Over the past decade there has been much speculation over when a wave of baby boomers would sell their businesses. Study after study predicted a mass transition that never came. As a result, there has been a shortage of supply that has pushed up prices for good businesses. Why are business owners staying on well into their retirement years?
Bob Lawrence, certified planning adviser at Veer Business Advisors, advises business owners on what it takes to be ready to sell.
“First and foremost the business owner needs to be ready for the next stage of their life,” Lawrence said. “Many have spent more time in their business than with their family; to some, being a business owner is what defines them.”
This emotional connection to the business can be powerful. It stems from our basic human need for social connections and status. We fear losing our perceived place in the world’s social hierarchy. For many, it is their life and purpose.
Lawrence said the void has to be filled with something else.
“By identifying their post-ownership goals and objectives, they can plan their transition in a way that fills the void of ownership with new feelings of accomplishment, connection and satisfaction.”
Not easy, because building new friendships and purpose is challenging.
Once the emotional decision has been made, time is needed to get the business ready for sale. The first item to look at is tax planning. Lawrence’s advice is to start early: “What might seem like minor details in the balance sheet or share structure could cost a seller hundreds of thousands of dollars in avoidable income taxes.”
Perhaps the most important item is determining the value of the business. When assessing a business, there are dozens of factors that might concern a potential buyer. Planning and work are needed to mitigate those risks, before the business is exposed to the market.
According to Lawrence, these are some of top five most common factors that inhibit the salability or value of a business:
Stable and predictable cash flow
Revenue and cash flow are the No. 1 attraction to most purchasers, so a business with an established pattern of growth will generally attract a premium price. Recurring revenue streams are often valued higher than non-recurring revenue streams, since there is less risk that they will not continue after a transition. Buyers are willing to pay the highest amount when they perceive the cash flow is predictable and will increase into the future.
Reliable financial information
When purchasing a business, a buyer will perform financial due diligence to ensure that reliable financial records support the revenue and profit claims of the seller. If the financial records are incorrect, unsupportable or incomplete, the buyer will likely move on to the next opportunity.
A broad customer base in which no single customer accounts for more than 5% or 10% of sales helps to insulate a company from the loss of any one account. It reduces the risk of reduced cash flow if one or more customers do not stay under the new ownership.
Strength of management team
Buyers look for situations where management and key employees want to stay for the long term. If the company’s success relies on strong management and capable, well-trained employees, and not just the owner, the business should not be negatively impacted under new ownership, resulting in lower risk and a higher purchase price.
Goodwill attributable to the business, and not just to the owner, can significantly raise the value of the business. Name recognition, intellectual property, customer awareness, history and reputation are all part of business goodwill and can influence value. However, personal goodwill attributable to the business owner will generally have no value to a buyer. Strategies can be identified and implemented to transition personal goodwill to business goodwill, so that it increases value in the eyes of the purchaser.
Lawrence said a business owner should start thinking about exit readiness “ASAP.”
“About half of business exits are unplanned, resulting from unanticipated events such as health issues, divorce or disability. Keeping your business in an exit-ready state prepares the owner for these circumstances. But for those baby boomers anticipating retirement, five years is a great lead time – it provides time to identify issues, implement solutions and start to see some tangible results. •
Robert Napoli (email@example.com) is vice-president of First West Capital, a line of business of First West Credit Union that finances acquisitions, buyouts and growth.