Exit Planning Tools for Business Owners

exit planning

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.

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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.

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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Can Franchising Survive The Baby Boomers?

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As a consultant to business owners, this is a column I’ve hesitated to write for a long time. There are over 800,000 franchised businesses in the United States, and I’m not going out of my way to make that many owners mad at me. Since I often write and I speak nationally about the trends of Baby Boomer businesses, however, I frequently wonder whether the franchise business model can survive another generation in its current form.

A quick recap of franchising in the USA. “Business Model Franchising” (the sale of a turnkey concept) began in the 1940’s with KFC, A&W and Howard Johnson’s. In 1975 the first Boomers turned 30 years old, and the sale of new franchises grew from about 2,000 to over 20,000 annually in the next five years. Educated and competitive Boomers, squeezed out of Corporate America by their sheer numbers, embraced franchising with enthusiasm.

In turn, franchisors got highly motivated owners, who were willing to work very hard and make personal sacrifices for their piece of the American Dream. Predominantly in service industries, franchising benefitted from an exploding workforce of people who were focused on success.

The franchised restaurateur discovered that he or she could spend more time in the business by outsourcing other service tasks (like cutting the lawn or servicing the ice maker) to another franchisee. That franchisee could focus on building a bigger landscaping business by outsourcing his housekeeping to yet another franchisee.

The impact on our country was huge. Small business owners are productivity machines. They work long hours and weekends. This economic pyramid of highly productive small business owners spending their incomes with other highly productive small business owners has been the underpinning of American economic success for the last 35 years.

Failed franchiseNow it is coming to an end. The oldest Baby Boomers are turning 68 this year. By 2018 they will be reaching retirement age at a rate of 8,000 a day. From then until 2023, the next generation’s birthrate is half that of the Boomers, and they have considerably less enthusiasm for 65-hour or 6-day work weeks.

In addition, Boomers will consume less. The retired restaurateur starts doing his own gardening. The former landscaper does his own housework. The velocity of money (how many times it changes hands) will also slow as Boomers belatedly save for retirement.

This affects franchises particularly, because they are built on a model that assumes an owner is driving the business. If there aren’t enough owners, the model has to change. Depending on the franchise, it will happen in one of several ways.

  • Franchisors who have the foresight to develop strong manager training programs, along with the financial strength to purchase units from retiring operators, will convert to largely company-owned chains. For them, franchising will have been a developmental model, to be replaced as the first generation of franchisee partners makes its exit.
  • Successful multi-unit operators will grow as they take advantage of acquisition opportunities. Add-on units already have common systems, and family ownership succession is easier in a company with well-defined management structures. As these operators grow to nine-figure revenues and thousands of employees, they will no longer meet any normal definition of a “small” business.
  • Franchisors who remain dependent on a model that requires substantial start-up equity, long hours and hands-on management by an owner must change dramatically or fail. The franchisee they built their business model around is going away.
  • Franchisees with one or two units that they work in personally, and who don’t have children, employees or a franchisor willing to purchase the business, will close. There are simply too few small business buyers with too many alternatives.

All in all, the stereotype of a franchise as a local, mom-and-pop owned business will disappear. You can’t dispute the numbers. There aren’t enough operators  in the pipeline who fit the model of a shirtsleeve owner. Whether run by big multi-unit operators or the parent corporation, franchises will be very different ten years from now.

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The Pig in the Python

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The title of this section refers to a well-known biological phenomenon. The python family of snakes have hinged jaws that allow them to swallow animals much larger than their heads. These animals are gradually consumed as they pass through the snake’s digestive system. If the prey is very large, you can plainly see the shape of the animal as it moves through the snake.

It is just as easy to identify the progress of the Baby Boom generation through the American population. Whatever stage of life the Boomers were experiencing, the country was experiencing. And we all experienced it together. (see my timeline at The Boomer Bust) Although the pure size of the Boomer generation underlies a lot of its impact, there were two other factors, commonality and competitiveness, that greatly enhanced it.

I grew up in the industrial Middle-Atlantic Northeast. “Ethnicity” in my world meant Polish, Italian, German or Irish. Of course we had discrimination, bigotry and ghettos. I cringe at some of the racist nursery rhymes I was taught by my friends. (Thankfully, if I recited them at home my parents quickly explained why those words were bad.) But we didn’t have Jim Crow laws, or poll tests, and although my schools were largely white, it was as a reflection of the neighborhood, not of the law.

I had no idea what rhubarb or okra were until I was an adult. I had never heard of ice fishing. Iced tea came in one flavor; if you wanted it sweet you put sugar in it. When I was 20 or so, I remember reading a debate in a restaurant industry magazine about whether America was ready to accept a regional ethnic food as mainstream…pizza! I had a pizza parlor on virtually every corner. It shocked me to realize that everyone else didn’t.

Like most early Boomers, I grew up in a culture that was defined by regional and ethnic dominance. Children had for generations grown up with roughly the same attitudes, the same ideas, and the same habits as their parents. They just hadn’t experienced much else.

Then came television. The first stations broadcast in the late 1930’s, and television was a huge hit at the 1939 World’s Fair in New York, but WWII had put a stop to production of TV sets. Returning GIs were ready to spend on consumer goods, and factories built for wartime electronics production were more than ready to deliver. In 1948 the first networks began broadcasting syndicated content, and in 1951 color televisions first became available. The oldest Boomers were 6 years old.

Unlike almost every other country, the United States developed television as a private enterprise. As in radio, content was paid for by commercial advertising. In fact, many of the consumer brands that made radio so successful were the first to move headlong into the new medium.

Thus people watching television became “consumers.” The success of a show was determined by the number of products it sold. How long do you think it took for these advertisers to figure out that two out of every five people in the country could be targeted as a distinct audience? For the first time, a generation was identified as a market, and sold to by age, not by the regional or ethnic orientation of their parents.

The WWII generation had already proven their willingness to spend on their kids. Scarred by the Great Depression, they focused on working to give their kids got the things they had lacked. They started by making Benjamin Spock’s 1946 book, The Common Sense Book of Baby and Child Care a huge hit, buying 500,000 copies in its first six months.  Children’s toys, books and shows quickly became an entire segment of the marketing industry.

For the first time, children were growing up encouraged to perceive themselves as children. They weren’t little adults in training. They weren’t just future farmers, or future factory workers. They were taught by parents and advertisers to think of themselves as children first, and as the life successors of their parents second.

And, for better or worse, 78,000,000 of them were all being raised pretty much the same way, at the same time.

Commonality made the Boomers a cohesive force in the American culture and economy like no generation before them. But sometimes that commonality took on the aspects of a school of fish, where thousands of individuals all turn in the same direction at the same time. This happened again and again and, as you will see, not least in the transformation of small business in America.

When it was combined with Boomer competitiveness, it changed everything. Next week, how the American Baby Boomers became the hardest workers in modern history.