Creating Equity In Your Business

Many business owners today are confronted with assessing the value of what they have or, more appropriately, may have left in their privately-held businesses.  Consequently, most business owners are looking at their business to determine the value and how it can be extracted.  This is a part of the exit planning process.

There are two very different aspects to getting the money out of your business.  On the first hand, there is the income that you draw from the business in terms of salary, personal/business expenses, and bonuses that you pay to yourself and/or retirement plan savings. All of this constitutes money that’s coming to you from the cash flow of the business going towards the lifestyle that you have built for yourself.  The second and much more important aspect, particularly in light of the recent economic condition, is getting to the equity – the illiquid part – of your business.

As a part of the exit planning process, an owner will want to know their Value Gap – i.e. how much money they need to extract from the business in order to maintain their lifestyle without the business.  The chart below helps to illustrate this point.  We see that Bill Brown has $1,000,000 saved for retirement but needs a little more than $7,000,000 to maintain his lifestyle.  Bill’s Value Gap is $6,000,000.  The question becomes, ‘How can Bill get to the equity in his business in order to close this Value Gap?’

 {2009 Savings: $1,000,000} > {Value Gap: $6,027,783} > {2013 Asset Base Required: $7,027,783}

Like most business owners, Bill is focused on running and growing his business (and surviving the current economic conditions).  Bill has some money saved for retirement.  However, as we can see, it is nearly impossible for Bill to extract enough ‘income’ from his business to meet his exit goals – Bill needs to get to the equity in his business.

 Essentially, the equity that’s in your business is representative of more than the accumulated earnings.  It is representative of the value that somebody else would pay for it, so the question becomes, ‘How can you plan to tap into that equity over a long enough time period to draw it out to meet your personal goals?’

The first step is to realize that there are many ways to get to the equity in your business.  You can find a buyer, groom a successor, or even create a buyer for the shares of your company’s stock.  The most important part of this planning process is the recognition of the need to plan for your exit and to measure the amount of equity that you will need to extract from your business.

In today’s environment, the equity can be managed in many different ways.  What’s important, first of all, is that you set a plan and an expectation as to how you can access that equity.  The natural inclination is for a business owner to want to sell – to pull the equity out all at once.  Today’s marketplace has fewer buyers than previous years, due mostly to the economy and the contraction of credit throughout the world markets.  As an owner, you need to know that options other than selling the business are available but may require some creativity on your part.  The key is to understand what somebody else would be willing to pay and identify that person.  From there, we can go and take a look at how that other person would value what you have and how you would receive those ‘equity’ payments.

So, in Bill’s example above, he needs to achieve a net amount of $6,000,000 for the equity in his business in order to achieve his exit goals.  If Bill were to sell the business, he would need to get an asking price in excess of $6,000,000 because taxes (both federal and state) are going to be owed, and advisory fees are going to be a part of the difference between what Bill ‘gets’ for his business sale and what he keeps.  Like many owners, Bill is challenged by today’s lack of buyers and lower values.  Therefore, he wants to look at alternative ways of getting to the equity in his business.

Bill may look at the option of selling a portion of the equity in his business to an Employee Stock Ownership Plan (ESOP).  By selling a piece of the equity today, Bill can bolster his current savings (i.e. increase his financial readiness) while continuing to own a majority of the stock in his company.  Although Bill will likely get a lower value for the shares sold today, he can begin to diversify himself away from the business and, potentially, receive important tax benefits that go along with the ESOP sale.  This is a controllable way of getting to the equity in your business.

Bill may also look to his management team to assist him in extracting the equity from his business.  Bill’s management team has the potential to continue to run the business in Bill’s absence.  However, Bill has not started the conversation with these managers as to his future expectation that they will be so empowered.  This is a delicate conversation to have with the managers because the future is too difficult to envision today.  What this means is that Bill may decide to sell the company in four (4) years when the next exit window opens for him.  So, he does not want to over promise his managers a future ownership stake that he cannot deliver.  Bill should recognize that there are ‘higher level’ conversations that he can be having with his managers today which would make the company stronger, while also positioning those managers as potential successors to the business.  When measured against what Bill needs to extract from his business, it may turn out that having his managers pay him out over time is his best option and he can build a stronger company in the meantime.

In conclusion, whether you’re looking to your managers to help you pull the equity out of your business, or you’re looking to sell to an ESOP, or you are biding your time, waiting for an outside buyer to arrive, it is important to have a concept of equity beyond just the cash that flows from your business to you.  And from this very important concept and realizationFree Web Content, you can begin to think of your business as the investment that it is and begin to create your exit plan to get to that equity and achieve your personal exit planning goals.