Michael Jacobs
Counseling clients on cashing in from a business sale

Here’s a look at the questions you should be asking clients years in advance of a liquidity event.

August 7, 2013
by Michael Jacobs

Business owners may have started their company to pursue a passion, or to escape corporate America, but all entrepreneurs long for the day when they can cash in on their efforts through some liquidity event. The most trusted financial adviser most business owners have is their CPA, so accountants need to ensure that they are providing sage counsel to their clients on liquidity strategies.

One question CPAs should be asking every client every year is: “What is your exit plan?” The answer may evolve or change over time, but if there is no focus on the end game, the inevitable ownership transition will not optimize the client’s objectives.

CPA firms can provide many services, from estate planning to business valuation, to help clients minimize the tax consequences of a liquidity event and understand what metrics they need to focus on to achieve the proceeds they desire. But to truly serve clients’ interests, accountants need to coach them to assemble a team of advisers. Business owners need a complete advisory team that includes their CPA, lawyer, and investment banker (or business broker, depending on the company’s size).

I have worked with about 200 business owners on planning for or executing a liquidity event, and the most satisfied ones are those that had a full team working with them years in advance. Waiting until the year the owner wants to exit to assemble this team would be like a football team waiting until the week before the first game to begin practice. A lot goes into a successful liquidity event, and much of the work needs to be done years in advance.

Questions to ask
Here is a list of questions I ask when first meeting a business owner. CPAs should be asking their clients some of these same questions as well:

  • What is your legal corporate form? There can be serious tax consequences to selling a C or S corporation in an asset transaction, which is the deal structure most buyers prefer.
  • Have you considered partial liquidity options, like a majority or minority sale to a private equity firm, a leveraged recapitalization or dividend recapitalization? Business owners don’t need to be ready to head to the nursing home in order to take money off the table. Most should consider two bites at the apple. Until ordinary income and capital gains rates converge, not pursuing some form of liquidity event years before the ultimate exit is highly tax inefficient.
  • Are your books sufficiently organized to withstand rigorous due diligence? Are your revenue recognition policies in conformity with GAAP? Would a review or even an audit be warranted? The more uncertainty buyers have about a target’s books, the lower multiple they will pay. I coach my clients that paying their CPA more to do more rigorous work years in advance will reap them many times that cost in the form of a higher valuation.
  • Do you know what your company is worth? Most business owners have a magic number in their minds that they want to achieve when they sell their company, and that number generally has no correlation whatsoever to the business’s true value. (Working with a business valuation expert, such as a CPA who has the ABV credential, will help owners find out what their company is worth ahead of time.)
  • A related question is: What metrics do you manage to? The metric most buyers focus on, EBITDA, appears nowhere on a CPA-prepared financial statement. Few business owners even know what EBITDA stands for. They manage to the top line, which is not the primary driver of valuation.
  • Have you gifted shares and taken other measures to reduce tax obligations upon a sale? This needs to be done years in advance of the exit event to avoid IRS scrutiny.
  • Is your CPA a team player? Quality advisers embrace others who can help their client achieve their objectives. 

Making the transition
There may be a natural inclination for the client and his or her business advisers to transition ownership to kids or to the company’s existing managers. That satisfies familial or loyalty obligations for the client—and those types of transitions lessen the risk that new ownership will change advisers. But neither family nor existing management typically have the resources to allow the founders to cash in on their efforts.

Less than one-third of companies successfully make an internal transition, and many of those that do wish they hadn’t. If you are to be the true “trusted financial adviser” to business owners, you need to have candid conversations annually with them about their liquidity objectives. That is the most important financial advice you could ever give them.

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Michael Jacobs, CEO of Jacobs Capital, is the former head of corporate finance policy at the U.S. Treasury Department. A finance professor at Kenan-Flagler Business School at the University of North Carolina at Chapel Hill, Jacobs has run M&A practices for more than 20 years.