What 2019 Means for Exit Planning: Is now the time to sell?

Heading into 2019 we are at a bit of a crossroads. With 36 consecutive quarters of economic growth in the rear view mirror, most experts believe we are in the last throes of a bull market[1].  The M&A market has reflected the health of the economy- it’s been a seller’s market with valuation multiples largely high across the board.  With that in mind, is now the time for family businesses to consider a sale?  The bottom line is likely that you should either go to market now, or be prepared to wait 4-6 years. How does one decide?

This is often the decision of a lifetime for most entrepreneurs.  In fact, we’ve seen countless owners struggle for years trying to make a “go to market” decision, only to falter at the finish line.  To help firm up the decision process three variables need to align for a great M&A transaction: the economy needs to be ready, the company needs to be ready, and the owner needs to be ready.

Assessing Company Readiness

Company readiness is what most folks think of when they think “exit planning.”  Just how well is the company positioned for a buyer?  We typically think of company readiness in terms of core business fundamentals, as well as the harder to determine intangibles. Strong fundamentals imply steady growth, healthy gross margins, increasing earnings, a well constructed balance sheet, etc. The intangibles are often hard to sort out but critically important- especially when you consider that in the vast majority of transactions intangible value – or goodwill- vastly exceeds the value of tangible assets. Intangibles might include the customer base or book of business, the strength of an assembled workforce, the process and procedure that makes a company hum, or even a consistent base of recurring revenue. Taken together, strong core fundamentals and associated intangibles implies that a company is well positioned for a sale.

Owner Readiness

A company itself may be well positioned to sell, but that certainly doesn’t mean that the ownership group is ready.  Studies show that 80%[2] of private company owner’s net worth is often locked up in a privately held company, meaning that the sale of that company is often critical to funding retirement goals.  For this reason, it’s critically important that entrepreneurs have worked with their financial planner to model their retirement based on transaction proceeds.  Equally important is having a current business valuation performed.  The best financial planners with the most intricate models fail every time if the largest assumption in the model – the business value- is incorrect.  Armed with a financial plan and a fresh valuation, owners should be in a position to answer “Am I financially in a position to exit now, or do I have some work left to do to grow value?”

One more point on owner readiness: not all decisions are financial ones. Most entrepreneurs have dedicated much of their adult life to their company – often working 50 to 60 hour weeks towards building a successful family business. That company has become part of their identity and walking away isn’t easy. We’ve seen countless deals where owners have serious misgivings about how they are going to spend their time after closing. A flush bank account and endless rounds of golf seem perfect in those rough months where making payroll is hit or miss.  But weeks out from closing, the realization that you don’t even really like golf that much starts to take some of the shine off of the dream! Having a personal plan for post-closing life and coming to peace with a new, non-business owner identity may well be the most overlooked (yet one of the most important) aspects of assessing deal readiness.

Timeline and the Economy

Let’s assume that owner has worked their financial plan, they’ve looked in the mirror, and they’ve determined themselves “Ready to exit.” Great. And the company? If they haven’t been working hard towards positioning for a sale there very well could be some fixing to do – a pretty common scenario.

This brings us to the economy and that “now or in 4-6 years” notion.  Deal timelines can vary greatly from one to the next, but on average most transactions take 9 to 12 months. What we have seen in past downturns is that when the economy turns, the deal market evaporates.  That’s not to say the solid companies cannot go to market in a down economy – but the private capital markets are not kind.  Interest rates increase, lending standards tighten, private equity evaporates… all leading to longer deal timelines and often lower valuation multiples.  Bottom line: with our current “late cycle” economy the clock is ticking.  We certainly don’t know exactly when a downturn is coming – but we do know it’s coming.

The 9 to 12 month deal timeline implies that waiting much longer to start in on the process is tempting fate. The key question to ask is “Do I wanted to take advantage of this seller’s market?  Or am I comfortable waiting another 4-5 years to get back to the same type of deal environment?” Adding complexity to this decision is the risk inherent in managing a company through such a downturn.

What’s the almost-ready owner to do? We’d suggesting working with a professional to really dial in how well the company is positioned. If fixes can be conducted on the fly it’s time to hit the market. If there are minor problems it may still be worth it to go to market and take advantage of the current deal environment. On the other hand, a company that still has some “heavy lifting” left to do is likely better off waiting until the next cycle (but digging in to aggressively build value in the interim)!

Takeaways

Bottom line, these decisions are complex in any market. They are even more nuanced as we hit the tail end of an economic expansion. Family business and entrepreneurs should assess their personal and company readiness in the context of our late economic cycle. If both the company and entrepreneur are reasonably well positioned for a transaction, it may be time to make a serious run at getting a deal done.

 

[1] https://www.bea.gov/data/gdp/gross-domestic-product#gdp (Consolidated here for easier consumption: http://www.multpl.com/us-real-gdp-growth-rate/table/by-quarter)

[2] Several sources for this statistic.  The Exit Planning Institute publishes various studies that generally coalesce around this value. See:  http://exit-planning-institute.org/state-of-owner-readiness/

Thoughts on Exiting the Business (aka Work the Plan)

Here’s a quick one: A common objection we see from owners exploring an exit is “well if my company is only worth X annual earnings, I could just keep running it.”  And you know what? Yes, you could.  In fact, you could keep running it until X approaches infinity. Read more

Business Sale-ing into Retirement

Retirement planning is a long uphill battle.  As financial planning professionals will tell you, the sooner you start putting in place a comprehensive plan, the better off you’ll be.  Oftentimes, small business owners invest everything into their companies and bank on utilizing the proceeds from the future sale of the business to fund their retirement.  With an average sale price of $180,000 for small businesses, this lump sum is far from an adequate base to live off of for the next 20+ years. Granted, the majority of companies that we work with are much much bigger – but our experience is that owners consistently tend to overvalue their companies.

Here are some key statistics provided in an interesting article regarding funding your retirement with this onetime liquidity event:

  • Out of 1,987 small businesses sold in Q3 2014, the median sale price was $189,000 (BizBuySell.com).
  • By age 65, an average full-career worker needs to have banked 11 times annual pay. That means a household earning $75,000 a year would need to have saved $825,000. Work to age 67 and the multiple drops to 9.4 ($705,000); retire at age 62 and the multiple rises to 13.5 ($1 million).
  • EBRI estimates that a 65-year-old couple in 2019 that does not have any employer-provided health benefits will need $450,000 to have a 50% chance of funding health care expenses not covered by Medicare. Even with employer benefits, there is a 50% chance that out-of-pocket expenses will reach $268,000. Plan for this big expense.
  • But most alarming is the fact that 43% of small business owners have no formal financial plan in place (Source: Exit Planning Institute).

Still think that $180,000 (or $1.8 million) is enough to live comfortably and enjoy a life of leisure?  Even if a business owner believes their business is worth more than this average, it is prudent to work with a financial advisory team in order to determine the true value of one of their largest assets in order to bridge the difference in what will need to be saved and invested over time.

It’s incredibly important to set yourself up for success:  well before the decision to go to market you should be arming yourself with two critical pieces of data:  what is the business worth, and how much do I need?  We call this process “Gap Analysis” – and it’s literally the first step of every exit planning engagement we take on.

Takeaway: Understanding business valuation early, and working with a financial advisor, can help you set the right track.

When Do Earn-outs Really Work?

Here’s a universal truth about earn-outs: buyers love them and sellers hate them.   From a buyers point of view, what could be better?  We are deferring a portion of the purchase price and transferring risk back onto the seller.  From the seller’s point of view…. what a load of horse-hockey!   Read more

Fiscal Fitness Checklist: Get Ready for ’19 Now

Running your business requires you to manage dozens of tasks each day, and delivering a quality product or service to your customers is the first priority. Some owners become overwhelmed by daily business operations and neglect their financials, which may cause big problems down the road. Use this list to evaluate your financial fitness and to keep your business on track.

An Example – Getting to Fiscal Fitness

Assume, for example, that Julie owns and operates WoodCreations, a customized furniture manufacturer that generates $10 million in sales each year. The company buys wood and other components parts to create high-end furniture.  What to do? Where to start?  Good thing we have a handy 15 point plan…  Read more

Due Diligence: What is It?

Sometimes when thinking about business concepts it’s helpful to think in terms of consumer concepts.  Due diligence – a term you’ll start to hear a lot when buying or selling a company- is a great example. Read more

Plan for Post Tax Proceeds

This won’t come as a surprise, but nearly every business owner who is approaching a sale is focused on realizing the highest possible price. What may come as a surprise though, is that few are focused on the right number. The question “how much can I get for the company?” should always be followed by “after taxes.”

There are a number of issues that are going to alter your post tax proceeds (which is why we always recommend embarking on an Exit Planning Process).  With an appraisal in hand, working with a qualified tax advisor is a great way to really drill down on how a transaction might look for you and affect your retirement.

So, what kind of tax are we talking about? Read more

#ICYMI Dan Doran Published in Financial Advisor Mag

If you’re a financial advisor you’ve likely spent ample time with clients that are focused on the more liquid portions of their portfolio… and ignore the elephant in the room.  By ignoring their operating company as a component of their portfolio the entrepreneur is potentially jeopardizing their retirement.

Check out Dan’s latest writing on the topic in Financial Advisor Magazine.

Dan writes “Financial advisors have the unique perspective on a business owners’ personal financial picture, but not necessarily an in-depth understanding of a company’s value. The entrepreneur’s business interests can be complex and difficult to work into a comprehensive financial plan.  Pairing an accurate assessment of a business’ Fair Market Value with your financial planning process can yield deep insights for entrepreneurs… and deepen client relationships with advisors.”

 

Learning From the Smart Money: What VC’s Ask Startups (And Good Stuff Generally)

ICYMI – Article originally appeared in 2015…. updated and revised for 2018!

While getting my daily dose of Quora this morning, someone posed the question “What are the Top 5 Questions a VC should ask a startup?”  Lots of good responses are in there, but Patrick Mathieson @ Toba Capital really had a great response.(Really suggest you head over to read directly)  While Patrick’s response is geared towards the startup / VC world, his response really has broad application across mature companies as well. Read more