Exit Planning Step 5 - Net Proceeds Analysis

The exit plan is progressing.  We have identified the goals under Step 1, determined the financial needs upon exit under Step 2, assessed the current value of the business under Step 3 and selected the relevant exit option(s) under Step 4.

The net proceeds analysis involves determining how much the business owner will "pocket" from the sale of the business after settling all liabilities, income taxes and other obligations such as sales commissions and professional fees.  Some business owners may not appreciate that the actual net cash received upon sale can be significantly lower than the agreed upon sale price.  This analysis should be conducted for the relevant exit option(s) and under various assumptions regarding the value of the business.

A good starting point is to estimate the net proceeds assuming a sale price equal to the current value of the business determined under Step 3.  Certain assumptions with respect to sales commissions and professional fees will be required.  

Does the resulting net proceeds meet the financial needs determined under Step 2?  If yes, then great, we are on track!  If no, then further analysis and action is needed.  Specifically, the sale price that provides net proceeds equal to the financial needs must be determined and the value enhancement initiatives that will increase the value of the business to that level must be identified and implemented.

It is vital to conduct this analysis 3 to 5 years before the intended exit in order to allow sufficient time to implement the value enhancement initiatives that will enable the business owner to meet the financial needs and achieve the goals.

Whereas the seller is interested in net proceeds, buyers are generally interested in a company’s enterprise value (i.e. value of the operations attributable to both debt and equity holders).  In order to reconcile the two, enterprise value is increased by the company’s redundant (i.e. non-operating) assets and decreased by the interest-bearing debt outstanding, closing costs and taxes to be paid on the transaction.  Redundant assets are not required to generate operating cash flows and generally not sold as part of the business operations.  Examples include excess cash, marketable securities, real estate and related party loans. 

With respect to transaction structure, the business owner may prefer a share sale to realize the benefit of the capital gains exemption.  A purchaser, however, may prefer to purchase assets to avoid undisclosed liabilities or to take advantage of the tax benefits from "stepping-up" the cost base of certain depreciable assets.  Transaction structure is often a key agenda item in negotiations between the buyer and seller.  As such, the seller should understand the implications of both an asset sale and a share sale.

A Chartered Accountant, Certified Financial Planner or tax lawyer can assist with calculating the net proceeds under various scenarios, including: different exit options, different sale prices, and different transaction structures.

Next week we discuss the final step in the exit planning process: developing and implementing the action plan.