Family Business Transfers: The Recipe For Success

Personal Motives and Business Conditions to Consider when Exiting a Business

If you are like many owners, you have spent numerous sleepless nights staring at the bedroom ceiling endlessly speculating about and weighing the outcomes of the answer to one question: "Should I sell my business now?" If you have finished your deliberations, have resolved all of the questions and are prepared to move directly to the sale process, then call our offices today and we will help guide you through the process of preparing your business to sell it for top dollar. 
 
Most owners consider selling their businesses when two decision paths converge. The first path is the subjective or personal decision to sell: it is time to sell because personal goals can now be met better by selling the business than by staying active in it. The second path is the objective or business decision: both the Merger and Acquisition Market and your company's readiness make it the right time to sell.   

Personal Motives
The personal decision to sell is usually based upon some combination of the following:

• A desire to "take the chips off the table." Your tolerance for risk just isn't what it used to be.
• The joy of going to work each day is fading. Not only has the fire in your belly gone out, but it's been replaced by the desire to do "something else," known or unknown.
• The "Successor Designate" can't or won't succeed. Neither child nor employee is able or willing to fill your shoes.
• You realize that now is the time to sell because you can attain financial security.
• There are a lot of activities other than running a company that you still want to experience.

If one or more of these reasons resonates for you, don't be surprised. This list is a representation of what many business owners have felt as they approached the difficult decision of whether the time is right to sell their businesses. If you would like to discuss your personal motives as they relate to your business exit, please contact our offices today. We can help guide you through the process of creating a comprehensive Exit Plan that takes into consideration all of your personal motives.

Taking Chips Off the Table
 As we age, our tolerance for risk diminishes and our desire for safety and security increases. If you doubt this observation, compare the typical driver in any Florida retirement community to a driver in your local high school parking lot as the school day ends.
Owning and operating a business places the majority of your assets at risk. Every day these risks might include:

• Competitive - from consolidators and others with more money than you;
• Financial - the need to constantly keep more money in the business to sustain growth;
• Personal Health - owners are not immune from health issues that can (and do) pop up without warning;
• Liability - there are hundreds of thousands of practicing liability lawyers in this country;
• Business Conditions - key employees leave or your industry changes; and
• The Economy - when it cycles down will it take your business with it?

For most owners, there is a point at which these risks become overly burdensome, especially when the business itself has become valuable. You no longer want to expose your most valuable asset to constant risk. When all of your eggs are in one basket and the basket is now worth a lot of money, it makes sense to lower the risk of losing that basket.

Owners tend to continue in business beyond an optimum departure date because they don't know what else to do with their time.

The only way to eliminate the risks inherent to owning a closely held business interest is to sell it - for cash. Doing so not only takes chips off the table by converting an illiquid asset to cash, but it also allows you to eliminate personal guarantees, reduce liability exposure and remove personal collateral (used for business purposes) that was at risk.

No Fire in the Belly
 Few owners reading this are as energetic and enthusiastic about their businesses as they were when they started (or even during the middle years of the business). Owners tend to continue in business beyond an optimum departure date because they don't know what else to do with their time. They continue on and spend months or years in their businesses long after the passion has died.

First, once lost, owners typically don't regain their enthusiasm for, excitement about, or enjoyment of their businesses. The reason is pretty straightforward - entrepreneurs like to create. Once a business has a life of its own, it is left to wreak havoc or to succeed. Making money and all of the other by-products of a successful business are nice, but it is the act of creating, of successfully meeting the challenges, that brings satisfaction to the entrepreneur. The fire in the belly is the passion that gives birth to and nurtures your business. Once the business is on its own, once it no longer needs you, it may be time to move on to the next challenge, the next call for your passion and creativity. It is at this point that many owners begin searching for the exit door in order to find the next passion.
Second, one of the few solutions to the loss of fire is to sell the business and get out. Your business will move to the next level under new ownership for whom moving to the next level provides ample stimulation and challenge.

 The Successor Designate Won't or Can't Succeed
 A "Successor Designate" is anointed from within the business (a key employee or usually two) or from within the family (a child or two). If no one has:

1. stepped forward;
2. the talent to take the business to the next level;
3. demonstrated sufficient commitment to the business (at least equal to what yours had been); or
4. the money now or through future cash flows from the business adequate to buy the business;

then the business has become too valuable or too complex to transfer to anyone other than an outsider. Let's look at how one fictional business owner tried (and failed) to lure his desired successor into ownership.
It was the most unexpected outcome imaginable. Dick Langenberg owned a water drilling service (highly demanded in the eastern plains of Colorado) that had prospered for the last 20 years. As a careful, conservative businessman of the "old school," Dick had amassed a significant fortune outside of the business - a business that earned $1 million or more each year. One of Dick's Exit Objectives then, was to reward the key employees who had helped build and sustain his successful company. After much soul searching, Dick decided to give the business to his key employees. They would pay him nothing out of their own pockets.

There's more to life than building & running a company.

The mechanism Dick used to give the business away was to have the business contribute money to a separate fund for three years. At the end of that time period, Dick would receive the money in the fund as a down payment for the purchase of the company. The down payment would equal 50 percent of the purchase price. The remaining 50 percent would be paid to Dick over the subsequent six years from the available cash flow of the company. If cash flow was insufficient, Dick was willing to accept a longer pay out period, although if cash flow continued as expected, it would be more than adequate to pay Dick the remaining balance.

In short, Dick would pre-fund his own buyout with three years of revenues (money he would otherwise be entitled to) and would obligate key employees and the company to provide the remaining 50 percent of the payment - solely from the future cash flows of the company. In essence, Dick was giving the company to his employees.

At the end of six years, without one penny coming from their own pockets, Dick's employees would own a company producing at least $1 million of cash flow per year. Imagine Dick's surprise when their unanimous response was, "Thank you very much, but we don't want to own the company. There's too much risk in this business." Dick's Exit Planning Advisor was not nearly as surprised as Dick because through experience the Advisor had come to realize that many key employees - wonderful, valuable and contributing employees that they are - simply have little tolerance for the risk that is part and parcel of business ownership. In Dick's case, the employees weren't even willing to be given the company.

There's More to Life than Building and Running a Company
Many business owners reach a point where they realize that there are a lot of things "out there" that they want to do while they are young enough to enjoy them. Active vacations, spending time with family and friends, service work, personal growth and development are all items that appear on owners' lists of things to do. These items remain on the list because owners are simply too busy running their companies to pay them more than passing attention.

 Many Boomer owners, in particular, are deciding to pursue a second life or second career full of possibility, activity and involvement. This crowd gravitates toward race car seats, rather than toward rocking chairs. To be strapped into the driver seat, owners need financial, emotional and time freedoms.

Reviewing Objective Conditions Important to Successful Business Sale
Along with personal motives, there are objective conditions that must be present to maximize your chances for a successful business sale. These include:

• The Merger and Acquisition Market should be vibrant and near the peak in deal activity and pricing.
• Your company should be experiencing increasing cash flow.
• Your company should be maximizing the "Value Drivers"

On a regular basis (no less than annually), you should discuss with your planning team current business value and how best to increase and protect it. If your business has reached a Value Threshold that permits a sale that allows you to realize your financial goals, you have reached a point where you may be able to sell. If this is the case for your business, then the next step is to call our offices to discuss the process for selling to an outside third party. With access to an experienced "deal team" (such as a Transaction Intermediary) who can estimate the marketability and pricing if you sold your business today, we can help guide you through the process of cashing out of your business and moving on to the next stage of your life.

Remember, it usually takes years to significantly and consistently increase cash flow and business value.

If your business is not ready to be sold, even though you are ready to sell it, you may need to focus on increasing cash flow. This is best achieved by focusing on the Value Drivers recognized by the Merger and Acquisition professionals. For example, having a motivated management team, quantified operating systems and diversified customer base are a few of the key Value Drivers that are important to selling your business. Again, meeting with your planning team is key to maintaining a focus on increasing business value and cash flow through Value Drivers. The planning team will help you make the decision to sell as early as practical - hopefully years before the actual sale - so that the business is ready when you are!

Remember, it usually takes years to significantly and consistently increase cash flow and business value. Once you've made the decision that you would like to someday sell your business, the time to begin planning and implementing begins immediately. If you are ready to exit, and your business is saleable given the current M&A marketplace, the decision is usually straightforward. It is when you are ready to sell, but your business isn't, that the chance for burnout increases.

Being Aware of the M&A Market Important to Successful Business Sale
It is important to take into account personal motives and objective conditions when you are trying to determine the best time to sell your business. For owners who toil long and hard to overcome the endless challenges that test the survival and success of their businesses, the thought of someday selling out for a lot of money seems, at best, a pipe dream. A typical business owner in this situation may think, "Who would want to buy my business?"
Yet, as many owners are discovering, the Merger and Acquisition (M&A) marketplace can be receptive to acquiring closely held businesses - maybe even businesses like yours. In some niches, even smaller businesses are able to sell to much larger cash buyers. But the market can be fickle. A number of factors can fuel or damper the Merger and Acquisition mania. These can include:

• Fluctuating interest rates. Low, stable interest rates can provide buyers with inexpensive funds to buy your business. Climbing interest rates can increase acquisition costs and dampen buyer enthusiasm. 
• Availability and pricing of financing. The availability and cost of financing can directly impact deal activity. When financing is readily available to buyers at attractive rates, deal activity can become frenzied because buyers can leverage their equity investment. For example, instead of requiring one dollar of their cash for every $2 of financing (in 2001 timeframe), in 2005, they could borrow almost $4 for every $1 of their own. This means they could pay more for businesses and this is the point in the M&A cycle when it may be favorable for owners to be poised to sell their businesses.
• The current state of the economy. A healthy economy tends to encourage investor confidence and a greater willingness to put money in otherwise illiquid businesses. A stagnant or contracting economy can depress valuation, thereby creating favorable conditions for a buyer's market.
• Corporate earnings overall and in your industry. Strong earnings can provide cash and the tendency for future cash availability; weak earnings tend to portend the opposite.
• Stock market value. To keep corporate earnings ever-increasing, it can make sense for publicly owned companies to acquire closely held companies whose price/earning ratios are lower than the acquiring company.
• M&A currency. When publicly owned stock is trading at high earnings multiples, it can make sense for those companies to use their stock for acquisitions. As the stock market contracts in value, it can be a reasonable expectation for a chilling effect on the M&A marketplace.
• Supply and Demand. According to a 2005 PricewaterhouseCoopers' survey of 364 CEOs of privately held, fast-growing companies, "nearly two-thirds . . . plan to move on within a decade or less; 42 percent within five years, and 23 percent in five to ten years." ("Wide Majority of Fast-Growth CEOs Likely to Move On Within Ten Years, PwC Finds." January 31, 2005.) If these owners, and others like them, follow through on these plans, there could be a glut of companies on the market, resulting in lower valuations and a buyer's market.

A healthy economy tends to encourage investor confidence......

It is important for owners to be constantly aware of the condition of the M&A market. If it is healthy, owners may have the opportunity to adjust their personal timetables to take advantage of it. When the M&A market is favorable (a lot of buyers offering high multiples), you need to recognize that adjusting your "ideal" departure date can be a whole lot easier than adjusting your financial needs. Conversely, when markets shut down, your personal goals may need to likewise adjust. 

Why Owners Choose Not to Sell
If you simply are not emotionally ready to sell, if there is still fire in your belly - enough fire to fuel your continued investment in the company - or if you ultimately want to leave the business to family members or employees, then you may not be in a position to sell your business - yet. If you and the business are ready to sell, but you still hesitate, let's look at typical reasons for that hesitation and what you may be able to do about it.

Owners typically don't sell when they should because they procrastinate, or they fear the unknown and, perhaps more specifically, they fear losing the known.

Procrastination on the part of an owner is not uncommon and can arise for one of several reasons. First, some owners just don't know where or how to start planning an exit. If you are one of those owners, then reading the remainder of this article is a good start. The next step is to contact our offices to begin the process of creating an Exit Plan that allows you to cash out of your business and leave in style when you are ready to do so.

Second, some owners think that they can sell later, but as we have been discussing, when most Boomers reach retirement age, the glut of companies in the marketplace may drive prices down. Further, the M&A cycle can have a huge affect on the sale price of a company.
In the third group of procrastinating owners are those who believe that because they have "good" businesses, the process will take care of itself. When they think about selling, they simply assume that there isn't much for them to do. They believe that when the time is right, the right buyer will appear and pay them a great price for their company. It does happen, albeit quite rarely, that the right buyer appears and pays a great price for a great company. However, it can be much better to prepare for the biggest financial transaction of your life, instead of leaving the success of your business exit to the luck of the draw.

...owners typically don't sell when they should....

In our experience, the owners who suffer from the fear of the unknown usually hold one (or more) of the following opinions: 

• I don't think the business is worth enough to satisfy my financial needs and objectives.
• If the employees discover I'm trying to sell, they will all quit.
• Because I'm indispensable to the company, I'll be required to work years for a new owner and I don't like working for anyone!
• The sale process will take too long and cost too much.

On the other hand, the fear of losing the known is usually based on the following:

• The business has been my life - or at least it has given my life a great deal of meaning and focus; without it I may feel lost.
• The government will take too much in taxes - it's easier, less risky and more lucrative to stay, enjoy the cash flow and then leave getting paid over time.
• What will I do after I sell and leave the business? I don't know what my life will look like if I leave.

Overcoming Common Objections
One of the biggest obstacles in exiting your business is overcoming your objections, many of which tend to be based on misunderstanding the "facts."

The objections that tend to hold back owners from selling their businesses are usually based upon some combination of the following perspectives:

• The business isn't worth enough to meet my financial needs.
• The employees (or customers) will leave when they discover I'm trying to sell.
• I will be required to work years for a new owner.
• The sale process will take too long and cost too much.
• Given the tax bite on sale proceeds, it makes more sense to stay, enjoy the cash flow and get paid over time.
• What will I do after I sell and leave the business? This business is my life!

The Business Isn't Worth Enough To Meet My Financial Needs 
You can't know whether your business is "worth enough" unless you know what it is worth, and what value is needed in order to meet your financial needs. That's why obtaining a valuation range for your company based upon current market conditions can be very important. Use an investment banker (for companies with a likely value of more than $5 million), business broker or other transaction intermediary (for smaller businesses) familiar with what your business can fetch in the M&A marketplace. It is important to not simply depend on the historical valuation performed by your accountant or the "rule of thumb" used in your industry. Both "rules of thumb" and traditional valuation approaches tend to rely on what has happened, not on what businesses - businesses just like yours - are selling for in today's market, and tend to overlook the importance of current deal activity levels.

...to determine the value of your business in today's marketplace, ask an experienced professional....

To illustrate this point, let's look at Sam Reed, a hypothetical business owner who was thinking about selling his business a number of years ago - near the last peak in the M&A cycle.

When Sam Reed started thinking about selling his business, he asked his CPA for an estimate of value. After some investigation of historical valuation multiples, the CPA ventured an estimate of $14 million. The owner needed significantly more than that just to pay off business debt.

Although inclined to give up the idea of selling, at least temporarily, Sam asked his attorney what he thought his business was worth. The attorney's response was, "I have no idea. You need to work with someone who knows what your type of business is selling for in today's marketplace."

At that point, Sam hired an investment banking firm to answer the question of what his business was worth in the current market. The firm returned with a baseline (or minimum value) sale price estimate of almost $30 million for Sam's business. With that information, Sam chose to proceed with a sale and eventually sold for more than $40 million.

The point of this story is that to determine the value of your business, in today's marketplace, ask an experienced professional who makes a living working in that market.

Another way to determine the value of your company is to hire a valuation specialist, even if you are a few years (or more) away from selling. Doing so is also helpful if you plan to sell or gift part of your business before the sale in an effort to meet your Exit Objectives (such as transferring wealth to children, charity or employee/s).

The Employees (Or Customers) Will Leave When They Discover I'm Trying To Sell 
While this is a legitimate concern, when properly handled, no one should find out about the sale process until you inform them. Typically, a potential buyer does not even set foot in your business until you have made a tentative decision to sell the business to that buyer. When conducted by experienced professionals, the sale of a business is highly confidential, and the likelihood of anyone discovering you are selling your business before you inform the public is minimal.
If either of these common perspectives resonates with you, then the time may be now to call our office for a further explanation of how to overcome these objections. We can help guide you through the process of reviewing all of the factors associated with exiting your business, while addressing all of your personal and business objectives.

I Will Be Required To Work Years For A New Owner
If one of your Exit Objectives is to leave the business as soon as possible, it is important to make that objective known to your Exit Planning Professional and it will be a prerequisite of any sale. That objective will determine which type of buyer you should seek. There are categories of buyers who typically do not require the former owner to remain with the company beyond a short transition time period - usually no more than a few months - provided your management team is strong.

The Sale Process Will Take Too Long And Cost Too Much
Cost, of course, is a matter of perspective. But the only way for you to make the determination whether the sale process is too expensive or not is to discuss costs and expenses with your advisors before you hire them. It usually takes from six to eighteen months to sell your business. The more you know, the better prepared your company can be for sale. Better preparation on your part can mean less time and expense on the part of your advisors.

...exiting a business can end up uncovering new & exciting opportunities....
.

Given The Tax Bite On Sale Proceeds, It Makes More Sense To Stay, Enjoy The Cash Flow And Get Paid Over Time
With proper tax planning, Uncle Sam's cut of the sale proceeds can be minimized so that you are in a better position to meet your financial and personal objectives upon your exit from your business. But planning - and implementation - can take years to be fully effective. Delays in beginning to plan works to reduce time available and can increase taxes.

What Will I Do After I Sell And Leave The Business? This Business Is My Life!
For many business owners, the old "fire in the belly" is gone, but there is nothing to replace it. So many hang on to their businesses, willing to accept what they know because they fear that the unknown may be even worse. Yet, many owners don't know what they will do when they exit. In the words of a real-life business owner who faced this dilemma; however, exiting a business can end up uncovering new and exciting opportunities for owners to pursue after the sale.

"Doing the same thing every day was getting old. I wanted to do something new and different and the buyer I chose (one of six) presented that new and different opportunity," said Wayne Berger, former business owner whose story of cashing out of his business is shared in the new book Cash Out Move On, by John H. Brown and Kevin M. Short, published January 2008.

Final Thoughts
Certainly, the decision to sell the business you created and nurtured is an intensely personal decision. No one is more qualified to tell you what to do with the rest of your life than yourself, especially when it comes to the decision to sell your business. The fear of the unknown is natural, but you do not have to venture on this journey alone. Our office is available to help guide you through the process of preparing for the biggest financial event of your life. We can help you review all of the factors associated with exiting your business and work to help remove the common roadblocks you may be facing, while addressing all of your personal and business objectives.