The Small Business Crunch
ATTN: Baby Boomer-Aged Small Business Owners
Congratulations, you’re one of the 4 million Baby Boomers who currently own and operate American companies. You deserve credit for building strong brands and reputations, for employing countless others, for providing for your families and communities, and for effectively living out the American Dream. But as strategic as you’ve been in business, you’ve likely kicked the succession-planning can down the road and continue to do so. That’s a mistake, and hopefully this gets your attention.
You and your peers represent roughly 66% of all domestic businesses with employees.
You, being a member of the generation born between 1946 and 1964, began turning 65 years old in 2011 at a rate of about 10,000 people per day and will continue passing that age milestone through 2029.
Many business owners have 80% or more of their personal assets tied up in their businesses. More broadly, “about 75 percent of all private equity is owned by households for whom it constitutes at least half of their total net worth. Furthermore, households with entrepreneurial equity invest on average more than 70 percent of their private holdings in a single private company” (Moskowitz and Vissing-Jørgensen).
For 57% of Baby Boomers, household finances have worsened since, and you’re the most likely to still be recovering from general investment losses incurred during, the Great Recession.
The next 15 years will be the largest intergenerational transfer of private businesses in the history of the world. 2012 marked the first year that “Baby Boomer retirement” was the primary driver of business sales in the private lower middle market. Researchers have estimated that more than $10 trillion in business assets may be transferred by 2025.
The marketplace for investment dollars will continue to become more competitive as the world becomes more globalized and other countries experience similar aging trends. Close to home, CIBC World Markets estimates that 550,000 Canadian business owners will need to transition their businesses for retirement, representing $3.7 trillion in business assets.
What It Means for You
We are in the beginning of a transition within the American economy where more than half of all businesses with employees will need to sell, restructure, or close their doors. The numbers are finite and inescapable. Mortality is a real thing. Liquidity issues and estate taxes don’t take care of themselves. Without a plan, the likely result is a legacy of chaos and confusion.
Whether begrudgingly or willingly, every Baby Boomer owner must confront this question: What will my company look like without me involved, and what process needs to take place to ensure my family’s financial health and the company’s prosperous future?
An ownership transition can take many forms. Here’s an overview of some general options:
Internal Family Transitions: You may choose to transition ownership to other family members, which can be done by selling and/or gifting shares. Careful consideration should be given to your family members’ ability to carry the company forward (e.g., financial commitment, time, health) and competency to lead and operate. This option is typically available only to those who already have their financial retirement options met because only rarely do family members have the financial capacity for a buyout.
Selling to an Individual: Because of size, structure, or industry, some companies are ideally led by an owner-operator. The best place to find this individual is through an industry organization. The ideal buyer would be an executive who is seeking more flexibility, autonomy, or financial gain and who is also willing to assume risk. Financing-wise, as long as the person buys out 100 percent of the equity, there are special loans available through both the SBA and USDA, with varying requirements.
ESOP: Perhaps you would like existing team members to own the company. An ESOP is a tax-qualified retirement plan that allows you to transition ownership to employees. It is a heavily regulated structure, but it has tax advantages if you qualify. Like any structure, it also has its drawbacks, which you should fully understand before making a decision.
Selling to Private Equity: Should your company meet investment criteria, you may sell part or all of your company to a private equity firm. In today’s marketplace, there are all different types of firms, including those that invest in small or unprofitable companies, for short (as little as three years) or long (more than 10 years) time periods, with very little involvement (such as board seats only) or active management (in some cases, installing executive leadership to operate). Some operate with committed capital from outside investors, while others have internal capital (e.g., family offices) or search for the right company before raising capital (i.e., search funds). It is a complicated group that requires research and conversations to determine whether it is appropriate for you.
You should not expect private equity groups to necessarily find you. As Deloitte has noted, private equity groups struggle to get many Baby Boomer-owned companies, particularly those valued at $2 million to $20 million, on their radar because they are more likely to be outside of major metropolitan areas and lack relationships in the investing community.
Post-Death Transaction: Should you wait too long to make a decision and there are no estate-planning documents in place, your organization will be considered part of your estate and subject to kin hierarchy, as well as unshielded tax consequences. But the non-legal consequences can be far worse, sparking decades of family feuds and permanent rifts.
Shutting Down: Although it sounds simple, “winding down” is no easy task. The liquidation of assets takes a large amount of time, requires significant paperwork, and will likely result in forced transactions with undesirable prices. If this is the correct path, you should make sure it’s done sooner rather than later.
Determining what type of transition is best for you and your organization requires introspection and assessment of your business operations. In certain situations, multiple types of transitions can be employed (e.g., gift 20 percent of the company to a child, and sell 80 percent to a private equity firm).
Preparing to Transition
While it’s important, transition planning is easily put off for the immediate. However, it’s not a short process, and the longer you wait, the bigger the burden will become for you, your team, and your family. As such, there are three primary, albeit overlapping, areas of preparation: your personal plan, the company, and estate planning.
Your Personal Plan: Many of you may be shaking your heads, trying to come up with a lifestyle scenario in which you would be happy not working. Others of you are ready to spend more time on golf courses or with grandkids. Regardless of how and where you want to spend your time, if health is not yet a major factor, you have the luxury of figuring out what you want. Do you want to sell the business outright, or would you like to continue working, and in what role? Are you looking for a new challenge? Time is your most precious resource, and you need to determine how you want to use it so you can guide the process accordingly.
The Company: Most companies owned by an individual or small group of people take time to get in transition-ready condition (generally measured in years, not months). And generally, the better the planning, the better the outcome. The best place to start is with a reality check by finding comparable public companies on which to benchmark the health of your organization and evaluating what would happen to the company today if you got hit by a bus (morbid, but truth-telling).
There are structural considerations to address, such as grooming non-owner layers of management and stabilizing things like client and employee relationships. Depending on how meticulous and scale-oriented your team has been over the years, records and processes may also need to be reviewed in detail. Other considerations include determining what entity type is required for operation and most tax advantageous for transitioning; this can be a multi-year process (e.g., converting a C corporation to an S corporation can take more than seven years).
Estate Planning: You need to be having transparent conversations with personal advisers about your needs and how your accumulated wealth should be distributed after you pass. Many owners run their companies as lifestyle businesses, with significant personal expenses running through the company and a reliance on annual salary and profit distributions. What must be in place to provide for you as you age? These determinations are essential to understanding what type of transition makes the most sense.
Regardless of to whom you want to bestow your legacy, rest assured that the government will be involved. Bequeathing stock to children or grandchildren will require significant documentation and possibly capital for associated taxes. Ensuring your wishes are known — and the associated tax and legal ramifications are handled — give both you and your loved ones peace of mind.
Realities of Transitioning
Even after all your internal preparations, if the path you choose involves attracting outside parties to consider buying your company, you should expect to “date.” Dating is time-intensive and emotional, and transitioning is no different. Company dating is a multi-step process, with almost 80 percent of sales taking between nine and 18 months to close. Even after coming to material terms, the vast majority of transactions don’t close, and the process must be restarted.
The Baby Boomer-owned business crunch has started. There are only so many credible, capable buyers for your specific situation. Regardless of whether you want to transition out within a year or 10 years, begin dedicating time and energy to determining your best options, talking with prospective buyers and advisers, and preparing accordingly.
This post originally appeared in Forbes.