Boomers with Businesses...Developing an Exit Strategy

A manufacturing client in the Midwest, with revenues in excess of $5 million, asked for assistance in developing an exit strategy with a target date of 2011. The first generation owner had a son and daughter, both in the business. The owner was aware of the statistics that showed 1-in-3 private companies succeed through the second generation and 1-in-10 succeed through the third generation. He did not want to jeopardize his retirement based on an earnout agreement, so he hired us to assist him in developing an exit strategy favorable to all family members.

Candid discussions with the owner, the owner’s financial planner and a survey of potential buyers provided the information used to develop the plan. The strategy consisted of three elements:
1. Ensure the company has a leadership team that will continue to perform after transfer of ownership.
2. Develop a potential source of financing without engaging in a stock deal, earnout agreement or extended payments.
3. Capture sweat equity value on an annual basis rather than relying on it to be there on the date of sale.

How We Did It
There are a limited number of ways to separate the owner from the business; The owner can sell it, transfer it to the next generation, turn it into an ESOP, or take it public.

ESOPs work but are complex and expensive and taking it public was not an option. The owner wanted tactics that would provide the flexibility to either sell outright or transfer to the children. This flexibility required a strong and focused management team and a loyal and dedicated workforce.

To develop a strong and focused management team we customized a deferred incentive compensation plan for them. We used a design called LeaderShare®, specifically designed for closely held companies. Working with the owner and financial advisor, we developed a 5 year revenue and profit plan. This became the company vision for profitable growth. A deferred wealth building mechanism was established that rewarded the participants for performance toward the plan. The annual targets were adjustable to cope with the unforeseen changes but the ten year objective was considered realistic by all involved. It was the first time the management team had considered what the company might look like in the long term and everyone found it an exciting experience.

This tactic acted to retain and focus the leadership team. In keeping with the owner’s desire for flexibility, it provided the option of financing a management buyout. The option to overlay another LeaderShare® plan in years six through ten provided a strong retention mechanism for the management team should ownership transfer to the children. (The owner and children also participated in the plan, thus providing them with access to the value of the company as it accrued.)

Funding
The plan established a predictability of future earning and the financial planner used this projection to develop tactics for funding the deferred payout. He addressed the risk management element with term insurance on the owner and each plan participant. He developed an investment program that emphasized strong performance in a portfolio while maintaining low turnover. Because the portfolio was owned by the business, capital gains would be taxed at 20%, dividends at 8% and any interest payments would receive a low tax rate.

All that remained was to establish a process that would develop a loyal and dedicated workforce. To accomplish this we customized a cash incentive pay plan for them. We used a design called ScoreCard™, because of it’s ability to measure financial and operational performance on the front line level.

With funding, a leadership team and a dedicated workforce, the value and desirability of the company would be assured. Even if a buyer could not be found, the owner would have the flexibility of disengaging from the day-to-day business while continuing to receive a revenue stream.