The Owner's Journey Executive Summary

Few entrepreneurs start companies with the sole goal of getting rich. Often, they launch companies to fix a problem, to create something new, to act upon an insight that only they see, or even simply to make the world a better place. In many ways, entrepreneurs are like artists, bringing huge passion to what they are doing and creating. Making money may be important to them, but it tends to be only one of many motivating factors. Often, it is far down the list.

Entrepreneurial Research — Expanding the Scope

Historically, business schools and business journalism focused on the culture, success and management of large, publicly held companies because these large employers once powered the overall economy. That has changed gradually and steadily, and today there is a more widespread recognition that privately held companies play a major role as job creators. The early stages of entrepreneurship have garnered serious scrutiny from academics and journalists for some time, and people now have a better understanding of what it takes to move from an idea to a startup. Somewhat less attention has been paid to the next stage, which is how a small but proven business scales to become a major enterprise.

An even more neglected topic is the subject of this white paper: how founders or their successors create financial value in their businesses and prepare them for ownership change, whether through a sale or through transfers to family members. While getting rich may not be the primary motivation at startup, capturing wealth and ensuring the sustainability of one’s life’s work become very important later.

Business Ownership and Wealth Creation

Entrepreneurship in the United States continues to be a major path to wealth creation for individuals and their families. Yet many companies do not create wealth. They are essentially self-employment and never survive the founder. These small companies can provide a wonderful lifestyle, pay mortgages and put kids through college, but they are not designed for growth and to thrive on their own. They are an extension of the entrepreneur and die with him or her.

What distinguishes firms that survive the founder from those that don’t? First, does the business have some special characteristic, knowledge or asset that gives it a competitive advantage? If not, survival is unlikely. Beyond the nature of the business, has the entrepreneur put the necessary elements in place for the business to have a life of its own? Has the entrepreneur conceived the business as an entity unto itself, with its own needs and trajectory?

The critical difference between failure and success is how well the entrepreneur personally adapts over time. Many entrepreneurs fail because they get stuck in the routines that led to their initial success. Continued growth and success require continual change. Entrepreneurs must embrace change for themselves and their companies, and they must deal flexibly with the various stages and steps.

Planning for the Transfer

Preparing a company for sale or transfer of ownership demands a special kind of personal growth and planning. Unfortunately, most entrepreneurs have no plan for who eventually may take over the business and how that transfer will occur. In fact, 37% of business owners who responded to the 2018 U.S. Trust Insights on Wealth and Worth® Survey¹ have not crafted a formal exit strategy. And for those who do have plans, many never get around to implementing them.

The reasons for this planning gap? They are as varied as the entrepreneurs themselves. Some business owners are reluctant to cede control of their company or to make decisions they cannot change later, particularly with regard to ownership and management. Some want to avoid management or family conflict and rivalry. Some are waiting to see if family members are ready or willing to accept the leadership. Still others are simply consumed with the many day-to-day responsibilities of managing their business, and succession planning inevitably slips down to-do lists, even when they recognize its importance.

Whatever the reason, in the absence of a plan, business owners are often forced to exit on other people’s terms, selling to the first suitor who comes in the door, or rushing into a sale because of other external factors. Without a timetable and specific strategies to create value, an exit also may not occur when the owner wants. Most important, the planless owner may become reactive rather than controlling and yield to pressure to sell the business at a less than optimal price. Or, in the event of an untimely passing, they may jeopardize business continuity and leave unprepared successors to navigate a mess.

Even worse outcomes are possible. Uncertainty can lead to anxiety and departures for valued executives and employees. On the personal wealth planning front, the lack of estate and family wealth transfer planning can result in much higher income taxes on a sale, lead to ruinous estate taxes, or negatively affect family harmony. Not planning can result in a lifetime of great ideas and hard work disintegrating.

Entrepreneurs and Selling a Business

In the last few years, a number of internet sites have been created to help in the sale of privately held companies, and they provide a window into a complex market. Bizbuysell.com, a leading internet site for buying and selling smaller businesses, shows 9,919 closed transactions for 2017, compared to 7,842 in 2016. The strong end of 2017 has Bizbuysell optimistic as it looks forward to 2018. Key drivers for the growth are stronger financials, confident millennials and baby boomers looking for entrepreneur opportunities.

With this greatly increased inventory of businesses for sale, multiples for smaller businesses have been eroding. Smaller sellers are now lucky to receive multiples of only one- or two-times earnings, which in effect will only pay owners a price equal to a couple of years of the income they have been taking out of the business.

That said, over the past two to three years, the market for medium-sized companies (companies with revenues of between, say, $25 million and $1 billion) has been robust. In 2017, middle market sale activity — in terms of value — was historically high, and competition from strategic buyers and private equity firms for high-quality businesses was particularly stiff, though lower acquisition points to an activity shift toward the upper middle market (UMM).² The combination of a generally stable economic outlook, cheap and readily available credit, and renewed C-suite and board-level confidence all created a seller’s market in the middle market space. Consensus expectations are for more of the same in 2017, notwithstanding the likelihood of higher interest rates, which may result in a dampening effect on deal valuations.

But what are the exit strategy options for an owner of a privately held company?

• Liquidation and bankruptcy are real, but obviously unappealing, options.
• Going public is possible, but only for a small number of carefully groomed companies that have achieved a critical size with clear growth prospects.
• Transfer of ownership to employees, management, or partners is an option.
• For most companies, the most plausible options are to transfer ownership to family members or to sell to a financial or strategic buyer.

Challenges of Family Business Succession

Transferring ownership within the family is often the preferred exit plan. Entrepreneurs are often more focused on the people and culture of their companies than on squeezing the last dollar from a deal. They also see that keeping the company in the family may be the best way to sustain income flow and increase wealth. As committed creators, they find it much more satisfying to pass their legacy on to someone who shares their passion and pride of ownership.

However, transferring a business to family members can be challenging. If the decision is to sell or transfer ownership to more than one family member, they must choose who will have a say in the running of the business and ultimately make final decisions about the business. Questions of leadership and control can put family dynamics front and center. Are all successors equal? Should succession be based on birth order, experience or interest? What vehicles are available through estate planning to help minimize wealth transfer taxes?

These decisions are further complicated by family members who work in the business but do not own shares, family members who are not involved in the business, family members who are owners but not working in the business, and owners who are not the final decision-makers. And then again, many nonfamily members who are management, key employees, shareholders, partners, or investors must be considered.

Choosing a nonfamily buyer, whether financial or strategic, can seem like a simpler matter in comparison.

Considerations in Selling to a Financial or Strategic Buyer

In general, financial buyers (private equity firms) are investors focused on the financial return they can achieve by purchasing a company— either in terms of expected future earnings growth or the return from a future sale (perhaps to a strategic buyer) or IPO (initial public offering) of their acquisition. Financial buyers may be looking to enhance the company’s cash flow through revenue growth, cost reductions, or even by creating economies of scale by acquiring additional similar companies.

Strategic buyers, on the other hand, tend to be companies focused on seeking acquisitions as part of their own long- term growth strategy. Maybe they are looking to eliminate competition, strengthen their company’s operations in certain areas, enhance vertical integration, expand horizontally into new geographic regions or products, or otherwise achieve economies of scale and other synergies.

Is one type of buyer preferable? That really depends upon one’s specific situation, priorities and goals. Often, strategic buyers may be willing to pay a higher price than financial buyers. On the other hand, strategic buyers are more likely to eliminate employees and otherwise restructure the acquired company. Several factors need to be considered when choosing the best buyer for one’s company.

In either case, owners who wish to sell in the next few years will likely face stiffening competition. Owners who have not created healthy cash flow or taken other measures to make their businesses valuable and more saleable may well encounter difficulties.

Not all businesses are saleable. Even long-standing, successful businesses will face challenges if they have not been deliberately managed for sale. Although no two deals ever look alike, professionals tend to mention the following as the characteristics that make a business of any size attractive to a buyer:

• Contractually recurring and stable, healthy revenue stream and cash flow
• Good visibility into future financial performance
• Strong history of profitability with the potential to expand over time
• Strong industry fundamentals
• Leading and defensible or unique market position
• Diversified and loyal customer and supplier base
• Proven, strong, competent and remaining management team (or belief that value can be created through management changes/additions)
• Tangible assets— equipment, inventory, property, computers in good shape
• Intangible assets— patents, brand, proprietary products, trade secrets, copyright
• Desirable location
• Growth potential (organic and/or through acquisition)

In sum, creating value to sell or transfer a business and creating a succession, transition, estate and exit plan are complicated processes.

Addressing What Comes Next

The eight entrepreneurs in our paper, “The Owner’s Journey,” have arrived at their own answers to the question, “What comes next?” Some are classic tales of immigrant success in which a new arrival to the United States triumphs over the odds and builds a successful business. For some, a founder’s death or years of careful planning brought a talented and prepared child into the business. For others, a financial or strategic buyer provided the transition.

In many of these cases, there were psychological and family dynamics to negotiate. Some struggled. Others successfully brought children into the decision making and arrived at a solution that satisfied everyone.

In still others, the business proved so valuable that a large corporate buyer stepped in and provided a dramatic and lucrative finish. Yet even then, the question of what comes next can pose challenges — at least one founder was unprepared for the sudden identity change that selling a business can impose.

The paper explores several themes:

• The differences between estate planning and succession planning, and the importance of being proactive with each of them.
• The process of exiting a business is long, and few owners are prepared for how time-consuming it can be.
• Luck, both good and bad, plays a role. A founder’s unexpected death is a possibility, and the appearance of a well-capitalized and appropriate buyer is another. Founders need to prepare for anything.
• Money may not be the most significant factor in planning for a transition. Many founders need to acknowledge their underlying priorities and goals and choose their advisors accordingly.

Finally, the paper also provides tips on selecting an advisor, properly valuing a business, allowing for the long time frame of succession planning, assessing the next generation’s capabilities as part of an exit plan, and being ready if events move quickly.