Business profits are causing serious problems! They have caused these problems for years but most people don’t see this as a problem until it is too late. Over the next ten years, these problems will become even more serious. Profits are generally a good thing as everyone one knows, but the serious problem they cause is that Business Owners become complacent when it comes to planning for the future and put themselves, their families, and their employees at great risk. When there are profits and all is going well, Business Owners tend not to look into the future and take the steps they need to.
Every business owner will leave their business either voluntarily or involuntarily, and to meet the future needs of themselves and their family, they need to do the proper planning. Some of the names for this planning are Business Succession Planning, Exit Planning or Business Transition Planning. When all Business Owners will exit their businesses, why don’t they do the proper planning to meet their future needs and protect their business investment? What are the costs of this complacency? What is a Business Transition Plan and does it have a high return on investment? What are the first action steps that Business Owners should take? This White Paper answers all of these questions.
Why Business Owners are Complacent
502 Business Owners in the U.S. and Canada were surveyed (2007 ROCG) and asked why they haven’t prepared a formal Transition / Succession plan. The majority said that it was too early. In the under 40 years old category, it was over 60%. Even in the 60+ age group, over 30% said it was too early. They think there is a lot of time to work on this and need to spend all their time running their business. I have heard a number of stories where the parent was over 80 years old and the so-called child was over 60 years old, and there was still no succession plan. What they haven’t considered is that the unexpected could happen at any time and that they need to be ready for that as well.
Most people don’t want to think of their own deaths, and business owners, similarly, don’t want to talk about the end of their business or at least the end of their involvement in it. They often feel that they are losing a part of themselves, being the center of their social network, purpose and meaning in their lives.
Of course business owners are very busy with the day-to-day activities taking up all their time and often already working long hours. They can’t imagine how they would fit transition planning into their schedule. The real problem is that they are spending all their time working IN their business instead ON their business and in order for them to realize the full potential value of their business and protect their business investment, this focus needs to shift.
Business Owners often find the idea of transition planning a daunting task that appears to be too complex and intimidating. There are few resources out there to guide business owners through a step by step process. Knowing that it needs to be done, but not knowing what is involved, can create a lot of tension, thus Business Owners often avoiding it instead of attacking the problem head-on.
Many businesses are what are called “Life Style” businesses. These are businesses that meet the current needs of the owners and their families. Often their life styles expand to the level of income that is being created by the business. These same owners are doing very little to save for, or plan, for the future. They also think that everything is going to work out for the business to meet their retirement needs and that they will be able to sell the business when they are ready, for the price they want.
Other reasons Business Owners give for not doing Transition / Succession planning are:
- They don’t want to deal with family / employee issues;
- They can’t think of doing anything else so why try;
- The business owners considers themselves as irreplaceable and thus there is no point in planning a transition out;
- It is easier to make no decision at all when there is no obvious successor in sight;
- When there is no obvious funding solution, they don’t bother looking for a successor;
- Some also believe that their business will be bought by a big conglomerate for more money than they need, thus long-term planning is ignored.
Most business owners don’t realize the tremendous return on investment that transition planning can provide and thus don’t know what they are missing. I’ll cover the ROI of transition planning a little later.
The Cost of Complacency
“The soul of the sluggard desireth, and hath nothing: but the soul of the diligent shall be made fat.” Proverbs 13:4 KJV
Business Owners are not generally lazy. They are in fact, some of the hardest working individuals in our society. They often work very long hours and do much for the economy by employing the majority of working individuals. However, less than 10% of Business Owners have a written plan. King Solomon was the richest man that ever lived and his wisdom is unquestioned. Business Owners need to consider Solomon’s wisdom when it comes to becoming diligent about planning for their transition out of the business.
With less than 10% of Business Owners having a written transition plan, it is interesting to note that less than 10% of businesses are successfully sold. In the book, Valuation for M&A, Chris Mellen and Frank Evans state that “Mergers and acquisition (M&A) advisors disqualify roughly 65% to 75% of prospective sellers and, according to a U.S. Chamber of Commerce Study, only 20% of the
businesses that are for sale will successfully transfer hands to another owner. This implies that only 5% to 7% of companies actually get sold.” (pg. 89, 2nd Edition) With such poor results in being able to sell, it is very concerning to know that 89% of Business Owners are dependent upon the proceeds of the sale of their business to fund their retirement.
Even the few that are successful at selling their business without a transition plan, they often are not happy after the sale. A study of 300 former Business Owners who sold their companies, showed that 75% of the respondents felt the sale did not accomplish their personal or financial objectives. The Owners surveyed, stated that they:
- Were not aware of all their options for transitioning out of the business;
- Did not make Exit decisions that were well thought out;
- Had not created a plan for their post-business life;
- Did not know professional Business Transition Planners who could help them create a successful transition strategy.
Even in those cases where Business Owners that plan to transfer the business to a family member, the lack of a thorough Business Transition Plan could put the family and the business at great risk. Statistics show that only about 30% of family businesses survive to the 2nd generation and about 17% survive to the 3rd generation. The following Case Study, that is a real possibility for many businesses, helps to illustrate this risk.
------------------------------------------------------------------------------------------Case Study - Ben, Owner of Left Handed Widget Company (LHWC)
Ben is 53 years old and is married to Brenda (50 years old). They have a son Ben Jr. and daughter Jane. Ben is the President of his own company, Brenda is the Receptionist and Ben Jr. is a management trainee. Jane is a University Student and works in the business part-time. Ben has no Business Transition Plan, has $300,000 saved in a registered retirement plan, a house that is guaranteed against the business, $500,000 Term Life Insurance and no Disability Insurance.
Ben’s company, LHWC generates $4 Million in Sales and $500,000 in cash flow (EBITDA) each year. It has 26 employees, $750,000 bank debt and $250,000 loan from the shareholder.
Unexpectedly, Ben dies suddenly. Even with tax advantages like Capital Gains Exemptions in Canada, the combinations of taxes, probate fees, funeral costs, lawyer fees, accountant fees and executor fees, only $250,000 of the $500,000 Term Life Insurance is left. Brenda is worried that this
plus the $300,000 retirement savings isn’t enough. Will she have enough to live on for the rest of her life, can she continue to support her daughter through university? Who is going to run the business and how will it fair?
The family decide to make a go of the business and make Ben Jr. the President. He is only 26 years old, but got his business degree from University and is confident he can make a go of it. A short time later, the bank lost their confidence and decided to pull their $750,000 loan. Ben Jr. still feels sure that he can succeed because he has great ideas on how to grow the business. Brenda also wants to provide this opportunity to her children. To pay the loan, Brenda sells the house and gives up the remaining life insurance proceeds. Now, she is even more worried.
Nine months later, the business is in a major decline. Employees don’t have confidence in Ben Jr. and nine of them have already left including a key employee, Linda the VP of Sales. Linda went to a direct competitor and took two major customers with her. LHWC also lost a major supplier, there are product quality issues, sales have dropped 40% and the business is now just breaking even but getting worse.
At this point, the family gave up trying to turn the business around and decided to sell. It took another nine months to sell and they could get only a discounted asset value. After paying severance and professional fees, there was little left.
Two years after Ben death, Brenda got a job at a local coffee shop earning minimum wage and living at a much lower standard of living than before. Ben Jr. is unemployed, still looking for work. Jane is in her last year of University but has to work while in school to pay her tuition and will end up with a lot of debt to pay off when she is done.
Case Study will continue later ---------------------------------------------------------
Naturally, most people believe that bad situations like the above case study couldn’t happen to them. I sincerely hope it doesn’t but it isn’t wise to not plan for that possibility. Business Transition Planning includes planning for contingencies like this and many others.
Some of the costs to Business Owners for not having a well-defined exit plan include:
- Paying too much in taxes;
- Failure to realize all their business and personal goals;
- Having to sell their business as a result of pressure from outside circumstances instead of their own terms and time table;
- Selling for much less that the business could be sold for, leaving hard-earned wealth on the table;
- Not selling the business at all and not having enough to fund their retirement;
- Possible suffering of unnecessary psychological stress;
- Losing confidentiality during the sale or exit process.
Unfortunately, in the next ten years, it is likely to become even more difficult to sell a business without a through exit plan. Over 50% of all businesses are owned by Baby Boomers. With so many wanting or needing to exit their business, all of the problems listed above will become more amplified. The following are possible things that will happen:
- The supply of businesses for sale will far outpace the demand;
- Valuations of businesses will likely be lower;
- The probability of closing a sales transaction will drop;
- Buyers will only pay top dollar for the most attractive businesses;
- Without a proper plan, sales of businesses will likely be at a significant discount or not at all.
There are some Business Owners that believe they have an Exit Plan in place, when in reality they have only focused on just one element, such as estate plan or management succession. These Owners have ignored other equally important components, resulting in them usually making poor decisions and not achieving all their personal and business goals. The cost of insufficient or faulty planning can be huge, measured in terms of higher taxes, reduced productivity, job losses and increased rates of bankruptcy.
Sophisticated Investors, like Venture Capitalist and Private Equity Groups, recognize the value of a well-defined Exit Plan. They know that without it, there is no strategic road map for all stakeholders to follow to ensure that everyone’s goals are met. These sophisticated Investors will not invest in a business without a detailed exit plan, thus every Business Owner should do the same whether you are starting out or just a few years away from a planned retirement.
What is a Business Transition Plan?
Also known as an Exit Plan or Business Succession Plan, a Business Transition Plan is a method of achieving the written goals for the succession of a business’s ownership and control, derived from a well-thought-out and properly timed steps that include increasing the value of the business, best method of transfer, protection from unplanned events and efficient distribution of the estate. Think of this process as an advanced form of financial, retirement, insurance, estate, and business planning, all wrapped into one business exit strategy plan.
In order to create a well-thought-out Business Transition Plan, there needs to be a “transition team” made up of a variety of professionals. A typical team would include a Business Consultant, Accountant, Lawyer, Insurance Expert, Investment Advisor, Banker, Business Valuator, Business Broker, Relationship Facilitator and other professionals as needed. The key is that all these advisors need to work together as a team and have the Business Owner’s goals as the focus of all their analysis and recommendations. In order to do this and to function effectively and efficiently, the team needs a leader to coordinate its activities and organize everyone’s special abilities into one cohesive group.
One of the problems that prevent a successful transition is when owners try to work with the various professionals separately. Often professionals working on their own are focused on the transactions that center on their speciality and don’t see the inter-connection between all the advisors and their recommendations in order to achieve the goals and objectives of the Business Owners and their families.
Copious Insights follows a seven step process for creating a Business Transition Plan. Components of the plan may be implemented while the plan is being created, but ultimately, the entire plan needs to be completed. The seven steps are as follows:
1. Address Owners Current Concerns
This first step is very important and is often not considered. How can Business Owners consider Exit Planning when they have other issues glaring at them? They could be worried about meeting payroll or a decline in sales and profits. There may be cash flow concerns, relationship problems between those involved in the business or the Owner’s time management. This first step needs to be address so that the proper attention can be put on all the other steps.
2. Set Personal / Family Goals
What is the “End” that is to be achieved in the phrase, “Begin with the end in mind”? This will end up being the frame of reference for the entire goal. It is the goals and motives that drive the exit strategy planning process. Setting Goals will include goals for yourself and your business. It could also include goals for your spouse, your family and your successor. It therefore stands to reason that you should meet with a Business Exit Planning Professional who asks questions not only about your business and what you are trying to achieve, but also about your personal situation and what type of results you would like to see from this business exit so that your overall goals in life can be met.
Clear goals increase your confidence, develop your competence, and boost your levels of motivation. ‘Goals are the fuel in the furnace of achievement.’ After writing down your goals, every alteration that you make to your business should be directed toward achieving the end result of having the business continue in a profitable manner without your participation.
3. Quantify Business & Personal Resources and Needs
Will the amount of money you have saved today outside of the business satisfy all of your future financial goals? If the answer is no: Do you have any idea as to what you need in after-tax, after-fees, risk, and inflation adjusted net proceeds from your business exit in order to meet your financial goals? It is important to measure this financial gap and work with a financial advisor who understands these concepts.
This also includes finding out the value of your business which is a critical determinate of whether or not you can afford the exit option that you most desire. If the exit strategy that you desire does not produce a value that will meet your personal financial goals, then you can: 1) grow the business to meet your goals; 2) execute a partial exit today in order to diversify yourself while still maintaining
control of the business; or 3) reduce your post exit living expenses. These calculations go into your written exit strategy plan.
Not only is Financial Readiness important, but so is the Owner’s Mental or Emotional Readiness to exit. Subconscious resistance could be preventing them from protecting the wealth that they have accumulated in their businesses over many years.
When both the Financial and Mental readiness are taken into account, the type of exiting owner you most resemble and the path the exit plan will initially, take can be determined. Developed by John Leonetti, author of the book “Exiting Your Business, Protecting Your Wealth”, Mr. Leonetti created an Exit Quadrant Chart and the Exit Options Chart (see right). He also determined through surveys that the far majority of Business Owners are in the lower left hand quadrant where they are “Stay and Grow” Owners because they have low financial and mental readiness to transition out of their business.
4. Maximize & Protect Business Value
As mentioned earlier, of those businesses that were put up for sale, only 20% of them successfully transferred hands to another owner. The factors that make a business salable include good management teams, steady and defensible profits, customer and vendor diversification and loyalty, a solid reputation, predictable transferability, intellectual capital, and many others.
When Business Owners were asked what is the most important component of a Transition / Succession Plan, 50% of them said that it was maximizing business value. They also stated minimization of taxes and control over how and when the exit will take place are very important.
Potential buyers of your business want to see that you can plan out the future of your business for growth and that you meet that plan. This growth plan will need an understanding of the main drivers that increase future value of the business and focusing on those drivers. Think of the
business as an engine. It’s revenue and profits are the outputs. Will the gears of the business have the ability to work together to drive future revenue and profits at or above its current rate.
When business owners begin to view their businesses as investments and not jobs, they begin making better financial decisions. Many exiting owners don’t appreciate the amount of risk that truly exists in their business. Buyers or successors to your business will pay you a multiple of your company’s cash flow, depending on the risk that they perceive to be in your business. The higher the perceived risk, the lower the price someone will pay. Understanding the true risks in your business is a large part of this process.
So this step includes determining how to increase the value of your business and taking steps to make that happen. It also includes protecting you and your business from various ways that it could lose value or prevent you from selling or transferring your business. Even when the plan is to transfer the business to a family member, it is important that the health of the business is strong and it is placed in prime shape to succeed before the full transfer has been completed.
5. Ownership Transfer Plan
How will the ownership be transferred to meet all the goals determined in step 2 in the most effective and efficient way? This step considers the following:
- Tax Planning to minimize Capital Gains
- Investment of sale proceeds
- Analyze possible legal issues
- Cash Flow Timing Strategies
- Identify Successor and whether their goals are compatible
- Financing Options
- Possible Estate Freeze
- Funding Expected Tax Payment
- And so on
Too many owners of privately held businesses believe that selling the business is the only way to exit. They do not understand the motives of the players, and, more important, they do not understand their options for exiting the business. As a result, they seek the counsel of transactional advisors and engage their services with less than perfect information.
The goal of advisors that focus on the relationship rather than the transaction, is to help you to reach your goals, keep you happy by providing good representation, good service, and attempting to add value to your business and personal situation where possible.
6. Contingency Plan
Likely the most important task for any Business Owner or CEO is to determine who their successor will be in the event of death, permanent disability or retirement. Sadly, this task is not planned and is left to the assumption that someday, somehow, it will all work out just fine.
A contingency plan is simply a proposed implementation plan that is triggered by some event, emergency or new information. The event or emergency may or may not happen but is liable to create significant business problems, potential or real liabilities if not dealt with quickly.
When a family business owner dies or becomes disabled, most family businesses have the momentum to run, business as usual, for about 4 – 6 months before the business starts to decline. Vendors get worried, key employees start seeking other jobs, customers start seeking alternative sources for product and services.
There are several things that can be done to protect you and your business under these possible “What ifs”. Let’s go back the case study from earlier.
------------------------------------------------------------------------------------------------------------------------------------- Case Study (con't) - Ben, Owner of LHWC
The first part of the Case Study was very bleak for Brenda and her children after the death of Ben. However, it didn’t need to be like that. If Ben had done a Business Transition Plan that included contingency planning, the situation would have been very different. To plan for the possibility of a premature death, the Business Transition Plan includes a succession plan, a plan to retain employees, sufficient life insurance, an estate plan and a tax plan.
If it was determined that the best course of action was to continue the operation of the business upon Ben’s death, a succession plan would temporarily appoint an outside President that had the skills to continue to grow and operate the business profitably while mentoring Ben Jr. to take over the position when he was ready.
To keep the business on the right track and prevent it from losing value, steps would be taken to retain employees and discourage them from taking customers if they leave. Such measures could
include deferred bonus plans, operating procedures, job descriptions, non-compete and non-circumvention agreements. Even if the plan was to sell the business shortly after Ben’s death, employees need to be encouraged to stay up to and after the change in ownership, by using Stay Bonuses that are funded by life insurance.
Life Insurance would also have been considered with Ben’s Business Transition Plan. It can be a tool used to pay off debts and cover dependent’s expenses so that their needs are met and they don’t have to drop their standard of living. It can also be used to pay taxes that occur at the point of death due to deemed dispositions. There is also the consideration of who should own the life insurance, whether it is an individual, the operating company or a holding company.
The Business Transition Plan also includes an Estate Plan that will determine the ideal structure to
minimize taxes and probate, efficiently meet the needs of dependents and achieve their goals. The Estate Plan may use instruments like a 2nd Will and Trusts.
Tax Planning is also included to ensure that the owners are eligible for the lifetime capital gains exemption at any time and that steps are in place to reduce and defer taxes where possible and split income between individuals in order to pay less taxes overall. This also includes knowing the implications of decisions like selling the business more than a year after a deemed disposition and not being able to apply the capital loss against the capital gain.
End of Case Study ---------------------------------------------------------------------------------------------------------------------
Other things that could have been included in Business Transition Plan but not considered in this Case Study are Shareholder Agreements, Emergency Action Plan, Key Employee Insurance, Disability Insurance, Critical Illness Insurance, Marriage Contracts, and so on.
7. Estate Plan
Most people have no idea what they could accomplish in the estate planning process. They often think that they are done once they have created or updated their Will without ensuring that clear, concise objectives are developed first. The planning goals that should be considered are 1) financial independence; 2) tax-effectiveness; 3) maximum inheritance; 4) social capital; and 5) wealth control.
Business Owners should view an exit strategy not as leaving something behind but rather as stepping into something new and exciting that lies ahead. By the same token, they should plan their estate not to challenge their thoughts of immortality but rather in recognition of the fact that the government has set the rules of the game and they can end up on the losing end if they do not make plans for their inevitable death.
An Estate Plan sets out to create the state of financial affairs the Business Owner desires either at
death or later in life when the transfer of family property is desired. This must be reviewed at each phase of the business exit plan and updated accordingly. In many cases, an Estate Plan is much more than merely creating or changing the terms and features of a will. It may include determining the best structure of holding assets to meet the estate planning goals. For example, the use of Trusts could be better for carrying out wishes, be more tax-effective and protect against creditors.
What is often not considered in estate planning is recognition and capture of the full value of the Business Owner’s social capital. Social capital is either the taxes paid or the charitable gifts given. They often think of minimizing taxes but not how the amount that must be paid in taxes could be diverted to their favourite charities instead. A proper Estate Plan within a Business Transition Plan includes helping the Business Owner to direct their social capital in a way that reflects their values.
As mentioned before, think of a Business Transition Plan as an advanced form of financial, retirement, insurance, estate, and business planning, all wrapped into one business exit strategy plan. As you will see next, a Business Transition Plan has a very high Return on Investment (ROI).
Business Transition Plan has a high ROI
“Where there is no vision, the people perish.” Proverbs 29:18 KJV
When Business Owners first started their business, they often have a vision of what they would like their business to become over time. However, very few have a clear vision of how they will exit their business and what they will do after they leave.
To illustrate this point, let’s consider Edmund Hillary. On May 29, 1953, Edmund Hillary achieved his goal to reach the summit of Mount Everest. It was even stated that he was the first to conquer Everest. But was he? It is widely believed that others had reached the same point before him. However, Mr. Hillary became famous because he was the first westerner to survive the descent back down the mountain. The others who went before him are still frozen up there.
Creating and implementing a Business Transition Plan provides the Business Owner with the ability to successfully exit the business while meeting their goals and achieving their ideal post-business life. It prevents them from being frozen in their business.
When Business Owners have been working in their businesses for many years, often they are operating it without a clear vision for the business or for themselves. When there is no vision, they lose direction, motivation, joy, passion, energy, creativity and their commitment. Once the Transition
Planning process begins, a clear vision for the future is created, the Business Owners gain new energy and discover or re-discover their direction, motivation, joy, passion, energy, creativity, and commitment. They also get to know their business better than they ever did before. The key staff have their capabilities honed and the competencies nurtured. The business becomes more competitive and agile. It causes the Business Owners to reinvigorate their enthusiasm and passion for the business which rubs off on the employees.
A well-designed and implemented Business Transition Plan is a valuable business and personal planning tool that enables the Business Owner to:
- Achieve business and personal goals
- Facilitate retirement
- Control how and when they exit
- Improve family harmony
- Attract and retain good employees more easily
- Maximize company value in good times and bad
- Cash for surviving family members
- Reduce stress and uncertainty for themselves and their families and employees
- Provide uninterrupted service for clients
- Have a greater chance of continuity & growth of the business
- Enhance employee loyalty
- Minimize, defer, or eliminate capital gains and income taxes
- Have strategic options from which to choose
- Maximize retirement income and assets
- Greater flexibility and choices.
Initial Action Steps
It should now be clear that the only problem with profits is that it often causes Business Owners to be complacent or procrastinate when it comes to doing the critical planning they need to do for their enviable exit from their business. There is a huge cost to not doing this planning and there is an excellent return on investment when this planning is done right.
To get started, it is important to create a sense of urgency. Even if you don’t plan to exit the business for many years, it is crucial to put the business is prime shape to sell because an unexpected offer, or worse, an unexpected death, disability, divorce or illness could happen at any time.
A great way to start is to answer some free questionnaires that let you know your readiness for a business exit (BERI™), the dependence the business has on the owner (ODI™), and the level of commitment the owner has to grow the business (GPI™). You can find the links to these questionnaires at https://copiousinsights.com/service/business-transition/ and https://copiousinsights.com/service/business-growth/
Get started right away. Set short term deadlines and actions to do immediately. Go to https://copiousinsights.com/ today and start the process of creating your Business Transition Plan.
By Kevin Ballantyne, BBA, CBEC®, CPA, CA
President, Business and Transition Advisor
Copious Insights Inc.
About Copious Insights
Copious Insights helps businesses and their owners to prosper. We work with Business Owners and Senior Leadership to build, fix and reorganize their businesses to higher profits, increased enterprise value and enhanced saleability. We also help Business Owners to develop and execute business transition plans so that they meet their goals and are more likely to achieve their ideal lifestyle in retirement. Our Business Assessment process allows us to review the health of a business effectively and efficiently and to perform a pre-Due Diligence when considering selling or buying a business. We achieve this by:
- Quickly and thoroughly assessing your business;
- Implementing one or more profit improvement techniques;
- Planning and Tracking business value improvement;
- Helping to implement tasks to increase value and enhance saleability;
- Planning the Business Owner’s transition out of the business;
- Preparing an in-depth Financial Needs Analysis.
Copious Insights is committed to helping Business Owners to realize the full potential from their business, experience their ideal next phase of their life after leaving their business and to have a contingency plan in place for unexpected events. We roll up our sleeves to understand your goals and your business, pinpoint the steps needed to reach your goals and increase your business’ value, and then help to implement these steps. Our approach helps to turn complex, painful, and uncertain issues into clear, confident solutions. When needed, we work with your accountant, lawyer, and other professionals to ensure your goals remain the central focus for all team members. This is done in order for you to feel in control of all aspects of your life and to enjoy your life now and into the future.
To meet this need, Copious Insights was created by Kevin Ballantyne, a Chartered Professional Accountant and Certified Business Exit Consultant with over 35 years’ experience in helping businesses improve financial results. Kevin is also Life Insurance Advisor with Experior Financial Group providing clients and their families with customized solutions that build and protect their financial futures, including estate planning and tax-efficient income solutions.
Contact Kevin today to arrange for a no obligation initial meeting.
(226) 791-0374