Exit Strategies for Small-Business Clients

March 09, 2012

For successful entrepreneurs, the road into the business is often more clearly laid out than the route from involvement. However, a well-drawn roadmap for the endgame makes the difference between achieving success and missing the target on important life goals. As a result, preparing an effective exit plan provides a valuable service.

Laying the Groundwork

Since a viable entrepreneurial exit strategy must take account of both where your client is today and where he or she would like to be in the future, exit planning starts with a comprehensive appraisal of business and personal finances. Many planners find it valuable to start with their clients’ net-worth assessment. This not only helps to identify all available resources, but also to match those resources against specific goals (The assessment process also assists to identify potential opportunities for client relationships unrelated to the exit plan). Perhaps less objective but no less key to a successful exit strategy is values clarification. For example, if some or all of your client's children are involved in the business, does your client want them to continue in their current roles or expect that all will move on when the business is sold? Your client might have a clear choice for a successor, and might wish to consider how that choice will impact other family relationships. Keep in mind that many exit plans have foundered because of internecineconflicts. A related area of concern that forms a backdrop for the exit strategy is your client's vision for life after the event. Is he or she planning to retire? To remain involved as a consultant or part-time executive? To start a new venture in another field? How each of these questions is addressed will direct the practical thrust of the nascent exit strategy. Finally, a successful exit process is based on a sound understanding of existing business relationships and provisions. Your client should identify the key professional and executive talent in his or her firm, and then formulate appropriate reward and retention strategies for them.

Potential Deal Forms to Consider

The various choices of deal structure each offer unique cost/benefit tradeoffs (Options overview):

Buy-sell agreement - This arrangement is designed to permit the dissolution of a partnership by setting the parameters for some partners to buy out others. It enables one or more partners to maintain involvement in a business when others might wish to sever their ties to it. A buy-sell agreement requires careful design to ensure that its execution does not work at cross-purposes with other estate and succession planning tools.
Cash sale to a third party - A pure cash transaction may create the greatest immediate liquidity for the seller, but other financing structures may have the potential to generate greater net yield over time. A cash sale may also be the simplest means to execute a complete and immediate separation from the business.
Buyout or recapitalization - In leveraged transactions, partners, managers, or the business as a corporate entity borrows the funds to purchase the stock of the exiting entrepreneur. These deals may be especially useful for dissolving a partnership while otherwise maintaining the business as a going concern. They are also often used for transferring business responsibility to children or other heirs while creating financial independence from them. Recapitalizations can also be used to finance an annuity for a business owner who might wish to combine financial independence with limited business involvement.
Employee Stock Ownership Plan (ESOP) - An ESOP is a form of leveraged buyout designed specifically to give control of the business to a broad base of its current employees. ESOPs may have higher transaction costs than ordinary cash sales, but in many cases these costs are not out of line with the costs of other more complex deals. There are also specific tax benefits for ESOP transactions that may improve their net value significantly.

Managing the Proceeds

A key part of any exit strategy is the financial plan for managing the proceeds of the deal in a manner consistent with the client's post-sale goals. Such plans typically include a blueprint for investing sale proceeds in a diversified portfolio. They also typically include an estate plan crafted to take advantage of the trust structures and tax code features that allows you to preserve wealth and protect the future interests of heirs. Among the favored devices are family limited partnerships and grantor retained annuity trusts, which can reduce the estate value of shares passed on to heirs. In addition, many entrepreneurs are interested in charitable remainder trusts. These are used to fund philanthropic programs that realize specific charitable goals while maximizing tax benefits and minimizing costs.

Points to Remember

The sale of a business is only one small transaction at the center of a larger plan often referred to as an exit strategy.
The most successful exit strategies are those that give the business owners the greatest probability of comfort with the results as seen in their financial security, family dynamics, and long-range goals.
There are many options for structuring the sale of the business, and each has different implications for other elements of the broader strategy. Buy-sell agreements can help maintain continuity for remaining partners in a wide range of circumstances. Pure cash transactions typically yield the greatest immediate liquidity. Leveraged transactions may enable managers, partners, or family to take over and maintain continuity for the business. ESOPs can provide tax benefits and empower employees.
Trusts can be valuable tools for managing the income tax and estate planning implications of the wealth derived from a business sale.

If you’d like to learn more, please contact Angel Chavez, CIMA® at 415-984-6008 http://fa.smithbarney.com/angelchavez. Morgan Stanley Smith Barney LLC, it's affiliates and Morgan Stanley Smith Barney Financial Advisors do not provide tax or legal advice. This material was not intended or written to be used for the purpose of avoiding tax penalties that may be imposed on the taxpayer. Clients should consult their tax advisor for matters involving taxation and tax planning and their attorney for matters involving trust and estate planning and other legal matters. The author(s) and/or publication are neither employees of nor affiliated with Morgan Stanley Smith Barney LLC ("MSSB"). By providing this third party publication, we are not implying an affiliation, sponsorship, endorsement, approval, investigation, verification or monitoring by MSSB of any information contained in the publication. The opinions expressed by the authors are solely their own and do not necessarily reflect those of MSSB. The information and data in the article or publication has been obtained from sources outside of MSSB and MSSB makes no representations or guarantees as to the accuracy or completeness of information or data from sources outside of MSSB. Neither the information provided nor any opinion expressed constitutes a solicitation by MSSB with respect to the purchase or sale of any security, investment, strategy or product that may be mentioned. Article written by McGraw Hill and provided courtesy of Morgan Stanley Smith Barney Financial Advisor Angel Chavez, CIMA® Morgan Stanley Smith Barney LLC. Member SIPC.