Business Owners… set your retirement date now!April 2018
With each tax season, business owners usually reflect on their prospects regarding retirement. Since a majority of business owners are dependent on the revenue stream generated by their businesses for day-to-day life and additionally to fund retirement, meeting with your accountant and financial advisor to evaluate the performance of your nest egg and annual tax burden can be stressful events. Unlike many workers who will rely on the benefit stream of a company or government pension, business owners must rely on their own planning for a comfortable retirement. The majority of business owners fail to choose a realistic goal for their future retirement date and postpone the planning process until their ultimate dreams are out of reach.
If you plan on retiring at 65 and you don’t have an exit strategy by 55 you are already behind the curve.
This newsletter is written for business owners who run their own companies and have the majority of their personal net worth tied to that illiquid business. 2018 may be the opportune time for you to begin planning a future exit from your business. Listed below are seven (7) reasons why you should consider planning your exit in 2018.
- The Timing is Right
In real estate, the saying is ‘location, location, location’ – with business transition planning, it is ‘timing, timing, timing’. Just as timing was important as you built your business, it is critically important during your exit. If you are ready to exit within the next three (3) years, then 2018 could be an ideal time to plan for, and potentially execute your exit. To put this in perspective, let’s look at the transfer spectrum chart below which indicates that we are currently in the middle of a prime selling time.
If you are ready to exit your business then you may want to take advantage of the fact that the chart forecasts another three (3) years of prime selling time in the transfer cycle. If you do not exit in this ‘window’ you will likely have to wait another six years (until 2023-2028) when the next ‘exit window’ opens.
- There is Still Good Demand Today for Solid Businesses to Be Purchased by Private Equity Groups
Investment groups, called private equity groups, are continuing to purchase solid companies today. These investment groups exist to purchase private businesses and add value to them. As a result of thousands of these groups being in the market today, there is solid demand for good companies. If you can catch this wave of buyers you may be advantaged in achieving a higher value for your exit. There are two (2) caveats to this statement. First, the demographics show that a large number of owners will want to exit their business, and second, interest rates may be higher.
- The 2018 Tax Overhaul is “Deal Friendly”
The impact of the 2018 tax overhaul for business owners considering either selling or growing their business through acquisition is significant. Above and beyond the estate tax ramifications, the new law makes it easier for buyers and sellers to exchange assets in a more efficient manner. For firms considering an asset sale, the new law allows acquiring companies to write-off $1mm in hard assets (new or used) immediately. In addition buyers are more likely to engage in longer consulting agreements with sellers because 100% of these costs may also be expensed. The overall effect is more flexibility for asset allocation during deal structure and an incentive for buyers to seek out deals that benefit their growth strategy.
- The Supply and Demand of Exiting Owners is About to Shift Dramatically
The oldest members of the Baby Boomer generation started turning 71 this year. This means that over the next five (5) to ten (10) years, roughly 3.6 million business owners per year will be looking to exit their business via a sale to a future owner. Simply put, there will be more sellers than buyers in the marketplace. Therefore, in order to stay ahead of this cycle, you might consider 2018 as a starting point for your exit planning before too many businesses create a large supply of sellers.
- Interest Rates Could be on the Rise…Rates go up Prices go Down
Interest rates are likely to begin to creep upward after a decade of historically low levels. When interest rates rise, borrowing costs increase. When this happens, a segment of the market that finances acquisitions with debt, i.e. the private equity groups mentioned previously, is impacted as these buyers have more expensive debt. When the cost of borrowing increases, generally speaking, this reduces the levels of value that these buyers will pay for a business. As a result, some of the buying demand that exists today could begin to wane when borrowing costs rise.
- Your “Lifestyle Business” May Not be Providing you with the Lifestyle You Expected
If you are like many owners of privately-held businesses you probably have a lifestyle business, meaning that the business provides for your personal lifestyle. One of the negative effects of the 2018 tax overhaul is the non-deductibility in most cases of travel and entertainment expense. In other words, your vacations and client entertainment will be under close scrutiny. Planning for your exit in 2016 may help you focus on your post-exit lifestyle and assesses your current ability to define and meet your post exit objectives. If your business value is higher today because of increased profitability, then perhaps an exit plan can help you pull the pieces together.
- Your Business Likely Showed Improved Performance in 2017 – Hence A Trend Towards a Higher Value
The future owner of your business will ultimately care about two (2) financial components related to your company’s performance: (i) the future cash flows and (ii) the [perceived] risk of receiving those cash flows into the future. Therefore, each additional year that you can show a trend towards improved performance is one more arrow in your ‘negotiation quiver’ to argue for – and defend – a higher value for your business exit. This is particularly important if you need that additional value to meet your personal, financial goals, as presented above.
This newsletter was written to inform, educate, and provide a template and some rationale for thinking about your plans for an exit from your business. It is our hope that this objective was met and that you are further along in your thinking about forming an exit plan in 2018.
Eric C. Bratt
Business Legacy Strategies