In this session you will learn about:
- Functions for each member on every world class transition team;
- 3 things any owner can do right now to prepare for an exit;
- The most common exit options;
- Best way to discuss your exit strategy with internal and external stakeholders;
- Most common mistakes owners make when discussing an exit strategy with their executives.
About the GuestWarland Griffith, CFP, CEP is a graduate of the University of Miami's School of Business Administration and the College for Financial Planning at Florida Atlantic University in Boca Raton, Fla. He has the professional designations of Certified Financial Planner and Certified Estate Planner, and is an active member of the Financial Planning Association.
As an independent advisor with clients ranging as high as $20 million in net worth, Warland offers personalized coaching in a variety of areas. He has been a featured speaker at public seminars and a continuing education instructor on tax-advantaged investing, the importance of asset allocation, investing for growth in both bear and bull markets, and optimizing retirement income while reducing the potential loss of principal.
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Read the Full Transcript Here:Noah Rosenfarb: Hello and welcome today to another of our series of podcasts. I’ve got a great guest today, Warland Griffith. He’s the founder of Wealth Management Advisors. He’s an expert Exit Advisor for business owners. Warland and I have some overlapping on how we help clients, and I thought he’d be a great guest for the show. Warland, welcome.
Warland: Thank you, Noah. It’s a pleasure to be here.
Noah Rosenfarb: Let’s start the interview by maybe describing for our listeners what a great team looks like when people are trying to plan a transition, who are the players that everyone should have and what should their functions be, and where do you fit in and versus maybe an accountant?
Warland: Okay. That’s a great question. Obviously, in the work that we do there’s many different advisors and types of advisors that are involved. I mean, there are merger and acquisition attorneys; there are maybe specialists in succession planning or perhaps in ESOPs - employee stock ownership plans. Obviously there’s going to be the CPA firms of the client. There’s certainly going to be estate planning involved, so you’ll be looking at insurance people and perhaps some financial planners and clearly attorneys that have practices in estate planning. There’s also going to be a need for income replacement for the owner who’s actually in a business. And that is going to also require that a wealth management advisor become involved as a management planner. And then obviously, and this should be done upfront, is you’re going to need a valuation appraiser.
The income replacement, as I’ve said, typically will require the expertise of a financial planner to determine exactly what the asset base is going to be that’s required to generate that income, and do an analysis of the strategy to replace that income, and a wealth manager to manage the assets that are going to generate that income. So simply put, the business owner sits in the middle of all of these together with the advisory team, Noah. There’s going to be a lot of coordination that’s going to be needed in this. As a certified exit planning advisor, the exit strategy advisor is working with the business owner to coordinate this team and all of the members that are involved on it to execute the option and the plan that was written for that business owner.
The assembly and the functioning of the advisory team is absolutely critical to that business owner’s success. That’s why it’s so important to choose the members very carefully and let the owners plan. And the owner’s wishes and goals will drive the process, not the goals or wishes of the individual members of that team. So that has to be quarterbacked.
It’s typically quarterbacked by somebody like me who’s doing the exit planning and then following through and executing on the option that has been chosen as the optimal option for the owner.
Noah Rosenfarb: That’s well said. So, you mentioned about 8 or 9 different types of people that may or may not be involved in the transaction. What’s the exit advisor’s role in coordinating all of that? Do you find that you’re communicating everything to the owner? Or do the owners want you to just handle it and form a monthly or quarterly meeting and give them the feedback that they need?
Warland: As the quarterback in a relationship, you have to work with everyone but to ensure everyone is on the same page. First of all, I guess the most important thing is to choose the right advisors upfront. There are a lot of transaction advisors that are more focused on production for themselves and they are achieving what the optimal results are going to be as supplied by the plan and by the owner himself.
On the other hand, there are transaction advisors that are absolutely outstanding. They understand and realize that there’s business to be had for everyone, but it has to be a good business - meaning that you’re serving the best interest of the client; you’re working together as a team. So, my role is to make sure: a) that the right advisors are on that team by interviewing those advisors; secondly, ensuring that they understand what the plan is, what the goals and objectives are, and that we’re working together to arrive at a consensus of what the best possible solutions are for that client.
It doesn’t mean that I have to control every minute of what’s said and everything
has to be funnelled through me, but it does mean that I have to give the advisor the freedom to design the strategy, design the solution, discuss it with me and anybody else that’s involved, any other advisors that might be involved, and putting together the strategy. And they can converse directly with the client on any issues that need to be discussed. But this has to be closely coordinated so that we can stay on target and be on the same page.
Noah Rosenfarb: Yes. With that kind of process and coordinating, in your experience how long of a process is it? How much time should an owner plan before...when they meet someone like you and decide to engage, what’s a typical transition is going to look like?
Warland: Typically the exit plan, the plan itself, will take around three months to do everything that’s involved on the planning side of this process. On the execution side, it typically will take a year or even more depending on the complexity and the number of things that need to be accomplished. I’m talking about the overall delivery of all of the results that need to be achieved on the execution or implementation side, if you will.
One piece of it may be two or three months depending on what it is. It might be an estate plan as an example. It may be involved, very involved, and it may take three months and coordination of meetings and putting together solutions with the estate planning attorneys or perhaps tax specialist, and so forth. But overall, my experience has been that, on the delivery side, producing those results it typically takes around a year to do that.
Noah Rosenfarb: And so for owners that maybe aren’t ready to start that process but they’re thinking about intentional transition, what are some of the things that you would encourage them to start doing that apply to general businesses, and no matter they’re in, no matter what type of business they have? A few suggestions of things they could start implementing three, five or ten years out just to create value in their business.
Warland: Okay. The first thing I would tell them is that they should have a plan for not having the plan, which means that they could die at the desk today or on the way home tomorrow and they don’t know that. So risk management is number one on the list. Those issues should be discussed and the solutions put in place immediately.
But the three most important things I think that an owner can do to prepare for an exit is: first, to be aware of just how critical it is to be prepared and understand that there’s going to be winners. The winners are going to be ones that prepare proactively. And there’s going to be losers, and they’re going to be the people that did not prepare.
The second thing is for them to educate themselves on what their exit options are and the planning steps that are needed to protect the value transferability of their business.
The third is not waiting to the last minute to start the planning process. They need to take action to improve the value...First of all, you have to know what the value their business is. They need to educate themselves on what are the drivers of value in their business and what makes it attractive. By doing so, they’re going to protect their personal wealth and financial independence.
For instance, Noah, if you want to talk about how critical it is to be prepared:
there’s about 78 million baby boomers that are going to retire in the next six to fifteen years, approximately. Interestingly enough, they own about 12.5 million businesses. In many cases, the younger generations don’t want to or they’re not qualified to take over those businesses, or there’s nobody internally to move into that role. About 70 percent or 8.4 million of those businesses are going to have to have something happen to them. They’re either going to have to be sold to a third party or they’re going to have to be liquidated or they’re going to have to be transferred internally to the employees, perhaps through a management buyout or through an ESOP. But there’s something going to have to happen and it’s going to be a tsunami. This has never happened before in terms of this kind of volume in the history of our country.
The thing is, and you probably know this as well as I do, a business typically represents anywhere from 80 to 90 percent of that owner’s personal wealth. But statistically, 80 percent of businesses that are put on the market are not successfully sold or transferred. Those are pretty stiff statistics. Not only that, but there’s going to be many more sellers on the market then there’s going to be buyers. So that’s going to help to drive the value of your business down.
The number of buyers that are out there who are willing to talk to you will be even less. So unless you are proactive about this and you plan ahead to increase and protect the value of your business by increasing its transferability and its attractiveness in the market, you’re going to end up being a real loser because that’s what you’re future is depending on - it’s the value of that business.
Noah Rosenfarb: Yes. So one of the things you mentioned on those top three things is to get educated about exit options. maybe you could start that conversation with some owners who are listening, and just give them a brief overview of the highlight reel of what exit options there are and maybe a few minutes of education that they could get started walking down that process.
Warland: Okay. Educating yourself on your options and the planning steps is obviously very critical. You need to know what your options are; you need to know what the pros and cons are; you also need to know how they lined up with your personal goals and those of the business. You need to learn the fact that there’s not just one value associated with your business, but there’s actually a range of values. And so you need to be able to understand what you can or project what you can reasonably expect to net out after fees and taxes, and expenses for each of those options.
The planning steps typically include like any kind of planning: setting your goals and your objectives; knowing what your timeline is for your exit; how financially prepared you are today making that exit personally. Are you going to be able to replace that income that you’re currently receiving from the business and the benefits that you’ve been enjoying, or not? For the price you’ll be able to get for your business, you need to know that. So, you need to educate yourself on the options. You need to know how they apply to your situation. Specifically, you need to understand the value of the options that you choose. You need to start working on increase the value of the business and know how to go about doing that, and actually follow through because the plan sitting on a shelf has no value, as far as I’m concerned. You actually have to follow through and execute that strategy to achieve that goal.
If I understood your question correctly, I think you asked me that you want to know what some of the options are. Is that what you asked me, Noah?
Noah Rosenfarb: Yes. I mean, I think in the general sense most people think "I can leave it to my heirs or whoever’s left after I’m done to figure out how to exit the business," or "I could transfer it while I’m alive." If I plan to transfer it while I’m alive, I could sell it to a third party, to my management team, give it to my family. So maybe we could walk through some of those decision criteria on what are the options.
Warland: If they’re going to leave it to their family to figure out, that’s going to be a mess in the business. They need to work with that family member who is working in the business to prepare them for that transfer. But anyway, there are a number of primary exit options that are available. There’s the sale of business, obviously, which you’ve already mentioned. There’s also the private equity, recapitalization option that could be on the table if you’re the right kind of company with the right kind of circumstances. There’s the employee stock ownership plans that are a possibility in some cases, and also management buyouts. There are maybe some gifting options on the table as well.
An owner needs to choose their business carefully. I mean, they may choose, for instance, to exit the business by way of a sale to an industry buyer - what we refer to as a strategic buyer, synergistic buyer - because there’s going to be some synergies involved. They’re going to have to go through some formal process to make this happen. There is a merger and acquisition that takes place. They’re going to have to go through that process to find a buyer.
The other thing is when you’re going to sell the business, you need to be aware of what’s going to happen. If you prepared your business properly, you probably will get the highest value but not always compared to the other options that are available to you. But be aware, you’re also losing your job. So make sure, again, that you’re going to able to, once you net out with what you’re takeaway is that you’re going to be able to sustain your lifestyle. You’re going to give up strategic and financial control of the business, and there’s no future value that’s going to be available to you. By the way, what you got paid isn’t what you’re keeping. You’re going to have to pay some taxes. There’s going to be some legal fees to be paid; accounting fees and etc. So you need to be well prepared for that.
A recapitalization typically...that transaction includes a business owner who’s selling the majority of their business, probably around 80 percent, to a private equity group. By the way when that private equity group comes in, they already have an exit plan in mind. They’re typically looking maybe five, six or seven years out in which they’re going to get return on their investment, and they’re going to exit. So, an owner should be doing the same thing. They should be looking at their business as their most important and their biggest investment, not a job.
But anyway, in the private equity option, the owner does stay on board with the private equity group, typically continues to run the business at an operation level. The private equity group will provide capital and management expertise to pursue business opportunities with that owner. Otherwise, he would not be able to fund himself probably. So that’s the way that works.
When it’s sold there will be what they call a "second bite of the apple," if you will. In other words, the owner’s taking some of the value of his business off the table. He’s leaving maybe 20 percent behind with this group that he still owns, and he’s hoping that the value of that business is going to go up. When he sold that 20 percent, he’s going to make much more than he would have if he had sold 100 percent from the start. So that’s all about if he keeps his job, the owner keeps his job. He has an employment agreement, typically. He’s going to have a stake in future value of the business. The other thing is he now has partners who own a financially and strategic control of that business. It’d be wholesome to know whether or not they can work together.
There’s an ESOP option that could be on the table. One of the neat things about ESOPs is that it actually makes it possible for the owner to create a market for the purchase of his or her shares. It allows the owner to diversify instead having all of his or her eggs in one basket, and they can continue to maintain control as well. It can benefit and incent the employees because shares are allocated to them. They don’t actually own the shares but it’s a qualified retirement plan. So they participate in the future value and growth of this business. It can be very incentivising for the employees.
I think it’s a win for the business owners if the ESOP is the buyer of the stock. It’s a means of diversifying and succession planning for their company. The ESOP is an alternative to a sale. It means, oftentimes, increasing the productivity and offering a qualified plan to the employees. With the employees, an ESOP company has a funded retirement plan. It affects their personal wealth because they’re going to have their shares bought back by the company when they retire.
Management buyout, Noah, an owner may choose to exit by selling the company to the management team. But I really recommend very, very strongly a high level of personal financial readiness before making that decision. If you don’t, you’re running the risk that this management may not be able to run the business as well as you did. If you exit too early in the process, you may find yourself with the business losing tremendous and/or perhaps going out of business, and all of sudden your retirement plan is done and over with.
Some of the special issues that you face with a management buyout situation are: typically, the employees don’t have the money to buy the business. The managers oftentimes don’t like to take the risk. Sometimes, the owner tries to fund that buyout by increasing their salaries. And what happen is a couple of things: he’s financing the purchase of his business through the managers, and here’s the taxation. One at the individual level, and one at the level of the individual employee. When the owner sells the stocks, he’s going to pay capital gain stocks on that stock as well. There’s two tiers of taxes that he’s paying, and he’s got to be very careful about how he goes about doing that transaction. So those are some of the considerations in a management buyout.
On the plus side note, the managers do know the business. If they’re excellent managers, the value can be maintained and there’s continuity in the business. They know the business better than anybody else does, certainly anybody from the outside. A control exit can take place over many years, so the owner of the business needs to be aware of that and do this in a very systematic manner.
Noah Rosenfarb: Yes. Just to recap, you did mention the sale to a strategic acquirer, bringing in a private equity firm, going through a transaction with an ESOP, and taking a look at the management buyout. Those are all options for the owner to transfer perhaps out of their family. How do you see transfers inside of a family, if parent want to give the shares to their children? What are some of the common ways to do that?
Warland: Well, it could be a combination of gifting strategies, and a management buyout. With the gifting program, there’s estate tax issues that can include getting the assets out of the owner’s estate. It has to be based on a fair market value standard. And so there’s going to be discounts typically for lack of marketability and lack of control. What that does is it allows the owner, those combined discounts, to help move more of the assets out of the estate in a tax efficient manner. So those are some of the ways that they can go about it.
With regard to the management buyout, I feel very strongly that a child or a family member who is working in the business should actually buy the business in one form or another rather than just have it just gifted to them because the owner is the one who put all of his or her blood, sweat and tears into the business; he’s put everything at risk. This typically is not the case with the son or the daughter who’s working in the business. So they need to really bring that person up to speed with regard to maturity and risk taking, and put them in different roles throughout the company so that they can experience the same thing that the owner or parent has. And also come up with a way in which they can have only one tier of taxation, if you will, with the greater majority of the transfer versus paying taxes at two levels.
Noah Rosenfarb: Yes. You mentioned a little bit in the transfers to family is about estate tax issues and fair market value standard. But in a general sense, what are some of the pre-sale or pre-transfer tax and estate planning opportunity that you see clients implement? Maybe you could describe a few of them or maybe tell a story about how an owner chooses to implement one.
Warland: Sure. Three of the most important one...if there’s more than one owner involve by sale agreement to protect owners from each other, if you will, and to protect the continuity of the business in the event that one predeceases the other, becomes the force or wants to retire, etc. The other is to protect a spouse’s income and lifestyle in the event that the owner dies early unexpectedly leaving that spouse and dependants without income from the business. Another one is disability to replace the owner’s income. Not only for that, but also to buy the owner’s shares in the business.
In other words, all business owners eventually are going to transfer their ownership interest in one form or another. But unfortunately, many owners actually fail to plan. They don’t plan for these events, and that ends up causing a forced transfer of their business in a way that they would not have wanted during their lifetime. At best, when they don’t plan and these things happen, an owner’s failure to plan for the transfer of the business can result in very serious losses of capital due to debilitating tax obligations that could have been avoided. There can be heavy demands on the company’s cash flow and impairing its ability to grow. There could be terminated banking relationships and credit lines due to loss of confidence in the business’s ability. For instance, loss of confidence in the business itself by the company’s creditors and suppliers.
And then there’s the loss of control of the business itself because all of a sudden that business and the owner who remains behind has new unwanted shareholders who weren’t working the business but they’re making demands on the surviving owners. Maybe they want to sell their shares or they want to help make decisions on the direction of the business. So, all of these cause very serious interruptions to the business’s day to day operations.
At worst, that the best side. At worst, the owner’s failure to plan for the transfer of the business can result in the failure of the business altogether, or the unintended liquidation and distribution of your estate in a way that you wouldn’t have wanted to happen in the first place. So, clearly all of these are possible scenarios that could potentially result in the loss of some of your best employees even. You might find the best employees in the company jumping ship when they see this kind of thing happen. It creates very serious problems and this needs to be avoided.
I have another engagement that I’m working on, and we were talking about advisors early on. It’s interesting. We moved on to the execution side, the implementation side if you will. Excellent client relationship with the owner, and we have a whole schedule of things that need to be done. Among which are included estate planning issues that also involve a buy-sell agreement. So I laid all of these out for him, educated him on the different strategies, made recommendations on solutions and also recommended a transaction advisor who is a specialist in business related issues for business owners.
I brought him in to talk with the owner, and offered solutions to him. And also put on the table for him to bring in any other advisor that he felt might be qualified. But what he did is he brought in an advisor that sold him his insurance risk for a fleet of cars. That advisor ended up selling him...He did not coordinate with me. He did this without my knowledge. This happened to be a friend of his. They run together every week, and this guy sold him a couple of policies that were totally inappropriate. They were structured inappropriately, and they compounded the problem. This guy’s daughter is the one who is going to take over the business but he also has other two children outside of the business.
As a result of what this insurance guy did and the precipitated manner in which the owner moved forward without coordinating with me on buying these policies, he actually created a much bigger problem, the estate planning problem, and also defeated his own objective of having his daughter being the only shareholder in the business upon his death. And so I had to deal with that very tactfully, as you can imagine. And now he realizes the importance of working closely with someone who’s looking out for his best interest and managing the orchestra, if you will.
Noah Rosenfarb: One of the things you mentioned was: if you don’t have a plan and something happens, oftentimes key employees leave just because of the changes thrust upon them. But do you have a best practice that you would say for owners when they’re going to discuss exit strategy with their executive team? When is the right time to bring up the topic and when is the right time to share plans?
Warland: I think the biggest mistake they make, honestly, is not doing it early. You should be talking with your executive management team about your succession plan and you should be transparent about it. If they actually involve a transaction, and it’s not just a succession, you should also be talking to them early about that and put it on the table. They are the stakeholders in the process, so you have to bring them into that process.
Unfortunately, most owners don’t. I mean, that’s really astonishing because even though they’ve worked with these people for a long time and frequently they go to them for advice about everything that’s important about the business. On this particular issue, they often say nothing about it and they keep it a secret or they feel they can’t go to them because they’re afraid they might leave the company.
It shouldn’t be succession planning just at the top. It should be succession planning at all important positions, right? I mean often what becomes clear is when you get these things out on the table, lots of good things start to come out of it. The executives are physically aware when the owner is approaching a point where it’s that time because of, perhaps, age or some other reason; Approaching a time when they may want to make a transition of some sort.
But if it’s properly handled, the owner has actually prepared that executive team. If that’s been done for an excellent manager, that process can actually begin 4 or 5 years or more before they exit. So that owner should be frank and the owner should above board with all of his people, and let them know he’s going to retire some day; he’s going to help them become successful, and by the way guys, I’m changing my role right now. I’m going to be more of a strategic player in this company rather than tactical. I’m going to delegate a series of roles to you so I can see you in action in different areas of the company. That way you’re going to grow in value to the company, and you’re going to experience what I’ve experienced running it.
As an added incentive, they can do an ESOP or a management buyout or a combination of that over time. Everybody in the company is going to see this transition. And the owner says, "I’m going to set up a board, guys. I’m going to be the chairman of the board. You’re going to see all kinds of changes over the next four to five years, and I’m starting now. I’m not waiting. So we’re going to take a five year horizon here, but I can tell you at some point in the future the ownership is going to change hands. That’s my intention. And somebody else is going to be the executive in this company, but we’re doing this together."
Noah Rosenfarb: Yes. And do you think that if that gets implemented in conjunction with some type of phantom equity plan or phantom stock plan, the bonus plan, to retain to employees?
Warland: Yes, I do. I believe. In fact, that’s the best approach to take rather than giving them actual stock shares early in the process because that can end up causing serious problems later on that you didn’t anticipate. It takes time to actually assess all of this and monitor it, and measure it to see what’s working and what’s not, and who are going to be the leaders, who’s going to be the CEO, and make the most at the right time. So I do believe that is the way to approach it.
Noah Rosenfarb: How about talking about exit strategy with other stakeholders like vendors, your supply chain, your customer base? What would you say is the best practice around that?
Warland: I think the best practice is actually doing what I just said. If you’re running your business the way I just laid out for you and that’s the way you’re working with your executives and you’re transparent, and you’re professional, effective, productive and you’re top of your game, and you’re on the cutting edge of your industry, your suppliers know it. They know what kind of management team you have.
You don’t want to wait until the last minute when you’re moving out into retirement to be exposing those people; the banker that you’re working with, the suppliers that you’re working with, your clients and so forth. This has to be done gradually and very professionally over a reasonable period of time.
Noah Rosenfarb: Maybe you could with our listeners a few stories, either about owners that you have meet that came to you after they fail to plan or some owners who maybe made some difficult decisions early on in the process that really benefitted them. Just a few good ones for our listeners. I think they enjoy hearing stories about other owners and even what challenges they face or what success they’ve had.
Warland: Okay. I have a client now who actually before coming to me to do the exit plan for him, I had done a personal financial plan for him. He was already in the midst of a management buyout strategy. He had just initiated it. It was planned to take place over four to five year period of time. What happened was that the management buyout did not work out. It did not work out because a proper assessment of the management team capabilities was not made, and a succession planning expert was not brought in to assist in that process of identifying and cultivating, if you will, a leader to take over in the future.
The timeframe for this owner is "I want to get out within a year." And so there’s no time to try this management buyout strategy again with different players. Not only that. He did sell some shares to three key players in the management team. Now there’s a need to buy back those shares. One of the members of the team has become has a very, very difficult individual who is not trustworthy, who is quite a bit of a terrorist, if you will, in the organization. It’s turned into a situation where it’s going to require some legal counsel to determine the best possible way to deal with that situation because it can obviously cause problem with regard to this owner’s desired exit successfully from the business at an optimal price if this problem is still there.
We’re working with him on doing some reverse due diligence. An individual I worked with, who is a merger and acquisition expert and an expert in valuations; we were working together as a team to do the reverse, or seller side do the diligence if you will, to look at all of the key areas in the company that need to be looked at with a fine tooth comb, including the management team and the financials and any environmental issues, and so forth. This particular issue, I don’t know, how it’s going to come out but I guess the moral of the story is before you start selling shares make sure that you’re ready to do that.
Noah Rosenfarb: Yes. What else would you like to tell our listeners before we wrap up our conversation for today?
Warland: If you’re a business owner I would tell, by all means...number one, the first thing that you need to do is have a professional evaluation of your business done so that you can know what your value is from a merger and acquisition standpoint and/or transfer internally. Secondly, start preparing for a transition proactively. The more time you have in working in your favor, the better you’re going to come out at the end especially in line with the statistics that I just gave you. By doing that you’d be surprised by how much you can benefit yourself, all of those members of your organization, your team, your management and your employees from a tax standpoint as well. It benefits that you can reap that you’re not even aware of because you’re not educated around these issues.
I would say, work with a great financial advisor that you have a lot of confidence in and to get a good fix on how much you’re going to need when you do exit to be able to retire comfortably and sustain your lifestyle because you need to know what you’re shooting for. You have to have a target and you have to know how you’re going get there. At a minimum, I would say find out what the value your business is, and educate yourself on what the options are, get started as soon as possible on an exit plan, and also do the same thing from a personal standpoint with regard to your personal finances.
Noah Rosenfarb: Great. I want to say thank you very much Warland Griffith. I’m really pleased to have you. Why don’t you tell the audience how they can get in touch with you if they have any interest in calling?
Noah Rosenfarb: Great. Thank you so much, Warland, for joining us today and thanks to all our listeners. We hope you keep tuning in.