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.”

Recognizing Reality
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.

In these situations, advisors can help by urging business owners to get a comprehensive appraisal by someone familiar with their industry. That can produce a hard number so the advisor and the client will have a good idea of how much will be available for reinvestment to generate retirement income.

Business owners might not welcome such advice. A thorough appraisal can be extremely expensive, for one thing. Also, they might be reluctant to “go public” with a valuation, alarming employees and customers. “They think the word will get out,” says Kamen, “especially if they’re in a small industry. We suggest that business owners avoid accounting and valuation firms in their circle, for this purpose. They might go out of the area, even to another state, for an expert appraiser.”

A comprehensive appraisal may not necessarily be welcomed, even if the estimate runs into the eight figures. An owner selling a business for $10 million, for example, might net $8 million or less after tax.

Quitting Time
Business owners who find that their company’s likely selling price won’t provide them with a desirable retirement can simply decide to keep working. Generally, that solution will have limits. “What was fine at age 45 is not as much fun at age 65,” says Carter. “Business owners might have health issues or just get tired of working. When they see their peers traveling or spending time with the grandchildren, they may not want to keep getting to the office by 6 o’clock every morning.”

Therefore, working indefinitely is not usually a practical answer for business owners. They might stay on the job until they literally can’t do it anymore, then sell the company to the highest bidder. At that point, though, a desperate seller is in a poor negotiating position.

Instead, advisors can urge clients to start succession planning in advance and exit with the best possible terms. Brendan Burke, director of business development at Headwaters MB, an investment banking firm in Denver, suggests starting the process at least 18 to 24 months before the target retirement date.

One approach to succession planning is to look for a successor, someone who’ll take over from the business owner. “It’s usually important to find a successor who is capable of running the company well,” says Carter. “Clients who are long-term business owners tend to be emotionally attached to the company, to their customers and to their employees. The owner’s name might be on the door, even after the sale [or transition to a sale], and the owner may be upset if the business is mismanaged.”

As Carter notes, a successor’s failure may put the company back into the hands of the business owner, who is then older and even less eager to continue running a now-devalued enterprise. Depending on the terms of the deal, the business owner’s full selling price may depend on some sort of earn-out, requiring continued success, while “clawbacks” might be triggered if the post-sale business falters. (A clawback clause can require the seller to repay money already received if certain goals aren’t met.)

For all of these reasons, a valid succession plan requires a qualified successor. The owner’s family is a natural place to start looking, but the challenge may be finding a relative both capable and willing to take over. “Working with a business-owner client, we recently identified the owner’s son as a likely successor,” says Cheryl Holland, president of Abacus Planning Group in Columbia, S.C. “However, the son said that while he was good at some things, he wasn’t good at all the things he’d need to be able to run the company well.”

This heir apparent was only 25 years old, and his understanding of his weaknesses as well as his strengths impressed Holland, who says that about one-third of her clients traditionally have been business owners. “We listened to the young man,” Holland explains, “and realized we could create an environment where he would feel safe as the business owner. It took a few tries, but he came around. We ultimately worked out a plan where the client’s son would take over the business but would share management responsibilities with three other employees with experience there.”

Indeed, business successors are often employees, either homegrown or brought in for that purpose. “Ideally,” says Carter, “the business owner will be able to train a successor who knows the business and knows the customers. That can make for an easy handoff.”

Not always, though. Holland describes a client who wanted to turn the business over to a proven employee—but that person was 55 years old. “The employee said, ‘By the time I’m finished with the buyout, I’ll be ready to retire,’” Holland recalls. “‘Then who will I sell to?’”

According to Holland, she helped her client discuss the deal with the chosen employee, until they finally came to terms. “We’re fans of the book, Getting To Yes,” Holland says, “and we follow its principles in this type of negotiation. As a financial advisor, my job is to create and preserve clients’ wealth. In some cases, that involves learning and using negotiating skills.”

Money Matters
In other cases, though, finding a relative or an employee to take over a client’s company might not be easy. The more valuable the company, the harder it might be for the successor to come up with the funds necessary for the buyout. In such a situation, an advisor with contacts among investment bankers and other sources of capital might be able to bring in outside buyers, increasingly family offices, to acquire all or part of the company.

“It can be difficult to find investors for small companies,” says Jim Murphy, a managing partner at Belden Hill Partners, an investment banking firm in Stamford, Conn. “Investment bankers generally want to put $3 million to $5 million or more into each transaction. Practically speaking, companies may have to be worth $15 million or more to attract much attention. The larger the company, the more choices of capital it’s likely to have.”

Besides introducing business owners to potential investors, financial advisors can give clients an idea of what they’ll have to provide. “Most small companies have not done a full-blown strategic plan,” says Murphy, “yet they can benefit tremendously by this exercise. Such a plan can show who the customers are and what value-added provisions a company offers. The plan can identify which businesses they might go into and which they should get out of. Companies that make the indicated changes may command more than a market multiple on a sale. There are lots of buyers for good companies.”

Jack Maier, head of investment banking at Headwaters, says that getting an investment banker involved well before the ultimate sale can result in profitable changes for the company. “To begin,” he suggests, “have an accounting firm do a full financial audit. Business owners don’t like to do it because it’s so costly—in management time and attention as well as money. However, buyers will insist on such an audit.”

In addition, a small company that wants to attract outside investors should have the same good governance as a public company. “Updating financial reporting systems and software enterprise systems can help the business run more efficiently,” says Maier. “The management team may need to be filled out and the company’s board should go beyond friends and family. With such changes, a company will be better positioned to go to market.”

Such enhancements can pay off for closely held businesses looking for capital. Murphy points to the example of a beverage company with more than $50 million in revenues being run by the third generation of owners. “There was no one in the next generation of the family to take over,” he says, “but there was good non-family management. The company implemented a strategic plan, emphasizing some better-margined market sectors and de-emphasizing other sectors. Eventually, this company found a strategic partner, a supplier of raw materials, which enabled the owners of the original company to exit the venture entirely.”

In another case history mentioned by Murphy, the owner of a catalog marketing company in his 50s was tired of the daily grind. He sold 85% of his interest to investors, rolled the remaining 15% to the new company and phased down his workload. “The business was recapitalized, with more leverage,” Murphy says. “Things went well, and the business was sold after seven or eight years. Not only did the original owner get liquid right away, he received almost as much for selling that 15% interest as he had received for the first 85% of his company.”

Kamen has similar success stories to report, including a client with a manufacturing business he thought he might attract an offer of $20 million. “We put together a beauty contest of investment banking shops,” says Kamen, “which resulted in the client getting $45 million—and that was after he took the building out of the company name into his own.”

Despite such upbeat reports, Kamen adds a cautionary note. “The sale price of a business is really largely irrelevant,” he says. “You need to look at the covenants and clawbacks in the deal. We demand that the buyer include a marked-up contract with a bid.” As with so many things in the lives of business owners, it’s not so much what they get but what they get to keep.