What's A CLAT And How Can It Help With My Exit?

A CLAT, or Charitable Lead Trust, is an Irrevocable Trust designed to provide financial contributions to one or more charities for a specified period of time, with the remaining assets eventually being distributed to family members or other beneficiaries. A CLAT also provides an owner with estate and income tax benefits that can be particularly helpful in the year of a business sale.

For example, our fictional business owner Sarah successfully sold her business this year. Following are a few key data points:

  • The payout in year of sale is significant as she is in control exiting on her own terms and conditions. She built a sellable business.

  • As a result of the large payout this year, she also has income and estate tax problems. Her exit goals include minimization of both income and estate taxes.

  • Not only has Sarah been impactful through her business, but also through her generous and strategic giving to favorite charities through the years. She wants to increase giving with sale proceeds.

  • Along with personal values that she wants to transfer to heirs as part of her legacy, she also has financial legacy goals. So, she would like for a portion of her charitable trust assets to eventually return to her family and beneficiaries.

  • Due to her comprehensive planning process, Sarah has been able to sell her business on her own terms and conditions and have strategies in place to accomplish her tax minimization, charitable giving, and legacy goals — one tool playing a role in her strategy is the Charitable Lead Annuity Trust (CLAT). Sarah’s Charitable Lead Annuity Trust will provide her with both income and estate tax benefits, and work to accomplish her charitable and legacy goals.

If you’re a business owner like Sarah in the year of selling your business, and have goals of minimizing estate and/or income taxes, charitable or philanthropic goals, and financial legacy goals, establishing a CLAT could play a key role in your comprehensive plan. Also, the current interest rate environment is particularly suited for CLATS as they are most effective when rates are low.

Check with your estate planning attorney and/or CPA, or contact us to see if a CLAT would be the right strategy for you. You can also learn more in our latest ExitReadiness® PODCAST episode with Estate Planning Attorney Jonathon Morrison of Ryan Frazer Goldberg & Arnold.

Starting Vs. Growing a Business

Most company founders are good at the first stages of entrepreneurship. But in the phases that follow, they may only be average. Just because you have a knack for starting companies, doesn’t necessarily mean that those skills translate well into growing one.

There are celebrated cases of founders who have successfully started and grown a business – Elon Musk and Bill Gates come to mind. There are, however, many more examples of entrepreneurs who perform well initially and then hold back their company as it ages. But, as a business owner, you can avoid this.

How One Founder Unlocked the True Value of His Company

Damian James grew up in Melbourne and learned a lot about the aging population in Australia. Realizing that healthcare could be a lucrative field, he discovered a sector ripe for disruption, podiatry. This is a branch of medicine devoted to the diagnosis, medical and surgical treatment of foot and ankle disorders.

At the time, most podiatrists in Melbourne worked from a retail location where the doctor owned and operated a private practice. The podiatrist would rent space, hire some staff, and charge patients per visit. At night, some enterprising doctors would also visit old age homes to offer care. Reasoning that many old people nodded off shortly after dinner, James saw an opportunity for a podiatrist to visit old age homes during the day when it was more convenient for patients.

The Million Dollar Idea

James, who had earned a bachelor’s degree in Podiatry in 1996, started Aged Foot Care. He approached old age homes with a compelling offer of removing the traditional overhead of an office.

Aged Foot Care went through a variety of growing pains over the years, including an expensive rebranding to the name Dimple. By 2015, Dimple was generating roughly $200,000 of profit on $2.5M in revenue.

Time to Grow

Despite his success, James was frustrated. The company’s growth had stalled. His management team seemed perpetually incapable of hitting its targets.

Quarter after quarter, he would set goals with his team, but they would fall short. James decided it was time to bring in outside help, so he hired a Chief Operating Officer.

To recruit the new COO, James knew he would need to give up some equity, so he commissioned a valuation for Dimple which came in at $2.5 million. He offered a salary, plus 5% of the company. James also offered another 3% of the business (up to a maximum of 20%) for every $1 million the COO would grow Dimple’s revenue past $5 million.

The new role was a success. James quickly promoted him to Chief Executive Officer and stepped back from the day-to-day operations. He decided to let the company thrive under the new CEO’s leadership.

Down to just one day a week, James limited his involvement to providing a vision and protecting the company’s core values. The CEO, on the other hand, ran the day-to-day business – pursuing James’ core strategy of contracting with aged care facilities.

The company hit $11 million in revenue by 2017.

The Big Bonus

Zenitas had a similar strategy of bringing healthcare to patients in homes or care centers rather than having them languish in hospital beds. The company was keen to add podiatry to its stable of services. The decision makers realized that acquiring Dimple would allow it to become an overnight market leader.

In July 2017, Zenitas announced they had acquired Dimple for $13.4 million. Under different leadership, the company had grown in value over 500% in less than three years.

Starting and growing a company require different skills which are rarely found in the same individual. This begs the question, ‘is it time to find someone else to run your business?’

Contact us and ask how our Strategy Advisor engagement can help with growing the value of your business: email@ennislp.com or 301-859-0860.

Should You Use Your Business Equity As Compensation?

It can be tempting to offer shares in your company to finance its growth. These days, there are plenty of investors chasing promising new companies and, in today’s tight labor market, employees are getting more brazen in their demands for equity-based compensation. However, using equity as a form of currency dilutes your position and may not be necessary with a pinch of creativity.

How David Hauser Bootstrapped His Way To a 9-Figure Exit

David Hauser has been an entrepreneur for most of his life. He had a number of small money-making ventures in high school and studied entrepreneurship at Babson College. He started a web design business after graduation, followed by an internet advertising company.

Through his early experiences in entrepreneurship, Hauser discovered that one of the most frustrating parts of starting and growing a small business was acquiring a phone system. Back in the late 1990’s, big companies used a PBX system to route calls throughout a switchboard, but a PBX system was prohibitively expensive for most small companies to acquire and maintain.

Hauser and his friend Siamak Taghaddos imagined a “virtual PBX” which allowed small business owners to leverage the internet to create a phone system without having to buy any of the hardware.  They built a crude version of the technology, named their new company GotVMail (later rebranded as Grasshopper), and launched in 2003.

By 2004, they had acquired their first few customers and could see that in order to scale they would need to buy servers and a lot of advertising to drive demand. The venture capital markets were starting to thaw after the dot com bust of 2001 but Hauser chose not to raise venture capital. Instead, they clung to their equity and bootstrapped their little business.

Instead of ordering servers from Dell, Hauser found a local computer company and sold it on his vision for the future. Hauser asked the owner to make a server for him below cost arguing that if Grasshopper achieved its vision, Hauser would soon buy many more. When Howard Stern moved his show to satellite radio, Grasshopper offered to support Stern’s new medium in return for major concessions on the price of a commercial.

Grasshopper also offered discounts if customers paid for a year’s worth of service upfront, effectively turning its customers into financiers of the business. Despite its growth from start-up to $30 million in revenue in just 12 years, Hauser was able to retain the majority of the equity in his business, which he sold to Citrix in 2015 for $165 million in cash and $8.6 million in Citrix stock.

As the story of David Hauser illustrates, owners who focus on value building will guard their equity. Rather than selling their friends and family cheap shares or giving every new employee options, they use other forms of financing to start and grow their business.

Rather than thinking of your shares as a currency to distribute lavishly, consider your stock as the essential ingredient to building value.    

What Business 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 incapacity, following are other 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 goals. And, we have found that most owners have not only goals pertaining to financial security, but also their personal core values and legacy. For example, for one of our clients, transferring the business to his son and key employee (values-based goal) was as important as his financial goals.

It is helpful and important for you the business owner to understand each of these exit routes and how their particular characteristics either align with your plans and goals for the future and how they might not. And, to have this understanding as soon as possible so that you can begin planning for that chosen route (that could change) as soon as possible.

To help you further your understanding, we created an eBook outlining these exit routes and their advantages and disadvantages and included a few worksheets. You can download the book free of charge here: EXIT eBOOK - What business exit route should you choose?

Please don’t hesitate to reach out at email@ennislp.com or 301-859-0860 if we can serve you in building sellable value and planning your successful exit.

How Can A Cash Balance Retirement Plan Help Attain My Exit Goals?

If your goal is to exit your business at some point in the next ten years, you should answer these questions as soon as possible:

  • When in the next 10 years do I want to leave or exit?

  • How much $$$$ will I need (net of taxes) to do everything I want to do after the business?

  • To whom do I want to sell the business…third-party, insiders, children/family, ESOP?

  • Is my business sellable? For how much?

  • What is my plan for life after the business? (Most owners are miserable within two years of exit because they didn’t have a post-exit life plan).

You may decide to head down one of the following paths once you thoroughly answer these questions and others like them:

  • Over the next ten years you decide to work hard to maximize the sellable value of your business (having a goal of selling for top dollar in the next 10 years), while at the same time accumulate as much $$$$ outside of the business as possible — in order to maximize your exit route options.

  • After learning that you would need to invest much more time and money for your company to be sellable, and decide that you don’t have the energy for that, you might also decide that simply “closing the doors” and liquidating for asset value in 5 years will be your exit strategy — but in the meantime you will , “sock away” as much $$$$ as you can in savings and investments outside of the business.

  • Maybe you have a professional practice (i.e, Attorney, Dentist, M.D., etc.) with neither a clear successor option or potential buyer, and you definitely want to exit within the next 5 years.

In all of these scenarios and others like them, where the owner wants to maximize savings outside of the business, a Cash Balance Retirement Plan could be an effective tool, if certain parameters are met, in accomplishing that objective.

A Cash Balance Plan is an IRS Qualified Retirement Plan that affords participants the ability to accumulate money for retirement in amounts well beyond the 401k and Profit Sharing contributions. If your comprehensive plan for exit includes maximum asset accumulation outside of the business, you should consider the pros and cons of a Cash Balance Plan and how it might serve in accomplishing your goals. If you need help contact us. You can also access further information by listening to our latest ExitReadiness® PODCAST with guests Financial Advisor Erik Fromm and Retirement Specialist Les Risell of Janney Montgomery Scott.

And for a FREE assessment of your business sellability and personal exit readiness, please contact us today at email@ennislp.com.