Building a business is about building transferable value, or the value of the business minus its owner. When an owner begins a business venture, he will have goals for the company, both financial and personal. As the company grows and gets larger and more profitable, business value builds. The purpose of good exit planning is continuing to build that value so that when the time comes for the owner to leave, enough of it can be extracted and used for future goals like retirement. Another of the benefits of succession planning is that it helps protect business value from the slings and arrows of a bad economy.
We all know the economy can be unpredictable. In the past two decades we have seen wild shifts in the business and banking landscapes. It has been a challenging time for owners, and many of them haven’t known how to navigate the changes. Many large and successful companies closed because they had weaknesses that brought them down during recessions. Other owners planned for the long term and involved a team of professionals who could provide advice on tax law, business management, and financial planning.
Benefits of Succession Planning
What kinds of exit planning strategies protect business value? Let’s consider a (hypothetical) tale of two businesses.
Wendell Heath and Aspen Taylor each founded construction companies as C corporations in the late 1980s, in similar but non-competing markets. In the early 2000s, Wendell and Aspen each decided that they wanted to leave their businesses by 2010. They each had their businesses appraised for $5 million. Both wanted to increase their businesses’ value to $8 million.
Mr. Heath took the shorter term approach that owners who have decades in front of them use to build value: he worked 60-hour weeks, he bought expensive equipment, and he hired a lot of new employees to keep up with the demand for new housing. His company was making good money, so he thought he was doing well, despite the fact that his business was entirely dependent on his expertise and efforts. Good money now equals a good retirement later, right?
Ms. Taylor did things differently. She began by talking to her CPA about her retirement goals and her timeline of 8-10 years to accomplish them. Her CPA suggested that she involve an exit planner, and that exit planner worked with her to identify weaknesses within her business. Over time Ms. Taylor worked on attracting a great management team and gave them incentives to stay on through the sale of the company.
Over the course of five years, Ms. Taylor scaled down her involvement in managing the business, leaving that more and more to the team she’d hired. She also hired a tax specialist who advised her to convert her C corporation to an S corporation and minimized her income tax burden. The business broker she hired helped her acquire two smaller competitor businesses which broadened her company’s market share. She also began talking to and training key employees who might be interested in running or purchasing the company when she was ready to exit.
In 2008, the Great Recession hit. Hard. Small businesses, unable to pay their employees or acquire short term financing, went down in droves. Mr. Heath’s cash flow dropped dramatically, and he had to lay off most of his employees. The equipment he’d purchased went unused. Having spent the last decade working 60-hour weeks, he was ready for retirement, especially in such a depressing climate. His business was valued at $6 million, but he chose to sell because he wanted out. The best offer he received was $5.5 million which resulted in a $2.25 million payout.
Ms. Taylor’s company also suffered, but she was able to keep more of her employees on staff because strategic tax planning had saved her more money which she banked. Her business was larger due to the two acquisitions and it was valued at $15 million, up $10 million from a decade previously. Because her management team was installed and committed to staying through a transition, she was able to attract the interest of multiple buyers. The conversion of the company from a C corporation to an S corporation lowered her tax liability when the company sold, and she exited in 2010 with $10 million.
Obviously, this is a hypothetical situation, and every business is different as is every economy. No owner can predict what the economy will be like when he wants to sell. Planning and involving a team of experts early on in the succession planning process can mean the difference between a disappointing sale – or no sale at all – and a great return on a lifetime of investment. Owners need to be aware of this. You only get one chance to sell the company you’ve worked so hard on, so make sure to go into that sale with every advantage. Good exit planning gives owners that advantage.
If you have any questions about the benefits of succession planning, please contact Prometis Partners today. We would be more than happy to discuss the benefits of succession planning and how it can ensure an better retirement for you and your family.