Transfer of Ownership to a Business-Active Child

All business owners will need to answer these three questions at some point:

1. What is my desired date of departure or exit?

2. How much $$$$ will I need for my goals and for life after the business?

3. To whom will I sell my business?

For many business owners, the preferred answer to the third question is a sale or transfer to my child, or children, that are active in the business. In such cases, the owner would have legacy or values-based goals that would be realized with a transfer of the business to their children. And, it’s not uncommon for these goals to be as important to the owner as their financial goals.

First steps in deciding if this is your best option for exit would include the following:

• Does my child want to be an owner? It can be surprising for an owner to discover that their business-active child has no desire to own “the family business”.

• Is my child capable or have the temperament for business ownership? Owning a business is quite different than having even a significant leadership role in the business. And, as parents, we can be very generous in the evaluation of our children so it is wise to obtain an expert assessment.

• Should my child pay for the business interest? Would I want them to pay for all or some of the business? Do I want them to experience the financial challenges that often occur in the early years of owning a business?

• Is minimizing the overall estate, gift, and income tax burden important to me?

• Am I concerned about the “fair distribution” of my entire estate to all my children including those not active in the business?

• How soon do I want to transfer meaningful ownership interest to my business-active child?

• Quantify available assets and resources to accomplish financial goals:

  • Estimate the value of the business.

  • Project future net cash flow of business available for planning.

  • Value and income from non-business assets.

  • Calculate any gap between the current value and what will be needed post-exit.

Following are the most common methods for transferring a business interest to a business-active child:

• Sale of stock

• Gift of stock

• Bonus of stock

Each of these methods has advantages and disadvantages, but a good place to start is having your Wealth and Tax Advisors conduct an analysis of the tax consequences of each scenario for your specific situation.

Please contact us if we can be of service to you in helping plan for a transfer of your business to your business-active child. Also, consider investing 15 minutes in our FREE exit readiness assessment.

Trust the Process of System Documentation

In business, one key aspect often separates successful ventures from those that struggle to thrive: systems documentation. It's the roadmap, the blueprint outlining how a business operates, from its day-to-day processes to long-term strategies. In a recent ExitReadiness® PODCAST episode with guest Jason Henderberg, we discussed how meticulous system documentation can significantly enhance a business's value, ultimately paving the way for a higher sales multiple.

With over 30 years of experience, Jason has witnessed firsthand the transformative power of systematizing business operations. His advice? "Trust the process."

During our conversation, he emphasized the importance of documenting systems comprehensively and likened it to crafting a playbook encapsulating every facet of your business, from customer interactions to backend processes. This documentation serves as a tangible asset, offering prospective buyers a transparent view of how the company functions efficiently and profitably.

But why does this matter? It's all about perception and value. Businesses with well-documented systems exude reliability and scalability, qualities that are immensely appealing to potential investors or buyers. When every operation is meticulously outlined, it instills confidence in a prospective buyer and mitigates risk, two factors that can significantly impact the valuation of a business.

Moreover, Jason highlighted the operational efficiencies that stem from system documentation. By streamlining processes and clearly defining roles and responsibilities, businesses can operate more smoothly, increasing productivity and profitability. This, in turn, enhances the industry's attractiveness to potential buyers who seek revenue streams and sustainable and scalable operations. He also pointed out that system documentation is not a one-time task but an ongoing endeavor. As businesses evolve, so too must their systems. Regular updates and refinements ensure that the playbook remains relevant and reflective of the current state of the company. It's a continuous improvement journey that pays dividends in the long run.

But how does one go about documenting systems effectively? It starts with a systematic approach. Strategically identify critical processes within your business and break them down into manageable steps. Document each step meticulously, leaving no room for ambiguity. Visual aids such as screen recordings or diagrams enhance clarity and comprehension. He also emphasized the importance of involving key stakeholders in the documentation process. Who better to provide insights into day-to-day operations than the individuals directly involved? By soliciting employee input at all levels, businesses can ensure that their systems documentation accurately reflects reality while fostering a sense of ownership and employee engagement.

In essence, Jason advises to "Trust the process of system documentation." It's not just a mundane task; it's an investment in the future value of your business. The sooner you start developing a company-wide culture of following best practices, the sooner you will have a safety net in case you need to sell your business during an emergency. So, roll up your sleeves and get to work following his proven methods. The value of your business depends on it.

A Succession Plan or an Exit Plan? Savvy Business Owners Need Both!

One of the questions we often hear from business owners is, “What is the difference between Succession Planning and Exit Planning?  Aren’t they the same thing?”  Surprisingly, they are not.  The next question usually is, “Which one do I need?” The answer is simple.  Whether the business is small or large, family-owned or not, astute business owners always need both.

Nearly $10 trillion dollars in business assets will be transferred globally in the next decade, according to Forbes Magazine.  Baby Boomers selling privately owned businesses or transferring them to family members will comprise much of that $10 trillion dollar transfer.  As the market becomes crowded with owners ready to sell, the advantage will go to those owners who have done their due diligence, considered all of their options, and planned for unexpected contingencies.

Succession Planning

Succession Planning focuses solely on transferring leadership inside the business from one generation to the next.  Succession plans identify key individuals within the organization who can be trained and mentored to someday take over as the existing business leaders exit.  Succession Planning is just one necessary aspect of a more comprehensive exit plan.

Exit Planning

Exit Planning incorporates succession planning with strategies for building transferrable value, reducing tax liability, preparing for unexpected contingencies, minimizing family stresses, and increasing the likelihood of a successful business transfer.  Exit plans also incorporate the personal and financial goals of the business owner, their spouse, and their family.  A prudent exit plan starts and ends with the long term business and personal objectives of the owner.

Plan Ahead for A Successful Exit

Succession plans and exit plans so share an important characteristic – neither should wait.  Business owners who eventually want to sell for top dollar with the least amount of trouble must start the planning process early enough to give it the thought and consideration it requires.   With the proper plans in place, you, the business owner, gains the ability to make critical long-term decisions that will significantly increase the likelihood of selling or transferring the business when you want, to whom you want, and for the price you want.

Take our FREE 15-Minute ExitMap® Assessment and find out how ready you are to exit successfully.

Get 15% off of our ExitReadiness® ACADEMY online exit roadmap course with videos and planning template using code BLOG10.

Year End Action: Sole Owners Should Review Business Continuity Instructions

The end of each year is an ideal time for a sole business owner to review and update their Business Continuity Instructions. An owner’s death or permanent incapacity often leads to the failure of a business, resulting in very difficult consequences for the family, employees, and customers. Written and distributed Business Continuity Instructions will provide those left behind with essential short-term and long-term instructions regarding the continuance of the business.

Very practical short-term information needed on day one, such as…

• Bank account information

• Insurance coverage and location of policies

• Location of spare keys, security codes, and passwords

• Who has the authority to make immediate decisions? Operations? Finance? Administration? Etc.?

• What Key Advisors need to be contacted and engaged?

Long-term information about the continuance of the business, such as…

• Who comprises the Board of Directors (if applicable)?

• How do you want the business transferred? Sale to third-party? Sale to family? Sale to insiders? Liquidated?

• Do you have a current estate plan?

• Is there long-term debt and/or lines of credit that you’ve personally guaranteed?

• What are the sources of working capital during the time of transition?

• What agreements are in place with key employees? Employment Agreements? Stay Bonuses?

Having data like the above current and readily available for those left to continue the business could be the difference between the business continuing for as long as needed and being liquidated at a fire-sale price.

As we approach the end of this year and the start of 2022, we suggest investing time in creating or modifying your written instructions. Contact us today for a free copy of our Business Continuity Instructions fillable PDF.

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What are The Critical Elements in Training My Business Successor?

Training your Business Successor is crucial in ensuring a smooth transition of ownership and leadership. The following are critical elements to consider when preparing your Business Successor:

Knowledge Transfer:

1. Identify the knowledge and skills necessary to run the business effectively.

2. Document and share critical information, processes, and best practices with your successor. This includes financial management, sales and marketing strategies, operational procedures, customer relationships, vendor management, and industry-specific knowledge.

Mentoring and Shadowing:

1. Provide your successor with hands-on experience by allowing them to shadow you and observe your day-to-day activities.

2. Encourage them to ask questions, participate in decision-making, and gradually take on more responsibilities.

3. Act as a mentor, providing guidance and sharing insights from your experience.

Delegation and Autonomy:

1. Gradually delegate tasks and responsibilities to your successor, allowing them to practice decision-making and leadership skills.

2. Start with smaller tasks and gradually increase their level of autonomy as their competence and confidence grow. This will help them develop their management style and take ownership of their role.

Communication and Collaboration:

1. Foster open and transparent communication with your successor.

2. Encourage them to share their ideas, concerns, and observations about the business.

3. Establish regular meetings or check-ins to discuss progress, challenges, and future plans.

4. Involve them in important meetings with key stakeholders, such as clients, suppliers, and employees, to develop relationships and gain a broader understanding of the business ecosystem.

Strategic Thinking:

1. Provide exposure to strategic decision-making by involving your successor in developing business plans, goal setting, and long-term strategies.

2. Discuss market trends, competitive analysis, and growth opportunities.

3. Encourage them to think critically and creatively about the future of the business and how to adapt to changing circumstances.

Building Relationships:

1. Introduce your successor to essential stakeholders in the business, such as key clients, suppliers, and industry contacts.

2. Help them establish and maintain relationships, as these connections can be valuable for the business's future success.

3. Encourage networking and participation in industry events and associations to expand their professional network.

Emotional Intelligence and Leadership Development:

1. Focus on developing your successor's emotional intelligence and leadership skills.

2. Help them understand the importance of effective communication, empathy, conflict resolution, and team management.

3. Provide opportunities for leadership development through training programs, workshops, or executive coaching.

Continual Learning and Adaptability: Encourage your successor to embrace continuous learning and adaptability. The business landscape is ever-changing, and staying updated on industry trends, technological advancements, and best practices is essential. Encourage them to attend relevant seminars, conferences, and workshops and engage in professional development activities.

Remember that the training process should be tailored to your successor's specific needs and capabilities. It's essential to be patient and supportive and allow for a gradual transition of responsibilities. By investing time and effort in training your successor, you increase the likelihood of a successful handover and the long-term sustainability of your business.

Learn more about our ExitReadiness® Successor Coaching service HERE.

Understanding the Taxation of Key Person Insurance

Key person insurance plays a vital role in protecting businesses from the financial impact of losing key individuals within the organization. It provides a safety net by compensating the company for the loss incurred due to the death or disability of a key employee. While key person insurance is a valuable risk management tool, business owners must understand the taxation aspects associated with these policies.

Tax Treatment of Premiums

Generally, the premiums paid for key person insurance policies are not tax-deductible as a business expense. The Internal Revenue Service (IRS) considers key person insurance premiums as a capital expense rather than an ordinary and necessary business expense. As a result, the premiums are typically not deductible from the company's taxable income.

Tax Treatment of Proceeds

When a key person insurance policy pays out due to the death or disability of the insured employee, the tax treatment of the proceeds depends on various factors. Generally, the insurance proceeds the business receives are not considered taxable income. Therefore, the payout is not subject to income tax.

However, there are situations where tax implications may arise. For instance, if the business has previously deducted the premiums paid as a business expense, any insurance proceeds exceeding the total premiums paid would be subject to income tax. Additionally, if the business has transferred ownership of the policy to the key employee, the proceeds may be taxable to the employee.

Tax Treatment of Cash Value

Some key person insurance policies, such as whole life or universal life insurance, accumulate cash value over time. The growth of this cash value is tax-deferred, meaning that the business does not have to pay taxes on the growth of the policy's cash value until it is withdrawn.

However, suppose the company surrenders the policy and receives the cash value. In that case, any amount received above the total premiums paid is subject to income taxes. It is important to note that withdrawing cash value from the policy can have tax implications, and consulting with a tax professional is recommended.

Tax Treatment of Premium Financing

Premium financing is a strategy where a third party provides a loan to the business to cover the premiums of a key person insurance policy. The company repays the loan with interest over time. From a tax perspective, the interest paid on the premium financing loan may be tax-deductible as a business expense, subject to certain limitations and restrictions.

Conclusion

Key person insurance is essential for businesses to mitigate the financial risks of losing key individuals. While the premiums paid for key person insurance are generally not tax-deductible, the death benefit received by the company upon the insured individual's death is typically tax-free. Businesses need to be aware of the potential tax implications of key person insurance, especially regarding cash value growth, policy transfers, and premium financing. Consulting with a qualified tax professional can help ensure compliance with tax regulations and maximize key person insurance benefits while minimizing tax burdens.

Contact us at email@ennislp.com or 301-859-0860 if we can be of service in reviewing your key person insurance program.

INVEST 12-15 MINUTES IN THE FREE EXITMAP® ASSESSMENT AND GET A 12-PAGE REPORT SCORING YOU IN FOUR KEY EXIT PLANNING AREAS: FINANCE, PLANNING, REVENUE/PROFIT, AND OPERATIONS.

What Happens When a Sole Proprietor Dies Unexpectedly?

A sole owner of a business who has a spouse and/or family has not a few key planning issues that need to be addressed before it’s too late.  “Too late” is the unexpected event of death or permanent incapacity or disability.  To illustrate, let’s use the following story that is based on real-life events…

John Doe owned a very successful commercial real estate development firm.  He regularly met with his Business Advisor and “game planned” aggressive growth strategies that were proving to be successful in building the value of the business.  To the point where John was seriously considering expansion into other geographic areas.  Life was good and the business was growing rapidly!

One evening after meeting with his advisor, John experienced a sudden heart attack and died later in the hospital.  At age 55 he still had family financial responsibilities, yet he had not been as thorough in his personal and family financial planning as he had been in planning to build the business.  It was a time of extreme grief and mourning as well as uncertainty for Jane…

• She didn’t know what to do next.

• She didn’t know if John’s salary would, or could, continue.

• Employees and customers started to leave as there was no plan, and so the business became less valuable and sellable.  This was problematic as Jane was dependent on the sale value of the business as John had limited life insurance and investable assets.

• Due to the high level of uncertainty, there was a lack of peace and stability for Jane and for everyone who was at all dependent on the business.

There were too many things that John didn’t do, and that should have been done, to mention in a short blog post. So, highlighted here are just a few (not an exhaustive list) of the key planning solutions that, if John had put them in place, would have helped in minimizing the agony that Jane and the family experienced…

• Clear written instructions that were aligned with updated and adequate estate planning documents as to how to continue the business.

• A personal financial plan that included a cash flow analysis of how much money Jane would need both short-term and long-term in the event of John’s early death. 

• A written resolution for Jane to continue to receive John’s salary until insurance proceeds were received.

• Plans for the business bank line of credit to continue uninterrupted.

• A current and adequate personal life insurance program.

• Key person life insurance on John that would have provided needed liquidity for the business to provide key employee stay bonuses, etc.

  Invest 12-15 minutes in the FREE ExitMap® Assessment and get a 12-page report scoring you in four key exit planning areas: Finance, Planning, Revenue/Profit, and Operations.

Salary (Wage) Continuation or Deferred Compensation?

Non-Qualified Deferred Compensation (NQDC) often plays a role when structuring either a sale to insiders or a transfer of the business to children in the business. It is a type of retirement plan that allows highly compensated employees (in this case the exiting owner) to realize tax advantages by deferring a percentage of their compensation (and current income taxes) beyond what is permitted by the IRS in a qualified retirement plan (i.e., 401K). In essence, it is paying out INCOME EARNED at some point in the future, with a primary goal of minimizing income taxes.

A Salary, or Wage, Continuation Plan, however, is used to ensure personal financial stability for an owner, or key employee, during a triggering event such as death, disability, or retirement. It is a plan for continuing income NOT YET EARNED after the trigger event having the following goals:

• Ensuring salary for a set period of time (typically 60 days to 12 months) when unable to work

• Bridge the gap until insurance benefits begin

• Protect from personal/family financial loss

The following are pertinent questions in deciding whether a Salary Continuation Plan should be considered:

• What are the short-term gaps in your personal insurance/benefits package?

• If you die or become disabled, is it important for your spouse/family to continue to receive your salary for some period of time? For how long?

• Would the company be able to continue your salary if you are not working? For how long?

• Are you relying on your co-owners verbal commitment to provide ongoing payments?

If you think a Salary Continuation Plan could be helpful in your situation, your Business Attorney, Employee Benefits Advisor, or Insurance Advisor, could be of assistance in the analysis and execution of a plan. And, as always, please contact us if we can be of assistance.

Take our FREE ExitMap® Assessment and get a 12-page report scoring you in four key planning areas: Finance, Planning, Profit/Revenue, Operations. It will take about 15 minutes and we do not ask for confidential information.

ennislp.com | email@ennislp.com | 301-859-0860

Before Moving Forward with a Sale to Key Employees...

If you’re a business owner with a desire and vision for selling to key employees who have helped you build the business, the following is a short list of important issues to seriously consider prior to moving forward. And, the sooner you begin the greater chance of a successful transition.

• Identify and test your assumptions. For example, it’s not uncommon for owners to assume that employees want to buy and own the business. Often this simply isn’t the case due to differing values, life goals, risk tolerance, etc. You and they will be better served if this is established sooner rather than later. It’s not unusual for key employees to prefer a cash-based incentive plan such as Phantom Stock, particularly if they are approaching an age for retirement.

• Employees may be enthusiastically willing to become owners, but perhaps not equipped or even well suited to become owners. Facilitating an objective evaluation of their skills and characteristics, and professional coaching if needed, early on in your process is advisable.

• Avoid making premature and unsubstantiated promises about ownership, either written or verbal, that can result in employee expectations of ownership.

• Be clear on common mistakes to avoid such as selling too much too soon and giving up control prior to realizing goals or including employees in the buyers’ group that will not work well as partners (see the Partnership Charter).

• Be clear on your own risk tolerance. For example, how much $$$$ of a deal would you be willing to self-finance, and for how long? Forecasting business cash flow with a “sanity check” on how the business would financially support the transaction will help you decide how much risk you’re willing to take on.

These are things you could do on your own without assistance, but a safer and risk-averse way to proceed is to engage professionals who can identify and test your assumptions, what you know and don’t know, and then provide advice as to how to proceed wisely.

Invest 12-15 minutes in the FREE ExitMap® Assessment and get a 12-page report scoring you in four key exit planning areas: Finance, Planning, Revenue/Profit, and Operations.

Will Your Buy-Sell Agreement Solve Problems or Cause Problems?

The most important business planning document that multiple owners of a business can have is a buy-sell agreement.  A buy-sell agreement provides direction to owners and other stakeholders when certain events trigger the transition of an ownership interest in a business. 

These agreements can be very effective in minimizing uncertainty and indecision during challenging and emotional times.  However, it’s not enough to simply have a buy-sell agreement, it needs to be written skillfully to accomplish the desires and goals of the owner(s).

Buy‐sell agreements, in some situations, can create as many questions, problems, and conflicts as they seek to address.  A primary benefit of having this agreement is to avoid having to make decisions that could lead to disagreements at an inopportune time.  Unanswered questions, outdated agreement language that no longer represents the goals of the owner(s), an agreement that is not comprehensive and too simplistic or was poorly implemented can render the buy‐sell agreement ineffective and fail to accomplish the intended purpose.

Opening questions:

• Do you need a buy-sell agreement, and if so, do you have one?

• Is your buy-sell agreement outdated?  When was the last time your agreement was reviewed to ensure that it still well represents your goals? 

• Will your buy-sell agreement cause more problems than it would solve in its current form?

Too often buy-sell agreements have one or more of these planning gaps:

1. Ignores lifetime trigger events such as divorce, bankruptcy, voluntary exit, and involuntary exit.

2. A simple valuation method that does not consider the ever-changing dynamics and growth of the business. 

3. The timing of valuation is not adequately addressed.

4. When buy-sell agreements are not regularly reviewed, they can become outdated and result in unpleasant surprises when they are needed. Owners rely on Buy-Sell Agreements to manage emotional situations, and if those agreements don’t account for changes in their goals as well as the business, they can cause significant problems for everyone involved.

5. Many buy-sell agreements are too simplistic to manage the personal complexities of the individual owners who sign them, and their relationships with each other. For example, companies with multiple owners often don’t want to treat all owners similarly, or one owner subject to the agreement may be uninsurable. In family businesses, non-business considerations may affect the design of buy-sell agreements.

6. Fails to address threats to business continuity.  Most buy-sell agreements don’t address the challenges that the business, surviving owners, and deceased owner’s family will face after an owner exits. Too often they only address the transfer of ownership upon an owner’s death or permanent incapacitation. For example, if the surviving owner does not have enough assets to satisfy the personal guarantees previously made by the deceased owner, once that financing is pulled, the business may not be able to continue. Likewise, if the deceased owner was the company’s rainmaker or COO and no one can step into those roles, the business may be unable to survive.

7. Buy-sell agreements are typically deficient in considering the financial security of the decedent’s family. 

Questions your buy-sell agreement should answer include the following:

• Are “lifetime triggering events” addressed as well as death and disability?  Divorce?  Bankruptcy?  Voluntary exit?  Involuntary exit?

• What type of valuation estimate is required?  Book value?  Fair market value?  Fair value?  Investment value?  Agreed upon value?

• What is the desired timing for the value calculation?  Date of the trigger event?  Subsequent event?

• Does the entire business need to be valued, or a partial ownership interest? 

• What method of funding will be used to complete the transaction?

  • Cash – Requires sufficient cash flow or reserves to pay the full sale price in a lump sum.  May not be available when needed.

  • Loan – Future credit availability and cost of borrowing are factors. 

  • Installment Sale – Requires repayment from earnings and is contingent upon the future growth and success of the business.

  • Insurance – Provide liquidity when needed for either death or disability trigger events.

• Should the buy-sell agreement method of funding be taken into consideration in the value?

• What method will be used for valuation?  Fixed price?  Formal valuation?  Formula-based?

• Is there clarity as to what is mandatory and optional regarding the purchase or sale of an ownership interest?

• What goals for your spouse and family do you want to be realized if you die, become incapacitated, or otherwise exit the business unexpectedly? 

Contact us today to learn more about our STRATEGY RENOVATION® Business Continuity Plan if you need help creating or “renovating” your plan for the unexpected.

Preparing a Successor...How Long Does It Take?

It’s an important question to answer. The company’s future, the successor’s success, and the ability to make buyout payments depends on it.

When it comes to learning the business and the industry, an owner probably knows best as to how long that will take. Generally, this will take anywhere from 3-15 years. However, learning the mechanics of a business does not necessarily make someone a good leader nor a good owner. (After all, most successors have only been an employee.)

Clearly, some people are more natural at leading than others, but one thing is sure. We're not very good at self-assessment (especially when it comes to leadership). Assuming a successor understands the business, their effectiveness as a leader and as an owner needs to be objectively assessed and their weaknesses improved.

A leadership assessment followed by a program of executive coaching will accomplish this. After 20 years of developing leaders, I can say that the process generally takes about 6-12 months.

But a major challenge can arise. What if that successor turns out not to be competent as a leader and an owner? By way of example, years ago I had a client who kept bringing on potential successors (without my help, by the way...), only to have each of them fail. One after another (three in total), each failed and either left the company or had to be fired. Before they found a suitable successor, almost 4 years had transpired.

The bottom line is that it's better to start the leadership development process sooner than later. Don't hand over the keys to your business before your successor's competence is assessed, their weaknesses addressed, and their leadership and judgment demonstrated.

————————————————-

Michael Beck is an executive coach, business strategist, author, and president of Eliciting Excellence.  His 20 years as a professional executive coach has helped leaders improve interpersonal skills, sharpen strategic thinking, and enhance judgment.  He has worked domestically and internationally with a wide range of clients from diverse industries including technology, manufacturing, professional services, healthcare, financial services, and not-for-profit.  Michael has held executive positions ranging from CEO to  VP of Business Development and has a background in engineering (BS, MS – University of Pennsylvania) and finance (MBA – Wharton School of Business). Michael is the author of the book “Eliciting Excellence”, has a Black Belt in self-defense,  and is a competitive dart player.

Negotiating an Exit Strategy with Business Partners

Sarah and Jane founded their business 15 years ago, when Sarah was age 45 and Jane was 30. Now, at age 60, Sarah is beginning to think about “what’s next” and how much longer she wants to remain in the business. She very much wants more time to spend with her new grandchildren, and her husband Jack, age 65, who recently retired from the government would like for them to travel more and spend more time at their beach house.

Meanwhile, Jane at age 45, has a vision for massive growth over the next 10 years and is fully engaged in making that happen. She has no plans to leave anytime soon, and actually now has her son Sam working in the business who has expressed interest in one day owning the business.

Fifteen years ago, Sarah and Jane shared a common vision for the business as their personal goals were much more in alignment. Things have now changed as their personal goals and dreams have shifted. And, at times these differences result in tension and relational conflict. What is good and promising is that they both realize their situation has indeed changed, and agree that they will need outside help in planning a way forward that considers their respective interests and goals.

Too often owners, in a situation like the one here with Sarah and Jane, quickly move to the tactical or practical before first doing the difficult but critical work of clarifying interests and goals while considering all possible solutions thoroughly and objectively. Emotions can begin to drive actions and reactions motivated by a sense of urgency to “just finalize something and be done with it.” Whereas, if adequate time was invested, with skilled help facilitating a thorough process of negotiation, both Sarah and Jane’s interests would be clarified and addressed in a mutually satisfactory manner, while the process would also be much more productive and less antagonistic.

Following are key steps, often neglected, that Sarah and Jane would be well advised to take in deciding on the strategy they could both be excited about:

• Clarify their own interests and goals: personal, financial, values-based, legacy.

• Seek to understand the interests and goals of one another.

• Identify and clarify alignment and misalignment of interests and goals.

We have found that most business partners will require, and desire, professional assistance to ensure a thorough, peaceful, and effective process. And, in that there is typically not be one perfect strategy that will meet all interests and goals of each partner, there will probably be a need for negotiation.

In their book, GETTING TO YES: NEGOTIATING AGREEMENT WITHOUT GIVING IN, Roger Fisher and William Ury propose an effective method of principled negotiation developed at the Harvard Negotiation Project. Fisher and Ury describe the following as basic principles of this method:

1. People: Separate the people from the problem.

2. Interests: Focus on interests, not positions.

3. Options: Invent multiple options looking for mutual gains before deciding what to do.

4. Criteria: Insist that the result be based on some objective standard.

Because Sarah and Jane cared much about each other and preserving their much-valued relationship, as well as doing what was absolutely best for the business they had both worked so hard to build, they readily agreed to commit both time and finances to ensure a mutually beneficial and effective process.

There is much at stake on both sides of the table, as well as with the business itself, when negotiating strategies and solutions for partner exits. Make sure you invest adequate time and resources in getting it right. GETTING TO YES is a highly recommended resource, and engage the professional assistance you know you need. You can reach us at email@ennislp.com or 301-859-0860.

Invest 12-15 minutes in the FREE ExitMap® Assessment and get a 12-page report scoring you in four key exit planning areas: Finance, Planning, Revenue/Profit, and Operations.

Low Employee Engagement or High Turnover and Building Business Value

There may not be a greater management challenge in building the value of your business than engaging and retaining your employees. 

It is not unusual to hear business owners, with frustration, express as one of their greatest ongoing concerns the engagement and retention of their employees.  And it’s costly if you don’t do it right. A few years ago, The Society for Human Resource Management (SHRM) reported that on average it costs a company 6-9 months of an employee’s salary to replace the employee.  For example, for an employee earning $60,000 per year, the costs of recruiting, training, etc. would be in the range of $30,000 - $45,000.  These figures are probably higher today.

Business owners typically understand from experience that low employee engagement and high turnover are financially expensive, but sometimes they’re not aware of how costly these challenges can be to the business culture they have worked so hard to establish (which is also financially expensive).  We’ve all heard the Peter Drucker quote, “Culture eats strategy for breakfast”, implying that the culture of your company always determines success regardless of the impact of your business strategy.  So, culture is clearly very important for building and protecting business value, and a key driver of a strong culture is employee engagement and retention. 

Low employee engagement and high turnover are costly on all fronts.  What can a business owner do about it?

Our firm does not currently have a practice area or special expertise in employee engagement and retention, but we have observed some common practices among business owners who have a track record of success in it. 

• Clearly established vision, mission, and values that are continually communicated and modeled by leadership/management, which serves to facilitate a strong corporate culture.

• Clearly defined growth and succession plan that involves the retention of key employees.

• Clearly defined and communicated employee incentive (rewards, retention) plans that are aligned with corporate goals for growth.

•  Employee expectations are clearly defined and communicated.

•  Employees are held accountable and receive regular feedback on their performance.

• There is an employee selection and onboarding process in place that is well-defined, disciplined, and values-based.

For most small business owners, employees represent their greatest asset as well as their largest expense.  And hence, it is imperative that employee engagement and retention should be a high priority in managing toward a sellable business with maximum value.  It should be so valued by the business owner and management that it is seen as a significant aspect of the business culture by the employees. 

So, if you are in need of assistance in this area, it is well worth the investment of time and finances to get professional help as soon as possible.  The right advice can save you both money and time.

Invest 12-15 minutes in the FREE ExitMap® Assessment and get a 12-page report scoring you in four key exit planning areas: Finance, Planning, Revenue/Profit, and Operations.

Year End Action: Sole Owners Should Review Business Continuity Instructions

The end of each year is an ideal time for a sole business owner to review and update their Business Continuity Instructions. An owner’s death or permanent incapacity often leads to the failure of a business, resulting in very difficult consequences for the family, employees, and customers. Written and distributed Business Continuity Instructions will provide those left behind with essential short-term and long-term instructions regarding the continuance of the business.

Very practical short-term information needed on day one, such as…

• Bank account information

• Insurance coverage and location of policies

• Location of spare keys, security codes, and passwords

• Who has the authority to make immediate decisions? Operations? Finance? Administration? Etc.?

• What Key Advisors need to be contacted and engaged?

Long-term information about the continuance of the business, such as…

• Who comprises the Board of Directors (if applicable)?

• How do you want the business transferred? Sale to third-party? Sale to family? Sale to insiders? Liquidated?

• Do you have a current estate plan?

• Is there long-term debt and/or lines of credit that you’ve personally guaranteed?

• What are the sources of working capital during the time of transition?

• What agreements are in place with key employees? Employment Agreements? Stay Bonuses?

Having data like the above current and readily available for those left to continue the business could be the difference between the business continuing for as long as needed and being liquidated at a fire-sale price.

As we approach the end of this year and the start of 2022, we suggest investing time in creating or modifying your written instructions. Contact us today for a free copy of our Business Continuity Instructions fillable PDF.

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Key Employees and Building and Protecting Business Value

You may have people working in key roles who are instrumental in growing and building the value of your business. These key people can be identified as having the following characteristics:

• makes a substantial business contribution

• possesses critical information or knowledge or

• maintains and nourishes key contacts and relationships

In helping clients plan to build a business that’s sellable, and then eventually exit on their own terms and conditions, we emphasize that “key people are a key value driver “ in realizing success in both of those strategic goals. And, we find it helpful for owners to have two categories in mind when considering key employees:

1. Building business value

2. Protecting business value

Key people help owners build value and exit successfully as their roles serve in removing the owner(s) from the day-to-day management of the business, and by accomplishing objectives and key results for growing the business, that are aligned with the exit goals of the owner(s). An important planning focus for the owner(s) in building value, as it pertains to key employees, would include alignment of the employee’s performance goals with the exit goals of the owner(s), and a well-defined key employee incentive plan that provides impactful awards for goal attainment and retention.

Owners need to be aware, that there is also inherent risk related to key employees. Risks involving departure and competition, solicitation of customers and/or employees, and disclosure of confidential information. There is also the risk of losing a key employee due to unexpected death or disability. It can be costly to recruit, train, and compensate for a replacement in such a situation, as well as makeup for any loss in corporate earnings. Important planning areas in protecting business value, as it pertains to key employees, would include: Well-written and regularly reviewed employee documents (i.e., Employment Agreement; (listen to ExitReadiness® PODCAST Episode 43 w/attorney Marc Engel) and adequate life insurance coverage on the key employee (listen to ExitReadiness® PODCAST 54 w/Bill Betz of Betz Financial Advisory).

Check out our virtual exit planning resources and solutions at exitreadiness.com

Will Your Successors Be Good Partners?

Deciding on an exit route of a sale to insiders or children can be more complicated and less expedient than a sale to a third party. There are not a few key planning issues when considering this exit option SUCH AS:

• Will the owner’s financial goals be achieved?

• Is the business cash flow strong enough to support a transaction?

• How can the transaction be structured to minimize taxes?

Along with questions like these, that can be more directly related to the owner, there are issues pertaining to the successor or successors that can at times be somewhat taken for granted, or assumed, by the current owner:

• The willingness of the successor(s) to be an owner

• The readiness of the successor(s) to be an owner

It is not uncommon for an owner, who has assumed both the willingness and readiness of a successor(s), when eventually proposing a potential ownership transition, to learn those successor candidates either don’t want to own the business, or they’re far from ready to be owners. This of course can completely derail the hoped-for exit timing and plans of the current owner. And, it can result in the owner being required to come back into the business if indeed the transaction moved ahead without these issues being thoroughly addressed prior.

The successor(s) willingness and readiness questions are often neglected, but not always. There is another successor issue however that is almost always overlooked, and it is fundamental for the future success of the business and ownership transition: Can the successors (if there is more than one) be successful as partners in the business?

If an ownership transfer involves more than one insider (key employees and/or children), the fact that they’ve worked well as co-employees does not ensure they will be as cohesive and collegial as co-owners. When we raise this issue with owners, they immediately “get it” as they often have had their own experiences with partners or they’ve heard stories. This is important because in most insider sale transactions the selling owner needs the business to continue to do well, as part of the sale price is almost certain to be self-financed. And, if the business falters or fails the selling owner may not get paid. So, it is essential that the new owners function well as partners.

Following are a few key areas for potential successor partners to consider prior to moving ahead in purchasing the business:

• Alignment of vision and direction for the business

• Personal core values

• Roles, authority, accountability, and expectations

• Contributions and rewards

• Governance

• Personal styles, strengths, and weaknesses

• Managing conflict

• Money

A process to discuss these issues, which are central to any partnership, would benefit the successor partners but also the selling owner who has a vested interest in seeing the new owners and the business continue to prosper. The Partnership Charter provides such a framework for discussions, negotiations, and agreements. Please do not hesitate to contact us for further information.

Invest 12-15 minutes and complete the FREE ExitMap® Assessment and receive a 12-page report scoring you in four key exit planning areas: Finance, Planning, Revenue/Profit, and Operations.

Living Trusts and Avoiding Probate in Estate Transfer of Your Business

Probate

Probate is the legal process through which property is transferred after a property owner’s death. Generally, the probate process requires the gathering of all assets, paying off debts, and distributing the remaining assets in accordance with the deceased person’s estate plan and the law. The probate process is facilitated by a court-approved, or appointed, a person known as the administrator, executor, or personal representative of the estate.

If a person passes away with a will with assets held in his or her sole name, the estate must go through probate. The court will oversee the distribution of assets according to the terms of the will. As you might imagine and may know from experience, probate can be a tremendous burden and very expensive as the personal representative of the estate deals with the technicalities of the court system. 

Following are some key disadvantages of having an estate go through probate:

·       The time required for probate and administration of the estate

·       The cost of estate administration is significantly increased with an additional cost of probate

·       Court involvement is time-consuming and expensive

·       The probate process is public

Living Trusts and Avoiding Probate

If a business owner’s goals include the stable and uneventful continuance of the business and a peaceful and expedient transfer of ownership in the event of their premature death or permanent incapacity, the owner should, with legal counsel, consider a Living or Revocable Trust as a planning tool in their overall estate plan.  Living Trusts can help in minimizing taxes and legal fees, affording privacy and flexibility, avoiding probate, and making the entire process of business transfer and continuance much easier.  If a business owner passes away with their business titled in the name of the Living Trust, the distribution of assets will go much more smoothly.

With all the positives, there are reasons that a Living Trust may not be the best solution for avoiding probate in the estate distribution of your business.  They include the following:

·      Transferring S-Corporation business interests to certain types of trusts could result in negative tax consequences.

·      Once your business passes to your heir(s), planning steps must be taken to prevent the S-Corporation from reverting to a C-Corporation.

·      Some business interests may lose marketability when transferred to a trust.

·      It could become more challenging to secure bank debt.

·      Depending on the type of trust selected, your interest in the business might be diluted.

·      Transferring interests to a trust could possibly trigger provisions in your buy-sell agreement (if applicable).

In summary, if a smooth and expedient transfer of your business at death or your permanent incapacity is a goal, a Living Trust may be the solution. As with all legal matters, we advise that you seek legal counsel as to the pros and cons and whether it would be a wise strategy for your plans for business continuity and estate distribution.

Invest 12-15 minutes and complete the FREE ExitMap® Assessment and receive a 12-page report scoring you in four key exit planning areas: Finance, Planning, Revenue/Profit, and Operations.

Five Warning Signs Your Business Is Too Dependent On You

If you were to draw a picture that visually represents your role in your business, what would it look like? Are you at the top of an organizational chart, or stuck in the middle of your business like a hub in a bicycle wheel? 

The Hub & Spoke model is a drive that shows how dependent your business is on you for survival. The Hub & Spoke model can only as strong as the hub. The moment the hub is overwhelmed, the entire system fails. Acquirers generally avoid these types of managed businesses because they understand the dangers of buying a company too dependent on the owner.

Here’s a list of the 5 top warning signs that show your business could be too dependent on you.

1. You are the only signing authority

Most business owners give themselves final authority… all the time. But what happens if you’re away for a couple of days and an important supplier needs to be paid? Consider giving an employee signing authority for an amount you’re comfortable with, and then change the mailing address on your bank statements so they are mailed to your home (not the office). That way, you can review everything coming out of your account and make sure the privilege isn’t being abused. 

2. Your revenue is flat when compared to last year’s 

Flat revenue from one year to the next can be a sign you are a hub in a hub-and-spoke model. Like forcing water through a hose, you have only so much capacity. No matter how efficient you are, every business dependent on its owner reaches capacity at some point. Consider narrowing your product and service line by eliminating technically complex offers that require your personal involvement, and instead focus on selling fewer things to more people. 

3. Your vacations… don’t feel like vacations

If you spend your vacations dispatching orders from your mobile, it’s time to cut the tether. Start by taking one day off and seeing how your company does without you. Build systems for failure points. Work up to a point where you can take a few weeks off without affecting your business. 

4. You know all of your customers by first name 

It’s good to have the pulse of your market, but knowing every single customer by first name can be a sign that you’re relying too heavily on your personal relationships being the glue that holds your business together. Consider replacing yourself as a rain maker by hiring a sales team, and as inefficient as it seems, have a trusted employee shadow you when you meet customers so over time your customers get used to dealing with someone else. 

5. You get cc’d on more than five e-mails a day 

Employees, customers and suppliers constantly cc’ing you on e-mails can be a sign that they are looking for your tacit approval or that you have not made clear when you want to be involved in their work. Start by asking your employees to stop using the cc line in an e-mail; ask them to add you to the “to” line if you really must be made aware of something – and only if they need a specific action from you. 

Invest 12-15 minutes in the FREE ExitMap® Assessment and get a 12-page report scoring you in four key exit planning areas: Finance, Planning, Revenue/Profit, and Operations.

Assigning Value to Key Employees

Key employees are “key” because they have a significant impact on the current and long-term success of the business. Hence, the business owner(s) will want to be intentional and strategic in aligning compensation and incentive plans for those key employees with the owner’s goals for business growth and exit. Owners should also protect against the potential loss of these valued employees due to death or disability, as their loss can be quite damaging and even destructive to business value and future growth. Following are suggested steps to take in assigning value to your key employees.

First, it’s important to identify the key employees of your business. An employee should be considered “key” to the success of a business if they:

• make a substantial business contribution (i.e., marketing, sales, administrative) and/or…

• possess critical knowledge or information (i.e, products, service, customers, operations) and/or…

• maintain and develop key contacts and relationships (i.e., customers, suppliers, vendors, etc.)

Once key employees are determined, an insurable value must be assigned to each, which is generally more difficult than assigning value to physical, financial, or real assets. A value must be estimated for the amount of insurance to be purchased by the business on the employee’s life. The value of the key employee to the employer combined with the employee’s anticipated replacement costs equals the amount of insurance that should be purchased.

There are a number of methods that can be utilized in determining the value of a key employee or manager. Following are methods most often used:

• Multiples of Income Method: The easiest and probably the most common method used. Insurance companies often estimate the amount of key insurance needed on a multiple of 5-7 times an employee’s total compensation.

• Replacement Cost Method: The cost to locate, recruit, and train a suitable replacement.

• Employee’s Contribution to Earnings Method: The earnings of a business, for purposes of estimating the insurable value of a key employee, come from its return on invested assets and the skill of the management team (plus expenses for recruiting and training replacement).

• Present Value of Lost Earnings Method: Estimate the business’ lost earnings resulting from the loss of a key employee. The present value of the lost earnings plus the expense of recruiting and training a replacement becomes the insurable value of the key employee.

• One Year’s Business Earnings Method: This method is generally considered to have the least credibility as it is not based on the actual or perceived value to the employer. But instead, it simply determines insurable value by assigning an amount equal to the total of the prior year’s before-tax earnings (plus expenses for recruiting and training replacement).

Protecting the value of your key employees is a critical step in protecting the value of your business. Oftentimes, until a sellable business value is built and realized, the most key employee is the owner(s).

For assistance, contact your insurance professional or contact us at email@ennislp.com or 301-859-0860.

Invest 12-15 minutes in the FREE ExitMap® Assessment and get a 12-page report scoring you in four key exit planning areas: Finance, Planning, Revenue/Profit, and Operations.

Internal Sale with Modified Buy-Out

This internal sale method works best for most owners who have the following goals:

• Transfer their business to key employees

• Motivate and retain key employees

• Receive full value for their business

Let’s look at a short case study regarding the concept of Modified Buyouts.

Donna is age 52 and wants to remain in her business for at least 5 more years.  She would like to “handcuff” her senior managers and salespeople to the company (making it economically rewarding for them to stay with the company) and at the same time, explore his own exit strategy. Her plan is to accomplish both goals by beginning to sell her company to the key people.

A draft Exit Plan was prepared for Donna, listing three primary goals:

1. Establish a plan for the eventual buyout of all of Donna’s ownership of the business.

2. Begin the buyout of a portion of her interest by selling to two existing key employees, Michael Brooks and Alice Patton. Donna would select additional key employees at a later date.

3. Have the plan in place and effective as of March 1st of the following year.

The Exit Plan recommended that Michael and Alice purchase up to a total of 10% of the ownership of EPD (represented by non-voting stock). In the future, other key employees (as yet unidentified and probably not yet hired) would participate in the stock purchase plan. The plan also included a two-phase sale of the business.

Phase One: Sale of Initial Minority Interest. Donna will make a pool of 40% of EPD’s total outstanding stock (converted to non-voting stock) available for current and future purchases by key employees. Initially. Michael and Alice would each own 5% of the outstanding stock (non-voting).

For purposes of the initial buy-in (and any future repurchases of that stock), the value of EPD is based on a valuation (with minority and other discounts) provided by a Valuation Specialist. In EPD’s case, those discounts totaled half of the true fair market value. A lower initial value is necessary to make the purchase affordable for the employees and to provide them an incentive to remain with the company. The initial purchase price will be paid in cash. If either key employee needs to borrow funds to secure the necessary cash, EPD will be willing to guarantee the key employee’s promissory note to a bank.

Phase Two: Sale of Balance of Ownership Interests. At the end of Phase One (three to seven years), Donna will choose one of the following courses of action:

• Sell the balance of her interest to the key employees at the true fair market value by requiring the employees to finance an all-cash purchase.

• Finance the buyout by means of a long-term installment sale to the key employees at true fair market value. Alternatively, Donna may decide to sell to an outside third party. In either a sale to employees or to an outside third-party, her intention is to retire from the business and not to continue to maintain ownership in the business and continue her management and operational involvement.

Benefits to Employees. Even though the key employees will not receive voting stock, there will be sufficient benefits to them in purchasing non-voting stock, as they will be able to do the following:

• Enjoy actual stock ownership in EPD and the ability to receive any appreciation in the value of their stock.

• Participate (pro-rata) based on their stock ownership in any S-Corp distributions made by EPD.

• Receive market value paid by a third party for their percentage of stock (if EPD were to be sold to a third party).

• Participate more directly in day-to-day operating decisions.

• Initially, be appointed as directors to serve under the terms of the bylaws (such positions not be guaranteed).

• Participate in determining which additional key employees will be offered stock out of the 40% pool. This determination will be based on written criteria developed by all three shareholders.

 As each key employee purchases stock, they will enter into a stock purchase agreement with the company that provides for the repurchase of their stock in the event of death, long-term disability or termination of employment.

Contact us if you would like to discuss this option or any strategy for an internal sale to insiders or family.email@ennislp.com | 301-859-0860