While large multinationals like Apple, Google and Amazon tend to dominate the daily financial headlines, smaller firms may have more of an impact on the US economy. Indeed, in many ways, small businesses are the backbone of the country, employing nearly half of all Americans and accounting for 99.9% of all businesses.
Of course, not all small businesses thrive: almost 20% fail within the first year. But many of them are growing rapidly, bringing in millions of dollars in revenue year after year.
However, many of the owners of these incredibly successful firms face liquidity problems as much of their net worth is tied to the value of their firms. In other words, they are rich in paper. but no money.
At first glance, this may not seem like such a big problem. Eventually, sooner or later, they will sell their business, and when that day comes, any liquidity problems they may have seem to be gone. However, it doesn’t always work out that way.
One reason is that many business owners don’t plan their exit properly—or don’t plan at all. To complicate matters further, most of them ultimately have no control over exit time.
Instead, the decision is usually made for them by a life event or one of the five Ds: death, disability, divorce, disagreement, or suffering. And when one of these events occurs, it is often too late for the business owner to guarantee a good result.
As a result, thousands of successful entrepreneurs each year do not choose how and when to sell their companies. Here are some basic things consultants should keep in mind to help business owner clients avoid this fate:
GET A BUSINESS ASSESSMENT
Imagine that you are meeting with a client for the first time. You ask them how many investment assets they have and what their annual income is, and they say they don’t know. Obviously, it would be almost impossible to help without getting more information from them. Similarly, if a small business owner says he has no idea how much his firm is worth (many either don’t know or have a grossly exaggerated opinion), drawing up a financial plan is a difficult task for him.
BUSINESS CANNOT BE THEIR PERSONAL CHECKBOOK
Some small business owners who are short on liquidity sometimes need to focus on cash flow, which is how they pay their mortgage and other bills. A much more pragmatic approach is to help them look at their companies through the lens of earnings before interest, taxes, depreciation and amortization, or EBITDA. Cash flow alone does not create transferable value, let alone the legal and tax issues associated with using company accounts for personal use.
THEY SHOULD KNOW EXIT OPTIONS
According to a recent survey by the Exit Planning Institute, two-thirds of all business owners are unaware of their exit options. While this figure is shockingly high, it highlights why many small business owners never start the exit planning process: after all, how can you plan anything effectively if you don’t know where to start? Therefore, consultants must understand and be able to communicate all alternatives to their small business clients who are contemplating an exit plan. “External” options include sale to a third party, recapitalization, IPO or liquidation in due course. Meanwhile, “in-house” options are intergenerational transfers, a management buyout, or a sale to existing partners or employees through an employee shareholding plan.
For some clients, being a small business owner is an integral part of their identity. It’s who they are and what they’ve always done, so it’s hard to think of being in a different role – that’s another reason why some plan minimal exit at best. So the key is to give them a sense of post-transactional purpose, whether it’s building a foundation, working as a mentor, or learning new skills. Many successful entrepreneurs tend to have an overwhelming desire to stay relevant and engaged.
One recent study found that 3 out of 4 business owners who sold their companies “deeply regretted” their decision within 12 months. But selling their business isn’t necessarily the root of their regrets. So they sold it – without a plan.
If they had one, their business might be worth more, their finances would be in better shape, and their lives would have more meaning—all of which lead to fewer regrets and highlight the importance of having an exit plan.
Michael Radford is a Certified Care Planner and Managing Director of Choreo, a $11.8 billion national RIA.
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