help your clients plan and execute a successful business transition

Help Your Clients Plan and Execute

a Successful Business

Transition

Presented By

Odee Ingersoll

Director of NBDCUniversity of Nebraska Kearney

Businesses. Where Do They Come From?

There are only three waysbusinesses happen:

• We Start Them

• We Buy Them

• We Inherit Them

Businesses. Where Do They Come From?

Too many Communities and Statesonly focus on ONE of these:

• We Start Them

• We Buy Them

• We Inherit Them

Businesses Transition Planning – Start Now!

• A recent Gallup survey of Midwestern business owners found that over the next 10 years, of those owners who would leave their businesses during this period, 27% had no plan to transition their business other than to simply close the doors.

• Uh Oh…

Businesses Transition Planning – Start Now!

Faced with this outcome – states have a combination of three choices:

1. Develop an equal or greater number of new businesses just to stay even

2. Develop a fewer number of businesses resulting in a net decline of economic activity

3. Encourage and assist business owners to develop a successful business transition plan

Why DoBusinesses Transition?• New opportunities

• Change in owner priorities

• Positive sales offer

• Change in market conditions

• Change in performance of business

• Generational or family succession

• Age or health of owner

• Death of the owner

• External Forces

Some Facts About Selling A Business – From Brokers

• Most Small Businesses Are Sold To Individuals

– Most buyers are not professionals

– They are not number crunchers

– Most buyers buy with emotion, then rationalize the purchase


• People Who Are Not Entrepreneurial Do Not Usually Buy Businesses

– Buyers seek lifestyle benefits

– Timing is an important factor

– Bragging rights are important

– Buyers just want a “good deal”, and are concerned about paying too much $


• The Larger The Deal, The More Complicated The Sale Is

– Recast financial statements

– Create value for the buyer

– Pre-qualify buyer before taking business off of the market

– Buyers offering or required to pay “all cash” may want a discount


• The Higher The Price… The Fewer Buyers In The Pool; The Lower The Price… The More Buyers In The Pool

• The Trick Is To Maximize Price And Not Lose Qualified Buyers

• Some Brokers May Market Businesses With Out A Price To Attract Multiple Competing Offers… Allowing The Market To Set The Price

$100,000

$300,000

$500,000

The pool of potential buyers generally decreases as asking price increases


• Many Brokers / Realtors Support The Use Of A Business Appraisal To Substantiate Business Value – Value Based On A Hypothetical Willing Buyer and Willing Seller, Each Equally Motivated

• But Business Value Does Not Equal Listing Price

• And Business Value May Not Equal Sales Price


• In 2004, 690,000 Businesses Listed By Brokers Did Not Sell… Why?

- The Seller Was Not Motivated- Business Was In Financial Disarray- Un-Real Seller Expectation –

A seller cannot recapture a lifetime of experiences in the sales price.

The buyer is purchasing future performance, not past experiences.


• Buyers Will Ask Three Questions…

Will The Business Pay A Salary?

Will The Business Service The Debt?

% Return On Investment vs. Risk?

• Seller Should Ask...

What Would I Pay For This Business?


• Value May Be Affected By Time

Time On The Market

$Asking Price

Offers OverTime


• Example Sale vs. Expectations…

$1,000,000 Total Sale Price$ 200,000 Equity Needed – Cash$ 800,000 Loan or At-Risk

Buyers Expects a 15% ROISalary To Be PaidPrinciple and Interest Payments



$ 200,000 Equity Needed – Cash

Buyers Expects a 15% ROI = $30,000 Annual Return From Operations



Salary To Be Paid

$60,000 for Owner Management



$ 800,000 Loan or At-Risk

Principle and Interest Payments$80,000 – 7.5%, 18 years blended real assets, equipment and working capital



$30,000 ROI$60,000 Salary$80,000 Principle & Interest

+____________

$170,000 EBITDA Required

Includes Seller Discretionary Income, Earnings Before Interest, Taxes, Depreciation and Amortization


• Businesses Must Have A Transition or Succession Plan – Whether Selling A Business or Transferring To The Next Generation…

• Business Model Must Be Able To Be Successfully, Reliably and Continuously Replicable By Someone Other Than The Current Owner…

… Can Someone Else Really Do It?


• A Retail Gift Shop May Be Successfully Sold And Replicated –

Sale may include assets and future opportunity

• An Art Studio May Be Sold Only As An Asset Sale –

Sale cannot include the “talent” of the current owner


• Rising Trend In Business Sales Are “Earn Out” Sales

• Seller wants credit for potential of business, buyer concerned about price vs. actual future performance

• Seller and Buyer may split price or gap and with base amount paid initially, and then remaining balances paid over time based on actual performance

Preparing For A SuccessfulBusinesses Transition

• Preparing For A Future Sale

– Most business owners operate their business year-to-year with two goals…

– Maximize benefits to ownership• Income, assets, benefits

– Minimize tax liability• Reduce reported taxable income even

to a taxable loss through purchases, leases, benefits, depreciation, other



– To successfully sell a business, maximize price and allow for a successful financing package for the buyer, a business needs to take a different approach.



– For at least three years prior to listing, the business needs to…

• Maximize sales, net profit, net operating income (net profit + interest expense + depreciation expense + amortization expense)

• Demonstrate opportunity

• Reduce expenses


• Remove questionable expenses

• Reduce or remove excess owner compensation, benefits and discretionary spending

• Pay off or abstain from additional leases

• Simplify financial reporting where possible to reduce questions about historical performance


• Report ALL income… even if you have not in the past

- If you withhold $10,000 per year for three years, you have saved $4,000 per year in taxes, or $12,000 total

- But an extra $10,000 in gross sales with a 3x price multiple yields a sales price $30,000 higher

- You have cost yourself ($18,000) by NOT reporting all of your income, plus that whole “against the law” thing…


Using the same $10,000 / $30,000…

- The buyer may have to borrow another $30,000 to pay you more for your business, but the extra funds only cost the business $3,340 per year over 15 years at 7.5%

- You have demonstrated the business will return an additional $6,660 in net income to the buyer annually. These monies improve ratios and cash-flow that make a purchase and financing more likely!


• Increase collections efforts

• Seek transferable leases or agreements with extensions that would be favorable to a buyer

• Maintain a positive or increased public presence, curb-appeal

• Settle any legal or contractual issues before seeking a sale

• File amended IRS returns if applicable with consultation of CPA or attorney

Why Three Years?• Lenders and buyers will seek historical

financial and performance data – typically three years

• Trend analysis

• Ratio and performance analysis

• Anomalies

• Make sure your annual financial reporting matches your tax returns

?

If 3 Years Is Not Possible?• Apply as many of the listed

recommendations as possible

• Gather all financial reports, check registers and tax returns and consider having a professional prepare a supplemental set of “Normalized” financial statements…

…Done by a professional appraiser, accountant or NBDC consultant

?

If 3 Years Is Not Possible?

• Normalized Financial Statements– Each expense and income transaction is

reviewed and considered as to its impact on the businesses operation and future impact under a new owner

– Items considered not to be normal expenses or incomes, or deemed to be one-time incidents or very discretionary in nature may be removed or adjusted off of the financial statements to demonstrate “true” company performance – that is the performance expected under a new owner

– Must be noted and disclosed

?

• Consider using a professional to establish a price suitable to your business transition situation

– Businesses may be appraised or valued by one or more of a number of methods:

• Book or Asset Value

• Adjusted Book Value

• Income Capitalization

• Discounted Future Earnings

How To Decide On A Price?

• Discounted Cash Flow

• Price to Earnings Multiple

• Dividend Capitalization

• Sales Multiple

• Profit Multiple

• Liquidation Value

• Replacement Value

• True Value (Synergistic Value)

How To Decide On A Price?Business Valuation Methods:

Use A Professional Appraiser

• A professional appraiser has significant resources available to provide a non-biased judgment of value for your business

– If an appraisal costs you $10,000 and allows you to sell your business for $30,000 more, you’ve made a profit

– If an appraisal demonstrates that you have overpriced your business, it will save you valuable time on the market or keep you from losing potential qualified buyers or brokers

Build A Team.The Sooner The

Better.Preparing a business transition plan

isn’t a do-it-yourself project.

To Sell A Business, 3-4 Years Out:

• SBDC Consultant• Attorney• CPA• Business Appraiser• Lender or Financial Partners• Broker or Realtor

Build A Team.The Sooner The

Better.

A Generational Transfer, 4-10 Years:

• SBDC Consultant• Attorney• CPA• Business Appraiser• Appropriate Family Members• Family Business Counselor• Lender or Financial Partners

The Basics of Business Transition Planning

In all successful businesses the issue of succession from the current owner to the next generation comes up, and one question that often arises is: when is the most appropriate time to begin planning for succession?

The start-up phase is obviously too early, but all too often business owners wait until the last minute - when many options are closed before beginning the process.

There are generally seven stages of business succession:

Survival

• Once the business has survived the start-up stage, the founder should begin giving consideration to succession, regardless of his or her age.


Commitment

• The founder must commit to the concept that the business has to continue in order to create opportunity for those to come.

• This commitment must be communicated extensively and often.


Recruitment

• The business cannot survive unless it is staffed with the best people. Recruiting good people will always pay dividends and is a key item in succession planning.


Development

• Investing time in developing your family members and other management team members and allowing them to exercise authority and control is key to a successful transition.


Selection

• Having developed a successful transition plan and recruited the right people, selecting a successor or successors becomes easier.

• By empowering a broad range of key people, the selection process is simplified and options are enhanced.


Announcement

• Having come this far, it is time for the founder to announce his or her future plans. This gives key management people and family successors a clear path to the future and a definite goal.


Implementation

• In implementing the succession plan, the founder must be ready to step aside and allow his or her successors to take over.

• The founder needs to be prepared to take on new challenges in retirement knowing that his or her financial future is secure.


Ways To Transition A Biz

Generational Transfer

– Include an attorney and CPA experienced in family business operations

– Such a transition may still require an appraisal with a stated purpose

– May include a full or partial sale, inheritance or gifted equity

– Requires excellent planning and communication between all parties



Concerns of the owner:

– Debts paid at death

– Tax issues dealt with

– Federal Estate Taxes

– State Estate Taxes




– State Inheritance Tax

– Income Tax

– Who gets property

– How do we transfer title

– What happens if you are impaired




– Trusts are private

– Conservatorships are not

– Titles must match goals of the estate distribution plan




– Joint Tenants: 100% goes to the surviving person

– Tenants in Common: % of ownership stays in estate and goes to named beneficiaries

– Solely owned assets transferred with an affidavit <$25,000 - > subject to probate proceedings




- Most Trustees Are Family Members

- For Small Business Owners, most of the family’s wealth is tied up in the business, not in stocks or other liquid assets

- Make Sure Trustee is objective and capable of doing what is going to be required




– Power of Attorney

• Management of Assets

• Make Medical Decisions

• Effective either upon signature or when a person is incapacitated

• Terminates upon death




Basic Rule on Estate Tax is“if you own it, its subject to tax”

Business Valuations should be done at the time a trust is set up, including appropriate life insurance policies.

Update Every three to five years to keep current.




Insurance is purchased to help settlebusiness tax and debts at death.

If owner is too old or in poor health to insure, no insurance may be possible. Then a long-term or staged buy-out may be required.

Generational Transfer Continued

– Buyer or successor must have adequate assets or equity to accomplish additional financing if required, now or in the future

– Must have enough experience to instill confidence in lenders or partners

– May require compensation for other family members not included in the transition

– Minimizes opportunity for legal challenges upon death of owner



– Plan for transfer must allow business performance to be replicated

– The business must be able to be operated successfully by others

– Select the operational successor as early as possible and train extensively

– Sit down and explain the selection to other family members early to avoid conflict



– Don’t try to piece a company out to 4 kids if doing so reduces the value enough to each person that the business cannot be sustained or successfully financed

– The more family members involved in a transition, the more likely it is that one or more members will experience issues, personal or financial that will negatively impact the business’s future

– Plan other rewards for family not involved in the business transition



Choose successor by…

• Experience• Willingness To Learn• Demonstration of Judgment• Demonstration of Energy• Demonstration of Commitment• Demonstration of Temperament• Ability to Adapt• Ability to Handle Pressure• Personal Leadership Skills• Personal Life Situation• Personal Financial Health• Support of Immediate Family


Sale By Owner

– Include an attorney and CPA to answer buyer questions and write contracts


– May require a level of seller financing

– Requires a marketing budget

– May use new internet services like BizFind.org or BizBuySell.com


Sale Through Broker

– Include an attorney and CPA to answer buyer questions and write contracts


– May required a level of seller financing

– Brokers only accept approximately15% – 20% of business inquiries and may charge a marketing fee up-front

– Will charge a fee of 3% - 15% of gross sales price: 5% – 10% common


Sale Through Broker

– The majority… more than 50% of listings are on the market 9 months to greater than 18 months

- Types of financing used?- Seller – 48%- SBA – 37%- Bank – 38%- Other – 35%

- 84% want or perform some type of business valuation before listing a business, 67% charge a valuation fee


Sale To A Partner

– Include an attorney and CPA to write contracts



– Requires level of good faith

– May be planned through a buy-out agreement or previously agreed to options


Sale To Employees (ESOP)

– Include an attorney and CPA to write contracts & answer employee questions



– Requires level of good faith, communication & employee involvement

– May be planned through a buy-out agreement or previously agreed to options


How Do We Reach Them?

• Topic driven seminars are not successful

– Most small business owners don’t want to attend a 2 - hour business transition seminar where everyone else in the room will know why they are there

– …Especially their lender or other business owners

– …Sometimes not even their family


• Short guest appearances do work

– Present at regular meetings of organized groups where everyone attends regularly

– Monthly Chamber of Commerce luncheons, Service Clubs, other

– Present at multi-topic seminars or roundtable events for regional or statewide development groups


• Provide economic development partners with program materials

– Local Chamber or Development professionals in your community know what businesses need to be approached

– They can drop-off or send materials to open the door

– Coordinate a follow-up and a referral to your SBDC through them


• Use technology to provide seminar delivery into the privacy of their home or office

– Streaming web seminars hosted by your university or SBDC - available 24/7

– Preplaned Webcasts sponsored and promoted by a specific community

– Seminars prepared and distributed by CD for playback on computer

– Seminars prepared and distributed by DVD, audio tape or CD

Thank you! Please contact me

with anyquestions or for

resources.

Odee Ingersoll

308-865-8429

[email protected]

help your clients plan and execute a successful business transition

Documents

business value value

business appraisal

motivated business

motivatedbut business

price increasessome

market businesses

discountsome facts

purchasesome facts