Small Business Succession Planning The CHRISTMAN Group LLC


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  • Age, illness, divorce, shareholder disputes, etc. all force a business owners hand. However, each of these things is somewhat predictable – after all business owners are human.
  • Often forced to sell in a recession, after the loss of a major client, during an earnings slump, or during or following the owner’s illness – this has a horrific effect on the value of the company.
  • Business owners typically do not have any idea of what their business is worth. They typically do not know what terms and structures are standard and customary.
  • Often business owners think they are clever if they structure the deal so that most of the proceeds receive capital gains treatment, but with good planning, you can dramatically reduce, defer or in some cases even eliminate capital gains taxes.
  • Lack of control come from 1. being reactive rather than proactive. 2. not being sufficiently prepared. 3. dealing with one buyer at a time.
  • Accomplishing the owner’s personal goals are the measure of how successful a transaction is, not the size of the transaction.
  • Discuss why this is. Don’t know where to start Are intimidated by the process Don’t know when to start Psychological/emotional component Assume advisors will bring it up when appropriate We’ll discuss this in more detail later on.
  • Why just middle market businesses? Why 40 years or older?
  • What risks is the business owner sensitive too: Market, business or personal timing? Personal financial security? Are all of the owner’s eggs in one basket? Personal succession? Are multiple successors vying for the control? Is there a succession vacuum? Breach of confidentiality? Are people already talking? Is exit planning an issue that needs to be addressed?
  • When: financing, financial planning, estate planning, tax returns, buy-sell agreements, exit planning, divorce, litigation, etc. Type: depends on purpose – types range from quick opinion, market assessment, all the way to detailed Sec. 59-60 compliant valuation for use in litigation and with the IRS.
  • The first way to protect existing value
  • Nonqualified deferred: A non-qualified deferred compensation plan is a written contract between the corporate employer and the employee. The contract covers employment and compensation that will be provided in the future. Three basic types: 1. defined benefit - pay the employee a fixed dollar amount or fixed percentage of salary for a period of time after retirement 2. defined contribution plan – deposits a fixed amount into the employee's "account" each year 3. Death benefit plan - death benefit paid to the employee's designated beneficiary Qualified deferred: tax-favored treatment: arrangements include qualified defined contribution and defined benefit pension plans such as qualified annuities, tax-sheltered annuities, savings incentive match plans for employees, known as "SIMPLE" plans, and simplified employee pensions, or "SEPS." qualified retirement plans are subject to a set of IRS rules that limit the amount of annual contributions to the plan, require equal participation for all rank and file employees, define an acceptable vesting schedule, and require annual reporting to the IRS. Qualified fringe benefits: cars, small life and disability insurance policies, day care, transportation allowances
  • The second way to protect existing value Damage control in the event that a key employee does leave during or after the owner’s exit
  • The third way to protect existing value
  • I think it is reasonable to say that exit planning services can ethically justify relatively high fees Time and effort required are high It requires a highly customized level of service The results can often save the client $100s of Ks or even Millions of dollars Good exit planning cannot be done in a short time frame Only advisors with some many years of experience and some gray hair have the wealth of experience required Exit planning fees should always be quoted on either an hourly basis or on a fixed fee basis. We believe it would be a conflict of interest to take a contingent fee based on the results delivered.
  • Small Business Succession Planning The CHRISTMAN Group LLC

    1. 1. Small Business Succession Planning The CHRISTMAN Group LLC
    2. 2. Our Goals: Make this a fun and informative day for you. Teach you how to begin to include exit planning in your practice. As a result: Questions are encouraged!
    3. 3. Small Business Exit Plans: What Are They, Who Needs Them, and Why
    4. 4. What Is An Exit Plan? <ul><li>An exit plan is a comprehensive road map to successfully exit a privately held business. </li></ul><ul><li>It asks and answers all of the </li></ul><ul><ul><li>business, </li></ul></ul><ul><ul><li>personal, </li></ul></ul><ul><ul><li>financial, </li></ul></ul><ul><ul><li>legal and </li></ul></ul><ul><ul><li>tax questions </li></ul></ul><ul><ul><li>involved in selling a privately owned business . </li></ul></ul>
    5. 5. What Is An Exit Plan? Investment Banking Estate Financial Tax Legal Exit Plan
    6. 6. Why is This Important? <ul><li>Huge Need = Huge Opportunity </li></ul><ul><li>Huge Opportunity = Huge Responsibility </li></ul>
    7. 7. Why is This Important? <ul><li>Demographics – The Age Wave </li></ul><ul><li>Baby boomer generation - more entrepreneurial than any other generation in history </li></ul><ul><li>7,700,000 business owners will need exit planning services in the next 15 yrs. </li></ul><ul><li>These businesses represent $10 trillion in market value </li></ul>
    8. 8. Let’s look at some of The Risks of Not Having an Exit Plan
    9. 9. Owners are Reactive, not Proactive <ul><li>Most business owners exit their companies as a result of pressure from outside factors, not as a result of their own desires </li></ul>
    10. 10. Owners Have Poor Timing <ul><li>The exit their companies on a timetable that’s forced on them instead of one that meets their needs </li></ul>
    11. 11. Owners Leave Money on the Table <ul><li>They undervalue their companies and leave hard-earned wealth on the table </li></ul>
    12. 12. Owners Pay Uncle Sam <ul><li>They pay too much in taxes because they don’t know the have options </li></ul>
    13. 13. Owners Lose Control <ul><li>They lose control over the process by being reactive and limiting their exit options </li></ul>
    14. 14. Owners Fail to Achieve Goals <ul><li>They fail to realize all of their business and personal goals </li></ul>
    15. 15. Owners Create Unnecessary Stress <ul><li>They suffer unnecessary psychological stress </li></ul>
    16. 16. Owners Put Business at Risk <ul><li>Owner’s are the primary reason that confidentiality is breached during the sale or exit process </li></ul>
    17. 17. Owners Put Legacy at Risk <ul><li>They risk watching a lifetime of work disintegrate as a result of poor business continuity planning </li></ul>
    18. 18. The Benefits to Business Owners of Exit Planning <ul><li>Achieve business and personal goals </li></ul><ul><li>Empowerment and control </li></ul><ul><li>Business preservation </li></ul><ul><li>Preserve family harmony </li></ul><ul><li>Reduce employee and family uncertainty </li></ul><ul><li>Increase proceeds in owner’s pocket </li></ul>
    19. 19. The Sad Reality <ul><li>Fewer than 25% of business owners have anything close to an exit plan </li></ul><ul><li>70% of business owners report that they did not accomplish their goals in exiting their business </li></ul><ul><li>Very few advisors are asking the right questions </li></ul>
    20. 20. Exit Planning Advisors a multi-disciplinary approach <ul><li>Attorney </li></ul><ul><li>Financial advisor </li></ul><ul><li>CPA/tax specialist </li></ul><ul><li>Insurance professional, and </li></ul><ul><li>Investment banker </li></ul>Investment Banking Estate Financial Tax Legal Exit Plan
    21. 21. Attorneys <ul><li>Raise the exit planning question </li></ul><ul><li>Meet with owner regarding exit planning objectives </li></ul><ul><li>Help form advisory team </li></ul><ul><li>Help prepare formal exit plan </li></ul><ul><li>Conduct pre-transaction due diligence </li></ul><ul><li>Prepare client’s estate plan </li></ul><ul><li>Prepare tax minimization strategy with accountants </li></ul><ul><li>Handle M&A legal work </li></ul>
    22. 22. Accountants <ul><li>Provide owner and other advisors with information regarding historical and projected financial performance </li></ul><ul><li>Prepare audited financial statements for client if warranted </li></ul><ul><li>Analyze owner's business goals and assumptions </li></ul><ul><li>Develop a tax minimization strategy with attorneys </li></ul>
    23. 23. Financial / Insurance Advisors <ul><li>Help business owners understand the importance of financial planning prior to selling </li></ul><ul><li>Perform a financial needs analysis </li></ul><ul><li>Develop recommendations regarding investment strategy that is aligned with the owner’s exit plan </li></ul><ul><li>Implement strategic wealth management plan after the sale. </li></ul>
    24. 24. Investment Bankers <ul><li>Value business </li></ul><ul><li>Make value enhancement recommendations </li></ul><ul><li>Provide quantitative financial analysis for decision making </li></ul><ul><li>Prepare offering materials </li></ul><ul><li>Conduct marketing program to attract buyers </li></ul><ul><li>Negotiate letter of intent </li></ul><ul><li>Coordinate due diligence and documentation process </li></ul>
    25. 25. Identifying Clients in Need of Exit Plans <ul><li>Owns a middle market business </li></ul><ul><li>Is age 40 or older </li></ul>
    26. 26. Section II: Setting Goals and Identifying Risks
    27. 27. Setting Goals <ul><li>Personal </li></ul><ul><li>Family </li></ul><ul><li>Financial </li></ul><ul><li>Business </li></ul><ul><li>Legacy </li></ul><ul><li>Community/Philanthropic </li></ul>
    28. 28. Evaluating Goals <ul><li>Specific </li></ul><ul><li>Realistic </li></ul><ul><li>Measurable </li></ul><ul><li>Lifestyle-based </li></ul><ul><li>Consistent </li></ul><ul><li>Honest </li></ul><ul><li>Compatible </li></ul><ul><li>Agreed to </li></ul>
    29. 29. Understanding Risk and Risk Tolerance <ul><li>Leaving the business on their timetable </li></ul><ul><li>Creating financially security for themselves and their family </li></ul><ul><li>Who should get the business? </li></ul><ul><li>Loss of confidentiality </li></ul>
    30. 30. Common Objections <ul><li>Not sure how to start </li></ul><ul><li>Difficulty discussing personal matters and goals </li></ul><ul><li>No time to focus on long-term planning </li></ul><ul><li>Believe the time is not right to start </li></ul><ul><li>Intimidated by the process </li></ul><ul><li>Afraid of life without the business </li></ul><ul><li>Concerned about confidentiality </li></ul>
    31. 31. Conflicting Value Systems Family Value System Ownership Value System Management Value System This is where exit planning needs to take place. Classic Interference Patterns Affect Exit Planning
    32. 32. Understanding Transition Satisfaction <ul><li>Personal Identity </li></ul><ul><li>Marital Status </li></ul><ul><li>Financial Resources </li></ul><ul><li>Involuntary vs. Voluntary Transition </li></ul><ul><li>Contact with Others </li></ul><ul><li>Having a Plan </li></ul>
    33. 33. Timing is Everything 3.6 years or more Total Time 6 months – 1 year 4. Prepare exit plan 1 year or more 3. Implement value enhancement and tax planning 1 year 2. Investment banking/sales process 1 year or more 1. Transition process Min. Period Step
    34. 34. The Exit Planning Process <ul><li>Five Steps </li></ul><ul><li>1. Personal Financial Plan </li></ul><ul><li>2. Business Valuation </li></ul><ul><li>3. Maximizing or Protecting Value </li></ul><ul><li>4. Maximizing Proceeds </li></ul><ul><li>5. Investment Banking Process </li></ul>
    35. 35. The Personal Financial Plan <ul><li>1. Current Spending </li></ul><ul><li>2. Future Lifestyle </li></ul><ul><li>3. Major Future Capital Expenditures </li></ul><ul><li>4. Current Asset Base </li></ul><ul><li>5. Required Asset Base </li></ul><ul><li>6. Wealth Management Strategy </li></ul>
    36. 36. Business Valuation <ul><li>1. When is a Valuation Needed? </li></ul><ul><li>2. What Type of Valuation is Necessary? </li></ul><ul><li>3. Definition of Value </li></ul><ul><ul><li>Fair Market Value </li></ul></ul><ul><ul><li>Investment Value </li></ul></ul><ul><ul><li>Liquidation Value </li></ul></ul>
    37. 37. Purpose and Its Impact on Value $10,250,000 Investment Value or Market Value Buyer, Seller and their advisors Controlled Auction Third-Party Buyer $9,000,000 Investment Value or Fair Market Value Co-owners Buy-Sell Agreement Co-owners $6,500,000 Fair Market Value with discounts IRS Gifts/GRAT Family Resulting Value Value Standard Valuation Authority Exit Option Exit Channel
    38. 38. Section IV - Building, Maintaining or Minimizing the Value of the Business
    39. 39. Three Keys to Maximizing Value <ul><li>Fundamental Value Drivers </li></ul><ul><li>Protecting Existing Value </li></ul><ul><li>Investment Banking Process </li></ul>Investment Banking Process Focus on Value Drivers Protect Existing Value
    40. 40. Fundamental Value Drivers <ul><li>Good management team </li></ul><ul><li>Solid operating systems </li></ul><ul><li>Operating profit margins above industry average </li></ul><ul><li>Solid, diversified customer base </li></ul><ul><li>Realistic growth strategy </li></ul><ul><li>Effective financial controls </li></ul><ul><li>Good and improving cash flow </li></ul>
    41. 41. Value Enhancement Plans <ul><li>Importance of Goals </li></ul><ul><li>Balance Impact vs. Relevance </li></ul><ul><li>Resource Commitment </li></ul><ul><li>Accountability </li></ul>
    42. 42. Maximizing Value The Importance of Goals <ul><li>Action plans must be structured to deliver the most “bang for the buck” within the relevant time period. </li></ul><ul><li>This requires prioritizing goals and making difficult trade offs. </li></ul>
    43. 43. Maximizing Value Balance Impact vs. Relevance Low Relevance High Low Value, High Relevance Low Value, Low Relevance High Value, High Relevance High Value, Low Relevance High Value Low
    44. 44. Maximizing Value: Resource Commitment <ul><li>Handle In-house or Outsource? </li></ul><ul><li>Personnel? </li></ul><ul><li>Funding? </li></ul><ul><li>Appropriate expertise? </li></ul><ul><li>Bandwidth? </li></ul><ul><li>Accountability? </li></ul>
    45. 45. Maximizing Value: Accountability <ul><li>Launch meeting </li></ul><ul><li>Assign specific tasks to specific people </li></ul><ul><li>Set mileposts </li></ul><ul><li>Set deadlines </li></ul><ul><li>Monitor regularly </li></ul><ul><li>Assign one “coach or quarterback” </li></ul>
    46. 46. Protecting Existing Value <ul><li>Retaining Key Employees </li></ul><ul><li>Protecting Trade Secrets </li></ul><ul><li>Pre-Transaction Due Diligence </li></ul>
    47. 47. Protecting Existing Value: Retaining Key Employees <ul><li>Sales and profits </li></ul><ul><li>Potential exposure of trade secrets and loss of employees to competitors </li></ul><ul><li>Plans for expansion </li></ul><ul><li>Operations </li></ul><ul><li>Morale/loyalty of other employees </li></ul><ul><li>Mentoring of successor managers </li></ul><ul><li>Customer relations </li></ul>
    48. 48. Retention Programs for Key Employees Current Yes Stock Bonuses No Yes Dividends Current No Qualified Fringe Benefits Current Deferred Qualified Deferred Deferred Deferred Nonqualified Deferred Current Yes Salaries & Bonuses Employer Tax Deduction Employee Taxable Income Employee Compensation
    49. 49. More Sophisticated Retention Programs <ul><li>Restricted Stock </li></ul><ul><li>Phantom Stock </li></ul><ul><li>Incentive-Based Compensation </li></ul>
    50. 50. Protecting Trade Secrets - Employment Agreements <ul><li>Necessary </li></ul><ul><li>Protect confidential trade secrets </li></ul><ul><li>Prohibit solicitation of </li></ul><ul><ul><li>Clients/customers </li></ul></ul><ul><ul><li>Employees </li></ul></ul><ul><li>Non-compete </li></ul><ul><ul><li>Right to Work </li></ul></ul><ul><ul><li>In Terrorem </li></ul></ul>
    51. 51. Protecting Existing Value: Pre-Transaction Due Diligence <ul><li>Review and address: </li></ul><ul><li>corporate housekeeping </li></ul><ul><li>title to assets </li></ul><ul><li>approvals and consents </li></ul><ul><li>major contracts </li></ul><ul><li>environmental issues </li></ul><ul><li>employment policies </li></ul><ul><li>litigation </li></ul>
    52. 52. Section VI - Ethical Issues
    53. 53. Fees <ul><li>Fees should be reasonable taking into account </li></ul><ul><ul><li>Time and effort required </li></ul></ul><ul><ul><li>Custom vs. “off-the-shelf” solution </li></ul></ul><ul><ul><li>Results </li></ul></ul><ul><ul><li>Time limitations </li></ul></ul><ul><ul><li>Experience required </li></ul></ul><ul><ul><li>Whether fixed or contingent </li></ul></ul>
    54. 54. Confidentiality <ul><li>No disclosure of client information, unless needed to </li></ul><ul><ul><li>Prevent client from committing a crime </li></ul></ul><ul><ul><li>Establish a claim or defense against the client </li></ul></ul>
    55. 55. Conflicts of Interest <ul><li>No conflict with other clients </li></ul><ul><li>Transactions with client prohibited, unless </li></ul><ul><ul><li>Terms are fair and reasonable </li></ul></ul><ul><ul><li>Fully disclosed in writing </li></ul></ul><ul><ul><li>Client has ability to consult independent counsel </li></ul></ul><ul><ul><li>Client consents in writing </li></ul></ul>
    56. 56. Section VII – The Costs/Benefits of Exit Planning: Case Study
    57. 57. Case Study: The ROI of Exit Planning <ul><li>Introducing exit planning into your practice requires an understanding of the value you could deliver to your clients. </li></ul>
    58. 58. Roger Before <ul><li>Roger owned a successful medical equipment rental business. </li></ul><ul><li>Status: tried unsuccessfully to sell his company for 12 months </li></ul><ul><li>Goals: maximize the value of this company </li></ul><ul><li>Estimated value: $6 million </li></ul><ul><li>No personal financial plan </li></ul><ul><li>No estate plan (other than a will) </li></ul><ul><li>No tax minimization strategy </li></ul>
    59. 59. Roger After <ul><li>Roger needed to net $5.3 million from the sale after taxes in order to accomplish his goals </li></ul><ul><li>Roger’s company was worth $7 million, not $6 million </li></ul><ul><li>Even $7 million was too low to accomplish his goals </li></ul><ul><li>Value enhancement required </li></ul><ul><li>Tax minimization was a must, not an option </li></ul>
    60. 60. Keeping Score <ul><li>The business was sold for $7.2 million </li></ul><ul><li>A controlled auction process was used </li></ul><ul><li>He netted $5,600,000 after taxes and transaction costs </li></ul>
    61. 61. The Client’s Investment <ul><li>$25,000 in exit planning fees </li></ul><ul><li>$25,000 in legal and accounting fees </li></ul><ul><li>The exit plan showed Roger how to received $1.9 million more in after-tax proceeds than Roger had expected based on his prior efforts </li></ul><ul><li>Roger received a 38 to 1 return on his investment in less than three months </li></ul>
    62. 62. The Return <ul><li>When the transaction closed we received a success fee of approximately $300,000 or 4.2% of the total transaction price. </li></ul><ul><li>In total, the combined cost of the exit planning and the investment banking process was $350,000. </li></ul><ul><li>Even including the investment banking fee, Roger received a 5.5 to 1 return on his money in less than 18 months. </li></ul>
    63. 63. The Peace of Mind <ul><li>According to Roger, the best return on his investment was knowing that he had done everything possible to ensure his family’s financial security and that he and his family would now be able to retire with out financial worries. </li></ul>
    64. 64. Questions & Answers