As I meet with and assist hundreds of small business owners in our region each year, the number who request assistance to sell their businesses continues to increase.
No matter how much you enjoy working in your business, inevitably there will come a time when you want to retire and/or sell your business. With baby boomers transitioning into retirement by 10,000 each day, the next decade is predicted to bring one of the largest transfers of wealth in U.S. history as up to 70% of small businesses will change hands. But are you ready to exit? And is your business ready to be sold?
Check out these sobering statistics:
- Because of the increasing number of businesses listed on the market, experts predict only 20% will actually be sold.
- Three out of four business owners either can’t afford to retire, or plan to use their business as the primary source of funding for their retirement.
- 93% do not have a plan for life after exiting their business.
- Half have no written transition plan for their business.
- Nearly half will exit involuntarily due to illness, death, or forced exit; yet 40% have no plans in place to cover these events.
Having A Plan Matters
The key to a successful business exit is having a plan—and the earlier the better.
Research has shown that business owners who go through an exit and succession planning process 12-36 months prior to selling the company are more likely to:
- Increase the value of the business and payout to the owner
- Pay less in taxes and have more accumulated personal wealth
- Transition more successfully into the next stage of their lives.
- Have fewer regrets after exiting
A business owner should develop a master plan that integrates business, personal and financial goals into their exit strategy. This process consists of three major components, referred to as the ‘three legs of the stool.’
- Business value
- Personal wealth planning, risk and tax
- Personal wellness & life after exit
Consulting an expert or credentialed business advisor to help you work through these areas can help you begin planning for your business exit. Once you have this information you will be in a better position to make decisions around your exit options and timing. The earlier you begin planning before your exit, the more options you will have. Be sure to continually update your plan as circumstances change.
Below are some common ways a business owner might transfer ownership and control of a business; each has its pros and cons:
- Family Succession – The largest portion of small businesses are family businesses, and in some cases it’s possible to keep the business in the family.
- Employee buyout – An owner offers employees the opportunity to buy into the company, often funded over time, out of the growth of the business.
- Sale to outside third party – This could be a strategic partner or even current competitor.
- Liquidation – This involves the sale of assets and ceasing business operations. Typically, this is the least desirable option and generates the lowest payout to the seller.
An accurate business valuation allows you to make a realistic estimate of the profit from a sale, and whether this is going to be sufficient to meet future needs.
There are several different methods which are commonly used in pricing a business. While a costly formal business appraisal is sometimes beneficial and even required, an approximate value or “reasonable range of value” usually can be determined by doing a pricing analysis and applying industry specific pricing guidelines or “rules of thumb,” which are based on thousands of completed transactions and input of industry experts.
Paul Smith is Director of the ND SBDC Fargo & Southeast Center and Accredited Business Intermediary (ABI). The ND SBDC network of credentialed advisors empower North Dakota small businesses and entrepreneurs to thrive by providing no-cost, confidential business advising services and resources at every stage of a business life cycle. In 2021, the program assisted approximately 1,800 clients across the State and assisted in capital formation of nearly $74M. The Fargo and Southeast Center offices are located in the NDSU Research and Technology Park Incubator. For more information or to register for services, please visit ndsbdc.org.
These pricing guidelines typically include: 1. Seller discretionary cash flow, and 2. Applying a percentage to the annual gross revenue of the business. The most accurate of the two methods involves adjusted discretionary cash flow, which is the “total owner’s benefit” derived from owning the business (i.e. salary, net income, retirement contributions, health and life insurance premiums, vehicles). Almost all privately held businesses will appraise for somewhere between one to five times seller discretionary cash flow. Exactly where the business falls in this range depends on the type of business and risk factors which such as lack of marketability, which may reduce the price. None of these guidelines include the value of any real estate on hand.
In the final analysis, the value of the business is the price that a willing seller and buyer can agree on. Buyers look for a return on their money. The higher the perceived return on investment the more attractive the business. And of course, the more attractive the business the more buyers are prepared to pay.
Why Businesses Don’t Sell
There are a number of issues that can contribute to an unsuccessful sale or a completed sale for less than potential full value. Some major factors include:
- Unrealistic owner expectations. May include overpricing a business and/ or unreasonable terms and/ or structure such as refusal to negotiate equitable seller financing or earn-out.
- Decreasing revenues or profits. This will likely have a material impact on the business valuation since businesses are purchased based on anticipated future performance but valued based on historical earnings.
- Inaccurate or incomplete financial statements. A business owner should ensure that the books are accurate, detailed, up-to-date and professionally managed.
- Customer concentration. A business lacking a broad and diverse base of customers possesses a higher degree of risk for a buyer as the loss of any one of these large clients could have material impact on future earnings.
- The owner is the business. Buyers want a business that can operate independently from the current business owner.
- Industry or market is declining. Businesses in a shrinking industry will face an uphill battle when it comes time to sell.
- Commercial property issues. Business transactions involving the sale or lease of commercial real estate can be impacted by the value of the property, zoning changes, lease agreements, required environmental assessments and other issues.
- Lack of professional advisors. At a minimum, it is recommended you have a certified exit planning advisor, wealth manager, business attorney and CPA who specialize in structuring business transactions and tax strategy.
Get Help Early In The Process
The good news is most of the factors above can be minimized or avoided if given enough time to plan – ideally 12-36 months prior to your target date for selling your business.
Start by asking yourself the following questions:
- How much do you think your business is worth now?
- When would you like to sell?
- How can you increase the value of my business and improve profit and growth?
- What would you like to do after you exit?
- What annual income would you need post-exit to fund your future lifestyle?
- Who would you like to sell or transfer your business to?
- What steps do you need to do to achieve this outcome?
- What plans can you put in place now to ensure you will enjoy this transition and have no regrets?
We can help you manage the process so you are better prepared and can maximize the value of your business. For a copy of our free Exit and Succession Planning Guide and/or request help from a credentialed business advisor, please register online at ndsbdc.org. Start now!