Even if your company is still growing, you should be planning your exit, no matter when, or if, you’re going to retire. “Every business, regardless of its revenue, should have a succession plan. For a small business, it’s probably even more important,” says Mark Brumbaugh, JD, a consultant with the Business Resource Center for Advanced Markets at the Guardian Life Insurance Company of America. Since small businesses usually make up a large percentage of the owner’s estate, the lack of a succession plan could result in an inability to convert the business into cash down the line. “This is especially problematic if other estate assets are insufficient for the owner's retirement, for the owner's family upon the owner’s death, or to pay estate taxes due on the value of the business,” he says.
With closely held businesses, there’s no built-in market where shares of the business can be sold if necessary. “The owner must create that market by implementing a succession plan that mandates a legal obligation for the buyer to buy upon the owner's retirement, death, or disability,” says Brumbaugh.
Convinced? In a recent NYER webinar, Brumbaugh offered these three steps to putting an exit plan in place.
1. Decide Who Should Buy Your Business
Even if you are the sole owner of the company, you should still have a solid succession plan. Business owners have several options here, including a partner, a co-shareholder, a key employee, a family member, or a third party, such as a vendor or competitor.
“If you have family members working in the business, they would be logical successors,” says Brumbaugh. However, he cautions that if you leave your business to your children, you risk disinheriting your spouse, which could lead to tax obligations for him or her. Rather than passing a bill to your heirs in your will, Brumbaugh suggests you talk to your advisors about having your children plan to buy you out instead.
2. Find out How Much Your Business Is Worth
Business owners misjudge the value of their businesses by a median of 58.9 percent, Brumbaugh says, which is why getting a professional valuation of your business is critical.
If you’ve never had a professional valuation done on your business, Brumbaugh suggests you get one as soon as possible, and that it be updated every year or every 18 months. When the company is valued after a business owner dies or is disabled, the process can become very complicated, and potentially expensive, due to such an important decision being made so quickly, leading to disagreements, multiple valuations, and disharmony between the remaining staff and the owner’s family. “It’s a recipe for chaos,” he says.
An accurate valuation is necessary not only to build and fund your exit plan, but to ensure that you and your family receive a fair price when your company is sold, and for estate tax purposes.
3. Develop a Buy/Sell Agreement
A buy/sell agreement is effectively a business owner’s will for the company, which covers when a business will be sold (because of, for example, the owner’s death, disability, or retirement), and the purchase of the business by the appropriate people. A buy/sell agreement establishes a fair and reasonable price for the business, allows for continuity of management within the company, and ensures that the settlement of the business’s sale occurs as quickly, and with as little conflict, as possible.
There are many types of buy/sell agreements, and your professional advisors can help you decide which is most appropriate for your business. Two types mentioned by Brumbaugh are an entity purchase agreement (where the business itself is obligated to buy the owner's interest) and a cross purchase plan (where, if there is more than one owner, the other owner(s) as individuals are obligated to buy the owner's interest). No matter which format you choose, however, there are several important criteria that your agreement should include. See a checklist here.
If you don’t have a buy/sell agreement in place when you need one, you will most likely not be able to find a buyer quickly—and, if you do, you’re unlikely to be pleased with how the deal pans out. “If you do have to sell in a short period of time, you and your family are going to be sorely disappointed in the amount of money you’re going to receive,” Brumbaugh says. “The whole point is to not leave it to chance.”
8 Buyout Triggers
According to Brumbaugh, these events should be included in a company’s buy/sell agreement:
Loss of license
Conviction of crime
(Insolvency and divorce are often included in buy/sell agreements to prevent the owner’s creditors having a claim against shares of the business.)
Michelle Court is the managing editor at The New York Enterprise Report. She can be reached at firstname.lastname@example.org.