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Ifyour objective is to sell your company for the highest possible price, you would be well served by building reliable systems that can sustain the growth of the business. Before we get started on discussing this important value driver, here are a few quick definitions:

• Systems refer to a group of related processes.
• Processes have purposes and functions of their own and are components of a system. Taken independently, a process alone cannot do the work of a system.
• Procedures are the approved way we do things and often include a sequence of steps.
• Steps are the actions we take to get something done.

A solid management team is one of the first important value drivers to focus on when you are preparing your business exit. In addition to building a strong management team, it is important to build reliable operating systems that can sustain the growth of the business. The second value driver then is the development and documentation of business systems that either generate recurring revenue from an established and growing customer base or create financial efficiencies. For most businesses, this includes all of the core processes that generate revenue or control expenses. These systems may include processes related to production or service delivery, but also may include people-related processes such as a succession planning or a performance management approach.

Look at your business from a buyer’s perspective. If you leave shortly after a sale, what remains? If the answer is top management and highly efficient business systems, you can be more confident that you will be able to get top dollar for your business.

In addition to the business systems related to revenue and expense, some systems are related to customers, such as tracking systems, and the delivery of your products and services such as distribution systems. The documentation of these systems and their related processes and procedures is important to ensuring that quality and consistency can be maintained after the sale. They also signal to the buyer that elements critical to the successful transition of a business are in place. Some examples of items worthy of documentation are:

• Financial control systems and accounting policies.
• Policies to ensure compliance with legal and regulatory matters, especially those related to employer/employee relationships and safety.
• Data management and information systems that tie the company together.

Again, put yourself in the shoes of a would-be buyer. Buyers want assurance that the business can continue to move forward after new ownership and that operations will not break down if and when the former management leaves. This assurance can be obtained when there are documented systems in place that enable the buyer to repeat the actions of the former owner to generate income and grow the business.

There are several business systems, which, once in place, enhance business value whether you plan to sell your business now or decide to keep it. These systems include:

1. Human capital management including: recruitment, selection, hiring, and retention; performance management; training and development; compensation and benefits.
2. Production including product or service quality control and improvement.
3. Product or service research and development.
4. Inventory and fixed asset control.
5. Sales, marketing and communications.
6. Procurement including the selection and maintenance of vendor relationships.

Obviously, appropriate systems and procedures vary depending on the nature of a business, but at a minimum, those resources and activities necessary for the effective operation of the business should be documented. After you have built reliable systems designed to sustain the growth of the business, the next value driver to focus on is establishing a diversified customer base. We will discuss this value driver in detail in the next Exit Planning Review™ Article.

If you have any questions about increasing the value of your business prior to your exit, please contact us to discuss your particular situation. We can help guide you through the process of identifying the current value drivers in your business and creating a road map for increasing value to meet your overall exit objectives.

This article contains excerpts from an article in The Exit Planning Review™  published by Business Enterprise Institute, Inc. Subsequent issues of The Exit Planning Review™ provide unbiased and advertising-free information about all aspects of Exit Planning.  Please contact us or if you would like to sign up for a free subscription to The Exit Planning Review™, if you have any questions or want additional Exit Planning information.

All of these are great reasons to build value, but we look at building value a little differently because in exit planning, we take a longer view and help business owners prepare to exit their companies when they choose, and for the amount of cash they desire.

So building value is not exit planning, but building value is a necessary and principal part of every owner’s Exit Plan. In turn, Exit Planning provides the context for building value. In other words, building value serves many masters—one (and I’d argue the primary one) is to enable owners to reach their ultimate goal of converting their lives’ work into the post-business lives they desire.

When we talk about building value in the context of Exit Planning we ask:

1. What is the company’s current value?
2. What value must the company achieve to enable its owner to reach his/her lifetime income and other exit objectives?
3. What tactics will you employ to close any gap between today’s business value and the value you need upon exit?
4. How can you transfer business value most efficiently (tax and otherwise)?

To see how we answer these questions in an Exit Planning context, let’s look at the case of fictional owner Peter Daniels.

Peter:

• Age 58 married to Pam, also age 58.
• Sole owner of Daniels Food Processing, Inc.
• Salary of $250,000.
• Exit Objectives: 1) Exit at age 63 (five years from today); 2) Post-exit income of $200,000 for 30 years. (I note here that owners consistently tend to underestimate the future amount of annual income they will want and need. In doing so, they set themselves up for a disappointing post-business life style. In Peter’s case, he used a Financial Planner to arrive at a realistic income goal.); and 3) No specific successor in mind.

Daniels Food Processing, Inc.

• Annual cash flow of $250,000.
• Estimated value today: $1,000,000 to $1,250,000 as calculated by a business appraiser.

Bottom Line:

• To finance the Daniels’ post-exit income needs, given the number of years they want income and their assumed rate of investment return (7%), Peter needs to sell his company for between $3M and $3.5M to net $2.5M.
• Peter must increase the value of his company by at least $2M if he is to exit on his terms.

In Peter’s case, the Two Million Dollar Question is: How can he increase the value of his company by $2,000,000 over the next five years and thus close the gap between the business value he has and the business value he needs?

1. What is the company’s current value?

Based on an industry rule of thumb, Peter thought he knew the current value of his company. Because in Exit Planning the company’s current value is a fundamental cornerstone of the work to follow, guesses and assumptions about value don’t cut the mustard. Owners must retain valuation experts to establish (at least) a thumbnail valuation. Do you know what your company is really worth?

2. What value must the company achieve to enable its owner to reach his/her lifetime income and other exit objectives?

In creating an Exit Plan, owners quantify the amount they will need to support the post-exit lifestyle they desire. Usually, they work with a financial planning professional to establish the “Working Assumptions” Peter established above (life expectancy, the future value of non-business assets, and rates of return on investments). Owners must also ask and answer hard questions about how lavishly or simply their post-exit lifestyles will be. Without an accurate and realistic assessment of where you are and where you want to be, it is difficult to develop and implement any plan.

3. What tactics will you employ to close the gap between today’s business value and the value you need upon exit?

Only after you have determined the size of the gap between current and desired business value, does it make sense to decide what needs to be done to close it.

Understanding how far you have to go within a specific time frame provides the context for achieving your goals. Without a timeframe, most owners do not take the sustained action to accomplish what is needed and instead pledge to plan “right after this crisis,” “this major project,” or “this busy season.” But somehow these pledges are rarely kept.

The timeframe inherent in the gap analysis creates responsibility: it requires self-discipline and each small step is subject to the accountability we teach our children but—when it comes to Exit Planning—fail to practice.

Using the gap analysis as its foundation, owners can then identify and implement specific actions that will increase the value of their companies. While there are a myriad of value-building actions from which owners can choose, the most critical are those that enable a business to operate successfully without its owner’s involvement. These include the creation of a stable and highly-skilled management team, understanding and using current financial information to track and alter company performance and the installation of sustainable, organization-wide systems.

An Exit Plan should also include collecting, interpreting and using the data necessary to track progress toward your goal. Tracking may include monthly, quarterly and annual cash flow projections, as well as the creation of an annual business.

4. How can you transfer business value most efficiently (tax and otherwise)?

Good Exit Plans view value-building and all other activities through an income tax lens. Owners use every legal strategy and tactic to minimize taxes while they earn money, grow value and transfer that value. Because taxes simply skim off the value it takes decades to create, it is far more effective to act with a grasp of current and future tax consequences. Use knowledgeable advisors years in advance of the eventual transfer of your company in a way that limits (as far as legally possible) the tax burden on both the owner/seller and the buyer.

Exit Planning’s value-building tools can close the often significant gap between a company’s current and desired values. We are eager to help you figure out if you are facing such a gap, and if so, to quantify it, and help you close it.

This article contains excerpts from an article in The Exit Planning Review™  published by Business Enterprise Institute, Inc. Subsequent issues of The Exit Planning Review™ provide unbiased and advertising-free information about all aspects of Exit Planning.  Please contact us or if you would like to sign up for a free subscription to The Exit Planning Review™, if you have any questions or want additional Exit Planning information.

 If you suspect that the children, key employees or co-owners you would pick to succeed you do not have the funds to cash you out, consider the following 10 elements that make insider transfers successful.

Element 1: Time.

A transfer to insiders takes time: time to plan, time to implement and to pay the departing owner. Typically the more time owners take to transfer the company, the less risk they incur and more money they receive from the new owners.

For that reason, the first question an owner must answer is: Am I willing to take time (typically three to eight years) to execute and complete an insider transfer (while maintaining control)? If the answer is no, then it is probably best to consider other exit paths.

Element 2: Defined Owner Objectives.

If owners are willing to devote the time necessary for this exit strategy, they also must define and or quantify their objectives. These may include:

• Financial security and independence;
• Departure/retirement by a chosen date;
• Keeping family legacy or company culture intact;
• Rewarding key employees; and/or
• Taking the business to the next level—on someone else’s dime.

In a well-designed transfer plan, these objectives are met before control is transferred.

Element 3: Cash Flow.

Healthy cash flow is critical to any sale. No buyer, (whether outside third party or insider) wants to buy a company with anemic cash flow. In a transfer to insiders, however, cash flow assumes gargantuan importance because initially it is the major, if not sole, source of your sale proceeds.

Element 4: Growth In Business Value.

Like healthy cash flow, buyers look (and pay top dollar) for companies that have the potential to grow in value. In transfers to insiders, only if cash flow continues to grow does the ownership transfer generally occur. For this reason, it is vitally important that owners contemplating an insider transfer install and cultivate Value Drivers before and during their exit transition. (For a quick refresher on Value Drivers, please contact me for one of our Value Driver White Papers. )

Element 5: Capable management desiring ownership.

Having a motivated management team in place and capable of replacing you is hugely valuable to any buyer. In a transfer to insiders, such management is essential. That management group must desire ownership and be willing to sign personally for any acquisition financing or ongoing company debt. Owners often assume that their management teams want to own their companies, and they do…but sometimes only until they realize that they have to pay for ownership.

Element 6: Minimize Taxes.

While no owner we know wants to pay more taxes than absolutely necessary, those contemplating insider transfers must focus on minimizing taxes. In an insider transfer it is imperative that you and your advisors structure the sale to minimize taxes on the company’s cash flow (pre-tax income) because without planning the cash flow is taxed twice:

• once when the insider receives it (as the new owner) and then pays taxes before paying you to purchase the company; and
• again when you pay taxes on the proceeds you receive.

One goal of tax planning is to subject the company’s cash flow to taxation only once. Accomplishing this feat takes considerable planning, but it’s worth the time and trouble to save a third or more of the cash flow from this type of double taxation. One-time taxation means owners receive more money more quickly and thereby reduces risk of non-payment.

Element 7: Regulate an incremental transfer of ownership.

One of the most important advantages of the well-designed insider transfer plan is that it gives the owner the ability to regulate how ownership is transferred, when it is transferred and how much ownership is transferred. If company performance falters, employees stumble or if the owner chooses instead to sell to a third party, the well-designed insider exit plan keeps the owner in the driver’s seat.

Element 8: Increase Control = Decrease Risk.

While business owners take risks every day, they don’t relish risking their own and their families’ future financial security. Therefore, we use strategies to retain voting and operational control in the hands of the owner and shift operational business risk from the owner’s shoulders to that of the incoming owners so that owners stay in control of their companies until they receive the entire sale price. If you’d like to talk about the many ways to accomplish this, just call.

Element 9: Written Road Map with Deadlines.

To succeed, we believe that you must put your transfer plan in a written document and communicate it clearly (and regularly) to the eventual owners. If the plan is not in writing, it simply is not credible and neither you, nor your employees, will take it seriously. More importantly, the written plan is the playbook for your exit that you’ll use to coordinate your actions with those of your advisors (thus reducing delay and cost). The plan should include a timeline and provide accountability—who will do what, when—for all participants, including the owner! Without incremental, staged checkpoints, don’t bother starting. You’ll never finish a marathon if you don’t have mile-by-mile goals to meet.

Element 10: Education (yours).

You need to understand the ins and outs of insider transfers because, unlike sales to third parties, you will control your business and the exit process until you’ve gotten all of your dough. That education begins as you read this newsletter.

This article contains excerpts from an article in The Exit Planning Review™  published by Business Enterprise Institute, Inc. Subsequent issues of The Exit Planning Review™ provide unbiased and advertising-free information about all aspects of Exit Planning.  Please contact us or if you would like to sign up for a free subscription to The Exit Planning Review™, if you have any questions or want additional Exit Planning information.

“I never worry about action, but only about inaction. ” Winston Churchill

“I haven’t decided what I ultimately want to do with my business, or when I want to exit, or how much money I’ll need, or whom to sell to, so how can I plan my exit? Besides, I don’t want to exit right now. ”

If you’ve said this, or thought it, you are not alone. Many business owners are either overwhelmed with the thought of exiting or are so busy fighting daily business fires that they assume they cannot plan their exits.

If you aren’t sure about what you want, or when you want to leave, why is it so important to decide to act today?

First, recognize that when you take a passive attitude toward the irrefutable fact that you will—one way or another—leave your business, you are settling for less than the most profitable exit for yourself and for your family.

Second, understand that preparing and transferring a company for top dollar takes time—on average five-ten years. Most of those years will be spent preparing your business for the transfer and, if you decide to sell to employees or children (two groups who rarely have any money), giving them time to earn the money to pay you for your interest.

The more time you have to design and implement income tax-saving strategies, build value, strengthen your management team, and begin a gradual transfer of ownership (not control) to key employees or children, the more likely you are to reach your goals.

Third, if you decide to sell to a third party, remember that the market does not operate on your schedule and may not be paying peak prices when you are ready to sell.

If the prospect of leaving your company with little to show for it is unacceptable to you, let’s look at your three options.

Wait for a buyer. According to Deloitte’s Entrepreneurship UK: 2008 survey, 35 percent of business owners said they will wait for a third-party offer for their businesses. Owners in this group believe that one day a buyer will contact them, negotiate a fair price, and that will be that. Well, this is a course of action—but one that flies in the face of reality. There is a pent up supply of businesses owned by Baby Boomers who, as soon as the M&A market recovers, will be clamoring to sell their companies. The simple law of Supply and Demand tells us what kind of market that will be for sellers.

In a buyer’s market, only the best-prepared businesses sell for top dollar. And the owners of those well-prepared businesses will be those who made the decision to prepare their company years ahead of the actual sale.

Liquidate. Liquidation is a common exit path for owners of companies whose cash flow is declining and has little probability of improving—absent the design and execution of a business/exit plan. If this description fits your company, we recommend that you meet with your tax and other advisors to do the planning necessary to create the most tax-efficient liquidation possible.

Decide to exit and plan accordingly. Start today and take the following steps:

1. Fix a departure date.
2. Determine your financial needs.
3. Decide whom you want to succeed you.
4. Have your business valued to see if: a) you should sell today; and/or b) it has the value necessary to meet your financial and other exit objectives.
5. Based on your objectives and the realities of your business, use a skilled Exit Planning Professional to forge a plan with accountability/decision deadlines.

Acting today to create your best possible exit path is not difficult.

Your failure to act, however, can potentially be fatal to your successful exit. You and your family depend on the success of your business exit. Can you afford to fail to act?

This article contains excerpts from an article in The Exit Planning Review™  published by Business Enterprise Institute, Inc. Subsequent issues of The Exit Planning Review™ provide unbiased and advertising-free information about all aspects of Exit Planning.  Please contact us or if you would like to sign up for a free subscription to The Exit Planning Review™, if you have any questions or want additional Exit Planning information.

We will examine why cash flow is also crucial to those owners who wish to transfer their companies to insiders (employees, co-owners or children) and how to allocate cash flow.

Let me suggest the following definition of cash flow. Business cash flow is the portion of the annual net cash flow from operating activities that remains available for discretionary purposes (after the basic obligations of the business have been met). Because we are discussing cash flow in the context of exiting your business, the “discretionary purpose” referred to above is the purchase of your ownership in your company.

As you prepare to transition out of your business (using any type of ownership transfer other than liquidation or, in some cases, a gift of the company to your children), it is imperative that you secure an accurate future cash flow model. Why?

In a sale to insiders (employees, co-owners or children), cash flow may be the source—the sole source, at least initially—of payments to you. Insiders may not have enough money of their own with which to pay you. Without significant planning and implementation, insiders may not be able to quickly acquire or borrow that cash.

If you choose instead to sell to a third party, the valuation upon which buyers make their offers is likely to be based on a multiple of cash flow.

Should you plan to sell part or all of your business beginning in 2012, your CPA should make cash flow projections for 2012, 2013, 2014, 2015 and 2016.

If you are preparing your own cash flow projection, resist the temptation to create an overly-optimistic forecast. Your projection must be grounded in the reality of past actual performance rather than in your rosy hopes for the future. To avoid this temptation, owners usually ask their CFOs or CPAs to create these forecasts.

With a realistic cash flow projection in hand, you can begin to plan the most tax-effective way possible to achieve that future cash flow.

It bears repeating here that the future cash flow of the business may be your buyer’s only source (at least in the early years) of funds to pay you. If the company, under new ownership, cannot achieve the cash flow numbers that you project, you may not receive the payoff that you expect.

How to Use the Cash Flow Forecast

Forecasting cash flow is the first step. The second is to calculate how that cash flow will be allocated during the ownership transition. Determining the net after-tax distribution to you is the goal of this exercise.

To do so, you must calculate, for each year of your exit plan period, the expected available cash flow reduced by: 1) reasonable compensation to you and 2) the cash the company must retain (for growth, working capital, etc. ).

The remaining cash flow is distributed to the shareholders, you, and—to the extent you have sold part of your company—the new owners.

New owners use that distributed cash to pay you for shares of ownership. If the projected cash flow to new owners is insufficient to pay you through an installment note, your exit is at best temporary.

Since cash flow is the core of an Exit Plan, how do we 1) increase cash flow; and 2) use it wisely?

A successful Exit Plan minimizes taxes for both seller and buyer and keeps sellers in control (and minimizes their risk) until they receive full value for their ownership. All plans begin with an informed understanding of current and future cash flow and require considerable planning and action to achieve these goals.

Your Exit Plan is founded upon your exit objectives (when you want to leave, how much money you want and need, and who should own the business after you) and upon the likely future cash flow of the business. Forecasting the amount of cash flow and determining how that cash flow is used is, indeed, the ultimate reality check for your business exit.

This article contains excerpts from an article in The Exit Planning Review™  published by Business Enterprise Institute, Inc. Subsequent issues of The Exit Planning Review™ provide unbiased and advertising-free information about all aspects of Exit Planning.  Please contact us or if you would like to sign up for a free subscription to The Exit Planning Review™, if you have any questions or want additional Exit Planning information.