Time is Essential In the Transfer To Insiders

Time: Too Much or Too Little?
Active business owners seldom slow down. We all know that the only things likely to reduce your pace are death or terminal burn-out. This is not to imply that you are not well intentioned; quite the contrary. You are so well intentioned that you’ve taken on more tasks than you can possibly complete.

Indecision: The WRONG Decision
“I haven’t decided what I ultimately want to do with my business, or when I want to exit, or how much money I’ll need, or whom to sell to, so how can I plan my exit? Besides, I don’t want to exit right now.” If you’ve said this, or thought it, you are not alone. Many business owners are either overwhelmed with the thought of exiting or are so busy fighting daily business fires that they think they cannot plan their exits.

Meet Today's Challenges and Exploit Today's Opportunities 
Over the past few months we have shared with you a number of ideas about how you and your company can approach both the challenges and the opportunities that this economy has thrown at all of us. We’ve discussed specific issues such as fraud, and more general issues such as preserving value, focusing on cash flow, increasing revenue and keeping all actions consistent with your ultimate goal: leaving your company when you want, to the successor you choose, for the amount of cash you want or need.

Fraud - Do you know it when you see it? 
The subject of employee dishonesty is a delicate one. Owners generally want to trust their employees, and given all the other battles owners fight on a daily basis, they are often not as vigilant as they can or should be. Vigilance requires an investment of time and money in return for an uncertain payoff. So let’s look at a typical fraud scenario.

Preserve and Protect Your Business On All Fronts 
We kicked off our discussion with the final item — creating value — because today, most owners are so focused on cutting expenses and minimizing risk and taxes that they’ve ignored their ultimate goal: creating a company with enough value to leave it for an amount of money that will support them — in style — for the rest of their lives.

Time is Essential in the Transfer to Insiders
In this series of articles about transfer to insiders, we identified a number of elements that are part of the well-designed transfer to insiders. The first element we identified was the qualifier: Time.

In this series of articles about transfer to insiders, we identified a number of elements that are part of the well-designed transfer to insiders. The first element we identified was the qualifier: Time.

We suggest that the first question an owner considering a transfer to insiders ask is: Am I willing to take time (typically 3-8 years) to execute and complete an insider transfer? If the answer is no, then this type of exit is off the table.

Transfers to insiders take time: time to plan and, most critically, time to implement. The good news is that in the typical case, the more time owners take to transfer the company, the less risk they incur and more money they receive from the new owners.

Time to Plan.

Advisors trained in Exit Planning know how to design successful transfers to insiders. If you call your advisor today, it could take as few as 60 to 90 days to create your plan to exit via a transfer to insiders. Those days are vital and necessary, but just the beginning.

Time to Implement.

The lion’s share of the time needed for an insider transfer is spent implementing that transfer. During this three- to eight-year period, owners work to build the value of their companies, transition management responsibilities to their management teams, and actually sell a substantial portion of their ownership to the insiders.

Building Value.

Because the company’s cash flow supports the purchase price, owners must focus their energy on supporting business value and cash flow. We recommend that they concentrate on the Value Drivers we’ve talked about (and will talk about again) in this newsletter. To review, those Value Drivers include:

A stable and motivated management team;
Operating systems that improve sustainability of cash flows;
Operating profit margins, at least as good as industry average;
A solid, diversified customer base;
A competitive advantage
A realistic growth strategy;
Effective financial controls; and
Good and improving cash flow.

Keep in mind that there may be additional value drivers specific to your industry.

While owners pursuing a sale to a third party also work on enhancing their companies’ Value Drivers all of the value those owners expect to realize must be created before the sale event (as that determines the amount of money the seller receives).

In a sale or transfer to insiders, however, the initial transfers of ownership often begin many years before the transfer of the bulk of ownership and control. This allows the KEG (key employee group) to demonstrate a serious interest in growing business value because it owns part of the company and because increasing the cash flow of the business will enable it to buy more in future years.

As the insider buy-out occurs, the owner receives increasing amounts of cash (payments for his/her ownership interest) at ever increasing values and is entitled to increasing cash distributions with respect to his/her remaining ownership.

Thus, a central feature of most well-designed insider transfers is to keep the original owner in control over time (perhaps three to ten years, depending on the owner’s objectives) so that the owner receives most of his or her sale price before leaving the company.

It bears repeating that the key to successful insider transfers is to create a generous timeframe so that:

owners can make incremental annual transfers of small percentages of ownership interest as insiders/buyers attain the performance standards the owner sets. (Those performance standards are designed so that the KEG is only permitted to acquire more ownership if cash flow increases each year.) And
the KEG has ample time to pay for the ownership that they are acquiring.

Transferring Management Duties. As owners work toward their exits, they need to transition a variety of management duties to the new owner. To do so, it is important to create, at least five years in advance of your target date, a time-based plan that determines who will take over which tasks within a set timetable.

Some owners are able to accomplish this fairly quickly because they’ve already delegated management responsibility. Your advisors can help you figure out where you are on the management transition continuum. We’ll just provide an overview of the types of duties that need to be transferred: