Exit Planning Tools for Business Owners

exit planning

Personal Vision – Life After the Sale Part 2

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In our last article about life after the sale we discussed identity. Even when business owners are comfortable with who they are, however, there is still the nuts and bolts issue of activity.

A business owner spends 20, 30, or (not uncommonly with Boomers,) 40 years focused on running a business. Unless they’ve built a substantial organization that is run by employees, it likely remains their biggest single time commitment right up until they leave. That commitment is frequently a lot more than 40 hours.

Even if the time “in the office” or “on the job” is less than 40 hours, there are the emails before and after hours, the texts, phone calls from unhappy customers or from employees who aren’t going to make it to work, and just thinking about what comes next, frequently at 2 o’clock in the morning.

Extended Vacation

When asked about activities to fill their week, many owners will say “I’ll have plenty to do!” That isn’t enough. “Plenty” requires some planning if it is really going to occupy the bulk of their work week.

After exiting a business, most owners bask in their newfound freedom. If we presume a selling price that’s substantial enough to allow them a wide range of choices, their first reactions typically include a few lengthy trips. These may range from a long-promised European vacation with the spouse to purchasing an RV to tour the National Parks.

This extended vacation period usually ranges from six months to a year. After that, most owners are looking for something to do. Their grandchildren (and their grandchildren’s parents) are less enthusiastic about having Grandpa and Grandma around too frequently. Travel is too tiring to keep it up indefinitely. Friends are rarely in the same position. Either they are still working and lack the leisure time, or they’ve progressed beyond the extended vacation period and settled down into their own retirement routine.

And as astounding as it may sound to enthusiasts, I’ve heard “I never thought I could play too much golf,” any number of times.

Life After the Sale…and After the Vacation

We use an exercise that brings home just how much the business has dominated an owner’s life. It starts by asking the owner to think a year ahead.

We start with the owner’s “average” work week. Let’s say 50 hours for this example. Then we begin deducting those activities that comprise their impression of “plenty to do,” putting an hourly commitment to each activity.

Regular travel, either for relatives or recreation, still comes close to the top of the list. We ask “How about two weeks away every quarter?” The response is that eight weeks a year is a lot, but could be enjoyable. Then we do the math: 8 weeks x 50 hours= 400 hours of vacation, divided by 52 weeks = 7.7 hours a week. A good start, but we still have 42 hours to fill to replace the business.

How about fitness? Getting into shape is often a goal, but working out every weekday only absorbs another 5 hours.

Working for a cause such as serving lunch at the local homeless shelter a few days a week, can use up another 10-12 hours. We still have 25 hours to go, or about half the time currently spent working.

We can still fit in 18 holes twice a week. That’s 8 more hours. At this point, many owners run out of ideas. That still leaves 17 hours a week, or two full “normal” work days.

The objective isn’t to merely fill up the time slots. It’s to illustrate just how big a void needs to be filled to replace the business. Whether your exit is planned for a year from now or ten, it is time to begin thinking about life after the sale.

John F. Dini develops transition and succession strategies that allow business owners to exit their companies on their own schedule, with the proceeds they seek and complete control over the process. He takes a coaching approach to client engagements, focusing on helping owners of companies with $1M to $250M in revenue achieve both their desired lifestyles and legacies.

How to Value Your Business

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Your guide to the secrets of business valuation and exit planning

Valuing a business can be an extremely complex process when the audience is the IRS or the Court System, but for most business owners trying to get a sense of their business value for the purpose of a sale it is more straightforward.

We’ve created this guide for business owners to gain a better understanding of the fundamentals of business value and spark some ideas around exit planning. This guide focuses on privately held businesses in mature industries, not tech start-ups. This includes “Main Street” businesses to lower middle market businesses. Let’s group them together and call them “SMBs”, a popular acronym to define small and medium-sized businesses. Before we dive into the numbers, it is important to define the key stakeholders.

Potential Buyers

In our experience, SMB owners do not spend much time thinking about the potential buyers of their businesses. There are a number of methods to transition a business, and the method you choose should align with your desired goals, whether it be immediate liquidity, legacy, or both.

Internal – A buyer for the business could be an employee, manager, business partner, family member, or Employee Stock Ownership Plan.

External – Strategic buyer (i.e. competitor), or financial buyer (i.e. private equity)

Internal buyers can be a great way for companies to transition the business, preserve legacy, and reward internal managers, employees, or family for their hard work or loyalty. However, it may take years to develop this succession plan. Owners that don’t consider these options will miss this opportunity.

External buyers will typically pay more to acquire a business due to potential synergies or diminished competition. However, external buyers will exert more control or influence over the future of the business and this may include layoffs or relocation.

Transferrability

Only 20-30% of businesses marketed for sale actually sell according to research by the Exit Planning Institute. Before we get into the attributes of a business that affect its price, you must first consider whether the business can be transferred at all.

The top three reasons for a business not being marketable in our opinion are:

1. Poor financial quality. A business must be able to produce timely and accurate financial statements at a moment’s notice. If a buyer cannot assess the business’ ability to generate cash flow, the business has no value.

2. Owner centricity. If all the trade secrets, relationships, and procedures leave with the exiting owner, the business has no value.

3. Customer concentration. If the majority of business is concentrated amongst a few clients, the business has no value. The loss of one or more of these clients would devastate the business.

If the business has strong financial quality, a decentralized business model, and little-to-no customer concentration, now we have a business that is able to be sold or transferred.

Valuation

Many firms offer “business valuations.” A certified valuation report is written by a credentialed appraiser and assigns value to a business based on an Income Approach, Market Approach, and Asset Approach.

The Income Approach is based on the premise that the value of any asset is the present value of future cash flows. In this method, an appraiser will assess historical cash flows (Capitalization of Earnings Method) or create projections (Discounted Cash Flow Method) to value a business. The cash flow stream is then discounted or capitalized according to the risk free rate of return and various risk premiums including company-specific business risk.

The risk premiums and application of the various methods can be complicated, but ultimately, the income approach is a function of earnings and risk. Risk can be broadly thought of as the risk of the likelihood the earnings will continue in the future.

The Market Approach is based on the premise that the value of an asset is determined by the price of similar assets in the market. Using this approach, the appraiser will determine the appropriate cash flow and apply various multiples. Common multiples for SMBs are revenue, EBITDA, and SDE. EBITDA is an acronym for Earnings before Interest, Taxes, Depreciation, and Amortization. In short, it is a common measure of true cash flow in the business. SDE, or Seller’s Discretionary Earnings, takes cash flow one step further. It adds in compensation for a single owner plus any personal expenses. SDE is more commonly used in Main Street businesses that can be operated by a single owner. EBITDA is more commonly applied to larger businesses with less direct owner involvement and a proper management team.

The Asset Approach is determined by calculating the market value of the assets of a business. This method is typically only applied in a liquidation scenario. In the income approach and market approach, we assume that the value of a business is more than the value of the tangible assets because the assets are used to generate positive cash flow. If that is not the case, the asset approach may be applicable.

Certified appraisers analyze all three methods and arrive at a conclusion of value using one or more of the approaches. Business brokers typically rely on the market approach when determining a list price for a business. Brokers will calculate SDE for 3 years and apply a multiple of SDE. We’ve seen most brokers average SDE over a 3 year period and multiply it by 3 (more to come on multiples). More aggressive brokers will apply the multiple on the best year, or most recent period.

Market multiples for SMBs are published in a handful of databases. The downside to relying on comparable transactions is the limited information. While you can see the transaction price, date, and the market multiples, you cannot get a sense of the qualitative attributes of a business such as strength of management, location, employee tenure, etc. To get a glimpse of businesses listed for sale, check out BizBuySell.

Rules of Thumb

There are a vast amount of factors that affect the multiple a business may receive on the market. To name a few, let’s consider financial statement quality, owner dependency, customer concentration, barrier to entry, capital intensity (the amount of equipment required to operate), location, profitability, management, customer contracts, recurring revenue, etc.

Revenue: 40-60% of annual sales (accounting firms and insurance agencies excluded)

SDE: 2-3.3x

EBITDA: 3-5x

Most main street and lower middle market businesses will fall into these ranges. Generally, the larger the business the higher the multiples due to lower perceived risk. We’ll characterize the low and high end of these ranges:

Low end

  • Retail business relying on walk-in customers
  • Minimal barrier to entry
  • Low capital intensity (no equipment required to operate)
  • Little repeat business
  • Low employee loyalty
  • Business has been entirely dependent on a single owner
  • Low profit margins

High end

  • Annual or multi-year contracts
  • Contracts are documented and transferrable
  • Repeat business
  • Product differentiation
  • High profit margins
  • Superior location with multi-year lease
  • Strong management / no owner dependency
  • Specialized equipment required to operate

Accounting firms and insurance agencies trade a little differently. These businesses typically are priced based on multiples of revenue or annual commissions.

Exit Planning

We hope this guide has provided some transparency and insight into the value of your business. Once you have an understanding of the value of your business, you can better plan and prepare for life beyond the business. The sale of your business is typically a one-in-a-lifetime event and it should be treated as such. Statistically, that has not been the case. According to the Exit Planning Institute and their State of Owner Readiness survey:

60% of business owners do not understand their exit options

30% have no transition plan in place

49% have done no planning at all

80% have not formed a transition advisory team

An advisory team comprises experts in distinct fields all working towards your successful transition. Financial advisors can provide guidance with the amount of after-tax liquidity you need to live the lifestyle you want. Estate planners can help minimize tax impact and provide for your dependents and loved ones. M&A attorneys will guide the transaction and ensure your interests are represented and protected. An exit planning advisor serves to bring the team together, working towards the same goal on the owner’s timeline.

Mark Ahern started Amp Business Valuations in late 2020. He has a background in financial services and a passion for helping small businesses. Mark was formally trained in commercial real estate and C&I credit. He also held posts in retail banking, retail mortgage, and loan operations. Mark earned an MBA from DePaul University and teaches Business Finance at Regis University.

Personal Vision – Life After the Sale Part I

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Life after the sale is often both the most important and most neglected factor in exit planning. Although (according to two different surveys in 2013 and 2022,) 75% of owners report regrets or unhappiness a year after the transition, exit plans continue to be constructed primarily around financial targets. In the event you haven’t heard this since you were five years old, “Money doesn’t fix everything.”

Superficial Planning

To be fair, most advisors include some conversation about “life after” in their planning conversations. Unfortunately, they are often satisfied with the features associated with an abundance of free time. Visiting the family, RV’ing through the country, playing 72 holes of golf a week, or seeing the great capitals of Europe can all be accomplished in the first year after ownership.

When they attempt to broach the idea of longer-term activity, the client’s answer is often “Let’s get the money. Then I’ll worry about what to do with it.” It’s challenging to push beyond the client’s desire to focus on the most obvious goal, especially when it seems to enable everything that follows. Nonetheless, owners who are unhappy because they didn’t get enough money failed either to understand the realities of their transactions or the future cost of their life plans. That certainly isn’t 75% of planning clients.

We are discussing the far greater number who have sufficient funds, but after their initial splurge of free time are unsure of what to do next.

Emotional Preparation

The first issue an exited owner faces is identity. “I used to own a company” quickly wears thin, and increasingly fades as years pass. “I’m retired” is a nebulous identity, and lumps them into a group with every wage earner who says the same. That’s a class they’ve proudly differentiated from for most of their lives.

Some mental health professionals have compared the emotional reaction to missing ownership identity to post-partum depression. Their world has changed overnight. The principal subject of their interest is gone, and they aren’t sure what replaces it. Post-partum is characterized as including “a feeling of guilt, worthlessness, hopelessness or helplessness.”

As an owner, there was always something else that needed their attention. Now there isn’t. Distress from discussing the daily news (which they now watch more frequently) used to be countered by a requirement to attend to the business. Now there is no business to attend to. The feeling of “What I do is important to a lot of people” has gone.

Identity in Life After the Sale

We encourage clients to at least mentally design their next business card. Handing someone your card is a shorthand version of declaring your identity. The first attempt by many is jocular but meaningless. “Part-time Philanthropist, Bon Vivant and Man About Town” is funny, but only once. “Grandparent, Outdoorsman and Classic Car Mechanic” is better. At least it describes real activities for further conversation.

“Business Counselor and Chairman of the Board of (Charity Name)” describes an identity, ongoing contribution to something or someone, and a role of importance. It doesn’t have to be true today (we aren’t printing the business cards yet,) but it’s at least aspirational.

Building a plan for life after the sale begins with establishing a future identity. There are several other components that we will cover in the next two articles.

John F. Dini develops transition and succession strategies that allow business owners to exit their companies on their own schedule, with the proceeds they seek and complete control over the process. He takes a coaching approach to client engagements, focusing on helping owners of companies with $1M to $250M in revenue achieve both their desired lifestyles and legacies.

Exit Planning – Lifestyle and Legacy

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Lifestyle and Legacy are two very different types of owner transition objectives.

When we ask a client “What do you expect as a result of our exit planning?” the answer may be about the money, the time frame, or the impact on people. No matter how it is phrased, the response will break down into one of two major categories. It’s either about the owner’s future lifestyle, or the legacy that is left behind.

Lifestyle Objectives

Many clients want to exit to an enjoyable retirement. Usually, their primary concern is financial security. They want enough money to live comfortably, and to take care of their family. This is the reason many start their process by consulting with a financial planner, but lifestyle objectives can extend well beyond their bank account.

A separate but related objective is time. It may be the time to travel without being chained to a laptop. The time to explore new things outside the business might result in formal education or training. Undertaking a new wellness regimen requires time, as does exploring a new hobby.

Time might be used to engage in community service. An issue that is increasing in the Baby Boomer generation is the time to care for older family members.

Another lifestyle issue is the ability to relocate. Moving to a place for favored activities, a better climate or to be closer to children (and grandchildren) often requires separation from the activities of the business.

Legacy Objectives

Some owners run their businesses for other than purely financial reasons. In these cases, they may be more concerned with how the business continues than the proceeds to be realized from a sale.

Of course, a chief motivation for putting legacy at the top of the list is family succession. It might be a sense of obligation in a company that has already passed through multiple generations, or just a desire to provide future generations with the benefits of ownership.

The role of the business in the community is also a legacy concern. The company could be a key employer in a small town, or a primary sponsor of a school or Little League. The owner’s name on the door or the preservation of long-standing business relationships can often affect the desirability of a buyer in the seller’s eyes.

Environment, Social, or Governance (ESG) concerns have become increasingly important to some sellers. They want to make certain that the importance they place on these issues is shared by future ownership.

Finally, the future growth and success of the business can be considered a legacy issue. An owner could have concern for the opportunities such growth provides to loyal employees, or whether innovations and proprietary processes will be expanded beyond their current limits.

Lifestyle and Legacy

Every owner’s objectives will have some combination of lifestyle and legacy concerns. They don’t necessarily conflict, but they involve differing perspectives.

John F. Dini develops transition and succession strategies that allow business owners to exit their companies on their own schedule, with the proceeds they seek and complete control over the process. He takes a coaching approach to client engagements, focusing on helping owners of companies with $1M to $250M in revenue achieve both their desired lifestyles and legacies.

Stakeholders in Exit Planning

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When preparing for the transfer of a business, there are many stakeholders who can impact your plan. Some have direct authority or decision-making capability over the transaction, but others may have substantial influence. In general, it’s best to presume that anyone who has a relationship with the owner or the business will have some impact on his or her decisions.

Internal Stakeholders

Of primary importance are partners and shareholders. Even when an owner has a voting majority, minority partners may have an official or unofficial veto. “Official” comes in the form of supermajority rights. Unofficial may be in the form of a threat to terminate employment, which in some cases may make the business unsaleable. If the minority holders are the intended recipients of the equity, they will function as both key components of the company’s value, and negotiators of the price to be paid for that value.

Employees are the other major internal stakeholders. Could they be a flight risk in the owner’s absence? Are they in danger of losing special status or privilege under new management? What is the plan for informing and updating them before and after a deal is struck?

Family

With most business owners, their equity in the business is 50% or more of their personal net worth. That makes future ownership, sale price and coordination with the estate plan items of great interest to spouses and children. In today’s serial family relationships, that can also involve step-siblings, former spouses, and their new partners’ families.

If there are children in the business, their future is inextricably tied to the company. If some children are in the business and some outside of it, the entitlements and expectations grow even more complicated.

Business Relationships

Customers may be transactional, as in retail, or strategic partners whose own business depends on what the company supplies. In such cases, or when customers are government entities, they may have contractual rights to approve a change in ownership.

In any case, the valuation of the business is going to depend at least partially on the retention of customers.

Suppliers have similar interests. We recently saw a distribution arrangement canceled simply because the supplier was insulted by not being informed about the company’s merger negotiations. The fact that they were conducted under a confidentiality agreement didn’t appease the supplier.

Creditors and lenders who hold personal guarantees are bound to be concerned about ownership changes. Be proactive in letting them know how their security interests will be preserved.

Public Stakeholders

StakeholderGovernment entities, especially any with regulatory responsibility over the industry, should also be approached proactively. Waiting for them to recognize a change may seem like “discretion as the better part of valor,” but untimely intervention could derail a transaction.

If the company is an important employer, a candidate for relocation, or a fixture in the community, some outreach to elected officials may be advisable.

Finally, consider the media. Plenty of business owners have complained about interviews that were slanted, reported inaccurately, or “just plain wrong.” If the transaction is newsworthy (and even if it isn’t,) prepare a professional announcement and a list of where it should be distributed. Refer to it, word for word if necessary, whenever someone calls for comment.

Thinking in advance about the impact of an exit plan on the various stakeholders can save advisors and their clients a lot of headaches when a deal is signed.

John F. Dini develops transition and succession strategies that allow business owners to exit their companies on their own schedule, with the proceeds they seek and complete control over the process. He takes a coaching approach to client engagements, focusing on helping owners of companies with $1M to $250M in revenue achieve both their desired lifestyles and legacies.