One of the favorite phrases of investment bankers, and sellers of all kinds, is, “Cash is King.” After all, when one is selling anything, cash can remove the seller’s risk in the transaction. When selling a business to a cash buyer, that buyer wants to know exactly how much cash the business is producing.

What the buyer wants and needs is a slight variation on our favorite phrase, “Cash flow is King.” In fact, few cash buyers are willing to part with their money unless they see an increasing stream of cash flowing from the business, both historically and prospectively — after they acquire your company. The balance of this article explores the definition and importance of cash flow when selling a business to an outside third party cash buyer.

The Importance of Cash Flow
The frenetic period of consolidation is over. Mergers and acquisitions activity is down as much as 80 percent from 1999. During the heyday of consolidation, companies used their own publicly-traded stock to aggressively pursue the acquisition of similar companies. This aggressive activity led to payment of multiples of earnings — sometimes of future earnings — that today seem stratospheric in our more sober business world.¹

Today’s buyers may still be anxious to acquire companies, but they are looking for what they call, “good” companies. Usually, these “good” companies have increasing cash flow, good growth potential, and strong fundamentals (such as a strong management team and good operating systems). Of course, these characteristics have always been important and have always been the signs of a good company. But, given the high failure rate of recent mergers and acquisition, cash flow has never been more important.² Acquiring a business with existing strong cash flow can help reduce the buyer’s risk in the transaction. So, for many sellers, getting “six times multiple” of cash flow may depend on what exactly is “cash flow.”

The Definition of Cash Flow
What is “cash flow?” Yet another favorite (albeit less succinct) saying of investment bankers is that they can get you five or six times multiple of your cash flow as a purchase price for your business. All you have to let them do is define cash flow. The devil truly is in the details, or in this case, in the definition. There are several definitions or measures of cash flow, each with a potentially significant and substantive difference. Typical measures of cash flow include:

EBIT: Earnings Before Interest and Taxes.

EBITDA: Earnings Before Interest, Taxes, Depreciation and Amortization

True Cash Flow: The amount of pre-tax money distributed to owners via salary, bonus, and distributions from the company such as S-distributions, and rental payments in excess of fair market rental value of the equipment or building used in the business.

Each of these measures of cash flow can produce a different cash flow amount. Add to these measures, the need to recast cash flow by using “add backs” such as excess rents, salary or bonuses paid to the owner and his or her family.

Which brings us back to our original question: Can you get a six times multiple when you sell your business? Sure . . . it just depends on how you define cash flow. To determine which measurement of cash flow is appropriate for your business, look first to the measurement that the marketplace uses when selling the business to insiders. This “true cash flow” measurement reflects what your “penniless” buyers must use to pay for the business.

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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.

 Company’s Loss of Key Talent (and subsequent loss of employees and customers)

Problem for Sole Owners. Your death will likely have the same impact on your company that the death of any one of your key people would have. Your talents, experience, relationships with customers, employees and vendors may be quite difficult to replace (especially in the short term). Once you are gone, expect employees to jump ship (unless the plans suggested in the First Part of this Series have been made). Without employees, your company is likely to default on its contractual obligations. Without planning few businesses have the financial resources or successor management to weather this storm.

Problem for Co-Owners. Multi-owner companies experience the same loss as solely-owned companies, if the remaining owners do not have the experience or talent to replace you. If you are the person who generates new clients, heads operations or maintains most of the company’s key relationships, your death or disability will jeopardize, if not ruin, your company’s survival.

Solution for Sole Owners. As described in the First Part of this Series, sole owners should create written stay bonus plans to motivate their key employees to remain with the company after the owner’s death. Additionally, you should create a succession of management plan that names the person who will assume your duties. Finally, you should decide now how you want your company to ultimately be continued. Do you want the company to be sold? Continued? Or liquidated?

Solution for Co-Owners. If your co-owners do not have the skills and experience to replace yours, you must put in place a plan to give them the skills and experience they lack. If your employees are confident that the surviving owners have the skills necessary to bring in new business, run the operations or maintain key relationships, they are unlikely to jump ship.

Successful business continuity requires cash—usually in the form of life insurance proceeds. But continuity requires more than cash. Your company will need to fill the talent void created by your departure. To do that, you must encourage (perhaps with cash through a stay bonus plan or perhaps through ownership) existing management to stay. If you business does not currently have, in place, management capable of assuming the reins, you must make it a priority to find and hire that management now.

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 will be required to work years for a new owner.
• I don’t need to plan. When the business is ready a buyer will find me.
• This business is my life! I can’t imagine my life without it!

Let’s see if we can dispel these three objections so you can move forward with planning to leave your business when you want, for the amount of cash you want and to the successor you choose.

I Will Be Required To Work Years For A New Owner

If one of your Exit Objectives is to leave your business as soon as possible, tell your Exit Planning Advisor to make that a prerequisite of any sale. Some buyers require sellers to stay on after closing, but, if the management team is strong, most require the former owner to remain only for short transition period–usually no more than a few months.

If your management team consists only of you, and you want to leave as soon as possible, plan on working for the new owner for a couple of years. If your exit is still several years away, you’ve got work to do. We’ll talk about how to create and motivate a management team that will stay beyond your departure in future issues of this newsletter.

The best way to be sure that you don’t become an employee of a new owner is to make yourself an unnecessary expense. You do that by creating a management team that has proven its ability to make the company profitable, and is motivated to do so.

I don’t need to plan. When the business is ready a buyer will find me.

According to a 2010 Deloitte study, 18 percent of owners share this “exit plan” (Deloitte, “Entrepreneurship UK: 2009/10: On Your Marks,” page 21). One of the hard lessons of The Great Recession of 2008-2011, however, is that the timing of an exit depends on a vibrant economy with an active M&A market and a company with strong cash flow and an owner ready to sell. These factors seldom exist in equal measure at the same time.

We suspect that some owners believe that waiting for a future economic tide to bring back well-financed buyers involves little to no risk. But this type of passivity is fraught with danger:

• What if a qualified buyer doesn’t show up?
• What happens if, when you are ready to sell:
• the M&A market is dormant; or
• your industry niche has fallen out of favor;
• a national competitor moves into your territory; or
• your business and/or the economy is in decline or worse?
• Your health (or personal circumstances) unexpectedly deteriorates?
• What happens if the economic tide doesn’t return at all, or at least not for many years?

This Business Is My Life! I Can’t Imagine My Life Without It.

We all know business owners whose belly fires are long cold and whose animating goals have grown stale. Yet, they hang on in their businesses because they can’t imagine their post-exit lives. We also know owners who remain energized and involved with their companies. Both types will leave their businesses.

If you are still passionately engaged with your business and happily making a difference in your life and the lives of others, don’t exit just to exit. But if the passion that once burned brightly has turned to cold ash, it’s time to act while you have time.

To start exit planning only when the end is near fails to exploit the majority of its benefits. Exit planning involves building business value, its cash flow, and its resiliency so that it prospers regardless of who owns it or what that owner’s exit objectives are. Exit Planning involves protecting value and minimizing taxes–both valuable endeavors regardless of an owner’s specific exit objectives. When departure day dawns, owners who have planned their exits are better positioned to achieve all their business and financial objectives.

Final Thoughts

Certainly, the decision to sell the business you created and nurtured is an intensely personal one. No one can tell you when to exit your business or what to do with the rest of your life. Having worked with other owners, we can help guide you through the process of preparing for the biggest financial event of your life. We can help you consider all of the factors associated with exiting your business and help you to reach your 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.

Believe it or not, most owners do absolutely nothing to consciously plan and systematically move toward that all-important goal. Anecdotally, the four most common excuses owners use to justify delaying and eventually ignoring Exit Planning are:

1. The business isn’t worth enough to meet my financial needs. When it is, that’s when I’ll think about leaving.
2. I will be required to work years for a new owner.
3. I don’t need to plan. When the business is ready a buyer will find me.
4. This business is my life! I can’t imagine my life without it!

Let’s look at the first hurdle that prevents most owners from making the necessary plans to cash out of their businesses and move on to the next stage of their lives.

Excuse #1: It makes no sense to start planning when my business isn’t worth enough to meet my financial needs. When it is, that’s when I’ll think about leaving.

This is a common, and not unreasonable, assumption: Why spend time, effort and money to plan to leave your business when, today, you can’t? Why not wait until it is at least theoretically possible to leave to begin the exiting process?

At age 45, Jerome Rowling was dreaming of the day he could leave his company. The past five years that Jerry had spent trimming fat, watching every dime and developing new marketing strategies on a shoestring had taken their toll. Like the trooper he was, Jerry kept his nose to the grindstone fully confident that if he worked hard enough, the exit he dreamed of would take care of itself.

Fast forward five more years and we find Jerry pretty much where we left him—dreaming more frequently, but doing nothing, about the day he will walk out the door. What had changed was that Jerry had reached his 50th birthday—a benchmark he had set years earlier—for the day he’d leave the business behind.

During the five years Jerry spent working in (rather than on) his business, he missed the opportunity to:

Clearly establish his personal exit goals and objectives. Create an exit plan (based on his goals) that would identify the most productive actions he could take to create and protect value, and to do so in the most tax-efficient way possible. Drive up business value to the point where he could sell, pay taxes and exit with the amount of cash necessary to achieve financial security.

What owners know to be true, but often fail to act upon, is that growing value usually does not occur unless owners focus their efforts on deliberate actions that move the company measurably toward their goals. In failing to act on what they know, owners don’t create or implement exit plans and so are never are able to exit on their terms.

Do you have a plan?

To avoid planning not only puts your future financial security at risk, it overlooks your company’s need to grow in value—efficiently and quickly—in carefully targeted areas. Growing and protecting value is at the core of Exit Planning. To identify where and how to spend precious company resources (your time and money) to make the greatest impact is a key exit planning task. It is just as important as identifying and implementing strategies to minimize current taxes and the tax bill when you transfer your company.

It makes sense to start planning for your eventual exit because you have to plan (and consistently take purposeful actions to implement your plan) if you ever want to exit in today’s (and likely tomorrow’s) economy. The simple reality is that most owners don’t plan and therefore most owners are never able to leave their businesses in style.

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.

Here’s one example of a typical fraud scenario:

Lou Spencer’s CFO, Marty Jacks, had been with Lou’s company for 15 years. While Lou reviewed company financial reports and often the accounts receivable aging report, he let Marty handle the day-to-day financial operations. To say that Lou was surprised when one of his vendors mentioned that he’d run into Marty on the floor of a Las Vegas casino at 4:00 a.m. would be an understatement. As far as Lou knew, Marty spent every weekend at home or camping with his family.

Rather than confront Marty immediately, Lou casually asked his golf partner (a CPA who also happened to be a Certified Fraud Examiner) about employee theft.

The CPA listed more ways to steal than Lou could imagine, but Lou did remember:

• Creating fictitious vendors or employees.
• Stealing inventory.
• Giving oneself undisclosed and unauthorized pay raises.
• “Lapping” or taking payment from one customer and applying it to another’s account.

The CPA explained to Lou the three conditions present in any fraud situation: motive, opportunity and rationalization.

“Has anyone run into financial difficulties?” he asked. “Maybe a sick kid? The unemployment of a spouse or even the readjustment of payments on a home loan?” Lou could not think of anyone in those situations.

Lou understood the “opportunity” factor immediately. He admitted that because he trusted Marty implicitly he was not reviewing every report carefully. Marty certainly had opportunity.

Rationalization: Lou was fairly confident that his employees—including Marty—were satisfied with their salary and benefit packages. Except for an occasional afternoon of golf, Lou believed he worked as hard as any of them.

The CPA suggested that before acting, Lou retain a fraud analyst to conduct a fraud audit. At a minimum, Lou should review his financial statements and this time, rather than focus on the decline in revenues, look for any anomaly or anything that “bucks the trend.” Lou returned to an empty office to do exactly that.

What Lou discovered caused him to call his golf buddy to schedule a meeting about a Fraud Deterrence Audit. Lou swallowed hard as he signed an engagement letter for an audit that would cost his $20M company between $20,000 and $25,000.

After several weeks of review, the CPA laid out the situation for Lou. Marty had a gambling habit (motive). Over the past 18 months, Marty had set up numerous bogus vendor accounts and had siphoned off almost $1 million to these accounts (opportunity). When Marty started pulling small amounts of cash out without Lou noticing, Marty decided that since Lou didn’t miss the cash, Lou could do without it (rationalization).

Armed with the facts, Lou fired Marty. There was no way to recover the money, so Lou and the Fraud Examiner concentrated instead on ways to prevent this scenario from reoccurring.

We asked Edward Bortnick, a CPA, Certified Fraud Deterrence Analyst and Certified Financial and Forensic Accountant, and Certified Valuation Analyst from Rockville, Maryland for his best fraud prevention advice.

“First, look for any anomalies in the company’s financial reports. Are there exceptions to trends over time?” To do this, Bortnick suggests preparing two Excel worksheets.

• On the first spreadsheet, enter the last five years’ income statements expressed both in dollars and as a percentage of gross revenues. Using that report, investigate any significant changes in income as well as significant changes in the expenses as a percentage of income.
• On a second spreadsheet enter your company’s balance sheets for the past five years. Using this report, compute the accounts receivable turnover and collection days for each year as well as inventory turnover. Again, investigate any significant changes.

“Second, change the schedule for running and reviewing reports. Lou’s new CFO (hired only after a thorough background check) should provide Lou with reports on a weekly, rather than monthly, basis.”

“Third, owners should carve out time to carefully review those reports without distraction.”

“Fourth, owners should ask their CPAs to conduct a quick ‘Financial Statements 101’ course,” says Bortnick. Many owners think they know how to read these Statements, but CPAs can teach owners what to look for and what the numbers mean.

Bortnick explains that, “Fraud Examiners will propose a number of changes tailored to a particular company and can follow up periodically to make sure that all changes have been implemented and that there are no new opportunities for fraud.”

“These are a few of the tools,” says Bortnick, “that can be used to monitor your operations and help detect whether anomalies are due to employee dishonesty or changes in your company’s operations. I suggest that owners contact their accountants (or forensic accountants) to help develop systems and forensic tools that owners can use to deter fraud and manage—financially—business operations.”

“Finally, if an owner sees anything he or she does not understand or that seems unusual,” Bortnick advises, “dig deeper. Doing so might just save the company.”

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.

1. Collect referrals, preferably from others within your industry.  If you don’t have anyone else in your industry that you can ask for referrals, check with the local Chamber of Commerce as a starting point.
2. Narrow down your list.
3. Interview at least three certified public accountants to find someone you can work well with.  Remember to actually look at their licenses and ask them why you should choose them over someone else.
4. Also be sure to check into the details of working with each accountant.  Ask about their rates and bring a copy of your previous year’s tax return to the interview.  They should be able to give you an estimate of what you can expect to pay them.  Also ask which accounting software they prefer that you use to keep your records.  Find out how each certified public account’s process works.  For example, do they want you to send in your records electronically, or do they prefer that you bring in the physical paperwork?  Also be sure to look into additional fees that they may have in order to go through your paperwork.
5. Consider the convenience of each certified public accountant.  Do their office hours make it easy for you to call them?  Is their office located in a place that’s easy and convenient for you if you need to drop some paperwork off?

If you make your selection based on these criteria, you will undoubtedly be happy with the accountant you choose.  Many business owners don’t even think to ask some of these questions until it is too late.  Remember that this accountant will have access to all of your financial numbers, so you can’t be too careful about whom you choose.

Acceler8 is one of the most trusted certified public accountant  firms in Arizona.  They specialize in corporate accounting, business valuations , and business advice.  They also handle corporate accounts, helping keep creditors and stockholders in the loop about your company’s current financial position.  Let their experts handle all of your financial questions and watch out for the financial welfare of your business.

For business owners, paying non-essential professional fees is nearly as unpalatable as paying unnecessary taxes. If you are convinced that you don’t require the services of a certified valuation analyst to value your company, this will not be your favorite issue of this newsletter. This issue (and an open mind) may, however, help you avoid an unpleasant encounter with the IRS and help you to reap all of the value of your life’s work.

Let’s look at six reasons why smart owners secure independent business valuations.

Reason One
As you know, Exit Planning is a seven-step process that is completely focused on each owner’s unique objectives. A major objective shared by many is to receive the full, fair value for their ownership interest. When discussing the value of their lives’ work, most owners are not comfortable with rules of thumb, informal or casual estimates. How do you know the true value of your business unless an experienced, trained business valuation specialist values it?

Ask yourself this question: If you were to transfer ownership to a sophisticated outside buyer, would that buyer acquire your business without first determining its worth? Of course not—nor should you sell it to anyone without first determining its worth.

Reason Two
When thinking about your exit, one of the first questions you must ask and answer is, “How much will I need from the sale of my company to maintain the lifestyle I want for me (and for my family) in retirement?” The next question should be, “Is my business worth enough (on an after-tax basis) to support those needs? You must know this answer before you proceed down any exit path.

Reason Three
It surprises many owners to learn that business value is relative, not fixed. It can vary, in part, based on the reason for transferring ownership and on the conditions under which a transfer is made. For example, an appropriate business value for a third party sale may be significantly higher than that established for a transfer of the same business to key employees over time, or a gift of the business to children. Business valuation experts understand this, “rules of thumb” don’t.

Reason Four
An important part of the Exit Planning Process™ (Step Three) is growing the value of the business. Whether you contemplate a transfer to insiders or a sale to outsiders, it is important to motivate and keep management/key employees. Incentive programs that both motivate and “handcuff” employees to a company are based on formulas. The most successful of these incentive programs (whether cash- or stock-based) use formulas that include linking the size of a bonus to growth in business value. Participating employees will be most interested to know how you established an accurate business value and whether that value is fair to them. Relying on an outside appraiser is often the best way to dispel these concerns.

Reason Five
If you are considering a transfer to key employees, do you believe that they will accept a “rule of thumb” valuation? Bear in mind, they likely have little sense for what the business value is, or how it should be determined. Even though you may (for tax and other reasons) decide to sell the business at a low value, employees may not consider the value to be low. It is best to anticipate these concerns and to obtain an independent valuation.

Reason Six
In a transfer to key employees, a common transfer technique (designed to reduce both owner’s and buyer’s tax liabilities) is to initially transfer a minority interest at a discounted value. Using a “rule of thumb” valuation to support a minority discount simply will not fly when the IRS asks you to justify the discount. You must depend on the valuation of an independent valuation specialist who is able and willing to defend her valuation before the IRS.

The transfer of your ownership interest is the final act in your business career. Doesn’t it make sense to maximize the value of your life’s work?

If the cost of a valuation seems “unnecessary,” compare it to the cost of underestimating your company’s value (thus leaving money on the table), or of defending a rule of thumb value before the IRS—unprotected by a proper valuation.

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.

• Ride out the storm doing one’s best to protect value.
• Use the time to build business value.
• Avoid the delay altogether by selling as soon as possible for whatever one could get.

If you are one of those owners who face staying in your company longer than you planned, there is both good news and bad news. The good news is that you are not alone: According to a 2005 PricewaterhouseCoopers’ survey of 364 CEOs of privately held, fast-growing companies, “nearly two-thirds … plan to move on within a decade or less: 42 percent within five years, and 23 percent in five to ten years.” (“Wide Majority of Fast-Growth CEOs Likely to Move On Within Ten Years, PwC Finds.” January 31, 2005.)

The bad news is that you are far from alone. On that golden day when the economy shows signs of recovery, all those Boomers (who were planning to leave in the next few years anyway) and all those owners whose exits were preempted by the recession will be clamoring for the exits. Selling a company in a buyer’s market is about as desirable as selling your company during a recession.

Today’s reality is that many owners find staying in their companies to be more palatable than attempting to sell for today’s prices. If those owners, however, do nothing to prepare for the day they’ll be able to sell, they will find themselves (three to five years from now) in a worse position than they are today: trying to sell a not-quite-ready-for primetime company in a market flooded with other (aging) sellers. That’s really unpalatable.

So, what can you do today?

• Begin with the end in mind. Create written goals and a timeline to accomplish those goals. For example, do you know how much cash you will need from the sale or transfer of your company to support a comfortable life after the sale? Most owners think they know the number, but haven’t carefully examined the assumptions supporting their guesstimate — especially given today’s new financial realities.
• Create a company that attracts deep-pocketed buyers (third parties or insiders). Today, buyers demand a well-run company with an experienced management team that enjoys a “competitive advantage” when compared to others in the industry.
• Time. Use the time afforded you by a flat economy (and by your inability or unwillingness to sell your company for what you want or need today) to develop your management team and create a superior performing company. It simply takes time to implement the changes necessary – within any business – that lead to the creation of more business value. You need time to figure out how to restructure the business to create additional value, time to make mistakes and time to correct and adjust course.
• Get help. Use others — ideally advisors trained to help owners plan and implement your Exit Plan. You will need someone who can help chart the path to more value and who will facilitate the full implementation of your plan. Let’s be candid, most owners – however aware they are of the need to develop and implement a plan to grow value – never do so. When they do exit, they and their businesses are as unprepared as your business is right now.
• The final element is not as much a mark of preparation as it is context: the M&A market must be more robust than it is today. Today, only the best of the best companies – and only those that are in niche industries – are selling.

Your goal as an owner who has postponed selling should be to use the time that the recession has given all of us to create a company that is the “best of the best.”

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.

In an economy when many of us are tempted to bury our heads until the shooting is over, smart business owners are realizing that this may be the perfect time to acquire smaller, less adaptable, less capitalized or less well-managed competitors.

As the sellers of goods or services, owners sometimes forget that they, too, can be buyers. And in this buyer’s market, you can expect to find not only lower purchase prices, but also much more attractive seller-based financing and earn-outs.

Consider for a moment that many of your smaller competitors are experiencing a fall in revenue that portends the end of their company’s viability. While their overhead is not large by your standards, it represents such a substantial percentage of their revenue that, as revenue sinks, they simply cannot correspondingly reduce overhead. The hypothetical business owner, Bob Eustice’s company, All-City Printing, is a good example.

For a good many years, All-City enjoyed a solid business based upon servicing many of the area’s top companies. When this economic downturn began, Bob prudently pruned expenses and actually increased the company’s gross margins. But he didn’t stop there.

Bob began acquiring less fortunate competitors who were unable to weather the downturn. These businesses were much smaller and undercapitalized. Less profitable in the good times they quickly became unprofitable when business declined. Their owners had two options: liquidate and receive very little (if any money) or sell to All-City.

Bob contacted the owners of several smaller print shops whom he thought would consider selling. Within 12 months he acquired three such businesses, or, more accurately, parts of three businesses. Here’s how he structured the purchases:

• All-City acquired only those assets it could immediately use, such as equipment directly used in printing operations. Usually this simply meant assuming existing equipment leases. If Bob purchased other equipment, he paid cash.
• All-City bought the customer lists. As All-City received payment from customers, it paid the sellers for their lists. For two years, All-City paid each seller 10 percent of the future gross revenues received by All-City from that seller’s customers. Payment in this form of “earn-out” was likely more money than the sellers would have received from those customers had they not sold. With its greater efficiencies and economies of scale, All-City was easily able to generate enough cash flow from these new customers to make the payments.

The net result for All-City was a very low risk acquisition financed by future cash flows of that acquisition with the promise of increased future revenues.

All-City’s acquisition methods are far from unusual in times like ours. In many situations, owners are able to acquire businesses — or the parts of businesses they want — with little up-front cash and no bank financing. While you would not sell your company on these terms, they may be the best — and only terms — offered to a less well-positioned competitor.

This is just one acquisition technique you can use to build the value of your company during a recession. If you have questions about other techniques or how to evaluate potential acquisition candidates, contact us.

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.

As is the case with any exit path scenario, the first step in choosing an appropriate exit technique is identifying your ownership transition objectives. After you have set your exit objectives, the next step is to align your objectives with the most advantageous exit path.

When choosing to transfer your ownership to a business-active child, there are a variety of options available to meet your unique business exit needs. Three of the most common business-active child transfer options include gifting ownership, selling ownership and transferring ownership via a stock bonus.

In the following article, we will compare the first two options – selling ownership and gifting ownership. We will base our discussion on the Ted Stevens case study. In this case study, Ted Stevens wanted to transfer 20 percent of his $5 million S corporation to his business-active child, Sharon O’Meara, as soon as possible. Ted also did not need any money from this initial transfer of ownership to meet his other exit objectives.

Scenario No. 1 – Sale of Stock

In most cases, a business-active child to whom a business owner would like to transfer ownership has little or no money to use to buy the business. In this situation, a purchase is usually financed with a promissory note. In Ted’s case, if Sharon purchases 20 percent of the business for $650,000, she will receive 20 percent of the S distributions generated by the free cash flow, or $200,000 per year, after the transaction. Sharon will owe about $80,000 per year in tax on company earnings since taxable profit is equal to free cash flow, leaving $120,000 per year for promissory note payments. Assuming a conservative interest rate on the promissory note (5 percent), the note will be paid in full in about 6 ½ years (76 months).

Ted will receive total principal payments of $650,000, which will result in $520,000 after a capital gains tax of $130,000 is paid. The total net taxes paid by all parties in this transaction, as compared to taxes that would have been paid by all if the transaction had not occurred, are essentially equal to the capital gains tax that Ted pays on receipt of stock sale payments, or approximately $130,000.

It is important to note in this scenario that Ted received payments of $650,000 – money that he really didn’t need and a portion of which may well be part to his estate for estate tax purposes and therefore taxed at his death.

Scenario No. 2 – Gift of Stock

If you are like the majority of business owners who are primarily interested in a transfer to a business-active child, then you may believe that you can “just gift” ownership to your child. However, this strategy may not be as simple as it sounds and it may have unintended tax consequences. You may try to use your annual gift exclusion to transfer business interests, but even in this situation, a married business owner can only transfer $24,000 worth of stock per year (based on 2007 allowable gifts). At this rate, it would take about 27 years for Ted to gift just a 20 percent ownership interest to Sharon—assuming no growth in value of the company.

If Ted chooses to transfer the 20 percent ownership interest to Sharon now, he can use part of his lifetime unified credit exclusion. The entire 20 percent ownership interest, with a value of $650,000, can be transferred at one time with no immediate income, capital gain or gift tax consequence. The tax consequences will occur later; however, when another asset in Ted’s estate, having a value of $650,000, is subject to estate taxes because that portion of the unified credit was used in gifting ownership to Sharon. This results in an eventual estate tax of approximately $292,500 at Ted’s death.

When you decide that the best exit route for you and your company is to transfer ownership to your business-active child, it is important to understand the tax and other implications associated with each transfer technique. Although selling ownership or gifting ownership to your business-active child may initially sound like the best options for this type of business transfer, each of these two options have potential tax disadvantages. 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.