One of the hurdles we must clear when illustrating the benefits of Exit Planning to business owners is the time factor. Owners generally assume that the right time to begin creating an Exit Plan is once they are ready to exit. They rarely consider whether their businesses are as ready as they are or that successful exits (those that achieve all of an owner's goals) usually take years. It takes years to overcome two fundamental and common issues: 1) A business unprepared to transfer at the value its owner requires for financial security, and 2) the majority of owners wish to transfer their companies to successors who have no money.
Let's look at each.
The Business Is Not Prepared for Transfer
If you ask owners if their businesses are ready to transfer for an amount that will secure their financial futures, many will say, "Yes." Why? Owners typically make at least one of six false assumptions. In general, they overestimate the value, sale proceeds, and growth rate of their companies and underestimate their life expectancies, the taxes they'll pay upon transfer, and the amount of money they'll need to live comfortably after they exit. They conclude, based on these false assumptions, that it won't take them much, if any, time to exit their companies successfully.
How do you fight a battle on this many fronts? In our last article (Getting Owners to Act), we suggested that owners only retain us when they feel a sense of urgency. To create that sense, we recommended that you:
- Demonstrate to owners the size of the gap between the financial and business assets they actually have and the assets they'll need to attain their exit goals.
- Help owners appreciate and accept that it takes time to execute a successful transfer to insiders.
To show owners the size of the gap between where they are and where they want to be, you will have to probe their goals, use facts to punch holes in some of their assumptions, and understand something about their businesses and existing resources. To do that, owners must engage you, but you've got to demonstrate the actual gap before being engaged. In the absence of those specifics, you must explain how the Exit Planning Process works, its benefits, and how it requires foundation in accurate information rather than guesstimates.
The Majority of Business Owners Wish to Transfer Their Companies to Successors Who Have No Money
Almost two-thirds of the Exit Plans our Members create are transfers to insiders. Insiders include management, key employees, children, or co-owners. Transfers to these successors generally take 5-10 years, a fact that is so stunning to some owners that they dismiss their first choice and decide they'll just sell to a third party.
Well, sales to third parties can occur faster than those to insiders, but only if a business is prepared for the transfer. Which brings us back to our first point: Few businesses are prepared to transfer at the value their owners need to achieve financial security.
The transfers to insiders that we design operate on a fundamental principle: The owner maintains control (and has a workable back-up plan in place) until he or she achieves all objectives, including, and especially, financial security. The best plan design then is an incremental transfer of ownership over a multi-year period.
Incremental transfers of ownership allow:
- Growth in business value and cash flow.
- Owners to transfer ownership (in small increments of 5-10%) only if insiders contribute to an increase in business cash flow or value. Owners set the terms of transfers by first calculating their financial security goal.
- Insiders to demonstrate their capability to run and grow the business without the owner's involvement. We refer to that capability as creating transferable value.
- Time for the owner to accumulate cash via excess cash flow distributions, the sale of partial ownership interests over a multi-year period, and perhaps a non-qualified deferred compensation plan for the owner.
- Time for insiders to buy sufficient ownership interest (usually 30-40%) to qualify for financing to buy out the owner's remaining (and controlling) interest.
This incremental transfer process ordinarily takes 5-8 years, often more, but seldom less. The time it takes depends on:
- The size of the deficit in value/cash flow that must be filled.
- The owner's other goals.
- The ability of the insiders to consistently meet their performance targets.
- General business and economic conditions.
- The owner's exit timetable.
We believe that you can enhance your effectiveness in helping business owners move forward with their exit or transition planning by:
- Understanding their existing assumptions (their "belief system") related to the readiness of their companies to transfer for top dollar. It is this set of incorrect assumptions that supports their false sense of readiness and financial security.
- Understanding how long it will take for most owners to exit successfully once they begin to plan and implement their plans because of lack of business value and their choice of successor.
- Possessing the tools and process necessary to explain precisely how you can help them craft and implement a plan to exit their businesses on their terms.
Next week's article describes specific tools and the process we use to dispel false assumptions and create the sense of urgency owners need to begin planning for a successful future today.