What’s your exit strategy?

Quitting your business has never been as difficult as it is now. The downturn has weighed heavily on asset prices and the market has been compounded by the huge number of Boomers headed for the exit door.

If you’re in the market to build your business through a merger or acquisition, there has rarely been a better time to buy.

But those entrepreneurs looking to sell their business will need three things: a plan, plenty of patience and realistic price expectations.

Unless it is a distress sale, an exit strategy is not something that can be knocked together in six months. It can take up to five years.

But for many Boomers, that can be a challenge. Unlike Gen Y, who are likely to set up small businesses with the idea of getting out in five years time with a big profit, Boomers think long-term and hate to get old. Many would never have contemplated selling the business when they started it.

Research by Pitcher Partners has found that the average age of small business owners is 55 years and 81% plan to retire in the next 10 years. Alarmingly, 75% of them had no exit strategy.

This is mirrored in data compiled by Cameron Research Group. It found that only 10% of small business owners had a documented succession plan. Another 44% had thought about succession with no plan. Nearly half (46%) had given no thought to succession. Only 15% of small business owners intending to exit their businesses in the next five years had a documented succession plan.

Despite this, 69% of small business owners surveyed planned to exit their businesses in the next 10 years. The result: a buyer’s market.

Buyer’s bonanza

David Bird, chairman of business brokers Biz Exchange, said prices will reflect that.

“With SMEs, what’s going to happen is that over the next year or two, there’s going to be an absolute wall of retirees. They will all be rushing for the lifts together and there won’t be enough buyers” Bird says.

“It’s a buyer’s market now and it may well remain a buyer’s market for a year or so, maybe a bit longer.”

Bird says many of the boomers wanting to quit should have done so when times were good.

“What happened is that they missed the boat. If they didn’t do a deal towards the end of peak prices, they now have to sit and wait. The question is, how long can they afford to wait? It’s going to go on for another five to 10 years. They’re all trying to get in the lift at once and it will push values down.”

Bird says that prices for trade sales are flat. There were now more distress sales and that number was likely to increase. Plenty of bargains were coming on to the market.

“The bottom feeders are out there having a birthday at the moment with all the cheap assets,” Bird says.

He says the alternative, bringing in private equity, is difficult, as most private equity players do not do deals for under $10 million to $20 million.

“There are certain principles that apply to succession planning but timing is important. It’s whether the market is good for you or not,” he says.

“At the moment, pricing is low so people are withholding good businesses from the market. If you have a decent business with cashflow and profit, why would you be selling it now when there is still uncertainty? People don’t know if the market will go back a little or if it will go up. They can afford to wait.”

Trade sale or generational change?

HLB Mann Judd managing partner Geoff Webster said passing the business on to a family member would be easier in this economic climate than selling to a third party.

“They have seen the history of the business, they know what its strengths are within the family group and they are probably working within the business as it is,” Webster says.

He says trade sales are happening but business owners are getting far less than what they were commanding when the market was strong.

“There is a bit of movement in that area. When people are getting to the stage where they want to extract themselves and the options include a trade sale, then that will always happen because they are adding market share or product range or geographical advantage so the multiples are probably a little stronger than if it was a straight out sale to an investor or a private capital company that would buy, hold on to it for three to five years and then pump it out.”

“If you are doing it on the private side of things you are probably talking three and a half to four (times earnings before interest and tax), you might be able to push that up to five or six.”

They key here, he says, is to put a realistic sales proposition together.

“You have to have it valued properly, rather than some wishful thinking the vendor might have,” he says.

“Then look at the competitors in the market and make some approaches privately and start talking to them about what some of the synergistic benefits might be.”

This is quite a significant reduction from the boom times when some businesses owners were selling for up to 11 times earnings, a situation that Webster now describes as “ridiculous.”

The debt dilemma

He says selling to private equity is another option because prices are cheap.
But the business would need to have certain features that make it unique and would attract buyers. If it has that, buyers could potentially pay five or six times earnings.

“If they can get it at a cheaper multiple and they have got the cash, then this is the perfect time for them to be in the market,” he says.

“They will be down at the bottom end obviously, but they will be looking at something that has presence, either a brand or a market position or a product that’s unique and in those cases, that will push the price up because they will work on the basis that they have got the sales part taken care of, it’s just a case of improving the overheads and lifting the profitability.”

The management buyout is another option although in this climate, that can only proceed with funding from private equity. Debt is now a dirty word. It’s also expensive.

Webster says: “The banks are still very conservative so management buyouts financed on debt are going to struggle… it’s going to get more expensive and the banks have been pumping margins up quietly, but I suspect debt funded management buyouts are going to be limited.”

Some business owners might choose to float their companies as an exit strategy. A recent HLB Mann Judd survey found there were eight floats last year and one since June but Webster expects this will pick up as the economy starts to recover.

“As long as there are no unexpected changes in the world economy there will be a lot more interest over the next 12 months than we have seen in the last 12,” he says.

Planning makes perfect

Whatever direction one chooses, the exit strategy needs to be planned carefully. Richard Shrapnel, director of strategy and organisation at Pitcher Partners, says owners need to plan what he calls “business evolution” where the wealth can be passed on from one generation to the next, leaving behind a legacy and achievement.

It’s a process that requires much thought and difficult questions about family members inside the business, outside the business, assets and indebtedness. Business owners need to look at continuity and value and there are many options here. These include selling to a third party, transferring it across to a management team and maintaining it as an investment, selling the business but keeping the property and either operating as a landlord or putting it in the hands of a property trust. They could transfer it across to family members for a partial consideration, full consideration or no consideration at all.

Alternatively, if they have not worked out an exit strategy, they would have to close the business down and walk away.

Another key issue is determining what sort of legacy the business owner wants to leave behind. It doesn’t have to be a lump of cash. Two business partners might, for example, choose to leave behind a legacy that would see their families continue working together. Another business owner might choose to leave money for the children and a sum for medical research.

But, Shrapnel says, working through these issues takes time. “It’s three or more years,” Shrapnel says. “When you are talking about a three to five year period, you are saying where does the business sit now, where you want it to go and what you have to do to make it happen?”

The price equation

One word of warning for those working out a price. It’s not as simple as multiplying the earnings by, for example, three or six.

“If the business is making a $500,000 profit, you have to ask what’s generating it,” he says.

“You need to understand where the value is. Value lies in certainty. The more certain I am that the $500,000 you earned last year, you will earn next year and the year after that and the year after that and the year after that, the more I will pay you. The less certain I am, the less I will pay you.”

In uncertain times, that could be a challenge for many business owners formulating an exit strategy.