Close Close

Life Health > Running Your Business

Seven Steps To Helping Clients Succession Dreams Come True

Your article was successfully shared with the contacts you provided.

How many of your clients are small business owners: people who have worked decades growing their company or professional practice into a successful enterprise that is now worth a substantial amount and provides livelihoods for many people?

Over the years your clients have plowed profits back into their businesses and dream of the day when they will cash out and move on. They imagine the process of selling their business as similar to selling their house: put it on the market, take the best offer, and ride off into a happy, affluent retirement.

Unfortunately, this “plan” is based more on myth than reality. A business owner must create a market for the company and that doesn’t happen overnight. It takes forethought and planning to ensure the business will yield the income the sellers need in retirement. Ironically, most business owners are reluctant to prepare for their exit by planning for it. Why? Here are some reasons:

o They don’t have time;

o They don’t see the point;

o There’s no rush;

o Thinking about the future makes them uncomfortable; or

o They will work until they “die in the saddle.”

It’s your job to help clients realize that someday they will be more than ready to sell the business because they’re bored with it, tired of it, physically unable to run it, wealthy enough to leave it or ready for the next stage of life. When that day comes, they’ll want out sooner rather than later. And a lack of planning could tie them to the business longer than they’d like.

A small business represents from 50% to 90% of the net worth of the owner, who likely cannot afford to leave money on the table in an unplanned departure. Once clients see the logic behind this train of thought, the stage is set for you to swing into action.

The exit planning process is simple in concept but can be difficult to execute, only because you cannot do it without your clients’ cooperation. Busy people are not inclined to focus on an event that will take place years from now, but you can help them imagine their future.

o Step #1: Identify client goals. Ask your clients tough questions. When do they want to sell their business? What do they plan to do afterwards? How much will it cost to live the life they envision? Do they have a buyer in mind? Does that person have access to the funds needed to buy the business?

The answers to these questions will form the basis of a succession plan that minimizes tax liabilities at the time of sale and maximizes retirement income for clients.

o Step #2: Determine the current value of the business. An appraisal or certified valuation provides an appropriate benchmark for establishing the company’s current market value. Often the appraisal can result in an unpleasant surprise for clients. But with your assistance, they have time to build more value into the business.

In the case of a sale to an inside buyer, talk to your clients about establishing what their valuation advisor may refer to as the lowest defensible value to minimize taxes. Clients will need to know how much future cash flow the company likely will generate after their departure.

This critically important number–generated by their accountant–comes into play when the owner sells to a favored buyer who cannot amass the cash needed to pay top dollar for the business.

o Step #3: Develop a plan for enhancing the company’s value. While some businesses own valuable hard assets, such as equipment or real estate, it’s the company’s reputation that makes any enterprise a viable operation. And reputations are made by people.

What would it mean for the business if a key employee left? You as the advisor can create value by developing incentive plans that motivate and retain the people who are essential to the company’s success. These plans, in turn, increase the value of the business, if designed properly.

Deferred compensation, phantom stock, stock appreciation rights (SAR) and other “golden handcuffs” are financial strategies that induce key employees to stay with the company and increase value.

o Step #4: Sale to a third party. If the owner pursues this direction, you should bring in a qualified business broker or investment banker. These professionals will assist the owner with the preparation and sale to an outside party.

o Step #5: Prepare for a sale to an internal buyer with inadequate funding. This is a far more likely scenario than selling to an outside buyer who is flush with cash. Owners prefer to see their life’s work in the hands of people–children or key employees –who care as much about the company as they do. However, these buyers seldom bring new money to the table.

The advisor is extremely important in this planning step. Because you’ve persuaded your clients to think about a succession plan well in advance of their departure, they have time to set up a deferred compensation plan for themselves.

Other strategies will help owners derive income from the business without saddling the buyers with a huge debt. Consulting and leasing agreements based on reasonable revenue projections may be manageable for the new owners; they also can meet the seller’s retirement income needs.

More importantly, these strategies can save hundreds of thousands of dollars in taxes if structured properly in relation to the valuation, as mentioned in Step 2. Estimated future cash flow projections generated from the accountant are critical to devising a tax-efficient payment strategy when selling to an inside buyer.

o Step #6: Prepare for loss of control of the succession process. Clients don’t like to think about what will happen to the business if the owner dies, becomes disabled, divorced or suffers from reputation-damaging publicity. When your client has a business partner, a buy-sell agreement can protect the business from these unpredictable events.

For sole owners, the biggest concern is loss of key employees. When the owner dies, the employees usually bolt, stripping the company of its most precious assets. A “stay bonus” plan can keep the team together. The plan is funded to pay employee salaries for 12 to 18 months, buying the business owner’s representatives time to put affairs in order. A life insurance policy funds the plan.

o Step #7: Create an estate plan. Your work is not done when the exit plan is complete. How will your clients manage the proceeds from the sale of their business? How do they ensure that their hard-earned wealth stays with those they wish?

Even if they are lucky enough to reap a windfall, departing owners will have to live off of the proceeds or income for 20 years or more. If a big-name celebrity can spend $30 million a year, it’s possible to imagine a middle-class retired couple blowing $500,000 or $1 million in 10 years time.

You can set up a plan to help ensure they won’t outlive their money. Equally important is planning to minimize the confiscatory nature of taxes that would be due upon death. Most owners would rather have their life’s financial achievements go toward family or charities, not the IRS.

As a financial advisor, you already know that the most difficult of these 7 steps is persuading your clients to recognize the importance of working on their business in addition to working in it. Planning for their eventual exit–no matter how far in the future–maximizes the value of the company and helps ensure the owner’s and his/her employees’ standard of living.

Throughout this process, the financial advisor performs the critical function of coordinating the work of the client’s other advisors. Defining the owner’s objectives, creating value, structuring the sale to inside buyers, and contingency and estate planning are our specialties.

No other professional your clients work with can provide this assistance: not their lawyer, CPA or banker. Though you should try to establish close, collegial working relationships with those trusted experts, you are the one who knows how to create an exit plan that preserves the value of the business and gives your clients control over their financial futures.

Dyanne Ross-Hanson, CLU, CFP, ChFC, is senior partner at North Star Resource Group, Minneapolis, MN. She can be reached at [email protected].

It’s your job to help clients realize that someday they will be more than ready to sell the business

Note: Caption for PPT graphic2:

With most owners wanting to transfer to internal buyers, maximum business value is not always best. What can be better is low enterprise value combined with tax-deductible payments (i.e., deferred compensation) paid to the owner. The result is less cash flow required from the business to accomplish the same result for the seller.


© 2023 ALM Global, LLC, All Rights Reserved. Request academic re-use from All other uses, submit a request to [email protected]. For more information visit Asset & Logo Licensing.