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Six Costly Mistakes That Business Owners Make When Exiting Their Business
Wednesday, September 17, 2014
The wealth of many boomers is tied up in businesses they own, and this can be a problem when it comes time to exit. Most owners are not prepared for the day when they want to cash out. They have not taken the time to determine what their business is really worth. Others diminish their company’s value by delaying letting go.Advance planning for the extraction of equity from a business is imperative, and the process is complex and time consuming. Moreover, the tax consequences can be huge without proper advance planning even when transferring ownership to the next family generation without a sale. Below are some of the most common mistakes business owners make when they want to exit, and how these mistakes can be avoided.
Mistake #1:Operating a business that is too reliant upon the owner
An owner typically spends years building and managing the company. When deciding to exit, they often still function as chief executive and continue to make key decisions in the areas of marketing, sales, and client service, even if they have hired qualified employees to whom they could delegate daily operating functions. They are the business! Having a business that is too dependent upon the owner or a handful of major customers can dramatically reduce the value of the company. Potential buyers are likely to perceive more risk. The owner ends up selling his business for less than originally planned and is required to stay on longer to increase value and ensure a smoother transition.
Mistake #2: Ignoring the tax reduction benefits of planning ahead
A growing number of baby boomer business owners will be exiting their business in the next five years, and probably will not receive the money they are hoping for because the taxes owed will gobble up a lot of the value they worked so hard to achieve.
Not planning ahead can be costly even if the business owner intends to gift equity to the next generation family members instead of selling the business. If the business is growing, it’s growing in value as well. A business that doubles in value over the next five years will potentially pay a much larger gift tax so it’s beneficial to start the gifting process sooner than later.
Mistake #3: Incorrectly valuing the business
We recently began working with a business owner client who is the founder of successful consulting firm. We calculated he required $7 million in order to maintain his lifestyle for his and his wife’s lifetimes. He was incorrectly optimistic that his business would be worth that much. The result was that he now has to continue working and significantly adjust his retirement plans. All too often, owners base their retirement plans on faulty assumed valuations, causing drastic overhauls in retirement plans, not to mention blows to their self-esteem. Therefore, well in advance of retiring, business owners should get a realistic appraisal of their business, to determine whether it will provide what they will need for lifetime retirement income. Also essential is understanding if there is a market for the company, how liquid the market is for lending and equity, what buyers are paying for similar companies and how they are structuring the deals.
Mistake #4: Rushing to accept a high offer
Sellers often jump at what appears to be the highest bidder, ignoring other bids. But that high bid may be misleading if the seller does not take into account the due diligence that the buyer is undertaking, and how that could change the final number. The seller also ignores other crucial elements of the bid, such as how employees will be treated, or how the buyer will finance the deal. In the end, the seller may have ignored what would have been truly the best deal. Do not be deluded by what is superficially the richest offer. Big numbers sometimes are used as a distraction. Stay focused, and anticipate how the due diligence the buyer is undertaking could subsequently change the offer. Consider all aspects of the transaction, not just the nominal price.
Mistake #5: Hiring family member, friend or existing long-time advisor to do the deal
While an accountant or attorney may have served the business owner well over the years, they may not have the specialized expertise required at exit time, and that can be very costly. Too many business owners continue to rely upon existing advisors who might be fine for the day to day, but which can be foolhardy when looking to exit the business. It is important to have know-how experience to structure the deal, helping with negotiations, and ultimately, getting the dollar amount required for the business owner to enjoy life beyond the business.
Mistake #6: Under estimating the emotional impact of selling a business
Business owners need to be thinking in advance about what their life will be like after exiting the business. It is a transition period that requires focus and adjustments being made for the entire family. Because the owner’s sense of self and purpose is often wrapped up in their business, letting go is often more difficult than they realize, and sometimes causes them to become bored, or even worse, depressed. Owners should map out their post-exit lifestyle well in advance of leaving the business. Deciding and imagining in detail how they are going to spend each day for the six to twelve months after exiting can help smooth the transition, and make living the new non-business lifestyle exciting. Or, maybe even deciding to do consulting work or start a scaled-down version of their former business is the solution, enabling them to stay in the business they love and adjust to a less demanding, more flexible schedule.