Pre-exit guide

Selling your company? 5 Steps to take now.

Receiving an offer to buy the company you founded is both exhilarating and scary. Exhilarating because this is what you’ve worked towards for years, but scary because your actions in the next weeks and months will have a profound effect on the rest of your life.

The founder’s dilemma

When considering an exit, many founders come face to face with a difficult reality they’ve been avoiding for years. To start and scale a successful growth company takes obsessive focus and complete commitment. Raising capital, building a team, driving sales, capturing market share and everything else a founder needs to do all guarantee there’s virtually no time for anything else. Not surprisingly, one of the things most often ignored is the founder’s personal financial life. Most have a nagging feeling in the that they should be thinking about whether they need to draft an estate plan, pay off debt, refinance their mortgage, manage their investments differently, etc. But the reality is that they often don’t know where to start, and even thinking about it can be overwhelming. Compounded by the demands of running the company, most promise themselves they’ll work on their personal financial infrastructure at some point in the future-when there’s time. They then return to focusing on what they do have a template for, growing the company. And unfortunately, the personal side of their financial life continues to be ignored. We call this conundrum The Founder’s Dilemma.

If you’re facing an imminent exit, you are approaching an inflection point between your company’s financial future and your own. Having worked for years to attain the financial freedom a successful exit can represent, you might feel unsure you’ve taken the necessary steps to make the post-exit life you’ve dreamed of a reality.

In a perfect world, your personal financial infrastructure would have been periodically updated to reflect the changing nature of your situation, you’d know the amount of net proceeds you’ll need to achieve your post-exit financial goals, and you’d have your dream team of professional advisors in place helping you navigate the process. In reality, though, this is rarely the case.

The question then becomes how, with limited time, can you manage both the company side of the transaction while making smart choices that put you in the best possible position post-exit? Without a template, it can be intimidating and overwhelming.

Moving parts

Because there are so many moving parts involved in managing the personal financial side of a successful exit it’s easy to miss a critical step. Many times this is compounded for founders by behaviors they’ve learned and utilized to build their companies. The very nature of starting and growing a successful company guarantees that you will again and again need to make important decisions quickly. When dealing with multiple inputs information overload can develop, and cognitive coping mechanism called “reductive thinking” engages to isolate the most relevant factors and discard the others. Because successful founders are usually highly intelligent people who have a deep understanding of how their company functions, most of the time this works. When considering an exit, though, you’ll be entering new and unfamiliar territory. Here, the tendency to employ reductive thinking can lead to important issues being ignored, often with serious consequences. In our work with founders, we’ve found an effective antidote to this pitfall can be the systematic completion of a series of specific steps in the correct sequence to ensure you’ve addressed each key risk and opportunity. This is analogous to the job of a commercial airline flight crew. In order to safely prepare a plane for takeoff, a long list of complex steps must be taken in a specific order. Faced with the magnitude and gravity of the task at hand, missing any step could have disastrous consequences. In order to make sure everything is done right, even the most experienced crews use a pre-flight checklist to make sure that they don’t fall into the trap of reductive thinking and miss a small but important detail. Just like the flight crew uses the checklist to safely operate the aircraft, founders can follow steps tailored to their own situation to provide the best opportunity for success. Taking the right actions in the right sequence is the key that can unlock the Founders Dilemma.

Steps to success

While more time allows for greater preparation, it is possible to effectively plan for a successful post-exit life with a short time frame. Focusing on the critical analyses and action steps that shouldn’t wait until the sale closes, you can be prepared if you follow a series of five important steps.

  1. Discover where you are, and where you want to be.
  2. Complete a pre-exit financial analysis to determine which goals are achievable at each potential exit valuation.
  3. Determine how much tax will be owed and how it will be paid.
  4. Develop an investment plan for sale proceeds.
  5. Create your philanthropic framework.

Taking these steps will allow you to understand if you should exit and will put in place the core infrastructure to manage taxes on the sale and help you understand the lifestyle your sale proceeds will support. Additional planning around your specific situation will also be necessary and can be completed pre-sale if time permits, but waiting to address less critical issues is generally not overly detrimental.

Step 1: Discovery process

In order to develop an optimal post-exit plan, it’s important that you and your professional advisors share a comprehensive understanding of both the financial and non-financial aspects of your life. This understanding will inform decisions around not only financial questions, but also in the way you would most enjoy embarking on your new life.

The Discovery Process has two parts. The first creates a complete picture of where you are and where you want to be in terms of life and goals. The second asks the questions that will help you and your advisors get there from a financial and investment perspective in a way that works best for you.

Life and goal discovery

Working with a professional advisor trained in gathering this information, the founder and any life partners should undertake a comprehensive personal discovery process. In addition to understanding your current and projected assets and investment preferences, this discovery process should also address your values and goals, financial and otherwise. In determining goals, you can start to identify what are absolute post exit “needs”, what are it-would-be-nice “wants” and finally aspirational “desires”.

Also highly relevant is recognizing the important relationships in your life, and understanding the causes and organizations you’re passionate about. Finally, it’s important to identify the members of your professional advisory team, and to share with them your preferences when it comes to working with them.

Having this assessment ready in an easily understandable format can provide you with two important benefits. First, it’s a great way to bring new advisors up to speed quickly, without having to conduct lengthy intake meetings every time a new professional joins your team. Additionally, many founders find referring to their assessment helpful as they prioritize action points and next steps. For example, one driven founder we work with has a graphic representation of his life and goals laminated and placed on his desk so he has a constant reminder of what he’s working for.

Investment policy discovery

The second part of the discovery process involves creating the framework of your personal Investment Policy Statement. By evaluating your attitudes and preferences and your comfort level with variation around investment returns you’ll develop a personal policy around which types of investment assets are appropriate and the percentage assigned to each asset class. These written guidelines have been utilized for decades by foundations, endowments, and large pension funds and have often contributed to superior long term returns. Individual investors can likewise benefit from the clarity of having a written set of “rules” that will govern their investment manager’s actions.

Step 2: The Pre-exit Financial Goals Analysis.

Having completed the discovery process, you’ll be able to reference your Need/Want/Desire goals to put a dollar amount on the different possible post-exit lifestyles. Using the combination of different investment asset classes which most accurately represent your comfort level in terms of target long term returns and variations along the way, a stochastic analysis using financial modeling software is performed to forecast the chances of success given different levels of investible proceeds. A best practice is to run 1,000 hypothetical economic scenarios to determine the likelihood of achieving all of your goals. Generally a result of 75%-80% probability of success lies within the “confidence zone”, but that will vary by the degree of certainty desired by the individual founder.

The resulting output will determine the level of net sale proceeds necessary to meet each level of financial goal. For example, you may require $8 million in net proceeds to achieve your “Need” goal, $20 million for your “Want” goal and $25 million for your “Desire” goal.

Many founders find it empowering to have this knowledge, as it allows them to make data driven decisions on whether to accept a current offer. In the absence of this information many founders have accepted offers which seemed like a lot of money but in reality turned out to be less than needed to meet their goals. Conversely, if a founder can achieve everything desired with a smaller exit than they’ve assumed it can be liberating to know that while you would like to sell for $100 million (for example) you don’t necessarily have to.

Step 3: Planning for taxes

If you decide to move forward with the sale, you’ll want to consider the tax you’ll owe. First, you’ll want to know what your tax liability is, and how you’ll pay it. In most states you’ll be liable for both Federal and State capital gains taxes. It’s very important to have a qualified tax professional on your team to determine specifically what this means to you, as being surprised with a larger than expected tax bill can severely impinge upon your plans. If you’re fortunate enough to be a founder who qualifies for the Qualified Small Business Stock provision of the IRS code your taxes may be mitigated, but you’ll want to seek the advice of your CPA before the sale to determine if this applies. Once you know your tax liability, you’ll want to determine when the tax will be due. If you’re negotiating with a potential acquirer late in Q4, depending on your situation and potential tax-changing legislation it may be desirable to delay the transaction into Q1.

The source of funds to pay taxes is also something to consider. In most cases it’s appropriate to simply hold the necessary funds in risk free instruments such as federally insured CDs or Treasury securities or high grade tax free municipal bonds maturing before your tax bill is due. If you opt for CDs, make sure you’re limiting your exposure to $250k per bank issuer, as that’s the limit of FDIC protection. Some financial service companies can hold CDs from different banks, though, so you should be able to get the necessary diversification to ensure full coverage without the trouble of opening multiple bank accounts. In some cases an investment portfolio funded by the exit can be collateralized as security for a loan which can be used to pay the taxes owed. Providing that the dividend and interest income produced by the investments exceeds the interest rate charged on the borrowed amount more assets can stay invested to provide additional growth potential over time while the income produced covers the cost of borrowing. This strategy is generally more attractive in a lower interest rate environment, though, so you’ll want to carefully examine the positive and negative aspects with your professional advisors before coming to a conclusion.

Step 4: Investment planning

Part of your pre-exit analysis included the development of a personal Investment Policy Statement which includes guidelines around the percentage of funds allocated to different asset classes, such as cash, bonds, stock, real estate, private equity, and venture investments. Research has demonstrated that the strongest determinant of how a portfolio acts is the type and combination of asset classes composing it, much more so than the specific underlying investments or at what time in a market cycle the funds were invested. The performance assumptions which will drive the 1000 scenario stochastic analysis stem primarily from the asset allocation which was in turn created based on your preferences around long term return goals and comfort with variability along the way. In addition to your asset allocation, it’s wise at this point to begin considering the specifics of how that investment policy driven asset allocation will be implemented. Important factors to consider include whether you wish to include or exclude certain types of investments based on environmental, social and governance concerns, management modality, relative tax efficiency and costs.

Step 5: Planning for philanthropy

Now is also the time to prepare plans for charitable gifts funded by the sale proceeds. If you have philanthropic intent, the year of the sale may be the time to fund a private foundation or donor advised fund. Doing so may reduce your tax liability and create a vehicle for future giving. Donor advised funds tend to be easier to establish with less administrative weight than private foundations, while foundations sometimes have greater flexibility in who can receive gifts. Your CPA, estate attorney and financial planner will be key advisors in developing a philanthropic strategy.

If you have children, creating a foundation or DAF can have an additional positive impact. Involving children as early as possible in family philanthropic discussions often changes their attitudes towards money. Kids who have a seat at the table for discussions around family giving start to view money not so much as a pool from which they spend, but as a resource which should be stewarded for ongoing good. Foundations are also a good tool to preserve family unity with the potential to carry on good works for many generations with younger family members stepping in as older members eventually step away.

In conclusion

As a founder with a potential pending exit you will have a tremendous amount of due diligence, hard work and negotiation ahead of you. By taking time to methodically assess, develop and execute your post-exit plan you will be in a position to greatly improve your opportunity for success.