Align Key Employee Incentives With Your Goals For Building Value & Exit

Emily has been in business for 10 years and has plateaued in both revenue and profitability. Her exit planning advisor Mary has learned that she wants to exit in 5 years and how much $$$$ she will need net of taxes in order to exit successfully. An estimate of business value has revealed that her business is worth about 50% of what it will need to be worth for Emily to head off to Hawaii in 5 years in the way she wants to.

There are two employees that Emily would consider key (play a strategic role; unique talents and skills; to the success of the business; would experience harm to the business if they leave) to the success of the business. Currently the two key employees realize the same employee benefits (health insurance, 401k with match, year-end cash bonus) that all other employees are eligible for, yet they have higher salaries commensurate with their roles and responsibilities. There is NOT an incentive plan in place that would be specific in further motivating them (in their strategic roles) to grow either revenue or profitability.

One of Mary’s recommendations for maximizing the sellable value of the business that she emphasizes, is that Emily installs an incentive plan that aligns with her goals of increasing the sale price over the next five years. Emily’s response initially was, “Wouldn’t that be taking more $$ out my own pocket…why would I do that???” Mary describes the following basic elements and structure that serves in alleviating Emily’s astute question:

• Mary explains that the plan would need the following elements to be impactful:

  • The plan is in writing and specific.

  • The plan is performance-based.

  • The bonus is substantial.

  • The bonus serves in “handcuffing” the employee to the business.

• Emily sets a threshold for either revenue or profitability. For example, $500K in profitability.

• Emily creates a bonus pool of 30% of all profitability that exceeds the $500K threshold:

  • She informs the two key employees in writing how they would be rewarded for increasing the profitability of the business. The pool would be split 50/50 between the two key employees.

  • In the following year, an additional $300K (over the $500K threshold) is realized and a pool of $90K is established ($300K X 30% = $90K). Each key employee receives $45K in incentive compensation split between immediate cash or stock payments and deferred compensation.

So, Emily was quick to see how this plan would actually put more $$$$ in her pocket and her exit goals could be attained successfully as the value of the business would increase as profitability increased. And, she understood how it didn’t “take $$ out of her pocket”.

With Emily’s enthusiasm about implementing an incentive plan, Mary made sure they now had an expert on the exit planning team with extensive experience and expertise in stock and cash bonus plans and how they need to be designed and maintained to also meet all IRS/ERISA regulations.

If you want to increase the sellable value of your business, aligning the performance metrics of your key employees with your goals and implementing a well-designed incentive plan can be most impactful. Contact us if you’d like to discuss further: email@ennislp.com | 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.

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.

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.

Focus On Net Proceeds And Not Just Sale Price When Selling Your Business

John was excited as “today is the day!” Twenty-five years ago this month he had started his home remodeling business with a truck and a tool belt, and today at 3pm he was going to the deal table to sell his business to a much larger remodeling company. It would be a strategic purchase for the buyer who was willing to pay a premium with a goal of expansion in the region. With the check received today, John knew he could now do everything he and Kim had thought about doing for years — travel, more time with the family and for hobby’s and other interests they both enjoyed.

The amount received actually exceeded John’s “number”, and hence, he and Kim spontaneously pulled together a celebration dinner with family and a few close friends at their favorite restaurant. John had done a great job through the years building a “sellable business” focusing on a strong management team, strong financial performance, a plan for growth, up-to-date systems and processes and other value drivers which and now he was reaping the rewards. There was indeed much to celebrate!

Fast forward, six months later: John has come to realize that his number needed to be quite a bit larger than what he had originally calculated. In whatever way he had performed his calculations, he failed to consider to the extent needed, or at all, the following important factors in the equation:

• Of the $10 million in proceeds, he was going to net approximately $6 million after these charges/expenses:

  • Transaction and professional fees.

  • An asset sale was negotiated and there was income tax on some asset depreciation recapture.

  • $1 million in business debt needed to be repaid.

  • Capital gains and affordable care act taxes.

  • Miscellaneous expenses including “stay bonuses” for two key employees.

John was in a small percentage of small business owners who have built a sellable business and actually sold it for their “number”. For that, he is to be commended and congratulated. At the same time, John was now experiencing much regret and was actually concerned about his financial ability to do everything he and Kim had planned on. What could have John done differently when planning for this most significant event? Worked with his exit, financial, transaction, and tax advisors well in advance of the sale in calculating the real number… net sale proceeds…and whether or not he and Kim could do all they wanted with that number.

If you need help contact us at 301-859-0860 or email@ennislp.com. 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.

Expensive Sentences When Planning Your Business Exit

Following is a post that we’ve published in the past that we believe is good to be reminded of annually.

Following are just a few examples of “Expensive Sentences” mentioned by my friend Jack Quarles in his book, Expensive Sentences, Debunking the Common Myths that Derail Decisions and Sabotage Success.

“It’s too late to turn back now.” 

“We’re too swamped for that now.” 

“We can probably do that ourselves.” 

“It’s too crazy busy around here to make changes.” 

Jack explains how conversations and discussions containing expensive sentences most often lead to decisions that negatively impact the future of businesses, families, individuals, and nations.  And, how the faulty logic and false constraints of expensive sentences can lead to derailed and expensive decisions.  He describes how conventional wisdom such as “You get what you pay for” or “We can’t change horses in mid-stream” can be a costly and destructive trap.  Jack paints a picture as to how we can over time drift away from a disciplined analysis of a decision, and instead be drawn by a “particular idea as if pulled by gravity.” 

When it comes to Exit Planning, or designing and implementing a plan to successfully and responsibly exit from a business, there is a seemingly endless list of expensive sentences….

“I’m not ready to exit yet…I will begin planning when I’m ready “ 

“I have a pretty good idea of how much I’d pay in taxes”

“I am confident my key employee would be a good owner”

“I am confident I can sell my business for enough to live on for the rest of my life” 

“Yeah…I think we arranged it so that my spouse will get the business if I die” 

“I’m not worried about my employees leaving if I die or sell the business…I have been good to them and they’re very loyal”

“One of my friends, who is in the same business, sold for $$$$...I’m sure I will be able to sell mine for at least that much…I don’t need an outside valuation”

“I don’t need a personal financial needs analysis.  I have a good idea of how much $$$$ we would need”

“I am confident I can sell my business when I want or need to”

It’s expensive sentences like these that result from common owner misperceptions and can result in bad and expensive exits.  The author of EXIT PLANNING; THE DEFINITIVE GUIDE, and Founder of the Business Enterprise Institute, John Brown, says the following: “…your misperceptions create complacency and inaction when you should be pedaling as fast as you can.” We would agree with John Brown and would add that complacency and inaction are always expensive and at times destructive when it comes to a business exit.

Business Owner Exit Planning employs a process of assessment and analysis that will reveal expensive sentences and owner assumptions (that are then tested) helping you to instead leave on your own terms and conditions and realize a successful exit. Start planning today.

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.

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

Customers Want to Be Treated as Individuals

I recently participated in an ExitReadiness® Podcast episode hosted by Pat Ennis and Walter Deyhle and our topic was “When You Start Making a Big Decision, First Talk with The People Involved.”  The high-level summary of the conversation is when you must make a major decision regarding your products and services, talk first with the people who will be impacted by your decision.  Otherwise, if the decision goes against what the stakeholders consider to be in their best interest, the outcome will fail to achieve your objective.

 Climate Control

Consider this example.  If I have power over climate control, you can count on the thermostat set at 70 or 71 degrees.  In our home, this results in many discussions, as my wife prefers the temperature at 73 degrees and my daughter at 68 degrees year-round.  Fortunately, we’re able to move ahead with a shared willingness to communicate and make appropriate compromises. 

But what if this were my office environment? If I’m the one person permitted to adjust room temperature, I may lose some key or important employees if they don’t feel their needs are being seriously considered and accommodated as room temperatures are consistently not to their liking.  The same could happen if my business depends on customers entering my place of business and spending a fair amount of time inside, they might just give up on visiting the store. 

In that there is much competition in attracting both key employees and customers, both may end up leaving my business for greener pastures without even sharing with you the reason why. 

Proactive Problem Prevention

Be proactive in preventing this problem with “The Platinum Rule” investing the time to find out how your customers, employees, and all stakeholders want to be treated.  And then create a plan and execute it.  Being considerate about how you treat customers and employees will go a long way in making your business more valuable.

About Sam Klaidman

Sam has consulted with Fortune 500 companies like GE, Pfizer, Corning, and Honeywell as well as many small and midsize businesses in a broad range of industries. Many of his SMB clients are privately held and still controlled by members of the founding family.  Sam and his firm Middlesex Consulting specialize in helping service businesses grow.

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.

Why Bother Doing It The Hard Way?

Whether you want to sell your business next year or a decade from now, you will have two basic options for an external sale: the financial or the strategic buyer.

The Financial Buyer

The financial buyer is buying the rights to your future profit stream, so the more profitable your business is expected to be, the more your company will be worth to them. Strategies that are key to driving up the value of your business in the eyes of this buyer include de-risking it as much as possible, creating recurring revenue, reducing reliance on one or two big customers, cultivating a team of leaders, etc.

The Strategic Buyer

The alternative is to sell to a strategic buyer. They will care less about your future profit stream and more about what your business is worth in their hands, typically calculating how much more of their product they can sell by owning your business. Strategic buyers are usually big companies, so the value of being able to sell more of their product or service because they own you can be substantial. This often leads strategic buyers to pay more for your business than a financial buyer ever would.

For example, Nick Kellet’s Next Action Technologies created a software application that takes a set of numbers and visually expresses them in a Venn diagram. Next Action Technologies was generating approximately $1.5 million in revenue when they received their first acquisition offer; Kellet’s first valuation was for $1 million, a little less than revenue, which is a pretty typical from a financial buyer.

Kellet knew the business could be worth more to a strategic buyer, so he searched for a company that could profit by embedding his Venn diagram software into their product. Kellet found Business Objects, a business intelligence software company looking to express their data more visually. Business Objects could see how owning Next Action Technologies would enable them to sell a whole lot more of their software, and they went on to acquire Kellet’s business for $8 million, more than five times revenue – an astronomical multiple.

Preparing For Every Eventuality

The question is: why bother making your business attractive to a financial buyer when the strategic buyer typically pays so much more?

The answer is that strategic acquisitions are very rare. Each industry usually only has a handful of strategic acquirers, so your buyer pool is small and subject to a number of variables out of your control; the economy, interest rates, the competitive landscape and a whole raft of other variables can all impact a strategic acquirer’s appetite to buy your business.

Think of it this way: imagine your child is a promising young athlete who’s intent on going pro. You know that becoming a professional athlete is a long shot, fraught with unknown hurdles: injury, the wrong coach, or just not having what it takes to compete at the highest levels. Do you squash her dream? No, but you do make sure she does her homework, so if her dream fades she has her education; you make sure she has a back-up plan.

The same is true of positioning your company for an exit. Sure, you may want to sell your business to a strategic buyer in a spectacular exit, but a financial acquisition is much more likely, and financial buyers are looking for companies that have done their homework – companies that have worked to become reliable cash machines.

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.

Wealth Management for Small Business Owners

Small business owners are at times neglected by the wealth management community as the business is commonly (not always) the owner’s largest asset rather than a portfolio of stocks, bonds, and mutual funds. You’d be well-advised as a business owner to engage a Financial Advisor who is proactive and experienced in factoring your future plans for the business into your overall plan for managing your wealth.

Impactful wealth management for you as a business owner would include at least these elements of exit planning:

• Clarifying what “exit” means to you. For example, do you want to leave entirely at some point, or gradually over time?

• Clarifying your financial, values-based, legacy goals, and what role the business needs to play in attaining your goals.

• A financial needs and gap analysis with an accurate valuation (not back of the envelope - meaningful planning requires accurate data) of the business. How much $$$$ will you need to do everything you want to do after the business? Is there a financial gap? Will that gap need to be closed by increasing the value of the business?

• Personal risk management including asset protection, insurance planning, tax planning.

• A current estate plan — a business owner cannot do exit planning without doing estate planning.

• A plan to preserve the value of the business (typically a small business owner’s largest asset), and a plan for it to survive during unexpected events of your permanent disability or death.

• An appropriate plan for managing financial assets resulting from the successful sale or transfer of your business.

Exit planning is wealth management for business owners that requires assessing, preserving, and building the value of your largest and most complex asset…your business.

Contact us at email@ennislp.com for assistance in building sellable business value or planning your eventual exit. Please also consider investing 15 minutes in completing our FREE Exit Readiness Assessment. We do not ask for confidential information.

Aligning Employee Incentive Plans with Owner Goals

Sarah wanted to exit in 5 years and had learned through planning and analysis led by her exit planner what “her number” was, as well as an objective estimate of the value for her business. She was pleasantly surprised to find that the financial gap for making her post-business dreams happen is not insurmountable. At the same time, she is aware that growing the value of the business (Sarah’s largest asset) will be necessary to close the existing gap.

With her newly designed comprehensive exit plan, and a decision to exit with a future sale to an unidentified strategic buyer, Sarah now has a crystal clear picture of what is needed to maximize and preserve the value of the business and attain her post-exit goals. Following are a few of the key value-driver action items identified during the analysis of Sarah’s situation:

• Strengthen Management Team

• Improve Financial Performance

• Establish and document a Growth Plan

• Increase Recurring Revenue

Now that Sarah knows how much she needs to grow the value of the business within her planned time frame for an exit, and what needs to happen to facilitate the required growth, she needs to take action in aligning employee incentive compensation with her strategic goals. For example, there is a need to increase EBITDA so she will implement an added incentive for the Chief Operating Officer that is tied to profitability. Currently, all that’s in place is a year-end bonus simply based on Sarah’s generous nature and whether or not they “had a good year.” She will do likewise for other employees who help drive the performance needed to accomplish her goals.

Sarah also now knows that it will be essential for these key employees to stick around during, and after, a sale transaction if the transaction is to be successful. Key employees who are not incentivized to remain through the owner's exit can seriously impact the owner proceeds at the sale and even destroy the deal.  

So, what does Sarah do? Stock Option Plan?  Phantom Stock Plan? Restricted Stock? Cash-Based plan? Stay Bonus? What plan or plans will be the most effective, easiest to implement, and cost-efficient?  Incentive planning can be complicated requiring deep expertise in statutory and technical requirements, tax planning, and other areas.   The Certified Exit Planner has made sure that the right experts have been involved and coordinated in designing and implementing Sarah’s new incentive plan, and so she is quite confident in the final plan.

In summary, be intentional in aligning your employee incentive compensation plans with your strategic owner-based goals for growth and exit, and get the needed expertise on your advisor team to help design and implement the plan. Effective incentive planning can play a key role in helping you attain exit goals within your desired exit time frame.

Contact us today for an exploratory conversation if you want to exit within the next 10 years. Don’t wait until you feel pressure to leave your business to begin planning. Plan now.

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 Is A "Stay Bonus" And How Is It Helpful?

Simply put, a Stay Bonus is an amount of money paid to “key” and/or “important” employees to prevent them from leaving when an owner either voluntarily (i.e, sale to third-party) or involuntarily (death or disability) exits the business.

Lifetime Stay Bonus example: An owner is approached with an attractive offer by a potential Private Equity buyer. The selling owner is excited about the offer and wants to move ahead with the proposed deal. As the buyer’s due diligence process is implemented, the key employees, who have not been incented to remain during transition periods, are all getting “nervous” regarding the uncertainty of their future with the business. One actually leaves and the others are “looking around”. If the selling owner had implemented a Stay Bonus prior to a potential sale it could alleviate this potential deal-killer.

Stay Bonus Upon Death example: In a meeting with a client and her estate planning attorney, the attorney was recounting the story of a business owner who recently passed away and how his passing impacted the family and business. Of course it was emotionally agonizing for the owner’s spouse and family, but what compounded the pain of the situation was there nothing in place to keep key employees in place to continue to run the business. Hence, key employees left and so did customers and the value of the business (which the owner’s wife was depending on) decreased significantly. A bonus that had been planned and structured to retain key employees during this time would have saved the family, the employees, and the customers from much pain and uncertainty.

Key considerations:

• Plans designed for a short period of time must provide a meaningful payout in a short period of time if the business is sold.

• Keeping key employees is almost always necessary for the business to be sold at a maximum sale price.

• The benefit should be greater when the business is actually sold while more affordable when a potential sale went through due diligence but did not sell.

• Key employees are often asked to do even more during transition periods than what their regular job description calls for.

• As all cash sales to third-parties are the exception, owners are often exposed to post-sale financial risk that can be increased with departing or unmotivated key employees.

Invest 15 minutes and get our FREE Exit Readiness Assessment HERE. We do not ask for confidential information.

An Often Neglected Means Of Protecting Business Value

One of the compelling and common characteristics of successful owners is their optimism.  Their “glass is always half full” attitude results in the risk-taking, perseverance, and innovation it takes to build and grow a successful business.  And, like it is with any personal strength, this strength of optimism can quickly become a weakness when there is a need to plan for the gloomy business contingencies of death and disability.  What happens to the business due to either of these less than optimistic events is probably the last thing an owner wants to think about. 

And, perhaps some business owners don’t care if the business fails as a result of one of these events.  Though, our experience has been that most owners do very much care about what happens to the business and all its stakeholders.  We’ve also observed, however, that the planning needed is often deficient.  And, one area that is most often overlooked is an owner’s potential permanent disability.

Whereas it’s fairly common for a business owner to have a level of life insurance protection (although often outdated in need of review) to benefit their business as well as their family, in the event of death, it’s not nearly as common to see the risk of permanent disability addressed adequately, if at all. 

And, becoming disabled for more than three months are greater than the chances of dying at every age: 

• Over one in four 20-year-olds will become disabled before reaching age 67. (1)

• Age 30 - the chances of disability are approximately 2.3 times greater than death

• Age 40 - the chances of disability are about twice that of death

• Age 50 - disability is 50 percent more likely than death (2)

• Not only does the risk of disability rise as we get older, but the severity of any disability that is incurred also tends to increase with age (3)

Your permanent disability (or death) and incapacity would most likely have the same impact on your business as the loss of any key employee.  All that you bring to the table in making the business a success, your experience, talents, knowledge, relationships would all be tough to replace.  And, there could be additional challenges such as the loss of concerned stakeholders, weakening financial strength of the business, bank financing re-examined, bonding capabilities interrupted, potential non-renewal of personally guaranteed leases, etc., etc. as a result of you not being able to work in the business.

The bottom line is this, that the value of your business could decrease significantly in the event of your premature permanent disability and incapacity.  All stakeholders would be impacted, and perhaps your family as well if financially dependent upon the continued success of the business.  Make sure you’ve thoroughly thought through this risk with your insurance professional.  Too often it’s neglected entirely.  You can also contact us for any assistance needed.

Invest 15 Minutes and take our FREE Exit Readiness Assessment.  We do not request any confidential information.

Endnotes:

(1)     The Facts about Social Security’s Disability Program, Social Security Administration Publication No. 05-10570, January 2018.

(2)     1985 Commissioners’ Disability Individual Table A and 1980 Commissioners’ Standard Ordinary Mortality Table.

(3)     Americans with Disabilities: 2010, U.S. Census Bureau, Current Population Reports, July 2012.

Using Cybersecurity to Improve Your Company’s Valuation

Thanks to increasing reliance on computers, data, social media, programs, and networks, businesses all over the world are at a greater risk of a cyberattack or data breach. Companies have to fend off malware, DDoS, and phishing attacks at unprecedented levels. Cyberattacks have become so common that the cost of managing cybersecurity risks has become more of an investment than an expense. Consequently, one of the hidden costs of a cyberattack is how it affects the value of your company.

Cybercriminals, like water, find the path of least resistance. Investing in cybersecurity best practices, including a layered security strategy will reduce the risk of an attack. Stepping up your cybersecurity game will, in turn, enhance your market position and add tremendous value to your business. From a valuation perspective, strong cybersecurity means less risk for potential buyers and future investors. Cybersecurity diligence is particularly important for business executives who are looking to sell or are on the verge of selling.

Add Value to Your Company with Better Cybersecurity

Cybersecurity has become a necessity for every business out there, whether they offer products or services. Cybersecurity is rapidly becoming a trend in company valuations. All the factors that go into the value of the company including data operations, assets, customer records, intellectual property, employee information, marketing tactics, etc. are all vulnerable to cyberattacks. Demonstrating cybersecurity strength and integrity contributes to a company’s value.

As you can see, improving your company’s cybersecurity stature will fetch you a better price when it’s time to sell. Here are a few ways to secure your business and improve its value.

Risk Assessment

Cybersecurity risk is the likelihood of reputational or financial loss from a cyberattack or a data breach. A cybersecurity risk assessment is essential to a company’s risk management strategy and data protection efforts. Assessing risks and vulnerabilities can help you understand, manage, control, and mitigate cyber threats across your business.

Network Encryption

Data theft, tampering, technical failure, eavesdropping, etc. have all become commonplace in data networks. Securing network transmitted data against cyberattacks and data breaches is imperative for businesses. Only encryption can make sure that your company data is protected while in transit across data networks and links.

Network encryption makes data unreadable by anyone who is not explicitly allowed to access the information. A VPN is one of the most effective encryption tools. It creates a secure tunnel between your devices and the Internet, protecting your data from snooping. A VPN can also be downloaded in simple steps.

Layered Defence Strategy

In today’s dynamic digital environment, having a cybersecurity defense strategy can help businesses strengthen their resilience to cyberthreats. This strategy employs a series of layered defensive mechanisms including antimalware and network security controls such as a firewall to protect your online presence.

An emerging trend in the business world is the use of cybersecurity in company valuation. Organizations must strive to improve their cybersecurity position and increase their value. But with the cyber threat landscape evolving at a faster rate than companies can keep up, this is easier said than done. Risk assessment, network encryption, and adopting a layered cybersecurity strategy are some of the steps business leaders can take to improve digital security and add value to their companies.

Chris Jones is the resident tech expert and managing director of #TurnOnVPN. #TurnOnVPN is an activist group whose mission is to promote free and unimpeded internet for all. We take part in numerous online events to advocate for a safe, secure, and censor-free Internet. Learn more at www.turnonvpn.org/blog/.

Invest 15 minutes and take our FREE Exit Readiness Assessment.

LEADERSHIP DURING A CRISIS: Leadership, Engagement and Culture

How do we lead employees in times such as these? Even without a global pandemic, leading employees can be a challenge that requires much time and energy. But now, in addition to trying to lead well, you are trying to keep your business afloat in a way that you have never had to do in the past. No doubt these are difficult times to be a business owner. The following are a few tips to strengthen your Leadership, Employee Engagement, and Culture in the midst of this crisis.  

Golf Bag Leadership

The first area of focus is Leadership. Invest a few minutes right now and assess your current leadership “style.” You may at times be democratic or a delegator, a pace-setter, or any other number of styles, but more than likely you have a “go-to” style. The recommendation is to move away from a singular style or “golf club” during this time of crisis and instead think of your leadership as a “golf bag” carrying different leadership styles for various situations.

In the great game of golf, you want to select the right club once you have assessed the lay of the ball, the distance, and various other factors. The same should be true for our leadership styles. For most of us, the lay of the ball has shifted — our environment has changed dramatically in the midst of this crisis. You need to now feel empowered to “select a different club” or style than you normally would because everything happening is unprecedented. That might mean you are a lot more directive and commanding in your leadership style for the sake of saving the company. Communicate this shift in your leadership style to your people. It certainly will not be like this forever, but this is how we will survive today. As a leader, you have the freedom to change that style in order to combat the present circumstances.

Your Employees’ Connection With You Drives Their Engagement

The second focus area is Employee Engagement. In the best of times, when employees are engaged, research shows that it leads to higher profitability, productivity, customer satisfaction, and lower turnover. An engaged employee gives their discretionary effort and goes well above and beyond what is required of them. That’s important during normal times—now, it is essential. As a leader, you have been pouring into employees, paying their salaries, and showing up for them. Now is not the time to abandon those duties. Your employees are on the same boat that you are on. You must step out onto the deck and continue to engage with them as you’re all fighting for the same thing; you all want your ship to stay afloat. This is crucial because we know that 47% of an employee’s connectedness to their work is directly correlated to the connectedness they feel to their leader. Therefore, in whatever bandwidth you have, you must make an effort to continue to connect and engage with your employees.

Culture Is Forged In Times Like These

The last area of focus is Culture. Organizations with strong cultures consistently outperform organizations with weaker cultures.  Culture is simply the values, beliefs, and experiences that a group of people demonstrate and enjoy collectively. In these unprecedented times, our values and beliefs are being tested, and new experiences are being created. Most importantly, your people’s beliefs about you as a leader and your company are being solidified.  As leaders, it is crucial that we step up right now and demonstrate intentionality in shaping those experiences. This will be a defining moment in the history of our country and your company. Your people are judging you and your response to it.  It is essential to respond well.

Summary

·       Feel free to lead differently. These are different times.

·       Engage with your employees. They need you and you need them.

·       Be intentional about your company culture. We will get past this and when we do, your employees will remember how you responded.

I wish you all the best. If there is some way I can help you avoid damaging your human capital as we get through this very difficult season of business, please call me and I’ll be happy to share openly with you.

Alan Kemper, DBA

678.346.1186

Alan@LEADWorkforce.com

Would Your Business Need To Continue Without You?

“It’s time to get the boat in the water!” is what Joyce has heard Jim say around this time for about 30 years now. Jim & Joyce and their five kids have many wonderful memories boating and fishing on the lake through the years. Now that the kids are all older, and there is a growing number of “grand-babies”, Jim and Joyce have been checking out larger homes on the lake with a vision of many more years of even bigger family gatherings.

Jim loves everything about the times at the lake, and is much looking forward to when he will have freedom from the business to “make it up there more often.” He’s says that “my goal is to pull back in five years so that I can spend more time with Joyce and the family” (Note: but he really hasn’t put a plan in place to ensure that happens). During the summer, Joyce is there most of the time, with the kids and their kids coming and going, but Jim is still greatly needed at the business and only makes it up occasionally.

As a successful business owner, Jim has been able to provide numerous lifestyle privileges for his family that they’ve all come to appreciate and expect. His income from the business has grown through the years to become more than enough to accommodate the way of life the family has become accustomed to. If Jim has any regret, it’s that he’s placed “most of his eggs in one basket.” In other words, most of his net worth is tied up in his business. And, more and more, in his solitary moments, he can feel concerned and anxious about what would happen if he could no longer work in the business. It would be unimaginable at this point for Jim and Joyce (and their kids) not to have these long summers at the lake as well as all the other life luxuries they’ve come to know and love.

Jim lacks freedom because his business cannot run without him. Too many customers still want to deal directly with him, he still needs to make too many of the day-to-day decisions, and if Jim’s not there “the place simply doesn’t run well.” Jim has at least two significant strategic planning issues he’s yet to address (he actually does more planning around getting the lake house open and the boat in the water):

1. If he’s going to “pull back in five years”, things need to change starting with his role. He needs to assess his current list of responsibilities and then who to delegate to. He may need to further develop current members of the “management team”, or he may need to get new next level managers on the bus. The goal is that the business becomes less dependent on Jim.

2. And with even more urgency, Jim needs to review his plan for the unexpected…his plan for business continuity…considering questions such as these with the appropriate advisors:

   • How much $$$ would Joyce need to continue our current lifestyle (with kids and grandkids) if I were to die or become incapacitated unexpectedly?

   • Where would these $$$ come from? Would the business be sellable? If so, for how much considering I’m no longer working in it? Would it be enough (net of taxes) to produce our same standard of living for Joyce? If not, how do I fill the gap…insurance?

   • What would Joyce want to do with the business? She doesn’t want to own the business without me, and none of the kids want to work in the business…what would happen and how would it happen?

   • What would keep employees on board if I’m not there? They will need to think of their futures, and if I’m not there will they see any kind of future for my business? Would the business need additional cash to incent them to stay and to operate effectively until a sale can happen?

These are among the many questions Jim needs to be considering in planning for his financial, values-based, and legacy goals as a business owner. After completing the needed analysis, Jim learned that his business “would need to continue without him” in order for Joyce and his family to be provided for in the ways he desired. But now, he’s got a plan in place to work toward the business growing less dependent on him, while at the same time being assured that in the short-term, if the unexpected happens, Joyce would still realize their life and family goals without the business having to continue.

What about you? Have you adequately addressed the all-important question of “Would your business need to continue without you?” To help you get started, please contact us for a FREE copy of our ExitReadiness® Business Continuity Instructions.

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.

Survive and Advance

In 1983, the NC State Wolfpack, coached by Jim Valvano, “survived and advanced” during March Madness by winning nine must-win games in a row (seven of which they were losing in the final minute) and having one of the most exciting runs to victory any team has ever experienced. On their unlikely journey, they had to beat Michael Jordan and three-time National Player of the Year Ralph Sampson. And then, this team that barely made it into the tournament now had to go up against “Phi Slama Jama”….the No. 1 team in the nation…Houston. A team loaded with talent including NBA Top 50 all-time players Hakeem Olajuwon and Clyde Drexler. Throughout this journey, their leader “Coach Jimmy V” consistently and passionately stated his mantra, “Survive and Advance!”. They indeed did survive and advance, as NC State, one of the biggest underdogs ever, went onto win the game that is considered by many to be the best college basketball game in history.

As a business owner in the midst of the Covid-19 crisis, you need to lead in both surviving and advancing. The normal course of life for you as an owner includes the ongoing challenges of increasing sales and growth of revenue and profitability, staffing decisions, cash flow and debt management, risk management, just to name a few. In the midst of this crisis, these routine challenges become even more intensified and worrisome as you do all you can to simply “survive”. And, the key to your survival will be a vigilant approach to cash flow and debt management. To assist you with staying on top of that crucial survival task we have created a Cash Flow Management Spreadsheet that you can access for free on our homepage along with a video tutorial.

This crisis will end at some point (hopefully soon), and life as your business has known it may need to change its mission, purpose, products, and product delivery. Some businesses simply will not be able to do “business as usual” going forward as the behaviors, desires, and needs of your customers may have changed as a result of the crisis. The owners who understand that possibility and begin to plan now will have the best chance of surviving, and also “advancing” and thriving in the future.

Any thought of “strategic planning” for the future currently can result in even more sleepless nights —“If we don’t do everything to survive today, there may not be a tomorrow!!!”. And certainly, there is truth in that. For some businesses, simply surviving will be enough when competitors are not able to make it through. However, a visionary leader will not leave that possibility to “chance” and will take the initiative to plan now and be more in control of future outcomes. There is a need for a “Level 5” (Jim Collins - Good to Great) leadership that can lead through the daily burdens while simultaneously planning for the future and the overall good of the organization. You would be wise to act now in adjusting, where needed, your strategy for the future.

This “strategy renovation” does not need to be a long and complex process. Following are areas that you could address with a measured investment of time while continuing to stay on top of crisis management:

• Forecast Future Products. Same? Add? Remove?

• Team. Who will be the key people needed to survive and thrive in the future?

• Markets. What customer segments will we market to in the future? Same? Different?

• Competitors. Who will be our competitors? Same? Different?

• SWOT Analysis. Strengths, Weaknesses, Opportunities, Threats.

• Goals. What should be our 3 big strategic goals coming out of the crisis?

• Financial Forecast. What do we project for sales, expenses, and profit over the next few years?

As Jimmy V and his squad survived, they also advanced. If you need any assistance in renovating your strategy for either survival or future advancement, please contact us at either 301-859-0860 or email@ennislp.com. We want to help you survive and advance.

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.

Creating Business Value Through Your Key Employees

A key driver of the value of your business will be how much the business does or does not run through you the owner. The more essential you are to the business, the less value you can expect when you leave. It is actually your key employees and their involvement in the business that creates value. It is not an exaggeration to state that the future value of your business, and the level of success you realize when exiting, is largely linked to your key employees.

Let’s define which of your employees would qualify as a “key employee”. Employees that are key to your business success take initiative in their work, they want to see the business grow and prosper, they embrace challenges, are exceptionally skilled and knowledgable, and demonstrate intentionality toward personal and professional growth. Because they are on your team your business is thriving, and if they weren’t “on the bus” your business would suffer significantly. You would realize great pain if they were to leave, and key employees can be easy to identify as they typically act like owners of the business.

When you consider what will be critical for building the value of your business, a key value driver is hiring, motivating and retaining your key employees. Following are common elements of impactful plans for incenting key employees to build and remain with the business:

• Provide financial awards that are meaningful and attractive.

• The plan is specific as to the expected performance of the key employee.

• The plan is structured to build the value of the business and align with the growth and exit goals of the owner.

• Plan rewards are vested-payments tied to the tenure of the employee facilitating retention of the employee. Often referred to as “Golden-Handcuffs”.

• The plan must be in writing and clearly communicated to the employee.

Then, there is the decision as to whether to install a plan that is cash-based or equity-based, or a combination of both. Too often owners, due to their generous nature, offer an equity-based plan without thinking through the potential ramifications. For example:

• Provisions for buying the stock back from the key employee if things don’t work out as expected or hoped for.

• A method for valuing the equity interest/shares in the case of a repurchase.

• Offering stock to an employee when a cash bonus would have been sufficient.

• Not having an understanding of the substantial rights a minority shareholder has in the business.

• Awarding equity to an employee, who at yesterday’s size of the business, was considered key, but now at today’s level (i.e., three times the size) they are more of a detriment to growth than a key employee.

So, there is much to think through when it comes to effectively implementing employee incentive plans. And, you would be wise to get expert advice prior to moving forward as you will want to make well-informed and confident decisions pertaining to timing, structure, tax planning, and the type or types of plans to install. To obtain an initial idea as to whether you should consider a cash or equity-based plan, the professionals at VisionLink have created a decision-tree tool that is quite helpful.

Hiring, motivating and retaining key employees is just one of the many key planning areas for building sellable business value and a successful exit. Contact us today to learn more about how we can help you in designing and implementing your comprehensive exit plan. You can get started today with our FREE Exit Readiness Assessment.