The Great Escape: Developing an Exit Strategy
By Thomas E. Houck
a common question on the minds of entrepreneurs when they think
about retirement: “How can I eventually get out of my business and
not lose my shirt?” The answer is simple: Develop an exit strategy
a few years before your desired retirement, and simply execute it.
case of Chuck, a 65-year-old-going-on-21 life-of-the-party type of
guy. He sported a big smile, and joked with everyone. But he was
plagued by a gnawing question: “In 10 years, I want to exit my
business, take care of my employees, have enough money to live out
my retirement dreams, and guarantee that my daughter inherits
everything if something happens to me. Some people may want to get
every dime they can when they sell; but these are the most important
things to me. How do I pull this off?”
had been an entrepreneur for his entire life, and about 20 years
before, started his current business from scratch. Due to his
insatiable appetite for nonstop improvement, his business blossomed
into one of the largest in Southeast Florida.
felt a great deal of loyalty to his employees, and wanted to develop
a plan to sell the business to his General Manager, Carlos. Since
Carlos was a young guy with a family, he didn’t have many financial
assets. Chuck needed to develop a plan that would make the buyout
process affordable for Carlos, while simultaneously assuring that
his daughter would get a fair value if anything happened to him.
develop a quality exit strategy, business owners like Chuck need to
follow some important steps. They are:
One: Create a financial plan. In Chuck’s case, the plan
helped identify how much income he would need after retirement to
fulfill his dreams. This number determined how much money Chuck
would need in his retirement savings, and from the sale of the
business on the day that he retires.
Two: Maximize retirement savings now. Over the next several
months, Chuck consulted with his financial advisors and developed a
comprehensive financial plan. A thorough analysis revealed that
Chuck needed to put $5,000 per month into a retirement savings
plan. Since IRAs and 401(k)s allow limited funding, a defined
benefit pension plan was a good choice for the company. These plans
work best with an older owner who has younger employees—in Chuck’s
case, a perfect match. This plan allowed Chuck to put $60,000 a
year into savings, all of which was tax deductible. The tax savings
alone helped fund a portion of the plan. A true win-win!
Three: Determine the company’s worth. Chuck didn’t want the
expense of hiring a valuation analyst to compute his company’s
worth. To come up with an approximate value, Chuck and his
financial advisors went through an exercise to determine the amount
of net cash from the business to Chuck in the previous year. A good
rule of thumb to use is three to five times that number equals the
Four: Establish a transfer strategy for the business to the buyer.
Because Carlos didn’t have much money or assets, he wasn’t going to
be able to simply go to the bank and get a loan to pay for the
business. To solve this challenge, annual performance incentives
were created for the company. If the business met those performance
incentives, Carlos, as General Manager, would be gifted 5 percent of
the stock of the company at the end of each year until he reached 49
percent ownership in year 10. At that point, Carlos would be a 49
percent owner with a 10-year track record, and a bank would likely
be willing to loan him half of the business’ value to complete the
buyout of Chuck’s interest.
Five: Get it in writing. Now Chuck needed to sit down with an
attorney and get all this in writing. Since his advisors had done
most of the legwork already, they were able to specifically tell the
attorney what was needed, which saved a considerable sum in legal
fees. The attorney drafted a stock purchase agreement for Chuck and
Carlos. The agreement laid out the performance incentives, where
the stock would be held, stipulated that the shares would be
non‑voting, and required Carlos to buy Chuck out at the end of the
10-year period. The attorney also created a trust, which laid out
the transfer of Chuck’s assets to his daughter, in case he died.
type of buyout strategy is useful when the owner wants to sell to an
employee or family member. The key element that allows these plans
to succeed is time. The greater the amount of time the business
owner plans for the exit of his business, the greater his chance of
success. If Chuck simply woke up one day and said, “I can’t take it
anymore,” there’s no way that Carlos could buy him out. Everyone
knows a business owner who’s had health problems, or unexpectedly
passed away, causing the business and all its value to go down the
tubes. This could have been avoided in almost every case by taking
the time to create an exit plan.
key element in making your exit strategy succeed is to work with
advisors who have extensive experience with this type of planning.
Many quality CPAs and attorneys don’t fall into this category, yet
they’re smart enough to bring in an outside advisor who does. Also,
it’s important that the advisors work as a team, so that everyone is
on the same page, working toward the business owner’s goals.
plan was enacted five years ago, and all has gone exactly as
planned. Chuck’s still the life of the party, and loves seeing his
vision turned into reality. Financial peace of mind hasn’t changed
him one bit—when his friends get together, they all smile, shake
their heads and marvel at the character everyone knows as Chuck.
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about Thomas E. Houck.
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