Business Transitions are more difficult in owner-dependent businesses
St. Louis-area owners are learning the essential themes of planning
and timing for business transition – sometimes the hard way.
Metro has conversations with those ready to sell and occasionally with owners who must reach the emotional understanding that their life’s work will not sell for an amount greater than the liquidation value. Over the next few months I will use three examples to help you avoid missteps in your journey to your “Life Beyond Business” through business transition.
The owner of a small shop in the professional services industry for 30 years would like to transition out of the business within 18 months. Four full-time employees handle the majority of the work, with more workers on call for part-time work as needed. The owner has made a decent living over the years – some better than others, of course – and has reached a life stage (mid-sixties) when family, traveling and just not being The Responsible One is appealing.
It turns out the reality was not what the owner hoped.
The owner is the keeper of all the relationships with the clients – clients do business with the firm because of the owner. The owner’s average annual compensation is approximately $60,000 to $85,000. No employees have the talent or desire to take over the relationship role of the business.
Some facts are very clear:
• The value of the business is in the owner – nothing else. Without the owner, the business would just close up shop. So where is the value to a buyer? Only in the owner, who wants to prepare, market, sell and be out of the business in 18 months.
• If a buyer were to purchase the business, he/she would need the seller to stick around to ensure the transition of the accounts so the buyer could generate the revenue to pay the seller for the business. This case would probably require three years, with earn-out (retention) of a portion of the selling price to be paid through a formula based on whether the clients stayed with the new owner.
• The owner compensation from the business is $60,000 to $85,000. The pretax value of the business’s cash flow is approximately $130,000. The company is an S corporation, so gain on the sale will be paid at the individual taxpayer level according to their income tax bracket, as transferred to the seller (over three years). Let’s just say 35% federal and state tax, or $45,500, producing net proceeds of $84,500 over three years.
So how could this situation have turned out better for the seller?
Years before reaching burnout, the owner could have intentionally groomed a strong Number Two leader in the organization, specifically in the sales side of the business. That person would have eventually assumed the owner’s role in the client relationships.
Creating this type of succession plan years before the owner wanted to sell would have accomplished several things:
• It would have created a potential inside buyer for the business.
• Because two leaders focused on selling would have generated greater revenue, the income and value of the business would have been higher. The result would be a better payday for the owner’s life’s work at the time of business transition.
• The owner would have been marketing a larger business for sale with greater earnings that was not owner-dependent, resulting in a larger buyer pool and removing/minimizing the transition period needed.
One critical recommendation: Be sure your Number Two person is under a noncompete, nondisclosure agreement. Be certain those sales skills and client list are not taken to one of your competitors.
Next month I’ll share insight from advising a 40-year-old owner who is looking 15 to 20 years ahead with a goal of supporting his lifestyle and not predestining his now-young children into a future with the company.