Don't Let Miscalculation Be the Little Big Horn of Your Exit Planning

In my company’s 2014 survey of business owners, we included these two questions:

When do you want to exit your business?

What prevents you from planning your exit?

75% responded with some version of “I have little or no sense of urgency” and “I’m not planning until I’m ready to exit.”

Like many of these owners you may be thinking, “Revenue, cash flow and my profits are all increasing. Why do I need to do anything now? I’m not ready to exit. ”

And in that, you share the mindset of George Custer on the day before the Battle of The Little Bighorn.

As you may recall, after a streak of good luck that lead to an abundance of confidence, Lt. Col. Custer was given the task of locating and forcing the Sioux and Cheyenne back to their reservations. But he failed to conduct adequate reconnaissance and consequently enjoyed a false sense of security. He didn’t realize what he was facing or, in today’s parlance, “He didn’t know what he didn’t know.”

Once the battle was underway, insufficient resources (troops and ammunition) made victory impossible. Custer had not taken the time to determine, before battle, the strength of his adversaries. When he finally did so in the heat of battle, Custer’s confidence could not overcome his lack of resources.

Owner over-confidence, however, lies not in hubris but in “not knowing what you don’t know.” Consequently, owners underestimate what needs to be done to transfer their businesses to the person they choose, when they want, and for the amount of money they need.

Owner complacency is caused by:

Underestimating the amount of capital needed to replace today’s income.

Overestimating the net proceeds needed from the sale of the business. (Remember: sale proceeds are reduced by taxes, expenses of sale, and business debt, and may be reduced by earn-out requirements as well.) Your advisors can easily calculate what your net proceeds are likely to be long before any transfer of ownership. Don’t assume, as did Custer, that your resources are up to task.

Assuming that children or key employees want to own the business and can get financing to pay for it.

Assuming that key employees will remain with the company through the owner’s exit—a necessary condition for a successful sale.

Let’s look at the last of the four: Years ago I met with Mr. and Mrs. Stiles, owners who were interested in selling their business to three key employees. We discussed several possible designs to structure the transfer to the mutual benefit of all parties. They left my office with a promise to weigh their options.

When I heard from them again two years later, I assumed they had finally decided to begin the design of their Exit Plan. In a sense I was correct, but the exit was not the one we had discussed. As soon as Mrs. Stiles sat down, she blurted, “Our three key people quit two weeks ago. Yesterday they opened up shop two blocks away from us. They have taken our best customers and employees with them! We’re ruined!”

Mrs. Stiles was right: they were.

The Stiles had assumed their key employees would stay indefinitely. I learned later that when the Stiles had approached their employees to determine their interest in buying the company, the employees thought the asking price was way too high. They also realized that, to a large extent, they were the business—not the Stiles. As do many mature owners, the Stiles had been throttling back for years as their employees assumed more responsibility. With nothing to prevent them from doing so, the three employees left and set up a competing shop—complete with employees and customers, courtesy of the somewhat stupefied Stiles.

Rarely is a surprise a good one in the course of a business exit, but surprises due to miscalculation and false assumptions can prove deadly.

How could the Stiles have prevented their key employees from leaving and competing? In my next post we’ll discuss non-solicitation agreements designed to prevent key employees from leaving and taking other employees and customers. We take the sting out of the non-solicitation agreement by offering an incentive compensation plan designed to reward key employees for remaining with a company and growing it.

For now, remember the old adage: It’s far better to start planning two years earlier than you think necessary than five minutes too late.