Baby boomer business owners are beating a path to the retirement door, and it’s causing a surge of interest in the field of succession planning.
Attorneys who specialize in estate work are seeing or expecting to see a marked upswing in clients wanting to transition from active owner to retiree. The national trend suggests some 60 percent of small businesses are going to be affected in the next few years.
“The demographics force that conclusion,” agrees attorney Kevin J. Richter, a partner at Mathis, Marifian and Richter, Ltd, of Belleville.
While many businessmen simply want to sell and retire, others want their family to succeed them, and that’s sometimes a challenge.
By some estimates, up to 80 percent of family businesses don’t make it to a second generation. And 80 percent of those that do don’t make it to a third generation. Most of the failure is because of poor planning or targeting the wrong successors, said Richter.
“Usually the originator of the company is very Type A, a very high energy individual who is passionate about what they do,” he said. The second generation takes over and has its own growth and capital issues with which to deal.
“By the third generation, everything’s kind of set up, and they sometimes take the risks associated with running a business for granted, not working as hard to maintain the status quo of the company,” Richter said.
Often the topic of business succession comes about as part of estate planning, when owners conclude their companies are worth more than any other thing they own, including real estate.
Buy-sell agreements are fairly routine, but the challenges are greater when the owner wants to have family take over. The big question is, who gets what?
“There are a number of ways to approach this,” Richter said. “One is to afford some kind of control to the family member who is most involved in the company, making them an officer, giving them 51 percent of the stock or other arrangements where they feel they have the ability to run the company.
“Other times, you might give ‘Johnny’ the company assets and split up other assets among the other family members. It might not be a dollar-for-dollar, equal distribution among everybody.”
The problems can come when there is an equal distribution of company assets, and no clear majority owner to run the company as he sees fit. Family members can take sides.
“It can lead to be a very, very frustrating experience,” Richter said.
Attorney Curtis Bailey agrees: “Splitting (successor ownership) among several members of a family is not a good omen for keeping it going in a family.” A better idea is to find the one or two members of a family who are really serious about the business.
Bailey, who handles many small- to medium-size clients for the Shiloh-based firm of Huffman Law Offices P.C., says the transition process can range from a few weeks to many months.
“The more complex, the more owners, the longer it takes,” he said.
Some owners want to pass the business on to their children. Others want to sell to the highest bidder or a trusted employee.
“And some just want to be done with it,” he said.
Regardless the direction, boomers nearing retirement have a lot of questions, and the sooner an owner can begin the transitional planning process the better.
“A year ahead is not a bad idea” to get the process started, Bailey said. “The farther in advance, the easier the transition is going to be. And the more time to change things if needed.”
Just as each business is unique so may be each path to transition. Some owners want to gift a business; others want to sell.
“There are strategies built around each,” Bailey said.
Many of today’s retiring owners are those who launched businesses after being downsized out of other jobs a few years back.
“It’s changed, because we have a lot more small businesses out there,” Bailey said.
According to Jules Lichenstein, who addressed trends in an article earlier this year for the U.S. Small Business Administration’s Office of Advocacy, the share of business owners age 50 and over is increasing.
“Business owners tend to be older than non-business owners. In 2012, the age makeup of business owners was shifting toward the older age groups. Between 2007 and 2012, those 50 and over had an increase from 46 percent to 50.9 percent, the likely result of the Baby Boom cohort’s aging past their prime working-age years,” Lichenstein wrote.
At the same time, he said, the proportion of owners age 35 to 49 decreased from 38.8 percent to 33.2 percent.
“This may reflect the unprecedented withdrawal of prime age workers from the labor market — a cyclical condition which could reverse as the labor market recovery solidifies. The share of younger business owners is holding steady. In 2012, 15.9 percent of business owners were under age 35, a slight increase from 15.2 percent in 2007,” Lichenstein wrote.
Money, of course, is the glue that must bond most ownership changes, but there are a lot of other considerations — and potential snags — in the process.
Bailey said one of the first things he does is look at relative corporate documents. If the company was formed as an limited liability corporation, he’ll review the original agreements. If the company was formed as a C corporation, he’ll look over its bylaws.
People who are not bound by partnerships can move forward on a sale fairly quickly, and the best way to do it is already have a buyer in mind — a trusted employee, for instance, although that option has its own concerns, Richter said.
“Many times that individual is not going to have the capacity to go to the bank and pay you off on Day 1. You’re going to have to be somewhat of a seller-financing agency,” Richter said.
If that happens, “The question you need to ask is, ‘Are they capable of running a profitable operation?’” An owner’s only security is the business he’s selling and “if the buyer runs it into the ground the security is also run into the ground,” he said.
Many great employees don’t make great owners, Richter pointed out.
“They don’t want to be the center guy. They don’t want the phone calls at night nor have to worry about the bank loan or making payroll.”
Owners who don’t have an interested family member or an employee to turn to have a couple options.
“You can go to a business broker and they can hit the bushes for a while trying to see if anyone’s interested,” Richter said. “Or if nobody comes forward, you close the doors and auction off the inventory, so you at least realize some proceeds that way.”
You also put the real estate up for sale, if that’s part of the business.
Besides seeking sound legal advice, businesses should approach their accountant, Richter said.
CPAs can help help determine a purchase price, analyze cash flow and other oddities.
“Sometimes transactions are structured so the owner stays on the payroll as a consultant,” Richter said.
Sometimes, an outside appraiser can be used to determine value. Other times, businesses can rely on whatever standard their industry uses.
“Some businesses have a rule of thumb, a two times gross (revenue) or a one and a half times net. There are different guidelines that generally businesses go by for their value,” Richter said.
“The difficulty with an appraisal,” he said, “is it’s one person’s opinion of worth, and there are a number of different ways of determining value, even for an appraiser. They can do a book value — assets minus liabilities. They can do an income approach, which determines how much cash flow in essence you can have. You capitalize that income and come up with a value. Then there are hybrid methods that combine both of them. They usually take an average or weight the different methods, depending on the industry, and they come down to what they feel is a fair appraisal of the company. But the true worth of any company is what the buyer is willing to pay.”
Richter notes that there will be a lot of opportunity for people wanting to get into business with so many retirements on the horizon.
The easiest company to sell is probably the one that is making the most money, but there are many other things to consider, including staffing, identification of assets and liabilities, representation of warranties, licenses, contracts and indemnification and miscellaneous provisions.
“Those components generally will comprise an agreement and be present whether it’s a contract for a few hundred thousand or $20 million,” Richter said.