Business Valuation: Baby Boomer Business Owners Retiring and the Need for Adequate Planning
Trends in the Baby Boomer Population
Baby boomers now comprise approximately 78-80 million Americans and account for the largest age cohort of the population in the United States. This age cohort includes those born between 1946-1964. Of this population age cohort, approximately 10.0%, or 8.0 million Americans have household incomes greater than $50,000, and also own small businesses.
Simply put, 7.0-8.0 million businesses in the United States are owned by individuals that will retire from their businesses. Currently, 33% of business owners in America will successfully transfer their family business to the next generation (Family Firm Institute), and a mere 13% are passed on to the third generation.
If you fall into the majority of US business owners (67%), then your children have most likely opted to not follow in your footsteps of taking over the family business, leaving you with significant, life shaping decisions. It is probably safe to say that 5 million (67%) baby boom business owners do not have children willing to take over their family’s privately held business.
If you fall into this latter 67% category, then what is your exit strategy with your business?
Ownership Transfer Options
Business owners will find themselves evaluating various ownership transfer options for their companies, especially as they near those golden years. Wise owners have planned for the transition of their businesses from the first day they stated their businesses.
Appropriate planning, well in advance of any contemplated transaction, will enable business owners to maximize overall company performance, as well as the rate of return on their investment. However, in reality, most business owners exit their businesses with less than six months of advanced planning. Smart business owners are beginning to initiate the following courses of action with regards to their businesses:
- Keep the business well into their retirement years, possibly leaving it to estate planning, and estate settlement proceedings,
- Gift ownership interests in the business to children and other heirs,
- Dissolve the business should competent leadership not be in place after Retirement, and
- Sell the business to a qualified buyer and have financial stability for retirement and provide a legacy to one’s heirs.
The Business Exit Advisory Team
A typical exit advisory group could consist of an attorney, business appraiser, investment banker, accountant, and financial planner. The owner business exit planning process can take 6-18 months, and is usually a painstaking process. Professionals and advisors to guide the business exit planning process will assist in getting your exit process right.
Business Valuation – A Tool to Assist You in Your Business Exit Planning
In order to start the process of selling your business, initiating estate planning, or gifting of ownership interests in your business, you first need to determine what the business is worth from a fair market value perspective.
Why the fair market value? Simply put, the Internal Revenue Service (IRS) will utilize this standard of value when assessing related gift and estate taxes, or normal and capital gains taxes on the sale of the business to independent third parties. Internal Revenue Service (IRS) Regulations define fair market value as:
“the price at which the property would change hands between a willing buyer and a willing seller when the former is not under any compulsion to buy and the latter is not under any compulsion to sell, both parties having reasonable knowledge of relevant facts”.
Determining the fair market value of your business can be a complex process depending on the particular facts and circumstances surrounding your business. Issues and decisions that you may confront include the determination of how much of the ownership interest will be transferred or sold. For example, will you transfer or sell just a minority ownership interest (<50.0% of the ownership interest), or a controlling interest in the business (generally greater than 50.0% ownership interest), or in the case of an outright sale (100% ownership interest).
Professional valuation specialists with appropriate certification and accreditation from one of the four credentialing bodies, will be able to assist you by determining the fair market value of your business enterprise, as well as the specific value of any ownership unit, common stock, partnership interest, or membership unit. The valuation credentialing bodies include: the National Association of Certified Valuation Analysts (NACVA), the American Society of Appraisers (ASA), the Institute of Business Appraisers (IBA), and the American Institute of Certified Public Accountants (AICPA).
Based on discussions and recommendations from either your accountant, or corporate or estate planning attorney, you can find a professional, independent valuation specialist who can conduct an accurate business valuation assessment. For the purpose of planning and determining fair market value, the cost to prepare a valuation will vary based on the size of the business, its complexity, the complexity of the company’s capital structure, whether there is real estate involved, and other specific facts and circumstances.
Once you have retained a valuation specialist and provided your Company’s financial and operational data and information, the specialist will begin working and analyzing your Company’s historical financial performance by reviewing five years of tax returns and historical audited financial statements, comparing your Company’s sales and earnings financial information to recent purchase transactions in the merger & acquisition (M&A) market (direct market data method), making discount adjustments for lack of control. The valuation specialist will also compare your Company to companies traded on the national stock exchanges (guideline public companies method) which participate in your company’s industry segment, making adjustments for discounts for lack of marketability.
In addition the valuation specialist will review and analyze your budget and any 3-5 year forecast that you may have prepared. The value of your company is worth the present value of future economic benefits (capitalization of earnings and discounted cash flow methods). The valuation specialist will want to interview management as part of the valuation exercise. The valuation specialist may select the results of one of these valuation methods, or apply weights to all three methods to derive the Company’s fair market value.
Once you have determined the fair market value of your Company’s business enterprise, you can then make decisions with confidence and choose your exit option, accordingly. Once you complete the business valuation process, you will also be able to better understand the value drivers specific to your type of business and industry. If you Company’s value is more than you expected, you may be motivated to sell your Company sooner rather than later.
If the value is lower than you had expected, you may want to defer selling immediately and regroup and reorganize your business so as to increase value in consideration of a future sales date. Timing is everything in the sale of a business.
The are several questions that the business owner must ask: a.) what new challenges, traveling plans, or personal hobbies do you want to take on during the golden years of your life? b.) can you afford to do these things and live comfortably?
Determine your ideal end result, then reverse engineer your plan to reach those desired goals. For the retirement planning of a business owner, the starting point in all of this should be a business valuation. It takes years to build a successful business, therefore, know the value of your business when the time is right.
If you have any questions you may contact:
Ronald J. Adams, CPA, CVA, ABV, CBA, CFF, FVS, CGMA
Managing Director – Valuations
Foxboro Consulting Group, Inc.
36 Lancashire Drive
Mansfield, MA 02048
(774) 719-2236 – office
(508) 878-8390 – mobile