The Impending Business Owner Crisis

The Impending Business Owner Crisis – The Reasons Why Most Business Baby Boomer Business Owners Will Be Crying In Their Beer

The Coming Crisis

Not all economic implosions are crashes (such has happened recently with the real estate market in 2008 and with the dot com market in 2000). Other times, there is a long slow deterioration caused by the inexorable changes in environmental and economic factors. If you are  part of the baby boomer generation (for purposes of this discussion let’s say between the ages of 50 and 65), you are the owner (or part owner) of one of the thousands of mainstream businesses that are under $10 million in sales, and you hope to transition out of your business into a position of financial independence over the next five to 15 years, unfortunately this is the environment you are now in.

In 2008 and 2009 I wrote in The Podolny Group Newsletter of the major structural changes that business owners were going to have to account for if they were to expect prosperity in the future. I remember at the time that many did not pay heed to this because “they were waiting for the normal cyclical bounce back of the economy”.  Well guess what?  As we are going into the last part of 2011, the basic over leverage, lack of credit, and lack of demand forces are still firmly in place with no end in sight.  So perhaps, it might be time to accept this new reality and consider what you need to do to about it.

The New World – What It Means To The Smaller Business Owner And Their Plans For Financial Independence

For the vast majority, if your expectation is being able to sell your business and have sufficient proceeds to fund your lifestyle, you are going to find that you are in a brave, new, and unpleasant world.  There are two groups of factors that are driving this – the realities of how business sales unfold and the larger demographic factors. Let’s deal with the former.  (Note: the examples below put each of these cases into a highly favorable light.  In reality, most businesses will have made decisions in the past that will inhibit them from getting these results).

Examples of how the sale of a smaller business unfolds for an owner

Sample One – Smaller Business

Assumptions:

  • Annual Sales – $2,500,000
  • One Owner – Compensation of $150,000
  • Business Free Sustainable Cash Flow – $250,000
  • Tax Rate on Sale Proceeds – 25%
  • Earnings Rate on After-Tax Proceeds to Fund Lifestyle – 5%

How it unfolds:

  • Valuation of Business at 4 Times Cash Flow = $1,000,000
  • Tax on Sales Proceeds = $250,000
  • After-Tax Proceeds from Sale = $750,000
  • Earnings at 5% = $37,500!
  • Loss of Lifestyle = $112,500…A 75% Hit!

Sample Two – Larger Business

Assumptions:

  • Annual Sales – $7,500,000
  • Two Owners with 50% Ownership- Compensation of $250,000 each
  • Business Free Sustainable Cash Flow – $500,000
  • Adjustment to Cash Flow – Add back One Owner’s Salary
  • Tax Rate on Sale Proceeds – 25%
  • Earnings Rate on After-Tax Proceeds to Fund Lifestyle – 5%
  • Adjusted Free Sustainable Cash Flow = $750,000

How it unfolds:

  • Valuation of Business at 5 Times Cash Flow = $3,750,000
  • Tax on Sales Proceeds = $937,500
  • After-Tax Proceeds from Sale = $2,812,500
  • Each Owner’s After-Tax Proceeds = $1,406,250
  • Earnings at 5% = $70,312!
  • Loss of Lifestyle = $179,688…A 72% Hit!

I think we can all agree that these are pretty grim results. And remember from my note, this is assuming you’ve made all the right moves in the years prior to your sale.  If this wasn’t enough depressing news let’s now factor in demographic factors.

Long-Term Conditions Will Make Smaller Businesses Harder To Sell And At Diminished Values And Terms

Look at these basic demographics.

  • The baby boomer generation generated a spike in absolute population numbers.
  • As such there are a larger number of business owners
  • Smaller absolute population sizes following the baby boomer generation mean smaller numbers of business owners coming up
  • Credit availability for smaller businesses is significantly less
  • Credit standards for smaller businesses have significantly been raised.

What does this imply?

  • There are more people in the ‘want to get out’ generation than the ‘want to buy in’ generation – More supply of sellers + less demand from buyers = lower valuations
  • Less credit available means fewer funds to finance acquisitions – less capital means fewer qualified buyers.  Fewer qualified buyers + more supply of sellers = lower valuations + fewer deals getting done
  • Higher credit standards (usually meaning a lot more equity needed in a transaction) mean buyers have to either come up with more money or they go back to the seller and ask for financing from them. Less cash available from buyers and banks + more supply of sellers = sellers less able to get all cash deals and retaining more risk instead of gaining financial independence.

The Silver Lining

As in the melodramas of old, I have no intention of leaving you, the business owner, tied to the rails while the train comes to run over you. In fact, this dire outcome is totally avoidable! It can be avoided by using the time tested, pragmatic strategies that I’ve been writing about for over a decade.

The one thing you must do – absolutely must do – if you wish to avoid this crisis is be willing to change! The strategies and tactics of the pre-2008 world are not going to create the financial independence you seek and deserve. Most who read this are going to go to their familiar space of denial and will suffer the consequences.  But, you are different.  You can take charge of your destiny. You can achieve the financial independence you deserve in spite of a poor economy and a poor climate for business sales.

 

 

 

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