Note: I was recently interviewed by the Corridor Business Journal regarding my views on business ownership transition. Here is the article for which I was interviewed.
As a growing number of baby boomers prepare to pass the baton of business ownership, they face a complex and sometimes lengthy process for which many are unprepared.
â€œThe most frequent comment I get is, â€˜I had no idea how difficult this would be,â€™â€ said Maurie Cashman of Aspen Grove Investments in Cedar Rapids, which specializes in business valuation and business transfers.
Mr. Cashman has been involved in hundreds of business transfers, both as a private consultant and as an executive of the huge ag cooperative Land â€˜O Lakes. He said each sale is unique, â€œlike a fingerprint,â€ and they are never easy.
Studies by PricewaterhouseCoopers and other consultancies have pointed to a major â€œtransfer of wealth eventâ€ during this decade as baby boomers retire and pass on their businesses. The outcome is often critical to the financial future of the owner, Mr. Cashman said, and yet most owners wait until they are almost ready to retire before they start making plans.
Itâ€™s an opinion shared by Jeff Hennessey, who specializes in selling businesses at The Jennessey Group.
â€œYou canâ€™t start early enough planning for it,â€ Mr. Hennessey said, noting that the average time required to sell a business in the United States is about one year. In some cases, the time frame can be much longer, he noted, as in the case of businesses that are losing money and need to be restored to profitability before they are a good candidate for sale.
When it comes to the sale process, Mr. Cashman believes thereâ€™s one place every business owner should start.
â€œItâ€™s important that you understand your objectives and that the people around you understand your objectives,â€ he said. Those could include how soon the owner wants to sell, how much they need to receive from the sale to pay off debt and retire, and other priorities such as the ownerâ€™s desire to maintain the independence of the business.
A valuation of the business is another important early step. Three primary methods of appraising are an income appraisal, asset appraisal and market appraisal. Different methods can be more suitable for different types of businesses, but â€œI tend to look really hard at the income approach,â€ Mr. Cashman said.
The income approach uses different analytical methods to determine the expected future value of owning and operating the business over a period of years.
Owners often think they know what the business is worth.
â€œThey will often say, â€˜It should be worth three or four times EBITDA,â€™â€ Mr. Cashman said, referring to a standard measure of business earnings. But what that means can differ depending on how the business does its financial reporting.
â€œYou need to be able to understand and explain why itâ€™s worth that much,â€ he added. A business owner with several businesses might, for example, report common overhead expenses through just one of the businesses, when, in fact, a buyer would have to account for all of them.
Mr. Cashman reviews the sellerâ€™s financial statements during the valuation process and makes adjustments for such things, but he said itâ€™s important to have â€œcleanâ€ financial statements because too many adjustments can frighten off a buyer.
The valuation process can help the consultant identify the potential field of buyers, and can also point to risk factors in the business that might concern a potential buyer and affect the price. The fact that 70 percent of a companyâ€™s sales come from a single customer may be something the owner has grown comfortable with, Mr. Cashman said, but it could also set off alarm bells for a potential buyer, who may wonder how the business could survive without that key client.
â€œI prefer to deliver that kind of news upfront [to the seller] rather than waiting for a buyer to say that,â€ Mr. Cashman said. â€œIf youâ€™re not realistic going into it, you wonâ€™t have a realistic idea of the price you can get for your business.â€
Structuring the deal
Most business owners shouldnâ€™t try to negotiate the sale contact alone, Mr. Cashman said, explaining that the consequences of errors can be costly, and even catastrophic.
â€œYou have to have strong people to negotiate that,â€ Mr. Cashman said. â€œThe devil is always in the details.â€
Outside communication and mediation skills are also crucial, according to Mr. Hennessey. He said business owners are often passionate about â€œtheir baby,â€ and prone to walk away from negotiations or make remarks that could drive off a buyer, particularly if they feel insulted.
â€œYou keep them in the game and let the negotiation run its course all the way through,â€ Mr. Hennessey said. â€œHaving that person to filter out what one person said about the other is huge.â€
Another reason to use a business broker or consultant is the importance of preserving confidentiality in the process, Mr. Hennessey said. Putting out a â€œfor saleâ€ sign can drive away customers and cause employees to begin seeking other jobs. Brokers advertise the business confidentially, and use confidentiality agreements to keep prospective buyers from sharing proprietary information they receive access to during the sale process.
Mr. Hennessey said he is paid by and represents the seller in his work, but probably spends the most time working with the buyer on numerous issues they need to conclude the sale, from financing to permits to transferring equipment leases.
The Jennessey Group is compensated as a business broker with a percentage of the selling price at closing. Mr. Hennessey said the companyâ€™s fees are close to the national average of 10 percent of the selling price, although it is subject to a minimum. A sale can bring a six-figure payday, but Mr. Hennessey said there are also times when Jennessey Group spends months working on a deal, only to receive nothing when one party backs out in the final stretch.
Mr. Cashmanâ€™s Aspen Grove Investments, by contrast, has transitioned away from the business brokerage model. After learning how much preparation it takes to sell a business, Mr. Cashman said Aspen Grove began to specialize in business valuation and consulting. [Note: this is somewhat misleading. Aspen Grove has modified its approach to provide enhanced services including business valuation. Aspen Grove continues to provide business brokerage when needed.] He negotiates fees with clients based on their needs rather than charging a sales commission.
The multitude of ways that a sale can be structured are among the things Mr. Cashman has learned over the years. Although most business sellers would like to deposit a check in the bank and â€œwalk awayâ€ when the business is sold, Mr. Cashman said that may not be the best scenario for making a successful sale. A significant number of buyers want some owner financing both to help fund the deal, and show that the seller has confidence in the strength of their business. The tax consequences of taking one lump-sum payment can also be a factor.
Business owners often donâ€™t start planning for a sale until they are ready to retire, have a health problem or are having problems with the business. The realization that the owner is under pressure to sell tilts the playing field to the buyer if that knowledge gets out, Mr. Cashman noted.
â€œLife becomes very difficult when you donâ€™t have a level playing field,â€ he said. â€œSome things like bankruptcy can even make a business unsalable.â€
Early planning for a sale can also broaden the field of potential buyers. A business owner can, for instance, groom a family member to take over the business, encourage key employees of the business to buy it, or sell it to an employee stock ownership plan (ESOP).
Although transfers to a family member are common, Mr. Cashman has become an enthusiastic supporter of finding ways to transfer a business to key personnel already working for the owner.
One simple tool is to offer company stock as part of the employeeâ€™s compensation package. By the time the owner is ready to retire, key employees may have enough stock to use as equity to get a loan to buy the company. In the meantime, Mr. Cashman said, the stock provides an incentive for the employees to stay and boost the value of the business.
Transitioning the business to a family member is often a different financial proposition than selling it to employees. The owner may be more flexible in offering seller financing or gifting part of the business through a grantor retained annuity trust, or GRAT â€“ a financial instrument that enables large gifts to family members without paying a gift tax.
One of the intangible factors that Mr. Cashman has encountered over the years is the personal satisfaction owners receive from owning a business. He said many owners who decide to sell outright feel cut off from a large part of their personal identity, and would have been better off staying on under an employment contract.
Like so many other things in selling a business, however, an employment contract â€œis not a silver bullet,â€ he said. New owners often want to do things differently, and that can cause conflict with the former owner, so the contract should be written carefully.
Neither Mr. Cashman nor Mr. Hennessey have seen the huge spike in business sales predicted from baby boomer retirements. They say boomer business owners have extended their retirement time horizons for a variety of reasons, primarily financial. Mr. Cashman believes the 2008 recession put many businesses off their financial track, while Mr. Hennessey blames the cost of Obamacare and other regulations that small businesses have faced in recent years.