What You Need to Know About Family Businesses
Family businesses are critical to both the US and World economies. In fact, in the US alone, there are approximately 5.5 million family owned and controlled businesses.[1] While much of the world’s wealth is a byproduct of family-owned businesses, the fact is that most are not actually prepared to sell in a way that will profit the owners for their life’s work.
Many owners of family businesses care deeply about the legacy that they built and want it to remain in their family or with someone that will continue it with the same mission, vision, and values on which it operates. This is often difficult as the owners lack an established succession plan or exit strategy.
Studies show that about one-third of family owners never even plan to retire. As a result, they have no succession or exit plan in place. In some cases, the business is forced to form a strategy by default when the business owner becomes burned out, disabled or worse, passes away. This is clearly not the best path when it comes to maximizing profits.
Pros and Cons of Conveying Your Business to Family Members
According to Businessweek.com, the average lifespan of a family-owned business is 24 years. About 40% of family-owned businesses are successfully passed down to a second-generation with only about 13% passed down to a third generation. [2] With the fourth generation and beyond, the survival rate is 3% or less. Regardless of whether a family business owner intends to convey their business to a third party or have it remain in the family, it is important to maintain confidentiality and have the proper documentation in place for a successful transition.
There are disadvantages that need to be considered if you plan to sell your business to a family member. One key disadvantage is that a family business owner will typically receive less value for their business than engaging the sale with an independent third party. Selling to an independent third party can often force a family business owner to also paradoxically agree to a lower value in an effort to negotiate the retention of jobs and incomes for the family members they wish to remain with the business after the sale. It is important to prepare the remaining family members that they will have to accept the fact that they now answer to new ownership and management with the business.
Handling Multiple Owners and/or Decision Makers
If there are multiple owners and/or decision makers in the family-owned business and the business is being sold to a third party, it is important to appoint one family member to represent the negotiations. Having multiple decision makers at this critical step in the process of conveying the business to a third-party owner can lead to numerous issues and headaches for both the buyer and seller. Many times, multiple decision makers cause failure in the ability to transition the business to third-party ownership, as the parties involved have competing priorities with the sale of the business that prevents satisfying everyone involved in the process. Keep in mind that all family members must be in consensus with the price, terms and sale of the business or it will never happen. This fact can be true even if the family members involved are just employees or active/passive investors in the business. Disagreements among family members often derail the possibility of a deal happening.
Obtaining Outside Assistance
To increase your probability of success with conveying a family-owned business to future generations or new independent ownership, having a third-party guide you through the process who is not emotionally involved like the various family members involved, can be critical in making the deal happen. That’s why a variety of professionals including business brokers, M&A advisors, lawyers, and accountants should be brought in to help.
This article highlights just a few of the myriad of issues and process involved in conveying your business to new ownership once you decide it is time to retire or move on to a new venture. If you are just beginning or actively considering transitioning your business to new ownership, please do not hesitate to reach out to us for advice and assistance.
[1] https://www.gvsu.edu/fobi/family-firm-facts-5.htm
[2] https://www.johnson.cornell.edu/smith-family-business-initiative-at-cornell/resources/family-business-facts/
Copyright: Business Brokerage Press, Inc.
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Justifying Your EBITDA
All too often a business owner decides to sell, only to learn a number of harsh realities. For example, oftentimes a business owner discovers that their lack of financial data represents a major problem. The simple fact is that prospective buyers will dive in and scrutinize every aspect of EBITDA (Earnings Before Interest, Taxes, Depreciation & Amortization) when looking at their perceived value of your business. This will most likely take place through what is called a Quality of Earnings Analysis Report (Q of E). General Accepted Accounting Principles serves as the key basis and language for financial reporting (known as GAAP Accounting). GAAP Accounting and Reports often represent a marked departure for how many companies handle their general and day-to-day accounting. The end result of all this can be a substantial shift in EBITDA as compared to what the actual number really is.
Potential buyers will ultimately receive numerous documents that outline the financial and operational health of your business during what is called the due diligence process in acquiring a business. This means that you, as a business owner, must be ready to invest a good deal of time in the process of disclosing as much accurate information as you can, in support and defense of the true and accurate EBITDA of your business. In short, preparing your business to be sold is no small affair when it comes to making sure that information is fully disclosed and in defense of the actual quality of financial and operational health to ensure the highest and best acquisition price.
EBITDA is one of the most common ways to value a business based on multiples of that number. When engaging your business for acquisition in the open market, you should expect that any buyer or potential investor will perform a review of your income statement for adjustments in order to arrive at an adjusted EBITDA that makes sense for THEM.
You need to be ready and fight back as to what the true Adjusted or Normalized EBITDA is, that serves as the basis for a purchase price of your business creating a value used with a multiple to negotiate a final price and terms that make sense for both parties. Miss out on the correct EBITDA for your business by $100,000 on a 3 multiple and you just gave up $300,000 in acquisition cost of your business – as an example.
There are three common EBITDA adjustments:
- First, items related to conversion based on a GAAP Accounting basis; this number can have a considerable range.
- Second, one-time events such as legal expenses, PPP loan forgiveness, insurance settlements, unusual expenses associated with issues/growth of the business can greatly factor into an adjusted EBITDA amount.
- Third, certain personal expenses a business owner takes that would typically not be part of the future cash flow of your business is another potential impact on EBITDA.
It is important not to ignore balance sheets when it comes to representing the financial health and aspects of your business as well. Smaller businesses typically focus strictly on profit, and this factor can result in balance sheets not being reviewed as often as they should be. A balance sheet needs to be recast in a way that the potential buyer truly understands the assets and liabilities that convey in a sale. It is better to recast the balance sheet upfront to what truly conveys with the business as the end result can be items popping up during due diligence causing hiccups in deal making and negotiations.
As an example – many times we see that business owners may park large amounts of cash in their business and on their balance sheets – over and above what is normally necessary. The minute a potential buyer sees a $1,000,000 cash position on a business when a $60,000 working capital position is needed, they are going to want that $940,000 cash to convey with the business. That’s fine if they are willing to pay $940,000 more for the business but not if they want the sale price of the business on a “cash free, debt fee” basis when the business conveys to stay the same with a reasonable sale price.
The same is true with liabilities. If you intend to convey the business without debt – if $500,000 in liabilities is relieved from the business, the value and burden of debt on the business logically increases by an adjusted amount in cash flow that is not needed by the business moving forward. This mathematically (and logically) increases the value of the business based on the cash flow used against the multiple used for valuation. Relieve $100,000 debt service to the business against a 3 multiple for the value equates to an additional $300,000 in value and price that the business should sell.
There are three key points that business owners should keep in mind when they are planning on selling their business:
- Make sure that managers and key employees are able to step in and run the business during the transition period.
- Review your financials, and get ready for GAAP reporting requirements during due diligence with a potential acquisition.
- Consider having a Quality of Earnings analysis performed with your business before going to market so you truly understand the financial health with your business.
As this article underscores, selling a business is a process with numerous moving parts. Well organized and solid financials – defensible EBITDA and operational health, represents to buyers and investors a sound and well-run business with an owner that is professional and realistic in their expectations.
Bottom line? Even if you believe it will be years before you place your business on the market, it is never too early to begin preparing.
Copyright: Business Brokerage Press, Inc.
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The Complexities of Valuations
A lot of training and experience goes into good valuations. A variety of complex factors are involved. Plus, there are certainly some subjective elements. That means that one professional’s valuation may be different from the next. Let’s take a look at some of the factors involved when it comes to achieving an accurate valuation.
Intellectual Property
Determining the value of IP or other intangible assets can be difficult. If the business in question has trademarks, copyrights and patents, it can be far more challenging to properly assign a value.
Products and Services
As it turns out, businesses that only offer one product or service are far more difficult to analyze. If a company has a lot of product diversity, a professional will typically assess a higher value. The same is true for companies that have only one or two key customers. Lack of customer diversity can bring down overall values.
Employee-Owned Companies
If a company is partially or completely employee owned, it can lower its marketability. Many company owners do not realize that employee stock ownership plans (ESOP) can change its overall value.
Life-Cycles and Supply Chains
In some cases, a business is nearing obsolescence due to advancements that have taken place. We often see this in technology companies. It should come as no surprise that if a business is near the end of its life cycle, this will raise potential issues during the valuation process. On a similar note, could the business be susceptible to supply disruptions? If a business is assessed as vulnerable in that area, it could also lower an overall valuation amount.
Accuracy of Data Received
Of course, the person handling the valuation must rely on the accuracy of the factual information they receive. If the numbers are off, the valuation simply cannot be as accurate.
These are just a few examples of the list of issues that can impact a valuation. If you’re trying to get an idea of what your business may be worth or if you ‘re wondering what factors might impact your valuation, reach out to our team. We’d be happy to discuss this in greater detail.
Copyright: Business Brokerage Press, Inc.
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What Do Buyers Really Want?
When sellers get ready to put their businesses on the market, they often wonder what buyers are really looking for in an effort to make their businesses as attractive as possible. The answer to this question can seem mysterious when you are on the other side of the bargaining table. So, what are buyers typically thinking about when they make the decision about whether or not to purchase a business? It should come as no surprise that much of this is tied into earnings and stability.
Guarantees of No Surprises
Earnings that are sustainable are very attractive to buyers. After all, it allows them to know what to expect. Buyers can then factor in if they can advance the business in a way in which it would grow faster than the current pace. If not, they at least would have the confidence to know that the business will proceed at the same rate. Of course, no buyer would want to acquire a business only to find that it only had high earnings temporarily due to a one-time contract.
Accuracy of Information
Along the same line of avoiding surprises, buyers will want to verify the information they receive about a business. Anything involving past, present, or future legal issues will be scrutinized along with other issues, such as pending product returns. The due diligence process is when you can expect the buyer to really dig into the details of your business. You can expect that he or she will often do so with the assistance of an attorney and accountant.
Oftentimes, accountants or appraisers add back one-time expenses or non-recurring expenses. Buyers will want to look at the earnings and have proof of expenses that are non-recurring, such as fees for a lawsuit or heavy repairs to a building. Since this process inflates earnings, it can make it difficult for buyers to understand the actual earning potential of a business. Otherwise, those expenses would obviously throw off the true earning potential of the business.
In Closing
These are just a few of the critical considerations made by business buyers when looking at a potential acquisition. There are numerous other considerations that a buyer will make and it is important to be prepared to address those questions and potential concerns a buyer may have up front, or they will quickly lose interest and move on to other potential acquisition opportunities. Put yourself in the shoes of a potential buyer and think about the kinds of assurances you would want before buying a business.
Working with a Business Broker or M&A Advisor can be tremendously beneficial in this regard. These professionals have worked with many buyers in the past, and therefore easily see things from a buyer’s point of view. They will not only be able to help you get prepared up front when buyers begin looking at your business, but easily identify and point out areas of concern that a potential buyer may have in order to keep the journey to closing on track.
Copyright: Business Brokerage Press, Inc.
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No Replacement for Experience
When it comes time to sell your business and sign on the dotted line, you only have one opportunity to get it right. In many cases, business owners have made critical mistakes while attempting to sell their business. This kind of scenario can often occur when an owner trusts a friend or relative to help navigate the process. In some cases, business owners have even been known to try to broker their deals on their own. Let’s take a look at some common errors that have occurred during the process when experienced professionals were not brought in to assist.
Not Prioritizing Confidentiality
We cannot understate the importance of confidentiality. When business owners try to go it alone, they often share valuable information with the wrong people, such as competitors. Or accidentally alert employees, suppliers and customers that the business is up for sale. When confidentiality is breached, unexpected and unfortunate consequences can result, such as employees looking for new work or customers switching over to work with different businesses. If any of these scenarios occur, it can devalue the business or even interfere with a sale going through properly.
Mistakes in Financial Information
If the party assisting you to sell your business lacks experience, he or she may accidentally omit preparing critical paperwork. Additionally, if the financial records are not properly audited, it could negatively impact the numbers. This could lead to lower offers and less interest from prospective buyers.
Failing to Involve Key Parties
Another error that could be caused by inexperience is neglecting to bring key parties into the deal. For example, when a business owner is guided by a layperson or trying to handle everything on his or her own, important people, such as the CFO, might accidentally not be brought into the due diligence process. While an error like this one might not necessarily kill the deal, it could lead to delays and complications.
The bottom line is that when it comes to a large transaction like selling your business, it is time to rely upon trustworthy professionals. There is a long list of protocols and steps that lead to a deal going smoothly. Experienced business brokers and M&A advisors will make sure that all the best practices are followed and that you come out ahead in the end.
Copyright: Business Brokerage Press, Inc.
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