Chien: Myths about business succession
By Guest commentary Friday, November 23rd, 2018
By Chia-Li Chien
Anyone can start a business, but maintaining a successful business requires careful and deliberate actions. Successfully cashing out is even harder.
Peter started his restaurant business with three partners 20 years ago. BG Inc. is located in a quaint New England town that has a great reputation. Peter is approaching 70. He wants to retire and start receiving his Social Security retirement benefits. Peter discussed the exit plan with his three partners: David, Jerry and Mike. They collectively agreed to engage a business broker in listing BG Inc. for sale.
Peter was the majority shareholder with 45 percent ownership. David, 64, owned 35 percent. Jerry, 55, and Mike, 43, each owned 10 percent. The annual revenue is $3 million. The average monthly revenue is $250,000. According to Peter’s experience, BG Inc. was worth approximately 10 times the average monthly revenue.
BG Inc. was on the market for more than a year with no suitable buyer. Mike decided to take over the business, but he did not have the capital. The partners agreed that Mike would buy each of them out with the initial investment. Peter’s initial investment was $60,000. Peter, David and Jerry all retired after they completed the sale transition. Peter was happy to walk away with his initial investment, which was better than closing with nothing back.
There are three myths about business succession in privately-held businesses:
For-sale sign means sold. Listing your business for sale does not mean it will get sold. The No. 1 misconception about exiting your business is that there is always a ready buyer. Nineteen percent of sales listings terminated from the business broker, according to the 2018 Private Capital Markets Report. Just like Peter, the other owners of BG Inc. believed that they could sell their business. But they couldn’t.
Time on your side. In the consumer goods and services industry, it takes an average of about 9.08 months to close the deal if everything fits. Unfortunately, this timeline doesn’t include preliminary screening of viable buyers, negotiation and post-sales transition. Therefore, selling to a third party may take a lot longer than most business owners imagine.
Sales proceeds are enough to fund retirement. The sales proceeds may not provide enough for retirement. The owner will likely need to have saved up enough in their retirement resources to make up the difference. The largest assets for business owners are home equity and business equity. If the owners did not plan early, the sale proceeds from their business may not be enough. The $60,000 amount is not even enough for someone to live in the New England area for one year.
Three major factors impact an exit from privately held businesses: timing, timing and timing. The three significant timing factors that must be aligned when planning a successful business exit are the following:
• Personal timing. This is the readiness of the owner to move on to something else. In Peter’s case, everyone was healthy and there was no divorce or other personal family issues.
• Business timing. You need to consider whether there is a management team that is able to operate with or without the owner or founder. Luckily for BG. Inc., the business could sustain itself without the owners.
• Economic timing. Take into account where the economic cycle is and if the client industry is trending up. Imagine selling BG Inc. during the 2008 financial crisis.
You have full control of the personal and business timing. Unless you pay attention to building equity value in your business now, the economic timing can take control of your business value.
How much equity value you want to cash out and transition into retirement is entirely up to you.
Just keep in mind that timing isn’t everything. Peter’s BG Inc. had all three timing factors in its favor, yet he still walked away with meager results. Don’t be like Peter and his partners. Plan early to get the most out of your hard work.
• Chia-Li Chien, who has a doctorate in financial and retirement planning, is a certified financial planner specializing in succession planning and director of the financial planning program at California Lutheran University.