Lifestyle and Enterprise Business

In John Brown’s June 2019  blog , the article discusses the difference between Lifestyle and Enterprise Business, he discusses that fact that many businesses are formed to accommodate the lifestyle of the owners without giving too much thought as to the long-term effect of the business value when it is sold.

While the business is up and running, it is doing exactly what the owner wants it to do, and that is to provide a steady and profitable income to carry the lifestyle of the owner and their family.  Again, this is  great for the business owner, their families and businesses in general.  However, the article discusses the problem when the owners are forced to sell, or just want to sell and exit the business.

Business owners may think they can run their businesses as a lifestyle business and still plan for an exit of their business for the highest potential value.  This is a myth, since the strategy of exit planning involves different philosophies and strategies used to grow the business best potential value.

Most business owners don’t really know what their businesses are worth.  Because of this, they never understand why they don’t receive the perceived value upon post exit.    Also, many business owners take for granted, the perks from the business as normal and ordinary.  These perks evaporate once they exit.  A double hit to the owner of a lifestyle business model.

The article emphasizes the fact that you can’t have it both ways if you wish to exit your company at the best possible price. Business owners who are running a lifestyle business, must turn that business into a business enterprise if they expect to exit their business at the highest possible price.

A business enterprise has transferable value.  It needs to be worth something to the purchaser, for example an equity group, as lifestyle value means nothing to a private equity group compared to the business owner of a lifestyle business as they both have different philosophies of business purpose.

Turning a business into a business enterprise is basically creating a business that is worth something to people or entities beyond the owner.  Brown suggests the transforming of a lifestyle business to an enterprise business is a challenge mostly because of the owner’s emotional attachment to the business, and limited owner resources. 

It has given him and his family a nice lifestyle, freedom and pride.   “Why should he change anything?” The owner created this baby, loved it, invested in it and build it.  Consequently, it is not only a physical transition but a psychological transition. 

When you look through the eyes of an outside investor, they are looking for other aspects about the business, mostly  flaws  of the business, inefficient  areas of the business, management, potential return on investment, cash flow, potential growth and  a host of elements needed to make a future profit from the purchase and sales of the business, not lifestyle to the owner. 

Continue reading “Lifestyle and Enterprise Business”

Disadvantages Of The Buy And Sell Agreement! [i]

Certainly, having a Buy and Sell Agreement (BSA) has many advantages, many of which I have discussed in our past posts (May 2019, Advantages of Buy and Sell Agreements).  However, I would like to go over the disadvantages of a BSA.

RESTRICTIONS ON ESTATE PLANNING

BSA can restrict ownership transfers and consequently management duties. These restrictions can be applied to you also. The restrictions could limit your personal planning by limiting your options for the ownership interests during your lifetime or at death. It may prohibit you from making gifts of your ownership interest to your family. Depending on your planning, your BSA could limit your plans to leave ownership interest to your family. The BSA may require your ownership interest to be sold at your death.

RESTRICTIONS ON FINANCIAL PLANNING 

A BSA can restrict the persons to whom you could sell your ownership interest to and restrict when you can sell it.  An example would be in a situation that you need to sell your interest because you’re in a financial bind. The BSA may require you to sell to your entity or your co-owners, who may not want to buy.

Special election to the defer federal state tax of deceased owners

This could limit an estate owner from using Code Section 6166 which is a way of paying your estate tax over a period of time, giving you the option of paying over a 15-year period, five years of deferral and a ten-year payout.  A purchase from your estate could cause the loss of the right to defer the estate taxes.

A sale of Corporate interests may result in a loss of the entities corporate structure

This could limit the entities right to use its own loss carry back and carry forward losses on a significant change in ownership, which is possible without a well throughout BSA.

The cost of putting together a BSA

It takes time and money to put together a solid buy and sell agreement, Of course this is a disadvantage and it can be expensive, however, in order to have an optimal BSA, you will need to invest time and money.  You will also need a competent council to prepare the necessary documents.  This incurs costs.  Being educated in this strategy is to your advantage when designing your BSA.

A poorly drafted buy sell agreement can be costly:  By failing to carefully work out the terms of buy-sell agreement or by having mismatches between triggering events and the identity of the purchaser versus the funding source, a real mess could be created.

[i] Buy -Sell Agreements for Baby Boomer Business Owners Z. Christopher Mercer, ASA, CFA, ABAR

Advantages Of A Buy Sell Agreement And Some Dynamics Of The Agreement!

It’s important to understand that every Buy and Sell Agreement (BSA) is different and has a separate purpose when put together and implemented. Because of the vast differences in BSA’s, using a standard form of BSA rarely accomplishes the needs and wants of the parties involved.

Each participant in the agreement has different purposes and objectives and looks at the transactions very differently. Neither party knows when the agreement will actually be needed, and what the triggering event will be. A triggering event could be death, disability, divorce, termination,  bankruptcy, and other defined events.   One thing that can is consistent in most cases is that when a triggering event happens, then each party becomes visionless to the other parties’ best interests, and only focuses on their own and best interests.

The two participants in a BSA are a seller and a buyer. They come in different forms, as individuals, trusts, or estates. Usually their purposes and objectives are very different, and there usually is a conflict between the parties.

While creating the BSA  the parties tend to be very fair before a triggering event. This is because everybody is in the same position and no one knows who will suffer the future triggering event. This is a positive viewpoint, as the parties are reasonable and objective about the possible and various scenarios. Everyone’s objectives are personal, and range from financial, tax, to personal protection for their families.  Having a designed BSA can offer the owners some satisfaction that their needs are documented and witnessed.

Objectives of BSA

  • To provide a predetermined roadmap for the business based on a triggering event which may call for the sale of a participant’s ownership interest.
  • To provide a guaranteed buyer for the owner’s business interest and to create a market for that interest.
  • If funded through life insurance or some other means, the BSA will provide liquidity for the payment of the business interest and help the estate pay for the estate taxes and other settlement costs of the deceased owner’s estate.
  • Can avoid an impasse between the parties in the event of a triggering event.
  • To protect the company and surviving shareholder from subsequent competition, should a terminated owner wish to sell to a 3rd
  • To avoid potential conflicts between the surviving owners and the deceased owners’ heirs, by creating a roadmap through the agreement at the owner’s death.
  • Can level the playing field for the estate or deceased owner’s as the agreement gives the deceased owner a say on how settlement of their interest will be to their heirs and estate. Especially, when the surviving family have little knowledge of the business entity.
  • Establishing the price and method of valuing the interest, establishing the terms of payments, and providing a method of funding for the payment of that purchase price.
  • Can create job stability for minority owners and key non-owner employees.
  • Can establish the value of the entity for tax purposes.
  • Can preclude owners from selling their interest without the consent of others thus avoiding the third-party ownership or voting percentages.
  • The agreement can restrict ownership to people who are actively engaged with the entity of full-time basis.
  • Can improve the credit worthiness of the entity.
  • Can avoid transfer violations/Licensing requirements.
  • Avoid transfers to individuals that would terminate the S corporation status.
  • Can dictate discounts for lack of marketability (minority interest discounts).
  • Can provide for voting agreements where necessary.
  • Can dictate what happens to in force life insurance policies on the terminated or surviving owners.

These are only a few of the many reasons for a buy and sell agreement, and the advantages of funding the agreement.

 

The Final Act! The Day Will Come! Part 2

In part-one of this article, I mentioned how purchasers will prefer to buy a business where everything looks good and there are no apparent problems. Smart and neat operations will attract serious buyers; however, this is only one part that is needed to achieve your selling objectives.

There should be no hidden problems or secrets which can jeopardize the purchase. Any undesirable factor not disclosed to the purchaser can lead to a non-sale, or at the very least, something they can use as a negotiating tool. The fact that a deal has fallen apart, is not only frustrating, but will cost you money, time, and distraction from your business.

An owner who unknowingly discloses secrets or situations in their business can end up becoming a deal breaker. Issues which are known need to be dealt with to have the best chance of a good sale. Since there may be issues which are unknown the best answer to this is to search for the problems in advance and take care of them. Think of this the same way you would treat the sale of your home. You would normally fix up, repaint, and clean up before you put the home on the market. You should do the same thing with your business.

Not only would you want your physical location to be clean and tidy, but this also flows over to the other parts of your business, such as accounting, financing, marketing material, department procedure manuals, and an array of other business items. Prepared written policies and procedures are a great selling point for a prospective buyer. Remember, when someone is interested in your business, it’s their team that inspects every aspect of your business in doing their due diligence. This is a micro inspection of all aspects of your business, so it will pay to make sure there isn’t a bunch of dirty secrets hanging around.

FIRST IMPRESSIONS AND PHYSICAL APPEAL
The first time a prospective buyer visits your company they make value judgements. They will observe everything from your reception area to your signage in and on the building. If the impression they get is positive, they will want to investigate your company more. You don’t want to lose their interest based on visual appeal of your business. No matter how good your business seems to do on paper, the prospective buyer may lose interest based on your first impressions.

This observation doesn’t end with just the building. Your premises, marketing literature, dress attire of you employees, uniforms, office settings, rubbish areas and a host of other areas should be updated and tidy. Continue reading “The Final Act! The Day Will Come! Part 2”

Business Valuation After The 2017 Tax Cut And Jobs Act

Because of the Tax Cut and Job Acts of 2017, the marginal rates are lower.  The impact of the recent tax cut is very straight forward.   Lowering the rate, means a higher after-tax cash flow which translates into higher value for businesses.

Business owners know their business better than anyone.  That being said, you would also assume they would know the value of the businesses? Not so fast!

Knowing your business and knowing what you think it is worth in reality can be two separate issues.  If it were that simple, appraisers would not be needed, but they are, and they play very key role.  They arrive at a fair market value after taking many facts into consideration.

Valuations; “The Walk Way Number

The “country club” concept of a business owner having a number in his/her head as to what they would take, if offered, offers some interesting conversations during happy hour!

Over the years I have spoken to business owners, and periodically I have been told that the owner has a figure in their head, and if they were offered that figure for their business, they would take it!  They seem to know their business better than anyone, so it is reasonable to believe they have a handle on the value of their company.   In more cases than not, that figure would allow the owner to go and do what they want in life as it would give them the capital needed, and the can walk away from the business.

However, there are some different sides to this concept!   A more logical way of knowing the business value!

Continue reading “Business Valuation After The 2017 Tax Cut And Jobs Act”

Questions you need to ask yourself if you are a business owner!  

  1. When would like to be done working in your business?
  2.  After you leave your business how much cash will you need (each year) to achieve your personal financial objectives?
  3. Who can afford to buy your company and who would you like to buy it.
  4. As you think about leaving your business, what keeps you up at night?
  5. What is the business worth?  How do you know its worth that amount?
  6. Do you have key people that handle the day-to day operations of your business which you feel is a substantial contribution and one that would be hard to find a replacement?
  7.  Would their be a great burden if they left abruptly?
  8. Do you have a strategy in place to reward those employees who you feel are helping you grow your business?
  9. Do you and your partners have a buy and sell agreement in place which is funded and up-to-date?
  10. If so, when was the last time you reviewed the agreement, and discussed the method of business valuation at a trigger event?
  11. If you could no longer run your company , what arrangement have you made to make sure that your family will benefit from your life’s work?

 

Why Would Anyone Want To Buy Your Business At The Price That You Set?

The present value of the cash flow is a way of pricing out your company.  A high certainty that the company will produce steady, predictable cash flow.  Cash flow is king! Predictability only creates more value.   

 A buyer is willing to pay your price  if you have a plethora of tangible and intangible assets and systems that function like a Swiss watch.  

 Swiss Watch” of a company needs to produce the consistent cash flow without you.  As an owner you want to sell your business and move on.  In many cases, a purchaser may want the owner to stay on and run the company for  a period of time.  However, if your company is able to produce a cash flow without you, it not only allows you to get your price, but allows you to get out of dodge.   

It is worth your while to put together a talented management team, that can not only keep the cash flow consistent, but has the ability to keep the cash flow machine working even if you are not there.  Your key management team may be the most important element of your business.   

 Whether buyers are strategic buyers, or financial buyers, they will be looking for value drivers.  From the beginning of your business ownership, these are the things you need to start working on.   

Partial list:   

  • Key management group 
  • Loyal client base with diversification (most of your firms revenue should come from more than 10% of the clients)  
  • Efficient production and manufacturing facilities 
  • Leading edge products or services 
  • Supplier network 
  • Intellectual property rights (patents, trademarks, trade name) 
  • Steady, predictable solid profits and cash flow 
  • Proven growth record 
  • Effective workforce in place 
  • Transferable franchise or license 
  • Key location or territory 
  • Barriers to entry for a startup 
  • Research and product development team  
  • Company name 
  • Exclusive territory  
  • Above industry average financial ratios 
  • Systematized business processes/documented so continuing success is not dependent on any particular person (including the owner) 

 

These are the areas of your business you need to develop and maximize in order to demonstrate the potential for steady predictable growth in the future.   

 Since the price you will be asking for your business is relevant to your successful retirement (to fill the retirement gap), you will want to spend the time in the areas which will increase the value of your business.  Usually, they will be Industry-Specific Business Benchmarks.   

 Knowing how your competitors are using their resources and the efficiency which they are utilizing them can give you ideas about the strategies being used, and strategies you can compare to your methods.   If you are utilizing your resources better than your competitions, you will be able to negotiate a better price for your business.