Exit Planning Tools for Business Owners

small business advice

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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Ready…Set…Exit! Part I

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For the last six years I’ve been writing and speaking around the country to business owners about the coming tsunami of retiring Baby Boomer business owners. My e-book “Beating the Boomer Bust” details the  statistics (For a free download, go here and enter the seminar attendee password “Woodstock”), but the numbers are inescapable.

According to www.bizbuysell.com the brokerage industry reports the sale of less than 8,000 small (under 500 employees) companies each year. There are between five million and six million such businesses in the USA that are owned by Boomers between 48 and 68 years old. That makes business owners about 7% of the Boomer generation (78,000,000).

By 2018, Boomers will be reaching their 65th birthday at a rate of 8,000 a day. That pencils out to over 550 business a day reaching  a logical point of sale. At current volumes, the brokerage industry can handle from January 1st almost through January 15th of every year. The other eleven and a half months you are on your own.

There are hurricanes, super storms, and perfect storms. The arrival on the ownership scene of GenX and the Millennials, who have less money and less enthusiasm for 60-hour work weeks, makes the wave of retiring owners a super storm. The need of big businesses to replace their retiring Boomers by offering higher salaries, better benefits and more flexibility make it into a perfect storm.

out the doorOf course, business brokers and the burgeoning industry of exit planning professionals (disclosure: I am certified in both) intend to cash in on the wave of sellers by vastly increasing their businesses. Even with a shortage of buyers, I’m sure they can double or triple their number of successful sales. Tripling would reduce the number of unsold businesses to only 485 per day. That’s 20 small companies with employees unsold hourly… 24/7/365. Do the math.

Of course, not all of the companies that change hands sell through business brokers. Some are passed on to families. Many are acquired privately, with accountants or attorneys facilitating the transactions. Others are sold to employees.

For small business owners, the third option, selling to employees, is too often the option of last resort. Owners ask their legal and financial advisors what to do. They prepare their company for sale (for a really solid new book on getting your company ready for a third-party sale check out The Exit Strategy Handbook by Jerry L. Mills). They list the business on the Internet or with a broker.

For any number of reasons, the business doesn’t sell. Perhaps they don’t have enough time because  the owner is burned out or ill. Their return on assets is too low, or their industry outlook is poor. The financial markets are tight, or there are just too many other businesses available for a limited number of buyers.

Finally, in desperation, they “sell” the business to employees for an installment note. In some ways these transactions often resemble the subprime mortgage market. The employees really aren’t qualified to grow the business. They need a job, and the terms can be stretched to any length to fit the cash flow available, so they are willing to sign whatever looks sustainable. If they don’t make the payments, the only recourse is for the owner to take back a company that he doesn’t want, and whose value has declined.

It’s a bad way to get rid of a company, but for many owners it is the only one they have left. It doesn’t have to be that way. We will talk about the alternatives next week.

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Boomer Business Owners’ Retirement Accelerates

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Pepperdine University, in cooperation with the International Business Brokers Association and the M&A Source, publishes a quarterly Market Pulse Survey on the sale of small businesses in the United States. The most recent report, covering the fourth quarter of 2012, shows that “retiring Baby Boomers” is for the first time the number one reason for selling a small business in the United States.

I’ve written since 2007  in this space and elsewhere about the impact of Boomer business owners leaving their companies. You can download my e-book on the subject at www.theboomerbust.com. (The password for my faithful readers is “Woodstock.”) The Market Pulse Survey is just the latest indicator of a crest that is building, and which will have a huge impact on the American business landscape.

hedge mazeIf you are as acutely aware of the impact of Boomers on the American economy as I am, you begin to see it in a lot of places. I attended a luncheon with an official of the Federal Reserve a few weeks ago, and a question was raised about the recovery of residential housing. He pointed out that the introduction of 30-year mortgages with only 20% down transformed the US into a country of homeowners.

Home ownership grew to over 60% of households by 1960, fueled by larger families (Boomer children) and the GI Bill. It stabilized at around 65% from the 1970s through the late 1990s, when it began climbing again, largely as a result of political pressure to let the Federal Government (through their proxies, Fannie Mae and Freddie Mac) make mortgages available to a wider portion of the population. By 2007, the percentage of homeowners had reached almost 70%.

Residential housing markets began cratering in 2007, largely because too many people had been financed into homes they couldn’t really afford. They weren’t just the poor, but also included millions of Boomers who “traded up” in their quest for material success. (See the e-book for more on that Boomer drive.) The presenter pointed out that the population of homeowners was now stabilizing at much closer to 65%, which is assumed to be the normal equilibrium.

What if that is only a “Boomer equilibrium?” After all, the growth in home ownership occurred in a 50-year long expanding economy fueled by Boomers, first as household size increased, then as they became consumers. Aren’t we working with an assumption that the following generations will repeat the Boomer quest for more? Will GenX and the Millennials really get in line to splurge on ageing McMansions, or will they be satisfied with a more reasonable standard of functional shelter?

If the housing market suffered so badly in adjusting from a temporary high of 70% back to a more “normal” level of 65%, what will it look like if the next normal is 60%, or even 55%? (Prior to WWII only about 40% of US households owned their homes.)

The Market Pulse Survey also found that it is increasingly a buyer’s market for small businesses. That trend will inevitably accelerate, especially as we reach the 2018-2023 period, when Boomers turning 65 years old out number the GenXers turning 45 by 4,000 a day. If you are a young business owner, or plan to be one, the time is coming when you can pick and choose your opportunities.

But I’d be cautious of businesses focused on high-end residences.

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Beating the Boomer Bust

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We’ve looked at the coming generation of business buyers, and many things about that picture aren’t pretty. When I present to business owners about the Boomer Bust, this is around the time that someone in the audience says “So, are we just screwed?”

No. There are things you can do to make your business more transferable, and more appealing to those buyers who will be looking for an opportunity.

First, remember that my generalizations about a generation are just that. Both words derive from the Latin root genus, which meant both “birth” and “type.” A historical comment: it’s interesting that one word meant both things, because it was an era when your birth determined your type, or your role in society for life.

Not every Boomer is a workaholic. I know plenty of slacker Boomers, although none that are successful business owners. I also know plenty of hard-charging X’ers. So the first thing to remember as  Boomer business owner is that Generation X buyers for your business aren’t nonexistent. They are just far fewer than the number of sellers because of their numbers, values and choices.

Second, every business problem is better tackled with planning and preparation. Positioning your business for a successful sale is like putting timers on your lights at home. Any experienced burglar will tell you that he can case a house for a few nights to determine whether there are timed lights, but why should he? There are far more houses that don’t have any precautions at all. Most privately held businesses aren’t planning for transition, and won’t be ready when the time comes.

A third reason not to be depressed is remembering who you are. If you recognize yourself in our profile of the hard-working, driven Boomer business owner we’ve presented here, then your competitive nature should kick in as you think about being one of the winners in the transition.

After all, selling your company is probably the most significant financial event of your lifetime. Why wouldn’t you approach it with all the energy and problem-solving ability that you possess?

Any successful transition of your business is a sale, whether it is to a third party, to employees or to family. We will use sale as a generic term synonymous with succession, transition. merger or acquisition just to keep things simpler. When I am speaking about a specific approach, I will differentiate between an internal sale (to employees or family) and an external sale (to a third party).

I’m also focusing on the transfer of a business from an individual, or a few partners, to another individual or partner group. Many small business owners approach me looking for a third party sale to a “strategic buyer.” All they know is that they’ve heard a strategic buyer pays far higher multiples than other buyers, so that’s the kind of buyer they want.

Very few companies selling for less than $10,000,000 are sold to strategic buyers. It is more frequent in technology and in some distribution channels than in other industries, but it isn’t common at all. If you are a typical small business providing services on a local basis, a franchisee, a retailer, or a professional firm; there is little likelihood that you offer the kind of strategic differentiation required to attract a large (and wealthy) corporation to your door.

Understanding your prospective buyer is a key part of the selling process, but it isn’t the only part. before we discuss how to position for the next generation(s) of buyers, we have to step aside to talk about where you begin.

The Starting Point

Preparing for a successful sale to a typical small business buyer begins with an honest assessment of where you are today. What is your company really worth?

Most business owners have a very subjective approach to valuing their business. They talk to colleagues at trade shows about rumored prices for sales in their industry. They ask other business owners in their local area about the sale prices of unrelated companies. They read stories in the news about publicly traded acquisitions. Then they pick the number they like the best. “After all,” they say, “my business is as good as anyone else’s.”

I see too many cases where owners become emotionally committed to that number, to the point where they are highly offended by any other. They tell their personal financial planner to use the number in their retirement planning. They put the number on their personal financial statements to the bank. After a while, that number becomes fact, whether it originally had any basis or not.

Your planner or your banker isn’t qualified to verify the value you place on your business. For many owners whose net worth is 50% or more dependent on their business asset, picking a number based on hearsay or second-hand information is tantamount to insanity. It is your biggest asset, don’t you want to know what it worth?

There are a number of valuation specialists who can appraise your company. Any qualified professional will look at comparative sales, the market, your industry and the current  cost of financing.For most small businesses, a reasonable appraisal can be purchased for a few thousand dollars. (A side note: “free” appraisals or those generated in one-day seminars are often worth what you paid for them.) Once you have it, you can use the logic and multiples to track your approximate value for at least several years.

The Target

Once you know what your business is worth, targeting becomes much simpler. You take your net worth today (without your business), determine what you will need at retirement, and the sale price of your company has to make up the difference. A Certified Financial Planner has the ability to help you project your retirement needs, as well as the software to calculate tax implications and inflation.

With the company’s real present value documented, and a target amount based on realities of the market, you can set a date for your exit.

Setting a date is much, much more than just a theoretical exercise. Every plan must start with a goal, and your goal has to be both time and amount sensitive. “I’ll keep working until my business is worth $5,000,000.” isn’t a plan. “I’ll quit when I am 65 years old, and just hope that I have enough to live on.” isn’t a plan.

Setting your exit date doesn’t mean you have to stop working. It doesn’t even mean you have to leave your business. It’s just the target for when you can leave your business. Once you are there, the actual timing is up to you.

If you have a plan, you can start positioning for the sale. That’s where understanding your buyers’ market begins.

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

The Gen X Business Buyer

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

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

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

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

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

Values

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

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

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

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

Choices

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

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

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

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

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

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

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

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

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

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

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