Exit strategy | How to plan for the day you relinquish your business
Photo/David A. Rodgers
Peter Plumb, partner at Murray, Plumb and Murray, says early planning is key for handing over a business successfully
Starting next year, the first wave of the 76 million baby boomers counted by the Department of Labor will begin to retire. Among them will be thousands of small business owners who will have to resolve what happens to their businesses when they are no longer at the helm.
Succession planning is essentially devising an exit strategy for a business owner, an area of expertise that attorney Peter Plumb, partner with Murray, Plumb and Murray in Portland, has practiced for decades. Recently, he has seen his client load increase by 50% as more and more business owners get their houses in order.
“There are an awful lot of baby boomers in their early to mid-60s thinking, ‘How do I get out of this?’” says Plumb, whose client list extends from northern Massachusetts through midcoast Maine. “Maine in particular has a large employment sector of businesses with under 25 employees. Maine, and probably New Hampshire as well, has a higher concentration of small businesses out there — thousands, with many hundreds right here in Portland — all at the same point. They’re hitting the aging boomer stage, so there’s bound to be more people seeking these services.”
According to a pre-recession 2007 Kiplinger report, about 50,000 small business owners retired in 2001, a number that was expected to increase to roughly 750,000 in 2009. Businesses across the country are entering what Jeff Faulkner, a board member of the Orlando-based International Succession Planning Association, describes as the “beginning stages of a massive wealth and business transfer over the next 10 to 15 years as baby boomers reach retirement age.”
Contributing to that momentum are impending tax law changes that make transferring a business this year more appealing. Uncertainty surrounds expected changes to capital gains taxes and estate taxes in 2011, says Faulkner. Capital gains taxes could rise next year from their current level of 15%, and estate taxes, which have been suspended in 2010, are likely to “come back with a vengeance,” he says.
“That’s driving a lot of activity,” he says. “But also, we have just gone through a historic economic downturn, which brought business valuations down along with very low interest rates. If you have a family business that you are confident will be around, transferring those assets will give you a deeply discounted tax advantage.”
So how does a business owner prepare an exit strategy? First, determine how much of the transfer gains will be needed for overall retirement security, a decision best made with the help of a financial planner or accountant. Then, decide whether to step back from the business or step out of it completely, says Gary Vogel, an attorney with Drummond Woodsum & McCarthy in Portland who handles business succession planning. The difficulty is determining how to best achieve those goals within a specific timeframe, which is different for every business.
“You can’t do planning in the abstract,” he says. “You have to develop a plan that’s specific to your particular business.”
Because the execution of a business succession plan often takes years, Plumb says “it’s never too early to start planning.” His rule of thumb is to begin planning anywhere from five to 10 years before a retirement date. “Ten years is a good time frame, and five is on the inner margin,” he says.
First things first
Vogel advises deciding whether you’d like to leave the business all at once, step away gradually or continue in an ownership role into retirement. This will determine how lengthy and complex your plan will be.
Then consider how to transfer the company, which generally falls into three categories: transfer to family members; sell it to employees or an employee stock option plan; or sell it to an outside third party.
Start surveying the landscape for potential managers or owners. Is there a family member or someone within the company who would be a good candidate for succession? Faulkner says many transfers of family-owned businesses stall because of a successor’s lack of competence, a situation that can be exacerbated by the pressure of tax gains weighing in now.
“Often there’s a tax tail wagging the dog,” he says. “There may be tax advantages [to the transfer], but if your company has not dealt with a sibling rivalry issue, it doesn’t matter.”
Plumb says he’s seen businesses flounder because family members think they’ll inherit a cushy job and then waffle when they realize how much work is involved in owning or operating a business.
Family succession plans must be handled delicately. Often, in an attempt to be fair, a parent will provide each child an equal share in their business. That, Vogel says, can be a bad idea.
For example, if a business owner with four children — two of whom are involved in the business and two who aren’t — transitions 25% of his company to each, there will likely be conflict. Those who aren’t involved in the business and therefore have no idea how it’s run will likely challenge the others, creating a distraction and volatile family dynamic that could impair the businesses tremendously.
Had that same owner come up with a way to treat each child fairly — but not necessarily with an equal share in the business — the situation would have been better for everyone.
“Passing on a business without doing the proper planning often tears families, not just the business, apart,” Vogel says.
If you determine that family or existing employees aren’t the best candidates, you may need to seek a buyer or bring in someone from outside the company to groom as your successor, which can be a lengthy process.
This is especially true when it comes to specialized professions, such as doctors or lawyers, Vogel says. In those instances, a candidate has to come in, work in the practice and get to know the clients or she won’t succeed in taking over the business.
Whomever you choose as a successor, he or she must have the financial wherewithal to eventually purchase the business, Vogel says. Many business owners do some sort of seller financing, which not only helps a potential buyer afford the business, but also ensures a steady stream of income for the seller. If a business also owns real estate, selling the business while retaining the real estate can be another way to ensure steady, reliable income from leasing that real estate to the new owner.
“In that case, all you have to do is cash the checks, without having to worry about payroll or overhead,” Vogel says. “You just have to make sure the rent gets paid.”
Going outside
In the event you can’t find anyone to take over the business, it may be time to sell. To entice a potential buyer, financial records need to be prepared, including updating tax returns and the balance sheet, reducing debt and getting operations running profitably.
Failure to do so, Vogel says, doesn’t mean the business can’t be sold, but it does mean the owner is at a severe disadvantage.
“If a business is suffering financially, it’s not impossible, but if the owner had planned ahead of time, he could have realized more money from a sale,” he says.
Now is not the best time to be selling a business outside a family transfer, says Vogel. Banks have become tougher on lending requirements, which has the immediate effect of devaluing a business, making it harder to sell.
“Most business owners [will find] that if their original plan was to start the sale or transition process now, they may have to put it off for a while,” he says. “They’re not willing to sell at today’s lower valuations.”
Plumb says this reality has driven more owners to stay with their businesses in some capacity until valuations begin to rise again.
“The basic truth is that nine times out of 10, succession provides owners with a far greater income if they continue to own the business than if they sell it,” he says.
The unthinkable
When drafting a plan, it’s important to consider not only what will happen to the business in a planned departure, but also what would happen in the case of the owner’s death or incapacitation — a morbid but vital component to a good succession plan.
If an owner dies or is incapacitated, his family is left finding ways to pay off existing debt, finding someone to step into a chief executive or ownership role, providing for the family and keeping the business afloat.
“You hate to see a business suffer with death or incapacitation,” Vogel says. “That devalues the business at a time when you want it to be at its highest value because you may be looking to sell.”
In addition to having disability and life insurance, which are good tools for filling at least a portion of the void left by death or illness, Vogel says an interim management plan is a necessity. That may not be the same as the overall succession plan, but it will help ensure that the business can continue to run without the owner at the helm and stay on track with regard to the overall succession plan.
Considering how interrelated business succession planning and personal retirement planning are (the two are “one and the same,” according to Plumb), these are issues to consider sooner rather than later.
“Most people don’t even think about this until they hit 50,” Plumb says. “They wake up one day and start to wonder what they’ll live on, or if they sell, will they get enough to live on.”
“Those who don’t plan wind up losing,” Plumb says. “They usually end up completing the lifecycle of their business from cradle to grave.”
Derek Rice, a writer based in Saco, can be reached at editorial@mainebiz.biz.
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