Things To Understand Before Exiting Your Construction Business
Can You Afford Your Exit?
Can you afford to exit? Most owners, whether their business is worth $2 million or $30 million, continue to be stuck in their business until they can clearly see the path to replace their income and maintain their lifestyles in retirement. Owners cannot move forward until they cross this financial bridge (exit planning) and then move into replacing the empty chair (succession).
The fear of outliving their money can easily be diminished with an investment of some basic exit planning. Why? Most owners have seventy percent of their wealth trapped inside of their illiquid business. You must find a way to unlock that wealth … and without being clobbered by taxes, which can exceed sixty percent.
As I enter the tenth year of my second career as an exit planning consultant, I have a much deeper understanding and appreciation for this complex process. Even though I bought and sold an ENR Top 20 Specialty Contractor, my real technical learning came through my exit planning training and guiding owners through the exit process. This includes the various dynamics of business ownership, as well as the tools required to successfully transition a business in a seamless and tax-efficient manner.
These newly discovered tools and concepts were never provided by our advisers to my team when we exited our business. I would like to share with you a few key concepts you need to consider when you start to plan your business exit.
The following are six key points I have learned as an exit planner. An owner needs to understand them.
- The owner is stuck until they have clarity of their financial future outside the business. This requires a plan.
“At any given time, 40 percent of U.S. businesses are facing the transfer of ownership issue. The primary cause for failure … is the lack of planning.” — Small Business Administration
- As the leader of the organization, everything stops with the owner and CEO. Until he or she is committed to implementing change, the owner/s will stay stuck in the business. Owners are so preoccupied with their day to day concerns that they fail to concentrate on their largest financial asset and how they are going to get hard earned wealth out of the business.
- Procrastination often is the extension of fear and the unknown. Owners must educate themselves on the exit process, so they can harvest their wealth. They do not want to fall victim to the statistical 70 percent failure rate of owners who never sell or transfer their businesses and settle for a 10 percent liquidation value for their company.
- The exit process can be arduous and intimidating due to the integration of the various disciplines, as well as the coordination of advisors (accountant, valuator, attorney, tax adviser, estate attorney, financial planner and insurance professional) and their mixed messages.
- The purpose of an exit plan is to architect a plan with all those disciplines to provide the owner and his advisers with clarity and a centralized coordinated understanding of the task at hand. While simultaneously, devising a strategic blueprint to move the owner out of the business in a harmonious and tax-efficient manner to meet his business, personal and financial goals.
- Good planning should allow the owner to utilize the many tools that can provide options that most closely support his goals by increasing cash flow, reducing the tax burden and asset protection of what has already been built.
Can I Maintain my Lifestyle in Retirement?
One of the biggest obstacles in getting owners to begin the exit planning process is the fear of outliving their money. Exit planning begins with establishing the “number.” This number represents the amount of liquid assets needed from the company to generate enough income that will replace the owner’s lost income from leaving the business.
The first step is to complete a valuation of the company to determine its worth. The second step is to inventory the owner’s personal and financial wealth to determine assets outside of the business. The shortage is then measured against the value of the business and the net proceeds the owner can expect from his chosen exit.
If there is a shortage, then the value of the business needs to be increased. They would also need to implement a tax efficient saving plans while in control of the business or the business owner must adjust his post-exit lifestyle.
Attaining the number needed and filling the gap and the year you can retire is all part of the exit planning process. A key is tax planning to reduce the financial friction on the company, the buyers and sellers.
$25 Million is Not Enough to Retire
Most private business owners are not good savers, as they reinvest their profits back into the business to defer taxes or invest in growth. Having a sound tax-reduction strategy is a critical part of being able to afford the exit.
The exit taxes can range from zero percent to amounts of more than 60 percent of the proceeds. The planning must consider tax-efficient alternatives that support the owner’s exit goals and reduce their financial risk.
I tell the story of an owner of a successful manufacturing business in New York that was valued around $25 million. When we completed the plan, he was confronted with the sad reality that he could not afford to sell and still retain his lifestyle!
In addition to a large salary, the company paid for his jet, vehicles, travel and entertainment. He was stuck because his lifestyle could not be replaced by the sale, which leads to my next point.
Time is your Best Friend during your Exit
I have come to learn that exit planning is a process, not an event that occurs after we deliver the plan. It is the complicated coordination of many moving parts that usually takes more time than originally anticipated.
The writing of the plan can take from five to eight months to compile, and the delivery is just the beginning of the process. Usually the plan is implemented within a year but we have had plans that have taken over three years due to restructuring, determining the succession team buyers and saving more money while in control of the company.
A critical time consideration is whether the owner can utilize all the favorable tax savings vehicles that can help leverage the money needed in retirement and supplement the sale/transfer. There are numerous tools that can be implemented in an exit strategy, including retirement plans, investments, trusts and insurance vehicles, which will allow Uncle Sam to subsidize the exit.
Each exit is unique, and therefore, needs to be tailored to an individual owner’s goals. Time and compounding is an owner’s best friend with investments that help leverage the exit and increase savings for retirement.
Once the plan and the buyers are determined then the obvious time consumer is succession and replacing the empty chair. It takes time to move senior management into leadership and replace the CEO.
Managers need this time and independence to experience the scars and bruises of running the business independent of the owner. During this time the owner becomes the mentor and coach, allowing the team to mature, and time to envision themselves outside the business and in their retirement.
Once the management team gets momentum then their next level of growth is embracing leadership, thinking like owners and always putting the company first.
Making a Mountain out of a Mole Hill
When selling to an outsider (consolidator, competition, public company or private equity) a seller wants to maximize the value of the company. A good mergers and acquisitions adviser can assist the seller with “cleaning up” the company and its records in a manner that will present the company in the best possible light and increase its value.
It seems counterintuitive to reduce the value of the company in a sale but that is how it works for many internal sales (management buyout). Why? Because selling internally is typically accomplished with after-tax corporate dollars.
If a manager or team of managers is targeted to buy the business, the company not only pays the seller the price he needs to get out of the business but must also pay for the taxes to get the managers the dollars to buy the business. The company profits usually pay for everything. Utilizing strategies to help prefund an owner’s exit while reducing the value of the business provides the transaction with the best of both worlds to save money for the business, the buyers and sellers.
In a recent engagement with a regional consolidator, we provided a strategy that would reorganize the company and effectively increase the value of the company by nearly 40 percent. This became a dilemma for the owner because he immediately recognized the increased tax burden for the company.
By introducing vehicles to reduce the business value and create savings outside of the business, Beacon redesigned a plan to achieve a successful exit at a reduced overall cost. This made the transaction affordable to the buyers/management and allowed the owner to meet his financial goals, reducing his financial risk—thus making a mole hill out of a mountain.
The bottom line is that you as an owner will be stuck in your business until you have clarity of your financial future and then commit yourself to succession—a retirement date with the reassurance of not running out of money. The key is unlocking the wealth trapped inside your illiquid business since that is the reservoir of a majority of your money.