According to UBS Investor Watch, a record 41 percent of business owners are looking to exit their companies within the next five years. More than half of those seeking to exit want to sell the business outright, and 20 percent want to pass the business on to the next generation.
The real question is: How many will actually be able to exit? According to the International Business Brokers Association, 90 percent of businesses listed for sale never sell at all. Moreover, of the 10 percent that do change hands, many are sold at a discount to what could have been obtained.
Those looking to pass the business on to family face some long odds too: Anywhere from 66 percent to 75 percent of the businesses transferred will not survive to the next generation.
A successful exit requires time and a plan. Here’s what that plan should look like.
Business owners sometimes seek a financial solution to a non-financial problem. They may say that they are selling because they are “ready to retire” (65 percent of UBS survey respondents did). But what that may mean is they are tired of dealing with certain problems they haven’t been able to solve or don’t know how to solve.
Business owners should consider whether they’d still want to sell if they could eliminate the real issue. For example, they shouldn’t feel compelled to retire because nobody is trained to handle the responsibilities they are no longer passionate about.
How is the business performing right now? Given current conditions, what is a reasonable estimate of the company’s value? Equally important is how the business should be performing. What would the valuation be with optimum operations?
Having some preliminary estimates of value for both of those points will lead to an informed decisions about how to maximize the return on the transaction.
Conduct some personal goal-setting and planning. Take time to envision the kind of life desired after the sale, and how much of that life the transaction needs to fund based on current circumstances. Reduce that to a lump sum number of cash needed. This is the “net investable proceeds target.”
Get a picture of whether the net investable proceeds from the transaction will reach the target. Measure both current and optimal performance. Can the current value of the business achieve the target? What risks is the business owner willing to take to achieve that financial security?
These first four steps should help prevent someone from making an emotional decision that may impact an optimum financial result.
To position a business to be successful for another generation, some things will need to change. The amount of change that needs to happen will depend on how the firm has been operated. If the owner has been content to “be” the business, and he or she doesn’t have systems to run it, then a good deal of work must be done in order to capture any value, or prevent heirs from failing.
Business brokers occasionally contend that some problems are better solved by a new owner. Before accepting that premise, ask: “Am I limiting my buyer pool to people who can fix this problem?”
Operating systems and repeatable processes sell small businesses. Up to 90 percent of the knowledge needed to run the business can’t be in the departing owner’s head. Reduce this information to operating procedures that make money for the new ownership, and they will make money for the seller at the closing table.
When passing down the business, there are a number of scenarios to consider: Will a family member manage the business, or is it best run by a key employee? Or will one child manage it while his or her siblings maintain ownership interest?
A good succession plan should allow for the transfer of wealth over time to children who aren’t active or able to run the business. All of this will take time. According to the UBS report, 58 percent of owners planning to sell believe that they could do so in a year or less. This is unrealistic.
Be sure the exit doesn’t cripple the business financially. How will it need to perform over time so that it continues to build value and pay the seller’s note or compensation? Establishing the amount of revenue that will take will provide the data points necessary to set realistic goals and profitability objectives to give the successors a good starting point.
It’s time to bring in the attorney and accountant to flesh out tax minimization strategies and the legal issues surrounding succession. Gifting techniques, installment sales and other strategies can be utilized in a manner that provides the amount of control or input the departing owner wants over time without a big tax bill.
Preparing for a successful exit is a process. It requires an investment of time, thought and perspective. It’s also likely to be the most financially rewarding work that a business owner will ever do.
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