According to a recent survey by the Canadian Institute Of Chartered Business Valuators, half the businesses in Canada have no succession plan or exit strategy, and 70% of business owners will be at retirement age by 2020.
For more specifics on the Financial Post article that features this survey, click on this link … http://www.financialpost.com/Management+exodus+threatens+aging+boardrooms/4918926/story.html
Not having a succession plan is not necessarily new in the world of business. But what has been changing are the competition dynamics brought upon us by the last recession.
In the past, business owners were not overly concerned about finding a way out of their business at retirement age as the booming economy provided ample opportunity for continuation of the family business or sale to a the open market.
But since 2008, the economy has tightened up, capital for business financing is not flowing as freely, and competitors are taking more drastic actions to either retain market share or out right survive in the market.
As the article mentions, many business owners have moved from a position of just riding their cash cow into the sunset to now struggling to figure out what to do with an Albatross now hanging around their neck.
All of this speaks more than ever for the need of a plan and a longer time horizon for completing a succession or exit.
And none of this is to say that the sky is falling or that all hope is lost for small and medium sized business owners without a plan.
Far from it.
But they are going to have to start knuckling down and start spending some serious time and money building a plan that is going to take them out of the business and provide the retirement they are looking for.
Its hard to say when the days will return where you could get away without planning the end and still do ok financially.
Continuing to take that type of position may put all you’ve worked for in jeopardy, both in terms of your legacy and retirement comfort.
As baby boomers inch towards retirement age, those that own small businesses should be considering their exit strategy if they haven’t already.
With a majority government in place, commercial financing loosening up, and interest rates staying at relatively low levels, the current environment for sellers is gaining strength.
On the flip side, you never know when a window of opportunity can close, so putting things off for a couple of years could lead right into a tougher market.
And let’s face it, the last 4 years have not been a whole lot of fund for sellers. Sales have been down, profits are down, and buyers have been struggling to secure the capital necessary to complete a purchase.
But if you own a business and want to take a serious run at selling in the short term, then here are some things you may want to consider.
First, make sure that your business is in a sell-able position or attractive selling position. This is accomplished through three years of accountant prepared financial statements at a review engagement or audited level. Notice to reader statements are not going to cut it for anyone that is going to require financing. Outside of being able to support the numbers and performance, the next big item on being attractive is the ability for the existing owner to exit without causing business disruption. If everything is still flowing through the business owner’s hands and dependent on their direct relationships on customers and suppliers, then the chances of transitional business failure are going to be higher, which will impact price and sale-ability.
Second, be prepared to work with the buyer to come up with a purchase and sale transaction that is going to be win win for all sides, including a third party lender. It’s unrealistic in most situations to just ask for a selling price, collect it, and exit stage right with no further involvement or risk in the transaction. If the transaction needs to financed by a third party lender or investor, they are going to expect that the seller is going to help reduce the risk of loss through transition assistance, meaningful recourse agreements if financial disclosure proves to be inaccurate or misleading, and business financing assistance to at least cover off the value of goodwill built into the purchase price.
Business owners that get properly prepared for selling and actively participate in the process to secure a buyer are more likely to sell faster and for good value than those that do not.
The essence of any for profit business enterprise is to generate a positive net cash flow over time from business operations for the benefit of the owner or owners.
If the above would be considered the primary goal, then the secondary goal would be to increase the businesses ability to produce more profits and cash flow over time. The more consistently the business can produce positive returns, the more valuable the underlying business is to others.
Ultimately, the strength of the businesses ability to create profits, value, and cash flow is the essence of any profitable and successful business exit strategy.
The most successful business exits will occur when the market is most interested in what the business has to offer and the business itself has demonstrated a strong business model that has taken advantage of the opportunity in the market.
So while the best business exit strategies have a lot to do with a point in time or the right timing when market opportunity and business performance come together, most business exit strategies are more focused on how to sell the business or liquidate the business assets at the retirement age of the business owners.
The odds that this selected point of exit is going to create optional or even above average results is slim.
There are two main reasons for this.
I’ve already talked about the first reason and that being the timing of peak market interest will exist when it exists. While it may be possible in some situations to create the demand for the business during the owner preferred time period, its more likely that larger market forces in play like the state of competition and customer demand at any point in time will significantly determine the potential success of a business sale.
The second reason is that at the point of business sale, the business is not properly set up for sale. There are a number of things that go into getting a business into a sale-able position. Financial statements need to show solid business returns and hopefully growth over the last 3 to 5 year period. The financial statements need to be prepared under a higher level of review than most businesses would typically undertake. There needs to be systems in place that will allow others to believe they can take over the business without a large risk of business transition failure. Core staff and management will not only need to be trained and committed to the ongoing business, but also be prepared to continue on in the event of business sale. Basically, the business needs to clearly demonstrate its value to interested parties through clear and acceptable representation of all critical aspects of the business including marketing, operation, and financial structure.
So when should you start planning your business exit strategy?
If you haven’t already started, right now is a good time, especially if you have any interest in having a successful and profitable business exit.
For an optimal business sale, the business needs to always be in a sales position to take advantage of the opportunities as they arise.
For those businesses where the business owner is committed to exit at a certain time period in the future, its perhaps even more important to create and maintain a sell-able position versus scrambling to make the business look more appealing near the end of the owner’s working life. Once a state of business decay creeps into a company, it can take a tremendous amount of business capital and effort to return the operations to an optimal level of performance and repair.
So your in the process of selling your business or planning for a business sale in the future as part of your exit strategy.
As you go through the process of getting your business ready for sale, take some time to consider how you can assist potential buyers with their purchase.
While cash sales do occur, most purchases of business assets or shares require financing against the assets and/or shares to be acquired.
If business financing can’t be arranged, the deal will not close and you’re going to have a harder time completing the sale process.
Yes, all business financing applications are unique and draw into consideration a number of factors outside of the business being purchased. But regardless of the profile of the borrower, if the underlying business acquisition can’t secure financing, there won’t be a deal.
Going one step further, its not unusual that in addition to third party debt or equity acquisition financing, vendor financing may also be required. Especially in cases where the purchase price contains a portion of goodwill (which is likely in most transactions involving a going concern business operating at a profit), the vendor is expected by many third party capital sources to provide some of the overall financing requirements.
As a vendor, there are two important things to take note of.
First, how much acquisition financing would the historical financial performance of the business, asset value, and present state of being attract from third party lenders and investors?
Second, how much vendor financing is the vendor comfortable providing and under what terms?
In response to the first question, if the business has focused on lowering it’s tax position in recent years and the owner has creatively taken money out of the business, lowering the retained earnings in the process, there may not be as much borrowing power as one might think. Lenders and investors are going to look at the financial performance of the business over a 3 to 5 year period to ascertain the amount of debt the business can manage. Recasting of numbers aside to allow for creative accounting and tax reduction strategies, the historical financial performance may not support the type of leverage the buyer expects against the purchase price.
Vendor’s that take this into consideration and create a business financing picture over recent history (3 to 5 years) that supports higher leverage will not only sell their business faster, but also come closer to getting their target sale price.
This is where the second question comes in. If less acquisition financing is available than expected, the vendor has to either reduce the purchase price or provide more vendor financing.
Too often in deal negotiations, the vendor will provide very rigid vendor financing terms and conditions that are designed to reduce the vendor’s risk, and not the risk of anyone else. And there are other risks. For the buyer, if the vendor financing repayment terms are too aggressive, the buyer could risk giving the business back to the vendor it repayment falls short. For a third party lender or investor, the cash flow stress of an accelerated vendor repayment plan could jeopardize the long term health of the business.
The reality is that any financing package will need to cover off the risks of all parties and that’s unlikely to happen when the vendor provides take it or leave it terms for a vendor financing component before third party acquisition financing is even figured out.
Basically, it comes down to the vendor helping the buyer buy the business.
Acquisition financing can be hard to pin down for some of the very reasons alluded to above. If the vendor wants to reduce or eliminate the need for vendor financing, then he or she needs to make sure the business being sold can generate as high a level of leverage as possible.
If vendor financing is required, its likely going to have to be coordinated with the third party financing in terms of security positions and debt repayment schedules.
The key takeaway here is that the vendor has tremendous influence over buyer financing which will be the key in a successful purchase and sale transaction in most situations.
One of the many challenges in creating a viable exit strategy for selling off your business interests is how to determine the timing.
Its one thing to say you want to work until your 55 and then sell the business, but it could be quite another to actually have a motivated buyer show up willing to pay your price.
So I propose the evergreen exit strategy whereby the business is always up for sale in a figurative sense i.e. there is no permanent for sale sign sticking out of the lawn or hanging from the side of the building.
With an evergreen exit plan, the business owner has developed the mind set that he or she cannot control when the best time is to sell, so they have to focus on what they can control, which is making sure everything in the business is up to date and supportive of a potential sale, and making sure that the day to day actions of the business are directed towards increasing the overall value of the business.
This mind set is not easy to develop as many business owners are more locked into the thinking that they will sell at retirement, period.
But an evergreen mind set always allows for the ability to consider and react to any opportunities that may arise at any time.
Think of it this way. If you’re 10 years away from your expected time of exit and a highly motivated buyer comes along for some reason and wants to offer you considerably more for your business than even you think its worth, would you not want to seriously consider any potential offers that interested party is prepared to make?
Even if you develop the proper mindset, there’s still some work that needs to be done to allow you to even seriously consider opportunities that may arise.
First, the business must maintain what I call a “sell-able” state of being. There has to be a continual effort to make sure that the financial statements are up to date, that all equipment and facilities are in a good state of repair, that regulatory issues or legal issues are dealt with quickly and not left to linger, that employee, customer, and supplier contracts are up to date, that the business has developed sufficient management depth to allow profitable operations to continue once the owner is gone, and so on.
If your business can’t stand up to the due diligence process of the prospective buyer and his or her advisers, then any opportunity that does materialize may just as quickly pass you buy.
Second, the business owner(s) has to be prepared to look at any opportunities quickly as motivated buyers don’t tend to stand still very long and could very well move on to the next best option.
Following this strategy also doesn’t require you to do anything if you don’t want to, or don’t feel the benefit is sufficient to sell. What it does do is allow you to be as opportunistic as you want to be.
Over a period of 10 to 30 years, the future is going to be very hard to predict. So when opportunity comes knocking, it may very well be worth opening the door and seeing what’s on the other side.
Don’t feel bad if you don’t have a business exit strategy as you’ll be in good company with the vast majority of small and medium sized business owners out there.
But to be fair, you can define an exit strategy in a lot of different ways.
So lets go over the ways I would describe it and you can send me your comments if you see it differently.
The first type of exit strategy is to sell your interest in the business when its worth the most to others. The focus here is to work on increasing the enterprise value of the business and always have the business in what I call a sellable position, so when opportunity comes calling, whenever that may be, you’re ready to take advantage of a good payday.
The rationale is that you can’t predict when a highly motivated buyer will be looking to invest in what you have been building. So when ever the situation presents itself, you are ready to entertain top level offers.
The second type of exit strategy or approach to business exit is to build up the business to a point where its doing very well in its market and getting close to peak performance where incremental efforts to increase profitability will only generate marginal gains. The rationale is that the best price for selling an interest is when a business is at the top of its game and has a solid near term track record to back it up.
There is never any guarantees that performance at that level can be sustained, so why not try and sell out when you can paint the most glowing picture? If a new competitor enters the market, or an old competitor re-invests, or the economy turns, or whatever … will the spin off effect create a drop off in business, which in turn reduces the business value? Here, we never assume that business will be good and like any other market you want to sell at or near the height of the market.
While similar to the first strategy, this approach is more fixed on the near term where the owner may give himself up to 5 years to build up the business and get out. In the first strategy, while a short term sell out is possible, the main focus is to always be ready to sell if the opportunity arises whether that be in 5 years are 25 years.
Following the first two strategies towards exit, you are always treating your business as an active market position that you are prepared to sell for a good profit at any time.
The third and most common approach is to own and operate a business until you reach retirement age or you just get pain sick of it. The problem with this approach is that its not really a strategy at all in that its far easier to say my exit strategy is to sell when I retire. Therefore, no work is required right now, especially if you’re 10+ years to retirement, right?
Wrong, or at least I say its wrong. Why? Because when that day comes when you decide its time to retire, what are the odds that the business is at or near its peak value, what are the chances its been built up for sale over a series of years to support a solid sale price, what is the probability that there will be a demand for what you’ll be trying to sell?
If you want to take this approach, then in order to get the most out of your business for retirement, you need to be planning the exit strategy years in advance to build a profitable exit versus hoping a profitable exit will happen.
Unfortunately for many, there is no profitable exit and still others that could have been a lot more profitable with some planning and for thought.
If you don’t have an exit plan, its definitely something to start seriously thinking about.