Newsletter Articles
Why you should always have a Business Exit Plan or a Succession Plan for your business?
Leading business broker, NBS, is our guest author this month. It makes for very interesting reading.
According to a survey done by KPMG and Family Business Australia, 61% of the business owners are planning to retire within the next 10 years, which is not surprising, as 58% of them are over 50. Although the survey found that 40% of business owners plan to exit their business in the next 5 years, the majority (78%) of them has no formal exit strategy. 38% of the owners plan to sell on the open market while 60% will pass it on to the next generation. This is not surprisingly as 50% of small business owners will be dependent on selling their business to fund their retirement.
This is not surprising to NBS! With over 12 years history in business sales and having sold over $145 millions worth of businesses in the last 3 years, we have rarely seen a vendor who came to us with a well prepared exit plan. Moreover, most business owners never realised that in order to maximise their exit value, they need to prepare their business for sale, ideally 1-2 years ahead and time their exit well!
In today’s world, it is not uncommon for most of us to have a relative, a friend or a business associate who has been unexpectedly diagnosed with a life threatening illness or have suffered a life threatening accident.
You may have been running a successful business that you really enjoy and therefore never thought about selling it anytime soon. But what happens if unfortunately one day, you fall into one of the above statistics? Without you, especially if your business is reliant on your special skills, knowledge, expertise and relationship with your customers and suppliers, the business can go downhill the very day you are hospitalized! Your wife, sons or daughters may not be well prepared to take it over. Within a few months, your profitable business may turn into a liability as it will fall into “auto pilot”.
Lying in your hospital bed, you may start thinking of selling your business. You start looking for a business broker but don’t know who you can trust. Even if you have found the right broker, it would take at least few weeks and most likely a few months before you get an offer. Even if you have an offer, don’t be surprised that the offer could be way below your expectation as your business was never “prepared for sale”! You consult with your accountant who is likely to agree with your view! But as “time is of the essence”, you grudgingly accept what the market is willing to offer! The financial stress unfortunately will not help your recovery and most likely would do the opposite! Touch wood, this is not happening to you as no healthy business owner believes this would happen to them!
Besides health reason, there are several other reasons why business owners need an exit strategy in place, including:
•
Partnership break-ups
• Cash flow problems requiring a quick sale
• Tired of your business (after running it for 5-10 years) and now want a change of direction/life style,
• Found a better business with more attractive fundamentals and better prospects
• Wanting to retire but have no suitable successors to take over the business
To maxize your exit value, timing your exit can be a very important consideration, especially if you believe that we will be faced with an impending slowing economy. For those who plan to retire now, you may have missed the boat, in terms of getting the optimal exit value!
Buyers may pay you a premium* while they are still confident about the general economic future and the maintainability of your profit going forward (refer to Chart 1).
Chart 1 – Buyer may pay you a premium in an upward earning trend. But with a global recession looming (I have not doubt that the US, UK and Europe will go through a deep recession in the next 6-18 months. With China eventually also slowing from approx. 11% GDP growth perhaps down to 5-7% (a very pessimistic view though), Australia could also face a much slower growth, and perhaps even a mild recession), buyers are likely to discount* in their mind the earning potential (refer to chart 2) and therefore the value of your business sharply!
Chart 2 – Buyer most likely would discount the earning trend and thus the valuation
In a normal economy environment, with a downward earning trend scenario, buyers may discount your earning only but not the multiple. But with a slowing or weakening economy, the valuation will be hit by a double whammy - 1) earning discount and 2) a lower earning multiple to be applied by the buyer!
For those who are still expecting a historical valuation multiple (going back 2 years ago), you will be wasting your money and effort trying to sell your business as it will not sell!
To illustrate my point, say you have a retail business which could have been worth $270,000 (if sold in a normal economic environment 2 years ago). In a slowing economy (a consensus view shared by most economists now), the future buyer is likely to apply 1) a discount to the future earning potential (say down from $180,000 to $150,000) and 2) a lower earning multiple. Consequently, your business value could drop by a whopping by 33% (in a slowing economy) when compounded by a contracting price multiple (down from 1.5 times to 1.2 times)!
In Normal Economy |
In a Slowing Economy |
Profit - Yr 2008 |
Profit – Yr 2009 |
$180,000 |
$150,000 |
(Est. Earning Multiple) |
(Est. Earning Multiple) |
1.5 |
1.2 |
Estimated Value |
Estimated Value |
$270,000 |
$180,000 |
Potential % Drop in Value of Business |
|
-33% |
|
To conclude, all business owners must have an exit strategy in place whether you are just starting your business or you are planning to retire!