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This first part of many deals with business owner exit planning. What is a business owner’s exit plan? At its most basic, a business owner exit plan recognizes that business owners don’t run a business forever, and in many ways it parallels what you know as estate planning. Stated differently, if you, as a business owner and operator, can’t – or don’t want to – run, what do you want to happen? Similar to estate planning, there are many proactive things you can do now to save time, money, and headaches for your eventual exit.
There are areas where business owners can, and probably will, think about finally getting out. So, we start at the first stage of the business life cycle: getting started.
We often think of businesses that start as ideas. The idea can come from the experience of some legends and the idea of ​​doing “it” better than everyone else. A passion can come from being changed by a hobby. It can come from having a unique understanding of the industry or simply looking for an opportunity to turn arbitrage into profit. Regardless of the idea, entrepreneurs should consider exiting before they even start. The reason is this:
You can pay more in taxes.
A properly structured exit plan can result in material tax savings when it comes time to sell the business or relocate for key employees or family. The federal tax code creates special incentives for certain types of businesses. For example, new business owners can take advantage of provisions that allow business owners to exclude up to $100 million in taxable profits when they sell. Similarly, employee stock ownership plans (ESOPs) can defer unlimited taxable gains on sales and provide a tax-deferred mechanism for the appropriate transfer of ownership. New business owners may or may not qualify for such a plan, depending on how the business entity is classified for federal tax purposes.
On the other hand, certain types of businesses do not qualify for this preferential tax treatment and not all buyers may be willing to find your business in a way that suits them. In such cases, an improper structure may result in two different levels of income tax. The first level of taxation is when the business owner sells the property and the second level is when the business is liquidated. Exit planning from the start allows professionals experienced in business transitions to provide new businesses with an efficient tax structure, to minimize taxes over the life of the business.
You can create an obstacle to the desired exit
Starting a business is a daunting task involving many different specialties, which may be completely unrelated to your new company’s mission. You may find yourself overwhelmed at the start-up stage without giving the slightest thought to finally getting out. However, not picking up the exit during startup can block your way to the exit you want. For example, you might challenge yourself to encourage early employees equally across the company. What happens if your governing documents require unanimous consent from the equity holders to approve the required equity sale down the road? Trying to convince minority owners to agree to a desired exit can result in unnecessary headaches, delays and costs associated with the exit.
You can manage the business towards a chosen exit goal (rather than annual profit).
A startup may find it tempting to focus on short-term metrics such as free cash flow or earnings before interest, taxes, depreciation and amortization (EBITDA). However, an exit plan may involve selling everything to private equity or a larger competitor. If potential buyers value purchase targets (That is(your business) using sales multiples or other metrics and relying solely on annual EBITDA may not increase your profitability at exit.
After you leave, you can train, hire and motivate those who lead the company
In the current business environment, finding and retaining talent is a challenge for any business. On top of that, there are additional considerations for business owners who want to hire one or more employees to eventually run and own the business. You may want to incentivize new employees with cash and equity compensation. It’s an outlet you’ll want to let your service providers know about the transition of one or more employees, giving them valuable information to set up your new business.
You may disagree with your business partners.
Many businesses start at a honeymoon stage. Everyone is satisfied and has high hopes for future success. If your business plan involves more than one person, it’s important to think about an exit plan before you start. Not every owner shares the same view on exit planning. Therefore, it is important to put in place mechanisms to prevent premature or unwanted withdrawal. These mechanisms may include, among others, voting agreements, pass-through laws, arbitration or arbitration provisions, rights of sale, and insurance requirements. Failure to consider these strategies can lead to premature exits or even the end of a successful business.
Key employees may leave
A successful business must attract and retain talent. What happens when a key employee leaves for greener lands? Planning to reduce employee turnover from the start can help increase the likelihood of a business exit. Businesses should consider the benefits of maintaining employee handbooks, employment agreements, employment clauses, non-compete clauses, incentive compensation arrangements, etc.
You may be asking yourself, how is this useful for exit planning? The answer is that any potential buyer of your business is going to look under the hood and kick the tires hard. Having strong employee-related agreements in place from day one can help minimize issues that may arise during the due diligence process and maximize the value business owners receive upon exit. As long as you are the only one who can run the business, the business value to a third party can be low.
Your heirs may not want to take over the business.
Some new businesses may plan to hand over responsibility to their children when retirement comes. While this is an exit plan that can work for many businesses, it isn’t for everyone. If you know that you will pass the business on to your children, it is best to plan for this outcome from the beginning. It may be possible to gift interests in the business over time and reduce the tax implications. By transferring economic interests to one or more children, it may be possible to retain control and voting rights in the business. If a business owner doesn’t plan for this exit from the beginning, they can let the business die on the vine when their children take over and are unprepared or lack the necessary skills to run a business. It’s important to start the transition early and plan for contingencies when a child says, “Thank you, thank you.”
It’s easy to get things right the first time. Most owners only get one chance to exit their business the way they choose.
Even the best laid plans are always subject to change, but planning is better than not planning. In my experience, it is more expensive to “fix” an issue after it happens than it is to plan and do it right the first time. Businesses should work with experienced and qualified consultants to get things done right the first time. Failure to properly record title and other business-related transactions can be costly to clean up later. The worst case scenario for your exit plan? Not doing it right the first time will cause the buyer to walk away or the transfer of ownership to fail.
Be prepared to think about your exit before you start. Confused about where to start? Below are five questions to get you started. Still have questions or ready to take the next steps?
1. How will your role with the business change over time?
2. What issues might arise that prevent you from achieving success?
3. What is your plan for your ownership interest in the business?
4. Who will run the business after you?
5. What can you do to retain suppliers, employees and customers once you leave?
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