Clients who own a business, at some point, must think beyond their lifetime or at least their desire to work. For many, that eventually concludes with the sale of the business. Whether the sale is to a family member, employee or a third party, many financial planning opportunities need to be evaluated well in advance of that ultimate sale.
The opening conversation should be about when your client would like to exit the business. Many have a hard time articulating the “when” because they probably do enjoy how they spend their time in the business. Most CPAs and accountants will end the conversation as soon as the client indicates that they do not know when they would like to sell. But the accountant who really cares about the client will at least ask the client to choose a hypothetical jumping-off point so the planning can begin. The timing of when to sell is an important detail in the forecasting and planning for the client. The ideal situation is having a client who exits on their own terms, not because they have to.
The purpose of the initial number-crunching exercise is to help figure out how much the client needs to net to remain financially independent for life, as well as to fulfill any other financial objectives they may have. To do this, you will need to have a decent idea of what the value of the business is at the time of engagement. Of course, a full valuation is recommended, but many clients balk at forking out that kind of money when they don’t know when they may exit. At this point, you may ask the client what they think the business is worth and what valuation they’d like to use for the forecasts. Hopefully, they’ve paid attention to industry activity and have some comparable sale information inside their head. If not, pick a low number to be conservative, and let the forecasting begin.
Be prepared
No one knows what tomorrow may bring, so I believe that the best practice would be to have your client’s business in shape and ready to sell at all times. It is never too soon to be prepared to sell in case of the worst possible scenario, such as the owner’s death or disability.
This would include making sure that there is some level of financial statement package from an outside accounting firm that can be relied upon. Depending on the size of that business, it may be a compilation, review, or audited set of statements. For a very small business, a compiled set of statements and tax returns may suffice. For any business where a buyer is likely to utilize outside financing, a review or audit may be best.
For larger businesses, the audit would be the preferred set of financials presented to a prospective buyer. In fact, not just a set of audited financial statements, but audited financial statements from a larger firm with a solid reputation. If you are a small firm, do the right thing and encourage your client who is ready to plan for a sale to work with a larger, known firm for that engagement. You may still be involved with some of the work, but the report is best coming from the larger firm.
In addition to the financial statements, a quality of earnings report is also frequently desired by buyers and lenders alike. This is commonly a routine part of the due diligence process and is designed to flesh out one-time issues or matters not evident from the financial statements alone. Ideally, when your client decides to sell, there will be at least three years of such statements and reports already prepared. This helps in the event of a sudden need to sell the business. The cautious owner and advisor would encourage clients to start on this sooner rather than later so the sale process can be expedited, whether it’s voluntary or not. And, P.S., if it’s not a voluntary sale, and you already have these documents together, a buyer may have more respect for your client’s business savvy, which could ultimately lead to a higher purchase price or a quicker transaction.
In addition to the two aforementioned financial information packages, a diligent seller or advisor may suggest that your client begin building their “data room” as soon as they can. The data room is a term used to describe a place, typically electronic, where data is stored and ready for examination by any interested party. Most buyers will want at least three years of such data, so the sooner your client begins to build that, the easier it will be when they eventually do go to market with the company.
If your client is predisposed to an intrafamily sale or a group of key employees, this data may not be as critical, but it still matters.
If the sale is to a group of key employees, conversations are most helpful when started early in the process, assuming that these key employees have an awareness of the financials, including the owner’s compensation and profit distributions. In fact, if you’ve got the management team already in place to succeed your clients, you may start with smaller sales now, rather than waiting to do one large transaction later. The advantages of starting these transactions sooner are many.
First, you are giving the group of buyers a chance to have skin in the game now. This may keep them motivated to continue working hard to grow the business, rather than waiting until they stand to benefit via ownership. The second part of that is as owners today, they are now your client’s partners and owe the owner a duty of care that is more than implied as fiduciaries to each other. And third, it makes it easier for customers to view your client’s successors as owners already, thereby mitigating the possibility that the client’s retirement is viewed as a total change of ownership and leadership.
Keeping it in the family
For a sale to a family member or a group of family members, there are other considerations.
The first tough consideration is, is your client selling to them because they are family or because they are uniquely qualified to successfully run and operate this business profitably? If the answer is the former, they may want to reconsider or come up with a more robust plan. A sale based on nepotism alone may alienate their best employees, damage client relationships, and eventually cause a problem for the business.
They should consider having other nonfamily owners or at least key employees with employment contracts where they stand to benefit from continuing to profitably run the business. If their family member objects to this concept, they should have a meeting of the minds to talk about their thoughts or need to reconsider them as successor candidates.
It’s the same concept when a client has more than one family member. If they are all working in and familiar with the business, the client needs to immediately start by having titles and job descriptions for all family members employed. They need to set the stage that, like most businesses, this one will be professionally owned and operated. There will be a president, key management people, and whatever else is needed. If their brother is not capable of being president but can function as the director of customer service, he needs to understand that his compensation and benefits will be commensurate with the job, and not equal to the president simply because he is family. The benefits of employment need to be dictated by the job and performance. The benefits of ownership are those that are shared equally among the owners.
When there are family owners who do not work in the business, make sure that the corporate governance documents do not give them any operational powers. They can be owners, maybe even directors, if the client feels they have talent and energy, but nonactive owners who meddle too much may cause a rift that deteriorates over time. Business owners may be well advised to equalize their estates to exclude those not working in the business from future ownership.
One tactic that I’ve used successfully is to engage with a mergers-and-acquisitions specialist sooner than you may think necessary. Some firms will help with many matters as far as five years in advance of the sale. A good M&A consultant can give your client a current valuation for a reasonable cost, as well as deliver a report to identify the weaknesses they see in your business and what the client may do to improve. They should consider engaging with a firm each year up until the sale so they have some continuity and can start to track their advice and their execution on the idea. They may also help with spotting trends in the client’s particular industry or with buyers that can help the client be even better prepared to maximize
