Industry Insights

One commonly overlooked aspect of running a successful business is establishing an exit strategy. Business owners typically focus most of their efforts on day-to-day operations and constantly looking for expansion opportunities, which is what helped the company grow and become successful throughout the years. But what happens when the business owner wants to retire? As retirement looms on the horizon for owners and managers from the baby boom generation, exit planning is becoming a more significant issue.

There are a number of ways for an owner to exit the business. The business can be sold to a third party, to an employee stock ownership plan (ESOP) or sold or given to other family members. Each strategy has its own unique planning considerations.

The most common exit strategy BKD sees with closely held businesses is the sale of the company to family members or key employees. This strategy allows the business to provide jobs, support the local community and continue to be a resource to customers who rely on the company’s products or services. Selling to a family member already involved in the company and continuing business as usual appears simple, but statistics indicate it is very difficult to successfully transition a closely held company from one generation to the next.

Forming and implementing a game plan prior to the transition has helped a number of clients successfully make the transition. While each situation is unique, here are some areas that should be addressed when establishing the game plan.

Assembling the Right Team – It is important to assemble the right team of professionals to plan for, monitor and carry out the succession plan. The team should include the owners and upper management, as well as CPAs, bankers and attorneys. The team also should provide the requisite resources and knowledge necessary to plan and oversee the process, including accounting, tax and legal considerations.

Management – Obviously, the right management is essential to any successful business. Transitioning from the outgoing management to the next group of company leaders should be a planned process. Key personnel should be groomed for their new positions through involvement and exposure to all areas of the business. Wherever possible, these responsibilities should be shared with and performed by the identified successors before the transition date, which provides for an assessment of the successor’s competencies and allows for any necessary development or reconsiderations. Family members who are part of the identified successor management team may present unique transitioning challenges and preparation, placing a greater emphasis on open and proactive communication with key personnel.

Ownership Transfer – In general, ownership of closely held businesses starts with individuals actively involved in company operations. When the founders transfer ownership to their heirs, not all of the heirs will necessarily be involved in the business. In these situations, consideration should be given to whether the involved family members should get a greater share of the ownership or whether voting and nonvoting shares should be used to give those in the business more control. The business is just one asset being transferred to heirs, and the transfer should be consistent with the family’s overall estate planning goals.

Documenting & Monitoring the Plan – Stakeholder buyout and redemption agreements should be reviewed on an annual basis to ensure they are consistent with the aforementioned anticipated ownership and management changes. Company valuation, whether formula-driven or determined by third-party appraisals, should be reviewed, discussed and clearly documented in the minutes of annual meetings. A plan also should be put in place to fund the buyout or redemption of the owner either through annual cash flow or with insurance. Unique considerations, such as a salary continuation plan for surviving spouses and transfers due to death, should be well-defined in separate agreements or in the annual minutes.

There are numerous factors involved in transitioning a closely held business from one generation to the next. Proactive planning with internal personnel and external advisors can help establish a plan addressing both the change in ownership and company management. After establishing the plan, it should be reviewed on a regular basis and updated as circumstances change. There are a number of different potential exit strategies and each situation is different, but establishing, monitoring and updating a succession plan can lead to a more successful transition of your closely held business.

To discuss the strategy that best matches your goals and objectives, contact your BKD advisor.