Owners who start to think about exiting their business often fancy the idea that someone else will certainly want to own their company after them. These owners look at the struggles that they faced to get the business up and running relative to the stability and lifestyle that they are living today. The natural thought that crosses these owner’s minds is that another person or company would surely want to have ownership of this now stable business and gain access to the cash flow and opportunities that it presents. To these owners, we want to share the two (2) critical elements that are necessary components of any business transfer. Those two (2) elements are (1) someone who really wants to sell/exit the business, and (2) someone who really wants to buy / own the business after you. So, this newsletter examines these two (2) critical issues and what owners can understand to help make for a more successful transaction.
Why These Two (2) Elements Are Required
The reality of business exits is that there is a tremendous amount of complexity involved. History shows that in order to make it through these challenging levels of complexity there really needs to be two (2) highly motivated parties, one seller and one buyer. At the end of the day, negotiations will center around what the future may or may not bring to the next owner. Many potential transactions fall apart at this stage in the transition. Therefore, it is often said that a ‘good deal is struck when each party is equally unhappy with the final outcome’. In this context it is important to see that without some motivation pushing both the seller and the buyer, it becomes all too easy for either party to walk away from the negotiations that surround these transactions.
The Owner’s / Seller’s Mindset
As stated earlier, an owner will often believe that ownership of his business would be desirable to a number of potential buyers. For that reason, the owner feels as though he / she has a lot of leverage in the initial phase of the exit process. Many owners approach the potential transaction with a feeling that they need to negotiate from a position of strength in order to get the optimal result and showing any kind of weakness as to wanting or needing to sell will reduce their standing in the negotiations. There is a bit of truth to all of this.
However, the owner who does not truly understand why they are motivated to sell is likely to take too hard a line in the negotiations and resort to the notion that they are perfectly fine with life as it is and will reject the buyer’s advances, creating a failed transaction. The owner who does not really want to sell or exit is likely to not go the distance with the negotiations because they are not clear on why they are looking to transition ownership in the business to someone else.
Alternatively, the seller may hold out in the negotiations because they have an inflated expectation of the value of their business. In fact, this is the primary reason why most business exits fail. Therefore, if you know why you want to exit and you are committed to the process, it is really good idea to incorporate a realistic range of values in your exit planning process to avoid this trap.
The Buyer’s Mindset
Now let’s take a look at the buyer of a business. From the buyer’s perspective, they don’t know what they are going to find when they look to acquire a privately-held business. There are just as many risks in what they don’t know about the business as there are in what they do know. Now, even though many of these risks can be mitigated through the legal agreements that are signed, the reality is that a buyer wants to see a ‘clean’ transaction because they are going to invest a tremendous amount of their resources into making a successful acquisition.
If the buyer is not ready to navigate the unknown and work with the exiting owner to understand all aspects of the business, then they too are likely to back away from the process midstream. Buyers need to want to own your business and you need to understand their motivations for doing so. You see, it’s not just about the cash flow. Buyers have endless other motivations for wanting to purchase and own your business into the future. If you do not know why they are interested in owning your business as well as their level of commitment to the process, then you need to dig further. You see, one of the most damaging things that can happen to a seller is that a buyer backs away at the last minute for unknown reasons. At these later stages in a transaction, the seller asks other buyers to go away as a transaction is pursued with your chosen buyer. Having that buyer back out of the process because they are not committed can have very negative consequences not only to the immediate transaction but, potentially to future transactions as well.
Determining the Motives of the Players
So, how do buyers know that an owner is ready to exit and how do owners know that buyers are committed to the process?
Well, an owner who has spent a few years preparing for the transaction demonstrates an intention to see the transaction go through smoothly. That owner has evaluated why they want to sell, what selling price is required for their lifestyle, whether that selling price is reasonable, and what they are going to do next. The company is ready for a new owner and the evidence is clear when a buyer arrives – we call this the ‘exit planning process’ and it improves the confidence that buyers have in the seller’s motives and overall preparedness for the transaction.
So, how do sellers know that a buyer is truly interested in owning their business? Well, this one can be a bit more difficult because buyers will not always share all of their reasons. After all, if they really see that they can do more with your business than you can and they share all of it with you, then you may just try to do it yourself. Instead, a fall-back position may be to ask to interview other companies that the buyer has purchased to find out from the other exiting owners how the process was handled. By interviewing the owners who have already exited you’re likely to get an honest accounting of how your buyer conducts themselves through the process.
Having a seller who wants to exit and a buyer who wants to come into ownership really are two (2) critical elements of any transaction. Understanding the motivations of the buyer of your company will help you build your confidence not only in their ability and willingness to complete your transaction, but also in the future of your company in your new owner’s hands.
Pinnacle Equity Solutions © 2013
By Meribah Knight May 21, 2013 from chicagobusiness.com
It’s called a multiplier effect: when one job generates another job that is dependent on that job, and so on. In the Chicago area, each new manufacturing job creates another 2.2 jobs in the region, on average, according to a new study by the University of Illinois at Chicago.
The most robust areas for job multiplicity are in the manufacturing of petroleum and coal products and in pharmaceuticals, each generating 8.3 and 5.7 jobs, respectively, in the region, according to the report from UIC’s Center for Urban Economic Development.
The study found that chemical manufacturing generates 3.8 jobs, and beverage and tobacco products create 3.6 jobs. Textile manufacturing jobs came in last, generating only 0.5 additional jobs, the study found.
“Most of these industries are powerful job creators,” said study co-author Howard Wial, executive director at the Center for Urban Economic Development and a Brookings Institution fellow. He worked on the report with Elizabeth Scott, an economic development planner in the Center for Urban Economic Development.
To find the overall multiplier, the study added each new manufacturing factory job with jobs in supply industries, and then jobs in service industries that each manufacturing employee patronizes. The study, which begin measuring the impact with only factory jobs — it does not include research and development or administrative positions at manufacturing companies — analyzed seven counties in Illinois: Cook, DuPage, Kane, Kendall, Lake, McHenry and Will.
The Chicago region’s overall average of a 2.2 job multiplier for the manufacturing industry is on par with other metropolitan regions, Mr. Wial said. On a national scale, the multiplier for a manufacturing job is 4.6, higher because of a larger geographic scope for supply chains and induced spending.
Manufacturing tends to have a higher multiplier than other industries because of its sturdy wages and long supply chains, Mr. Wial said.
The finding that petroleum and coal — realized mainly as the region’s oil refining industry — generated the most impact in the Chicago area was unexpected, Mr. Wial said. He said it was surprising to find that the region’s oil and coal industry had such a lengthy supply chain, making even more of an impact than automotive or machinery sectors.
The report found that Chicago’s two largest manufacturing industries, food and fabricated metal, create 2.6 and 2 additional jobs, respectively.
“When a new job in an industry leads to the creation of even one other job in the region, that’s a very good return,” Mr. Wial said. “That’s why policymakers still prize manufacturing for its potential to create jobs, despite growing automation.”
In other words: Even while manufacturing jobs dwindle as human capital is replaced with robots and automated machinery, a higher output will still result in more jobs, Mr. Wial said.
“Industries with higher productivity typically pay higher wages, leading to more induced jobs,” he said.
And the region’s recent growth in the manufacturing sector can only mean good things for putting the multiplier into action.
“Until recently, offshoring, consumer spending on imported goods and the growing use of out-of-region suppliers reduced manufacturing’s impact on job growth in the Chicago area,” Mr. Wial said. “The recent rebound of manufacturing employment may change the situation.”
By Paul Merrion May 14, 2013 Crain’s Chicago Business
State tax officials plan to withdraw a little-noticed proposal to impose Illinois sales tax on delivery charges after a bipartisan panel of lawmakers raised objections today.
The proposed regulation was strongly supported by Illinois retailers, who saw it as a way to stop a spate of costly whistle-blower lawsuits claiming that they owe sales tax on any shipping charges beyond the actual cost of delivery.
It’s a quirk in state law that the Illinois Department of Revenue wanted to clear up by making all delivery charges taxable, regardless of actual delivery costs, unless they are provided by a third party.
“Retailers need a bright line,” said Rob Karr, a lobbyist for the Illinois Retail Merchants Association. “We don’t know at the point of sale what (the actual cost of) delivery charges are going to be.”
But the rest of the state’s business community fought hard to block the proposal, saying that such a major change in tax policy requires legislation, not a change of regulation.
“For a lot of places, this (would) be a tax increase” if the proposed regulation had been adopted, said Carol Portman, president of Springfield-based Taxpayers’ Federation of Illinois, a business-supported tax watchdog group.
After quietly working through the rulemaking process for a year, the proposed regulation was about to become final when it ran into objections today from the Joint Committee on Administrative Rules, or JCAR, a little-known legislative body that can suggest changes or even block state regulations from taking effect.
Although JCAR voted to raise objections to the proposed rule, it stopped short of the three-fifths majority needed to prohibit the rule from becoming final. That means the Revenue Department has 90 days to respond to those objections in writing, after which it could still adopt the rule, with or without making any changes.
However, at the meeting a representative of the tax agency told Sen. Don Harmon, D-Oak Park, the panel’s chairman, that the rule would be withdrawn if JCAR filed objections, which the panel then proceeded to do by a unanimous voice vote.
Approving the proposed rule would have been “fraught with peril,” the senator said in an interview. “The department will withdraw and re-engage and see if a more palatable solution might be constructed.”
Said Ms. Portman: “We’ll work with them this summer to figure out a better way to accomplish their goals.”
A spokeswoman for the Revenue Department said agency officials are “reviewing our next steps.”
Business owners are well served in understanding the market forces that will likely impact their attempt to successfully exit their business. In 2009, Richard M. Trottier published a ground-breaking book titled Middle Market Strategies. The statistics that are provided in this newsletter are drawn from Richard’s book and are presented here to paint a picture of how dramatically the small business marketplace has changed in the last twenty to thirty years and to help you draw some conclusions on how these changes may impact your plans for a successful exit.
Richard begins Chapter 10 of his book with the following quote:
“The number of middle market businesses will have doubled between 1980 and 2010. Transfers will have tripled . . . it is safe to say that the middle transfer market is become more mature . . . in the sense that it better addresses the needs of its participants, at least those participants who know how to use it to their best advantage.” Trottier goes on to state that “the business transfer market now has more of everything: more deals, more buyers, more sellers, more transfer methods, more complexity, and more of each developing.” It is clear that this is a fluid marketplace with many changes. Let’s begin by looking at some trends from the past 30 years.
Key Trends That Could Impact Your Exit Plans
One of the first concepts that an exiting owner needs to embrace for a successful exit is the shape of the market that surrounds them and by examining the trends in that market it helps to understand it better.
Some Numbers Behind the Baby Boomer Trend
The first [more obvious] trend that owners need to be aware of is the surge of retiring baby boomer owners. To put this trend in perspective, Trottier writes “the number of mid-market business transfers doubled in the 22 years between 1980 and 2002. It is likely to double again in the eight years through 2010. We estimate that there were a maximum of 10,000 mid-market business transfers of all kinds in 1980. In the year 2010 they may reach 38,000. The number of transfers is growing faster than the number of businesses.”
To support these statements, Trottier offers a measurement of the middle marketplace as those businesses with $5 million to $500 million in revenue. He estimates that there are 300,000 of these businesses. He further states that “in 1980, the middle market had an estimated $635 billion in shareholder equity. It will reach $1.5 trillion by 2010.”
Trottier also points out that an avalanche of capital has come into the U.S middle market to support this growth. He states that “total middle market capitalization will rise from an estimated $1.8 trillion in 1980 to $4.2 trillion by 2010.” These capital providers create more complexity as owners need to know these sources and understand which ones are most appropriate for their growth and transfer needs. This is no longer the province solely of the community banks.
Private Equity Groups (“PEGs”
One of the leading sources of capital in the transfer markets is private equity. “In 1980 individual owners held about 91 percent of market equity; by 2010 they will hold only about 59 percent.”
He goes on to state that “we estimate that PEG investment in the mid-market in 1980 was $57 billion – at most. By conservative estimates it will reach $600 billion in 2010.” Another way to look at this change is to see that “PEGs controlled 10 percent of total private mid-market capitalization in 1980. They may control 48 percent by 2010.” In terms of numbers, Trottier estimates that “[PEGs] already own 30,000 to 35,000 of the 300,000 middle market companies, including many of the larger, top-performing firms.”
Underlying these new investors is another dynamic that is relatively new – an active and growing secondary market for the purchase of businesses bought by PEGs. You see, once a private equity group invests in a business, the mandate is [most often] to sell that business again in another 4 to 7 years at a higher price. Therefore, the PEG purchase today is going to lead to a cycle of increased transfers in the future, creating more competitive pressure for your day-to-day business as well as a more competitive market for you to sell into when it is your time to exit.
Trottier concludes with a message to owners unaware of these changes . . . “Gone are the underfinanced, struggling family businesses of days gone by. They’ve been replaced by well-financed, professionally managed, very aggressive competitors who are out to redefine markets.”
Knowing about these changes to the market may help inform you as to how you might successfully transition your business. You may find that you need to get to know these groups better or you may choose otherwise.
What About Keeping the Business in the Family?
Many owners react to the news about the changing external transfer marketplace and think that they’ll avoid this by selling to their family members. Trottier writes: “conveying full business control within a family represented about 30 percent of all transfers in 1980. This type of transfer may be as low as 15 percent of all transfers in 2010, depending on market conditions.” Trottier concludes that “family transfers declined 50 percent in one generation”.
Owners who are thinking about an internal transfer need to also navigate the generational divide and the different work ethics that are instilled in the next generation. Simply put, it appears that junior simply does not want to waste his expensive education on distributing widgets for the rest of his life. Further, junior sees how hard Dad works and is not aligned with this ‘career path’ either. If you were / are thinking about a transfer to family members, you may want to review these statistics and changes in attitudes to check the validity of many assumptions that you may be holding onto.
As mentioned, you wear many hats in the day-to-day running of your business. The statistics presented in this newsletter represent an ever-changing marketplace for smaller businesses. There have certainly been many significant changes to the middle marketplace in the last 30 years, many of which will likely impact your business plans as well as your plans for a successful exit. We hope that these statistics provide a basis for further examination as to how you will achieve a successful exit in the future.
Pinnacle Equity Solutions © 2013
By Kevin Daum Apr 16, 2013
As humans, even entrepreneurs must avoid temptations that easily derail success. These tips help you stay on the straight and narrow path to success.
The entrepreneurial life is filled with fun, excitement, and action. It’s fast moving and dynamic. It’s also filled with many choices. Some lead to happiness and success, but many others lead to destruction and failure. Whether you are an actual entrepreneur or simply entrepreneurial in your role, you are still susceptible to overindulgence.
The following are the most common traps that derail leaders from their intended vision. I’ve also listed simple ways you can protect yourself from falling victim to these temptations.
The trappings of success have lots of appeal. The vision of cash, fame, fast cars, and fancy houses can draw valuable focus, energy, and resources away from what is really important about building a business. Entrepreneurs seduced by lust will spend much-needed time and money on status items before the business is solid, putting the entire operation at risk.
Avoid temptation by setting a legitimate standard for success of the business before indulging in your own rewards. Keep the focus on building a sustainably profitable business with capital reserves that exceed one year of fixed overhead. Then you will have plenty of extra dough to reward yourself, and you’ll be relaxed enough to enjoy it.
A healthy appetite for business is good, but companies need to grow in a controlled and moderated manner to achieve great success. Entrepreneurs seduced by gluttony will take on too much before their infrastructure is solidly in place, ultimately delivering poor performance and ruining their reputation before it’s fully established.
Avoid temptation by setting targets based upon a manageable rate of growth. Be cautious about building sales beyond your infrastructure; make service and reputation your first priority for sustainable growth.
It’s important to maximize profits, but not at the expense of the long-term health of your company, industry, and reputation. Entrepreneurs seduced by greed will make immoral decisions that may increase short-term returns via shortsighted policies in pricing, marketing, and personnel, doing damage to their reputation and sustainability.
Avoid temptation by taking a long-term view. Build a reputation for playing fair with your employees, customers, and industry, including competitors, and they all will help you foster long-term growth and profitability instead of taking advantage of you at every opportunity.
Successful entrepreneurs know that hard work is required, and real, sustainable success takes time to develop and prove. Entrepreneurs seduced by sloth will make sloppy choices involving untested business models and marketing techniques, burning valuable resources and putting everyone involved at risk.
Avoid temptation by doing your homework, managing impatience, and testing constantly before committing other people’s resources and reputations. Remember, not every idea is a good one just because you are passionate about it.
Passion is a critical entrepreneurial component. Uncontrolled passion, however, can lead to irrational behavior and decisions. Entrepreneurs seduced by wrath will let unbridled emotion reign, creating fear, anger, and destruction internally and externally.
Avoid temptation by concentrating on the desired results. Practice self-awareness and determine the appropriate level of fire to remain a gracious leader.
It’s good to compare in the competitive landscape. But being hypersensitive every time your competition gets a win will take its toll on your progress. Entrepreneurs seduced by envy will spend so much of their time and resources trying to battle and sabotage competition that they will miss their own unique opportunities to perform and maximize growth.
Avoid temptation by concentrating on your own achievement. You will win some battles and lose others to those who perform well. But building a business is a marathon, not a sprint. You will prevail if all your energy is directed to maximize your own performance with little distraction.
A healthy ego is helpful when building a business. But too much pride can keep you from seeing the necessary truth. Entrepreneurs seduced by pride will insist their ideas are always the best and be closed to outside suggestion just to feed their ego.
Avoid temptation by being an open learner. Focus on being successful rather than trying to be right. Success has greater enjoyment when built on the contributions of many.
Mark’s comment: What is your ACA strategy? Feel free to contact me for assistance in assessing your alternatives.
By EMILY MALTBY And SARAH E. NEEDLEMAN, WSJ.com
But Rick Levi, a business owner in Des Moines, Iowa, is among those considering the government’s escape hatch: paying a penalty to avoid the law’s “employer mandate.”
Under the Affordable Care Act, employers with 50 or more full-time workers will be required to provide coverage for employees who work an average of 30 or more hours a week in a given month. An alternative to that mandate is for business owners to pay a $2,000 penalty for each full-time worker over a 30-employee threshold.
Mr. Levi currently spends about $140,000 a year on insurance premiums to cover 25 managerial staff at his business, Consolidated Management, which runs cafeterias at schools, offices and jails.
Under the new law, he will have to offer insurance to all of his 102 full-time employees starting in January. Assuming all of them take the coverage, Mr. Levi says the cost of premiums could exceed $500,000.
Small-business owners are grappling with whether they will offer health insurance to employees next year under the health-care law, or pay a penalty. Here are their considerations:
Offering Health Insurance:
Average premiums were $5,615 for single-person coverage, $15,745 for family coverage, in 2012.
Firms with health benefits can be more competitive in the labor market.
Premiums may be tax deductible.
Taking the Penalty:
Costs $2,000 per full-time employee, minus the first 30.
Removes the administrative burden of shopping for insurance.
Puts the onus on employees obtain coverage elsewhere.
“I’ve never made a profit in any year of the company that has surpassed that amount,” says Mr. Levi, 62 years old. “I don’t make enough money.”
He says it makes more sense to drop insurance entirely and pay a penalty of about $144,000.
Gary Epstein, owner of Firstaff Nursing Services Inc. in Bala Cynwyd, Pa., has similar plans. He intends to stop offering health insurance benefits at his home health-care company.
Mr. Epstein, 52, employs about 250 workers and currently provides health insurance to his 20 office personnel. If he were to start covering the 100 or so nurses and nursing assistants that work full time, his annual health-insurance costs would jump to roughly $600,000 from the current $100,000, he says.
Even if he takes the penalty option, he estimates he would have to pay about $240,000—a cost he doesn’t think his business could absorb. To compensate, he plans to cut the number of hours his nurses and nursing assistants work so they will be considered part-time under the law. He says he will hire more part-timers to ensure patients receive the same level of care.
“We’re going to do everything we can in order to stay in business,” he says.
The Department of Health and Human Services and the Treasury Department point to studies that suggest most employers aren’t expected to drop coverage. The Center for American Progress, a liberal think tank, found that the number of people in Massachusetts with employer-sponsored health insurance didn’t dip in the years following the passage of that state’s 2006 health-reform law, which was a model for the Affordable Care Act.
“This law will decrease costs, strengthen small business and make it easier for employers to provide coverage to their workers, as we saw in Massachusetts, where employer coverage increased when similar reforms were adopted,” says Erin Shields Britt, a spokeswoman for the Department of Health and Human Services.
Among 400 employers with 50 workers or more, 71% said they plan to continue offering health insurance while just 3% said they plan to pay the penalty, according to a February survey by the National Small Business Association, a nonpartisan entrepreneur-advocacy group in Washington, D.C.
One potential drawback to the penalty strategy: taxes. Health insurance is deductible as a business expense, but penalties aren’t.
Nearly half, or 46% of 889 small-business owners surveyed by The Wall Street Journal and Vistage International say they don’t know if providing health insurance will be more or less costly than facing penalties. More than three quarters, or 77%, polled online from March 11 to March 20, expect their health-care plans to cost more next year under the health-care law.
To avoid the employer mandate, some small firms are considering other strategies, such as increasing employees’ share of the premiums, so they don’t have to shoulder the entire cost of offering benefits. Others say they will stay under the 50 full-time employee threshold or deliberately turn full-time workers into part-timers. Average annual premiums for employer-sponsored health insurance in 2012 were $5,615 for single coverage and $15,745 for family coverage, according to the Kaiser Family Foundation.
Lois Rosenberry, owner Children’s Discovery Center Inc. in Maumee, Ohio, says she will opt for the penalty if it is cheaper than offering health insurance. Just 65 of the 150 full-time employees at her business are on its health plan today. But like Mr. Levi and Mr. Epstein, she says she can’t predict how many of her remaining employees will go onto the company’s plan next year, when all individuals will be required to have health insurance. Some of those who don’t take the benefit today may take it next year, while others may opt to go on a spouse’s plan or get coverage through the individual insurance markets, says the 64-year-old.
“It’s very frustrating for us as a small business in terms of planning,” she says.
Mr. Levi, the food service entrepreneur, is worried that failing to offer insurance could entice employees to seek employment at competing businesses that do offer benefits.
“If we don’t offer coverage, will it be harder to hire people?” he asks. “That’s the unknown.”
(AP) — Orders to U.S. factories rose sharply in February from January on a surge in demand for volatile aircraft. The gain offset a drop in key orders that signal business investment.
The Commerce Department said Tuesday that factory orders increased 3 percent in February. That’s up from a 1 percent decline in January and the biggest gain in five months.
The increase was due mostly to a jump in orders for commercial aircraft. Those orders rose 95.1 percent. Orders for motor vehicles and parts also increased 1.4 percent.
Orders for all durable goods, which are products expected to last at least three years, jumped 5.6 percent. Orders for nondurable goods, such as processed food and clothing, rose 0.8 percent.
Despite the gains, the report showed that a key measure of business investment plans fell. That could mean that some companies were worried in February about steep federal spending cuts that started on March 1.
Core capital goods, which include machinery and equipment orders, fell 3.2 percent. Demand for construction machinery, turbines and generators all fell sharply. Orders for computers and electronic products rose slightly.
Economists closely watch these orders because they signal business investment plans.
Still, the decline followed a 6.7 percent surge in January, the largest in nearly three years. Analysts said that when averaging the two months, business investment orders showed a solid increase for the January-March quarter. Many expect the gains to resume this spring, helped by a stronger job market that has kept consumers spending.
Consumers stepped up spending in February after their income jumped. The gain occurred even after Social Security taxes increased in January, reducing take-home pay for most Americans.
Many economists raised their growth forecasts after the report was released. Some are predicting that growth could increase to around 3 percent in the January-March quarter, up from 0.4 percent in the previous three months.
Other data show that some companies may start to pull back because of the government spending cuts.
The Institute for Supply Management reported Monday that U.S. manufacturing activity expanded more slowly in March than February, held back by weaker growth in production and new orders.
But factories did hire at the fastest pace in nine months, which was seen as an encouraging sign ahead of Friday’s report on employment in March.
The economy has added an average of 200,000 jobs a month from November through February, which helped lower the unemployment rate in February to a four-year low of 7.7 percent.
Economists predict a similar level of hiring in March.
Business owners who are considering how and when they will cash in the shares of their privately-held stock are often curious about whether or not an Employee Stock Ownership Plan (ESOP) can be of assistance in helping them reach their goals. Although there are many details to ESOPs that need to be examined with the assistance of professional resources, the summary is that there is an exchange of unique tax incentives for owners who are willing to share the equity in their business with their employees. The ESOP is an ‘internal’ transaction, providing privacy and control so owners do not have to take on new partners and, for the most part, can keep things running the way they want. This blog post highlights five (5) areas of primary benefits that an
S-corporation ESOP provides to owners to assist you in determining whether or not this unique tool will help you reach your exit goals.
1. The ESOP Structure Provides Continued Control for the Owner
The first benefit of an ESOP is in its structure. As mentioned above, a typical ESOP structure allows an owner to maintain control of their business and achieve personal diversification. Some of the benefits of structuring an ESOP transaction are that it is a [relatively] low-cost savings plan for the exiting owner. The ESOP therefore is a very useful tool for owners who are not mentally prepared to exit and want to keep their job, salary and reasonable company perks. The ESOP gives owners the flexibility to sell any number of shares to the ESOP at a timing of their choosing, without an outside party mandating the terms of a transaction. Finally, the ESOP structure allows owners to customize and combine their business exit planning with their personal retirement planning by selling some shares today to achieve some liquidity and plan to sell additional shares at a later date. Therefore, the overall structure and flexibility of an ESOP represents the first large benefit to owners.
2. Company Deductions From ESOP Payments
Because the ESOP is a ‘creature of the tax code’, the second benefit received from selling a portion of your company to an ESOP is that the company will receive tax deductions that are unique to ESOP companies. Without getting into too many details, it is easiest to simply say that ESOPs can, in effect, deduct principal and interest payments for the sale transaction. Therefore, an owner who sells $2,000,000 of stock to an ESOP can see their company benefit from approximately $800,000 in tax incentives over the time period that the ESOP is being ‘repaid’ through annual contributions. These company tax deductions are a large benefit and very attractive to the owner who wants to (1) remain in control of their company, and (2) gain significant tax advantages.
3. “Shareholder” Savings As An S-Corp
This newsletter is mostly focused on the benefits of S-corporation ESOPs (although different benefits are available to C- Corporations as well). Generally speaking, one of the benefits of structuring a company as an S corporation is that all of the taxable income is passed through to the shareholders, and not taxed at the corporate level. The ESOP is a non-tax paying entity (because it is a qualified retirement plan). Therefore, profits that are attributable to the shares that are sold to the ESOP are also exempt from taxation. Taken to the extreme, it is possible to sell 100% of the stock of an S Corporation to an ESOP and have the company become a ‘for profit, non-tax-paying’ entity. Once this happens, cash accumulates inside the business and the company becomes a formidable competitor to those businesses whose cash flows continue to be burdened by the payment of taxes. This third benefit is rather unique and compelling to owners who truly want to stay in control of the business and no longer have the earnings of the company subject to taxation.
NOTE for C Corporations. A C Corporation ESOP transaction also can take advantage of a special provision in the tax code under section 1042. This ‘tax-deferred rollover’ allows a selling shareholder, who meets certain conditions, to use the cash that he/she received from a sale of stock to an ESOP to defer tax on the sale proceeds. Once again, this is a unique provision in the Internal Revenue Code that only applies to ESOP transactions.
4. Owner’s Interest Earned From ESOP Payments
So far an exiting owner can use an ESOP to monetize a portion of their company, while staying in control and getting annual and / or total tax relief for the company’s profits. Another interesting benefit of an ESOP is that an owner can choose to finance the stock sale transaction by taking a note from the ESOP at the time of sale. When the sale transaction occurs an interest rate is established, based on the structure of the deal. The owner will earn additional income from this interest payment which will be paid over the life of the note. And, in fact, if the owner’s note is subordinated to another credit facility with the company, it is possible that the owner can receive high-single-digit, to low-double-digit rates of interest for that loan. This interest, coupled with the tax savings that the owner and the company would receive, starts to make the ESOP even more attractive.
5. The Owner’s Re-Accumulation of Shares
The final benefit of an S-Corporation ESOP transaction to an owner is their ability to receive shares as an employee of the company. Now, this might seem counter-intuitive that an owner would sell shares to an ESOP – cashing in a portion of his wealth – and then receive those very same shares through annual allocations. Nonetheless, it is true because the owner acted in the capacity of a shareholder for the sale of stock to the ESOP but participates in share allocations in their role as ‘employee’ of the company. And, in fact, the owner is in most cases one of the highest compensated employees so their allocations exceed most of the other employees at the company. This owner has an opportunity to cash in those shares a 2nd time upon retirement or if the company sells to an outside party in the future.
Although there are a great many other features and benefits of an ESOP transaction, this post was designed to offer five (5) of the most attractive. It should be noted that the ESOP also permits managers and employees to participate in ownership. Handled properly, it may also get these folks to think and act like owners. This intangible benefit is added to all of those enumerated above in an effort to communicate the value of an ESOP to an owner who is considering an eventual exit from their business.
As a member of Pinnacle Equity Solutions, I have contacts with ESOP subject matter experts should you be interested in a conversation on how this structure might fit your personal goals and Company culture. Please call or drop me a line if I can assist in this area.
Pinnacle Equity Solutions © 2013
from forbes.com George Bradt, Contributor
To successfully turn an entrepreneurial endeavor into a stable business, leaders must leverage their networks to fill critical skills gaps as the business evolves. Move from starters to transformers to sustainers.
Desktone CEO Peter McKay laid this out for me. He described the need to have different people at different stages: starters to prove the technology, transformers to take the technology to market, and sustainers to manage the business on an ongoing basis. The framework is appropriate for smaller organizations and for groups, units, and divisions within larger organizations.
Evolution of Desktone
For those of you that don’t know, Desktone is in the business of virtual workspaces – “applying server virtualization to desktops.” When McKay joined Desktone his challenge was scaling from an entrepreneurial venture to a real, ongoing business.
The company had great ideas for the product, but needed help on areas like “how to go to market.” Their core promise of “Access anywhere” resonated with people looking for the freedom to use any device anywhere. The time was right to accelerate things.
Start with Starters
These are the entrepreneurs or intrapreneurs passionate about their ideas. As Eric Wagner laid out in his article on 7 Traits of Incredibly Successful Entrepreneurs, these people are abundantly curious, creative, and visionary communicators and leaders who love risk and action and are tenacious beyond belief. You don’t want to get in their way as they drive to get the ball rolling. Let them do what they do at the start.
Shift to Transformers
Once the idea or technology is proven, it’s time to go to market. This requires an entirely different set of skills. As McKay explained to me, you need new people, a new approach, a new vision and a new financial model depending upon your route to market. For example, Desktone chose to go to market through channel partners, requiring a completely different approach than would going direct.
This is where you need to leverage your network. As McKay pointed out, the world is full of people who want to help and can help with things like packaging, pricing and market communication. You don’t have to hire and onboard all these people full time for this transformational stage – but you do need to tap into their expertise.
Evolve to Sustainers
The good news about successfully going to market is that you get customers. That bad news is that customers complicate your life. All of a sudden you need things like systems and processes. Entrepreneurs hate systems and processes. Transformers know you have to have them, but find them less fun than transforming things. Thus, the people best suited to manage sustaining systems and processes with the appropriate levels of detail and discipline are different than the starters and transformers.
This is why each phase of building an ADEPT team starts with acquiring and ends with transitioning. As McKay put it, “The world is changing so dramatically, you’ve to stay on top of it.” Change the team as the bus changes if you want to avoid getting run over by your own bus.
This is a good example of step 9 of The New Leader’s Playbook: Secure ADEPT People in the Right Roles and Deal with Inevitable Resistance
Make your organization ever more ADEPT by Acquiring, Developing, Encouraging, Planning, and Transitioning talent:
- Acquire: Recruit, attract, and onboard the right people
- Develop: Assess and build skills and knowledge
- Encourage: Direct, support, recognize, and reward
- Plan: Monitor, assess, plan career moves over time
- Transition: Migrate to different roles as appropriate
Click here to read about each step in the playbook
The New Leader’s Playbook includes the 10 steps that executive onboarding group PrimeGenesis uses to help new leaders and their teams get done in 100-days what would normally take six to twelve months. George Bradt is PrimeGenesis’ managing director, and co-author of The New Leader’s 100-Day Action Plan (Wiley, 3rd edition 2011) and the freemium iPad app New Leader Smart Tools. Follow him at @georgebradt or on YouTube.
By Lisa Leiter May 12, 2012
Joe Perrino started succession planning eight years ago, mainly because he does not want history to repeat itself.
Even though the CEO of Woodridge-based Home Run Inn Inc. has been working at the company since he was a teenager, it wasn’t until his father, Nick, was on his deathbed in 1990 that they talked about succession.
“When I had to discuss this with my dad, it was not a pretty scene,” Mr. Perrino says. “When my dad died, there was a lot of uncertainty in the company of where we were going to head.”
Mr. Perrino wanted to grow both Home Run Inn’s restaurant business and its frozen pizza operation, but his father was reluctant to add on to the business started by his in-laws, Mary and Vincent Grittani, in 1923.
Mr. Perrino opened more restaurants—there are now eight—and expanded the frozen pizza operation into one of the largest retail brands in the business.
Now, at 58, Mr. Perrino and his two older sisters, Lucretia Costello and Marilyn Carlson, are transferring ownership of the business to their children. In the next seven years, he plans to step down as CEO and become chairman.
He and his attorney held a family meeting with his elder daughter, Gina Bolger, 31, marketing director at Home Run Inn; his son, Nick, 25, who works for the company’s distribution business, PowerPlay Distributors LLC; and his younger daughter, Renee, 23.
“We want to create transparency and trust through open communication,” Mr. Perrino says. “That’s why family businesses fall apart . . . when there’s no trust.”
Home Run Inn has developed formulas for compensation so family members know what to expect. Mr. Perrino is looking at which family member could assume the CEO role or whether the company should hire someone from outside the family. Three of his nephews also are involved in the business.
“I don’t want to set anyone up for failure,” Mr. Perrino says. He meets with an outside advisory board quarterly to discuss the issue.
Andrew Keyt, executive director of the Family Business Center of Loyola University Chicago, which worked with Home Run Inn, says that while families can’t necessarily breed CEOs of large and growing companies, that doesn’t mean a business can’t continue to be family-owned. “Family members have to have a sense of stewardship about the company, and when looking at a new CEO, they need to ask: What does that person need to look like for the company to be successful into the next generation, and do family members have the skill set to fulfill that role?”
As Mr. Perrino puts it: “What I want to give to this next generation is to let them run this company while I am still alive and let them make mistakes, and let me be here to stop them from making catastrophic errors and act as a balancing and reassuring force so that when I exit completely by death or retirement, it’s seamless.”