While large multinational corporations like Apple, Google and Amazon tend to dominate daily financial headlines, smaller companies arguably have more of an impact on the US economy. Indeed, in many ways, small businesses are the backbone of the country, employing nearly half of all Americans and representing 99.9% of all businesses.
Of course, not all small businesses thrive, with almost 20% failing within the first year. But many are growing rapidly, producing millions in revenue year after year.
Yet many owners of these hugely successful businesses face cash flow issues because so much of their net worth is tied to the value of their businesses. In other words, they’re paper-rich but poor in money.
At first glance, this might not seem like a huge problem. After all, they’re going to sell their business sooner or later – and when that day comes, any cash flow issues they’re having will likely disappear. However, things don’t always turn out that way.
One reason is that many business owners don’t plan their exit properly, if at all. To complicate matters further, most ultimately don’t control the timing of this release.
Instead, a life event, or one of the five Ds, usually makes that decision for them: death, disability, divorce, disagreement, or distress. And when one of these events occurs, it’s often too late for a business owner to be sure of a good outcome.
The result is that thousands of successful entrepreneurs each year cannot choose how or when their businesses will be sold. Here are some basic things advisors should keep in mind to help business owner clients avoid this fate:
GET A COMPANY ASSESSMENT
Imagine meeting a client for the first time. You ask them how many investable assets they have and what their annual income is, and they say they don’t know. Obviously, it would be almost impossible to help without getting more information from them. Likewise, if a small business owner says he has no idea of the value of his business (many either don’t know or have an exaggerated view), developing a financial plan for him is an exercise. hard.
THE COMPANY CANNOT BE THEIR PERSONAL CHECK
Some cash-strapped small business owners sometimes focus on cash flow out of necessity — that’s how they pay their mortgage and the rest of their bills. A much more pragmatic approach is to help them view their businesses through the prism of earnings before interest, taxes, depreciation and amortization, or EBITDA. Cash flow alone does not create transferable value, not to mention the legal and tax issues associated with taking corporate accounts for personal gain.
THEY MUST KNOW THEIR EXIT OPTIONS
According to a recent survey by the Exit Planning Institute, two-thirds of all business owners are unaware of their exit options. While this number is shockingly high, it highlights why many small business owners never begin the exit planning process: after all, how can you effectively plan anything if you don’t know where to start? Advisors must therefore understand and be able to communicate all available alternatives to their small business owner clients who are considering an exit plan. “Outside” options include selling to a third party, recapitalizing, or completing an IPO or orderly liquidation. Meanwhile, the “inside” options are an intergenerational transfer, management buyout, or sale to existing partners or employees through an employee stock ownership plan.
For some clients, being a small business owner is an integral part of who they are. It’s who they are and what they’ve always done, so it’s hard to think about playing any other role – which is another reason why some do minimal release planning at best. The key, therefore, is to create a sense of post-deal purpose for them, whether it’s forming a foundation, serving as a mentor, or learning new skills. Many successful entrepreneurs tend to have an inescapable need to stay relevant and engaged.
A recent study found that 3 out of 4 business owners who sold their business “deeply regretted” their decision within 12 months. But selling their business isn’t necessarily the source of their regrets. That’s how they sold it – without a plan.
Had they had one, their business might have been worth more, their finances might have been in better shape, and their lives would have had more meaning, all of which reduces regrets and underscores the importance of having an exit plan. .
Michael Radford is a Certified Exit Planner and Managing Director of Choreo, a national RIA with approximately $11.8 billion in assets.