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Friday, Jul 19, 2024

The End Game

There are plenty of options for small business owners looking to exit the companies they’ve started, including private equity sales, management buyouts, passing them down to family and even employee stock ownership plans.

But wealth managers, often a key confidant to business owners, say their clients are waiting far too long to seriously consider such a pressing decision.

Careful planning is increasingly important as more and more companies are expected to go on the market in the next decade, in part due to baby boomers retiring in droves. Active listings for small businesses on marketplace BizBuySell.com last year were up 8.4 percent to just over 135,000, the busiest year since 2009. The marketplace’s survey of business brokers showed most expected transaction activity to improve this year. General manager Bob House said several factors led to the increase, including many owners who put retirement on hold after the recession.

“You have a large supply of boomers looking to exit their businesses and many of them weren’t able to exit five years ago,” House said. “There is an inevitable wave coming and it’s smart to get in front of that wave.”

But most owners looking to keep ahead and sell before a market glut are unprepared. More than 80 percent of business owners either don’t have a transition plan or have an informal one that hasn’t been documented, according to the Exit Planning Institute, which called it “disturbing” that so many owners over 50 lack a viable plan.

Five-Year Plan

Anyone looking to start planning tomorrow will need years before they can take advantage of their legwork. Most wealth advisers cited a standard time frame of at least five years to formulate a solid plan and follow-through in ways that can boost a businesses’s value. That can include changing the corporate structure to better manage tax issues or integrating new employees to ease the transition to new ownership.

“The biggest mistake is not starting early enough,” Callan Capital managing partner Trevor Callan said. “Sometimes they’re already in negotiations with a buyer when they come to us.”

Even those with succession plans may not have touched them in years, another potential pitfall. Callan advises many private companies to have buy/sell agreements in place, providing for an owner’s partners to buy out their estate’s share of the business if they die. The agreement is often funded by a life insurance policy, but some owners last appraised their business at a fraction of its current value, requiring updated policies to cover the more expensive valuation.

Jeff Lysaught, managing director of United Capital Financial Advisers, said owners looking to sell quickly may not have enough time to do some standard housekeeping — updating technology systems or cleaning up financial records, for example — that can cause prospective buyers to offer a low price even to a company with strong fundamentals.

“You want to have all your books up to speed,” Lysaught said. “If you just pull out some raggedy reports, you’re going to get a lot less money.”

He also stressed five to 10 years as the ideal amount of lead time, but said business owners should be thinking about their exit as early as their third year in business.

Check Your TEVO Score

While many business owners may put off succession planning for years, partner Kevin Brown at accounting firm RBTK said many also don’t understand how their business practices correlate to the multiple of annual revenue their businesses can fetch.

Brown’s firm provides clients a number he likens to a FICO score for businesses he believes can solve both problems. The score, called a Total Enterprise Value Opportunity score, or TEVO, was developed by Sterling Creek Holdings and is based on a company’s financial information and a two-hour interview with owners. RBTK’s analysis also points out what are the largest negative factors for the business, such as poor financial reporting, that can drive a higher market price if fixed.

“How do you deal with feet draggers?” Brown asked. “Show them the score. Here’s how you’re going to be viewed. It appeals a little bit to their competitiveness.”

Exits can be especially challenging for doctors, lawyers and others running a small practice. Businesses that are not dependent on their owners drive the highest sale prices, according to Aspiriant principal and director of wealth management Neil Hokanson. It’s a counter-intuitive prospect for some owners who aren’t used to thinking about how their company could function without them. Those with a small practice, however, may have to do serious work before their company becomes attractive to an outside buyer, underscoring the need for several years of planning, Hokanson said.

“Is it a business, too?” Hokanson asked. “If it’s just a practice, then it’s not worth anything.”

Just handing off a practice to an outsider can turn off established customers, leaving many buyers cautious. Hokanson sometimes advises clients to bring in a younger partner years before they expect to retire, giving customers times to adjust.

“Professionalize your business such that the experience of the client is the same no matter who they deal with,” he said. “If you want to retire tomorrow, you’re not going to get a lot of value for your business. It takes time to integrate people.”

Another potential snag for founders looking to find an internal successor is an endless search for a carbon copy who can duplicate their success. That’s a common error, according to Pure Financial Advisors CEO Michael Fenison, who said that while owners need to be sure a successor shares their core philosophies about the business, other differences can make for an even better candidate.

“You want diverse talents to give you a broader perspective on the company,” Fenison said. “I’ve experienced that myself. You’ve got to be able to let go of the ego if you’re going to make a wise decision.”


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