Help Your Clients Plan and Execute a Successful Business Transition

1. Help Your Clients Plan and Execute a Successful Business Transition

2. Presented By Odee Ingersoll Director of NBDC University of Nebraska Kearney

3. Businesses. Where Do They Come From? There are only three ways businesses happen: • We Start Them • We Buy Them • We Inherit Them

4. Businesses. Where Do They Come From? Too many Communities and States only focus on ONE of these: • We Start Them • We Buy Them • We Inherit Them

5. 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…

6. Businesses Transition Planning – Start Now! Faced with this outcome – states have a combination of three choices: • Develop an equal or greater number of new businesses just to stay even • Develop a fewer number of businesses resulting in a net decline of economic activity • Encourage and assist business owners to develop a successful business transition plan

7. 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

8. 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

9. Some Facts About Selling A Business – From Brokers • 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 $

10. Some Facts About Selling A Business – From Brokers • 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

11. Some Facts About Selling A Business – From Brokers • 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

12. The pool of potential buyers generally decreases as asking price increases $100,000 $500,000 $300,000

13. Some Facts About Selling A Business – From Brokers • 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

14. Some Facts About Selling A Business – From Brokers • 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.

15. Some Facts About Selling A Business – From Brokers • 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?

16. Some Facts About Selling A Business – From Brokers • Value May Be Affected By Time $ Asking Price Offers Over Time Time On The Market

17. Some Facts About Selling A Business – From Brokers • 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% ROI Salary To Be Paid Principle and Interest Payments

18. Some Facts About Selling A Business – From Brokers • Example Sale vs. Expectations… $ 200,000 Equity Needed – Cash Buyers Expects a 15% ROI = $30,000 Annual Return From Operations

19. Some Facts About Selling A Business – From Brokers • Example Sale vs. Expectations… Salary To Be Paid $60,000 for Owner Management

20. Some Facts About Selling A Business – From Brokers • Example Sale vs. Expectations… $ 800,000 Loan or At-Risk Principle and Interest Payments $80,000 – 7.5%, 18 years blended real assets, equipment and working capital

21. Some Facts About Selling A Business – From Brokers • Example Sale vs. Expectations… $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

22. Some Facts About Selling A Business – From Brokers • 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?

23. Some Facts About Selling A Business – From Brokers • 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

24. Some Facts About Selling A Business – From Brokers • 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

25. 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

26. Preparing For A SuccessfulBusinesses Transition • Preparing For A Future Sale • 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.

27. Preparing For A SuccessfulBusinesses Transition • Preparing For A Future Sale • 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

28. Preparing For A SuccessfulBusinesses Transition • 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

29. Preparing For A SuccessfulBusinesses Transition • 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…

30. Preparing For A SuccessfulBusinesses Transition 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!

31. Preparing For A SuccessfulBusinesses Transition • 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

32. ? 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

33. ? 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

34. ? 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

35. How To Decide On A Price? • 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

36. How To Decide On A Price?Business Valuation Methods: • Discounted Cash Flow • Price to Earnings Multiple • Dividend Capitalization • Sales Multiple • Profit Multiple • Liquidation Value • Replacement Value • True Value (Synergistic Value)

37. 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

38. 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

39. 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

40. 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:

41. The Basics of Business Transition Planning Survival • Once the business has survived the start-up stage, the founder should begin giving consideration to succession, regardless of his or her age.

42. The Basics of Business Transition Planning 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.

43. The Basics of Business Transition Planning 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.

44. The Basics of Business Transition 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.

45. The Basics of Business Transition Planning 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.

46. The Basics of Business Transition Planning 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.

47. The Basics of Business Transition Planning 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.

48. 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

49. Ways To Transition A Biz Generational Transfer Concerns of the owner: • Debts paid at death • Tax issues dealt with • Federal Estate Taxes • State Estate Taxes

50. Ways To Transition A Biz Generational Transfer Concerns of the owner: • State Inheritance Tax • Income Tax • Who gets property • How do we transfer title • What happens if you are impaired