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Business owners who want to prepare for retirement face two big questions: First, is the business ready for sale (or transfer to the younger generation), and second, is the owner ready?
The former question is fairly straightforward: The basics for raising a business’s valuation include tracking and improving financial performance and recurring revenue streams, building up the management team, helping the business stand out from competitors, diversifying the customer base, and improving access to capital. Boosting these metrics will also shorten a buyer’s due diligence process and speed up the sale, or help launch a family member as the new owner. Many of these steps will take time, so it is essential to plan early.
The second question of whether the owner is psychologically ready to exit can often be more difficult to tackle, since they often gave birth to the business and devoted most of their waking moments to its growth. 75% of former owners experience some regret after the sale or transfer. Much of the owner’s sense of identity is connected to the business. They worry about whether their existing customers will be treated right and if their legacy will be protected, since the business name is typically transferred to the new owners. Sellers face the prospect of giving that up to someone else who may go in a different direction. As part of the sale, they may be asked to stay with the business longer in an advisory or diminished role to ease the transition, which also means a loss of control. When faced with these emotions, owners can procrastinate in their decision-making.
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Exit planners can help with both questions, according to exit planning consultants ENNIS Legacy Partners, whom we turned to for advice. Besides the technical aspects, exit planners should also help owners identify their personal goals and values.
The first step is deciding whether the owner is ready to give up control. He or she will likely need to replace the inevitable loss of identity and daily structure with something else. Entrepreneurs who had the drive to build a successful business tend to make terrible couch sitters. The second consideration is whether to sell to the highest bidder, or to a family member or valued employee. That will depend on what the owner needs to get out of the sale to fund their retirement. Financial planners can help with that.
If the owner does not need to maximize the selling price, then selling to a family member or valued employee could improve the odds of maintaining the owner’s legacy. However, this route will often involve formalizing a loan to the buyer, to be paid back out of future revenues. The payback period can often last seven to 10 years, which may sound like a long time if the original owner is dependent on getting their cash out fast. Another drawback is that the new owner may be inexperienced at being the boss, have trouble running the business and default on the loan. The original owner may end up back at square one, trying to sell all over again. Buyers who have never been owners before often don’t realize the amount of stress that comes with being an owner, and may be unprepared for it. Or the buyer’s spouse may not like the impact of that stress on their marriage.
Exit planners will also know which other consultants could be helpful. If the decision is to sell to the highest bidder, then business brokers, similar to realtors, will market the business. Typically, that will include listing the business on a website such as bizbuysell.com. Larger businesses often work with an investment banker instead of a broker.
Attorneys will be needed to review the documents of sale. Tax attorneys and accountants can estimate the tax consequences of the transaction. Owners can be surprised by how much tax is owed. Also, tax considerations are often an area that needs negotiation, since what’s advantageous to the seller may not be to the buyer, and vice versa. Employee pension obligations may need to be offloaded to a third party, typically an insurance company that provides an annuity to covered workers, or the sale price might be adjusted to reflect keeping such liabilities on the books.
Experts at the negotiating table will be needed. Owners tend to think that they are experts at negotiating, but they don’t know what they don’t know, and they will be dealing with buyer’s agents who do these kinds of negotiations all the time and know where to gain an advantage for their clients.
An early pitfall: Owners who intend to sell often overestimate market value because they underestimate how important they are, personally, to the survival of the business. Some businesses may not be sellable and will have to close their doors once the original owner leaves. Owners should use consultants to calculate market value, but can get a rough estimate by looking at previous sales on Bizbuysell.com for the past five years. Offered prices are often typically between two and three times annual earnings, depending on the industry, though they can go as low as 1.4 times for dollar stores and over four times for funeral homes, nursing homes and car washes. 60% of selling prices on Bizbuysell.com ranged from $50,000 to $500,000, but some are in the millions of dollars.
Finally, the current state of the overall economy can affect valuation, since that may determine the new owner’s chances of success. The level of interest rates is important for determining the cost of the deal to the buyer, since financing may be involved. Tariff policy can be important, too: Recent Trump administration tariffs have caused the valuations of small U.S. manufacturing businesses to rise, but retail businesses that depend on cheap imports to make a buck have been hurt.
This forecast first appeared in The Kiplinger Letter, which has been running since 1923 and is a collection of concise weekly forecasts on business and economic trends, as well as what to expect from Washington, to help you understand what’s coming up to make the most of your investments and your money. Subscribe to The Kiplinger Letter.