To help owners fund a growing business while diversifying wealth outside the business, we often suggest they adopt a M.O.O.S.E. Not the big animal with antlers, but a Monthly Out Of Sight Earning. Ask yourself the following: Would your business miss $10 per month? If it wouldn’t miss $100 per month, how about $1,000 per month? How about $10,000? There is an amount per month that your business would not likely miss. Identify that amount and set up an automatic transfer each month into a personal account. It’s essential that the withdrawal be automatic such as via a checking account sweep. If you rely on memory and self-discipline, your M.O.O.S.E. may go hungry and die a painful death. Often the withdrawal will be taxable income to you. The point is not tax savings but rather systematically creating personal wealth without undermining business needs.

Over time, your M.O.O.S.E. may grow into a significant asset, which diversifies your wealth, reduces dependency on your business and facilitates successful exits — all accomplished without reducing your business’s financial health or slowing its growth.

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We discussed his business and its many attractive attributes. But when the conversation turned to his key people, James said, “Well, that may be a problem.” I was surprised. Clearly his employees were running his business without James.

“They do run the business,” he confirmed. “But without me they might kill each other. They don’t get along. When I get back from trips I spend the first few days doing nothing but resolving conflicts. If I were totally gone, several of them might quit. It’s not that I’m greatest guy in the world, but I am the glue that holds them together.”

Many Outies (business owners who intend to exit by selling their company) dream that one day someone will walk in, drop a large check on the desk and tell them to hit the beach or break out the golf clubs. Unfortunately, it doesn’t usually work that way.

Selling a closely-held business, even a good business, is a challenge. Too many owners reach their ideal exit age only to realize they have made a massive mistake – they allowed their business to become more valuable to them than to anyone else. In other words, the business’s value is not easily or fully transferable to another party. If a potential buyer perceives that your business’s value cannot be safely and cost-effectively transferred, then that party is not likely to write a significant check.

Let’s consider some examples. If you are the business’s most key employee, transferable value is undermined. If your business’s highly efficient operations are not documented, it will be difficult for a buyer to cost-effectively leverage those operations. If your long-term customers have always done business on just a handshake without formal contracts or agreements, it’s harder for a buyer to transfer these relationships. If your strong financial results are not reflected in financial statements that a buyer can readily understand, we’ve undermined transferable value. Building transferable value may require growing your business in a different manner.

There are certain conditions that enhance a business’s transferable value. We call these Enhancers. Most Enhancers do not immediately increase revenues or profits, although over time they often will. Enhancers increase transferable value by reducing potential risk for the buyer. Buyers want to know not only what your business has accomplished, but also how the business accomplished those results. The more confidence a potential buyer has in how your business works, the less a buyer will fear the business will falter after your exit.

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I saw her a few weeks after making the change and asked how she was doing. “Well,” she replied with a smile, “you’d be so proud of me. I took a vacation with my family. I do not go to the office every day. As a matter of fact, I have not been to the office for three straight days.”

“That’s great,” I said, genuinely happy for her.

“No,” she said, “it’s not. I haven’t slept a wink since.”

Engineers, architects and contractors don’t erect a building without a site plan. Surgeons don’t cut into a patient until exhausting every relevant medical test and scan to understand what they face. Transferring your business to top employees requires just as much assessment and due diligence – commonly referred to as a feasibility study.

The feasibility study should review the current situation and assess what it will take to hand off your roles and responsibilities without adversely impacting the business – or you. Consider the following:

• What are your roles and responsibilities today? Which ones do you like and not like? (Most owners hold on to responsibilities they like.)
• What are each of the top employee’s strengths and weaknesses?
• Among your top employees, who aspires to be the next CEO?
• Are there any holes or weaknesses in your management team today? If yes, how will the holes be filled?
• How will other employees, customers, suppliers and lenders react to a transition? What can you start doing now to assure a smooth transition?
• Under what circumstances will you comfortably transfer strategic control of the business?

Innies (owners who intend to pass their business on to an internal group of employees) must address these issues very early in the game. Your team may not be ready, willing and able to buy your business today. Perhaps one or two key positions need to be filled, or you don’t have a successor CEO within the group. One or more major obstacles usually surface when the transition begins. Start planning now, and you can sleep like a baby later.

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“I’m tired,” he shared during the meeting, and he looked it.

Jeremy had sold his business three years earlier to his long-time minority owner Dale. Dale had tried his best to carry on the business, but Dale either was not prepared or not capable. Dale fell so far behind in the payments that he was forced to return the business to Jeremy. Now Jeremy was rebuilding just to get the business back in the black, and he had no idea how long it would be before he could try to exit again.

Employees usually have little cash and little ability to raise cash on their own. Innies (business owners who plan to exit by selling to employees) usually need to help their employees buy the business, either by taking paper at sale (commonly called owner financing), pledging the business as collateral against a loan, or both. The risks are clear. If the business falters after exit, the employees (who have become the owners) may be unable fulfill their obligations. If the business fails, financial freedom and the business legacy may be lost.

A low or zero Exit Magic Number (the value one must extract from the business in order to achieve financial freedom) reduces financial dependency on the business, which increases the flexibility to balance an owner’s wishes against the business’s capacity. For example, if an owner wants to sell to employees, but that owner has relatively little wealth outside of the business, he probably needs to get paid a large amount up front. This strains the company’s cash flow, potentially to the breaking point. With some wealth outside the business prior to exit, one is free to consider options that accommodate the business’ financial resources. Reducing taxes can reduce default risk because fewer dollars are sent to the government. An orderly transfer of control potentially smoothes transitions and increases everyone’s confidence of success.

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We asked Joe what his goals were for his business. He crossed his arms on his chest and replied, “I don’t know why this is so hard for everybody. I want my son to get the business and my other kids to be treated fairly. Is that so hard?”

I replied, “OK, I got it. That is clear. But could you tell me, what does “fair” mean to you?”

Joe said nothing for about ten seconds. He uncrossed his arms, leaned forward and said with a grin, “Well, that’s a good question, isn’t it?”

We spent the next two hours chewing on what fair meant to him. Joe soon opened up and from that point on actually enjoyed designing and implementing his exit plan.

Lesson Learned:  Fair is in the Eye of the Business Owner

A major issue that many Passers (business owners whose exit strategy is to pass the company along to someone else) face is how to be fair to all heirs. If you have more than one heir (we will assume your children) then your principles may require that you balance how you pass the business to some heirs while still being fair to the others. The more concentrated the wealth inside your closely-held business, the more difficult things can get.

Every owner that we have worked with wanted to treat all his children “fairly.” What does “fair” mean? “Fair” probably does not mean “equal” and “equal” probably does not mean “fair” in these situations.

Start with resolving what “fair” means to you. People who do not own a closely-held business often define “fair” as splitting up their assets into equal proportions to be shared with each heir. This straightforward approach rarely works for a Passer. Typically your business is the largest part of your net worth. Splitting up a business among children working in the business and those who don’t can create more problems than it solves.

Furthermore, the tax code encourages Passers to transfer the business now in order to minimize future potential gift or estate taxes. But transferring some or all of the business to one child now, without distributing other assets to other children until after your death, can cause family tension.

Finally, how is the value of the closely-held business calculated when determining “fair”? Do you use its fair market value? If so, who determines this? How do you take into account any valuation discounts on the business value applied to reduce transfer taxes?

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Patrick Ungashick is the president of White Horse Advisors. He specializes in financial planning for owners of successful closely-held businesses, helping them to achieve their major business and personal financial goals. He is the author of Dance in the End Zone: The Business Owner’s Exit Planning Playbook. With his colleagues at White Horse Advisors, LLC, Patrick advises clients in areas such as business exit strategies, estate planning, and tax-efficient compensation strategies. Patrick has worked extensively with business owners in general construction, subcontracting, manufacturing, and wholesale supplies.

Topics:

• Exit Planning
• Retirement Planning for Baby Boomer Business Owners
• Plan Sponsor Fiduciary Responsibilities Under Financial Reforms

Read more about Dance in the End Zone:

Explore White Horse Advisors’ groundbreaking research, America’s Entrepreneurialist Generation: Exit Planning and the Baby Boomer Age Wave.

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Businesses changing financial plans

For nearly 20 years, Patrick Ungashick has provided financial and advisory services to business owners — eventually founding White Horse Advisors LLC in 2004.

With 150-plus fee-based clients, White Horse now has more than $1 billion in assets under advisement. Ungashick recently shared with Atlanta Business Chronicle the impact of financial reform on local businesses.

Q. How can business owners evaluate what type of retirement plan is best for their companies?

A. Owners need to determine the primary reason for having a retirement plan. Most larger employers offer a plan primarily as a benefit to employees. However, many owners of medium to small businesses use retirement plans as a means to reduce income taxes, and benefiting employees is secondary. Getting clarity around this issue up front makes determining the best type of plan simpler, because different retirement plans are better suited to meet those two different objectives.

Q. What are some of the major challenges businesses face in terms of financial planning in a difficult economy?

A. Cash, cash and more cash. Cash means survival, or put differently, lack of cash can mean potential collapse. Businesses and their owners have to take aggressive actions to conserve cash. Cash also means the ability to take advantage of opportunities that arise in a difficult economy. Most everything right now is “on sale” — labor, real estate, businesses, etc. Cash is king more than ever in these difficult economic times.

Q. How have businesses changed financial planning strategies in response to the financial market meltdown?

A. Most business owners we work with have become far more conservative than they would like to be in response to the financial conditions. For example, revenue forecasts and budgets are cut way back. Many owners have lowered their paychecks and suspended or cut many of their compensation programs to conserve cash. This is a huge challenge for business owners, because many of them have 50 percent to 90 percent of their net worth tied up in the business and its supporting assets, which means most of the eggs are in one basket. It’s very difficult to diversify away from the business when the owner needs to keep cash in the business.

Q. In your opinion, what investment opportunities are out there for businesses looking to capitalize on today’s market environment?

A. There are many opportunities. It’s an outstanding market to consider buying or increasing leased commercial real estate to set up for future business growth. (Financing is tight but not impossible.) Multiples are also low for business sales — meaning a business owner looking to expand via acquisition can potentially make some great moves right now.

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By Michaela Cavallaro

A DOW JONES NEWSWIRES COLUMN

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