Exit Planning Tools for Business Owners

Baby Boomers

Owners Live in Two Different Worlds

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Business owners live in two different worlds. If you are a Baby Boomer, the title of this column might bring memories of any one of the many covers of the song by the same name. (Everyone from Nat King Cole to Roger Williams, and from Jerry Vale to Englebert Humperdinck recorded it.)

My application of it in business refers to the chasm between those owners who plan to sell a business valued at less than $3 million, and those who have companies valued at more than that. In M&A parlance; “main street” and “mid-market” businesses.

business presentationSome background is in order. I spent the week at two conferences. At the Business Enterprise Institute’s Exit Planners’ Conference we talk mostly about the complexities and structures of mid-market transfers. From there, I attended The Alternative Board’s International Conference for advisors who run peer advisory groups and provide coaching, principally for the owners of main street companies.

At the latter, I had the privilege of being on a panel with Bo Burlingham of Inc. Magazine, the author of Small Giants and Finish Big, and John Warrillow, the Founder ofBurlingham Warrilow Dini the Value Builder System and author of  Built to Sell. It would be challenging to find three people in the country who have spent more combined time studying how small businesses sell, and what determines their value to a buyer.

Even with two audiences of savvy professionals who are focused on the flood of business owners transitioning from their businesses, in many sessions the presenters had to explain the difference between the two markets. As an owner, it’s critical that you understand what the market is for your company. Using data from the other side of the fence is only destined to frustrate you.

Mid-Market

These are companies with a value (not revenue!) of greater than $3,000,000. To garner the interests of financial buyers (private equity groups), they have to generate pre-tax earnings of at least a million dollars a year. To attract strategic buyers, they must have some real differentiation in their industry or market. Those who are truly scalable and have already grown to over 100 employees are the hottest commodity; but according to Doug Tatum, the author of No Man’s Land, they presently account for about 30,000 of the 6.5 million private employers (2-500 employees) in the marketplace.

The acquisition outlook for these companies is wonderful. The financial market is blazing hot, with 7,000 private equity players and publicly traded acquirers chasing those 30,000 businesses, or at least any among them who will still take a phone call. Valuations  are growing quickly, with multiples in the upper end of the market up over 20% in the last two years, and well over a trillion dollars of “dry powder” waiting to be spent on buying them.

Main Street

Clearly, the odds are pretty high that you are one of the 6,470,000 owners whose company does not fit the description above. Welcome to Main Street, where differentiation is difficult or impossible to quantify. (Sorry, but in all but the rarest cases,  “service” is not a competitive differentiation.) The business exists primarily for the purpose of providing financial security for the owner and the employees.  Likely acquirers include individuals seeking to purchase an income, small competitors, or if you are close to the million dollar pre-tax mark, perhaps a private equity group looking for a “tuck-in” or “bolt-on” to an existing similar acquisition.

The news for these owners could not be more starkly different than for the chosen few in the mid-market. According to Burlingham, somewhere between 1.3 and 2 million of these businesses will come up for sale in the coming decade. According to both IBBA (the business broker’s association) and the US Chamber of Commerce, only about 20% of them will successfully sell to a third party. With the much lower population of Generation X, who have little in the way of liquid savings and eschew 50 hour work weeks, the pre-tax multiples in Main Street values are contracting, and the shrinkage grows worse the farther down the food chain you are.

The message is clear. As John Warrillow said, if you are anywhere close to the magic numbers that attract mid-market buyers, the most important thing you can do is drive your company over the top. The difference can mean double, or even triple the proceeds you receive. Here’s an exercise. A company making $700,000 a year with a valuation of 3x earnings can sell for $2,100,000. If they grow to $1,100,000 in profits with a value of 5x earnings they’d get $5,500,000 at sale. That’s 57% growth in profits for 161% growth in price.

Any questions?

Even the measurement of earnings between the two types of business is different. We’ll discuss that next week.

 

 

Ageing Boomer Entrepreneurs: Fearful or Smart?

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Do we become more cautious with age?

Startups are usually associated with younger entrepreneurs. By the time they reach their 50s or 60s business owners tend to tackle fewer big new ideas. Those that do tend to be successful enough that they can segregate the risk in a way that won’t threaten their core livelihood. Are they smarter, or just more fearful of failure?

There are any number of business axioms about the value of experience. “Experience is what you get when you don’t get what you want.” or “Good decisions come from experience. Experience comes from bad decisions.” Does the caution that accompanies age come from experience, or just from a natural reduction in adrenalin?

The youngest Baby Boomers turn 50 this year. Collectively, they represent over half the small business ownership in the United States. There is an important macroeconomic issue attached to the general ageing of owners. If risk-aversion is a biologic phenomenon, then we can expect millions of small employers to drift into “harvest mode,” maintaining their businesses as vehicles for current cash flow and retirement security. They will leave growth and innovation to a younger, but substantially smaller group of entrepreneurs.

Some of their caution is due to external influence. As companies grow and founders age, they become far more conscious of their responsibility to employees’ families and children. Putting everything on the line has potential impact not only on workers, but the extended small economy that depends on their wages. Greater responsibility generates greater caution.

danger aheadWhen you are starting out, have fewer people depending on you, and mistakes have fewer consequences (see my 2014 post The Luxury of No Resources),  it’s easier to take a leap. If you fail, you’re not much worse off than you were before. But there are costs to learning by trial and error. After a while, going back to the drawing board becomes tiresome.

Ideally, the caution that comes with age isn’t from fear. It’s because you’ve come to appreciate the value of planning. It’s not because you are afraid to make a mistake, but rather you want to avoid the delays that come with making repairs every time you hit a pothole.

Every school of business wisdom extols the value of planning. When we are younger, we tend to ignore it. We scoff at Abraham Lincoln’s quote “If I had eight hours to cut down a tree; I’d spend seven sharpening my saw.” The tree is right in front of us. The saw is in our hands. We can sharpen as we go. Sometimes that works. Often it doesn’t.

Many Boomer owners will operate from a fear of failure. Their businesses will fade as the world continues to change around them and they don’t adjust. Hopefully, they’ve been successful enough in the past to exit comfortably.

Some, likely a small minority, still seek to leave a bigger legacy. They have a shorter time frame, lacking the 30 or 40 years of a full career ahead of them. They’ve learned to spend the seven hours sharpening, so that the hour spent sawing is easier and more productive. Those entrepreneurs will adjust to change on their own timetable, but  with far better results.

Their caution isn’t from fear, but from experience.

 

Selling Your Business in a Buyer’s Market

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For almost ten years I’ve been writing and speaking about the issues facing Baby Boomer business owners as they begin a flood of small business sales. This recent article was syndicated in 16 trade and professional magazines. I reprint it here so readers of “Awake” can share it with their over-50 owner colleagues.

More than 50% of US business owners are over 50 years old, and many of them are looking toward retirement and the process of attracting and vetting potential buyers to take the reins. The differences in yesterday’s and today’s business landscapes are stark—as Boomers were raised in a highly competitive environment, many face the problem of having built companies that won’t attract a new generation of buyers. Three major trends impact the salability of a business. Understanding these trends can help owners transition successfully in a challenging market, and ultimately identify the buyer who will carry their company’s torch going forward.

Why Do Boomers Work So Hard?

Baby Boomers are 2 ½ times more likely to own a business than the generations before or following. Between 1975 (when the first Boomers turned 30), and 1986 the formation of new businesses in America jumped from 300,000 to 700,000 annually. Faced with fierce competition on the pathway to success, many Boomers chose to chase the brass ring by going into business for themselves. New business start-ups have never again reached that level. The result is that nearly two-thirds of all businesses with fewer than 500 employees are in the hands of people who are preparing to retire.

The impact of the Baby Boomers at each stage of life created a one-time surge in many statistics. They tripled the number of college graduates, and brought over 50 million women into the workforce. Between 1970 and 1980 the population of the United States increased by 11%, but the employment base grew by an astonishing 29%. Replacing such a massive segment of the population in the business sector is no easy feat.

The Perfect Storm

BtBB_CoverThere are three major trends that challenge a small business owner preparing to exit. Like the movie “The Perfect Storm,” these three trends; demographic, psychographic and sociographic, are combining to create a Tsunami that will change the entire landscape of independent business ownership.

  •  Demographically, the generation following the Boomers (Gen X) is much smaller. From a supply and demand perspective, there simply aren’t as many available buyers as the number of potential retirees seeking them.
  •  The psychographic profile of the buyer generation is unfavorable. What business owner hasn’t complained about the work ethic of the younger generation? Raised in a forty year period of economic growth (the longest sustained period of expansion in our history) Generation X and their successors (The Millennials) are more likely to choose family first, and perceive jobs and employers as merely the means to a personal end. They aren’t wrong. The parents of the Boomers’ understood the difference between work and personal life. One started when the other ended. In their drive for success, the Baby Boomers mixed the two and created the term “work/life balance”. Younger generations are actually returning to an older set of values.
  •  Sociographic trends favor alternative careers over business ownership. Corporate America is well aware of the issues and attitudes of the younger generations. They have already made many adjustments. Telecommuting, sabbaticals, family leave, and flex time are benefits designed to attract younger workers who have a different set of priorities. Few small businesses have the depth or breadth to allow skilled employees to come and go according to their individual priorities.

Young entrepreneurs have little interest in the service-oriented brick-and-mortar companies that dominate small business. They seek a level of freedom that doesn’t require being on call, schedules driven by customer convenience, or a 55 hour work week. Combined with the sheer lack of prospective buyers, a reduction in the number of small businesses becomes more than likely, it is inevitable.

Yet, many small business owners are depending on their company to fund a comfortable retirement. Their plan goes something like this: “I will work really hard until I am tired, and then I will find some energetic younger person just like me who is willing to commit everything for this great opportunity.”

 Beating the Odds

Fortunately, if you are a successful business owner, you’ve already proven your competitive instincts and abilities. With some planning and foresight, you can still beat the Boomer Bust and achieve your retirement objectives. There are two pathways to succeeding in a crowded sales marketplace.

Build to Sell

Your first option is to build a business that is attractive to your younger buyers. It allows for personal flexibility. It can’t require a huge down payment, since these generations were raised in a “buy-now-pay-later” world, where they are carrying substantial debt from the day they graduate college, and have little opportunity to amass liquidity.

Your technology doesn’t have to be cutting edge, but it needs to be current. Nothing turns off the tech-savvy young buyer faster than a company that is limping along on outdated software or (heaven forbid) paper. Of course, the other attributes of an attractive acquisition; growing margins, a distributed customer base and predictable revenues, are a given.

Hire Your Buyer  

The second option is to hire your buyer. The stereotypes of different generations aren’t universal. Certainly we all know Boomer slackers, as well as young people who are ambitious and hard-working. Lacking capital, many of those younger go-getters would like to own a business but have difficulty seeing how they can make it possible. Identifying such a buyer in your own organization, or even reaching outside and recruiting one, is a viable option if your target date for exiting is a few years away.

Creating your own successor requires a commitment to planning and development, but the financial aspects are fairly simple. A few years of selling equity in small amounts can let your successor build a minority stake. Then he or she can obtain third-party financing for the balance of the purchase so you can maintain control through the process, and take the proceeds with you when you leave.

Remember; “The more you work in your business, the less it is worth.” Everything you do to reduce your business’s dependence on your personal talents, to reduce the time commitment of running it, and to make it easier for any successor (whether internal or external) to take over the reins, also increases its value to any buyer.

You can’t change the factors that create the most competitive selling environment in history.  Understanding what the future looks like, and realizing that your buyer is unlikely to be someone “just like me” is a critical first step in the process.

My 48 page Ebook Beating the Boomer Bust is available as a free download in either printable or E-reader formats here.

Key Man Policies May Not Cover a Buy/Sell Agreement

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Over the last few weeks, I’ve had a number of conversations with clients about key man insurance. Let me say at the outset that I don’t sell insurance, and have no financial stake in whether any client has coverage or not. The use of such policies, however, may not always fit their intended purpose, especially in smaller companies.

The most common intended purpose of a key man policy is to fund a buy/sell agreement. The benefit payment goes to the company, which in turn uses the proceeds to purchase ownership from the family or estate of the deceased. If it works that way, it’s an excellent planning tool for your family’s security, but there are a number of things that can get in the way.

To begin, the company probably needs the money. If they are scrambling to replace you in the business, partners may be reluctant to part with a cash windfall that can keep them going. In most cases, the insurance company’s responsibility ends when payment is made. The buy/sell is a separate agreement, and enforcing it may require legal action by the bereaved family. In the meantime, the cash is being used elsewhere.

Surprisingly, some policies are in place to buy out a sole owner. A company can’t own all of it’s own stock. Someone else has to have at least minimum ownership, since treasury stock (repurchased by the company) has no voting power. If the buy/sell was put in place for former partners, you may want to revisit both the shareholder agreement and the policy.

DominosFinally, there is the small matter of company debt. The absence of the principle credit guarantor (which applies to most majority owners) will trigger repayment clauses. Lenders are in the business of mitigating loan risk, and credit agreements likely give them first call on any available funds. Unless the company remains on a strong footing, with another guarantor who can step into the primary role, the insurance payout might not be available to either the heirs or the business.

There’s one additional area where the objectives of a key man policy and a buy/sell agreement may not meet. That is in long-term disability. Because most buy/sells lump repurchase terms for death and disability together, many owners forget that the insurance only pays in the first event, and has nothing to do with the second.

There are many approaches to obtaining coverage to secure your family’s financial well-being and/or the sustainability of your business. Although I’m an exit planner, that world of split premiums, whole and universal life, insurance trusts and other, far more arcane structures makes my head spin. All I can advise is if your current broker advertises “auto/home/life” he is not likely the kind of specialist you need. Find someone who is experienced in reviewing shareholder or partnership agreements, and who can tailor a product for your requirements.

Thanks to all the readers who responsed to last week’s survey on energy costs. Just under 69% said either “Falling energy prices are good for my business” or “rising energy prices are bad for my business.”  Of course, 14% said the opposite, which just proves my point.

Ready…Set…Exit! Part II

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Last week we discussed the tsunami of Baby Boomer retirement, and how we will reach a peak of nearly 500 unsold businesses a day within the next 5 years. The statistics are immutable. The birthrates of the last century are fixed in stone. (If you haven’t read my e-book Beating the Boomer Bust you can get it for free here. Use the download code “Woodstock”.)

Once you understand the inevitability of competing to sell your business in a buyer’s market,  you have five choices.  The first  is to simply ignore it and hope for the best. For any owner who holds most of his or her net worth in the company, that’s not a great option.

The second is to watch, and wait for an opening. That requires following small business sales for favorable trends, and a flexible retirement plan that can take advantage of market conditions or an unexpected opportunity.

The third is planned liquidation. If you can achieve your financial goals by running the business a while longer, and you choose not to invest in building a company that runs without you, this is a viable strategy, albeit without the satisfaction of a large final payday.

The fourth is to build a business suitable for sale in a highly competitive environment. Such a company must have strong systems, dependable revenues, accomplished management (not including you), and profitability greater than most other companies a buyer might consider, whether those are in your industry or not.

handoffThe fifth strategy is to build your own internal exit plan, and execute it without many of the unknowns involved when taking your business to the market. It requires choosing an insider (family or employee) who understands the business, and is happy to have the opportunity to own it. Of course, that person should also have the ability to run it successfully, or at least the potential to learn those skills.

But wait. Didn’t I just write last week that selling the company to employees for a note was a terrible exit plan? I did, and it is. Selling the company to insiders doesn’t require that you bet your retirement on their continued success. With time and careful planning, it can be done in a way that minimizes or eliminates your risk.

First, any owner has to accept the fact that the company’s cash flow is the only means of payment for a purchase. Whether a buyer gives a note to you, borrows the price from a third-party lender, or invests cash with the expectation of a return on investment, the profits of the company are the source of repayment.

Selling to an insider is  a process where you take a note from the buyer before you leave, while you are still in control of the business. The buyer’s right to purchase is predicated on improving performance. You surrender some immediate income in return for incentive triggers that make your total sale price equal to or higher than what you would currently realize.

Once your internal buyer accumulates sufficient equity to qualify, he obtains a loan for the balance of your ownership. You receive 80% or more of your target price on the day you retire, and walk away with minimum ongoing liability. (I say 80% because most financial institutions like to see some incentive for the former owner to watch and advise for a few years. It can be up to 100%, depending on the lender and the company.)

With the right plan and the right people, the business transfers at a fair price with minimal cost and lower risk. The buyer(s) (whether one person or a management team) are incented to keep growing the business to qualify for ownership. While they are doing that, they are also assuming the management duties from you as a prerequisite for ownership.

Most important, you maintain control of the business until you are paid. For most owners, that is the most influential argument of all.

This is a column about the general issues of business ownership. I discuss exiting regularly because it is an important issue, but it isn’t the only aspect of ownership we discuss here. To receive my biweekly newsletter on exit strategies and issues, please subscribe here.

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