Article


The Fork in the Road
Exit planning for owners of smaller businesses
By Donald Feldman
Date Published: 4/1/2017

 

We are concerned here with businesses with a value in the range of about $1 million to $5 million. Typically, these businesses have fewer than 50 employees and revenues of about $2 million to $8 million. Smaller is, of course, a relative term. It is a significant accomplishment to have developed a business into an enterprise with several million dollars of revenue and several dozen employees. These businesses are the backbone of the American economy and are vehicles for substantial wealth creation. However, these owners typically don’t have the luxury of stepping back from their business and working on their business rather than working in them. They are caught up in the day-to-day and unless there is a crisis spend their time focusing on new sales, customer relations, and managing operations. Sometimes, the first business crisis these owners face is when they contemplate life after business. Then a flood of questions arises … How can I retire? What will happen to my employees? My customers? Can my business prosper without me? These questions can be overwhelming for the business owner who is otherwise highly competent in managing his or her business.

When this moment occurs, we recommend a few basic steps to get started. First, talk with your financial advisor and get a clear answer to the question of how much income you need to maintain your lifestyle during retirement and how much income your non-business assets can generate. The difference between these amounts will result in a gap for most business owners that must be filled by their business assets. Next, how much is your business worth and what are the net after-tax proceeds that you can expect to realize from its sale? Are these net proceeds enough to plug the financial “gap” that you identified?

When contemplating an exit from their business, these owners are generally faced with a choice between a sale to a third party or a sale to key employees. This is the key exit planning decision point for these owners and involves the bulk of our planning work.

All other things being equal, many owners will prefer a sale to employees. Owners generally appreciate the role that key employees have played in growing the business and often would like to give these employees a chance at ownership. However, “other things” are rarely equal. Given that owners are conscious of the financial gap that the proceeds from the sale of their business needs to fill, the first question owners ask is, do key employees have the financial ability to buy the business?

Key employees typically don’t have much cash, so owners frequently assume that employees can’t buy the business. However, with adequate planning, this is not necessarily true. In my experience, the more important questions are do key employees have the ability to run the business and do they have the desire to be owners?

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