shareholder pays another tax. On the other hand, an ‘S’ corporate structure eliminates the double tax. Given enough lead time, a ‘C’ corporation can convert to an ‘S’ corporation and eliminate the double tax. Several techniques can be used to minimize estate taxes. One we sometimes use is a grantor retained annuity trust. This is especially useful when an owner wishes to transfer to family without using his or her lifetime gift exemption.
ROYCE STUTZMAN is chairman of Vicenti, Lloyd & Stutzman LLP and president of Exit Transition Strategies LLC. Reach him at (626) 857-7300 or Rstutzman@vlsllp.com