The simple truth is that all business owners will exit their business. The timing will either be determined by you or for you. It is unfortunate, but statistics show thousands of businesses each year sell for a fraction of their market value because owners don’t understand the true value of the business. Others are transferred to family members only to fail soon thereafter. Many are sold at liquidation prices to satisfy estate taxes. Improper timing of the sale causes many entrepreneurs to receive less than maximum value. Worse yet, after a lifetime of work, the proceeds are not enough to sustain the owner’s retirement.

Many business owners are under the impression that because they have invested money and time into their venture, it is valuable and marketable. Nothing could be further from the truth. In fact, many owners have created perpetual full-time jobs, not sustainable, valuable and marketable enterprises. This problem exists in privately held companies of all sizes, from the small to the very large company. Contrary to the common belief, revenue size is not a formula for value.

Building business value is not necessarily the same thing as building bottom line. Let’s define value, recognizing that there are different kinds of value:

• Value for estate purposes – Takes into consideration the fact that the company will lose its driving force and have less capital to grow the business
• Value for stock ownership plans - Here we presume no change in running the company and no change in capital structure except, that which is necessary to service the new debt
• Value for mergers-and-acquisitions (M&A) – Here there will be new dedication, resources and an infusion of, or access to, the funds necessary for growing the business

To build value one must look at a business from an M&A perspective because value is the price which a willing and informed buyer will pay to a willing and informed seller with neither party being under duress.

Avoid the Common Myths of Value

Myth 1 – Value building is same as business building
It may come as a surprise but building the market value of the business is quite different than simply growing sales or profits. Certainly the more sales and profits a business has, the higher the value, but there are some hidden traps that will fool the naive owner. Higher sales or even greater profits may not always mean larger value!

Myth 2 – Value is constant
Market values of companies are dynamic, constantly changing, forever adjusting to the internal activities of the business and the external factors of the market.

Myth 3 – Value is obvious
There are no formulas, no rules of thumb, and no simple multiples that can determine with certainty what price an individual business will obtain in the marketplace. There can be general averages that apply across a broad number of companies in an industry, but such averages are usually inaccurate and often inappropriate for individual companies.

Therefore, value building must concentrate on what motivates sophisticated and serious buyers to pay premiums when they acquire businesses. In short, a practical strategy is one that is focused, specifically customized and stresses what works in the M&A marketplace. How the process works is not always obvious to owners who have difficulty seeing their companies from the perspective of a buyer.

posted by Susan Jones

Do you really understand the impact of the coming tax hikes on capital gains and income?

Our office has been working on a five-year business plan for a client that has really exposed the impact of the tax increases coming in 2011 and 2013.

Not only are increases in capital gains taxes going to take a bigger bite out of the proceeds of the sale of a company, but coming increases in income taxes and health-care taxes will take a bigger bite out of the income to owners who continue to own their companies.

We are all aware that the expiration of the Bush Tax Cuts will increase capital gains rates in 2011. For a company owner who is a resident of Minnesota, this will cause a 6.5% reduction in the after-tax proceeds the owner will take away from a sale.  Not everyone has noticed that the new Health Care bill also increases capital gains beginning in 2013.  When this kicks in, owners will take home 11.4% less compared to today’s tax rates.  This means that the company must be worth 6.5% more next year and 11.4% more 2 years later, just to stay even. Read more »

Entrepreneurs prepare extensively over the years as they build their businesses, but many fail to plan for an exit.  In my recent article, “Exit Planning for Business Owners”, I examined an area that many business owners neglect and that may be the most important part of the business transaction: life-after-business. In fact, during the current troublesome economic and tax environment, never before has it been so important for entrepreneurs to engage world-class wealth planning professionals prior to a business sale as part of their final exit plan.  There can be no small mistakes in the wealth management plan because once a deal is finalized, it cannot be undone.

In reality, when entrepreneurs sell their company they are really just transitioning from their current business (say, Smith Widget Co.) to another business, which we will call Your-Money-Inc.  This new company will have a completely new mission and will need to be guided through an entirely new set of challenges.  Creating a mission statement for Your-Money-Inc. should always begin well before your business is sold.  This planning process starts with a seemingly simple question: “What goals do I want to accomplish starting immediately after I exit?”

How can you be sure that your company’s market value will support these goals post-close?  Read more »

It’s no secret banks across the country have tightened their lending standards, and in many cases actually reduced the size of their commercial lending portfolios, as my recent newsletter article “Banking On an Old Model for New Loans” points out. Over the last eighteen months, many business owners have found their banks unwilling to support them beyond their present lending level, regardless of their strong lending history, current condition, or the length of the relationship. However, as banks recognize that the economy is slowly recovering, some are beginning to make new commercial loans. While capital for senior debt financing is once again beginning to flow, it does so within a new set of realities: less leverage, more collateral required, stricter covenants and higher pricing spreads. This new environment requires borrowers to find collaborative ways to work with the few active albeit cautious lenders.

We have experienced success participating multiple community banks in deals that are attractive with a solid sponsor, but too big for any one lender to take on alone. Why community banks? While many large national and regional banks are in holding patterns, the smaller community banks that have survived in this environment have done so due to traditionally conservative credit standards and a local market focus. These banks are lending, but with stricter guidelines than in the past, and at maximum loan amounts that are down from their historic levels.

Partnering on loans is not an every day practice for community banks, and the process is different than closing a deal with a single lender. Choosing the right combination of lenders is critical, and requires strong relationships with each one. These multi bank loan structures take creativity to develop and longer to close than single-lender loans, as multiple stakeholders are involved. Having an experienced adviser to quarterback the deal from application through closing is critical to successfully combining lenders.

posted by Peter Ventre

Today’s Wall Street Journal included an editorial (see below) that reports that the Financial Reform bill now in Congress will likely disqualify 77% of private party investors who have historically capitalized small, private companies.  This will have a major impact on capital formation for private companies with less than $20 million in revenues.

Angels Out of America – How the Dodd Bill Harms Start-Ups

Senator Chris Dodd’s 1,400-page financial reform bill contains many economic land mines, and here’s one of the worst: Provisions that would make it harder for business start-ups to raise seed capital. Read more »

As a business owner, at some point you will want to extract some, if not all of your wealth from your business. You need to determine not only how to achieve, but maximize liquidity in terms of your personal wealth.

The first step in this process is to become educated; a thorough understanding of your options is essential. The most typical liquidity options for an owner of a middle-market privately held business include:

A SALE
A sale to a public, international or large private company provides immediate liquidity and advantageous tax structures however it can sacrifice important personal considerations if you are not ready to exit or relinquish control.

A PARTIAL SALE
A strategically identified investment group can provide premium value and liquidity as well as financial resources to further the company’s growth. However you must be ready to share or relinquish control of the business.

GOING PUBLIC
Initial Public Offerings (IPO) are designed to provide capital to promote growth and can generate significant market value. However, it may be some time (years) until you can generate liquidity.

PRIVATE MARKET RECAPITALIZATIONS
Recapitalizations are often thought of as one of the best liquidity options, but are the least understood by business owners. Properly structured with a private equity group, a recapitalization can provide you with flexibility and a range of personal and financial advantages.

• Immediate Liquidity – Read more »

It’s always valuable to know what the other side is thinking. BDO Seidman, the nation’s #6 accounting firm, does a large number of due diligence reviews of companies for financial buyers. Their most recent newsletter to private equity clients gives BDO’s view of what they are going to look at before they give their clients the green light to close a deal – Six Keys to a Successful Deal

Whether you are getting ready to sell your company in the near term, or are planning for it a couple years down the road, today is the time to understand these issues and start working on making these areas look really good to prospective buyers.

This is what BDO is telling their clients (the fancy language and big words are theirs, not mine):

Look Forward While Looking Back.
Whereas previously a buyer could credibly base future earnings on past performance, economic conditions require buyers to take a more holistic approach to assessing the viability of the seller. If drastic operational cuts have been made, these need to be substantiated to ensure they’re sustainable for the long-term. Externally, greater emphasis must be placed on the diligence of the health of business constituents, such as vendors and business partners.

Cash Reigns.
Now more than ever, buyers must understand the cash generating abilities of a business. Watch out for sellers who may have underinvested in, or even deferred, key expenditures because this could mean that it will take more than just the initial investment to move the business forward.

Determine What’s “Real” In The Business.
Some key questions to ask include: Read more »

In addition to teaching a “How to Value a Business” continuing education course each year, I am also asked to speak to various groups of CEOs, entrepreneurs and business owners on the same subject.  Regardless of the audience, invariably, someone will ask, “Jim, this valuation stuff is all well and good, but what is a simple multiple of earnings or formula to use to value a business?”

Face it, we all love shortcuts. We learn at an early age the benefits of shortcuts: whether we cut through our neighbor’s yard on our walk to school, clean our room by stuffing our messes into our closets, or even feed our unwanted vegetables to our dog (surreptitiously under the table, of course) so we can get the dessert our mothers’ promised if we clean our plates, who can resist a good shortcut?

Today, I still use the shortcuts my high school mathematics teacher taught us to check our addition and how to quickly multiply by 25. I doubt any of us can get through the day without utilizing at least one shortcut we learned as kids. For business buyers and sellers, multiples are simply shortcuts to the valuation and/or negotiation process.

When applied properly, multiples can be used effectively as sanity or temperature checks/gauges. However, I personally would not want to buy or sell a business based strictly upon a multiple. There are always so many variables to consider when acquiring or selling a business; basing such an important decision on a simple multiple does not make sense. Take a look at the following, admittedly simple, example as a way of illustrating my point. Read more »

Suppose you own a valuable asset that does not earn any income or it earns very little income.  Let us assume that this property has substantially appreciated in value such that, if you sold it today, you would realize a substantial gain and resulting tax on the gain.  So how can you turn this valuable property into an income producing source without erosion to principal due to taxation?

Answer:  By conveying the property to a Charitable Remainder Trust (CRT).

Here’s how it works:  After the trustor/donor transfers property to the CRT, the property is sold by the trustee.  There is no tax on the sale since the CRT is exempt from income tax under Section 664(c)(1) of the Internal Revenue Code.  The proceeds from the sale are invested into income producing property.  The trustee distributes income to the trustor during his or her lifetime.  Upon death of the trustor, the remaining property (corpus) is transferred to a designated charity.

Besides the benefit of avoiding tax from a taxable sale, in the year of transfer to the CRT, the trustor receives a charitable contribution deduction for the computed value of the charitable remainder interest.  The charitable remainder interest computation is based upon the value of the property transferred to the trust, the type of trust, the payout rate, frequency of payments each year, the mortality table, the applicable federal interest rate, and the age of the trustor.

There are two types of charitable remainder trusts Read more »

Part 3 of 7

We have been looking at the two-fold challenge faced by Business Owners wishing to “extract themselves and their wealth” from their businesses in the next decade.  Firstly, that the economic recovery may be slow, and, secondly, that the retirement of the Baby Boomers will put “10 million” businesses on the market in this period.

From this perspective, we recognize that many companies will not sell without careful planning and preparation.  The point of considering possible “Positioning Strategies” is that most business are not being run with a mind to “selling”, and are typically not optimally prepared for an exit because:

1. the ownership and management roles are not properly separated, and
2. the key determinants of value, namely growth and risk, are not calibrated to the expectations and desires of market buyers (investors)

Exiting through a sale, recapitalization or merger generally involves investors and may involve lenders. Management is pivotal.  Exiting through a transfer of the business to family, management or employees, or through a gifting strategy, may or may not involve lenders but, once again, management is a pivotal issue.  Exiting through liquidation, on the other hand, does not depend on management to the same extent.

Generally, the different Exit Strategies depend on key considerations as follows: Read more »