More On Tax Planningfrom The Advisor's Professional Library
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- Health Insurance: Health and Medical Savings Accounts A Health Savings Account is a trust created exclusively for the purpose of paying qualified medical expenses of an account beneficiary. Although they are popular, they are not without their pitfalls and the regulations can be complicated. Learn more about how to avoid federal taxation on the accumulation and distributions of HSA.
“If you’re looking to sell, have a plan, but realize it won’t go according to the plan, but have one anyway.”
That comment from serial entrepreneur Jim Freeman, who recently exited a business he created and grew, kicked off a panel discussion on Tuesday morning, “From the Trenches: Three Successful Exits." Moderated by Bob Forbes, president and founder of Denver-based Forbes Mergers & Acquisitions, it consisted of three men who recently participated in the M&A process. Each shared his thoughts on everything from how the deals were structured, to tax implications, to incentivizing employees in order to ensure top valuation.
Freeman, who’s been involved in the sale or purchase of over 40 companies, currently holds the position of chief strategy officer of High Touch Technologies. He said he was “determined early on to start a business with my own money.” Raising capital from outside investors is one thing, but he started from scratch, then grew and ran the business for 10 years, before he got bored and decided to assemble a team to help him exit.
“If you have one buyer and one seller, you won’t get what you want,” he said. “We had about a hundred inquiries when we went to market. It’s easy to get distracted by the acquisition process, but you still have to step on the gas, steer the business and continue to operate. We also realized people would get scared and jump ship, which would cause the value to plummet, so we wrote into the deal that the buyers would retain certain employees (at management’s discretion).”
Enrique Krajmalnik also started his business, Illumen, from scratch in his basement with his father and brother. Illumen was an early telecommunications service provider in the VPN and managed service provider space. He sold it in the fourth quarter of 2012.
“We experienced hyper growth in the first few years,” he said. “We thought it would never end, but it did. We then decided to go with more of a recurring revenue model. We institutionalized and systematized a lot of our processes, which built value.”
Lon Sears, the third panelist, worked in health care upon graduating from college, but soon realized he didn’t want to stay in Big Pharma. He entered the entrepreneurial program at the University of Denver and used his master’s thesis to start his own health care company with his wife in 1993.
“I was focused on running, building and growing a business,” Sears said. “I was never focused on selling. You imagine that someone will just walk in one day with a big check and you’ll ride off into the sunset. We know that doesn’t happen. I was approached by a major player in the space about five years ago. I quickly realized I had no negotiating power. So we declined and I focused tremendously on top-line growth initially, and then bottom-line growth.”
Forbes asked Krajmalnik about the dynamics of involving family members in the deal.
“It definitely made it more difficult, which was complicated by the fact that I moved to Texas during the process,” Krajmalnik replied. “My general manager got nervous. He was the one person outside of my family who knew what was going on. Despite my repeated assurances that he would be okay post-merger, he left.”
He had to then call the buyer and tell him his “right-hand man” was gone, but was surprised by the buyer’s response.
“He said that as long as he had me for six months, it would be okay,” Krajmalnik related. “He felt that the business was so process-oriented that it could basically run itself. He didn’t want me for day-to-day expertise; he wanted me to teach him about the business over all.”
“Your business has to be bigger than any one person,” he said.
Forbes then moved to culture, asking Sears how he ensured the right fit. In a theme repeated often during the discussion, Sears mentioned people.
“Your people will be key to the deal’s success,” he said. “You have to tie your employees into the plan. Because we wrote into the plan that they would be retained by the acquiring company, they helped us narrow down the choice of possible suitors.”
Freeman added that there were “more deal structures than you can possibly imagine.” His deal was structured to provide half of the payment in upfront cash and the other half in a note held by him. In this way he could buy out the company’s other principals immediately, and then remain with the acquiring company.
“You’re selling your baby,” he added. “It can get emotional. I think it’s worth $10 million and the buyer might think it’s worth $10. You can get insulted, so it’s best to have an advisor in order to be one step removed from it.”
Krajmalnik noted that his deal was structured in such a way as to avoid double taxation, since the company was formed as a C-corp.
“The double taxation would have taken a big chunk. We had a third party do goodwill valuations for each family member’s stake, and then a goodwill valuation for the corporation itself. The personal stakes were paid in cash and the corporate portion was done with a note. In this way we saved about 20% on the tax burden.”
“You can only play so much golf,” Freeman interjected. “Make a plan for the money, for the business and for yourself. And you need a financial advisor. I acquired a company a while back and the previous owner just filed for personal bankruptcy. He didn’t have a plan.”
Following the presentation, Frank Traylor, a software entrepreneur who actually received notice during the presentation of the final payment of his recently completed deal, summed up the important takeaways.
- The leadership team needs to be ready for the transaction both personally (prepare to “be out”) and financially (tax planning is critical).
- Every deal seems to have nine lives. There will be problems, but you can work through them.
- The process starts long before ‘the process’ starts. Dressing up the company might require changing focus, restructuring, operational tightening and a general cleaning up of any messes.