Planning Considerations When Exiting Your Business

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1 Strategic Thinking Planning Considerations When Exiting Your Business overview Selling a business is one of the most important financial decisions a business owner or founder will make. This is truly an exciting time, but it can also be stressful, since the eventual decision is irrevocable and will very likely impact the rest of the owner s life. Ownership of a business frequently represents years, if not decades, of hard work and entrepreneurial savvy. However, even the best business owners are often unfamiliar with the complexities and meticulous preparation that must go into a successful sale. Put another way, owners are preparing for the deal of a lifetime, with possibly zero experience. The current economic environment further complicates this decision and has caused many to re-evaluate whether they can sell the business or whether it is best to leave the dream deferred. This paper will explore strategies and planning considerations at different stages in the selling process. While each deal timeframe will vary, for purposes of discussion, we have broken the timeline into four distinct phases: Long Term, Short Term, During Negotiation, and Post-Transaction. Long-Term Strategy (> 2 years) Short-Term Strategy (< 2 years) During Negotiation Post-Transaction continued

2 Who Should Be On Your Team? Assembling a team of trusted advisors should be one of the first steps in selling your business. Think of this as assembling your personal Brain Trust to bounce ideas, concerns, and scenarios off of. Who should be on this team? While each situation is different, here is a suggested list of essential members: Accountant Investment Banker Wealth Advisor Team Owner Estate Attorney Corporate Attorney Financial Advisor Work with an individual experienced in working through this process and who can help identify and address advanced wealth planning issues relevant to business owners. Estate Planning Attorney Choose an attorney who has experience in this type of transaction and who works with high net worth individuals as well as being capable of executing advanced estate planning strategies for business owners. Accountant Frequently this will be the Company s Certified Public Accountant (CPA). Again, as with the attorney, select a CPA who has experience in this type of transaction and the various tax aspects of monetizing a business, while structuring the sale so as to minimize the tax impact to the owners. Investment Banker or Business Broker Depending on the individualized characteristics of the company, either an Investment Banker or Business Broker can help you structure the deal. Additionally, they will conduct analyses and provide valuation assistance to help develop a possible range of prices for the business. Corporate Attorney Sometimes, this may be the company s attorney, but there are attorneys who specialize in documenting purchase and sale agreements. Working with an experienced attorney can add tremendous value in appropriately sized deals. Make a point to engage your team as early as possible and make sure they are collaborating on your behalf proactively, and not simply responding to your requests. As the deal gets closer, there will be many decisions made either through proactive planning or passive ignorance that can not be undone. Business Succession Long-Term Strategy Considerations Long term generally implies greater than two years from the sale. While selling the business may still seem like a long way away, it is during this time that you will make many of the most important decisions. 1. Identify Goals of All Stakeholders/Owners When multiple owners are involved, take the time to truly understand all owners goals. Are you really ready to relinquish control of this business? Are the other owners ready as well? Preparing a business for sale is difficult, and everyone must be committed to take the necessary steps to make it a successful sale. If you and your partners are not fully on board, this process will not go smoothly and resistance may sabotage the deal. Sometimes, an owner will become more passive, or express that they wish to retire earlier. This presents an opportunity for other partners, or the business itself, to buy out the noncommitted owner s equity stake. This will simplify the management structure and ensure that everyone moving forward is committed. 2. Identify your Team of Trusted Advisors Life can quickly become busy and hectic beyond the scope of your control and involve aspects and issues outside of your expertise. Assembling a team of trusted advisors early can help make your life much easier and their advice can help you achieve a more favorable result. When choosing advisors, focus should be given towards those who have experience in working through this process, and towards those that are competent in collaborating with other advisors. 3. Review Asset Titling and Ownership Once the decision has been made to sell the business, a professional review of how all personal and business assets are titled is a great first step in developing your overall strategy. Being aware of liability issues and the treatment of assets in a lawsuit or upon death may help to uncover problems that need to be addressed when updating financial and estate plans. Additionally, in light of the possible upcoming liquidity event, the 2 Morgan Stanley Smith Barney

3 structure of ownership itself may need to be changed. Working with your legal advisor you can address titling and ownership issues. 4. Update the Financial Plan Trying to update and review your wealth strategy during negotiations is very difficult due to the numerous commitments, stress, and required focus towards managing the business and the deal itself. It is important that your current wealth strategy is evaluated and updated during this long-term evaluation phase. Take the time now to figure out how much money you require to attain your retirement lifestyle goals. This will help reduce stress, increase commitment and be an important factor to keep in mind during the negotiation process. 5. Review Existing Estate Plan In conjunction with reviewing your overall wealth management strategy, a review of the Estate Plan is important. This goes beyond the basic will and Health Care Power of Attorney, although it is surprising how many individuals have not reviewed these basic components in the years preceding a sale. This is your main opportunity to coordinate with your financial advisor and estate attorney to determine what wealth management strategies may make sense. Remember that many strategies require significant time to be effective in helping protect and transfer your wealth (i.e., establishing trusts, LLCs, and leveraging discounts on gifts). Advanced Planning Strategies For Business Owners Grantor Retained Annuity Trusts (GRATs) In certain instances, Trusts can be helpful. A GRAT is an irrevocable trust where the grantor transfers assets to a GRAT and retains the right to receive an annuity payment for a fixed term of years. At the end of the GRAT term, as long as the Grantor survived the Trust term, the remaining assets are transferred to the named beneficiaries of the Trust or kept in the Trust for their benefit, removing them from the grantor s estate. The grantor is considered to be making a current gift to the remaindermen of the right to receive trust assets at a specified future date. The amount of the gift is based on the value of the transferred property less the value of the grantor s retained interest. A grantor who survives the trust term has the opportunity to realize significant tax savings. The biggest risk of using a GRAT is the possibility the grantor will not survive its term. If this happens, all or part of the GRAT property may be included in the grantor s estate for estate tax purposes. Gifting Discounted Shares Using valuation discounts such as Minority Interest discounts, it may be possible to gift shares of the business outside the estate while paying gift taxes on a smaller value than the shares are worth without the discount. This strategy can be used in conjunction with establishing Family Limited Partnerships or Grantor and Irrevocable Trusts, or simply by gifting shares to beneficiaries. Intra-Family Loans Another advantage of a low AFR is the ability to extend a loan to your heirs using the shares of the company. This freezes the value for estate purposes and allows the heirs to pay back only the original loan amount plus interest based upon the AFR. Any subsequent appreciation of the shares remains with the heirs, and outside of the business owner s estate. Limited Liability Companies or Family Limited Partnerships One important question to consider is What if I am sued following the sale? Incorporating account structures such as LLCs or LPs might help protect assets subject to lawsuits. Other Tools To review all the tools available is beyond the scope of this paper, however, there are many other strategies available such as Qualified Personal Residence Trusts, Charitable Annuity Trusts, Irrevocable Life Insurance Trusts, Dynasty Trusts, 2503(c) Minor Trusts and Intentionally Defective Grantor Trusts, etc. Morgan Stanley Smith Barney 3

4 When you are within two years from the sale, it is most important to grow the company as quickly as possible and create a cash flow machine so that buyers can envision taking over easily and smoothly. 6. Conduct Market Analysis and Construct A Marketing Plan for Exit Strategy Use an Investment Banker or a Business Broker to conduct a market analysis. This will help everyone understand what buyers are out there, what valuations are reasonable and most importantly what buyers are looking for. Running the business from this point on should be done within the context of what will be the most attractive to buyers, not necessarily what is the most desirable for the owners. 7. Explore and Evaluate Multiple Exit Strategies Engaging an investment banker or business broker early in the process can allow for owners to evaluate multiple exit strategies through a strategic alternatives analysis. For example, instead of simply looking for a strategic buyer, a business may decide to evaluate the possibility of a sale to a financial buyer, or private equity group, or an Employee Stock Ownership Plan (ESOP). These professionals allow for multiple options to be explored in an attempt to seek the most value in a transaction, and may create a larger pool of potential buyers and/or investors to approach. 8. Begin Cleaning Up the Company Once everyone is committed, it is time to begin forming the company that buyers can see themselves owning. Think of this process similarly to how you would sell a car (albeit a really expensive one). Cleaning up the company is like taking the car to the detailer before selling it; you want to be very meticulous so that you can ultimately show the company in the best light possible. While it seems like common sense, many owners delay or simply ignore common obstacles and red flags. At this stage, identify the issues so that they can be addressed in the upcoming year. Ask yourself: i. Who are the key employees? Is Key Man Insurance in place? Is there a retainer on the key employee? ii. Have the financials been audited? iii. Are there any key customers or clients? Are there contracts in place? iv. Are all the processes formalized and efficient? v. Are the key suppliers and contractors in place pursuant to a contract? 4 Morgan Stanley Smith Barney

5 vi. Do all contracts contain change of control provisions? vii. Is the management structure clearly divided and efficient? Is it transferable? viii. What are the top strategic priorities? Are they in line with what buyers want? ix. What threats are there to the continued success of the business? How are these threats mitigated? Short-Term Considerations When you are within two years from the sale, it is most important to grow the company as quickly as possible and create a cash flow machine so that buyers can envision taking over easily and smoothly. 1. Complete any remaining gifting or transfer strategies While time is beginning to get short, keep in close contact with the wealth advisor team and estate planner to finish up any remaining strategies. 2. Identify the Growth Levers and Push Them Full Speed Ahead It is important to identify what drives growth, and push forward as efficiently as possible. This becomes difficult when all owners are not fully engaged, which is again why an early buyout may be advantageous. 3. Conduct Market Analysis to Align Priorities with Strategic Buyers Another review should help provide clarity towards how the market has changed and what the strategic priorities need to be. 4. Continue Cleaning Up the Company Resolve any unfinished cleanup. The money and effort put into this process is often well worth it, as it will help the buyers see a well-oiled machine that can be easily transferred without endangering future cash flows and profits. 5. Become Comfortable with Negotiation Points and Process This process may become very hectic and taxing. This is the time for the owner to become familiar with the process, negotiation points, and priorities. By coordinating with their wealth advisor team, an understanding will be reached as to what is most important to the owner within the context of his or her overall wealth management strategy. During Negotiation When negotiations begin, it is very easy to become overwhelmed. Not only are owners running a business and pushing for maximum results, but they are now heavily involved in discussions with attorneys, CPAs, bankers, and wealth advisors to complete the deal. 1. Continue Running the Company Don t forget that the growth of the company is still being measured. A frequent obstacle to successful deals in recent years has been missing profit expectations late in the game. This is made even more difficult because now you are both dealing with buyers and running a company, but neither effort can afford to lose steam. 2. Be Aware of Confidentiality During negotiations, confidentiality is critical. There have been numerous occasions where deals have fallen through due to lack of discipline in this area. 3. Create a List of Things You Need to Keep Your Focus Understanding that this will be stressful, create a personal list of things you need to do in order to stay focused mentally. This list should include things like ensuring your personal phone numbers are unlisted, gaining the full support of your spouse, establishing recurring progress meetings within the inner management circle, keeping open communication with and leveraging your trusted advisors, and delegating whenever possible. Other things may include exercise, hiring a nanny and housekeepers, etc. 4. Key Negotiation Points By this point, you should understand your key negotiation points, and understand what to expect from the deal itself. Here are some common concerns: a. How will the purchase be made? Previously, it was very common to have stock being all or part of the deal. With the economic downturn and depressed share prices, many companies view cash as the cheaper currency for acquisitions. However, both may be on the table and worth evaluating. Morgan Stanley Smith Barney 5

6 b. Will the Owners become Key Employees Post- Transaction Sale? c. If you are going public or being purchased by a public company; you may become subjected to SEC Section 16 insider rules which generally apply to beneficial owners of more than 10% of the stock of a company and is an important distinction that requires filings and disclosures in addition to becoming subject to short swing profit rules. Furthermore, if you will be receiving stock subject to SEC Rule 144, selling Restricted and Control Securities; there will also be holding period and trading volume restrictions you will need to be aware of. This could be a good time to inquire about any 10(b)5-1 trading plans that may be available to monetize stock holdings in an orderly manner while complying with SEC and other Trading Rules. What techniques or strategies are permitted? There may be several effective strategies that can help you meet your goals and objectives Post- Transaction, but it is important to understand what restrictions will be in place. d. Will an Earn-Out be part of the deal? Basing part of the sale upon continued growth of the company is an increasingly common practice. Therefore, make sure you understand the benchmarks that will be used to evaluate success. e. Once the deal is complete, will there be residual ownership or employment? The importance of this obviously varies based upon the owner s goals; however it is an important consideration in any situation. Post-Transaction Considerations Now that the deal is complete, there are still several areas owners need to focus on to ensure an effective transition into retirement or onto their next venture. 1. Take your time It is not uncommon at this point to feel exhausted and just want to wrap things up. Unfortunately, this makes you prone to making investment decisions when you are not fully engaged or in a rush, which may result in poor investment decisions and/or improper management of wealth. Remember, there is no rush. Your Financial Advisor will assist you in developing short-term investment strategies. This will allow you time to decompress, relax, re-evaluate your goals moving forward and conduct proper planning before jumping into investment strategies. There is no such thing as a too good to pass up investment, but you are likely to hear about many of them from a wide variety of sources. 2. Review Goals Moving Forward Frequently, the financial, estate, and life goals of owners will change during the first six months following a large liquidity event. This is natural, and should be expected. Make sure to review and maintain open communication with your wealth advisor team about your changing goals so that they can be taken into account in your financial plan. 3. Update and Complete a Comprehensive Financial Plan Use the time following a sale to fully engage and review your financial plan to ensure your future goals and concerns are accounted for. True wealth advisors will help you manage your wealth and conduct advanced planning in various areas; some of which are listed below: a. Wealth Enhancement/Tax Planning This involves working with your tax advisor to make sure investments are in line with your individual tax situation and are positioned well in light of changing tax environments. b. Wealth Transfer/ Estate Planning In conjunction with your estate planning attorney, attention should be given towards how to best achieve your legacy and estate planning goals, including collaborating with your estate planning attorney to transfer your wealth efficiently without negatively impacting your retirement lifestyle or cash flow goals. Remember to consider how assets will transfer to your heirs and their ability to manage money and assets. c. Wealth Protection/Liability Planning With press releases announcing proceeds, and presumably liquid assets, you may become an attractive target for litigation. Pay special attention to how to possibly protect your family s wealth. An attorney, CPA, and wealth advisor should all participate. 6 Morgan Stanley Smith Barney

7 d. Charitable Giving/Philanthropic Planning If your goals include donating towards charity, special attention should be given towards finding the most effective way to incorporate this into your plan and investments. Proper philanthropic planning is critical to maximize the impact of your gifting strategy. 4. Create Investment Policy Following Plan Completion Once a thorough evaluation of goals, cash flow, estate, charitable, education and life goals has been completed and an updated financial plan is in place, it is time to begin looking at how to best manage the wealth that has been monetized from the sale. Establish an investment policy statement (IPS) to help set expectations and identify strategies to best protect the proceeds of your hard work. Planning for the sale of a business is a long-term process. Your Financial Advisor will review your plan with you and discuss how Morgan Stanley Smith Barney can work with your other advisors to assist in this process. 5. Budget for a Celebration Fund Following a successful sale, it is natural for owners to go on a spending spree without consideration of the impact on their overall plan. While it is important to celebrate the successful sale, budget an amount for this purpose. Planning for this in advance goes a long way in preventing an unnecessary squandering of wealth. Conclusion Selling a business will be one of the most important financial decisions you will ever make, and unfortunately there may not be an opportunity to redo it if the process gets off track. Proper and deliberate planning is essential in order to maintain control of the process and to ensure that the fruits of your labor are maximized within the context of your broader financial planning goals. We recommend that business owners, founders, and stake holders all begin planning long before the sale, follow a deliberate path, form a trusted team early, and leverage their expertise to help maximize success. Morgan Stanley Smith Barney 7

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