Covering the bases

Editor’s note: The information provided is not intended to be legal, accounting, insurance or tax advice.

If you own a roofing company, exiting it will be complex, emotional and potentially costly.

Before making exit plans, you should address misconceptions; visualize the moving parts of the exit planning process; and align your business, personal and financial goals to ensure you are making the best decisions for yourself, your family and the business.

Myths and misconceptions

Business owners often have several misconceptions about exiting their businesses and harvesting the wealth trapped in their illiquid business.

“I will sell my business and retire”

According to the U.S. Chamber of Commerce, less than 20% of all businesses taken to market for sale close. Because of the construction industry’s market variability and high risks, the closing rate to an outside seller is lower at about 10%, according to FMI Corp., Raleigh, N.C., a consulting and investment banking firm for the construction and engineering industries. Owners who sell to an outside party are successful because their companies may be larger, operate in a unique niche or location, and continue to perform well after retirement.

According to Deloitte,® London, 71% of small- and medium-sized business owners plan to exit their businesses within the next 10 years, and more than 90% of these owners will not be able to sell their businesses and meet their retirement cash requirements. Roofing contracting companies with cash flow under $500,000 are more challenging to sell than larger, more profitable companies with a permanent management team and systems.

“I will deal with my exit plan in five years”

When business owners are asked when they intend to retire, the answer is often predictable: “In five years.” When asked the same question three years later, the answer remains “In five years.” In these cases, the owner has no plan and is not mentally prepared for the complex exit process.

For an exit plan to work, the company and owner must be sale-ready. This means the company must have predictable cash flow and a strong management team prepared to perform without the owner. Time is helpful when creating a long-term strategic financial plan and training the next generation of management.

“I can do this myself”

You know how to run your business, but have you ever exited a business? As a business owner, you regularly speak with your accountant, lawyer, insurance agent, financial planner and other professionals. The problem is the advisers can be good at talking to you but poor at talking to each other, and information can be scattered and isolated.

You might be able to juggle advice from disparate advisers and successfully exit your business. However, the odds of success will vastly improve with a comprehensive written exit plan and the guidance of an exit planning professional.

“My business is worth ... ”

Most owners overvalue their businesses and falsely assume their actual worth. Simply because an owner has spent 30 years working 60 hours per week does not mean that value has been created in the company.

The actual value of a business is what someone is willing to pay for it, but a business has different values depending on who is buying it, which is called a range of values. Business owners should base the value of their businesses on the exit strategy they are trying to employ and learn what makes their businesses more valuable to an acquiring party.

Advisers accredited in business appraisals are trained in these situations and should be engaged to guide you with increasing business value.

“That will never happen to me”

Many business owners fail to plan for unexpected hardships, such as death, divorce or disability. Those who do prepare are protecting their business for the long term.

Oftentimes, buy-sell agreements are not aligned with the business owner’s motives or goals. They can be unfunded or established in a manner that creates more ambiguity than clarity.

For example, in one case, an owner was in court for several years, costing both parties hundreds of thousands of dollars in legal fees without a clear end in sight. In another case, the widow of an owner demanded her husband’s office, position and salary even though she had never worked with the business.

In another example, a company’s existing buy-sell agreement would unintentionally create an income tax liability on the insurance for the owner’s widow in the event of the owner’s death.

These situations are examples of unintended consequences that result from an outdated or poorly drafted agreement contingency plan. Creating or updating contingency plan documents, such as buy- sell agreements, is vital for building a successful exit plan.

“If I could get $8 million, I would retire tomorrow”

Owners often underestimate the amount of money they will need after they leave a business. The question you should ask is: How much do you need to replace your income and not outlive your money?

Owners must consider their money outside the business, including savings, retirement funds, real estate income and investments. From there, they can develop an estimate of the amount of money needed to replace their income in the long term.

Each exit plan has a different tax implication ranging from 0% to over 55%, depending on the state. It is critical to work with tax professionals who can implement a tax mitigation strategy for the company sale to align with the corporate structure to meet IRS requirements.

“My accountant does exit planning”

You probably have a good accountant and an estimate of your company’s value. However, it takes a proactive approach that coordinates ideas and documents to exit a business. What your existing advisers don’t know about the exiting process could cost you millions of dollars.

Exit planners can assist owners in navigating this process. They are trained as process consultants to move owners on a path that will meet their goals and financial targets.

Once owners understand the common misconceptions about exiting, they can begin planning their exits. The plan should focus on three areas: business, personal and financial.

Business planning

Business planning involves preparing the business for a sale transaction. There are multiple tasks to consider.

Business valuation. Understanding a company’s value is paramount to alleviating any unrealistic expectations. Every owner should have his or her business appraised and work with the appraiser to better understand what creates and detracts from value. This will help align expectations with reality and implement strategies to increase the company’s value.

Succession planning. To retire, an owner must grow and train a management team to take over the business. This is true whether the owner sells to an outside buyer or an internal buyer, such as an employee or family member. The succession process takes time, as managers must learn the business and make decisions.

Tax planning. Understanding a business exit’s tax exposure and ramifications will be critical in achieving financial goals. Some transactions are exposed to more than a 55% effective tax rate. It is crucial to understand these consequences and the available alternatives that can reduce financial risk and obligation.

Transfer options. Each transfer option has nuances that can substantially affect the business owner’s outcome. Valuation and taxation vary most prominently between internal and external types of transfers.

Payment. The company will pay for everything during the exit transaction and becomes the proverbial goose that lays the golden egg. The owner won’t get paid if a company doesn’t perform well. Therefore, protecting and supporting the company during the exit becomes even more critical.

This concept holds true for internal and external exits. In an external exit, the buyer counts on the future company profits for a multiyear payback. Additionally, an owner should implement sound asset protection techniques that will help minimize predatory litigation and lawsuits.

Personal planning

Personal planning encompasses the more personal aspects of running a business, including the owner’s emotional attachment to the company, legacy goals and family relationships.

Emotional ties. An owner who has been associated with his or her business for decades will undoubtedly have an emotional response, whether positive or negative, when exiting the company.

Legacy. Legacy addresses how the owner’s exit will affect everyone who depends on the business and the company culture: the owner and his or her family members, employees and their families, and potentially the community.

Legacy issues are real and run deep into numerous lives. It is incumbent to determine what an owner’s legacy will be and to what extent it will become a deciding factor in the exit strategy selected.

Family members. Having a family member in the business can create additional drama in the exiting process. A critical issue often arising is the adequacy of the family member’s talent over a key manager. Another factor is entitlement syndrome, in which a family member may feel entitled to certain rights and benefits that have not been earned.

Owners should confront any potential issues head-on to avoid creating a negative business nvironment and, perhaps just as important, maintain harmony at the Thanksgiving Day table.

Financial planning

The financial planning piece of exit planning establishes the steps an owner must take to achieve his or her financial goals.

Retirement planning. A reason business owners postpone their exit planning process is the recognition that they don’t know how much money they will need in retirement. The uncertainty is compounded by the fact most of their wealth is trapped inside their illiquid business.

We are living longer as a society, and costs continue to skyrocket. Business owners must learn and understand their income needs in post-exit life. Once the owner can visualize their financial future, exiting and succession can become more apparent and definitive.

Planning for family members. The process of transitioning a construction company will usually occur over time. Business owners should employ tactics to protect their families in the event of death or disability.

Life insurance, disability insurance, asset protection and comprehensive estate planning should always be considered to not create additional undue hardships for the family and company beyond the untimely event.

Tax planning. Taxes are a top consideration in financial planning just as they are in business planning. The lack of planning for corporate, income, capital gain and estate taxes can significantly erode the owner’s estate. An exit plan must consider these taxes and plan to minimize this burden on the family.

DAD: Discovery, Analysis and Design

Once an owner has considered all the elements of planning, he or she is ready to begin creating the exit plan. The process can take six to nine months to complete and several years to execute.

There is a process we use to help owners understand the planning sequence and develop an exit plan that addresses the primary considerations of each area of planning.

Discovery. During the first part of the exit planning process, an exit planning consultant should interview the business owner and spouse to identify the owner’s goals and allow them to envision life outside the business. How does the owner envision the future ownership of the company to look? How does the owner envision life outside the business for themselves?

Analysis. During the analysis process, the consultant will examine the in-place personal and corporate legal and financial documents, such as wills, trusts, buy-sell agreements, com- pensation agreements and life insurance policies. The key is determining whether these documents support the goals identified in the discovery phase.

In many cases, modifications are warranted because of outdated documents or because cookie-cutter strategies are insufficient to alleviate the ambiguity that might arise if the documents need to be executed.

Design. The end product in exit planning is a comprehensive, fully customized report that outlines the goals established by the owner and solutions for the owner to consider.

This is not the end but the beginning of the process. Learning and coaching can take multiple years to unfold into the final blueprint. After finalizing the exit plan, the owner moves to executing their chosen path.

During the selling phase, an exit planning consultant can be the owner’s voice to coordinate the different disciplines and professional advisers, including attorneys, accountants, estate planners, insurance advisers, financial planners and business consultants.

A worthwhile process

Exit planning is a long and challenging process. It begins with a customized plan that develops multiple paths, strategies and options to meet the owner’s goals, minimize risk and mitigate excessive exit taxes. But with plenty of time and help from professionals, you can ensure you successfully walk away from your business.

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KEVIN KENNEDY is co-owner and CEO of Beacon Exit Planning LLC, Southlake, Texas, and JOE BAZZANO is co-owner and chief operating officer of Beacon Exit Planning.