Lifestyle vs. Investment

The first limiting factor for the owners of many private businesses is their limited view of the business as providing only a job and a lifestyle for them. Owners who view their business as paying for their lifestyle will struggle with their exit vision because they can only see as far as the ‘bare necessities’. In other words, the objective of the business is not to fulfill a particular business vision. Rather, it is to provide a certain type of lifestyle to the owner while also taking care of the employees, customers, etc. In this limited vision, the owner is only focused on the now—not the future. And, as a result of this limited vision, the owner does not ask ‘how big (and profitable) can this business be?’ Moreover, owners fail to ask ‘how big can this business be without me’? A vision is a necessary and powerful concept. If your current exit vision begins and ends with the bare necessities, merely improving on what used to be, than it is likely to fall short and will likely have a negative impact the success for your exit.

Development of an Exit Vision – How Motivation Factors In

A true exit vision begins with where you are today and what is possible for your company to achieve, i.e. its true potential. What products and services do you provide to the marketplace and where do you stop short of expanding your offerings. Is it capital, talent, management or other issues that prevent your growth? If you are like many owners of privately-held businesses it may likely that none of these limitations prevent your growth. Rather, your growth is prevented only by the face in the mirror each day.

If you have a certain exit vision but are not motivated to grow your company to realize that vision then perhaps the potential for your business will be fulfilled by its next owner? However, if today you can clearly articulate that vision and begin to assemble the component pieces to advance towards the goals that you define, the more likely it is that the next owner of your business will both pay you more at your exit as well as have a clear picture of the opportunity. The only question left at this point is whether it is worth it for you to develop this vision and begin the execution process to start seeing it through.

Your Vision is Likely Aligned with Someone Else’s

Ideally, the next owner of your business should not be someone who simply wants to buy the job that you currently have. First of all, that person likely does not have the financial resources that another type of buyer will have. Next, if that person did have the financial resources and the skill to run your business, they would likely be already doing it themselves. So, the logical next owner of your business, someone who will complete your vision, may just be that person who is currently doing for themselves—i.e. your competitor.. And their vision for your company’s potential may be larger than yours. In effect, this will help you achieve your exit but with someone else’s vision. If you have your own vision first, you can work to align it with your future owner’s vision to have a more successful exit.

Completing the Exit Visionary Cycle

No matter whether your vision for your company’s future ownership includes your internal management team or is lead by the idea of selling to an outside buyer, you will want to develop and refine this exit vision as you build upon your planning. Without a vision, there is no direction. Without direction, there is no action and results. In order to complete the exit visionary cycle, you need to begin to see your business as an investment that someone else can run, which is moving in a direction towards fulfilling the potential for your company. Without these thoughts you are left with a job. And, with only a job, you have nothing to transfer except for a job that someone else may or may not want.

Concluding Thoughts

You are the visionary leader for the day-to-day running of your business. When you develop an exit vision, you begin to align the resources of your company with a transition to a new owner that recognizes the potential for your business as well as a future for you outside of your company. We hope that this newsletter encourages you to view your business this way and to see that having a solid exit vision and becoming an exit visionary is a critical part of your overall business and personal planning.

Copyright Business Exit Timing LLC and Pinnacle Equity Solutions © 2012

Not All Values Are Created Equally, Opinions versus Estimates – Valuations versus Calculations

According to the American Institute of Certified Public Accountants (AICPA), there are two types of engagements to estimate value—a valuation engagement and a calculation engagement. The valuation engagement results in a ‘conclusion of value’, while the calculation engagement results in a ‘calculated value’. The key distinctions between the two types of engagements are as follows:

• • A valuation engagement requires more procedures and steps than does the calculation engagement.
• • In a valuation engagement the appraiser is free to apply valuation approaches and methods he/she deems appropriate given the existing circumstances. In a calculation engagement the appraiser and the client agree on the valuation approaches and methods the appraiser will use as well as the extent of procedures the appraiser will perform in the process of calculating the value of the subject interest.
• • In a valuation engagement the appraiser must correlate and reconcile the results obtained under the different approaches and methods used in order to arrive at the conclusion of value. In the case of a calculation engagement, there is no need to correlate and reconcile the approaches and methods because these decisions were made by the appraiser and the client at the outset of the engagement.

The Final Work Product

The final work product in a valuation engagement can be either a detailed report or a summary report. The determination of which one to use is based on the level of reporting detail agreed to by the appraiser and the client. The detailed report is structured to provide sufficient information to permit intended users to understand the data, reasoning, and analyses underlying the appraiser’s conclusion of value. A summary report is structured to provide an abridged version of the information that would be provided in a detailed report.

By contrast, the final work product in a calculation engagement is referred to as a calculation report and contains far less detail and analysis than the two reports under a valuation engagement.

Can a Ballpark Estimate of Value be Useful (i.e. I’ve been offered a free valuation, what should I do?)

Budget conscious owners will often be attracted to the idea of a free valuation. The whole idea is that the owner can get a reliable estimate of their company’s value from a ‘free look’ and some simple, inexpensive software that is available online.

If you are considering such an approach this newsletter encourages you to consider the magnitude of the decision that you are making and whether allocating a few thousand dollars towards a more reliable number is not a more prudent course. To put this in perspective consider the following example:

A free evaluation is akin to a residential real estate appraiser driving by a house rather than looking inside. Two (2) identical and adjacent homes could have materially different values if one is in relatively poor condition on the inside and the other has undergone several renovations and additions that are not visible from the outside. The business valuation process is far more sensitive and complex than just plugging numbers into a computer software package or spreadsheet, requiring material professional judgment. The numbers in a business (for example, the pre-tax profits) may need to be adjusted for certain factors such as excess compensation, fair market rent, etc. These numbers may not necessarily reflect certain risks (e.g., dependence on a key person or on one customer) that would need to be factored in valuing a business. And when you accept a ‘free valuation’ from someone who does not make these adjustments or have the requisite experience, it is the equivalent of driving by a home and assessing the value without looking inside. Once again, is this the approach that you want to take for [likely] the largest financial transaction of your life?¹

The Short Story on What ‘Exit Value’ You Need For Your Planning

In short, there are a number of factors that would lead you to ‘order’ a valuation engagement or a calculation engagement. If you are in the ‘planning stage’ of your decision making process (i.e. not in the ‘execution stage where you are making decisions and taking action), a calculation engagement is often-times sufficient to give you a general idea of the estimated value for your business. In this case, you are deciding with the appraiser what level of detail you are going to use to examine the business. A calculation engagement may cost $3,000 to $5,000 and will provide an owner with more than a ‘surface level’ estimate of value for their business.

By contrast, if you are making gifts of stock and / or having your company valued for the Employee Stock Ownership Plan (ESOP) you will want to order a ‘valuation engagement’. In this case, the appraiser is providing an ‘opinion of value’ and is providing a much more in-depth look and review of your business. This opinion of value is often included with a gift-tax return for certain transactions and/or is used as a basis for a defense against a challenge by the IRS that a transfer occurred at too low a value (thereby avoiding certain transfer and gift taxation). In these cases you do not want to be relying upon a calculation or estimate of value to defend the actions that you are taking.

Concluding Thoughts

As you can see, not all valuations are created equal. The valuation that is best for you is unique to your situation (and to your budget) as well as your specific stage of planning. It is always best to consult with your professional advisors to determine which type of valuation you should be using. However, because the exit planning process is so complex, we wanted to provide some basic concepts for your consideration as you move forward with your exit planning and to be certain to ask your professional appraiser the right questions so that you remain in control by better understanding the exit values that you are being provided.

Copyright Business Exit Timing LLC and Pinnacle Equity Solutions © 2011

History of Income Tax Rates

The United States income tax came into being in 1913. And, for nearly 100 years, the government has taxed the income and investment income of Americans. It is worthwhile to gain some perspective on past tax rates as a potential indicator of the future. The highest tax on income was in 1944 when the highest income tax was 94%. This was immediately after World War II as the county was rebuilding itself. If we measure the time that one would need to work in order to retain any of their income for themselves it’s rather disheartening. In 1944 a wage earner would need to work 328 days just to pay their taxes. That is 11 months out of the year. Fortunately, ‘tax relief’ was just around the corner as Thanksgiving and the Christmas Holiday Season approached. Then the tax clock reset itself on New Year’s Day.

It may be worth noting that the highest average income tax rate, since inception—
100 years ago—is 55%. Referring again to our tax calendar, the wage earner wouldn’t get any tax relief until summer was nearly over. The top income tax bracket today is 35%. It is scheduled to revert to a prior rate, 39.6%, next year if the Bush Tax Cuts are allowed to expire without any further action from Congress. With this as a back drop, you may want to reconsider the tax impact of deferring the sale of your business, whether be to an outside third party, or depending on the circumstances, inside to family members, a management team or employees.

History of Capital Gains Tax Rates

Like the federal income tax, capital gains taxes have been in place since 1913. At that time, realized gains were taxed the same as other income at a maximum rate of 15%. Since then these rates have fluctuated greatly, with the highest rates in years 1936-1937 and 1976-1977. The rate then was 39% and 39.9%. More recently, the maximum capital gains rate has been steadily decreasing from the 1993 rate of 29.2%. This rate decreased to 21.2% with the Tax Payer Relief Act of 1997. The Economic Growth and Tax Relief Reconciliation Act of 2001 and Jobs and Growth Tax Relief Reconciliation Act of 2003 under George Bush led to further decreases in the maximum rate to 15.7% in 2006, 15.4% in 2008 and our current rate, 15%, which began in 2010. However, with the expiration of the Bush Tax Cuts, these rates will also change.

On January 1st, 2013, the capital gains tax rate is set to return to 20%, a 5% increase overall but a 33.3% increase from where it currently resides at 15%. It is helpful to think of taxes in relative, percentage-based terms – do you want to pay an extra 33.3% in capital gains taxes if you can avoid doing so?

Healthcare Legislation Mandates an Additional 3.8% Tax on Investment Income

If you sell your business in 2013, your sale transaction is also likely subject to an additional 3.8% tax that was put in place with the 2010 passage of President Obama’s Healthcare legislation. When we add the 3.8% to the new capital gains tax rate, we see that the taxes that you will pay on a sale of your business could go from 15% to 23.8%. On a relative basis, this means that the additional 8.8% increase in the taxes that you pay for your business sale equals an additional 58.67% increase over the 15% capital gains tax that exists today.

National Debts will Compel Higher Taxes

The public debt has increased by over $500 billion each year since fiscal year 2003, with increases of $1 trillion in 2008, $1.9 trillion in 2009, and $1.7 trillion in 2010. As of September 1, 2012 debt now exceeds $16 trillion. The annual gross domestic product (GDP) at the end of 2011 was $15.087 trillion with total public debt outstanding at a ratio of 103.3% of GDP. This growth in the national deficit has influenced many in Congress to entertain tax increases as a means for reversing this trend.

Increase in Capital Gains Taxes from 15% to 20%

Let’s take a look at a simple example to make our overall point more clear. If you sold your business for $10 million in December of 2012 and received capital gains tax treatment for the sale proceeds, you would pay 15% capital gains tax (plus state and other taxes but we are only focused on the federal taxes for now). You would pay $1.5 million in federal capital gains tax (this assumes no cost basis). If you sold this same business for the same amount on January 1, 2013 you be paying $2 million in federal capital gains taxes as well as an additional $380,000 in healthcare tax. That is an additional $880,000 out of your retirement account by waiting until 2013 to transition ownership of your business—ouch!

Concluding Thought – The Bigger Picture

As a successful business owner, armed with the history of tax rates and an understanding of our country’s current fiscal situation, you must assess the probability of tax rates going higher and just how that will impact your ability to retire. Converting illiquid business assets to cash in this economy with the added impact of twelve (12) million Boomer business owners approaching normal retirement age is challenging enough. Therefore, it is important that you plan the timing of your exit carefully because taxes could rob you of your desired retirement lifestyle—forewarned is forearmed.

Copyright Business Exit Timing LLC and Pinnacle Equity Solutions © 2012

Business Sales are Predicated on the Future Potential, Not the Story of the Past

Whoever is going to own your business after you will be more interested in the future potential of your business rather than its past performance. Why? Past performance may or may not be a reliable predictor of the business’s future performance. For example, if you are in a position of gaining new market-share and attracting new clients with new products, services and ideas, then the business’s future may look brighter than its past. It is reasonable for buyers to pay more for a business that is demonstrating a trend for solid future performance because they can see that the marketplace is accepting to the businesses new ideas or services.

However, many owners do not subscribe to this philosophy. In fact, most believe that the new owner of their business should pay for the future even if that owner has not currently demonstrated the potential for new ideas. And, this is the primary reason that seller’s price expectations end up being so misaligned with what the marketplace will pay to own your business.

Overcoming a Weak Past and Selling into a Brighter Future

Coming off of the ‘great recession’, many business owners are just now starting to see improvements in their income statements indicative of a healthy and growing business. This is against a back drop of trend lines from previous years, 2008 through 2010, indicating many businesses encountered significant reductions in revenue and corresponding reductions in market value—your business may fit this description. Though many owners in this situation would now like to pursue an exit, they themselves know they would not be willing to pay a pre-recession price for a business that is in decline or just beginning to pull out of a decline in revenues and earnings. Instead, most are holding out in an effort to re-establishing their businesses to pre-recession values and thus are cautiously optimistic that the future will continue to bring to them more good than bad.

That said, one way to overcome a reduction in business value due to past performance is to motivate your prospective owner with a vision of future growth and profitability. Beyond articulating the future potential of your company, you must also be able to demonstrate, with tangible evidence, the necessary strategies and steps to achieve measurable success—in other words you need a good story with substance. A story of a bright future accompanied by, loyal and productive employees, legitimate goods and services, quantifiable metrics and well documented financials is a strong foundation upon which a future owner can justify paying you to own that future potential.

The Power of a Five (5) Year Forecast

The first step in establishing the validity of your future story may be a fresh (or brand new) five (5) year forecast. Many owners are not in the business of building a five (5) year forecast for their businesses. Rather, too many owners of privately-held businesses view this activity as a waste of time because they assess that the future cannot be predicted. Owners know that numbers can lie when ordered properly by the presenter and they believe in the integrity of performance, not in projections. However, owners who hold this view of business are limiting themselves from telling the story of their company’s potential future. And, in effect, owners who reject forecasting are relegating the future vision for the business to someone else.

However, when a five (5) year forecast is presented to a future owner and the past story of the company reflects new products and revenue lines that are showing an existing trend towards executing on that plan, the [potential] future owner has a lot more confidence in buying into the future story, mainly because you are demonstrating that future today and showing them the potential for your enterprise once they own it. In the absence of you performing this task, you are leaving the job of forecasting to the new owner and are in a weaker position because in the absence of your insights they will be forced to assume the worst scenarios and not a story of the best outcome possible.

Concluding Thoughts – Create a Future Story on Facts that Support a Great Story

In conclusion, this newsletter encourages you to avoid trying to exit on a story alone. It is far better for all parties to an exit transaction to have the facts and stories straight and supported by actual (albeit initial) performance. When you as an exiting owner can provide this clarity to your future owner, you are in a position to substantially improve the odds that your future owner will buy more of your future story with the exit transaction, leading to a more successful exit for you.

Copyright Business Exit Timing LLC and Pinnacle Equity Solutions © 2012

Exit Metric #1 – How is My Relationship with My Future Owner?

In order to answer the question, ‘how is my relationship with my future owner?’, one must first know who that future owner is likely to be. If you have no idea who your future owner will be, then this is the first metric that you need to focus on. Let’s begin with a simple question – who would want to own your business after you? If a number of companies and/or people jump to mind that is a good thing. If this is a blind spot for you and your business, then it is the first area that you need to focus on (assuming of course that you want your business to continue on after your active involvement in the business). Without knowing who would want to own your business after you, it is difficult to design your business to be attractive (or at least successful) under another person’s ownership.

Exit Metric #2 – Do I Know the Range of Values for My Business and Can I Afford My Desired Exit?

Most privately-held business owners are dependent upon their businesses to fund their lifestyles. This includes not only W-2, salaried income and distributions but also perquisites that owners take for being the boss. If you do not know whether the value of your business – once sold to your future owner – will be enough to fund your continued lifestyle, it is very difficult to plan your exit because you are stuck in your business (at least from a financial perspective). This situation is made more complex by the notion that a privately-held business has a number of potential exit values depending upon who will own your business after you. Knowing these numbers is a key metric to a successful exit.

Exit Metric #3 – Have I Prepared My Key People for the Transition?

Let’s face it, you are where you are because you found, hired, trained and retained good people. No man is an island – and this is true for your exit as well. Now many owners fear the consequences of telling their key people that a change in ownership is occurring. However, there are two (2) reasons and ways to have this conversation. First, recognize and discuss the fact that you are getting older and won’t be around forever and that your key people’s careers are staked to your decisions. Second, recognize and discuss the fact that some new energy (and perhaps some new capital and management) may help the business reach its potential. Both of these conversation starters help open the discussion about a future transition (note that you do not need to be specific about the timing to begin the conversation). What you want to avoid is losing your key people as a result of your transition and exit. On this point note carefully that money alone (i.e. retention bonuses) is usually not enough to keep good people with your company after your exit. It is far better to have some honest, open-ended conversation so that your future owner will be in a trusting position to retain these key folks.

Exit Metric #4 – Is My Personal, Company and Market Timing Aligned?

This is not an easy thing to do, but ideally you want to have three (3) points of interest aligned – (1) your company performance, (2) your personal timeline, and (3) the proper external market conditions that support your exit. Alignment of these three (3) key areas will provide the optimal exit value and transaction timing (irrespective of who your future owner will be). A key to making this timing work is to understand when market cycles occur as well as to have enough time to plan, both personally and within your business. Knowing and monitoring this metric on a regular basis will give you greater confidence and traction with your exit planning. While you fight the day-to-day battles that are required to run your business effectively, it is important to look ahead as well as within to find answers to your timing issues.

Exit Metric #5 – Do I Know What I’m Going to Do Next?

This metric is all about avoiding seller remorse. If you do not have an answer to the question ‘what am I going to do next?’, you are overlooking a major part of all exit planning and assuming that you will feel happy and fulfilled once you no longer own your business. Do not underestimate what your business means to you and keeping you active and productive. Try this: create a blank calendar and begin filling in what you would be doing all day with the free time that you have achieved with the exit from your business. Once you can get past the ‘recreational’ activities that you enjoy and into some meaningful pursuits that you look forward to engaging in, then you will be well on your way towards knowing what you are going to do next. Build on this metric by returning to this exercise every few months. Find meaning and purpose in productive activities outside of work. Monitor this closely as well so that you enjoy the fruits of your exit transaction without the pain and remorse of letting go.

Exit Metric #6 – Have I Assembled a Team to Help Me Through My Exit?

Going it alone can be hazardous to your wealth. There is so much complexity involved with an exit plan that even the experienced professionals (i.e. those who have bought and sold many, many businesses) never try to do it by themselves. A team of trusted, trained and competent advisors is key to your success. Begin assembling that team today. And remember that the time and money that you spend on your planning today is nothing more than an investment in the protection of your wealth for yours and future generations. Executing on a long-term plan with a team of professional advisors is the essence of accomplishing your exit transaction and personal goals – begin finding those who can help you today.

Concluding Thoughts

By following these exit metrics, you will track your progress and begin to focus on the key aspects of your exit and succession planning which are vital to the success of your organization’s survival without you as well as to the achievement of your personal goals. Like all types of goal setting and metrics, get these in writing and refer to them often. Over time you will see that these exit metrics empower you with answers to a customized solution for your unique needs.

Copyright Business Exit Timing LLC and Pinnacle Equity Solutions © 2012

1. Uncertainty Continues to Dominate Our Business Lives

The weight of economic uncertainty has plagued business owners for many years. Forecasts cannot predict when we will return to ‘normal’ times, and for the present, there is no light at the end of the tunnel. Doubts have crept into our decisions and we are left paralyzed, unable to make solid decisions to move ahead. Despite this unsettling circumstance you can protect yourself by getting enough good information to make informed decisions, protecting your business from unforeseen contingencies—things out of your control—and assembling a qualified team of professional advisors that will provide you with objective advice.

2. Your ‘Business Lifestyle’ Has Probably Changed with Few Prospects for Returning to ‘Normal’

Many owners of successful businesses have been forced to work harder, reassuming tasks that were once delegated and clocking longer hours because of reductions in staff. They remain hopeful that eventually their business lifestyle will return to normal, the way it was before the Great Recession of 2008, but now realize that it is going to take much longer than a typical recovery. This is a good reason to start planning for their eventual exit or transition of ownership now. An exit plan will put their post-exit lifestyle back into focus by assessing their financial and mental readiness, identifying the optimal exit options and a road map for execution.

3. Your Business Likely Showed Improved Performance in 2011 – Hence A Trend Towards a Higher Value

The future owner of your business will ultimately care about two (2) financial components related to your company’s performance: (i) future cash flows and (ii) the [perceived] risk of receiving those cash flows in the future. Each additional year that demonstrates a trend toward improved performance adds another arrow to your ‘negotiation quiver’. This fact helps you defend and justify a higher value which in turn enhances your exit. This is important if you need an increase in business value to meet your personal and financial exit objectives. However, if our economic recovery continues at its current lackluster pace it may trigger an unsettling level of uncertainty amongst would be buyers of businesses, both internal and external, over the lack of predictability regarding future cash flows. This is a risk that can impact business value and so maybe now would be the best time to execute your exit.

4. Interest Rates Continue to Be Low – Increasing Buyer’s Ability to Purchase

The U.S. Federal Reserve is intent on printing money to prop up our economy. As a result, interest rates have remained low, making money cheap to borrow. Therefore buyers, at least those who qualify for loans, can borrow at historically low rates. And, similar to home prices, when money/debt is cheap, values tend to rise because of increased demand. Therefore, you may find that your exit value in a low interest rate environment is higher than in a good economy where interest rates have risen.

5. Political Winds are Blowing Harder than Ever

Whatever your political persuasion, it’s hard to deny that change is coming. Over the past year we’ve seen Tea Parties, Occupy movements, debt downgrades a deteriorating European economy, a slowdown in China and bare knuckle brawls in Congress. Heading into a heated Presidential election could stimulate a flurry of political and regulation changes beginning 2013 because each party is motivated by their own agendas.

6. The Entire Tax Code is Set for an Overhaul After the Next Election

This prediction goes beyond the political positioning of today because the last major overhaul of the tax code was in 1986 under President Reagan. These overhauls tend to materialize every twenty-five (25) years or so and prognosticators are forecasting that 2013 will be the year of the next one. At the moment it is very difficult to predict what will be included in this tax overhaul. However, given President Obama’s concept of ‘fairness’ and the rising U.S. deficit it seems likely that new sources of taxes and fees will be in the mix creating higher taxes.

7. Tax Benefits Expiring and Warren Buffet Giving his Blessing to Increase Taxes on the Successful

At the end of 2012, if no further action is taken, federal capital gains taxes will rise from 15% to ⁱ 23.8% and the Bush Tax Cuts that President Obama extended will expire. Warren Buffet (and a few others such as Alan Greenspan) said publicly that our government should simply go ahead and let those benefits expire. What do you say? Think about the impact this could have on you when selling your business to insiders such as a co-owner or key employee or to an outsider. Generally an owner’s basis is relatively low in a closely-held business compared to the value. When ownership changes hands it will trigger a capital gains tax in 2013 that is approximately 59% higher than in 2012—I’d call that significant, wouldn’t you. An exit plan will identify the best exit option to minimize this tax.

8. Europe and The United States Seem Functionally Insolvent

Currently the United States is more than $15 trillion in debt and increasing daily. Add to our economic situation the fact that Europe is now part of our financial lives and the overall financial picture looks less than promising. In fact, it is not hard to imagine just a few factors occurring (such as rapidly increasing interest rates resulting from so much cheap money in the U.S. system) that drive the U.S. back into recession. Or perhaps our foreign creditors will simply stop purchasing our debt or give up on the dollar. Business is about managing risks. Since there are storm winds blowing in the global economic system, an exit plan that articulates the impact on your business value and transfer is a valuable navigational tool.

9. Maybe, Just Maybe, the Mayans May Have Been Right about 2012

The Mayan calendar measured cycles in approximately 5,000 year increments. 2012 marks the end of a 5,000 year cycle and the beginning of a new one. While some speculate that the Mayan temples were warnings to future generations, there is no way to be certain. However, it is compelling to consider that with such a fast-changing world, perhaps there was something that these Mayans did know about rapid change and its impact on our now global, interconnected business world. No matter how you interpret the Mayan message, one thing is certain—as long as your money remains illiquid, your options in a fast-changing world continue to be limited.

10. Ending on a Positive Note – Buyers Are Still Buying Good Companies

The final reason to plan your exit in 2012 is that there are still a lot of companies and investors with a substantial amount of money sitting in cash and looking for good investments. If your company has prospects for the future, solid managers, and a recognizable brand in your market, it is possible that you are a candidate for acquisition. Given the importance of this financial transaction on your entire financial life, it is more important than ever to plan for your exit in 2012.

We hope that this newsletter encourages you to get off the sidelines and get proactive with planning your exit. It will most likely be the largest and most important financial decision of your life. Give it sufficient time and do it right with the help of qualified professional advisors.

ⁱincluding a 3.8% surtax on net investment income with AGI over $200k for single filers and $250k for joint filers.

Copyright Business Exit Timing LLC and Pinnacle Equity Solutions © 2012

This short quip illustrates an important point that all business owners must confront in their strategic and tactical planning because the job of a CEO is a lonely job. This isolation can have an impact on the performance of the person in the top role. When you add planning for an exit to this fact the formula becomes even more complex because the business is often the owner’s largest financial asset. If monetization is critical to the owner’s retirement, which is the case 85% of time, then it is understandable why exit planning can truly be a lonely task.

In fact, the January, 2012 edition of Chief Executive Magazine highlighted a new survey from RHR International which reveals that over half of CEOs (54%) felt the job was not what they had originally expected and that half also felt isolated in their role. First-time CEOs are particularly susceptible to this isolation, with nearly 70% saying it can negatively impact their work performance. The article went on to explain that ‘to some degree isolation is part of the job. A CEO can share only so much with his colleagues before he is open to favoritism or is ill-advised by those who may have their own agendas.’

Favoritism and Being Ill-Advised

The job of CEO requires a constant balancing of priorities and delegations. Unfortunately, the owner-operator of a business, in a fast-changing world, needs to make the best strategic decisions that they can with the information that they have.

If the owner relies too much on one person for their planning, it can be detrimental to their relationship with others and the owner only gets one perspective. Furthermore, when managers, key employees, family members and other influences in this owner’s life begin to participate in the exit planning decision, their contributions are often influenced by their own agendas.

Strategies, Tactics & Communications

Perhaps one of the reasons that owners do not successfully plan for their exit is because they are more alone with exit planning than they are in running their businesses. And, given the challenges of the current economy, most owners likely decide to simply ‘wait things out’ before engaging in exit planning. Most often successful CEO’s seek the counsel of others before making important strategic decisions. However, if the same sources relied upon for strategic decisions, like the owner’s management team, are also relied upon for exit planning decisions, the responses or opinions may be influenced by their own self-interest. Further, assuming most managers are not shareholders, communication regarding the owner’s exit can be risky—delivering the critical information at the wrong time could cause irreversible damage. This factor alone tends force the owner to make exit decisions in isolation.

Who Should the Owner Trust?

CEOs of successful businesses often pride themselves for recruiting and retaining key managers and employees to help operate and grow their businesses. They should feel the same way about assembling a team of trusted advisors to help them through the exit process.

This team of advisors should include multiple disciplines because exiting is a complex process that generally goes beyond the scope of any one advisor. The team should include an attorney to perform the legal documentation, an accountant to assess tax strategies, a wealth manager to oversee the investment of liquid assets, an insurance advisor for risk management and a merger and acquisition professional. This team should also include an experienced exit planner to help quarterback the exit process with the other advisors. This team of qualified professionals will help mitigate the owner’s ‘going it alone’ syndrome that often accommodates exit planning and implementation.

Concluding Thoughts

A CEO may feel lonely when faced with the operations of their business, but when a CEO’s isolation leads them to become the sole planner for the exit from their business they are doing themselves, their businesses and the constituents to that business a great disservice. Recognizing these challenges, being proactive and pulling together an experienced team of advisors to help navigate the exit planning process will help ensure that the right exit options are evaluated and the best decision is made with the greatest amount of clarity that an owner can obtain. Only at that point in time will the owner / CEO know that the wealth they have worked so hard to build within their business will be successfully reaped for the next stage of their life.

Copyright Business Exit Timing LLC and Pinnacle Equity Solutions © 2012

Now, admittedly it is natural to let your mind wander when you approach a certain milestone in life. This happens quite often to business owners. They can get tired of the endless grind of running a business and having it weigh on their mind without end. They may have lost the passion and enthusiasm for it that once consumed them. Further, it is not unusual to find business owners lost in the past, recalling earlier, perhaps more exciting or profitable periods in their business.

Or they may find themselves completely detached from the business and essentially thinking of all of the other things they want to do with their lives; traveling, spending time with their family, pursuing other interests and hobbies.

The problem is that all of these are symptoms of checking out too early which can be detrimental to your exit.

The Importance of being “Checked In”

Arguably the most important aspect of the exit planning process is an honest conversation a business owner should have with themselves about their personal and business goals. This conversation brings the owner back to the present and creates a deeper understanding of what really drives their decisions and their actions. Without this ‘internal’ conversation owners are all too often set adrift without solid plan for a successful exit.

This internal conversation can be very difficult because it requires the owner to confront realities that may have been intentionally disregarded. As an example, a business owner that ‘checked-out’ prematurely may experience a rude awakening with this self-assessment of personal and business goals-one that jolts them back to the present with a sobering realization that there is still a lot of work to be done to exit successfully.

It is crucial that the business owner be ‘checked back in’ to successfully execute the rest of the exit planning process. So much of a successful exit will depend on the owner’s full engagement, particularly when one considers the different roles that an owner plays for different types of exits.

The Exit Planning Process

The exit planning process is perhaps the most critical time in the lifespan of a business for the owner to be fully engaged. During this period the owner is actively learning about exit options while formulating, articulating and quantifying personal and business goals. Only with full engagement will a successful exit be likely. Furthermore, it is during this exit planning stage that key strategic decisions are made and executed-all the more reason a full engagement is necessary.

Internal Transfers

For example, the three main types of internal transfers, family succession, management buyout (MBO) and Employee Stock Ownership Plans (ESOP) tend to require a higher level of participation, i.e. being ‘checked-in’. The owner’s participation is crucial for the successful transfer of management responsibilities to the business’s new leadership team. During transition the owner serves as a mentor, not a manager. Also, continued participation may be critical to receiving a necessary exit price because the business must continue to generate profits, currently and in the future, in order for the new owners to pay the exiting owner.

External Transfers

With few exceptions, the business owner will need to stay engaged in the business even after an external transfer. For example, when considering a private equity group recapitalization as an exit option, the owner must show a full-scale engagement because few, if any, private equity groups will consider an investment of this type if the owner does not exhibit a complete grasp of their business. In fact, owners need to work concurrently with past data, present information and future planning. The private equity group is investing not only in future forecasts of business performance but also, in most cases, the active engagement of the owner in fulfilling these projections.

Even a sale to an outside buyer, i.e., a competitor in the same industry, may require deferred and contingent payments to complete the deal. This then mandates continued engagement by the exiting owner because he/she is now vested in the future performance of the company to ensure they get paid on time and to the full extent of the sale price. For example, many business sales are based on an earn-out structure. As a result, a significant portion of an owner’s selling price is tied directly to the future success of the business-a situation that could definitely be detrimental to the exiting owner if they were to ‘check out’ too early.

Conclusion

In conclusion, one the most dangerous aspects of the exit planning process is when a business owner checks out too early. This scenario leads to a decrease in the likelihood of a successful exit and may even take viable exit options off the table. Therefore, as they say, forewarned is forearmed – don’t check out too early with your exit.

Copyright Business Exit Timing LLC and Pinnacle Equity Solutions © 2012

When considering a successful exit from your business, it is important to develop an ‘exit mindset’, one that encompasses the past, present and future of your businesses’ potential. Unfortunately, the majority of owners are too busy running their business to allocate the necessary time to balance these different mindset ‘time zones’. And, they do not realize that their “time zone” mindset evolves and changes as their business develops. The result is usually a mindset that is improperly calibrated for a successful exit. This newsletter describes the various “time zone” mindsets that an owner experiences with the start up and growth of their businesses, while also offering a solution for developing an ‘exit mindset’.

New Business Owners are all Futurists

As a business owner, the allocation of your time has likely gone through transitions as the business progressed. In the beginning, the emphasis was focused on the future. Products, services and markets are developed. Plans are set to ensure that future benefits are realized. This is a time when the owner’s mindset is the most positive, full of hopes and dreams about the future. This mindset is accompanied by tremendous optimism, passion and creative thinking. There is very little thinking of the past—it just doesn’t exist at this stage of a business.

Past, Present, and Future – The Mindset of an owner during the growth phase

As the business grows a transition in mindset begins to take place. Though the owner is still focused on growth—the future—more time is now be spent on the present and past. Additional time will be allocated to the analysis of budgets and the reassessment of the previous year’s activities. Owners will find themselves dealing in the present tense with operational, employee and financing issues and in the past with prior performance issues. That said, business owners still continue to be engaged with the future, but to a lesser extent, so business development continues to occupy a portion of the owner’s mindset.

In this phase of the business cycle the owner’s mindset is fully engaged with all three time zones concurrently, past, present and future. However, the concept of exit planning will not occupy any of the time dedicated to thinking about the future. It’s not something, unfortunately, that most owners become occupied with until it becomes a ‘present’ tense reality. Note that an exit, as a ‘present’ tense reality, generally manifests itself in the form of an unsolicited purchase offer, pressure from a management team, a personal tragedy or an illness. A proper ‘exit mindset’ will allow you to be proactive with your exit instead of reactive. But let’s also look at the final stage of a business owner’s mindset – maturity.

The owner’s mindset in a mature business

As a business enters into the maturity phase of the business life cycle, there is a natural tendency for the owner to be more present and past tense oriented. The risk tolerance for expanding product lines, developing new markets and general business expansion—all future tense issues—start to decrease. The acceptance of limited growth and even status quo becomes more predominant. At business maturity, owners then tend to spend the majority of their time working ‘in the business’ rather than working ‘on the business’. At this stage, they simply lack the initiative to work on and think about the future.

This can be, perhaps, the most dangerous period for a business owner in the context of a successful exit plan. The business will have accumulated significant amount of wealth in equity and goodwill as products, services and the brand become established. However, the need for the business owner to allocate time to the ‘future’ has not diminished – in fact, one could easily argue that the ‘exit mindset’ is more critical than ever before because there is so much more at stake.

Exit Planning recalibrates the clock

Because owners lose the ability to develop an ‘exit mindset’ they lose out on knowing the optimal time and manner in which to exit. Actually, by the time most business owners begin to contemplate and plan for an exit, the business may have already been in significant decline, making the exit less beneficial to the owner. There is significant risk in not preparing in time.

Creating an exit plan with an ‘exit mindset’ essentially ‘recalibrates’ the clock of the business owner. It forces you to think about some crucial issues. Are you mentally ready to exit? What will you do after you have successfully exited your business? Are you too attached to the business to even contemplate an exit?

Conclusion

The discipline of developing an ‘exit mindset’ and writing a formal exit plan has the benefit of having the owner recognize the value of all that they have built into their enterprise of many years. The critical component of this mindset is the context in which you view your business and exit. Recognizing that the exit planning process is essentially a compendium of past, present and future time zone considerations wrapped in one, an owner is empowered to protect their illiquid business wealth with a well developed ‘exit mindset’.

Copyright Business Exit Timing LLC and Pinnacle Equity Solutions © 2012