Spend some time with successful sheet metal works business owners and you will likely discover there are some common misconceptions about them leaving their businesses and harvesting their trapped illiquid wealth.
If you do not understand what you face, you are probably putting your HVAC construction business wealth at a high level of risk. Here are some myths that many people believe.
Do not find yourself in the red zone of your business career only to fumble the ball before the end. The fact is over 70 percent of private businesses fail to transfer to the second generation or to an outside buyer.
I will just sell my business and retire.
Oh really? According to several national business groups, fewer than 20 percent of the businesses for sale actually close. Because of the characteristics of the HVAC construction industry, the closing rate to an outside seller is probably closer to 5 percent. And those that do sell to an outside party typically occur when the company operates in a unique niche, location or when the economy is moving out of the periodical recessions and growing.
Most transactions in the construction industry are internal, with the majority of transfers being management buyouts. A small percentage goes to outside sales, employee stock ownership programs, and some form of gifting. The good news is that internal exits are very flexible and have tax savings advantages.
I will deal with my exit plan in five years.
Right. I will talk to a business owner about when he or she intends to retire, and the answer is almost always predictable: “In five years.” Three years later, the answer is still, in five years. The simple translation is that the owner has no plan and has not mentally prepared for this complex process — and the procrastinating will continue.
A U.S. Small Business Administration study revealed that at any given time, 40 percent of companies are facing the transfer of ownership issue. So the real problem is the lack of a written plan to direct the owner on a measured path in tune with their exiting goals. Even though the actual exit may take an additional five, 10 or 15 years to execute, having a strategy and direction is a critical component towards meeting an owner’s post-exit financial goals. Furthermore, it takes time and training to align, grow, stretch and replace the owner with a formal succession process.
I can probably do this myself.
Maybe. You sure know how to run your business, but have you ever exited a business? Statistically, more than 70 percent are likely to fail. A study by the Family Firm Institute found that 70 percent of businesses fail to transfer to the second generation and 90 percent of businesses fail to transfer to the third generation.
Translation: Your grandson or granddaughter has about a 3 percent chance of running the business you hope to transfer to your son or daughter. Those are not good odds.
As a business owner you have probably already had conversations with your accountant, lawyer, insurance agent and many other professionals. The information is probably scattered and isolated. In other words, your information is not comprehensive, cohesive or holistic. An exit plan pulls all of your personal, business and financial goals together and unlocks the trapped business wealth in the most efficient manner.
My business is worth $7 million.
Sure. The reality is your business has different values, depending on whom you are selling the business to. This is called a range of values. You should understand the value of your business based on the exit strategy you are trying to employ. The true reality is that most owners overvalue their business and have a false impression of its actual worth. Just because they have spent the last 30 years working 60 hours per week does not necessarily mean that value has been created.
It is critical to understand what makes your HVAC construction business more valuable to an acquiring party. Advisers accredited in business appraisals are trained in these situations and should be engaged in order to provide you with the guidance of increasing business value. There may be instances where reducing value becomes more important as a tax strategy.
Here again, a comprehensive strategy is required to meet your needs. And remember, taxes, fees, and a poor exit plan could reduce what you make from selling your company by 20 percent to 60 percent.
But that will never happen to me.
Have you ever thought about death, divorce, disease, disability or departure? I get a call once a month regarding an owner’s untimely death or disability. In most cases, many of the buy-sell agreements are not aligned with the business owner’s motives or goals. Oftentimes they are unfunded or established in a manner that makes what should have been a nontaxable benefit taxable. Several of my latest horror stories have the owner in court for several years, costing both parties hundreds of thousands of dollars in legal fees without a clear end. Do you want to be distracted by your partner’s unwanted spouse, child or lawyer?
Two months ago, a buy-sell was structured in a way that unintentionally created income tax for a widow. In another case, the widow, who never worked in the business, was demanding her husband’s office, position and salary. In yet another situation, we identified an agreement that provided for a fixed amount to be paid out as a means of repurchasing the deceased owner’s interest. This agreement was created at the business’s inception but several years later the value of the business had grown exponentially. You can imagine the disputes that would have ensued. Clearly these are unintended consequences to an outdated or poorly drafted agreement.
If I could get $4 million, I would retire tomorrow.
Is that really how much you need? I know it sounds like a lot. Even though you probably have more than 70 percent of your wealth trapped in your business, the real question is: “How much do I need to replace my income?” You have to consider your money outside the business including your savings, retirement funds, real estate income, investments, etc. The bottom line is you have to understand the process of how do you replace your income so you don’t outlive your money.
Because so much is dependent on your exit, the process should coordinate three major areas of your life, namely business, personal and financial planning. When properly coordinated, the outcome should equate to a comprehensive plan that will not only satisfy your financial needs, post-exit, but will also support your other goals such as legacy planning and wealth protection.
But my accountant does exit planning.
So where’s your comprehensive exit plan? You probably have a good accountant and a book value for your company, but it takes a proactive approach and a significant amount of other information to exit your business. The focus of your exit should be based on your business, personal, and financial goals — not those of your advisers.
My past company’s team of owners invested six years and more than $250,000 for fragmented advice as we wandered down the exit path with two offers from industry rollups that were consolidating our space, and two offers from boutique private-equity firms that wanted to invest in our company. Additionally, we investigated an ESOP (employee stock ownership plan) and used a management buyout to transfer the stock of three existing owners to five new owners. We received reactive, cookie-cutter advice from our advisory team, but were still lost and had no direction.
As an exit planner, you are trained as a process consultant to move an owner’s goal into a matching path that meets the owner’s financial target, to replace the owner and to protect his or her wealth with a comprehensive, holistic result. You juggle the owners’ goal and scattered business, personal and financial information to arrive at one document that pieces the puzzle together, directing the owners and their advisers down a business exit path for a desired outcome.
Exit planning is the orchestration of many disciplines coordinated into one comprehensive report. That report defines all the options to determine the best fit for your goals and navigates a path out of the business. This combined information will give you the best overall result once the exit is complete.
After the exit plan is delivered, the next stage is a separate execution phase. An exit planner can also quarterback and coordinate different disciplines and professional advisers including attorneys, accountants, estate planners, insurance advisers, financial planners, business consultants and others involved in the execution of the exit plan.
I hope these seven myths of exit planning have provoked your thinking and helped you understand the challenges and risks of capturing your trapped business wealth. The good news is there’s a systematic, proven process that can guide you towards your ultimate exit goals. The process can take as little as three to six months, or up to two years in some instances. The key is to start planning today.
U.S. Treasury Circular No. 230 requires that this firm advise you that any tax advice provided was not intended or written to be used, and cannot be used for the purpose of avoiding penalties that the IRS could impose.
Kevin Kennedy is the founder and CEO of Beacon Exit Planning LLC and Beacon Merger & Acquisitions Advisors LLC. He is also a national speaker and author on exit planning and succession for private businesses. He provides written plans and strategies to private owners for succession and exiting their businesses. Email questions to KJKennedy@BeaconExitPlanning.com and visit www.beaconexitplanning.com.
This information is not intended to be legal, accounting, insurance or tax advice.