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New Hampshire Business Review
February 1-14, 2008
by Daniel W. Sklar
For the business owner, there is more to worry about than just death and taxes. There is also the eventual transfer of the ownership of that business. If you want to maximize the value of your company and minimize your taxes when that time comes, you need to plan for it well in advance. That’s where exit planning comes into play. Unfortunately, most business owners, especially those who are members of the “Boomer” generation, don’t have such a plan in place. Consequently, they run the serious risk of losing significant value, and paying more taxes, if they or their estate is forced to sell the business when they are no longer able to run it effectively. Let’s consider these two recent examples.
Example 1
Joseph owned and operated a successful manufacturing business which he started in the basement of a triple decker. By the year 2000, the business was easily worth over $10 million. That was also the year Joseph turned 65. Needless to say, Joseph didn’t have his fast ball any longer. The business environment became more complex with the onset of globalization. Joseph should have responded by going offshore to have certain items manufactured at a cost that was lower than Joseph’s domestic cost of materials. However, at 65 Joseph didn’t have the health or energy for extended trips to third world countries. Instead he hunkered down in his office hoping that he could rely on his long standing relationships with his old customers. Unfortunately, most of those customers were transitioning into the hands of new owners who were only loyal to their bottom line. Within 24 months the business was in the red for the first time in its 50 year history. Joseph was ultimately forced by his lenders to sell the company. He was able to sell the assets of the company to a foreign competitor for just enough money to pay off the majority of the company’s creditors. There was nothing left for Joseph or his family.
Example 2
Fred owned and operated a very successful aviation related business. In 2005, the value of Fred’s stock in the company was easily worth $5 million. At age 66, Fred started to think about selling the company, although he never went through the planning process nor did he engage the services of an investment banker. Instead, he started reaching out on his own to several competitors hoping that one of them would buy the company. The process was more time consuming than he had expected and as a result the business began to suffer. In 2006, Fred had to deal with certain health issues that resulted in several extended hospital stays. The decline in his health caused a further slow down in the sale of the business as the “potential” buyers tried to exploit the situation. Fred died before a “going concern” sale of the company could be completed. The business was ultimately sold to a totally unrelated third party but at a much reduced price that paid all of the creditors in full, plus $100,000 for Fred’s widow. Clearly, it was significantly less than the $5 plus million Fred could have received for his stock in the company just a few years earlier.
Avoidable consequences
Exit planning is the process by which the business owner can obtain a comprehensive road map that leads him/her to a successful exit from the ownership of a private or closely-held business. The plan must, therefore, focus on all of the business, legal, personal, financial and tax issues that arise from the sale or transfer of a closely-held private company. When completed, it covers a broad range of contingencies such as illness, burnout, divorce, death and disability. The purpose of the exit plan, therefore, is to maximize the value of the business at the time the owner decides to transition it and to make certain that it is structured in a way that will minimize the amount paid out in state and federal taxes. Additionally, the exit plan deals with the timing and type of transition the owner wishes to pursue. The word “transition” is used because it covers intergenerational transfers (sale and/or gifts), employee/management buyouts and ESOP’s as well as an outright sale to an unrelated third party or equity fund.
Between 1946 and 1964, 78 million people were born in the United States and they now comprise the generation known as the “Baby Boomers.” As of today, they range in age from 43 to 61. It has also been estimated that “Boomers” own approximately 12 million companies. According to the website www.babyboomerdealthcounter.com, 7.4% of the Boomers have already died. The site estimates that a “Boomer” dies every 52.1 seconds or at a rate of 1,658 per day. I really didn’t set out to ruin your day. However, the point needs to be made that if you are a “Boomer”, you need to start thinking about the future of your business and planning for it. Even if you intend to transfer it to your children or your employees, numerous things have to be done well in advance to make certain that everything happens exactly the way you want it for both your benefit and for the benefit of your family and your employees.
If you intend to sell your business to an unrelated third party, then exit planning and timing are even more critical. In most transactions, the buyer wants the seller to stay with the company for at least a year or more to assist in the transition. Couple that with the fact that it can take over a year to complete the sale and you are looking at a two to three year process. Consequently, if you thought that you’d be leaving in six months for that long awaited trip around the world, you’d better reschedule it. I know what you’re thinking, “more terrific news.” As I said before, I didn’t write this article to ruin your day or your week.
Instead, it was written with the hope that we can help a few “Boomers” avoid the train wreck of a situation that Joseph and Fred’s widow experienced in the two cases described above. In those situations the loss of significant enterprise value was heartbreaking primarily because it was so avoidable. So if you have read this far, it probably means that you are a “Boomer” and a business owner. In the majority of cases, the business represents your most valuable asset. Protect that value for your retirement and for your family. You worked hard to create it. Take the time to see an exit planning professional now so you can begin the planning process that is most appropriate for your particular situation.
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