Exit Strategy Planning Comprehensive Update2003

EXIT STRATEGY PLANNING

“Achieving optimum value for your business”

04/07/23 1PACE CAPITAL RESOURCES,

LLC

EXIT STRATEGY PLANNING

04/07/23PACE CAPITAL RESOURCES,

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Business Planning

Exit Strategy Planning

Estate Planning

“Exit Strategy Planning coordinates and integrates Business Planning and Estate Planning based on the Business Owner’s

objectives”

MARKET NEED

• Based on a 2005 survey by PriceWaterhouseCoopers’:

– More than 4.5 million business owners are 50 years old or older.

– 67% of business owners of firms with revenues from $5 million to $150 million plan to leave the business within the 10 years.

– More than 75% of the owners have not done much planning for what will probably be the single most significant financial event of their lives.

• M&A Marketplace:

― Success rate is 1 in 4 actually sells(1)

― Success rate for businesses with sales of $10 million – 1 in 3(1)

― Success rate for businesses with sales above $10 million – 50-50(1)

(1) 2005 Business Reference Guide by Tom West


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EXIT ALTERNATIVES

• Sell to a Strategic Buyer – 100% liquidity.

• Sell to a Financial Buyer – up to 100% liquidity.

• Sell to Management/Family– up to 100% liquidity.

• Recap – harvest a majority of your net worth and retain minority ownership “for a second bite of the apple” but still maintain operational control of the business.

• ESOP – up to 100% liquidity selling the business to the employees.

• IPO – initial public offering.

• Liquidate.

Is your company positioned to consider multiple exit alternatives or are your alternatives limited?


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ISSUES LIMITING EXIT ALTERNATIVES AND VALUE

• Is there an heir apparent to run the business in the future?

• Do you have the management depth to take the business to the next level?

• Does your largest customer account for less than 20% of sales?

• Do you have multiple suppliers for product or raw materials?

• Do you have systems and processes to properly manage the business in the future and provide the level of service expected from your customer base?

• Does the business have opportunities for growth through geographic expansion, product line extensions or new channels of distribution?

• Do you have excess capacity to support future growth?

A “NO” to any of these questions may limit your alternatives and depress the value of your business. Proper exit planning addressing these and other issues will produce the desired results positioning the business as an attractive investment from multiple sources.


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THE ISSUES

Exit Strategy Planning involves answering "Yes" to seven questions:

• Do you know your exact retirement goals and what it will take, in cash, to reach them?

• Do you know how much your business is worth today, in cash?

• Do you know to position your business to maximize enterprise value?

• Do you know how to sell your business to a third party and pay the least possible taxes?

• Do you know how to transfer your business to family members, co-owners, or employees while paying the least possible taxes and enjoying maximum financial security?

• Do you have a continuity plan for your business if the unexpected happens to you?

• Do you have a plan to secure financial independence for your family if the unexpected happens to you?


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ROLE OF PACE CAPITAL RESOURCES

Pace helps the business owner achieve a successful exit by providing the following turnkey services:

•Educate the business owner from start to finish on the exit process; guiding the owner down an unknown path, the single most significant financial event of an owner’s life, helping him or her balance two key emotions: “fear and greed”.

•Develop an advisory team initially consisting of an attorney, a CPA, an insurance and financial professional, most of which are probably the owner’s existing advisors.

•Coordinate and facilitate the creation of an Exit Strategy Plan based on the owner’s goals and objectives.

•Develop an operating strategy enhancing the value drivers of the business while addressing weaknesses, opportunities and threats.

•Implementation of the strategy to a successful completion of an exit.


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VALUE PROPOSITION OF EXIT STRATEGY PLANNING

• Higher exit multiple – the market will pay a premium for a properly positioned business.

• A 0.5 or 1.5 increase in exit multiple - equates to $1,500,000 to $4,500,000 in additional value to the owners of a $3,000,000 EBITDA business.

• Nominal upfront out of pocket cost – fee schedule is flexible with payments spread out over time.

• Alignment of goals – a success fee is charged based on the value received for the business at exit.

Each owner will have his or her personal objectives, each company has its own attributes and each industry has its own set of dynamics which will dictate or prioritize the execution strategy of your Exit Strategy Plan. The end result is a well defined plan for positioning the business to build strategic value and preparing for a successful sale in a reasonable time frame.


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INGREDIENTS OF A SUCCESSFUL EXIT

• A written Exit Strategy Plan based on an owner’s objectives.

• Designed and implemented by an experienced team of advisors.

• Cash flow, maximizing value

• Management Team capable of running the business.

• Time.


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EXIT PLAN COMPONENTS


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SEVEN STEP PROCESS

• Step 1 – Indentify Exit Objectives

• Step 2 – Quantify Business and Personal Financial Resources

• Step 3 – Maximizing and Protecting Business Value

• Step 4 – Ownership Transfer - Selling to Third Parties

• Step 5 – Ownership Transfer - Selling to Insiders

• Step 6 – Business Continuity

• Step 7 – Personal Wealth and Estate Planning


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1. IDENTIFY EXIT OBJECTIVES

The process begins with answering three questions:

• How much longer does an owner want to work in the business before retiring or moving on?

• What annual after-tax income does the owner want during retirement?

• To whom does the owner want to sell the business?

Benefits to the Owner:

• Clarifies priorities.

• Facilitates progress by indentifying a desired outcome.

• Controls and defines the Exit Strategy Planning process.


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Additional Objectives:

• Shift wealth to children.

• Provide charitable gifts or transfers.

• Reward employees.

• Receive full value for the business.

• Take business to the next level.


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Advisory Team:

• Who is the advisory team?– Attorney – Estate, Tax, Corporate– Wealth Management Advisor, Financial Planner– CPA– Insurance Advisor– Valuation Specialist– Exit Strategy Planning Specialist

• No one professional has all the answers.

• Diverse skills and talents are necessary.

• Team approach minimizes time and cost.


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2. QUANTIFY BUSINESS AND PERSONAL FINANCIAL RESOURCES

• Perform a “needs assessment” to determine the amount of after-tax dollars needed to lead the desired lifestyle after exiting the business.

• Perform a third party valuation of the business.

• Do the combined business and personal financial resources meet your target amount?


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3. MAXIMIZING AND PROTECTING BUSINESS VALUE


• Increase enterprise value by creating and enhancing the value drivers of the business.

• Tax strategy -reduce income taxes upon sale of business.

• Protect assets from potential business and personal creditors.

• Motivate and keep key employees.

• Create ability to sell the business.


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Value Drivers:

• Proven management team.

• Reliable operating systems and processes.

• Effective financial controls.

• Realistic growth strategy.

• Product differentiation.

• Proprietary technology.

• Market defensibility.

• Established and diversified customer base.

• Established and diversified vendor base.

• Consistent profitable performance trends


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Process:

• Assess industry structure, the balance of power of your business (Supplier Power, Buyer Power, Competitive Rivalry, Threat of Substitution and Threat of New Entry).

• Perform a SWOT (Strengths, Weaknesses, Opportunities and Threats) analysis of the business.

• Analyze competitive position, advantages and value drivers of the business.

• Review operating systems and processes.

• Assess human resources, asset and capital requirements.

• Assess value creation alternatives.

• Develop a strategic plan to enhance the value drivers of the business and address weaknesses and threats; positioning the business to achieve optimum value on an after tax basis.


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FIVE FORCES – BALANCE OF POWER

Threat of New Entry: Competitive Rivalry:

Cost advantages Number of Competitors

Economies of scale Quality differencesTime and cost of entry Customer loyaltyBarriers to entry Switching costs

Supply Power:Number of suppliers Buyer Power:Size Number of customersCost of Changing Price sensitivity

Ability to substituteThreat of Substitute:Cost of ChangePerformance


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Competitive

Rivalry

Supplier Power

Buyer Power

Threat of New Entry

Threat of

Substitute

SWOT ANALYSIS

Strengths: Weaknesses:

What do others see as your strengths?

What factors lose you sales?

What do you do well? What could you improve?

What advantages do you have? Where do you have fewer resources?

What unique resources do you have?

What do others see as weaknesses?

Opportunities: Threats:

What opportunities are open to you?

What trends can harm you?

Take advantage of current trends?

What is your competition doing?

Can you turn your strengths into opportunities?

What threats do your weaknesses expose you to?


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Possible recommendations:

• Management Team Development Plan.

• Profit margin improvements (outsourcing processes, procurement costs, pricing, production improvements, cost reductions, acquisitions).

• Key Employee Incentive Compensation Plan (stock bonus, stock appreciation rights, non-qualified compensation plan, cash bonus).

• Separation of business assets from business operations.

• Non- solicitation, Non-compete agreements.

• Wealth transfer to children during owner’s lifetime.


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4. OWNERSHIP TRANSFER – SELLING TO THIRD PARTIES

Benefits to Owner:

• Cash at closing.

• Eliminate or reduce financial risk.

• No family succession issues.

• Speed of exit.


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4. OWNERSHIP TRANSFER – SELLING TO THIRD PARTIES

Considerations:

• Ability to sell and business value determined by:― Intrinsic Value: the value drivers― Extrinsic Value: the value the market places on the business― Effectiveness of the sale process

• M&A Marketplace:― Success rate is one out of four actually sells(1)

― Success rate for businesses with sales of $10 million – one out of three(1)

― Success rate for businesses with sales above $10 million – 50-50(1)

• Positioning the business for sale, pre-sale due diligence and tax planning.

(1) 2005 Business Reference Guide by Tom West


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5. OWNERSHIP TRANSFER - SELLING TO INSIDERS


• Achieves exit objective of:― Selling to key employee group― Transferring to a relative

• Motivates and retains key employees.

• Planning reduces risk and increases amount of cash received by minimizing the tax consequences for both the seller and buyer.


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The 5 Rules of Engagement for Insider Transfers

• Do not take an inordinate amount of risk on the front end.

• Do not give up control until receiving the last dollar.

• Shorten the timeline as much as possible.

• Minimize taxes for both parties.

• Utilize the cash flow of the business as efficiently as possible since that is the resource paying for the transfer.


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Sale to a Third Party for Cash:


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Fair Market Value = $10,000,000Cash Flow = $2,500,000

Buyer

Cash for purchase

Owner

$8,000,000 Net of Tax


Sale to Employee for Installment Note:


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Fair Market Value = $10,000,000Cash Flow = $2,500,000

EmployeeCash flow from business $2,500,000 - $1,500,000 (net of taxes)Cash to Owner $1,200,000 (net of taxes)

Owner

$8,000,000 Net of Tax

Timing: 7 – 9 years


Transfer to Employee Phase 1:


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Fair Market Value = $5,000,000 - $10,000,000Cash Flow = $2,500,000

EmployeePurchased 40% for $2,000,000($1,000,000 of cash flow per year to employee)

Owner$480,000 Net of Tax$1,440,000 After 3 Years

OwnerCash flow from business $1,500,000

Owner$900,000 Net of Tax$2,700,000 After 3 Years


Transfer to Employee Phase 2:


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Fair Market Value = $5,000,000 - $10,000,000Cash Flow = $2,500,000

EmployeePurchased 60% for $6,000,000

Owner$4,800,000 Net of Tax

Timing: 3 years

Owner$8,940,000 After 3 Years


Possible recommendations:

• Sale of ownership interest (cash, note or bank financing).

• Bonus or gift of ownership interest.

• Grantor Retained Annuity Trust (GRAT).

• Non-qualified deferred compensation plan (409a).

• Buy back agreement for minority owner.


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FAMILY SUCCESSION ISSUES

• Only one third of family businesses are passed to the second generation

• Only 10% are passed to the third generation

Reasons:

• Children may not get along

• Different career goals

• Inability for parents to achieve financial goals

• Unable to run the business


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INGREDIENTS OF SUCCESSFUL TRANSFER

• A written plan– Defines financial independence– Defines fairness in distribution– Timeline

• Only one child becomes sole successor or at least control

• Business transition plan is fair to all

• Parents achieve financial security independent of the business

• Business active child demonstrates the ability and willingness to run the business

• There is a backup Plan B


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INGREDIENTS OF SUCCESSFUL TRANSFER

Reasons for backup Plan B:

• Value increases to a point a buyout is financially too difficult

• Increase in value exceeds value of other assets – “fairness”

• Business becomes too complex or sophisticated for one child

• Child losses interest or becomes ill


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6. BUSINESS CONTINUITY PLANNING


• Objectives can still be achieved if you do not survive your exit.

• Retains ownership and control of business if co-owners depart.

• Can force non-contributing owners to leave the business.

• Provides consistency between lifetime and death objectives.

• Ensures survival of the business for the benefit of others by:– Addressing continuity of ownership– Addressing the potential loss of financial resources– Addressing loss of key talent, customers and vendors


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6. BUSINESS CONTINUITY PLANNING

Possible Recommendations:

• Review and update continuity guidelines.

• Review and update Buy-Sell (Shareholder) Agreement– Valuation– Funding mechanism– Address voluntary and involuntary termination

• Insurance for continuity planning.

• Stay bonus plan.

• Plan for financial independence of the business.


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7. PERSONAL WEALTH AND ESTATE PLANNING


• Preserve wealth, minimize taxes using both lifetime and death planning tools.

• Coordinates and integrates lifetime exit objectives with the estate plan.

• In effect, estate planning becomes part of the business planning.

Possible Recommendations:

• Personal asset protection planning.

• Personal and family insurance.

• Transferring of specific non-business assets.

• Personal wealth management plan.


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REALITY

Eventually every owner will exit their business voluntarily or otherwise. Proper Exit Strategy Planning will enable you to:

• transition under your time frame

•maximize the after-tax value of your business

•ensure continuity in case of an unexpected event

•assure financial security for you and your family


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Date post:	13-Sep-2014
Category:	Business
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