Crafting a Winning Exit Strategy Now

Many entrepreneurs pour their time and passion into building a business but often overlook or delay planning for their ultimate exit. Steve highlights this common oversight, emphasizing that every entrepreneur needs a clear exit strategy, whether driven by desire, fatigue, or unforeseen circumstances. Byron McFarland, an advisor with over 30 years of experience in business exits, sheds light on the critical need for this foresight. He was compelled to enter this field after reading an early 2000s article revealing that 72% of business owners had un-executed exit-related documents, primarily because they were unsure if the plans met their goals. This, combined with the impending "10 Trillion Dollar Opportunity" of baby boomer wealth transfer, signaled a vast void for specialized exit planning services. Byron notes that most owners delay planning due to a lack of urgency, often only prompted by a significant life event like a medical condition or partner's desire to retire.

A major challenge Byron identified was the risk-averse nature of many traditional advisors (attorneys, CPAs) who might not offer comprehensive exit options beyond simple notes or broker sales. The rise of private equity as a common buyer for small to medium-sized businesses has somewhat alleviated the fear of revealing business conditions to competitors. However, private equity often sets up an exciting mental outcome that can later be "whittled away" in value. Steve raises the personal experience of outrunning life insurance coverage as business value grows, a "good thing" that signals the business can support itself or attract external funding from banks or private equity. Byron agrees that for unrelated owner-operators with substantial business value, it's often more strategic not to fully fund buy-sell agreements with life insurance, allowing value to outgrow coverage.

For businesses with multiple owners, especially those of differing ages, a well-contemplated buy-sell agreement is paramount. Byron explains the financial limitations of banks, which typically lend only two to three times trailing 12-month cash flow for buyouts. When bank financing isn't enough, alternative terms must be built into the agreement. He details three primary payment methods for a buyout: a single cash payment, a cash payment combined with a subordinated note, or a cash payment combined with tax-deductible deferred compensation. The latter, often preferred, provides tax relief for the buyer, making the transaction more financially viable for the acquiring partner. Both Steve and Byron stress the importance of specialized advisors (with "subject matter expertise") over generalists, as they can identify substantial tax reliefs, like Internal Revenue Code 1202 and Nebraska's LB 775, which could allow a C corporation with specific qualifications to pay no tax on a sale. They conclude by urging entrepreneurs to build an advisory group from the very beginning, highlighting that vulnerability and seeking help are signs of strength, not weakness.

10 Key Takeaways
Every entrepreneur needs a well-defined exit strategy from the beginning of their business venture.
Many business owners delay exit planning due to a lack of urgency, often only prompted by unforeseen life events.
Traditional advisors may not offer comprehensive exit options due to risk aversion or lack of specialized experience.
Private equity has become a common buyer for small and medium-sized businesses, reducing competitor-related fears but potentially leading to value erosion post-excitement.
"Outrunning" life insurance coverage as business value grows is a positive sign, indicating the business's self-sufficiency or attractiveness to external funders.
For multiple-owner businesses, a well-drafted buy-sell agreement is crucial to manage partner exits, especially when ages differ.
Bank funding for buyouts typically limits to 2.5-3 times trailing 12-month cash flow, necessitating alternative terms for higher valuations.
Utilizing tax-deductible deferred compensation in buyouts can offer significant tax relief.
Building an early advisory group and being vulnerable with them about concerns are vital for comprehensive planning and support.

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This podcast is produced by Two Brothers Creative.
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Chapter Markers
00:00 - The Importance of an Exit Strategy
00:54 - Byron McFarland's Entry into Exit Planning
03:34 - The Urgency Gap: Why Owners Delay Exit Planning
05:24 - Navigating Funding Limitations for Partner Buyouts
11:12 - Tax-Advantaged Buyout Structures
16:03 - The Value of Specialized Advisors vs. Generalists
20:12 - Critical Tax Implications for Business Sales
22:26 - Why Early Advisory Groups are Essential