Nobody actively wants to turn over and leave their business, but for whatever reason, if that day ever comes, as a business owner, you have to have an exit strategy in mind. Having a good, solid framework for exit planning is something that you should be considering right at the very beginning because in the long run, it could just be a huge benefit to you. Steve Migala is a Shareholder at Lavelle Law, Ltd. with a broad transactional practice. Steve chats with Domenic Rinaldi about his framework for how business owners should think about a potential succession or exit from their business. A smart business is one that planned with the end in mind, so make sure you’ve got a strategy lined up.
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Exit Planning: Turning Over The Business With Steve Migala
Begin with the end in mind. It’s a sound advice when thinking about how to plan for an exit from your business. Our guest, Steve Migala, has a framework for how owners should think about a potential succession or exit from their business. Steve is a shareholder of Lavelle Law with a broad transactional practice including banking, corporate real estate, and estate planning. Lavelle Law is a full-service firm with over 30 attorneys handling a variety of legal needs. Steve, welcome to the show. I’m looking forward to diving into the exit planning framework.
Thanks for having me, Domenic.
Steve, maybe we could start with a background on yourself if you can give the audience an overview.
I’m a shareholder with Lavelle Law. I’ve been practicing for many years. My practice areas are transactional, corporate, and M&A as well as commercial real estate and commercial lending for both banks and borrowers.
How is the market from your perspective?
I was more bullish, but usually the presidential years can be a little rougher. A little more headwinds, but with the Coronavirus and it looks like it’s having a good impact on global markets. I’m still optimistic, but certainly I think we’ll determine how the year might go.
Have you seen any deals starting to fall apart because of Corona?
Not quite yet, but it’s going to impact manufacturing, supply chains and things like that. It hasn’t quite hit the deals that are in the pipeline yet, but it’s certainly some of those that are still maybe pre-LOI stage.
I echo your comments about years with presidential elections. Our experience has been that those are usually soft years but not the case so far. The last few months were unbelievable and deal flow continues to be strong. We’ll see what happens here as the next couple of months unfold and we see the true impact of the Coronavirus.
The PE firms especially still have a lot of capital to deploy. People are still chasing deals, but it will be interesting to see how the Coronavirus and how it works its way through the whole process. With the deals that are in the pipeline, maybe not so much, but we’re on the road. It might have a bigger impact.
Your good point about PE with trillion and a half dollars raised to invest. That’s a lot of money sitting on the sidelines to find a home. They may find it at slightly lower valuations than they had thought a couple of months ago.
It could be, we’ll see.
Let’s get into the meat of the conversation here, which is your framework for exit planning. You’ve put together a nice overview from my perspective of how owners should be thinking about an exit. I love the comment that you made when we talked about, begin with the end in mind. It’s important. Many people just dive in and they don’t understand what their end goal is. Maybe you could start with what are the three legs of that stool from a framework perspective and then let’s dive into each of those.
From a business owner’s perspective, you definitely want to start with the end in mind. Get together a good team of advisors and start planning a few years out for that liquidation event or sale. You want to make sure too that along with your team of advisors and your planning, you have your estate plan ready to go to prepare for that any events. With your team of advisors, you want to explore what exit strategy makes sense for you and the business.
The first leg you talk about is the team approach, which is critical. I had this conversation with a buyer who is ready to launch into buying a business and hold together a team of advisors. I stopped the conversation. I said, “It’s great that you’re planning to do this, but let’s start with some things that you need to do first before you go out and start sourcing deals.” The team was number one on my list. Let’s talk about that.
Oftentimes, owners have different kinds of priorities. A lot of times, they want to take care maybe trying to find the right buyer, they have a desire to protect employees or take care of the family or whatever. You want to find a team that is sensitive to the owner’s priorities and a couple of members of that team for any kind of deals, the sale or liquidity event for the business. The first one, Domenic, is somebody like you. Somebody who’s more of a broker or investment banker who can determine where the business is and build a strategy to maximize value and achieve the desired sales price. I mentioned there’s a liquidity event for any sale.
You want to have a financial planner lined up and help you manage the liquidity that’s going to come in. Invest those proceeds and help you build a post-sale vision for what your life is going to look like after the sale of the business. The people that work on a deal, people like me who are attorneys with document negotiation and drafting. Also, a CPA or a tax advisor who can help with the tech structuring and minimize tax consequences. You want to have a team approach and make sure that the team buys in and understands the owner’s priorities and contributes to achieving those owner’s priorities and getting the deal done.
The thing I would add to that too is when you look at advisors, you want to make sure that you’re bringing in people who have significant M&A experience. There are lots of great advisors out there, but if they’re not doing M&A deals day in and day out, they may not be up on the latest things that are going on. That could cause you to leave some money on the table or maybe not even get the deal done. It’s important talking to people like Steve who have significant M&A experience and will be able to shepherd you through the process. The other thing that I would mention about financial planners is, one of the first things that we ask that sellers do if they haven’t done it already is work with their financial planner upfront to figure out what their number is. If they need the proceeds from the sale of the business in order to retire or do the next thing, if that’s going do another business or whatever, make sure they’re working with that financial planner upfront to understand the number. If we understand the number, then we all know what we’re shooting for. It may not even be appropriate to be going out to the market if the business can’t deliver that number.
I think that’s true. Certainly, when we meet with our clients, we want to ideally get them to start thinking about planning for that sale a couple of years out. If there are things that they needed to discuss with their financial advisor that there are some operational challenges or things that they need to do with respect to the business to try to increase their valuation, then having that runway is better.
Steve, let’s move on to the next part of the framework, which is the state plan from the owner’s perspective.From a business owner's perspective, you want to start with the end in mind. Click To Tweet
We do quite a bit of state planning and succession planning. We like to see an owner have a sound estate plan in place, primarily with respect to how that estate plan relates to the ownership interest in the business. We’d like to have that owner typically with a pour-over will and have that ownership interest often held by a trust. Also, have powers of attorney with respect to healthcare and property. What that allows for, especially in a case where an owner could become disabled. You then have the ability, assuming the ownership interest is in the trust where the successor trustee under the Illinois Trust Code and what previously was the trustees. They can take over ownership and management of the business as a shareholder or our member. Having that ability and being able to manage the business in case of the owner’s death or disability is helpful. Also, it ties nicely into the liquidity of that and what happens to those proceeds upon the sale of the business and how those proceeds are managed post-sale and distributed out to the owner and his or her family.
Steve, at that point in time, are you also bringing in accountants potentially to help the owner think through what their tax ramifications are or how to do things so that they have the most favorable tax outcome?
We often work with the company’s accountant. They have that experience. If not, we can recommend people. We can handle the tax structure, but oftentimes, we will also work in conjunction with the accountant to help design that tax structure. The accountant certainly knows the business sometimes more so than we do, especially for this brought in. We are happy to work with the company’s existing accountants and trying to figure out the tech structure and how to minimize taxes best.
I find that to be such an important piece when owners are evaluating the next step. Even if it’s not the next step to understand what their walkaway number is. I often tell people, the purchase price is one thing. How much of that purchase price are you going to keep in your pocket? That’s critical. I think people get surprised oftentimes at the closing table what their taxes are, and that should never happen.
They should have an idea of what the gross proceeds number is and exactly what you’re saying, what the walkaway number is after.
Steve, are there things happening with trusts and estate planning? Any changes in the law that would be helpful for people to understand or know or anything that’s looming out there that could impact what happens in the future? Not that we want to start to predict things, but if there’s anything that you’re aware of?
What’s going to happen with the federal estate tax situation, post-presidential election, I want to keep an eye on that. We have a change in party control if a Democrat gets elected. We might see maybe an increase or a reduction in the exemption amount or something along those lines. That’s something to keep in mind to monitor. I would also say to the Illinois Trust Code, a comprehensive rewrite of the Trust and Trustees Act and some other acts. It’s business-friendly in terms of what trustees can do with respect to the business. That’s not so much a new development that is a comprehensive consolidation and compilation of the present law.
Is it giving trustees more leeway in managing the trust?
It’s codified what’s already there under the Trustees Act and developing case law, trustees have significant abilities to manage the ownership interests of the business both the shares. It’s more of codifying existing law more than anything else, but it’s very helpful, especially for death and disability scenarios to have that in place.
Steve, let me ask you, as it relates to family members and family members that maybe aren’t in the business but are going to be benefactors as it relates to the estate and the trust. What are some of the best practices as far as an owner dealing with this family? Do you recommend incorporating the family into the discussion? How do you approach that?
I think that dovetails in with what the strategy is going to be for how to transition the business. We’ve mentioned this. What does the owner prioritize? Do they want to take care of the family? Is that an issue? They want to take care of employees, how do they want to see the business being owned and operated going forward? To the extent that family is going to be involved, it’s certainly helpful to have that discussion with family. I had been involved with many situations where transitioning ownership to second, the third generation. It’s helpful to have that conversation and convey those expectations from the owner to the family and try to figure things out. Oftentimes, family members aren’t often not involved in the business. Maybe only 1 or 2 of them maybe are. How do we compensate if at all for those family members who are not going to be in the business? If so, how do we do that? Do we allocate different or certain other assets that are not an ownership interest to these family members under that owner’s trust?
It makes perfect sense. In the case where you have maybe an owner who doesn’t have any family involved in the business. Do you advise that once they come up with this strategy and plan that they then presented to their family so their family at least understands what their plan is and their strategy? Is that something that it’s not that important and it will get revealed when the time comes?
It’s helpful to have that conversation. Even for business owners or non-business owners, for the person with the assets to have that conversation with their family members. It gives the family peace of mind in terms of what to expect, here’s what’s going to happen and could use them as a sounding board. Family dynamics to extend. Maybe you’d do that. Overall, it’s something to think about doing.
Anything else about that piece of the framework before we move on to the next?
It’s helpful to have that in place. If the owner doesn’t have it in place, to the extent that they’re looking at selling the business. I do have some of that runway. Maybe they started a year or two out or whatever and get those estate planning documents drafted or even update it. It’s good to have a review of those estate planning documents every five years or so. Anytime there’s a life-changing event, whether it’s a birth adoption, death, divorce, things of that nature.
Let’s move on to the last piece of the framework, which is the actual exit strategy, deciding what and how you’re going to exit the business.
From what we’ve seen, there are three basic strategies driven by owner priorities. First, we can do a slow sale to employees. Second, we can sell to a portfolio or a strategic buyer. That’s where the private equity firms come into play. Third, what we’ve seen more frequently in the middle market is sales to ESOPs. Those are the three strategies. We think that there’s definitely an underserved niche in the middle market for ESOPs and we think they can be viable.
Let’s talk about that a little bit. Maybe you could talk about ESOPs at a high level and then maybe dive into some of the details. What are the pros and the cons that owners should be thinking about as it relates to an ESOP?
Let’s start off defining what ESOP is. It’s a qualified defined contribution, employee benefit plan. What it does is invest in the stock of the company. What happens is a plan is created and it’s the buyer of the shares or the interest from the selling owner. It allows the employees to have an ownership interest in the company and it can provide the selling shareholders and the company with significant tax benefits. It could be a flexible and powerful tool in a variety of situations such as an owner’s retirement, if you want to buy out an active owner. There’s an estate or divorce sale. It will often with the case too is when you have a management buyout or other takeovers. It could be a great way to give employees across the board an ownership interest in the company.
What’s the tax benefit to the owner or owners of the business for doing this?Always have an idea of the gross proceeds number as well as the walkaway number after. Click To Tweet
If the company is a C corporation, the selling shareholders can often defer gain on the sale of the stock to the ESOP. The company’s contributions to the ESOP to a fund of share purchases are tax-deductible. There are tax benefits to both the owners and the corporation.
Steve, from a process perspective, I’ve heard that the ESOP can be expensive and take a lot of time to implement it. Can you give us some thoughts and experiences there?
There are often ESOPs that can be transaction cost heavy because there are multiple parties and they all need counsel rights. The selling owner needs counsel. The company often needs counsel and then the ESOP trustee is there and also needs counsel. It is a little bit transaction heavy, but we think that for the right company, it can certainly be a viable solution. There are certain characteristics that would constitute a good ESOP candidate.
Let’s maybe back up and move to the other one. You had talked about the first one being a slow straight sale to employees, maybe key employees. What do you see there?
With the slow sale to employees, this is going to accomplish a few things from the owner’s perspective. It’s going to allow the owner to get and take care of the employees, preserves the owner’s legacy, the owner can get future shareholders over a long period of time. The owner can have a full sale, still maintain control over the company and the process of the sale while being involved in the day-to-day operations of the company. If the owner still wants to do that, there are certain tax advantages too within multiple sales or slow sales. Have installment sale treatment and then spread that text impact over time versus having a sale of all the interests at once.
There are clearly some benefits to doing a sale to an employee. There are some cons too. Do the employees have the cash to come down with an initial equity infusion? Do you have a good solid core of key employees that can become the management team? There are lots of things to think through there. You always have the issue because we’ve been involved in a number of these transactions. What’s the value of that business? That always becomes a difficult conversation between either the owner and the employees or if the owner engages in intermediary and the intermediary and employees. That is a tricky discussion and you need to think through how to present that to the employee base that you’re going to offer the business to.
You want to make sure you have the key employees that are going to be potential buyers. You’d have to arrange for potential financing and things of that nature.
There’s the next piece, a sale to a third-party, whether it’s a strategic buyer or a private equity group or an investor group, but bringing it out to a third-party.
Here you definitely want to have clean books. Oftentimes, owners like to run things through the expenses through the business to minimize the taxable income. Certainly, that speaks to the need to plan this out a couple of years in advance. You’d want to stop doing that and start showing taxable income so you can drive up the valuation and reverse that trend. Having a broker or an intermediary is helpful to credit to drum up market interest. Maybe pursue some auction strategy is part of that or explore ways with the intermediary to maximize value.
We certainly agree with that comment. It does depend on what the owner is trying to achieve. There are some scenarios where owners have come to us. They have long since made their money and are set for retirement. They want to do something good for their employees and there’s a value that’s not a market value that they’re willing to offer their employees and everybody feels hopefully good about that process. There are others where the owner does need to take it out to a third-party because either there isn’t the key employee base or they need maximum dollars. In that case, you want to go out and bring as many buyers and as much leverage to deal as you can so you’re getting maximum dollars and the best terms possible. Steve, this has been great. Any high-level comments or thoughts that you would want to share with the M&A Unplugged community?
The theme of trying to work with people like me who can understand the driver of the owner’s expectations. Come up with a team approach, get the right advisors in place and come up with an appropriate strategy for the sale of the business, trying to make sure those owner’s expectations are realistic and achievable. What we talked about, having the right team in place and exploring the various sales strategies, that can be done.
Steve, for anybody out there who would want to get in touch with you, what’s the best way for them to reach you?
You can call our main number, which is (847) 705-7555. That way, you always get to speak to somebody live. You can also email me at [email protected].
Steve, thanks for being here. I appreciate it.
Let me recap the high level here. We talk about this time and time again, preparation. The earlier you start to prepare, the better. The better the outcome for you and for everybody involved, your employees, the buyer coming into the business. Preparation is key and the three elements that Steve talked about in his framework, which I echo and agree with, get the right team in place. Make sure you understand how this fits into your estate plan. The number is going to be the right number for you and you’re going to be able to walk away from the business and do the next thing, whatever that is. Start another business, retire, whatever it is. Third, what is the preferred exit strategy? Sale to employees and ESOP, taking it out to the market, determining what is in the best interest for you, your employees, and the highest likelihood of a transaction. If you would like to learn more about the process of acquiring or selling a business, please visit our website at SunAcquisitions.com or feel free to reach out to me at [email protected]. I look forward to seeing you again in the next episode. Until then, please remember that scaling, acquiring, or selling a business takes time, preparation and the proper knowledge.
About Steve Migala
Steven Migala is a Shareholder of Lavelle Law, Ltd. with a broad transactional practice including banking, corporate, real estate and estate planning and probate matters. Lavelle Law is a full-service firm of over 30 attorneys handling a variety of legal needs out of offices in Chicago and Schaumburg.
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