For successful entrepreneurs, the road into the business is often more clearly laid out than the route from involvement. However, a well-drawn roadmap for the endgame can be the difference between achieving success and missing the target on important life goals. As a result, preparing an effective exit plan can provide a valuable service.

Laying the Groundwork

Since a viable entrepreneurial exit strategy must take account of both where your client is today and where he or she would like to be in the future, exit planning should start with a comprehensive appraisal of business and personal finances. Many planners have found it valuable to start with a net-worth assessment with their clients. This not only helps to identify all available resources, but it also helps to match those resources against specific goals. (The assessment process may also help you identify potential opportunities for client relationships unrelated to the exit plan.)

Perhaps less objective but no less key to a successful exit strategy is values clarification. For example, if some or all of your client's children are involved in the business, does your client want them to continue in their current roles or expect that all will move on when the business is sold? Your client might have a clear choice for successor, and so might wish to consider how that choice will impact other family relationships. Keep in mind that many exit plans have foundered because of internecine conflicts. A related area of concern that will form a backdrop for the exit strategy is your client's vision for life after the event. Is he or she planning to retire? To remain involved as a consultant or part-time executive? To start a new venture in another field? How each of these questions is addressed will direct the practical thrust of the nascent exit strategy.

Finally, a successful exit process should be based on a sound understanding of existing business relationships and provisions. Your client should identify the key professional and executive talent in his or her firm, and then formulate appropriate reward and retention strategies for them.

Potential Deal Forms to Consider

The various choices of deal structure each offer unique cost/benefit tradeoffs. Here is an overview of the options:

• Buy-sell agreement - This arrangement is designed to permit the dissolution of a partnership by setting the parameters for some partners to buy out others. It enables one or more partners to maintain involvement in a business when others might wish to sever their ties to it. A buy-sell agreement requires careful design to ensure that its execution does not work at cross-purposes with other estate and succession planning tools.
• Cash sale to a third party - A pure cash transaction may create the greatest immediate liquidity for the seller, but other financing structures may have the potential to generate greater net yield over time. A cash sale may also be the simplest means to execute a complete and immediate separation from the business.
• Buyout or recapitalization - In leveraged transactions, partners, managers, or the business as a corporate entity borrows the funds to purchase the stock of the exiting entrepreneur. These deals may be especially useful for dissolving a partnership while otherwise maintaining the business as a going concern. They are also often used for transferring business responsibility to children or other heirs while creating financial independence from them. Recapitalizations can also be used to finance an annuity for a business owner who might wish to combine financial independence with limited business involvement.
• Employee Stock Ownership Plan (ESOP) - An ESOP is a form of leveraged buyout designed specifically to give control of the business to a broad base of its current employees. ESOPs may have higher transaction costs than ordinary cash sales, but in many cases these costs are not out of line with the costs of other more complex deals. There are also specific tax benefits for ESOP transactions that may improve their net value significantly.

Managing the Proceeds

A key part of any exit strategy is the financial plan for managing the proceeds of the deal in a manner consistent with the client's post-sale goals. Such plans typically include a blueprint for investing sale proceeds in a diversified portfolio. They also typically include an estate plan crafted to take advantage of the trust structures and tax code features that allow your client to preserve wealth and protect the future interests of heirs. Among the favored devices may be family limited partnerships and grantor retained annuity trusts, which can reduce the estate value of shares passed on to heirs. In addition, many entrepreneurs are interested in charitable remainder trusts. These may be used to fund philanthropic programs that realize specific charitable goals while maximizing tax benefits and minimizing costs.

Points to Remember

1. The sale of a business is only one small transaction at the center of a larger plan often referred to as an exit strategy.
2. The most successful exit strategies are those that give the business owners the greatest probability of comfort with the results as seen in their financial security, family dynamics, and long-range goals.
3. There are many options for structuring the sale of the business, and each has different implications for other elements of the broader strategy. Buy-sell agreements can help maintain continuity for remaining partners in a wide range of circumstances. Pure cash transactions typically yield the greatest immediate liquidity. Leveraged transactions may enable managers, partners, or family to take over and maintain continuity for the business. ESOPs can provide tax benefits and empower employees.
4. Trusts can be valuable tools for managing the income tax and estate planning implications of the wealth derived from a business sale.

Bruce Hemmings is a Financial Advisor and Senior Vice President with the Global Wealth Management Division of Morgan Stanley at Centerra.  He can be reached at bruce.hemmings@ms.com or (970) 776-5501.

The information contained in this article is not a solicitation to purchase or sell investments. Any information presented is general in nature and not intended to provide individually tailored investment advice. The strategies and/or investments referenced may not be suitable for all investors as the appropriateness of a particular investment or strategy will depend on an investor's individual circumstances and objectives.  Investing involves risks and there is always the potential of losing money when you invest. The views expressed herein are those of the author and may not necessarily reflect the views of Morgan Stanley Wealth Management, Member SIPC, or its affiliates. Morgan Stanley Wealth Management LLC. Member SIPC.