As we are regularly reminded by the media, we are entering a period of unparalleled intergenerational wealth transfer as the baby-boomer generation reaches retirement age.
It’s also a period where a large number of small businesses owned by baby-boomers will change hands. This high level of business transfer is completely unprecedented and could prove a very difficult time for business owners, not least because it is happening at a point where there is a smaller-than-expected pool of potential purchasers thanks to the global financial crisis.
It is an issue that is particularly critical for the financial planning industry, where there is a significant number of privately-owned practices, led by an owner that is approaching retirement age.
Like the old saying that a mechanic’s car always needs a service, many financial planners that I talk to are better at looking after their clients’ financial situation rather than their own. But investigating the options for the sale or transfer of their business, in a way that maximises their retirement wealth, isn’t something that can be put off indefinitely. Advance planning is the best way to ensure maximum value is achieved for the business, even during difficult economic times.
This may seem pretty obvious and straight-forward. And yet the fact is that many business owners lose value when they come to exit their business, primarily because they don’t take control of the process. 90% of SME businesses are sold to the purchaser who made an unsolicited approach rather than because the business owner actively sought out potential purchasers that match well with their business.
In addition, many business owners look at the sale of their business from the point of view of “how much do I need for my retirement?”.
Instead, a good strategy is to try to look at the business as a potential purchaser would, to identify strengths and weaknesses, and taking a good hard look at areas such as cashflow.
A purchaser is essentially buying a right to receive the future cashflow from the business. This cashflow will either be generated by the business as a stand-alone entity or from the amalgamation of the business with the other assets held by the purchaser.
As a result, different enterprises will value a business totally differently, as the expectations of the future cashflows will deviate substantially based on what they are going to do with it. Generally speaking, people don’t to buy a business to keep it as it is – the main reasons to buy a business are to:
- Gain a foothold in another state (or into the Australian market) for the first time
- Introduce new product lines into an existing business portfolio to diversify risk, get hold of new technology, or expand the customer base (e.g. a business that has focused almost exclusively on high net worth individuals may be more interested in purchasing one that has a strong ‘wealth accumulator’ client base)
- Reduce competition
- Secure a supply or distribution chain.
Once these areas are understood by the business, ways to improve this value can be identified and implemented.
The trick is finding the buyer that has the most to gain from the acquisition. Don’t think cost-saving synergies (most purchasers discount the real benefit of cost synergies as they are often easy to identify but hard to achieve). Instead, focus on revenue growth – what do we need to do to expand fees? This could mean developing a service in a new area, such as estate-planning or investment property management; or going into partnership with another firm such as an accountancy business.
Ultimately, price is determined by a combination of market forces and the buyer’s perception of risk in completing the transaction. It’s virtually impossible to do anything about market forces so business owners should instead focus on ways to reduce buyer risk. For example:
- Have financial documentation ready. The purchaser is buying future cashflow but will use historical results as a proxy to reduce risk
- Have a realistic, reliable and robust forecast model. Talk to an adviser about identifying and tracking lead indicators of revenue
- Make sure your personal tax structure and the tax leakage consequences for selling the business is fully understood. It is easier to improve after-tax returns by tax efficient structures than getting someone to pay more for the business