Exit Planning Tools for Business Owners

small business

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.

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.

I have just published a new eBook, “24 Tips for More Effective Meetings.” It is available for FREE when you sign up to receive “Awake” weekly. If you are already a subscriber, just reenter your email address in the small sign-up form above right (you won’t receive duplicate posts). You will be automatically redirected to a download page. Thanks for subscribing!

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.

What is Your Company Worth? II

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Last week we discussed how business owners frequently use hearsay or incomplete information to estimate the value of their companies. They give the number to their financial planner, or include it on a personal financial statement for their banker, neither of whom bat an eyelash at the estimate. Having the amount “accepted” by financial experts, the owner starts to treat it as fact. How do you know whether it is realistic or achievable?

alchemistValuation of a small business is a combination of art and science. No two small companies are alike. A multiple of profits or cash flow is only the starting point. Take two small companies, each with $4,000,000 in revenues and $500,000 in profits. Each pays the same salary and benefits to the owner. One does it by having systems that control most day to day activities, recurring revenue from contracts, and long-term employees who are incented by profit sharing. The other does it with an owner who works 70 hours a week, hasn’t had a two week vacation in ten years, and makes every new sale personally. Which business would you pay more to own?

Beauty lies in the eye of the beholder. The multiples paid for businesses depend on the type of buyers they attract. Commonly, those that sell for less than $2,000,000 are considered “Main Street.” Their target buyers are individuals who are purchasing an income. They intend to work in the business, and to earn a regular paycheck by running it.

Main Street businesses are valued by a multiple of Seller’s Discretionary Earnings (SDE). The value of the business is based on the sum of the financial benefits resulting from ownership. That includes profits, salary, benefits and any of a long list of possible perquisites like a company car, travel, or insurance. (For more on calculating your SDE and selling a business in general, you can read my book, 11 Things You Absolutely Need to Know about Selling Your Business.)

Main Street pricing is typically between 2.1 and 2.8 times SDE. It is based on simple arithmetic. The closer you come to 3 times SDE, the less able a buyer is to pay both the bank and himself. You can run your own numbers here, to see how it works (registration required).

For larger companies, those that attract financial and industry acquirers, the multiples are higher, but the multiplier is lower. Those buyers anticipate paying for professional management, so the owner’s compensation is less of a consideration. They look at EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization) to calculate available cash after all the expenses of running the business (including executive talent) are paid.

Competitors will calculate the savings they might realize from consolidation, but are usually reluctant to multiply those savings in a purchase price. Private Equity Groups (there are 7,000 in the US) and the acquisition arms of large companies seldom look at businesses with earnings of less than $1,000,000. As amazing as it seems to a small business owner, their due diligence and legal processes are too expensive to make smaller acquisitions worthwhile.

Private Equity Groups pay an average between 4.7 and 5.2 times EBITDA, year in and year out. That makes sense, because they are financial buyers with a targeted Return On Investment (ROI). Large company acquisitions of smaller businesses can range from 4 times EBITA up to around 7 or 8, although in a few cases strategic considerations (competition, exclusive contracts, proprietary methods) can drive that up substantially .

All of these are real numbers, based on actual sales data and industry surveys. Sellers often confuse the terms revenue and income, or apply EBITDA multiples to SDE. They are greatly disappointed and angry when legitimate offers fall far below their expectations. Just because your planner or your banker didn’t challenge your valuation estimate doesn’t make it fact.

My new book, Hunting in a Farmer’s World: Celebrating the Mind of an Entrepreneur, is now available on Amazon in paperback, hardcover and Kindle. It is an ownership book, not a management book, and is illustrated with the stories of real entrepreneurs who faced challenges that apply to us all.

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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