It is my passion for helping other business owners that has led me to write this article. While many of the facts may seem frightening, my intentions are far from that. Instead, I aim to open the eyes of and construct a guide for all those that take the leap into entrepreneurship.
To aid with the facts, I leverage studies already published through a few sources such as the Exit Planning Institute (EPI) and Chris Snider’s book “Walking to Destiny.”
In this two part series, I am going to review the methods of internal and external transitions of a business. However, before I even review the different options for selling your business, there are two items that every business owner needs to consider.
The Backdrop:
We first look at the market to give us a sense of how large a scale we are talking about. As of 2016, when Chris published his book, he had formulated that the U.S. alone is sitting on a $30 trillion stockpile of wealth locked inside privately held businesses. Assuming a modest 50% value that buyers will offer these companies, we get a more accurate number of $15 trillion value held by these companies. Out of this value, Baby Boomers own two-thirds of this family-owned wealth through their businesses. With the oldest Boomer now 73 (as of 2019) and the youngest 55, it is only inevitable that they will soon begin to exit their businesses. To quote Chris, “It is the greatest transfer of wealth in the history of mankind, set to hit in the next 10-20 years.”
The Frightening Truth
While many owners say they are ready for transition, studies paint a very different picture. When polled by the EPI in 2016, 76% of privately held Boomer business owners said they wanted to transition in the next 10 years, while 48% indicated they would like to exit in the next 5 years. In today’s economic environment, this doesn’t seem far-fetched, but when we look deeper, the facts say something different. Statistically 20-30% of businesses that enter the market will one day sell or transition to a next generation. This means that 70-80% of businesses won’t continue!! Leaving only one option at this point, business owners liquidate their business, close down their doors, and live the rest of their retirement years on this nominal value. As a business owner this is unacceptable to me. All of you owners reading this article please close your eyes and picture all the work you have put in to build your business. Now imagine entering retirement years and planning to sell your business for $5 million. Next picture how your retirement would change if this sale never happened and the amount you actually retire with is 1/10 of that price. Collecting only $500k for building and equipment sales changes everything doesn’t it? Many of you reading this may be saying, “This won’t happen to me” but the truth is 80% of you could be facing this fate. Remember that these numbers are as of 2016 when the markets were stable and it was a sellers’ market. This won’t necessarily be the case in 10 years when all Boomers decide to retire. The mass exit will create a buyers’ market and only the best looking companies in each sector will survive.
So what can you do to prepare for this event and realize the value of your business? The first thing you should consider is to begin to work on your business by creating value years before you plan to sell (reference my creating wealth article). If you don’t know what I am referring to, check out my previous blog post (www.edelmanwealthmanagement.com /blog/am-i-able-to-retire-creating-wealth-outside-of-the-business
After we prepare our business properly we are now planning our exit. Contrary to many beliefs, this is a long process and doesn’t happen overnight. So what are our options when we are ready? A 2013 EPI study showed that 2/3 of business owners polled were not aware of all their exit options. While I am aware of more than 8 exit strategies, I have chosen to list the top options for owners. Let’s start with the 4 internal methods for transitioning our business.
4 Options for Internal Transitioning::
- Intergenerational Transfer
Many of us who start businesses may plan to pass the business down to future generations. This is a great option as it is lower cost to do so while we train the next owner for years before taking over. In turn this causes potentially fewer hiccups when the business is transitioned and ensures that our legacy is preserved. Be warned though as this option is not always the best method for everyone’s situation. Factors that may sway us away from this option can be a dysfunctional family, next generation isn’t ready, or next generation doesn’t want to continue the business. Study your situation carefully and act on the business’ best behalf to thrive.
- Management Buyout
This option is great for an owner to continue his company he has built. Many times the managers are on the same page and want to grow the company in the fashion the owner had planned. This also helps reduce risk of changing business culture. Factors against this option may be that managers can’t afford to buy the owner out, the current managers aren’t the best owners, or the management may want to lower the buying price to help the company continue on.
- Sale to Existing Partner
With a buy-sell agreement in place this is a smooth transition with lower costs to the business and helps continue the business in the same direction. Downsides include partners exiting can create a lower sale price, tension between owners or lower realization of profits after the exit of one or more partners.
- Employee Stock Ownership Plan (ESOP)
Leveraging an Employee Stock Ownership Plan (ESOP) keeps the business in the “extended family”. This allows the company to be purchased through pre-tax dollars and can create employees that think and act like owners, which can further drive the business. Beware though as this option is expensive as it compels the company to buy back transitioning owner’s shares.
Stay tuned for next week's article where I discuss four options for external transfers.
Jon Gyles can be reached at: jon@ewmginc.com