Face it, we all love shortcuts. We learn at an early age the benefits of shortcuts: whether we cut through our neighbor’s yard on our walk to school, clean our room by stuffing our messes into our closets, or even feed our unwanted vegetables to our dog (surreptitiously under the table, of course) so we can get the dessert our mothers’ promised if we clean our plates, who can resist a good shortcut?

Today, I still use the shortcuts my high school mathematics teacher taught us to check our addition and how to quickly multiply by 25. I doubt any of us can get through the day without utilizing at least one shortcut we learned as kids. For business buyers and sellers, multiples are simply shortcuts to the valuation and/or negotiation process.

When applied properly, multiples can be used effectively as sanity or temperature checks/gauges. However, I personally would not want to buy or sell a business based strictly upon a multiple. There are always so many variables to consider when acquiring or selling a business; basing such an important decision on a simple multiple does not make sense. Take a look at the following, admittedly simple, example as a way of illustrating my point.

For example purposes, let us assume Company A and Company B each manufacture virtually identical widgets. Each company is organized as an “S” Corp with a single shareholder looking to sell for retirement and estate planning purposes. Also assume neither company has any interest bearing debt. (Note: the fact that we have to outline so many variables before ever discussing the performance of the companies should be a dead give-away: valuation multiples are not as valuable as we think.) The key operating data for each Company is shown in the table:

All things being equal, which business is worth more, Company A or Company B? A multiple of earnings would tell you both companies are exactly equal. However, Company A’s hypothetical net worth is more than 50% greater than Company B’s net worth. Is that important to a buyer or seller?

If the acquirer is using leverage to make the acquisition, theoretically, Company A would be more valuable because if both companies are valued by the same multiple of earnings, the buyer of Company A would have to infuse less of its own capital than if it acquired Company B. Thus, in theory, to a leverage buyer, Company A is more valuable and the buyer could, theoretically, afford to pay more for Company A than Company B (because while the acquirer’s own invested capital will remain constant, if the acquirer can use more leverage for Company A, the acquirer can pay a higher price or earnings multiple).

However, if the acquirer is a pure cash-flow buyer, Company B will be more attractive because of its ability to achieve earnings on the same level as Company A with a much greater return on overall capital. Thus, a cash flow buyer would be able to place a higher value on Company B than Company A.

Imagine one more variable to the above scenario: assume Company B earns the exact same amount of operating profit and EBITDA as Company A, but on revenues 40% lower than Company A. Using a multiple of earnings, these two companies have the same value, but would an acquirer pay the same for each one?

In the real world, no two companies are ever as closely matched as those in the example above. However, I think this much is clear: multiples are not the only metric to use when trying to determine the value of a business.

Of course, we know certain businesses and certain industries have long-established acquisition guidelines (fast food restaurant chains, auto dealerships, banks, etc.) but rarely are these multiples set in concrete. Multiples are generally used as a guide, not a rule. Used incorrectly, they can produce dangerous results for buyers or sellers.

For example, recently we meet with the owners of a local manufacturing business. When we discussed their value expectations, they said, “We heard you sold our competitor’s company to a Private Equity Group for 7 times EBITDA. That’s what we want.” We pointed out the following to these owners: our client was roughly 5 times larger than their company in terms of sales and profits; our client had proprietary products while they did not; we sold our client’s company at the beginning of 2008, not 2010; and, finally, without violating confidentiality, we could attest to the fact their competitor did not get 7 times EBITDA for their company. Despite these data points, the owners were unmoved: “We want 7 times EBITDA or we will not sell our business.”

Another challenge with multiples is they are, in essence, post-mortem accounting. Purchase price multiples are determined only after a transaction has closed, at which point the data is naturally “stale.” Furthermore, in times of rapidly changing fortunes, multiples rarely change as rapidly as the economy.

Consider this: if you are contemplating an acquisition today, in the Winter of 2010, would you want to base your decision on purchase price multiples calculated from data for transactions closed prior to the Fall of 2008 when the economy came crashing down? As a buyer, your answer is a resounding “no.” As a seller, the answer may be, “it depends.”

In my upcoming article to be published here early next month, we will review where purchase price multiples are in today’s market and the impact banks/lenders play in the game. Until then, remember: multiples are nice to discuss, but I would not want to make a multi-million dollar decision based on a multiplier.

posted by Jim Zipursky

Answer:  By conveying the property to a Charitable Remainder Trust (CRT).

Here’s how it works:  After the trustor/donor transfers property to the CRT, the property is sold by the trustee.  There is no tax on the sale since the CRT is exempt from income tax under Section 664(c)(1) of the Internal Revenue Code.  The proceeds from the sale are invested into income producing property.  The trustee distributes income to the trustor during his or her lifetime.  Upon death of the trustor, the remaining property (corpus) is transferred to a designated charity.

Besides the benefit of avoiding tax from a taxable sale, in the year of transfer to the CRT, the trustor receives a charitable contribution deduction for the computed value of the charitable remainder interest.  The charitable remainder interest computation is based upon the value of the property transferred to the trust, the type of trust, the payout rate, frequency of payments each year, the mortality table, the applicable federal interest rate, and the age of the trustor.

There are two types of charitable remainder trusts – the annuity trust and the unitrust.  The difference between these two types of trusts has to do with the determination of the amount paid to the trustor each year.  Subject to some restrictions, an annuity trust pays a fixed amount to the trustor each year.  Also subject to some restrictions, a unitrust pays a fixed percentage of the value of the trust assets each year.

In the context of an exit strategy, the stock of a closely held company can be the appreciated property conveyed to the CRT.  One disadvantage of a CRT is that the trust is irrevocable.  So once the transfer of property to the CRT takes place, the property cannot be returned to the trustor.  In planning a transfer of stock in a closely held company to the CRT, one would assume that a buyer will need to be in place to purchase the stock from the trustee after transfer of the stock to the CRT.  This is a delicate issue under federal tax law and competent tax counsel needs to be involved with such a plan.  The Internal Revenue Service generally frowns on a preplanned stock sale before a transfer to the CRT.

Another exit strategy involving the use of a CRT, with less risk than a transfer of closely held stock, has to do with qualifying replacement property that is acquired in an ESOP rollover (see the blog article of January 15, 2010).  The qualifying replacement property will usually have a fair market value that is greater than the tax basis in such property.  If the qualifying replacement property is sold, generally a taxable gain will result.  What if some portion of the qualifying replacement property is transferred to a CRT?  If the replacement property includes stock in a publicly traded domestic corporation, which does not pay dividends, the transfer of such property to a CRT can effectively convert this asset into an income stream, and, as described above, create a charitable contribution deduction as well.

The CRT is also a useful tool in estate planning.  Since the property of the CRT is transferred to a designated charitable organization upon the death of the trustor, the value of such property is not included in the measure of the taxable estate of the trustor.

Before considering any type of strategy that includes the use of a CRT, it is important to seek competent tax counsel who is experienced with transactions involving a CRT.

posted by David DuWaldt

We have been looking at the two-fold challenge faced by Business Owners wishing to “extract themselves and their wealth” from their businesses in the next decade.  Firstly, that the economic recovery may be slow, and, secondly, that the retirement of the Baby Boomers will put “10 million” businesses on the market in this period.

From this perspective, we recognize that many companies will not sell without careful planning and preparation.  The point of considering possible “Positioning Strategies” is that most business are not being run with a mind to “selling”, and are typically not optimally prepared for an exit because:

1. the ownership and management roles are not properly separated, and
2. the key determinants of value, namely growth and risk, are not calibrated to the expectations and desires of market buyers (investors)

Exiting through a sale, recapitalization or merger generally involves investors and may involve lenders. Management is pivotal.  Exiting through a transfer of the business to family, management or employees, or through a gifting strategy, may or may not involve lenders but, once again, management is a pivotal issue.  Exiting through liquidation, on the other hand, does not depend on management to the same extent.

Generally, the different Exit Strategies depend on key considerations as follows:

Let’s focus on the “sale / re-cap / merger” group of options which account for the majority of exits.

The first order of business is having a strong management

The Business Owner who runs his own business may expect that a buyer will operate the same way.  While this is a possibility, it is more likely that the buyer will be a larger enterprise with a separate management or an investment group with no interest in participating in the operating management.  With the possible exception of a competitor looking to add accounts, buyers will likely want to see themselves as “investors”, separate from the management.

In fact, if we take a look at the three key drivers of a successful sale at an optimal valuation, management is the key ingredient in all three.

• A business which is growing or has growth opportunity
• A business which is not unnecessarily exposed to known risks
• A business which is visible and open to a buyer and which presents very few unknowns or risks, i.e. a business which is marketable

The Objective is to optimize the value of the Wealth Transfer by attracting multiple competitive bids from Quality Buyers

Notice that we are talking about the value of the Wealth Transfer, not the “sale price” or even the “business valuation”.  What is exchanged (cash, stock, notes, earn-out), under what conditions of risk or uncertainty, and when it is received …. all play into the “value” which the seller seeks.

Value (to the seller) is driven by Price, Terms (timing) and Structure

Multi-Step Exits

If the risk of leaving some wealth in the business is acceptable to the Business Owner, he may take some cash now and the rest later when the valuation is higher.

A classic two-stage exit is accomplished by means of a “re-capitalization” in which an investor / partner / buyer acquires part of the business with an expectation to either buy the rest of the business or to market the business in cooperation with the remaining owner at a later time and at a greater valuation.  The owner “takes some chips off the table”, but retains a stake, and usually continues to participate in management.

Other “multi-step” exit strategies include:

• Selling an option to a qualified buyer
• Merging into another entity and liquidating that position later
• Growing the business through acquisitions, including consolidation or roll-up strategies

Valuation is driven by Growth and Certainty

Corporate Value Enhancement

The seller should look at the corporate structure and governance mechanisms to consider whether the business is optimally positioned, from both a legal and a tax standpoint, for the intended exit.

The make-up of the Board and any Advisory Board may have an impact on the value perceived by a buyer.  The “vision” of Boards and Advisors can open up growth opportunities.

From the standpoints of the critical mass of the business, product or market diversity, management strength or any number of others, the business may benefit from a combination with or consolidation into another business prior to its sale.  Alternatively, it may be desirable to spin-off one or more non-synergistic or non-performing divisions to increase profitability or allow greater management focus.

Business Value Enhancement

It doesn’t seem entirely logical that an exiting business owner would have unexplored opportunities available for increasing the value of the business, but the stakes are higher at the time of exit, and the focus on marketability and valuation greater, so that these opportunities become more visible.

With a mind to “setting the business on a higher level of sustainable growth” and/or “reducing the inherent risk (uncertainty) in the business”, the seller should consider:

• Reviewing & Revising the Revenue and/or Business Models
• Implementing Product / Market Enhancement Plans
• Expanding & Diversifying the Customer Base
• Securing title to Patents & Intellectual Property
• Commissioning Financial & Operational Audits
• Strengthening or upgrading Systems & Procedures
• Documenting or codifying Contractual Relationships (employees, vendors, customers, debt)

It’s what you keep … after tax

Tax Optimization

Sellers need to ensure that they have professional advice regarding the tax impact of an exit strategy.  Certain strategies may involve significant advance planning.

Generally, tax strategies address opportunities for positioning transactions as “capital gains” vs. “ordinary income” or for deferring taxes, thereby increasing the time-adjusted value of the wealth extracted from the underlying assets.

In certain instances, such as when a business is held in a “C” Corporation, the seller faces a risk that the sale of the business assets may create a tax obligation to the corporation, followed by a further tax obligation to the owner when the proceeds are distributed out of the corporation.  The result may be a “double taxation” on the proceeds of sale.

What you see is what you get

Business Marketability Enhancement

If growth opportunity, managed risk and strong margins are the foundation for building value enhancement strategies, then “clarity, transparency and certainty” are the engines which drive marketability.  Business performance is clearly reported and accounted for, activities and status are transparent to the buyer, and all information portrays a level of certainty about the future.

Experienced buyers know that completing acquisitions is a time-consuming and expensive exercise. Buyers will perceive greater clarity, transparency and certainty, and therefore be more motivated to engage, when the seller has:

• Audited Financial Statements
• A Business Plan with a clearly defined growth path
• An in-place sector-experienced Management
• Current Market metrics and Analysis

Next: Part 4 of 7:  Selling the Business

posted by Peter Heydenrych

ESOP is an acronym for Employee Stock Ownership Plan, which is a special type of qualified employee benefit plan.  An ESOP is a defined contribution plan that can emulate either a money purchase pension plan or a profit sharing plan.  An ESOP is similar to a stock bonus plan except that, unlike a stock bonus plan, it can utilize the credit of the company, borrow funds from outside sources, and use the funds to purchase company stock from existing stockholders.  The fact that an ESOP can enter into this type of leveraged transaction is what makes it different from all other qualified employee benefit plans.  The act of borrowing funds through the credit of the company and buying company shares is considered a prohibited transaction for all other employee benefit plans under the Employee Retirement Income Security Act of 1974 (“ERISA”).

As with other employee benefit plans, the ESOP operates as a trust.  Therefore, an Employee Stock Ownership Trust (“ESOT”) is created and a designated trustee or trustees serve in a fiduciary capacity on behalf of the employee beneficiaries of the trust.  The trustee or trustees for the ESOT are appointed by the company’s board of directors.

Section 1042 of the Internal Revenue Code provides a substantial tax benefit with respect to ESOPs.  Upon sale of company stock to an ESOP, the shareholder can reinvest the proceeds in “qualifying replacement property” (i.e., most domestic securities) within twelve months after the date of sale and defer the capital gains resulting from such a sale.  This is more commonly referred to as an “ESOP Rollover” transaction.  The qualifying replacement property is generally domestic equities and bonds, including those of publicly traded companies.  However, it is important to note that qualifying replacement property does not include mutual funds, municipal bonds, or U.S. Treasury obligations.  The tax basis in the qualifying replacement property equals the price paid for such securities less the deferred gain from the sale of company stock to the ESOP.

Other specific requirements for obtaining this favorable tax treatment include the following:

• The stock sold to the ESOP must be from a domestic C corporation.
• At least 30 percent of the outstanding stock is sold to the ESOP.
• The stock had to be held for at least 3 years.
• The stock sold to the ESOP must be acquired by investment (i.e., not by distribution from the ESOP).
• Disclosure and the tax election are made by the selling stockholder(s).

Effective January 1, 1998, ESOPs do qualify as a stockholder in an S corporation; however, there are limitations and restrictions with regard to ownership in S corporation stock.

With a leveraged ESOP, the repayment of debt is accomplished over time by the company making cash contributions to the ESOP, which, in turn, are used to pay back the debt.  Since the contributions to the ESOP are fully deductible by the company, in essence, both principal and interest on the loan are being paid back with before tax dollars.

As with any transaction involving significant tax benefits, it is important to seek competent tax counsel before pursuing a leveraged ESOP rollover strategy.  Since ESOPs have been around for a long time, there are good advisors that specialize in ESOP related transactions.

posted by David DuWaldt

In other words, like sheep who flock together, this investor group was satisfied with an investment so long as someone else came to the same conclusion.  “But what if you like the opportunity but do not find a co-investor,” I inquired of the group.  “Then we walk away from the opportunity,” I was told.

This group, and many others with same investment criteria, are not willing to trust their own instincts but need validation from others.  Ultimately, this is a sheep mentality… following others at all costs.

Eagles, on the other hand, hunt and soar alone.  They find their prey and seize the moment.  Eagles have the courage and temerity to make their own decisions based on their own standards and criteria and seize the moment regardless of what others around them are doing.

We need not look much farther than Warren Buffett’s investment strategy, which never changes; all would agree Mr. Buffett is no sheep.  Evidence of this was Berkshire Hathaway’s moves in the late 1990s.  While all the world was investing in any deal with a “dot com” attached, Mr. Buffett refused to follow the crowd, even while being skewered in the press for his “dinosaur investment strategy.”  Ultimately, as history has shown, Mr. Buffett had the last laugh.

When considering your acquisition options, lay out your strategy and stick to it, even if others in your industry do not follow suit.  Trust your process and your advisors and resist the temptation to follow the crowd; do not become a sheep.

Remember, ultimately, all sheep end up either shorn or slaughtered.  Soar like an eagle rather than risking losing everything.

posted by Jim Zipursky

The Issue is how to Extract yourself and your Wealth

We’re looking at how business owners can most successfully extract themselves and their wealth from the company they own and, typically, run, recognizing that the success of this critical process will have a direct and significant impact on their family, associates, employees and, of course, themselves. Business owners want to know that their legacy is assured and that a wealth transfer can be effected to assure their life-after-business goals, including the protection of their loved ones.

In Part 1 I noted that my Business Owner clients are encountering a challenging and demanding market, partly because credit has been tight, and partly because buyers are already anticipating the boomer exit era which will give them multiple acquisition options and the ability to be selective, pursuing only quality opportunities. I also noted that this “oversupply” does not appear to have an end in sight, which means that business owners expecting to exit in the next decade need to be systematic, employ a professional team, plan, prepare and execute a selected “optimal” exit strategy.

It will take a Military Campaign to engage and overcome this Market Condition

Not a single day goes by without someone in the media asking how it is that we’re engaged in Iraq or Afghanistan without an Exit Strategy. i.e. without knowing when, why and how we will ensure an endgame.

Don’t be reactive or opportunistic about selling your business! Be proactive, methodical and in control!

• Be clear about your goals
• Pick the best team
• Develop a written game plan
• Consider all of the alternatives
• Prepare thoroughly
• Execute your chosen strategy

Ask your M&A Advisor to assemble and coordinate a Team, including existing advisors where applicable, that will ensure that you:

• Have access to all appropriate options and opportunities
• Are fully informed as to the merits and demerits of proposed strategies
• Have expert counsel & representation

The Team must include the necessary knowledge, skills and experience in Mergers & Acquisitions, Corporate Law, Taxation and Financial Planning / Wealth Management. It may also include specialists in ESOPs, insurance, personnel and business consulting disciplines.

Have the M&A Advisor prepare a written plan incorporating (1) a valuation of your business, (2) a statement of goals and objectives, (3) a review of alternative strategies (options), (4) an analysis of the gap between the goals and the options, and (4) strategies for closing the gap.

The Value of a Business is inversely Proportionate to the Time taken to sell it

Business owners make a mistake when they allow too little time to complete a sale of their business. If the goal is to sell “no matter the price”, then, by all means, look for a quicker exit, but, if not, be thorough, purposeful and patient.

Another mistake owners make is focusing on the “price” while disregarding the terms and structure of a sale. If the goal is simply a “Price”, without concern for terms and structure, the lesson learned may be that “more” can sometimes mean “less”.

Other key mistakes business owners make in selling their companies are:

• selling to the (only) competitor who approaches them
• not using experienced advisors in the hope of saving transaction costs
• setting expectations without reference to the market
• failing to explore legitimate Positioning strategies

Buyers of middle market companies don’t “buy jobs” for themselves in the way that small business buyers do, they “invest” with the expectation of a return commensurate with the risk. Nothing enhances a buyer’s perception of “value” more than:

• evidence of sustainable growth
• a capable management

The Business owner who engages professional advisors, plans thoroughly, and negotiates to ensure that the wealth transfer mechanism chosen most closely delivers on his goals, is the business owner who will have executed the optimal exit strategy.

Don’t Pick a Play until you know the Endgame

The oldest wisdom in the world is to start with knowing where you are and where you want to go. The Exit Strategy begins with the M&A Advisor providing a likely range of the pricing, terms and structure expected from a sale in the current market. The Financial Planner or Wealth Manager then develops a plan to invest the after-tax wealth extracted from the business to meet lifestyle and life-after-business goals.

For the majority of business owners, this newly liquidated “business wealth” will constitute a meaningful portion of the total wealth driving the financial, tax and estate plans. The key, then, to beginning the exit planning process, is to clarify the endgame, taking into account the likely value of extracted business wealth.

• Legacy Goals – what will have been your contribution?
• Lifestyle & “Life-after-Business” Goals – what do you want from the next phase of your life?
• Estate Planning Goals – how will you ensure that your estate passes to your heirs in the most tax efficient way?
• Exit Strategy Goals – based on all of the above, what are the priorities to be met by your selected exit strategy as to time, wealth, risk, and cash flow?

Closing the Gap

For business owners, the years of building the business have clearly demonstrated the underlying reality of the “Risk – Reward” paradigm. Planning an exit does not seem like the time to indulge in risk-taking, but rather to be “cashing-in”. Certainly the levels of risk associated with starting a new business would seem to be out of the question, but other moderate risk strategies may deserve consideration if they serve to better ensure that the business wealth will be delivered in the context, amount, time and certainty needed to meet the goals.

“Closing the Gap” is an iterative process of evaluating combinations of strategies that will yield a release of wealth compatible, as to quality, time, value and certainty, with achieving the specified goals. It may also involve modification of the goals. These gap-closing strategies may include:

• Enhancing the value of your business
• Increasing the marketability of the business
• Reducing the risk profile of the business and the associated cash flow
• Structuring the sale/transfer of the business for a different after-tax and timing outcome
• Evaluating “Multi-Step” liquidation options to first “take some chips off the table”

Have your M&A Advisor walk you through this process with a view to evaluating the options before selecting both “Positioning Strategies” (see Part 3) and an “Exit Strategy” (see Parts 4, 5 & 6).

Next: Part 3 of 7:  Positioning Strategies

posted by Peter Heydenrych

No doubt, for the past 18 months, the current economic crisis has hung over our heads like a summer storm over the Great Plains.  We are certain it will pass, but its rains and winds can produce lasting damage for all in its path.  In times such as these, we can either seek the comfort and security of shelter, or, more aggressively, we can learn to sing and dance in the rain.

Recently, I was invited to attend a recent summit of CEOs of mid-market companies.  I heard many CEOs who literally shouted: “Now is not the time to seek acquisitions because we do not know if we have hit bottom yet,” “Banks are not lending like they once did,” “How can we consider an acquisition now when we have our own business challenges?”  These were common themes and common statements during presentations, around the lunch table, and at the bar during cocktail hour.

However, a few of CEOs, those who I will call the “enlightened elite” embraced an alternative approach, exclaiming for all who would listen: “There has never been a better time than now to make acquisitions. The time to make a strategic acquisition is when valuations are more reasonable, as they are today, when there are sellers who have good companies caught by the current economic mess, and when others in your industry are not in a position to take advantage of these opportunities.”  One of these CEOs said, “Many of the world’s greatest fortunes have been built during challenging economic times such as these.  You can either get on the field and play the game or sit on the sidelines and watch as your competition passes you by.”

These enlightened elite are actively seeking out acquisition candidates for their companies.  They have already lined up the necessary financing with their lenders of choice.  They told me they are seeing more reasonable priced acquisition opportunities than ever before.  “I looked at a strategic acquisition in late 2007 and was one of 50 companies invited to bid on the deal,” one CEO reported, “The winning bidder’s financing fell through and the seller took the company off the market.  Last week, we were invited to revisit the company; we are the only buyer looking, and our offer, which was slightly lower than what we were willing to pay 2 years ago looks like it will be accepted.”

If you had not considered making an acquisition now because of the uncertain economy, perhaps you need to rethink your ideas because you may never have a more opportune time than today to make a deal.  Take a cue from Gene Kelly: grab your umbrella and learn how to sing and dance in the rain.

posted by Jim Zipursky

In advising business owners during this past year, I have seen, firsthand, how unforgiving the market has become. In one case, rather than wait to sign an LOI, a seller invested in audited financial statements simply to increase the odds of being shortlisted. In another, a business owner accepted the buyer’s premise that a full-price deal required that he stand behind his projections in the form of a significant contingent payment.

Is the “unforgiving market” just the recession, or a reflection of a long term reality?

Boom-er Bust

I read daily about the challenges facing boomer business owners expecting to sell in the coming years. Frankly, it’s not just boomer business owners, it’s ALL business owners who are affected by this extraordinary situation. My clients are finding that it takes perfect planning and execution to reach the finals of the beauty contest. Good enough just doesn’t cut it any more … and won’t, for the foreseeable future!

According to an article published by Robert Avery of Cornell University in February 2006, “the majority of boomer wealth is held in 12 million privately owned businesses, of which more than 70% are expected to change hands in the next 10 to 15 years.” (Some European markets face somewhat similar circumstances.) Only 1 in 3 of these businesses will successfully “cash out”, we are told, because of a fundamental oversupply of opportunities and because of a relative undersupply of liquid capital.

If the fundamental laws of risk and reward prevail, only the least risky and profitable businesses will transfer successfully, and, most often, the least prepared will be the ones left out.

Exiting is not necessarily selling

Exit Planning is a key element of “Personal Strategic Planning”, an individual’s process of defining their strategy, or direction, and making decisions on allocating their resources of capital and time to pursue that strategy. (Wikipedia – “Strategic Planning”). An exit plan is not just a tool for the business owner. It is an insurance plan for family, employees and other affected parties.

In a series of articles, I will look at Exit Planning as a Process culminating in the selection and execution, from among multiple alternatives, of the optimal strategy. Absent this process, the business owner faces the very real risk of being one of those left out in the cold.

The Exit Strategy is a process involving the development and execution of a series of systematic steps taken to allow both the owner and the “invested wealth” to be extracted from the business, via one or more of the numerous available strategies, including:

• Selling the business to Partners, Strategic Buyers, Investors, Competitors, International Buyers, or the Public
• Recapitalizing the business for Partial Liquidity
• Merging the business to achieve desired scale, value and/or marketability through Acquisition or Consolidation
• Transferring the business to Family, Management or Employees
• Gifting the business to meet personal and/or tax planning goals
• Liquidating or Partially Liquidating the business

When the Whole exceeds the Sum of the Parts

The solution to the challenge posed by the boomer market, is, with the help of a team of experienced advisors, to position your business at a sufficient scale, with a strong market posture, and under a capable management, before you go to market.

Exiting is a complex subject with many moving parts. No single advisor is an expert in all aspects. Wealth Advisor, Insurance Advisor, Tax Consultant, Attorney, Business Consultant, M&A Advisor, Financial & Estate Planner, … the list goes on.

Not every business will (or should) sell to a 3rd party buyer. However, every business owner who understands what all the exit options are, plans an exit, and executes that plan with the help of a coordinated team of experienced professionals, will more likely extract themselves and their wealth from the business with optimal results.

Planning Precedes a Successful Execution

While the critical execution phase will not be a problem for most take-charge entrepreneur business owners, the planning for an exit will be foreign to them as “exiting” has never been their purpose. Their purpose has been to create and build, and to consider the exit (if at all) a “retreat”. But you can’t execute what you haven’t planned, and we will all eventually have to exit!

A Process, not an Event

The Optimal Exit will be achieved through the implementation of a managed process which includes:

• Clarifying “Life-after-Business” Goals
• Preparing a written Plan
• Identifying and evaluating the available and applicable Alternative Strategies
• Executing necessary Preparatory or Preliminary steps
• Executing the Selected Exit Strategy

“Failing to Plan” is “Planning to Fail”, an oft-quoted phrase. You wouldn’t try to sell your house in a poor state of repair in a buyer’s (or any) market. You’d probably first upgrade to ensure that your property stood tall on the street. You also wouldn’t want to be forced to liquidate by some outside event. Sadly, many business owners, without a plan, will be unable to protect their or their family’s interests in the event of death, disability, divorce, a market crash or similar event.

Don’t expect to exit your business successfully in the next 10 years without figuring out how best to exit and what preparatory steps should be taken. … and don’t assume you can wait until you are “ready”. Instead, have a plan and work that plan, so that you are “ready when you are ready!”

Next: Part 2 of 7:  The Solution

posted by Peter Heydenrych

Today’s economy has put many private companies in a tight spot.  Companies end up with too much bank debt as business volume and profits contract.  But lower earnings mean that company owners who would have been ready to sell their companies now can’t do it because they end up with too little after paying off their banks.

So, how can you reduce your bank debt, improve your cash flow, and stay tough while you wait for the outside economy and your earnings to recover?  One answer is mezzanine debt.

Mezza-what?  Mezzanine debt gets the name because it’s half way between senior bank debt and equity.  Because it’s kind of both, it serves really well in the right situation.  Mezzanine is semi-permanent capital, like equity, so the company does not have to make monthly or quarterly payments of principal.  It usually has a 5 to 7 year term.

Senior lenders, like banks, look at mezzanine, or mezz, as equity, because it is semi-permanent capital and because it is subordinated to the bank debt, which means that the bank gets paid first in the case of a problem.

For owners, mezz looks like debt, because it often does not dilute the ownership of the company, like selling stock would do.

So, a new investment of mezz into your company can pay off some of the burdensome bank debt with more patient capital without giving up a percentage of ownership that would come with selling equity.

Mezzanine lenders are very busy these days because their product is ripe for this market.  A well-structured Mezz investment will reduce a company’s leverage, improve immediate cash flow, and preserve the equity value for the owner in a sale a couple years down the road.

So, what’s not to like?  It’s a little expensive.  Compared to a bank loan, mezz carries an interest rate in the range of 12% to 14%, depending on the deal.  That’s more expensive than a bank, but the cash flow is often better because the principal does not need to be repaid until the end.  And those interest rates are less expensive than selling ownership shares in a company that has depressed valuation.  Sometimes, mezz deals include an “equity kicker” that gives the lender options to buy your stock at a fixed value so that they get an extra return when you sell the company down the road.  That’s not a bad thing because it brings in an experienced investor who shares you goal of a well-paid exit from the company.

If your bank is making you nervous, or if you are making them nervous, if you want to strengthen your balance sheet as you wait for the market to recover for you to sell the company, a mezz investment right now might make everyone happy.

posted by John Hammett

Recently, I was asked to speak to a group of CEOs of mid-sized companies regarding EBITDA and its importance to them as business owners. Several questions from the group centered on what I will loosely call “tax avoidance” and “tax deferral” practices commonly employed by owners of privately held companies. The questions focused upon the impact of these practices on the value of a business. The common theme from the audience was, “buyers understand owners do not want to pay taxes and they are willing to adjust for these practices.”

I reminded the group that buyers, or anyone who is reviewing the performance of their companies, will only be able to evaluate what they can see. If you are writing off inventory, expensing personal items, or employing any of the myriad other “tax avoidance” practices, you do a nice job of lowering your tax burden, but you may not be able to get a return on this “investment” when you look to “withdraw” these funds. All of these practices impact your cash flow positively for you, but not necessarily for those evaluating your company.

One of the CEOs said to the group, “I never thought about this until I needed to borrow money this year to support our business. We have plenty of assets, and I thought a loan would be easy. Every bank we spoke to turned us down because our cash flow was so low. I tried to explain about our inventory being undervalued and the family vacations I paid for out of the business, but the bankers were not interested. You can be sure in the future, I will show the profits, pay the taxes, and make my life easier.”

If you never plan to sell your business, never plan to borrow money and never plan on being audited by the IRS, you have no worries. However, if you might ever consider selling your business (even to an insider), might find yourself in a position to borrow money, or have the unfortunate opportunity to meet with your local IRS agent for an audit, the more transparent your earnings, the better off you will be. Of course, you can pay yourself a huge salary and/or bonus, everyone can see the impact of this on the business. This adds to transparency. We call this investing in taxes. Otherwise, with limited transparency, your options are limited as well.

posted by Jim Zupursky