The Essential Guide to Exit Planning: Maximizing Value from Day One

Written By Ryan McCaslin, CPA, CIA, CEPA – Transaction Advisory Partner

For the past 20 years, my career as a CPA has focused on providing buy-side consulting to private equity groups and strategic acquirers, as well as sell-side consulting services to companies working with an investment banker guiding them through the sale process. Historically, Quality of Earnings projects occur once a private equity group has signed a letter of intent to acquire a company or after a company has already made the decision to sell/exit. I recently obtained my Certified Exit Planning Advisor (CEPA) credential through the Exit Planning Institute (EPI) and joined the leadership team of the West Michigan Exit Planning Association. Though the main focus of my business will continue to be providing buy-side and sell-side consulting services, I am excited to become more involved in the Exit Planning space.?

Imagine if we were able to engage with a client before they were ever thinking about selling? What value would we be able to provide when the time does come to sell?? When should a business owner start thinking about an exit plan? From my perspective, an exit plan should be considered on day one of operations!

Call it what you want: operational improvement, business consulting, or value creation.? Exit planning is simply focused on building a valuable business that is well operated, well documented, and ready for sale when the time comes.

Exit Planning Awareness

The EPI defines exit planning as the combination of the plan, concept, effort, and process into a clear, simple strategy to build a business that is transferable through strong human, structural, customer, and social capital. The future of your family and your business are addressed by creating value today.

The EPI recently published (2023) its National State of Owner Readiness Report, which analyzes 1,162 United States business owners. The following are key statistics from this report, which indicate that the awareness and priority of having an exit strategy have increased significantly over the past 10 years.

• 75% of business owners would like to exit business within the next 10 years.
• 69% of business owners identified exit strategy on its priority list vs. 6% in 2013.
• 36% of business owners said exit strategy was a top priority.
• 70% were aware of exit options vs. 39% in 2013.
• Only 9% of business owners in 2023 have no plan at all regarding exit planning.
• The percentage of business owners having completed a formal pre-transition value enhancement or due diligence project rose from 14% in 2013 to 62% in 2023.??

Timing of Sale?

Some business owners may not know when they plan to exit the business. However, often the decision may come quickly based on certain uncontrollable factors. The EPI identifies five areas where the sale of a business may come unexpectedly (the “5 D’s”):

Divorce. Especially if you’re in business with your spouse and lacking proper documentation.

Disagreement. Conflicts with other business partners could cause operational issues leading to the company's demise.

Disability. Unexpected disabilities or health issues of an owner could cause business issues if no plan is in place.

Distress. Data breaches, supply chain disruptions, legal issues, and COVID-19 are examples of distressed situations that may lead to demise if not properly planned for.

Death. The death of an owner can have an impact on a business if there is no plan in place, especially when said owner is the main point of contact with customers and suppliers with no ready replacement.

?It is estimated that 50% of business owners will experience one of these 5 Ds during the business lifecycle. Doesn't it make sense to make sure a plan is in a place to continue, should one of these occur??

Value Acceleration Methodology

Although much more complex in nature, the Value Acceleration Methodology focuses on three distinct "gates": Discover, Prepare, Decide.

Discover. The Discover gate is based on the concept of a triggering event to begin the exit planning process. This includes obtaining a business valuation to determine what the business is worth today based on current operations. At times, there may be a disconnect between the business owner’s perceived company value and the company’s true market value.

Next would be an assessment of the business owner’s needs. What are their life goals? What amount of income would they expect to receive in retirement? What are their post-retirement plans? More importantly, in the near term, what is the current state of the business attractiveness and readiness for sale??

Finally, in the Discover gate, is creating an action plan. Typically, this is conducted through a series of workshops to map out and determine value-adding initiatives. It is important to include key employees in this exercise to spark innovation and collaboration.

Prepare. The Prepare gate is all about executing on the action items identified in the Discover gate. During this gate, owners and advisors work to increase business value, prove its value, and help move a business owner toward their desired personal, business, and financial goals. It is important to note that this preparation should be reviewed in 90-day incremental deliverables that enable focus, reinforcement, and accountability. Value initiatives should be consistently monitored and continuously updated during the exit planning process.

The Prepare gate also involves protecting what you have through documentation of appropriate contracts, estate and wealth management plans, and other legal documents. Some business owners are the primary key employees at the business, holding all institutional knowledge and closely managing customer/supplier relationships. Although this may have worked through the lifecycle of the business, buyers may view this as a drawback since there will be nobody available to take the owner’s role upon exit..One of the most simplistic ways to add value to a business is for an owner to decentralize themselves from the business. A business should be able to run seamlessly even with the owner stepping away from operations completely.

?Another important step in the Prepare gate is to document and prove your business value. Examples include organization of key legal documents, customer and supplier contracts, policies and procedures, and documentation of non-recurring expenses and income that may result in adjustments to EBITDA. The goal of this step is for the business to be fully prepared for sale, and become "diligence proof" by creating the ability to quickly provide all requested items during the sale process.

Decide. Chris Snider, author of “Walking to Destiny: 11 Actions on Owner Must Take to Rapidly Grow Value and Unlock Wealth,” states that "Value acceleration requires tireless commitment and relentless execution. Exit planning is simply good business strategy integrated with your personal and financial goals and objectives!” As the Company begins to add value, increasing its attractiveness and readiness to sell, an owner will start to ask themselves, "Should I grow or sell?" If the owner decides to stay on the growth path, then the company should continue to build value and stay prepared. Should an owner decide it is time to sell, they should decide the best path forward.

?During the sale process, there are many options for business exit, including:

• Sale to a third-party - Often a private equity group or strategic acquirer.
• Sale to another partner or employee - Employee Stock Ownership Plan ("ESOP").
• Investment from mezzanine lenders.
• Estate planning - Company shares provided to family members or charities through an estate plan.

?There may be situations where an owner would like to continue to grow the company, but has reached the point where they need outside help. One option in this case is to partner with a private equity group to assist with further growth. This is often referred to as a "second bite of the apple" whereby an owner cashes out a portion of equity and rolls a portion of equity into the partnership with the private equity firm.

Benefits of Hiring an Investment Banker

Historically, the norm had been that only sophisticated, well-run, and attractive businesses hired an investment banker; however, there has recently been a significant shift. Now, businesses of all types and sizes have the opportunity and ability to hire an investment banker to facilitate the sale of their business. Investment banks specialize in marketing companies to potential buyers, orchestrating competitive bidding processes to maximize the company's value. By leveraging their extensive networks and expertise, they identify and engage with multiple interested parties. The goal is to create a competitive environment where buyers bid against each other, ultimately driving up the price and terms favorable to the seller.

This process often culminates in granting exclusivity to the highest bidder, who then enters into a formal Letter of Intent (LOI) to proceed with the detailed due diligence and negotiation phases of the transaction.

?At EHTC, we work with multiple local and national investment banks to assist in the sale process through the sell-side quality of earnings analysis. Essentially, we are hired to perform a quality of earnings prior to the company being marketed, so an investment banker can provide adjusted EBITDA numbers that have been vetted by an experienced third-party CPA.? From our experience, the benefits of hiring an investment banker include:

• Increase likelihood of a successful closing: Investment bankers bring expertise and experience that significantly enhance the probability of closing a deal successfully.
• Stay focused on business and reduce stress during the sale process: By managing the sale process, investment bankers allow business owners and executives to concentrate on running their business without distraction. They take on the bulk of the workload, alleviating the stress and complexities involved in the sale.
• Add credibility to the process: Having an investment banker involved lends validity to the transaction, reassuring potential buyers about the legitimacy and professionalism of the sale.
• Obtain compelling offers and expert negotiation: Investment bankers leverage their networks to attract multiple buyers, creating a competitive bidding environment that can drive up the sale price. They are skilled negotiators who can secure the best possible terms and conditions for the sale.
• Provide comprehensive market knowledge: Their deep understanding of market trends and valuations ensures the company is positioned and priced optimally.
• Establish confidentiality management: Investment bankers ensure the sale process is handled discreetly, maintaining confidentiality and protecting the company’s interests.
• Allow access to a broad network of buyers: Their extensive connections provide access to a wide range of potential buyers, including those who may not have been previously considered.
• Give strategic advice and guidance: Investment bankers offer strategic advice throughout the process, from initial preparation to final closing, ensuring all steps are carefully planned and executed.

?In addition, the Forbes article, “The ROI of Hiring an Investment Banker” by David W. McCombie III mentions the following studies associated with realized values of hiring an investment banker.?

• A University of Alabama and Portland State University study involving 4,468 transactions over a 20-year period estimated that sellers who hired an investment banker received valuation premiums of around 25%, depending on methodology.
• Northern Trust's Business Advisory Services group analyzed 4,316 transactions and found that sellers represented by an investment banker obtained an EBITDA multiple 1.5x higher, with narrower dispersions in outcomes.

Pro Forma Adjustments and Effect on a Business Sale

Pro forma adjustments essentially present what a company's financial performance would look like under certain situations, had they occurred in the past. For example, cost realized from renegotiation of a contract with a key vendor can be applied historically to present the margins a buyer could expect to see once they purchase. Essentially, a company may integrate these adjustments in an attempt to present to potential buyers in the best light possible. The amount of value a buyer places in pro forma adjustments is dependent on the situation. From my perspective, a buyer does not assign full value to pro forma adjustments.

Why should a buyer pay for a seller’s past sins? (i.e., not properly maintaining customer relationships, lack of planning with supplier costs, and overpaying for business insurance, to name a few). Had these changes been made historically, then the results would be included in the reported results, which most likely a buyer would assign full value. Also there may be a specific reason why a company thinks that prices may be able to be increased (i. e., due to expected material pricing), which essentially could be viewed as a direct offset.

The underlying message to a business owner is: Why would you wait to incorporate these potential revenue increases or expense decreases through pro forma adjustments? Consistently review and implement these value-adding initiatives now to receive the maximum value during the sale process.

How EHTC Can Help

EHTC professionals are equipped to guide organizations through several stages of the exit planning process. Christopher Snider in “Walking to Destiny'' identifies five stages of value acceleration. Below I summarize these stages and what EHTC’s involvement can bring to the table.

Phase I (Identify). This phase determines the initial value of your business in its current state and identifies areas for improvement in order to add value. EHTC can assist in the following ways:

• Accounting Assessment
• Valuation Assistance
• Exit Readiness Review
• Estate Planning

Phase 2 (Protect). This phase is meant to protect the current value of the company—essentially being prepared for business sale, especially in situations out of the owners control.

• Cybersecurity Assessment. Detailed assessment of the company's current cybersecurity environment. Analysis of potential risks that could affect the company's value and cause interruptions.
• Advanced Estate Planning. Further analysis of the estate plan with business owners to protect property regarding estate taxes, prepare projections, model out different scenarios, and provide options to mitigate estate taxes.
• Referral Services. EHTC has a robust network of professionals to assist during the Protect phase. This would include engaging attorneys to ensure that all applicable legal agreements are in place, including but not limited to customer and supplier contracts, buy-sell agreements, and key employee agreements. In addition, we can refer professionals to review and provide suggestions regarding adequate business and life insurance.?

Phase 3 (Build) - This phase implements initiatives identified to increase business value that is expected to increase offers received when engaging with potential buyers.?

• Financial and Operational Improvements - The Build phase focuses on building value through identified financial and operational initiatives. The goal is to build value and be prepared for sale through complete and organized documentation and proof. It focuses on building both tangible and intangible value.

?EHTC professionals have more than 20 years of experience that will assist during the Build phase, including:

• Developing and documenting monthly accounting and reporting procedures.
• Providing detailed documentation of all operational policies and procedures.
• Establishing Generally Accepted Accounting Principles (GAAP) for financial accounting purposes.
• Establishing Operational reporting, including but not limited to, customer and product profitability, efficiency metrics, customer related statistics, customer satisfaction surveys, and inventory turnover.
• Developing customer pricing strategies, including detailed analysis of historical customer pricing, ability to increase pricing, and opportunities to pass cost increase to customers.
• Conducting a supplier viability analysis that includes documenting current supplier base to identity improvements. In addition, we can also assist in analyzing supplier health, especially in situations of concern or where a supplier provides a key part to production.
• Examining Full Quality of Earnings - During the Build stage it could be beneficial to perform a full Quality of Earnings analysis. This will enable a company to identify non-recurring and other adjustments to EBITDA and provide a model to be updated monthly to maintain preparedness for sale. This model can also serve as a valuable tool for management to analyze its business.
• Preparing and documenting forecasting and projections - Forecasting is essential to keeping a business on track with its expected goals developed during the value creation process.
• Conducting culture analysis and implementation - EHTC professionals have experience evaluating and reporting on the employees’ current view of the company's culture and providing suggestions for areas of improvement.
• Other Potential Services include:

As mentioned before, the Build phase includes building intangible assets in addition to the typical financial and operational metrics. The primary examples of intangible assets that build value are:

• Human. Strength of people and talent to operate independently of the business owner.
• Customer. Strength of customer relationships.
• Structural. Strength of strategy, systems, processes; and, are they provable and transferable?
• Social. Strength of culture and external market view and recognition.

?Phase IV (Harvest) - In the Harvest phase, the business owner decides on a path to a potential sale to harvest the value created during the Build phase. Alternatively, the business owner may decide to continue with the business and continue to build value. Ways EHTC can help during the Harvest phase include:

• Introductions to sell-side investment bankers, private equity groups, and family offices.
• Preparation of a sell-side Quality of Earnings report to assist with the sale process.
• Enact estate planning techniques to ensure wealth upon harvest goes to the correct individuals in the right type of structure to support harmony and protection of family members. This occurs somewhere between the Build and Harvest phases.
• Ensure that the stakeholder group understands the ramifications of a sale and also how the entity(ies) will perform if the ownership group decides to hold and grow further.

Phase V (Manage). This phase includes managing personal goals and personal value after exiting a business. Ways EHTC can help during the Manage phase include:

• Providing family office services including BillPay, accounting for retained assets, family accounting, and assisting in titling new assets.
• Collaborating with wealth advisors to make sure that investment policies are correct for each of the estate planning vehicles.
• Working with family members on how to best approach life after exit.?

?As this article demonstrates, the exit planning process is extremely important to achieving expected results upon business exit. Value creation is the hallmark of exit planning, and value creation is simply good business strategy. Business owners who plan for an exit early in the business lifecycle are more likely to achieve a seamless, less stress, and increased value when the time comes to sell.?

We invite you to take EHTC’s free ExitMap? Readiness assessment at https://exitmap.com/ehtc/ .