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Making Sure Your Bread Lands Butter-side Up


May 21, 2008
By Brent Baxter with files from Marika Wasaznik CMA

Exit planning ensures smooth and prosperous business transfer.

Today is the hottest sellers’ market in the food industry in 25 years. Mid-size food industry businesses are worth 30 to 40 per cent more today than they were three years ago, and investment financing is flooding the market. In 2006, investment firms and banks accounted for nearly one-fifth of the 348 mergers and acquisitions made during the year – setting record levels. Overall, 2006 was a record year for the industry, with a 7.7 per cent growth in mergers and acquisitions, according to a report issued by the Food Institute. With conditions like these, many food industry business owners have at least begun to consider selling their companies. However, to many owners, the prospect can be overwhelming.

Whether selling a business to a third party or key employees or transferring it to family members, the decision to sell, and to whom to sell, can be difficult. This is where the exit planning process comes in. The purpose of exit planning is to ensure that, when you are ready, you can leave the business on your own terms and schedule. It helps owners make decisions throughout the exit process and create a smooth transition to the new ownership. 

Of course, no two exit plans are identical, but they should share a number of common steps that guide the process.

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Step 1: Exit Objectives
"When a man does not know which harbor he is heading for, no wind is the right wind."
–Seneca

Seneca was, indeed, a wise philosopher. His advice is as sound for business owners today, as it was centuries ago. Although difficult, setting specific exit goals allows an owner to leave a business on his or her own terms, and feel confident about leaving in style. 

    There are three basic retirement objectives every owner must establish:

  1. How much longer do I want to work in the business?
  2. What is the annual after-tax income I want during retirement (in today's dollars)?
  3. To whom do I want to transfer the business? Family? Key Employees? Co-owners? Outside party?

No owner can effectively leave his or her business without establishing each of these objectives.Many owners set other objectives as well, such as providing for key employees, transferring wealth to family members, or giving to charity.

Remember, the objectives you set in this step control all future planning efforts and strategies, so it is critical to address all of your needs and concerns. While the process may seem overwhelming, owners need not tackle it alone. Only you know how long you want to work, or to whom you wish to transfer the business, but an insurance or financial advisor can help crunch the numbers. He or she should be able to help create a financial retirement model to aid in setting retirement financial goals.

Step 2: Valuation
A business is typically either an owner’s most valuable asset, or the asset that is mostly likely able to generate the value needed to meet retirement goals – or both.   Frequently, the business comprises between 65 and 90 per cent of an owner's assets. Financial security depends on converting that asset to cash, so it becomes crucial to know how much the business is currently worth. This will tell owners whether they can realistically meet the goals set in Step 1, or how much they need to grow the business in order to reach their objectives. 

Although many owners have a rough idea of what they believe the business is worth, it is always advisable to get an independent valuation. Options include:

  • A Certified Valuation Specialist,
  • An independent CA firm,
  • The business's regularly retained CA firm, or
  • An investment banker or business broker.

Consider using a valuation specialist to determine business value for planning purposes and for transfers of business interests to insiders (family members, employees or co-owners). </li></ul>
If, however, the business is to be sold to an outside party, consider using a business broker (if your business is worth less than $1 or $2 million) or an investment banker (if your business is more valuable.)  These advisors are in a better position to properly assess the likely sale price.

How can these advisors help? Consider this: according to the Food Institute, mergers and acquisitions activity was up in 2006, and an additional 102 deals announced but not completed. An investment banker with experience in the food industry should know about this and other market trends, which will help him or her give owners an accurate estimation of what their business could actually be worth in the current market.

Step 3: Increasing Value

In this step, owners should identify specific, realizable steps to preserve, promote and protect the value of the company through the exit. As prospective buyers investigate your company, they will want both proof of past success, and assurance of continued success. Having concrete plans in place to keep the business going through the transition to new ownership increases the value of your company. Consider factors such as:

  • Motivating and retaining key employees,  
  • Maintaining and consistently increasing cash flow,
  • Creating and using efficient systems, and
  • Documenting the sustainability of earnings.

Step 4: Third-party Sale for Maximum Dollars
Selling a business to an outside (third) party is often viewed as the best option for maximizing financial objectives in an owner’s exit, but this is not always the case. 

The key to investigating and completing a sale to a third party is an experienced transactions advisor – a business broker or investment banker. Not only should this person be able to evaluate the marketplace and accurately assess your business valuation, but he or she should also be experienced at creating controlled auctions, from pre-sale planning through marketing, negotiating, documentation and closing.

Here again, the experience of the transactions advisor in the food industry is key.  In 2006, nearly one-fifth of all food industry acquisitions were bought by financial buyers, a historic high. An investment banker should realize this, and include financial groups in the list of potential buyers in order to maximize profits during the auction process.
                        
Step 5: Transfers to Co-owners or Family
Almost 75 per cent of all business transfers are to inside parties, yet these transfers are the most complicated, because insiders usually have the weakest financial (cash) resources to effect a buyout, and are the most tax-sensitive (especially for family members facing estate tax issues). For this reason, owners must evaluate the dynamics of selling to an inside party against tax implications and the owner’s need for financial security.

Because inside parties, children or key employees, generally have no cash, the only way the owner will receive the purchase price is to receive installment and other payments (directly from the company) over an extended period of time. All the money you receive will come from the future cash flow of the business; that is, income the business earns after you depart. Therefore, it is imperative that the tax consequences to the business and to the buyer be minimized, in order to preserve a greater part of the company's cash flow for the departing owner. Similarly, the deal must be structured to maximize your security, because it will take an extended period of time to receive the full purchase price.

The main tax advantage in Canada, when selling your business, is to maximize your capital gains exemption, available to applicable CCPC corporations (Canadian-controlled private corporations) shareholders.  Other techniques can be used to minimize income tax consequences to buyer and seller, including: minimizing ownership value of the business; creating unfounded obligations (non-qualified deferred compensation, licensing and royalty fees, etc.), or transferring excess accumulated cash within the business prior to the sale. Your existing tax advisors, business attorney and investment banker – if experienced in the area of business transition planning – are your best sources for help with a transition to insiders.

Step 6: Develop a Contingency Plan

Creating a continuity plan for the business to guard against the death or disability of the owner is crucial, because no exit plan can stay on track if the owner’s unexpected absence is not addressed. The continuity plan tackles issues such as ongoing capital needs of the company, allowance for changes in decision-making systems, specific actions to be taken with the balance sheet and operations, and other items. A contingency plan should be a written plan that answers the following questions:

–In my absence, who can be given the responsibility to continue and supervise business operations? Financial decisions? Internal administration?

–How will these people be compensated for their time and, most importantly, for their commitment to continue working until the company is transferred or liquidated?

–Should the business, at my death or permanent incapacity be:

  • Sold to an outside party?
  • Sold to employee(s), and if so, to whom?
  • Transferred to family members?
  • Continued?
  • Liquidated?

–Who should be consulted in the transfer process described above?

Step 7: Exit Plan Maximizes Owner’s Estate
The final step is to make sure the exit plan and the owner’s estate plan are in sync, making sure there is a contingency plan for the owner’s family. This includes checking that the income/wealth needs of the family (spouse and heirs) can be adequately met within the parameters of the exit plan, and the exit plan ensures the equitable distribution of assets. It also involves reviewing the income/wealth needs for tax efficiency purposes. Life insurance and disability insurance play tremendous roles in this step, and your estate planning attorney and insurance advisor can assist with planning and calculation.

Sealing the Deal
The same techniques that produce operational business success do not guarantee a successful business departure. Most business owners only leave once, so there is little room for “trial and error.” Once most owners begin to think about leaving, they want out sooner, rather than later. To do so, owners need an effective exit plan, experienced advisors and time.
To orchestrate a successful exit, your exit plan should be in written form and should include an “Action Checklist.” This checklist describes each action to be taken at each step of the exit process. It assigns responsibility for each task to a specific advisor, and specifies a date by which this action must be completed.

Armed with these written tools, a team of skilled and experienced advisors, and (ideally) several years, you optimize your chance for leaving your business in style.

Brent Baxter is a founding partner and managing director of Clayton Capital Partners, a St. Louis, Mo.-based, investment-banking firm which provides merger and acquisition advice to mid-market business owners.

BUSINESS OWNERS BEWARE
Sometimes the best way to learn is from other people’s mistakes.  While business owners are almost always extremely savvy about running their businesses, they may not have the expertise necessary to effectively complete a deal.  Here’s a recent true story: 

The seller was the owner of a local, well-established wholesale bakery. The seller was confident he could do the deal on his own, and decided to sell to an individual who had hired an experienced investment banker.  The investment banker offered four times EBITDA and agreed to adhere to GAAP (Generally Accepted Accounting Procedures) standards throughout the deal.
 
The bakery owner, confident he knew his books better than anyone else, quickly agreed to the deal. Little did the owner know that the investment banker had already studied the books, and knew there were numerous problems that could be brought up during due diligence.  Sure enough, when the deal closed, the owner received only two-thirds of the original asking price after making multiple price reductions to accommodate unforeseen problems. 

In retrospect, this owner could have saved himself money and frustration had he retained an advisor upfront. Many of the details that emerged during due diligence could have been easily handled before they became costly problems. 

I tell clients that doing deals is like playing five level chess. The multi-tiered layers of the game require you to think on a variety of levels, and see the big picture as to how each level affects another. In a deal, attorneys, accountants and financial planners all deal on their levels. They are necessary experts in their disciplines, but they are not trained to understand how one level affects another. A good investment banker pulls it all together, and looks at the overall structure of the deal.  His or her job is to predict what will go wrong, and then fix it before it does.


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