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Down Market Presents Exit Strategy Opportunities For Business Owners

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In the best of conditions, the sale of a business is a complex process filled with minefields. In the current financial climate, it can be downright perilous. But it doesn’t have to be. For some small business owners, many of whom are your clients, today’s economy provides an unprecedented opportunity to shore up their exit strategies and receive the maximum value for their most important asset.

Consider the following statistics:

? The U.S. Census Bureau tallied just over 25 million U.S. businesses in 2004, the majority of which were closely held sole-proprietorships, partnerships, or LLCs.

? Over 90% of all businesses in North America are privately owned.

? An estimated 63% of business owners lack a written strategic plan.

These compelling statistics suggest the need for sophisticated strategies and technical expertise to develop and implement exit strategies, estate/wealth preservation plans and strategic plans for the owners of closely held businesses. Unfortunately, concerns about today’s economy, business growth (or lack thereof) and trying to manage day-to-day operations dominate the minds of business owners. Therefore, it is up to you to make sure your business owner clients are preparing for their futures beyond their businesses.

There are essentially two paths that business owners can take when they decide it’s time to transition to the next phase of life: selling the business to an outside party or transferring the business to “insiders,” such as family members or employees.

Several variations of the former should be considered by any business owner weighing his or her options. The first is an outright sale of 100% of the business. While this option could be attractive for certain industries in the current economic climate, it probably would not be a beneficial move for owners in industries that are negatively affected by the economy, for example, real estate, construction, and retail.

The second variation is to sell only a portion of the business’s ownership and retain a portion (either a minority or majority ownership interest). This option could be desirable because it enables business owners to diversify their net worth in an uncertain economic environment, access much-needed capital, and position themselves for growth and the potential future sale of the remaining balance of their company in better times.

More to the point, selling a partial stake of one’s business allows current owners to share future business risks and opportunities with a partner.

Case scenario

Consider the following example: Joe Businessman’s company is worth $10 million. Given the current economic climate, he decides to sell 70% of his ownership to an outside investor. He thereby not only gains $7 million (less taxes), but he still has a hand in the operation of his company. And by bringing new blood into the management structure, Joe could set the stage for future growth once the economy rebounds. If, in a few years, that occurs, Joe could cash out entirely. If the company grows successfully, his remaining 30% stake could be worth significantly more than at the time of the initial transaction.

A second path business owners may consider in these trying times is to execute an internal transfer to insiders, such as family members. If family succession is the objective, this path can be particularly attractive now given that gift taxes have the possibility of being diminished due to lower than normal valuations.

Business valuations today are generally lower than they were just a year or two ago. This is due to a combination of sales performance, profitability, tightening of the credit markets, and lower multiples across the boards. This provides an outstanding opportunity to transfer ownership interests to family members through a variety of techniques, such as installment sales, gifts, grantor retained annuity trusts (GRATs), and sales to defective grantor trusts.

With today’s low interest rates, many of the techniques work even better. In fact, even if your client’s objective is to sell to outsiders in the future, he or she can engage now in pre-deal recapitalizations and intra-family transactions to shift ownership and save taxes when the business is sold.

This could also be the best environment in which to sell the business to employees, either through a management buy-out with select key managers, or through the use of an employee stock ownership plan (ESOP). Again, lower valuations equal better economics for buyers and potential tax savings.

A silver lining

So stop with the doom and gloom and bring news of this silver lining to your clients! We may not see such planning opportunities for many years to come. Now is the time to help business owners lay the groundwork for the inevitable exit from their business on a proactive basis.

Without a doubt, the current economy is troublesome. But for some, particularly small business owners who have decided to work closely with trusted financial advisors, there could be no better time to design their exit strategy.

Daniel A. Prisciotta, CPA, CFP, PFS, ChFC, is founder and managing partner of Equity Strategies Group in Rochelle Park, NJ, and is affiliated with Sagemark Private Wealth Services. He is also a registered representative offering securities and advisory services through Lincoln Financial Advisors. His e-mail address is [email protected]