Exit Planning Tools for Business Owners

Building Value

Money is Only Money

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Last week I discussed the general parameters of the private equity market for small and midsized businesses. A rational look at the number of “funds” active in the market, measured against the number of legitimate candidates for investment or acquisition, paints a clear view of why so many small companies are receiving calls from interested investors. There simply aren’t enough profitable, growing companies to buy.

I put “funds” in quotes because not all Private Equity Groups are funds. There is a big difference between “We have money” and “We can get money.” Your first questions to any purported acquirer should be about the source and condition of their funds.

Some will say they have investors ready to fund. Walk away. You don’t have the time or energy to let your company be used as a beauty contestant for someone who is little more than a broker.

Others will say they have “dry powder.” That’s the PEG term for an actual bank account in which their investors have deposited real money. “Dry powder” is the amount they have available to invest. Ideally it should be sufficient to purchase your business for cash. although that might not be how things eventually wind up.

Rolls of 100 billsFor many of my clients who are approached, the next questions disqualify most of the remaining prospects. The conversation goes something like this:

Q:  What related acquisitions in our industry are currently in your portfolio?

A: We have over $400 million dollars to invest

Q: What is your strategy for our industry, and why do you find it attractive?

A: We have over $400 million dollars to invest

That’s an oversimplification, but not by much. Money is only money, and merely having it is no guarantee of success. You should remember that the average PEG has promised a target level of return to its investors, and most have a deadline for investing the money. If they fail to do so, the money reverts to its original owners, usually less the PEG’s costs of operations. That (not surprisingly) greatly diminishes the PEGs chance of raising more from those folks next time around. If that deadline is approaching, some funds get much looser about how and where they find deals.

Let’s say you find a fund that is already focused in your industry and has a strong plan for growing their investment. That is usually either by adding more companies like yours, or by using their relationships to generate a lot of new revenue. Whether you should give up control (and you are always giving up control) of the business depends largely on your personal objectives.

  • Family Financial Security: You want to take enough money off the table to eliminate the risks your family has lived with since you started the business. You still enjoy working, but would like to have more of a safety net.
  • Executive Expertise: As hard as it may be to admit, you’ve taken the company as far as you can. It has a lot of upside potential, but you know that you aren’t the one to take it there.
  • Capital Investment: You’ve identified substantial opportunity if you had the equipment or network to pursue it, and the investors agree with you.
  • Two bites: As I described last week, you see the investment partner as bringing the ability to make the minority share you retain worth more than the majority you are selling now.
  • Exit Strategy: Your new partners understand and agree on a time frame and method to let you move on to the next stage of your life.

I recently had a client who was offered a substantial 8-figure sum for his company. He is well under 40 years old. He decided that the company was (and the investors agreed) positioned for a period of very rapid growth, and he would rather make that run as a sole owner. Those members of his peer board who were over 50 years old strongly advised that he take the money and start another business if he had that much appetite for risk.

Age and attitude govern what is or isn’t a good deal. First you have to know what you want, but even then professional investors can’t read your mind. Unless you tell them what your objectives are (and you will have to eventually), they can only talk about their investment, and money is only money.

I have just published a new eBook, “24 Tips for More Effective Meetings.” It is available for FREE when you sign up to receive “Awake” weekly. If you are already a subscriber, just reenter your email address in the small sign-up form above right (you won’t receive duplicate posts). You will be automatically redirected to a download page. Thanks for subscribing!

Investing in Your Own Business: Will It Pay Off?

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A few months ago a business owner asked me to evaluate an acquisition offer for his small business. It was from a larger company headquartered in a different region of the country. They had a branch operation in his city, and wanted to expand their presence by combining it with his.

For an opening offer, the deal seemed very reasonable to me. The purchase price was about four times EBITDA, with half in cash and half with interest over the next three years, and without any conditions attached. (note: That doesn’t mean conditions wouldn’t have come later.) He would receive a three-year employment agreement at a higher salary than he currently paid himself, with additional bonuses for growing the business plus all the benefits he currently enjoyed.

He was unhappy with my assessment, and announced his intention to counter-offer for double the proposed purchase price, with a perpetual employment agreement that would allow him to work for as long as he chose.

While any opening offer is subject to negotiation, I expressed my doubts about attaining a public-company or strategic-level multiple, especially when accompanied by an employment agreement that would make any labor attorney flip out. I asked him how he planned to justify his asking price.

empty wallet“It just isn’t enough to retire,” he said. “I’d have to keep working indefinitely, and I don’t want to have to go find another job if this doesn’t pan out.”

Please understand; presenting this story in the abbreviated way that I have makes this owner sound like he is clueless or ignorant. Neither is the case. He has run this business for years, and built it to several times the revenue and profitability of when he acquired it. He has sacrificed personally, putting in long hours and scrimping financially to reinvest in his company. He  qualifies as a successful small business owner by most measurements of small business success.

But as a mid-generation Boomer (late 50s) he is coming to the realization that it may not be enough. Like many others, he decided that investing in his own business was more controllable and would produce a higher return than the vagaries of stock markets and  mutual funds. His business is his retirement account, and like hundreds of thousands of others, he eventually came to believe his own claim. He expected his company to fund his retirement, without really looking at its objective value in the marketplace.

I asked him if doubling the price would achieve his retirement goal. He thought for a moment, and said “I don’t know, but I doubt it.”

There are roughly 5,500,000 Baby Boomer business owners entering, or already well into, their retirement windows. (The oldest Boomers turn 70 this year.) Many have the expectation that their company is their retirement plan, but there is no assurance that it’s true. If you are over 50 years old, I strongly recommend that you do three things:

  1. Download and read my eBook “Beating the Boomer Bust.” It’s a collection of ten blog posts  from this site with an overview of the challenges that are inevitable with the wave of retiring Boomer exits.. It’s short (45 pages) and its free.
  2. Get an objective valuation for your business. You don’t need a full appraisal. An opinion of value can range from free to a few thousand dollars, but it shouldn’t cost more than that. (You pretty much get what you pay for, though.) It is critical to understand where you are today.
  3. Get a realistic projection for how much you will need to maintain your target lifestyle in retirement. A Certified Financial Planner (CFP®) has the training and software to include inflation and tax assumptions. Again, many insurance agents and stockbrokers will provide this for free, but I prefer someone who does it without offering products for sale based on the result.

Disclosure: I offer exit consulting for business owners, but I do not provide valuation services, financial planning, wealth management, tax guidance or insurance. I’m just trying to have fewer conversations like the one above. Additional information, including a free, online self-assessment of your business, is at http://exitmap.com.

 

 A Note to My Readers

This January marks the start of my seventh full year of writing Awake at 2 o’clock on a weekly basis. I got serious with the publishing of “The Strategic Triple Threat” in January of 2009, which will probably stand forever as my most accurate piece of economic prognostication. :-)

Many thanks to the hundreds of you who have commented, and who come up to me at speaking events and say “I’ve been reading your blog for years.” If you read regularly and find yourself nodding in agreement or quoting a column, then I feel that I’m doing my job.

It’s a big, wide Internet out there. Like any blogger, I’m thrilled that I touch so many people with helpful information, but would always like to reach more. Please help by taking a few minutes to pass along a link to any business owners or advisors that you think might also enjoy an owner’s point of view.

Thank you

If you would like a printable pdf of this column or any other, please let me know at jdini@mpninc.com.

What is Your Company Worth? II

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Last week we discussed how business owners frequently use hearsay or incomplete information to estimate the value of their companies. They give the number to their financial planner, or include it on a personal financial statement for their banker, neither of whom bat an eyelash at the estimate. Having the amount “accepted” by financial experts, the owner starts to treat it as fact. How do you know whether it is realistic or achievable?

alchemistValuation of a small business is a combination of art and science. No two small companies are alike. A multiple of profits or cash flow is only the starting point. Take two small companies, each with $4,000,000 in revenues and $500,000 in profits. Each pays the same salary and benefits to the owner. One does it by having systems that control most day to day activities, recurring revenue from contracts, and long-term employees who are incented by profit sharing. The other does it with an owner who works 70 hours a week, hasn’t had a two week vacation in ten years, and makes every new sale personally. Which business would you pay more to own?

Beauty lies in the eye of the beholder. The multiples paid for businesses depend on the type of buyers they attract. Commonly, those that sell for less than $2,000,000 are considered “Main Street.” Their target buyers are individuals who are purchasing an income. They intend to work in the business, and to earn a regular paycheck by running it.

Main Street businesses are valued by a multiple of Seller’s Discretionary Earnings (SDE). The value of the business is based on the sum of the financial benefits resulting from ownership. That includes profits, salary, benefits and any of a long list of possible perquisites like a company car, travel, or insurance. (For more on calculating your SDE and selling a business in general, you can read my book, 11 Things You Absolutely Need to Know about Selling Your Business.)

Main Street pricing is typically between 2.1 and 2.8 times SDE. It is based on simple arithmetic. The closer you come to 3 times SDE, the less able a buyer is to pay both the bank and himself. You can run your own numbers here, to see how it works (registration required).

For larger companies, those that attract financial and industry acquirers, the multiples are higher, but the multiplier is lower. Those buyers anticipate paying for professional management, so the owner’s compensation is less of a consideration. They look at EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization) to calculate available cash after all the expenses of running the business (including executive talent) are paid.

Competitors will calculate the savings they might realize from consolidation, but are usually reluctant to multiply those savings in a purchase price. Private Equity Groups (there are 7,000 in the US) and the acquisition arms of large companies seldom look at businesses with earnings of less than $1,000,000. As amazing as it seems to a small business owner, their due diligence and legal processes are too expensive to make smaller acquisitions worthwhile.

Private Equity Groups pay an average between 4.7 and 5.2 times EBITDA, year in and year out. That makes sense, because they are financial buyers with a targeted Return On Investment (ROI). Large company acquisitions of smaller businesses can range from 4 times EBITA up to around 7 or 8, although in a few cases strategic considerations (competition, exclusive contracts, proprietary methods) can drive that up substantially .

All of these are real numbers, based on actual sales data and industry surveys. Sellers often confuse the terms revenue and income, or apply EBITDA multiples to SDE. They are greatly disappointed and angry when legitimate offers fall far below their expectations. Just because your planner or your banker didn’t challenge your valuation estimate doesn’t make it fact.

My new book, Hunting in a Farmer’s World: Celebrating the Mind of an Entrepreneur, is now available on Amazon in paperback, hardcover and Kindle. It is an ownership book, not a management book, and is illustrated with the stories of real entrepreneurs who faced challenges that apply to us all.

The Road Less Traveled

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Somewhere ages and ages hence:
Two roads diverged in a wood, and I,
I took the one less traveled by,
And that has made all the difference.

Perhaps Robert Frost’s famous poem isn’t a perfect expression of what I am trying to convey, but the idea he expressed has been ingrained in us (the Boomers- I think Maya Angelou has replaced Frost as required poetry reading in schools) enough to serve my point.

Some thousands of business owners have heard my presentation on the inevitable issues of selling Boomer businesses. Hopefully, even more will  hear it in the future. Many have read my column, caught me on the radio, or bought my book on selling a business. Even so, they represent a small fraction of the estimated 6,000,000 Baby Boomer entrepreneurs with employees in the US.

If you are reading this, you are better informed than 99% of your peers. Whether you are a Boomer preparing to exit, or a gen X or Millennial thinking about becoming a business owner, you know more than almost all of your competition.

I can’t do anything about the birthrates of 65 years ago, or of 45 years ago, or of 25 years ago. Neither can you. From 2018 onward we will have a dramatic, decade-long imbalance between 60 somethings and 40-somethings in the workforce. That has implications for the economy, politics and general business, but it will have a special impact on retiring small business owners.

The Boomers will retire. Some have done so already, some will wait for as long as possible, but sooner or later they will all leave their businesses. We’ve discussed how “the curve” of Boomers entering any given age bracket exploded markets in home building, college graduations, franchising, fitness and so much more.

We could expand the discussion to other industries, from motorcycles (Harley-Davidson has been caught without a product for middle-aged Xers) and cars (Ford recently said that they had sold as many retro Mustangs to 55 year olds as that market will absorb), to garden homes and second-career counseling.

America has grown, and 78 million Boomers in  country of 320 million obviously won’t have as much impact as when they were 40% of a country with 190 million people. But it is a generation exceptionally oriented towards being successful, and working very hard to own the material indicators of that success. Their passing will still create huge ripples.

If you’ve read this series, you are armed with knowledge; the realization of an inevitable glut of small business sellers, and the coming shortage of buyers. You understand why the generational traits of Boomer sellers have made many of their businesses undesirable to their prospective buyers. You should also have a pretty good idea of what needs to change in your business, and how to start down the road of making those changes.

But tomorrow your business will still require the same attention that it does today. You will be just as busy, and making long-term changes will be just as easy to postpone until you have “more time.” Investing time, energy and money in a Second-in-Command or a Successor-in-Training is easily left for another day.

A few business owners will choose the road less traveled. They will begin to shift their perspective from the immediate issues of competing in the day-to-day marketplace, and instead start to focus on competing for a successful end game.

Those are the owners who will beat the Boomer Bust.

 (This is the tenth and final installment in a series about “Beating the Boomer Bust.” Previous installments are The Approaching Tidal Wave, The Pig in the Python,  The Brass Ring, Work-Life Balance, Outsourcing America ,  The X Factor, The Gen X Business Buyer , Beating the Boomer Bust and Choosing a Buyer for Your Business.)

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The Gen X Business Buyer

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Generation X’ers aren’t mini-Boomers. Raised in a rapidly growing economy by parents that approached child rearing as a competitive activity, they saw more, did more, and were given more than their parents could have dreamed of.

I took my first commercial airline ride when I was 25 years old (and before my mother’s first flight). My two sons had each boarded planes over 50 times before they were in high school.

I was not an athlete, and have no hardware to display testifying to any athletic prowess. My youngest son made varsity in one sport, for one year. Yet he has a bookcase full of trophies.

I received a couple of piano lessons from a neighbor who played. My children had paid instructors for martial arts, gymnastics, baseball, piano, viola, singing, and math. They are far from the most-coached kids I know.

The challenge of selling a business to a small and disinclined group of prospective buyers starts with their lack of numbers, but it is just as much about how they were raised by their Boomer parents. Generation X has different values and many more choices.

Values

The numbers are just the most obvious (and the most inevitable) factor impacting Generation X as buyers. The second factor is values. Every Boomer owner I know, and there are hundreds, has complained about the expectations and the lack of a decent work ethic among Generation X. This isn’t caused by a special laziness gene. It is a matter of values.

Boomer “super parents,” driven by their competitive  approach to everything, raised children who expected to be accepted for who they are, and to have things done for them. Boomers created the children’s ball team where everyone got a trophy just for participating, regardless of the team’s success. X’ers watched their parents struggle with a breakneck pace and the concept of work-life balance and, like every generation of offspring, saw their parents’ approach to life as stupid.

So Generation X, by and large, doesn’t equate material comfort directly with work. Their “balance” is oriented towards separating work and life. Unlike most Boomers, who live to work, the X generation only works to live. Work isn’t their identity, it is merely the thing that permits them to finance what they really want to be.

For Boomer entrepreneurs, who accept a 50 or 60 hour work week as simply part of the cost of business ownership, that isn’t good news. The next generation of buyers doesn’t agree with you, and isn’t interested in subordinating their lives to the quest for success.

Choices

I know five local CPA firms that have sold to regional or national competitors in the last 3 years or so. Each had the same problem. They had built a model where the retirement of the Boomer founders was dependent on the profits to be generated by the next generation of partners. Unfortunately, that generation wasn’t interested in assuming the required work load. In several of the cases, a younger partner was invited to a meeting, where the senior partners announced that he or she had been selected as the next leader of the firm. To their shock, the annointee turned them down flat.

Corporate America is aware of the coming shortage of educated, hard-working, middle-aged executives. They are recruiting them with far greater benefits and perquisites than a small business can afford.

Since the 1970’s, a flood of regulation and increasing liability connected to business ownership makes the entrepreneurial proposition riskier and more tedious. The Boomers have only themselves to thank for that.

The retirement of the Boomers is placing a crushing burden on Medicare, Social Security and pension funds. The likelihood of greater taxation, and lower benefits for those who follow, detracts from the attraction of working hard to make a lot more money.

Finally, technology has vastly expanded Gen X’s choices. Flex time, telecommuting, job sharing, family leave and home-based businesses make the traditional model of sitting in a business all day look far less appealing.

The bleakest future is for a small business that has few factors, other than the owner’s personal reputation, to differentiate it from its competitors. It depends on the ongoing efforts of its owner to produce revenue. It has a number of employees who are only trained on the job, or who possess few distinctive skills that make them an integrated part of the business. It has no incentives that lock the best performers into long term relationships.  It lacks middle management, or anyone who can run the business indefinitely without the owner around to make decisions.

If that describes the business you own, it is time to start making changes. The generation that is reaching business-buying age has more choices for earning a living, and many more choices that better fit their values.

This series is focused on Boomers who are preparing to exit their businesses. For owners who precede the Boomers (currently in their 70’s), there is still a market of younger Boomers (in their late 40s and early 50s) to sell to. We are describing a problem that is only going to accelerate in the next 5 years. It is unavoidable, and the numbers are irrefutable.

There is some good news. You can do something about it. Most small business owners will remain oblivious to the realities of the market until they try to sell, and even then probably won’t understand the reasons why they can’t.

Like the hiker running from the bear, you don’t have to be faster than the bear. You just need to be faster than the other hiker. Simply reading this puts you ahead of the pack. We next turn our attention to what it will take to successfully exit your business in the toughest selling market in history.

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(This is the seventh installment in a series about “Beating the Boomer Bust.” Previous installments are The Approaching Tidal Wave, The Pig in the Python,  The Brass Ring, Work-Life Balance, Outsourcing America and The X Factor.)