Q&A talks exit strategies with Ed Pratesi, managing director with Brentmore Valuation Advisors LLC in West Hartford and an exit strategies specialist.
Q: You’re the co-author of “Being in Business is a Funny Thing — Getting Out is Not!”, which is a business owner’s guide to growing and transitioning a business. In 2013, what is the number one concern an owner should have about transitioning a successful business?
A: When Attorney Hank Weatherby and I collaborated on our book in 2010, we were in the midst of one of the worst recessions that our economy had ever encountered. Clearly, over the years, 2008-2010, when many businesses were concerned about survival let alone attaining growth objectives, the thought of a transition strategy for many owners was postponed. Adding to this perfect storm was the “credit freeze,” which stymied the efforts of many to refinance, grow or to sell their companies.
Moving forward, while financing at the lower-middle and mid-market level has eased somewhat, finding lenders willing to consider “cash flow” lending versus asset-based lending is still an issue for sellers as well for those owners in need of growth capital. If I had to name the number one concern for business owners it is the need to have a plan — a transition or exit strategy that is both specific and actionable or to paraphrase Stephen Covey — “Begin with the Exit in Mind”.
Q: The prior question referred to transitioning a successful business. Are there strategies out there for transitioning an unsuccessful business? Can one transition a business on the brink of bankruptcy and come out ahead? Or does it make sense to let the business just fade away?
A: Once a business enters the “Troubled Zone,” the potential for survival is first priority. The plan or turnaround can be thought of a series of concurrent steps: Assessment — of the company’s strategic position; revision — of strategies and tactics: control of cash; communication — with all stakeholders; and improvise — as in improvise, adapt, and overcome.
So the answer is a qualified “yes” or perhaps best stated “it depends.”
Q: The book also ponders why a business owner must develop an exit strategy and succession plan. What are some of the reasons?
A: Simply stated, any business owner who has an expectation of a financial reward upon transition needs to have an exit strategy. In our discussions with owners, we ask: “What are the consequences if you do not create a transition plan?” The choice of transition is very important as the exit channel chosen will dictate the time necessary to accomplish the desired outcome. For an example of why an exit strategy is a must, consider the strategies or plans necessary should the owner encounter any of the Dismal D’s: Death, Disability, Divorce, Dissension and Debt.
Q: What does a business owner need to know to transfer a business to family members? Are there unique steps or tax advantages/disadvantages to transferring a business to a family member?
A. The first question is does the family member have the skill set or interest in running the family business? Family transfers need to be considered carefully as the choice of successor can have a significant impact on value, cause friction among other owners, employees and perhaps customers.
If the business owner has decided to transfer ownership to a family member, one of the tax efficient strategies is to gift ownership interests using the annual exclusion and valuation discounting. The annual exclusion provides the ability to gift small interests to family members. Discounting recognizes the fact that most interests in closely-held companies are illiquid and suffer from lack of control. Over the past year, we have also seen many owners use their lifetime gift tax credit in anticipation of the tax law change at the end of 2012. This strategy is available this year as well.
Q: What’s involved in a sale to employees or outside third parties? How does one plan an exit strategy for these situations?
A: Presuming that other exit strategies have been eliminated, the first question is “when do you want to sell” — we hope the answer is not tomorrow! The typical sale process takes from six months to over a year and that assumes that the company is ready for sale. Prior to bringing a company to market, the owner should have a clear understanding of the process and an understanding of how potential buyers will look at their company. Let’s assume that the timetable to sell is one year out. In order to enhance the value of the company the owner should consider the following initiatives:
• Establishing and incentivizing a management team;
• Protecting any proprietary processes/products, trademarks, patents, etc.;
• Ensuring that the accounting records are transparent and “clean”;
• Organizing and cleaning the office/shop.
Once the decision to go to market has been made, the owner needs to retain a team of professionals to assist in the process. At a minimum it should include your CPA, an attorney who understands M&A, and an investment banker or business broker. The process takes on three distinct phases — preparation, marketing and closing. The preparation phase involves a strategic and market assessment, a determination of a sale strategy and the preparation of an offering memorandum or the “book.”
The marketing phase consists of the initial contact with potential buyers, managing the sale process with the buyers, initiating preliminary due diligence and soliciting and negotiating an indication of interest and/or a letter of intent. Finally, the closing phase includes the management of the due diligence process, negotiating a final purchase and sale agreement and managing the deal risk issues, including employment agreements, operating performance, legal, etc.
Q: What about an initial public offering as an exit strategy? Is this like planning your retirement on winning Powerball? Can an IPO be a viable strategy?
A: For most business owners, an IPO is the least likely exit strategy. In order to be viable strategy, the market for IPO’s must be considered as well as the alternative strategy of selling to a larger competitor or strategic buyer. The initial costs and ongoing expenses of regulatory requirements are daunting to say the least.
