Business Exit, The Owner's Perspective - Doug Smith


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Doug Smith a partner in B2B CFO talks about exiting a business from the perspective of the owner.

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  • INTROI’m happy to be here today. Thank xxxxx for inviting me.I understand that many of you are estate planners and wealth managers. You help business owners figure out what to do with their wealth, once they free it from the company they founded.My job at B2B CFO is to help them maximize the creation of that wealth while it’s still in the company.Exiting one’s business is not an event. It’s a process that plays out over time, often several years. Today, I’m going to try to give you some insight into exiting a business as the owners sees and experiences it.First a word on B2B CFO[CLICK]
  • B2B CFO is 25 years old, and the largest firm of part-time CFOs in America. We are not as well know in the DC area as some other firms, but our presence is growing.Every company, regardless of its size, needs a Chief Financial Officer. Smaller firms can’t afford to hire an experienced CFO full-time. We bring CFOs within the reach of every firm, by offering services on a part-time basis.Although I am the first Partner in the immediate DC area, I bring a close working relationship with our other 200 partners with me. We have 5700 years of experience between us. There is no industry we haven’t worked in, and no small and mid-market business issue we haven’t addressed.
  • Here are some ways we can help improve a business. I’m not going to go into these today, but would welcome the opportunity to talk about these with you or your clients one-on-one at a later date.You’ll notice one of our specialties is Exit Strategies.
  • Just to let you know a little bit about my background prior to joining B2B CFO.
  • Give credit where credit is dueHold up copy of book, note that it is available on Amazon for $33.70. There’s also a Kindle edition.
  • Exit Planning is a very broad topic. We don’t have time to cover all it’s aspects today. Perhaps I can come back at a later time to talk about these.
  • Before we get into specific Exit topics, let’s talk about the business environment for owners exiting their business.Very few businesses get sold to an outside buyer. Only 25% of privately-owned businesses are offered up for sale. Only 20% of those sell. Thus, only about 5% of private businesses are sold to an outside buyer.
  • There are important differences between ownership through the public markets, and ownership in private markets.
  • Deal markets are impacted by a number of factors, including the overall economy. The state of the economy affects the availability of credit to finance transactions, and the supply-demand balance of buyers and sellers.For the past three decades, we’ve been on a ten-year cycle, and this decade doesn’t seem to be any different. There appears to be a prime selling time coming up in the mid-Teens.
  • Here’s a saying: To get rich, you need to own a lot of one thing. To stay rich, you need to own a lot of things.Due to the risks of private market ownership, business owners need to diversity their assets.Many business owners think that the only option for exiting their business is to sell their business. In face there are a number of options.You’ll notice that I called my talk “Business Exit” rather than “Business Sale”.Here’s my own definition of business exit. Please note that the definition talks about transferring some or all of the business’ value.
  • There are a number of options for exiting the business.Some of these allow partial transfer (e.g., recap, ESOP), allowing the owner to still participate in the business and the business’ growth, and allow a sale down the road. This gives the owner a “second bite of the apple.”These are the most common options for small and mid-market businesses, but they’re not the only options. [NEXT SLIDE]
  • To make today a little more interactive, I want you to break into 2 (4, depending on number of people) small groups. Each group should appoint someone to take notes, because we’ll want to hear the ideas you come up with.[AFTER BREAKOUT] Let’s hear what the business owner group came up with.Why exit?Free wealth tied up in the company’s equityDiversify investmentsReduce riskMore free timeRetire
  • Some owners are ready to exit their business. Many are not.We can measure the owner’s readiness to exit on two scales: financial readiness, and mental readiness
  • Much of the focus in exit planning is on this
  • Less of the focus in exit planning is on these factors, but they are just as important – perhaps more important – to a successful exit.Did you ever hear this joke:Q. What’s the difference between being bored and being burned out?A. About a year…
  • Business owners can fall into any one of these quadrants
  • Leonetti describes four classes of owner this wayThe first category of owners has a lot of wealth outside the business. Maybe they were already independently wealth, or they have moved excess profits out of the business over the years and invested them. However, they like working in the business, and are not mentally ready to leave. Maybe they’re young and not ready for retirement.The second category also have a lot of wealth outside the business, but may be older, or burned out. They’re ready for life after work.The third category are owners who still have most of their wealth tied up in the business, and are willing to work in the business to continue to grow it. Maybe they just want to take some of their financial cards off the table.The last category is an owner who needs to leave now, due to age, burnout, or health. They’ve been heavily dependent on the business to fund their lifestyle.In your own practices, you’ve probably met people who fit each of these owner types.
  • Here’s how these owners fall into the four quadrants.
  • Now let’s recall the most common exit options, and array those in the readiness matrix.
  • And here it is on page, matching the types of owners with the options available to them.
  • Now let’s hear from the “Buyers” breakout group
  • The addition of capital to the firm comes at different points in the company’s lifecycle.
  • Here are some of the things a buyers gets when acquiring a companyAmong the most important: management. Just as the secret to retail success is “location, location, location”, many investors will say the key to a successful sale is “management, management, management.”
  • Given the buyer mindset and background, here are some of the things that can get in the way of a successful exit. Remember that only 20% of small and mid-market business that are offered for sale are sold successfully.
  • A business does not have a single value. Instead, it has a range of possible values. Different exit methods use different valuation.A low value is not necessarily a bad thing – it can help reduce the tax burden of an exit transaction.The liquidation value comes when the business is closed down. It’s the value that comes from selling off the assets and paying off the debt.Fair market value is used in ESOP and gifting exits. There are standard methods, dictated by the IRS and others, for setting the FMV. When there is only a partial exit, the FMV may be discounted further.Investment value is used for Private Equity recapitalization. It’s also used for management buyouts.In a strategic sale (often to a competitor), there is additional value to the seller from potential synergies between the buyer once they own the selling company as well. Let’s look at what these synergies might be. [NEXT SLIDE]
  • In business school, I learned about the Capital Asset Pricing Model, using the present value of future cash flows.This is complicated, so we often use a proxy, a multiplier.P/E ratios are used for public stock. An EBITDA multiplier is a similar concept.EBITDA is a measure of profits that excludes activities that don’t relate to operating the business (Interest, Taxes, Depreciation, Amortization)5x EBITDA implies a 20% ROI
  • Few business owners look at their business with the eyes of an investor. Except for those who are independently wealthy outside the business, many owners have learned to expect a certain lifestyle, sustained by the business.Once they exit the business, the business is no longer their to sustain the life style. There’s not a salary. There are no company-funded benefits or perks. The net proceeds of the exit are what’s available to fund the lifestyle of the future. Thus, many owners “back into” the desired sale price of their company based on the lifestyle they want to continue to maintain (or better).Use the auto example as one of many pieces of value that must be pulled out of the business, based on the owner’s expectations.
  • So, there are really five categories of value. The owner’s “lifestyle” value is the fuzziest of all, and may be greater than the sum of the other types of value!
  • When the business is sold, the owner does not get to keep all that money. A significant portion goes to other people involved in the exit transaction, or to the government. Let’s walk through these.
  • Here’s a formula typically used to pay the broker or investment bank, contingent on a successful sale.
  • Remember that wealth is created in ways other than the single sale. In a partial exit (e.g., ESOP, PE Recap, Management Buyout), the owner still receives money from within the firm each year, and can still participate in the final exit (albeit with a small stake, but perhaps a larger overall sale price).
  • Now that we’ve talked about financial and mental aspects of the final exit, when should the owner start to plan for their exit? Many owners only start thinking about the exit when they’re close to the desired transaction date. Waiting this long can close down many avenues for a happy exit.
  • If planning starts now, the first thing to develop is a detailed plan for the exit.Here is John Leonetti’s definition of an exit plan. Since it’s a bit long-winded, I’ve pulled out some of the essential elements on the right.
  • The best outcomes can be had when the planning begins years ahead of the desired exit date. That way, improvements can be made to the operating basis to increase it’s ultimate end value when the exit happens. Here are a number of things business owners can do. They’re good business practices anyway.
  • Transactional advisors get paid for completing a single service. They can rarely offer a complete range of Exit Options. They do not get paid if a sale does not take place.
  • Relationship advisors often have long term relationships with clients, and they are also critical to an owner’s successful exit. They are paid on a fee basis (typically hourly). However, existing advisors (e.g., lawyers, CPAs) may not be the best people to help with the exit. The owner should seek out advisors that have previous exit experience.The smart owner will also appoint a “quarterback” to coordinate the team’s efforts. It can be one of the advisors, but someone independent of the other advisors may also be useful. Both the transaction and relationship advisors have their own incentives (e.g., transaction = getting a deal done vs. getting the best price; relationship = the owner has been steady income for them), which may cause them to tilt their advice. If there is not a quarterback, the owner will have to play the quarterback role him or herself.
  • Owners should take the time to familiarize themselves with the various types of legal documents that will need to be signed at the transaction close.
  • Business Exit, The Owner's Perspective - Doug Smith

    1. 1. Presentation to [list audience here] Doug Smith, Partner B2B CFO® Mmm dd, yyyy Business Exit:The Owner’s Perspective
    2. 2. What Is B2B CFO® ?Established: Founded in 1987National : 200 Partners in 39 states, 5700 years of experienceFocused: Privately-held companies with sales between $1 - $75MAffordable: Part-time CFO services, as needed
    3. 3. We are Specialists In:Banking and Lending Gross ProfitRelationships OptimizationProfit Improvement Expense ReductionFinancial and Timely & AccurateStrategic Planning Financial StatementsCash Flow Increased SalesProjectionsWorking Capital Exit StrategiesImprovement
    4. 4. Who Am I?• 33 Years in Operations, Finance, Administration• COO, CFO, CAO• Government Contracting, IT, Healthcare• M&A experience (seller, buyer)• American Management Systems, MITRE, other small and mid-market businesses• BS Engineering (Princeton), MBA (Harvard)
    5. 5. Some of Today’s Content is From…• John Leonetti is the Managing Director of Pinnacle Equity Solutions• Pinnacle Equity Solutions is a B2B CFO® partner Copyright 2008 by John M. Leonetti, Published by John Wiley & Sons, Inc.
    6. 6. What We Don’t Have Time for Today• Details of deal structuring• Asset vs. stock acquisitions• Multiple owner issues (e.g., buy/sell agreements)• Handling the proceeds – Estate planning – Investment – Tax planning/avoidance
    7. 7. The Exit Environment• 70% of private business owners report that their business is their primary source of income• Only 5% of privately-owned businesses successfully sell to an outside buyer – Only 25% of private businesses are offered up for sale – Only 20% of those successfully sell• 27 million U.S. businesses (2009) – 99.9% have less than 500 employees – 21 million have no employees – 18,000 large businesses• Firm survival – 70% survive at least 2 years – Half survive at least 5 years – One-third survive at least 10 years – One-fourth survive 15 years Source: SBA
    8. 8. Exit Environment (cont’d)• Much Baby Boomer wealth tied up in 12 million privately-owned businesses – 70% of these owners will exit in the next 15 years – $3-4 trillion in wealth will change hands
    9. 9. Public vs. Private Markets Public Markets (Wall Street) Private Markets (Main Street)C Corporation C, S, LLC, etc.Value established by market at any Value established at a point in timepoint in timeReady access to public capital No access to public capitalShareholders have limited liability Shareholder(s) have unlimited liabilityShareholder holdings are diversified Shareholder earnings not diversifiedProfessional management Owner managementCompany has long life Company life typically < one generationLiquid securities, efficiently traded Illiquid securities, inefficiently tradedProfit maximization goal Personal wealth creation goal ©2010, Pinnacle Equity Solutions
    10. 10. 10-Year Transfer Cycle Deal Recession Prime Selling Time Almost (Buyer’s (Seller’s Market) Recession Market) (Neutral Market)1980 198 1988 19901990 3 1998 20002000 199 2008 20102010 3 2018 2020 200 3 201 3 Exiting Your Business, Protecting Your Wealth by John M. Leonetti, ©2008, p. 19
    11. 11. Exit ≠ Sale• Exit definition: Transferring some or all of your business’ value to someone else, in exchange for more liquid assets
    12. 12. What are the Exit Options?• Sale to an outsider• Recapitalization (e.g., Private Equity investment)• Employee Stock Ownership Plan (ESOP)• Management Buyout• Gifting (to family, to charity)
    13. 13. What are the Exit Options?• Sale to an outsider• Recapitalization (e.g., Private Equity investment)• Employee Stock Ownership Plan (ESOP)• Management Buyout• Gifting (to family, to charity)• [Status Quo] Stay and (ideally) grow• Initial Public Offering (IPO)• Close down the business and liquidate assets• Bankruptcy• Death
    14. 14. Why Do Owners Exit TheirBusiness?Why Do Buyers Acquire ABusiness?
    15. 15. What Do Exiting Owners Do With Their Proceeds?• Provide for their own retirement• Provide for loved ones• Share rewards with others who helped them build their business• Contribute to charity• Invest – Diversified savings for growth and income – Start another business – Join angel or private equity investment groups
    16. 16. Owner Readiness to Exit HighFinancialReadiness Low Low High Mental Readiness Exiting Your Business, Protecting Your Wealth by John M. Leonetti, ©2008, p. 15
    17. 17. Financial Readiness• How much of my wealth is tied up in the business?• How much of the proceeds do I want/need to keep for myself?• Do I depend on the business to support my lifestyle?• Am I prepared for the loss of: – Salary – Benefits – Deductible Perks (travel, auto, meals)
    18. 18. Mental Readiness• How involved am I in the day-to-day running of the business? – Am I addicted to being a business owner – Will I know what to do with my time when I am no longer in the business?• Do I view my business as an investment? – Can I make dispassionate decisions, based on objective criteria, about the exit process?• Am I feeling burned out?
    19. 19. Owner Readiness to Exit HighFinancialReadiness Low Low High Mental Readiness Exiting Your Business, Protecting Your Wealth by John M. Leonetti, ©2008, p. 15
    20. 20. Four Types of Owners• Well off, but choose to work• Rich, and ready to go• Can stay and grow the business• Get me out right away at the highest possible price
    21. 21. Owner Type by Readiness Well off, but Rich, and ready High choose to work to goFinancialReadiness Low Get me out now Stay and grow at the highest possible price Low High Mental Readiness Exiting Your Business, Protecting Your Wealth by John M. Leonetti, ©2008, p. 15
    22. 22. What are the Exit Options?• Sale to an outsider• Recapitalization (e.g., Private Equity investment)• Employee Stock Ownership Plan (ESOP)• Management Buyout• Gifting (to family, to charity)• Stay and grow
    23. 23. Exit Options vs. Readiness Management High Gift, ESOP, Buyout, Sell ESOP,Financial GiftReadiness Low Recap, ESOP, Sell for the highest Stay and grow possible price Low High Mental Readiness Exiting Your Business, Protecting Your Wealth by John M. Leonetti, ©2008, p. 16
    24. 24. Putting It All Together Hig Well off, but Rich, and ready h choose to work to goFinancialReadiness Low Get me out now Stay and grow at the highest possible price Hig Management Low h High Buyout, Gift, ESOP, ESOP, Sell Mental Readiness Gift Financial Readiness Low Recap, ESOP, Sell for the highest Stay and grow possible price Low High Mental Readiness Exiting Your Business, Protecting Your Wealth by John M. Leonetti, ©2008, pp. 15-
    25. 25. Why Do Owners Exit TheirBusiness?Why Do Buyers Acquire ABusiness?
    26. 26. Sources of Capital IPORevenue PrivateGrowth Equity Angel Investors Venture Friends & Capital Family Time
    27. 27. What Do Buyers Buy?• People (management team, workers)• Reputation/Brand• Future cash stream• Intellectual property• Contracts• Customer/client relationships• Assets and Liabilities on the Balance Sheet – Cash (usually goes to the seller) – Fixed Assets (buildings, equipment, furniture, computers) – Inventory – Debt Obligations
    28. 28. What Can Prevent a Successful Exit?• Business cannot survive once the original owner no longer involved• Keeping family in the business is more important than selling to an outsider• Potential buyers can’t get the financing needed to acquire the business• Poor economy has reduced profitability• The owner’s price expectations are unrealistic
    29. 29. What is the Business’ Value?• Four types of value Strategic SV Sale – Liquidation value (LV) – Fair market value (FMV) Management IV – Investment value (IV) Buyout, Recap – Synergy value (SV)• FMV may be discounted FMV ESOP, Gift for partial transfers Discount – Lack of control – Lack of marketability LV Liquidation
    30. 30. Synergy Value (from the Buyer’s Perspective)• Removing competition• Reducing seasonal fluctuations• Critical mass• Expanded geographic reach• Increased prestige• Reduce indirect cost % through consolidation and elimination of duplication
    31. 31. My Business as an Investment• People/organizations it worth what I invest it is?”) (“Why isn’t with money can think it different ways – Equities have returned, historically, 10%+ annually – Buying a small business is inherently a risky investment • Can it prosper without the current owner? • Business will still be illiquid after the sale – Greater risk = greater expected return – Buyers expect 20-40% annualized return• Generally speaking, buyers pay for a multiple of company’s cash flow (EBITDA), adjusted for their risk perception• For given cash flow, higher risk premium → lower price
    32. 32. How Do Owners Determine Their Business’ Value?• What is needed to sustain (or improve) my personal lifestyle after my exit – Salary – Benefits – Some previously-deductible business expenses now become personal (travel, meals, cars) Replacing The Company Car Car Lease $500 Annual Cost $10,200 Insurance $100 Marginal Tax Rate 40% Fuel $100 Annual Cost (pretax) $17,000 Maintenance $150 Investment Return 6% TOTAL $850 Annual Cost $10,200 Assets Needed $283,333
    33. 33. What is the Business’Value? Strategic SV Sale Management IV Buyout, Recap “Owner’s Lifestyle FMV ESOP,Preservation Gift Value” Discount LV Liquidation
    34. 34. What Does the Owner Net? (“How Much Do I Get to Keep?”)• Sale/Transfer Price• Plus – Liquid assets pulled out of business • Cash above that needed for Working Capital• Minus – Payoff of business debt – Transaction Fee (Double Lehman Formula) • M&A Broker or Investment Bank – Hourly Fees • Lawyers, Accountant, etc. – Taxes (Federal, State, Capital Gains, Ordinary Income, Estate) – Earn-Outs • Replacing non-competitively-won business • Achieving certain milestones (e.g., revenue growth, profitability)
    35. 35. Double Lehman Formula• 10% of the first $1,000,000 $100,000• 8% of the next $1,000,000 $ 80,000• 6% of the next $1,000,000 $ 60,000• 4% of the next $1,000,000 $ 40,000• 2% of the next $1,000,000 $ 20,000• 2% of each additional $1,000,000• Sale Price of $20,000,000 $600,000
    36. 36. Total Wealth in a Partial Exit + + Net Proceeds from Final Sale Annual of the Continuation of Business Assets Salary,Removed from Benefits, and the Business Perksand Reinvested – compoundannual growth
    37. 37. When Should an Owner Startto Plan the Exit?
    38. 38. When Should an Owner Start to Plan Their Exit? Now! (Even if the exit event is years away)(Exit Planning is a process, not a milestone)
    39. 39. Exit Strategy PlanLeonetti: “The written goals • Written goalsfor the succession of abusiness’ ownership and • Succession ofcontrol, derived from awell-thought-out and ownership andproperly-timed plan that controlconsiders all factors, allinterested parties, and the • Detailed planpersonal goals of theowners in a manner and • Considers needs oftime period that all interestedaccommodates thebusiness, its shareholders, partiesand potential successorsand/or buyers” Your Business, Protecting Your Wealth by John M. Leonetti, ©2008, p. 2 Exiting
    40. 40. Get Ready to Sell/Transfer• Increase the value of the business – Increase sales – Improve profit margin – Reduce internal costs through efficiency, streamlining, focus – Strengthen infrastructure (management, people, systems, process documentation) – “Lock In” key individuals with incentives – Diversify customers and contracts, if concentrated – Document and protect IP – Build a track record of good financial management (financials reviewed by CPA, correct tax returns)
    41. 41. Get Ready (cont’d)• Get mentally ready – See your business the way investors will look at it – Make decisions like an investor, not as an emotionally-invested owner – Be prepared to not live out of your business – Decide what you’ll do with your time after exiting• Line up advisors
    42. 42. Transactional Advisors $5M - $25M $25M -$2M - $5M 100M+Busines M&A Investmen s Specialis t
    43. 43. Relationship Advisors CPA AttorneyWealth Insuranc eValuatio Estate n Independent “Quarterback”
    44. 44. Understand Paperwork to be Signed• Letter of Intent (LOI) – Outlines fundamental deal points – Starts due diligence process – Often has an exclusivity clause• Purchase and Sale Agreement (a.k.a Definitive Purchase Agreement) – Includes representations and warranties – Include any negatives – Must be in writing, even if discussed verbally during due diligence• Non-Compete Agreement• Earn-Out Agreement• Seller-Financing Agreement
    45. 45. When Should an Owner Startto Plan Their Exit? Now!
    46. 46. Questions? Comments?Doug Smith, Partner, B2B CFO®e-mail: dougsmith@b2bcfo.comphone: 703.927.9823