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.

What is a Certified Business Valuation and When Do I Need One?

A Certified Business Valuation is a comprehensive assessment conducted by a qualified professional to determine the fair market value of a business. It involves a systematic analysis of various factors such as financial statements, industry trends, market conditions, company assets, intellectual property, customer base, and other relevant aspects to estimate the worth of a business.

You may need a Certified Business Valuation in several situations, including:

• Selling or Buying a Business: When you're involved in a business sale or acquisition, a valuation helps determine a fair asking price or offer, ensuring both parties understand the business's value.

• Obtaining Financing: When seeking a loan or financing for your business, lenders often require a valuation to assess the value of the company and its ability to generate cash flow to repay the loan.

• Partnership Dissolution: If you're part of a dissolving business partnership, a valuation is essential to determine the fair value of each partner's share and facilitate a smooth division of assets.

• Estate Planning: Business valuations are necessary when planning for estate taxes or distributing business assets as part of an inheritance. A valuation helps establish the value of the business for tax purposes and ensures a fair distribution among beneficiaries.

• Shareholder Disputes: In case of disagreements among shareholders, a valuation can be conducted to determine the value of shares or ownership interests, aiding in resolving disputes or facilitating a buyout.

• Financial Reporting: Valuations may be required for financial reporting purposes, such as complying with accounting standards or fulfilling regulatory requirements.

• Litigation or Dispute Resolution: During legal proceedings like divorce settlements, bankruptcy, or insurance claims, a certified valuation can provide an objective assessment of the business's value, serving as evidence in court.

It's important to note that the specific circumstances and requirements for a Certified Business Valuation may vary based on jurisdiction and the purpose for which it is being conducted. Consulting with a qualified business valuator or professional accountant can help you determine when and how to obtain a valuation tailored to your needs.

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.

Cash Flow Projection and a Successful Exit

A small business owner named Simon understands how the cash flow of the business drives his current income, and as well how it would eventually impact the valuation and sale price. However, Simon lacked awareness of elements of potential exit routes that demand cash flow. For example:

• When considering an ESOP, his business met all the basic parameters EXCEPT having the adequate cash flow to service the debt needed to fund the ESOP.

• When running a “sanity check” as to whether key employees could finance an insider purchase with a bank loan, the bank would only finance a small amount…due to projected cash flow.

• In considering a third-party sale, and as a result of Simon’s exit planner’s financial gap analysis, there was a need to invest in updated systems, new hires (next-level management), and incentive plans for key employees in order to increase the value of the business…cash flow was needed to make it happen.

Simon has said that “he’s ready to exit”, but after analyzing his business’ readiness for an exit, and projecting future cash flow, Simon will not be able to exit the way he wants to for at least five years — there’s just too much to get done to realize the value he needs. So, the moral of the story is to have a ten-year cash flow projection and keep it current for planning both growth and your eventual exit. The stronger the cash flow and its management, the greater chance of building a transferable business and having multiple options for exit.

And, begin planning today…it will take longer than you think.

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.

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.

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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.

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.

Thoughts About Family Business Transfers

You might think that a transfer of your business to a child or family member would be the easiest exit route to facilitate. Whereas statistics reveal that only one-third of all family businesses pass successfully to the next generation, and only 10% to the third generation.

Owners considering a transfer to children often run into these obstacles, among others:

• The children not getting along with one another

• The children not interested in the business and with different career goals

• The children don’t have the same skill, ability, or temperament to be a business owner as the parents do

• Fairness in transferring wealth to both children active in the business and non-active

• The children want ownership and control of the business before their parents have achieved their financial goals

• The business is strong and large enough to support a transfer while also providing for the financial goals of the parents

All business transfers are challenging, but family businesses face especially significant challenges. However, with the right pre-planning, the obstacles can often be overcome and a successful transfer can be realized.

Following is a basic set of questions for evaluating whether or not a family business transfer is the best exit route for you and your family:

• How much wealth do want to keep? How much cash will you need post-transfer of the business?

• Do you children desire to be owners? How capable and prepared are your children for ownership?

• Is your business prepared for a successful transfer? Are growth and cash flow steady and increasing? Is the business large enough to support all children (if applicable) financially while providing each with areas of responsibility?

• Are you ready? Financially? Most business owners are unhappy within two years of leaving their business — do you have a plan for life after the business? Do you have a plan to minimize taxes in transferring the business? Do you have a plan to treat all children (business active and non-active) equitably?

• If applicable, can your children share ownership? Do you have any concerns pertaining to their relational harmony?

• What contribution do you want your business active child or children to make? Pay for all or part of the business? “Sweat equity”? Is their future ownership actually contributing to your retirement plan?

• Define fairness: What does “fair” mean to you and your spouse? To your business active child? To your non-business-active child? Do you need help with defining fairness?

• What is your contingency plan if transfer to family doesn’t work out? Sale to other insiders or ESOP? Sale to third-party?.

There is much at stake when and how you leave your business, and never is that more true than when transferring your business to children or family. You would be wise to be as thorough and detailed in your planning as needed well in advance of your eventual transition. For every question listed above, there can be ten or more “drill-down” questions. As always, please let us know if we can be of assistance.

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.

Goalposts, Goals and Your Business Exit

In this week’s episode of our ExitReadiness® PODCAST, we interviewed negotiation expert Randy Kutz of Scotwork USA on “key ingredients of a successful negotiation”, with an owner’s sale of their business in view. One of Randy’s main points had to do with “goals and goalposts”, and how an owner’s goalposts can continually move during a sale transaction if they don’t have strong convictions about their goals and objectives heading into the negotiation process. This uncertainty can easily result, and often does, in either seller’s remorse or a deal not getting done.

We have found in working with owners, that when giving any thought to their inevitable exit, they will often have a time frame for leaving the business (i.e., 5 years) and “their number”, or sale price in mind, but even these objectives haven’t been thoroughly tested and evaluated. Goals such as tax minimization, a plan for life after the business, care for key or important employees, sustaining the culture they’ve worked hard to create, family harmony, leaving on their own terms and conditions, may have received a head nod along the way, but frequently get little to no planning attention ahead of a potential transaction.

As a business owner, there is never a more critical event or time to be clear about what you want than when you exit your business. A reason being, there is a tremendous amount at stake…all that you’ve built…all that stakeholders have come to depend on…and all of your financial and values-based goals are at stake when you transition out of the business. And, you could at any time find yourself suddenly facing an offer from a potential buyer so it’s advisable to begin gaining clarity well in advance so that you can indeed move forward with conviction. If you’re not clear on what you want and need financially, what you value in regard to the future of your business in the hands of a new owner, or what you will do post-business to replace the significance and impact you’ve experienced as a successful owner, the likelihood of you experiencing regrets is quite high.

It is essential to “crunch all of the right numbers'“ in any transaction, and it is also critical to do the hard and often neglected “soft skills” work of establishing firmly your goalposts for a successful and satisfying business transition. Contact us at email@ennislp.com or 301-859-0860 for assistance.

Access the ExitReadiness® PODCAST with Randy Kutz HERE.

Invest 15 minutes and get a FREE Exit Readiness Assessment HERE.

What Exit Route Should You Choose?

There are not many absolutes in owning a business, but there is one thing that is absolutely certain….all business owners will stop being business owners at some point…100%. Along with death or permanent disability, the following are routes for leaving your business:

1. Sale to one or more key employees.

2. Sale to one or more co-owners.

3. Sale or transfer to children or family members.

4. Sale to an Employee Stock Ownership Plan (ESOP)

5. Sale to a third party (full or partial).

6. Become an absentee owner.

7. Engage in an IPO.

8. Liquidate for asset value and close the doors.

As you would expect, there are advantages and disadvantages to each of these exit routes, and other than liquidation, each can require much planning and time to execute in a way that will accomplish all of your values-based as well as financial goals. Certain exit routes will lend toward a higher financial payout, while others afford more control for values-based goals like sustaining culture and care for employees.

We believe that it’s imperative for business owners to understand all available exit routes and the particular characteristics of each, and how they align or misalign with their goals for the future.

Begin increasing your knowledge today with our Exit Routes eBook. You can download it for FREE on our ExitReadiness® site under PRODUCTS.

The Importance of Estate Planning for Business Owners

It is not uncommon for the business to be the largest asset in a business owner's estate, while also being the primary source of income for their family.  As estate planning is essentially taking control of how property is managed during life and distributed and transferred at death, a business owner cannot do exit planning without estate planning, or estate planning without exit planning.  Exit goals, such as transferring a business to children, always impact an owner's family and estate.

An example of where an owner's estate and exit plans intersect would be in the area of business continuity.  Sarah, a widow of five years, owned a large women's apparel retail store.  She started the business twenty-five years ago and remained as sole owner as the business continued to grow and realize success.  Sarah's daughter Sue graduated from college three years ago with a degree in design, and both she and Sarah had a vision for Sue eventually taking over the business. Sarah's son Jack, and another daughter April, have no involvement in the business.  

Tragically, Sarah passed away suddenly a year ago causing great distress to her children.  The fact that she passed without having finalized her estate plan resulted in even more hardship for her family.  It was one of those things that she knew she needed to do, but just never could "get around to it" due to the day-to-day trials of running a thriving business.  She had a will but it hadn't been reviewed in over fifteen years.  

The consequences of not having designed and coordinated an estate and exit plan, Sue did not end up owning the business as both she and her Mom desired, the business was sold at a deep discount due to uncertainty among employees and customers, other assets also had to be sold to pay high taxes and estate settlement costs, and there was resulting tension between the siblings due to a disorderly distribution of assets.  This is a shortlist of the potential consequences of the deficient and disjointed estate and exit planning for a business owner.  

Like our fictional character Sarah, most business owners lead busy and full lives.  They can understand that estate and exit planning are important, but it can be difficult to plan the time to make it happen as it represents even more work.  So, it can be very easy to procrastinate.  

The focus of an impactful estate plan is not simply death but also the arrangement of assets (ownership and utilization) in ways that will help estate holders achieve financial goals in a tax-efficient manner during life while providing for survivors’ needs and the disposition of property at death. A successfully implemented estate plan can:

• Minimize estate taxes and estate settlement costs

• Ensure that cash is available to pay estate taxes and costs

• Provide for an orderly transfer of assets that meets the estate owner’s objectives and intentions

• Preserve assets during life

• Protect business and ensure its successful transfer or sale

• Provide peace of mind and family harmony

A well-thought-out and executed estate plan, as part of a comprehensive exit plan, will be instrumental in ensuring that the right person takes over a business when the current owner dies. Other issues that would be addressed in a comprehensive estate plan would include the appropriate business valuation, equitable estate distribution among children, a properly drafted buy-sell agreement, tax, and philanthropic planning.

As a business owner, it is wise to regularly review your estate plan to ensure that it represents your current desires and goals for your personal and business asset distribution. Please contact us if we can be of service to you in the review of your estate plan.

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.

Business Valuations and Buy-Sell Agreements

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 it is not comprehensive, too simplistic or was poorly implemented can render the buy‐sell agreement ineffective and more problematic than helpful.

One of the most important elements of a relevant Buy-Sell Agreement is the issue of assigning value to the business at a “trigger event” (i.e., death, disability, lifetime transfer, divorce, bankruptcy, etc.). Following are some of the questions pertaining to business valuation that business owners should answer with assistance from their Advisor Team in creating their agreement:

• The type of valuation that will be required — Will you choose book value, fair value, fair market value, investment value, historical value, agreed-upon value?

• The method to be used in calculating value — Will you use a formula-based method, a formal valuation conducted by valuation specialist, or a fixed-price?

• The timing of the valuation — Will you value the business on the date of a trigger event, as of the last valuation, each year with a formal valuation, or at some other point?

• The entire business or partial ownership interest — Should the entire business be valued or a partial ownership interest when there are multiple owners? Should discounts (i.e, minority, lack of control, lack of marketability) be applied?

• Valuation perspective — From what perspective will the business be valued…a hypothetical buyer, the majority owner’s perspective, other perspective?

• The method of funding the Buy-Sell Agreement — Owner buy-outs can be funded in various ways including insurance proceeds, debt proceeds, and cash flow of the business. Should the chosen funding method be considered in the business valuation?

Too often Buy-Sell Agreements are written without these questions and others being adequately addressed with the assistance of experienced advisors (valuation specialist, business attorney, CPA, exit planning advisor) and result in poor execution and relational conflict requiring extensive investments of time and finances.

In addition, your Buy-Sell Agreement should be drafted in light of your financial and estate plans which requires a coordination and collaboration of corporate and personal advisors. For example, your financial planning “number” you need for financial security at a trigger event should be coordinated with possible estate planning goals of tax minimization and transfer of your business interest to family members. NOTE: The role of an Exit Planner could be likened to that of a Project Manager or General Contractor, coordinating the planning efforts of experts in the design and implementation of an owner’s plan. And, this might be a plan for Business Continuity which includes the drafting of a Buy-Sell Agreement and/or a Comprehensive Exit Plan.

Contact us today for a comprehensive review of your Buy-Sell Agreement and a copy of our 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.

email@ennislp.com | 301-859-0860