By 2030, the entire Baby Boomer generation—one of the largest generational cohorts in history—will be at or beyond retirement age. Baby Boomers make up about 40% of small business owners, and accordingly, in the next 5–10 years, a massive wave of small business owners will reach retirement age and wish to exit wealthy from their businesses.
A recent survey by the Exit Planning Institute revealed that over 70% of business owners aged 50 or older planned to exit their businesses within the next ten years. Yet less than a third of small business owners have an exit plan for when they retire, and historically, the success rates on both internal and external transitions are only 20-30%.
For baby boomers, you can see why exit planning is the number one business and personal planning challenge of our time. Here are some of the reasons why:
80-90% of your wealth could be tied up in your business
The exit from your company represents the harvest of your wealth from the business itself, which is most likely your most significant asset. When you consider your net worth, your business is the most significant line item on paper; according to financial planners, it’s like 80 to 90% of your net worth. But that wealth is without any value if it is not transferable. So, is that net worth number even real?
Only 1 in 5 businesses that go on the market actually sell
Unfortunately, the reality for small business sellers is challenging. Of the many small businesses that are put up for sale each year, over 70% fail to find a buyer. And only a small fraction of buyers are committed to keeping the business in business long term. The vast majority of businesses that go to market are simply not in a saleable state. If your business is completely dependent on you to be successful, how much value is there really? Investors are seeking cash-generating assets, not jobs.
The rise and fall of the private capital market
Of those that sell, many will receive a lower multiple or sale price due to factors such as poor or nontransferable intangible assets. A lot of transitions all at once means multiples are likely to fall. Only the best businesses will have the option to sell. Even if you have an inside option i.e. family, employees – valuations may fall, meaning a lower payout. The current high-interest rates mean financing is even more difficult.
The changing small business landscape
The past few years have been difficult ones for small businesses, especially those that rely on foot traffic for much of their revenue. With online shopping booming, supply chain issues, and rising costs, retail foot traffic had been declining even before the pandemic. Small business owners who have reached retirement age are facing a difficult decision: to hold on to their businesses as the industry and the wider economy stabilize or to explore options for retirement at an uncertain moment.
You aren’t immune because you’re banking on a family transition
Historically, the success rate of family-owned businesses transitioned to second generation is about 30%. To third generation, 12%, to fourth generation and beyond, 3%. You aren’t in a better position because you have someone lined up to inherit the business. In fact, you’re in a more complicated position. The need to sell could be exacerbated by a decrease in younger generations wanting to take over the family business.
The emerging trend of employee ownership
Most businesses lack a clear successor, and most employees who would be interested in purchasing a business lack the capital to actually take over the businesses they work for. To solve this problem of capital access and legacy preservation, several models have emerged in recent years that allow owners to transition the business they’ve built to their employees.
For small business owners who want to preserve their legacy, keep their business running, save employee jobs, and make sure their business will continue to serve the community, employee ownership is a uniquely attractive proposition.
75% of those who exit “profoundly regret” the decision within 12 months
Many baby boomers are motivated to sell their businesses to secure their retirement finances and unlock the value they have built in their enterprises over the years. However, retirement is a daunting moment for small business owners, evoking a range of intense and conflicting emotions: fear, relief, excitement, and trepidation.
Personal, financial, and business goals must be in alignment in order for you to successfully grow and transition your business. This includes maximising the value of your business, ensuring you are personally and financially prepared and have a plan for the third act of your life.
A focus on both income AND value is required
Business value is the primary long-term goal, not business income. This sounds like a subtle play on words, but in reality, it is a major paradigm shift. Most small business owners have “lifestyle” businesses. Lifestyle businesses usually generate a nice income for the owner. But focusing on income alone doesn’t mean the business has transferable market value.
When it comes to small business valuation, the most common valuation method is market value. The market value of a business follows a simple formula:
Pre-Tax Earnings x Valuation Multiple = Value
One of the most common pre-tax earnings metrics used to value a small business include is Earnings Before Interest, Taxes, Depreciation & Amortization (EBITDA)
Obviously, the more EBITDA, the higher the value. However, you can accelerate value by raising both the multiple and EBITDA. When EBITDA and your multiple increased simultaneously, you achieve an exponential increase in value.
Essentially the valuation multiple is a measure of risk. It can be difficult to completely de-risk your business. Risk is just a part of the great game of entrepreneurship. But there are ways you can lower or mitigate the risk associated with your business, which will result in a higher multiple – and increased value – in the eyes of a buyer.
Examples of factors that increase the valuation multiple include a loyal recurring customer base, a strong management team, consistent growth, recurring revenue streams, dominating a niche market, better gross margins compared to industry averages, outperforming industry averages, consistent or improving financial performance, an operationally irrelevant owner, and industry outlook.
Most owners focus on sales and income only. However, focusing exclusively on income is a mistake. Focusing on the multiples is where the real value creation lies. Your multiple not only accelerates value but also drives income. Focusing solely on income does not necessarily drive value.
Successful exits are based on what you do every day
Most of what has been written about exit planning focuses on the endgame. I can’t emphasise enough that exit planning is not accomplished by focusing on the endgame. Successful exits are based on what you do every day. There is no reason you can’t benefit today and in the future. You can do both. You don’t have to trade away income for value.
If you would like to get serious about pulling together a comprehensive exit strategy, let’s have a conversation. You can book an initial complimentary 15-minute call at TimeWithShane.com.
