Connelly vs United States and Succession Planning

The recent Connelly v. United States Supreme Court decision provides critical insight for closely held business owners considering succession planning and tax implications.

The Court's ruling clarifies that life insurance proceeds owned by a corporation, even if intended for share repurchase agreements, increase the corporation's value for estate tax purposes. This decision impacts business owners who use corporate-owned life insurance as part of their succession planning, as it reaffirms that the company's obligations to redeem shares do not reduce the company's valuation in terms of tax liability.

Key Takeaways from Connelly v. United States

1. Business Value Impact: Life insurance proceeds payable to the corporation increase the corporation's valuation, which affects the value of shares for estate tax calculations. In Connelly's case, the $3 million policy proceeds were added to the company's value upon Michael's death, which led to a substantial tax bill.

2. Planning Options: The Court suggested alternative structures, like a cross-purchase agreement where individual shareholders own policies on each other. This setup may avoid increasing the corporation's value upon a shareholder's death, potentially reducing estate tax exposure.

3. Professional Advisory Importance: This case underscores the value of consulting with tax professionals, insurance experts, and succession planners to design strategies that align with tax laws, which can help mitigate unexpected financial consequences.

Practical Steps for Business Owners

• Coordinate with your Advisory Team: Using a coordinated approach with legal, tax, and insurance professionals can ensure strategies align with tax regulations, reducing the risk of unintended tax liabilities.

• Consider Cross-Purchase Agreements: Cross-purchase agreements may provide tax advantages over corporate-owned life insurance policies for some businesses.

Connelly v. United States offers a valuable lesson in how business structure and tax planning interact. Proactively structuring ownership transitions could avoid similar tax outcomes, enabling smoother family business successions and a more straightforward path for future growth.

Contact us today for assistance in reviewing your current agreement: 301-859-0860 | email@ennislp.com.

An Overlooked Risk in Management Buy-Outs

An often adopted exit strategy for a founder of a small business is to sell to a group of employees who have expressed a desire to be the future owners. Factors to be considered in assessing the viability of this strategy for the selling owner(s) include their personal financial goals, risk tolerance regarding payment of sale proceeds, and the buyers' capabilities to be successful business owners. Another risk factor most often neglected is whether the employees, who may be working well together, will succeed as business partners. It’s one thing to become a sole owner when you’ve never owned a business; it’s another when buying a business with partners. If they do not work out well as partners, the selling owner(s) may not receive the expected sale proceeds.

Following are common challenges inherent to a business partnership that should be thoroughly considered in assessing risk for the selling owner(s) as well as the critical employee buying group before a deal is ratified:

Differing Visions and Goals:

• Challenge: Partners may have different long-term goals for the business or personal ambitions that lead to disagreements about the company's direction.

• Impact: Conflicting visions can lead to indecision, confusion, and a lack of clear strategy, potentially stalling growth.

Unequal Work Contributions:

• Challenge: One partner may feel they are contributing more time, effort, or resources to the business than the other.

• Impact: This imbalance can create resentment, mainly if profits are split equally despite unequal contributions.

Financial Disagreements:

• Challenge: Partners may have different views on managing the company's finances, including how much to reinvest versus how much to take as profit.

• Impact: Disagreements on financial matters can lead to cash flow problems, missed opportunities, or one partner feeling financially shortchanged.

Profit Distribution Conflicts:

• Challenge: Even if partners contribute equally, disagreements over profit-sharing can arise, particularly if one partner feels their contributions are undervalued or not receiving fair compensation.

• Impact: Profit distribution disputes can strain relationships and damage the partnership over time.

Decision-Making Conflicts:

• Challenge: Partners may struggle to agree on critical business decisions, such as product development, marketing strategies, hiring, or expansion.

• Impact: These disputes can lead to delays in decision-making, reduced efficiency, and missed opportunities in the market.

Personal Relationships and Emotions:

• Challenge: Personal relationships can become intertwined with business decisions, making separating emotions from professional judgment difficult.

• Impact: Personal issues may spill over into the business, leading to emotional conflict, reduced productivity, and strained professional relationships.

Responsibility and Accountability:

• Challenge: Clarifying each partner's role and responsibilities can be difficult, especially in the early stages of a business.

• Impact: Without clearly defined roles, tasks may be neglected, or partners may duplicate efforts, leading to inefficiency or confusion.

Trust and Dependency Issues:

• Challenge: Partnerships rely heavily on trust, and if one partner acts unethically or irresponsibly, it can lead to a breakdown in trust.

• Impact: A lack of trust can lead to micromanagement, unnecessary oversight, or the dissolution of the partnership.

Exit Strategy Conflicts:

• Challenge: Partners may have different plans for exiting the business, whether through sale, retirement, or transition to new leadership.

• Impact: Without a clear exit strategy agreed upon in advance, disputes can arise when one partner wishes to leave or sell their share of the business.

Legal and Liability Issues:

• Challenge: In many partnerships, each partner may be personally liable for the business's actions and debts, which can pose a risk if one partner makes poor decisions.

• Impact: Personal liability can lead to financial strain, lawsuits, or bankruptcy if the business fails or a partner engages in risky behavior.

Communication Breakdowns:

• Challenge: Partners may fail to communicate business goals, issues, or concerns effectively.

• Impact: Poor communication can lead to misunderstandings, misaligned objectives, and unresolved conflicts, which may damage the partnership over time.

Cultural or Values Misalignment:

• Challenge: Partners may have different business ethics, customer service, or company culture approaches.

• Impact: A lack of shared values can lead to disagreements and difficulty in establishing a unified brand or company culture.

Decision-Making Paralysis:

• Challenge: In equal partnerships, both partners may need to agree on major decisions. If they consistently disagree, the business may experience decision-making paralysis.

• Impact: This can slow down the business's ability to respond to market changes, innovate, or capitalize on opportunities.

Growth and Scaling Challenges:

• Challenge: Partners may have different ideas about how fast the business should grow or how to manage growth.

• Impact: Misalignment in growth strategies can result in either overexpansion (leading to cash flow issues) or stagnation (leading to missed opportunities).

RISK Mitigation Strategy:

Partners can build a more harmonious and successful business relationship by proactively addressing these potential issues. To address these challenges, ENNIS Legacy Partners facilitates The Partnership Charter in our process for assisting an exiting owner(s) in deciding whether selling the key employees is the ideal route for exit. The process also serves the employees interested in purchasing the business to determine if they could be future business partners.

SCHEDULE A VIDEO CONFERENCE TO LEARN MORE ABOUT THE PARTNERSHIP CHARTER HERE.

Challenges Faced in Moving from Founder Mode to Manager Mode

Transitioning from founder mode to manager mode presents several challenges for small business owners as they plan for their eventual exit. Different leadership styles and approaches will be required as the business grows and moves from the start-up phase to a more mature stage. Here are some key challenges associated with this transition:

1. Letting Go of Control

• Challenge: Founders are used to being involved in every aspect of the business, from strategy to daily operations. Letting go of control and delegating responsibilities can be difficult, as they may feel no one else understands the business as well as they do.

• Impact: The reluctance to delegate can lead to micromanagement, slowing decision-making and growth. It can also create bottlenecks, as the founder becomes overwhelmed with too many tasks.

2. Shifting from Visionary to Operational Focus

• Challenge: Founders typically excel in setting a vision, driving innovation, and taking risks. However, manager mode requires focusing more on operations, process optimization, and day-to-day execution, which may be less exciting for visionaries.

• Impact: Founders may struggle to pay attention to detail, follow structured processes, or deal with routine tasks, which are crucial to managing a growing company. This shift from creativity to structured management can be frustrating.

3. Building and Leading a Structured Team

• Challenge: In founder mode, the team is often small, agile, and close-knit. As the company grows, roles must be formalized, a leadership team must be built, and clear organizational structures must be implemented.

• Impact: Founders may find it challenging to hire the right people for specialized roles, trust them to lead, and give up the hands-on approach. Moving from managing a few people to leading a large team with hierarchies requires different communication and leadership skills.

4. Process and System Implementation

• Challenge: Startups often thrive on flexibility and improvisation, with founders and employees solving problems as they arise. Creating consistent processes, implementing systems, and formalizing workflows in manager mode are necessary for scalability.

• Impact: Founders may resist implementing formal processes, viewing them as bureaucracy or fearing they will stifle creativity and agility. However, the company can experience inefficiencies, errors, and miscommunication without systems.

5. Balancing Innovation with Efficiency

• Challenge: In the early stages, the focus is often on experimentation and rapid growth. However, as the business matures, the emphasis shifts to sustaining and improving existing operations, which can slow down innovation.

• Impact: Founders may feel restricted by the need for stability and consistency, leading to frustration or the fear that the company is losing its edge. They must learn how to innovate within a more structured environment and balance exploration with exploitation of existing resources.

6. Changing Decision-Making Approach

• Challenge: Founders are often comfortable making fast, instinct-driven decisions, especially in a startup’s early, chaotic phase. However, manager mode requires a more data-driven, systematic approach to decision-making, with input from multiple stakeholders.

• Impact: This change in pace can be frustrating, as it may feel slow or bureaucratic. Founders may also find adjusting to consensus-building and decision-making processes involving multiple teams or departments difficult.

7. Evolving Leadership Style

• Challenge: In the startup phase, founders often lead by example, working alongside their small team and wearing many hats. In manager mode, leadership requires more delegation, coaching, and empowering others to make decisions.

• Impact: Founders may struggle to evolve from a hands-on leader to a coach and mentor. Some may find it difficult to trust others to lead parts of the business they once controlled, or they may lack experience managing at scale.

8. Cultural Shifts

• Challenge: As a company grows, its culture evolves. A startup's casual, entrepreneurial culture may give way to a more formal environment with policies, procedures, and defined roles.

• Impact: Founders may struggle to preserve the original culture while adapting to the needs of a larger, more structured organization. If this transition is not managed carefully, it could alienate early employees or create cultural friction.

9. Increased Accountability and Reporting

• Challenge: As a business scales, there is a greater need for accountability, both internally (to employees and managers) and externally (to investors, customers, and regulators). Regular reporting, budgeting, and performance tracking become critical.

• Impact: Founders may find these new demands tedious or at odds with their entrepreneurial spirit. Learning to appreciate and manage financial statements, compliance, and performance metrics is essential but often feels like a departure from the freedom they once had.

10. Adapting to a Slower Growth Rate

• Challenge: Growth can be rapid and exhilarating in the startup phase. However, as the business matures, growth typically slows, and the focus shifts from rapid expansion to sustainable profitability and market share maintenance.

• Impact: Founders may struggle with the psychological shift from chasing hyper-growth to being content with incremental improvements. This can lead to dissatisfaction or impatience, as they may feel the business has plateaued.

11. Navigating Investor or Board Expectations

• Challenge: In manager mode, founders often have to deal with external stakeholders like investors or a board of directors who expect regular updates, transparency, and a focus on profitability and governance.

• Impact: Founders may feel constrained by these expectations and struggle with the shift from independent decision-making to being accountable to others. The pressure to meet financial targets and adhere to corporate governance can be overwhelming.

12. Emotional and Psychological Shift

• Challenge: Moving from founder mode to manager mode often requires founders to redefine their role within the company, which can lead to an identity crisis. They may feel like they are no longer driving the company’s direction or being pushed out of what they built.

• Impact: This emotional transition can result in burnout, loss of motivation, or frustration. It can also cause tension between the founder and other managers or team members, especially if the founder resists stepping back.

How to Overcome These Challenges:

• Hire Experienced Managers: Bringing in professional managers with expertise in operations, finance, and HR can help bridge the gap between founder and manager modes.

• Delegate and Trust: Learning to delegate and trust the team is essential. Founders should focus on empowering others to take ownership of critical areas.

• Focus on the Big Picture: As the company matures, founders should focus on long-term strategy for growth and exit, vision, and leadership while letting managers handle day-to-day operations.

• Develop a New Leadership Style: Founders must evolve from hands-on involvement to coaching, mentoring, and strategic guidance.

• Accept the Need for Structure: Embrace the importance of processes, systems, and data-driven decision-making to ensure long-term sustainability and growth.

This transition can be difficult, but successful navigation allows the founder to play a pivotal role in scaling the business while adapting to the new challenges and opportunities that come with a more mature company.

We can help you overcome these founder challenges, strengthen your management team, and train and equip your successor(s). Contact us today for an exploratory conversation at email@ennislp.com or 301-859-0860.

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.

What Role Will You Be Willing To Play Post-Sale?

A key element for an exiting successfully on your own terms and conditions is realizing the role(s) that you’re willing to play post-sale or transfer.

John sold to a strategic buyer and an earn-out with John working as an employee for 3 years as part of the deal. He had not planned in a way to avoid this, and after 2 years decided to forfeit the balance of his payout and leave because he was finding it too difficult to work for the new management.

Due to the small size of her business, Susan’s only option for a third-party sale was someone interested in “buying a job”. Susan did the deal and was forced to self-finance the deal and be a lender. After three years into the deal, the new owner was no longer able to make loan payments due to the weak performance of the business.

Bob planned for and was able to sell a majority stake in his business (that had very strong revenue, cash flow, and growth potential) to a financial buyer. In creating and implementing his comprehensive exit plan, Bob had decided he would be willing to be a partner in order to have a chance at “a second bite of the apple” years later.

In completing her sale to a key employee group, Sarah was willing to continue involvement as a consultant and her agreement is for 3 years.

It’s important to understand these roles and decide which of them you’d be willing to assume when selling or transferring your business. Each role is common to transactions of small businesses and at times unavoidable. However, with the right long-term planning, you might be able to avoid a role or roles you’d rather not play. For example, if you have built a business with significant revenue, a proven next-level management team, and a credible plan for future growth, you may avoid an earn-out. So, understand what roles you would be willing to play, and get started today planning for your exit because the more time you have the greater chance you will be in control when you leave.

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.

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

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

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

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

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

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

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

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

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

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.

Negotiating an Exit Strategy with Business Partners

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

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

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

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

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

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

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

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

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

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

1. People: Separate the people from the problem.

2. Interests: Focus on interests, not positions.

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

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

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

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

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

Key Employees and Building and Protecting Business Value

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

• makes a substantial business contribution

• possesses critical information or knowledge or

• maintains and nourishes key contacts and relationships

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

1. Building business value

2. Protecting business value

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

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

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

Will Your Successors Be Good Partners?

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

• Will the owner’s financial goals be achieved?

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

• How can the transaction be structured to minimize taxes?

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

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

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

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

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

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

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

• Alignment of vision and direction for the business

• Personal core values

• Roles, authority, accountability, and expectations

• Contributions and rewards

• Governance

• Personal styles, strengths, and weaknesses

• Managing conflict

• Money

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

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

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.

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