Small business owners not only have to plan their post-retirement, but they also need to create the road map to get there.
In other lines of work, you get a party, maybe a watch, and off you go into a life of endless golf and vacations. For business owners, if they want a party and a watch, they had better get ready to make a plan.
Demographic pressures may mean that help is on its way. Half a million Canadian small business owners want to retire by 2011. Another 750,000 expect to exit their operations by 2020. “It’s going to become an increasingly big issue over the next few years,” says small business researcher Lynne Siemens, who is working on two studies on business succession at UVic that may result in more support. One project surveyed small business owners to ask how government could help. A complementary study reviews what governments in other countries are doing. Results should be published this summer.
Despite what’s at stake, planning an exit strategy is a task people avoid. “I think there’s still some sense that ‘I don’t need to worry about it,’” Siemens says. People seem to think they can put it off until the very day they plan to retire.
Troy Fimrite encounters that, too. He’s president of Viking Pacific, a brokerage dealing with mid-sized business sales. He says most owners call him as a first step in succession planning. They plan to cash the “dream cheque” and turn in their keys in about a month.
“Very few people have a plan,” Fimrite says. It’s typically a health issue, or even the death of a friend, that gets people moving on succession planning.
Realistically, a seller should be prepared to wait six months to a year for a sale — at least. Buyer and seller may work together for another year to transfer knowledge and good will. Even in the case of a sale, the owner can structure the future of the company. Private equity can buy out a portion for the proprietor’s retirement and leave the rest for the next generation, or a group of employees, to carry on. Outside investors can simplify the deal by providing management and oversight after the transition. There are equity groups that will buy 100 per cent but let an appointed group run it.
Fimrite doesn’t put a sticker price on the businesses he handles because, once in a while, an owner undervalues the enterprise. In other cases, strategic buyers may be willing to pay more than market value because of the location. Thanks to its climate and charm, Victoria attracts that element.
Most businesses can be priced using an industry-specific revenue multiplier. Valuation multipliers are based on a large number of mergers and acquisitions in the sector. The revenue amount comes from the earnings before interest, taxes, depreciation, and amortization — familiar to most as EBITDA.
Smaller businesses can generally bypass the business broker, determine a price, and wait for the right entrepreneur to come along. Even then, the owner needs to prepare documentation, decide what to do about employees, and deal with tax implications and details like changing utilities over.
A few years ago, Dianne Bump knew it was time to sell. As she neared 60, she became tired after more than two decades running Zydeco Gifts on Lower Johnson Street. First, she tried selling her shop on her own, but after dealing with a few “weirdos,” she took it to a broker.
From the beginning, Bump organized her business like a librarian sorts books. “I made sure that everything was in order,” she says.She had two valuators analyze her operation and, when they came within $1,000 of each other, she knew she had her price. She then interviewed and selected a broker. “He sold it rather quickly,” she says. Bump got the price she wanted, she liked the buyers, and she loves what they’ve done with her store. “Everything went so smoothly.”
Mike Lenz of Sunbelt Business Brokers would love to deal with a client like Bump. He says most small business owners are wholly unprepared to go to market.
Valuing a small business using standard multipliers by earnings reveals little to a buyer, because the earnings usually equal the owner’s salary, Lenz says. The structure of the business can cause headaches when the tax implications of the sale haven’t been taken into account. Small businesses remain as sole proprietorships or partnerships to save money. By doing so, they are not eligible for the $750,000 personal capital gains exemption. To change that after the fact requires a tax lawyer and comes with a hefty bill. Lenz says small businesses don’t invest in audited statements that potential buyers want to see, or they run their books to show little profit. That makes sense until it comes time to sell.
With these issues hanging over the enterprise, Lenz says fewer than 25 per cent of businesses listed will sell. Then the would-be retiree sits with an asset they can’t liquidate. “It’s a sad story,” he says. He’s been to succession planning seminars and sees owners walk out with pamphlets, but often it doesn’t go beyond that. Individuals still have to figure it all out on their own.
“I don’t want people doing succession planning, that’s how I buy honey companies really cheap,” says Mark Pitcher. He never planned on being a honey mogul, but his Saanich neighbour Babe Warren, of Babe’s Honey, had other ideas.
Pitcher had been talking to Warren about buying half of her land for his vineyard, but when she became ill, the conversation ended. She died in 2006, and Pitcher was surprised to learn he had the first right of refusal on the honey business after her daughter said she didn’t want to take it on. Three valuators appraised the company, two on behalf of Pitcher and one for the estate. With appraisals in hand, the meeting around Warren’s dining room table was pretty straightforward. “Fifteen minutes later we were drinking wine on an agreement,” Pitcher says.
Most people think their business is worth more than it is, Pitcher says. Valuators, who often have accounting backgrounds, clear up any misconceptions, and sellers come to understand that however much they love their old truck, it’s not worth anything to anyone else. With an independent third party setting the price, the buyer doesn’t look like the bad guy. Pitcher’s advice for sellers: “Brace yourself. Get your emotions out of the way.”
As part of the buying process, he gets owners to fill in spreadsheets, list all equipment, give a rundown of the history of the business, and show sales lists and production methods. Then he gets two appraisals, looks at those in light of market conditions, and makes an offer.
Beekeeping is a quirky industry, and in light of colony collapse disorder, he deals with motivated sellers. “I am people’s succession plan.” He’s on purchase number six.
Good will is another area that owners tend to overvalue. There’s also such a thing as negative good will, Pitcher says. The value of a business can decrease because of all the things the owner didn’t do as they started to slow down, looking ahead to retirement.
On the other hand, owners need to be careful not to make major investments that subtract from the capital they plan to live on. A skilled succession team can help a business owner find that balance between protecting wealth and maintaining marketability.
Any time there are professional services, like lawyers and accountants, the costs add up says chartered accountant Shelagh Rinald, president of Rinald Tax Advisory Inc. But a succession planning team can help maximize earnings from either a sale or a transfer.
“The other challenge is you still have a business to run,” she says. Succession planning takes time and resources. It’s a long-term process and this is where having external advisors can help. At a minimum, the transition plan should begin between three to five years before retirement. The discussion with affected parties should
begin at least 10 years before or, ideally, from the inception.
Business Victoria deals with business startups, but in the eyes of CEO Ken Stratford, it’s never too early to be thinking about selling. Courses offered by his organization tell entrepreneurs how to structure and name their business for an easy sell down the road. “Right from day one, every one of [the owners] must have an exit strategy,” he says.
It gets more complicated in succession planning between generations. Rinald says people are generally good at the technical aspects, but the soft issues, especially in a family business, pose challenges. “I don’t think this is fun for anyone,” Rinald says. Tough questions are raised and the resulting decisions rarely please all of the relatives. And while it’s no wonder people avoid this, it is important. With no plan in place, poor health or a sudden death forces a succession in an atmosphere of crisis. Then the kids or spouse have to decide who is going to run the business, how they will be paid, and who is going to own shares. Should management be a birthright or based on capabilities?
Who is going to have voting power? “That’s when it gets difficult,” Rinald explains.
But it doesn’t have to be this way. Families can sit down years before the entrepreneur retires and make plans, so everyone knows what to expect. “The typical pattern is to bury your head in the sand and hope it will go away,” Rinald says. It’s a common attitude. A B.C. Chamber of Commerce survey found nearly one-third of its members planned to retire by 2014. Twenty-three per cent of those respondents also said they had no plan for what will happen to their business.
Start with communication and use a facilitator if necessary, says Rinald, who sometimes acts as a succession facilitator for the Canadian Association for Family Enterprise (CAFE). CAFE organizes personal advisory groups for their members, and business succession issues are a hot topic.
Mandy Farmer, CEO of the Accent Inns hotel chain has taken advantage of an advisory group since she took over from her father, Terry Farmer, in 2008. She says the confidential sessions bring all perspectives together and candid conversations happen because the family baggage isn’t there. “I’m hearing it from someone other than my dad.” Although she didn’t use one, Farmer says a facilitator is also a good idea. “That way everyone stays accountable.”
There are as many types of transitions as there are businesses. An owner can sell to an outside purchaser, partner, family, or employees, then leave as soon as the deal is done or stay on as a partial owner or employee to ease the transition. If the business has more than one division, they may retire gradually by selling off portions. A business owner may also merge with a competitor, a good avenue for professionals like dentists or lawyers to transfer their practice.
The Canadian Small Business Owner’s Guide to Financial Independence breaks business transition into manageable steps.
First the authors recommend working with a certified financial planner, who specializes in small businesses, to establish retirement goals. Next, the current financial position has to be analyzed to determine how much needs to be earned to reach those goals. Then owners can choose from the available transition strategies in order of preference and set a time frame to achieve their ideal outcome.
Aside from the owner’s retirement needs, the needs of the business have to be considered. Identify potential managers early on to prepare them for the transition. The new leaders may need training, not only to run the business, but also to add credibility in the eyes of the people they will be dealing with. For example, Farmer got an executive MBA on top of her considerable experience within the family business and at other hotels.
In some cases, the founder needs to stick around to transfer good will and customer confidence to the new proprietor, but what if they overstay their welcome? Farmer says her mother helped with that by whisking her father away on trips in the early days, but she’s not pushing him out the door. “He’s not one to totally retire. He needs an office to come to,” she says, and he’ll always have one.
Even in this seemingly perfect scenario, they haven’t dealt with the final transfer of ownership. Farmer is a part owner of the chain under the shareholders’ agreement, but that’s as far it has gone. For two years, she’s been trying to get her father and the other partners to sit down to hammer out a long-term plan. “It’s ongoing. It’s definitely a touchy subject,”
The subtext to that discussion is the founder’s mortality and, in a family business, that means the death of a close relative. No wonder people avoid it.
Another Option: Set Up A Trust To Run The Business
Paul Arsens was a Victoria business legend. He built a group of hotels and restaurants that started with a single coffee shop on Douglas Street in 1938, and left behind the Laurel Point Inn and Paul’s Motor Inn when he died in 1997.
Well known for his creative publicity stunts, he caught the attention of international media for things like allowing customers to set the price for a meal, or taking his entire staff to Las Vegas on vacation.
Along the way, Arsens met and married Arthura (Artie) Morrison. They had that rare combination of love and a great business partnership, according to Ian Powell general manager of the Inn at Laurel Point today. She ran the business for another decade until her death in September 2008. Because they didn’t have any children together, they put the business into a trust.
Its goals are clear: first, continue Paul’s legacy and carry on the enterprise in his name. Second, look after employees. Finally, invest profit back into the community through charity works.
Artie Arsens selected three trustees to direct the businesses: a lawyer, retired chartered accountant, and former employee, who was like a daughter to her. The trust’s clear goals simplify their task.
“We’re stewards of the legacy we were given,” Powell says. Employees running things educate the trust about the business, and the trust acts as a single shareholder in Paul’s Restaurants Ltd. “It’s a very good process,” Powell explains.
The trustees are not in this for money. “There’s no great creaming off,” Powell says. And there are no profits to share with the community — yet. For some time, capital spending has gone into upgrades at Laurel Point. Artie Arsens didn’t want changes after her husband died, but Powell was able to bring her around.
There’s been a name change and a new logo. The restaurant overlooking the harbour was revamped. Powell was relieved when Artie Arsens came to inspect the changes. “Paul would’ve done this,” she said, and he knew he had official approval.
There’s a chance that Paul’s Motor Inn could be razed and rebuilt from scratch one day. Anything is possible as long as it conforms to those three simple rules, Powell says. “What would Paul have done,” is the guiding sentiment for those entrusted with his kingdom.
The trust will exist “pretty much forever,” Powell adds. He started work at the Inn before it came into play, but it doesn’t affect his role much. “It’s not a straitjacket,” he says.
Powell believes this type of transition can work in other businesses, but the most important factor is who the trustees are. “They can’t be out for themselves. They really must be trustees.”