Exit Planning Tools for Business Owners

Boomer Bust

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.

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.

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.

Where Will All the Small Businesses Go?

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What would the small business landscape look like if over one million small businesses disappeared? Get ready, it’s about to happen.

I write and speak frequently about the passing of the entrepreneurial generation. Driven by competitive pressures to succeed, the Boomers became small business owners in unprecedented numbers not seen since. They now account for about 2/3 of all the small employers (under 500 workers) in the United States.

The two generations that follow, the Xers and Millennials, don’t have the capital, the material ambitions, or the need to chase the Boomers into small business. For a free download of my ten-article series on this transition, go to The Boomer Bust and use the password “Woodstock.”

For one moment, let’s just review the numbers. In 2018, all Boomers will be between 54 and 73 years old. Eight thousand a day will be turning 65. The Xers who can buy their businesses will be turning 45 only at a rate of 4,000 a day. Nothing can be done to change this gap.

closed doorsJust over 7% of Boomers own companies with employees, or about 5,500,000 small businesses. That equates to about 215,000 owner retirements annually. If the Xers were willing and able to buy businesses proportionate to their numbers (and they are neither willing nor able,) we will still have over 100,000 businesses a year without buyers. That is 300 businesses a day closing, seven days a week, 52 weeks a year, for ten years.

I’ve been discussing this demographic tsunami since 2007. A few other writers are beginning to realize how big this shift will be. There is no cure. We can’t make people who aren’t interested in a Boomer lifestyle into workaholics. We can’t fund budding entrepreneurs who  have no means to secure traditional financing. We can’t change the sheer volume of retiring owners.

The term “exit planning” is spreading fast, and with good reason. It is going to be the hot button for millions of small business owners throughout the rest of this decade and the next. If your plan is to work until you just don’t feel like it anymore, and then expect to have someone jump at the opportunity to take over from you, think again. The market will be crowded, and only the best-run small businesses will find a buyer.

This week we were reviewed by Martin Zwilling in the Huffington Post. Thanks Martin!  Hunting in a Farmer’s World: Celebrating the Mind of an  Entrepreneur is a nominee for Best Small Business Book of the Year. Please support us, and entrepreneurs everywhere, by taking a moment to cast your one-click vote here. Thank you!

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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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