Plan your succession before your next vacation

A 62-year-old business owner, George, contacted me regarding an interest he held in a small insurance company. At hand was his conscience—it had been bothering him—as he had already taken 11 weeks vacation that year and was planning for a subsequent 15 the following year. As a co-founder of the company, he felt he wasn’t being fair to his three partners.

George said he really enjoyed the business and—although he’s clearly powering down—did not feel ready to retire. We discussed what he liked and disliked about his business and his relationships with his partners, and he asked me what I thought he should do based on my experiences as a business intermediary.

The discussion turned to the issue of partnership arrangements and I was surprised to learn there was no written agreement in place. Each partner had his own book of business as well as a book they shared, while each person paid his proportionate share of expenses.

Potentially more problematic, however, was the fact there was no homogeneity in book size. Each partner earned a different dollar figure and each had a differing sense of the value model that would be used to calculate their respective books of business. Certainly this lack of value consensus could prove explosive at some point in the future.

Further disconcerting was the fact they did not execute a plan for any partner’s untimely death. Yet these partners sold life insurance and financial planning to their clients—a bit like the shoemaker who neglected making shoes for his own family, no? Our recommendations were straightforward and could be applied to any small or medium-sized business shareholders:

• Summarize the present operating arrangements amongst the three partners;
• Discuss changes in the operating statements to compensate for the extended time off George will be taking next year;
• Organize an independent valuation of each of the practices and the shared practice;
• Establish a lifetime buy-sell agreement between the three remaining partners that takes into consideration the financial capability of the individual partners to pay;
• Arrange sufficient life insurance to cover the values determined by those valuations;
• Consider arranging long-term income disability coverage; and
• Don’t procrastinate. Set reasonable timelines to complete these steps and retain competent professionals to complete the work in a timely manner.

The exit-strategy team should consist of the following key players:

An Accountant. Most business owners rely on their accountants to provide financial advice for the ongoing activities of their business. In the sale of a business, an accountant will assist the business owner in establishing the best corporate structure to help minimize tax ramifications.

A Banker. The bank manager can be instrumental in arranging different types of financing to help with cash-flow management throughout the sale process. Bridge financing may be necessary until the transaction is finalized, and money may be needed to finance the expansion plans for the buyout.

An Insurance Agent. These professionals will assist with the types of insurance required, especially when due diligence takes place. For example, if merging with another company, they’ll investigate key-man insurance and life insurance for each partner that clearly outlines who will be the beneficiary if a partner passes on. There have been many horror stories involving spouses of partners who have become involved with the operation of the business and then hindered sales to outside parties.

A Business Analyst. It’s important to have a realistic expectation of the value of the business. Many business owners underestimate the worth of their goodwill, while others want to base a price on what they have put into the business over a lifetime. A purchaser interested in the company will look at the ability of the business to generate profits. The analyst will need to select the best method to value the business based not only on profitability, but also on the marketability of the business, the comparability to others in the industry, and a review of transactions of similar businesses. Since there are many ways to evaluate a business, it’s wise to have an analyst who is experienced in the type of business being sold so she can apply the evaluation method best suited to the situation.

A Financial Advisor or Wealth Manager. You can help the business owner determine goals for managing his or her money while he or she is still active in the operation, as well as to assist in the planning of funds that will be needed to match the style of living the owner seeks for retirement. Planning for “life after business” should take place as early as possible after the business owner transitions in order to reap the sale-of-business funds and finance retirement. Advise the business owner to invest the proceeds from the business to maximize the best possible financial return. Too often, business owners leave succession planning until they are in ill health or the business has deteriorated to the point where it is not of much value to a prospective buyer.

A Lawyer. Someone experienced in transaction law is a must. The lawyer needs to know how to interpret complex purchase and sale documents and have the capacity to explain to the business owner, in layman’s terms, the legal documents involved in the sale of a business to ensure the contemplated transaction is in his best interests and complies with current laws.

A Business Intermediary. When assembling this team of professionals to help sell a business, the owner should also appoint a team leader, or intermediary, whose role it is to facilitate the activities of all the professionals involved and maintain a momentum that will result in a successful transaction. This person should have the ability to interpret financial statements provided by the accountant and understand the valuation provided by the business analyst. The intermediary will liaise between the business owner’s lawyer and the purchaser’s lawyer and act as a buffer for the owner so he can still concentrate on running the business. Not only should the intermediary be able to identify potential purchasers for the business, she should also qualify those purchasers before providing any confidential information.

When considering suitability of the team of professionals, business owners should ask:

• What experience do they have in selling a business?
• Have they been involved in a sale transaction in the business owner’s industry?
• Are they licensed according to local laws?
• When was their last completed sale transaction?

It’s paramount the business owner takes the time necessary to perform due diligence on the intended team of professionals and ask them to provide references—that is if he wants to get the best value for the business in the end. After all, the purpose in hiring this professional team is so it can manage the sale so that the owner can focus solely on business maintenance and continuing to grow the company pursuant to the sale.

Most people don’t realize the average entrepreneur spends about 68 hours a week in the activities of the business. In the case of George, as a senior partner of the insurance company, he had plans for plenty of leisure time, however, he left his exit-strategy plan a little late. Nevertheless, had he not gotten the planning help from his team of advisors, he could have been setting himself up for a full-scale retirement disaster. Had we met this business owner sooner, we would have shared these tips with him:

• Never give out financial or proprietary information to anyone without the interested party signing a comprehensive confidentiality agreement.
• Always take the time to qualify the financial capability of the interested party, and avoid providing any information until the buyer has demonstrated financial capacity to complete the transaction.
• Avoid making reactive decisions. Plan ahead, and have a competent third party provide a written valuation of the business.
• Never provide an asking price. If the asking price is too high, no one will buy, and if it is too low, money will be left on the table. The reasons a buyer is buying, and the point of view from which he or she sees the business will result in a different value perception for each buyer.
• Never sign anything that a lawyer has not reviewed in detail.
• Never sign anything until an accountant has reviewed the tax impact of the proposal. A simple allocation or a change in the structure can save hundreds of thousands of dollars. We were once involved with a transaction in which the initial estimate of income tax due from a transaction was close to $1 million, and after the tax accountant made a number of recommendations, the tax bill was reduced to approximately $85,000.
• Avoid negotiating directly with the interested party. Always use the intermediary for that and try to be the higher authority the negotiator must go to for a final decision. A competent intermediary will not be emotionally involved and should be able to maintain a level business head during the negotiations and between the parties.
• Maintain confidentiality at all costs. Failure to do so can easily result in the loss of key employees, customers, important suppliers, or worst of all, the sale of the business itself.

Planning an exit strategy before taking the next vacation may very well be the best decision a business owner could make.

Doug Robbins, FCBI, M&AMI, MCBC, CM&A, is president, Robbinex Inc., a company specializing in the sale of mid-sized privately held businesses, based in Hamilton, Ont.