Based on baby-boomer retirement rates, the number of business ownership transactions should be growing substantially every year, but recent economic events have caused a screeching halt in a mergers and acquisitions market that should be flourishing with activity.  While the economy is inhibiting buyers from making acquisitions, the lack of deal making in large part is due to sellers holding-on and holding-out for better times, but whether or not it will pay-off for them is difficult to know. (more)

A new study focusing primarily on the strategic use of benefit and insurance products conducted by Harris Interactive on behalf of the Principal Financial Group also offers some eye-opening conclusions concerning the failure of business owners to effectively manage their business equity.  A consultant for PFG summarizes the finding by saying: “they leave it vulnerable to be sold for less than it's worth, creating a negative financial impact for themselves and their family."

The study report concludes: “This may be the result of short-term focus and limited resources in a challenging economy.  But, it may also be due to a lack of awareness of possible solutions.”  While I believe both reasons have merit, my experience suggests misinformation and human behavior causes many business owners to jeopardize their future. (more)

Type: Business-to-business, manufacturing and distribution preferred.

Type: Business-to-business, manufacturing and distribution preferred.

The latest Thomson Reuters data shows the significant decline in M&A activity.  For the year 2008 there were 446 deals done in Minnesota with a total value of just less than $21 billion.  For first quarter of 2009, there were 52 deals with a total value of $1.73 billion, which annualized suggests 200 deals with a value around $7 billion.

For the United States overall the numbers were similarly dismal.  In 2008, 12,225 deals were made with a total value close to $1.31 trillion.  During the first quarter of 2009, only 2,170 deals with a total value of $175 billion were completed.  Annualized, this would equal 8,700 deals with a total value of just $700 billion. Given the above numbers, and the fact that there were over 14,000 transactions in 2007, the market fell short by around 5,000 transactions or about 40% of what may have been expected.

The decline in business values has many business owners waiting for market prices to rise.  Just two years ago, businesses were typically selling at four to six times EBIDTA and in the late nineties some businesses sold at double digit multiples.  Today, due to economic uncertainty and limited access to capital, many businesses are selling for the market value of assets or as little as one times EBITDA, and a two multiple is not uncommon (of course this is at least in part due to the fact that many of these sellers have no choice). 

The decline in retirement fund values has also contributed to the reduced number of transactions.  It is common to hear business owners say that they plan to work a few extra years to make back some of their losses.  This is an easy choice given the market value of businesses today.

For the business owner deciding whether to sell now or to wait it out, aside from evaluating other exit options and factors specific to the business, there are three critical questions to consider.  Firstly, will the economy come back quickly?  If not, it will be difficult for the market to absorb the back log of businesses for sale, putting sustained negative pressure on business valuations.

The second question to consider relates more to a specific aspect of the economy, because a regeneration of the economy doesn’t necessarily mean more money in the pocket of the business owner.  Current economic policy has lead to a massive budget deficit and large spending agenda.  So, the question is, as many economists predict, will inflation and a tightening of capital markets erode potential gains in business value?

The Stimulus Spending may help boost the economy, but the dollars poured into the economy are likely to lead to inflation.  Inflation, of course leads to higher interest rates.  Further, the massive debt used to fund the spending reduces the access to capital for funding deals, only putting more pressure towards higher interest rates.  As with real estate, there is a negative correlation between a rise in interest rates and the value of businesses.

Finally, if the economy doesn’t get you, will taxes?  During a recent CNBC special with Treasury Secretary Timothy Geihtner (available on Youtube.com), when confronted with a question about taxes and small business, Mr. Geihtner wouldn’t say it directly, but alluded to the necessity of small business paying for much of the recovery, in part through taxes.  He then went on to say that it was not fair, but necessary. 

Mr Geihtner also stated that the road to recovery will be slow and arduous, with which many economists agree.  Given the expectation of a slow recovery, inflation, and higher taxes, choosing when to exit is a question of individual circumstance and the value a business owner puts on post-ownership time.  Further, with the potential for a glut of businesses coming on the market, business owners should evaluate alternatives other than going to market. (top of page)

Respondents appear to recognize their need for long term equity management, but fail to follow through with a plan or to implement appropriate initiatives.  According to the study there is a disconnect between the actions of business owners and their stated priorities. 

“Business owners recognize the challenge of separating business assets and personal net worth.  They are making decisions on a daily basis on how to allocate resources between the two.”  The study goes on to say: “While business owners want to protect their businesses and their employees today, this short-term focus may have harmful implications for their long-term goals” and that the “lack of an exit plan could lead to numerous challenges when they are ready or need to transition out of their businesses.”

The economy undoubtedly influences the current focus on short-term goals as many business owners are just trying to hold on for now.  However, the study indicates that 75% of business owners have no exit plan at all.  For those that do, it is likely to be limited to a retirement plan.  The economy alone can not account for those statistics.

The failure of business owners to address issues affecting personal wealth, business value, and transfer costs may be due to a lack of understanding regarding exit planning, according to the study.  The study states it: “reveals a need for education around the needs of business owners and the wide array of solutions available to help them meet their needs – even in these times of limited resources.”

While “education” is necessary, much of the problem stems from a tendency to have a narrow view of “exit planning.”  I believe this limited view stems in part from business owners being bombarded with piece meal information provided by service providers that deliver only a portion of what would be considered a comprehensive exit strategy. 

The financial planning industry is a major contributor to a narrow definition of exit planning.  The industry has recognized a huge market in retirement planning for business owners and many in it now tout exit planning services, yet they tend to focus only on post sale financial management.  On the other hand, business brokerage firms now promote their exit planning services, but their focus is only on selling a business.  While these service providers may carry the banner, the vast majority of them are unable to bring all the tools necessary to develop an effective, comprehensive exit strategy, yet to some degree they are falsely defining it.

It seems clear from the study that there are two major challenges that must be met for business owners to reap the rewards of a well developed exit plan.  Business owners must first become aware of how a well developed exit strategy can pay for itself many times over and provide the peace of mind that comes with being well prepared.  Further, it is important that business owners understand what exit planning encompasses and how value is derived through this vehicle, which will help them work through the process and make intelligent choices when choosing service providers.  However, while awareness and education can go a long way, I believe there is a psychological hurdle that may be the most significant factor.

There are certain things we all know we should do like preventive car maintenance, getting a check-up, or writing a will, but we put it off, often until disaster.  Exit planning is like that.  Studies show that the majority of business owners make the decision to sell or leave their business as the result of an event that forces them out.  As expected, this often leads to getting less money, having more difficulties with the transaction and paying higher taxes and fees.

Human nature proves we often bury our head in the sand rather than address issues we do not want to face, but experience shows we often pay high price for it.  As the study states: “Ignoring exit planning and wealth transfer planning now could lead to personal net worth issues.” Therefore, why some business owners successfully implement an exit strategy and others do not will be explored in the next edition of Owner’s Equity. (top of page)