Financial advisors aren’t the only ones learning that a funny thing happened on the way to their big liquidity event. Across America, millions of baby boomer small business owners are entering their 60s and discovering that their big retirement plan—selling their company—isn’t the bonanza they expected.
Ken Kamen tells of a 60-something client who owns a profitable manufacturing company. “We’ve discussed selling the business to help finance his retirement,” says Kamen, president of Mercadien Asset Management in Hamilton, N.J. “We figured what he’d probably get from a sale, after tax. Adding that amount to what he has saved and using a 4% withdrawal rate, he would face a significant drop in his lifestyle. When I went through the numbers with him, he told me, ‘I can’t afford to retire.’”
According to financial advisors, this is a common problem for business owners in the post-financial crisis world. It can affect clients with businesses they assumed were worth $10 million to $20 million or more as well as entrepreneurs with smaller companies. Moreover, the economic environment of the past several years hasn’t helped. “Credit is tight and buyers are still looking for bargains,” Kamen says. But the other reason business owners hesitate when it comes to selling their business is that the proceeds won’t support the same lifestyle the company did.
Even in a slow economy, a handful of acquirers are offering appealing buyout prices. “The middle and high end of the market appears to have heated up again, at least according to the press releases from private equity firms and other players,” says David Foster, CEO of Business Valuation Resources in Portland, Ore., referring to transactions exceeding $30 million. “However, these deals are frequently either pre-revenue, or for firms with superior growth.” (“Pre-revenue” companies tend to be start-ups with little or no revenues to date.)
Yet Foster, who maintains a database with more than 25,000 private company mergers and acquisitions, says those transactions are the exceptions. “That leaves a group of longer-term entrepreneurs who may have enjoyed huge success at earlier times,” he says, “but who now have had negative or marginal growth for two to five years. Also, their gross margins might have decayed somewhat as marketing expenses or the cost of goods sold have increased.”
Foster asserts that it can be difficult for a business seller to get an offer with a valuation like those recorded before the crisis unless the company can show growth, or at least clear evidence that future growth is likely. “In fact,” he says, “our data show that growth (primarily top-line growth) is the only metric that really matters now when it comes to selling a business. A company with 20% growth may be worth two to four times more than a flat company to a financial buyer. Strategic buyers, though, might bid a bit higher to take a competitor off the market or because of synergies.” Strategic buyers are operating companies—perhaps competitors, suppliers or customers—looking for acquisitions that will add profits and enterprise value. Financial buyers are investors seeking to acquire a company and eventually turn a profit with a sale or an IPO.
Given today’s environment, how does Foster view the outlook for long-term entrepreneurs? “They may have to face up to the fact that they can’t grow their company,” he says. “In that case, they can adopt a ‘milk it’ strategy or sell at a lower multiple. Alternatively, they have to gear up and invest seriously so that three years from now (when the market may be hotter) they have good numbers and a good future to show. Without such a history, there are too many due diligence questions that can’t be answered well, and the value drops with each one of them.”
If that’s the current situation for business owners, how can financial advisors help such clients as they near retirement? The first step is to help them get a reasonable idea of what their company would actually be worth if it were sold to raise money for retirement.
Even the efficient markets for giant public companies are highly mercurial. In 1982, Coca-Cola sold for 7 times earnings. By 1999, its P/E multiple was closer to 50. “Most business owners have an inflated idea of what their company is worth,” says Bill Carter, president of Carter Financial Management in Dallas. “They’re emotionally involved in the business, and they think it’s better than anyone else’s company, so they overprice it in their minds.”
Some business owners will mentally price their company according to some multiple, perhaps X times revenues or earnings, said to be the norm for that industry. “Some owners,” says Kamen, “will annualize the best month they’ve had in the past five years to come up with the price they expect from a sale. They tend to look through rose-colored glasses.” Again, the expected selling price may be far greater than the going rate for such a company.