Does Selling to a Financial Buyer Make Sense for Your Company?

hello everyone i'm susan saravo with comerica's marketing team and i am joined by bob buchanan and bob is our national practice leader for business transition planning long title there bob welcome thanks susan great to be back great to have you here and today we're talking about does selling your business to a financial buyer makes sense for your company so we're going to get into a lot of detail but first the slide that we always start with is how many business owners are thinking about transitioning now you have data about the fact that a lot of business owners over the course of 10 years are going to be transitioning tell us more about that yeah i think the question is the answer is really they're all thinking about transitioning at some point even though this slide says seven will never transition um always cracks me up every business owner will transition at some point um whether it's in a way that they want to or a way that they don't but a huge number are going to transition over the next 10 years or over a 10-year period and i just read a statistic that something like 68 trillion dollars in wealth will be transferred over the next 20 years and of that some huge portion is business interests and when you think about you know a large portion of 68 trillion and more than 50 percent of business owners transitioning in 10 years that's a big number and it's a meaningful number not only in its entirety but to each of these business owners well it's really important to be planning for that transition whether it's going to happen soon or decades from now always have to plan so we're going to talk more about that coming up so thank you to all of you who are watching us live here on linkedin and if you have any questions go ahead and put them in the chat and we will monitor those and get to you a little bit later in our live stream here all right bob let's start with many ways there are many ways to transition so give us an idea of different ways that people can think about transitioning well transition isn't always a transaction so a lot of people actually keep their companies and they transition it to a next generation of their family or maybe to employees through management or ownership transfers and there's a big difference in that um you don't always have to transfer ownership you can transfer management and transition out of your company a lot of businesses end up selling and they sell in different ways often to strategic buyers because strategic buyers can frequently pay higher prices for companies because there's some synergy but what we've seen over the past several decades is that a lot of business owners are transferring in ways that are more meaningful to them non-financially and uh one of those ways might be to a financial buyer which is it's really sort of a a way of describing private equity groups or or private equity like groups so bob the financial requirement is a big consideration tell us more about what people have to consider about the financial requirement that's needed yeah and i think this is the place to start with every business transition um is personal planning and understanding what it is that the owner needs going forward to live the rest of their life in the way that they want to live it and when you start looking at what that financial requirement is whether it's a hundred million dollars or one million dollars it's important to understand that amount so that going into a transition you don't end up in a place where you can't live out the rest of your life sometimes you can't get there someone needs five million dollars and their business is only worth two and a half well that means maybe they need to do some planning around changing the way they live their life rather than how much they're going to get but once you know how much you need then you look at how much you have and if there's a gap the question becomes can my business fill that gap and if it can how does it fill that gap is it ongoing cash flow through ownership can i build wealth while i continue to own or can i sell it and have a liquidity event where i capture the value i've created over time and that fills the gap but the the real the real point here is that if you're starting to to seriously think about transitioning and you haven't done the personal planning you're starting from the wrong point all right well that brings us to focusing on a financial buyer if that's the route that you want to go having a financial buyer and you say that kind of along the lines of what you were just talking about starting with personal financial planning so tell us more about that right and with any buyer you have to start with personal financial planning so it's not just about understanding how much you need and how much you have but it's understanding things like what's the effect on my estate tax bill by selling one way or another and can i do things ahead of time to reduce that effect what's the income tax effect and understanding not just how much you're going to get but the timing of when you're going to get it is is incredibly important the other things to think about are those non-financial aspects of transitioning and each transition alternative has different non-financial aspects so selling to a strategic buyer for instance typically the owner is going to walk away from the company either at the closing or very near after where selling to a financial buyer might mean that the owner has the opportunity to stay for some period of time or maybe they have not just the opportunity but the obligation to stay for some period of time and so understanding what those things are really um drives the decision-making process and then there are other things like family harmony and legacy and will my company name change and all kinds of things that owners want to think about that come with a cost but might be more important than the dollars they receive particularly if they've done that early analysis and they know that they have more than they need already and everything they get from the company is going to be you know gravy on top it's just extra then they really start focusing on those non-financial aspects well that's true that a lot of business owners have family members that they employ or employees who've been with them for many years so they do have that as an extra consideration so thanks for bringing that up up okay next slide we're gonna go to um some more considerations and and you lay out four specific areas financial analysis pre-sale planning structure and risk so let's start with financial analysis yeah the financial analysis again goes goes back to a couple of things one one is that personal planning and and i i see this on almost every slide because it's so important is that the personal financial planning really has to drive the decision-making process because if if you don't understand what you need and when you need it then you will end up in a place that you don't have what you need during the time that you need it the second thing is is pre-sale planning and a lot of this is non-financial planning it is what am i going to do the next day what is my family going to do how am i going to live the rest of my life and keep myself busy what are the things i want to accomplish both financially and non-financially do i want to travel do i want to participate in volunteer activity and do philanthropic work those are the things that are really going to drive your happiness throughout the rest of your life but there are also lots of financial planning pre-sale planning things you can do and if if tax planning is important to you then it's important to start early because there are a lot of different um strategies that can be employed to reduce certain types of taxes the next thing would be structure and when you're thinking about structure and selling your business there's all kinds of ways to sell a company typically when you're doing a sale buyers want to buy assets and you want to sell stock and there are a number of reasons for that that are risk related as well as financially related so selling stock provides you with a different tax profile than selling assets typically but it also provides the buyer with a different tax profile it allows them to depreciate things in a different way and so you really want to understand what the structure is going to look like so that you can plan for the taxes but particularly when you're looking at a sale to a financial buyer it's important to understand structure because that structure may take different forms so most of these sales end up being some large percentage of the company early up front so maybe maybe a private equity group comes in and they say they want to buy 80 of your business they're buying 100 but you're going to roll back 20 of your equity into the new company and you first have to understand what that means for you financially what's the 80 valuation but secondly what's that 20 look like and when do you get it and what do you have to do to earn it and what are the what are your rights and responsibilities as a shareholder that's now a minority shareholder in a company you used to own also what are your job functions what what's your responsibility in working in the company so frequently what happens is these these private equity groups will buy let's say 80 of your business and you roll 20 equity back in they want to grow the business over the next say five to seven years and sell it for some multiple of what they bought it for and so let's say the first sale is a hundred million dollar evaluation they're hoping to get a four or five hundred million dollar valuation five to seven years from now which makes your twenty percent as valuable or more valuable than the eighty percent you sold today but that comes with a catch there's risk there maybe the company has a hard time getting to that place so you can't guarantee you're going to get that value out of that 20 or maybe when it's time to sell in five to seven years there's not a ready buyer and so it takes longer and over that time period that you're still an owner you're likely going to have to be one of the people leading the charge of building that business to make it larger and more valuable and frequently when people are ready to leave they're ready to leave and so this is a continuing commitment and it's a commitment that's different than the commitment you had as a sole owner because now the commitment is to your majority shareholder your new bosses and they're probably going to hold you to a level of accountability that's different than you held yourself to and so all of these things are incredibly important to think about especially in a sale to a financial buyer and then there's risk and i touched on risk a second ago but there is greater risk in selling to a financial buyer just sort of by definition than there is in most strategic sales most strategic sales you sell 100 of your business and you you get all of the cash day one or some near point in time but with sale to a financial buyer frequently you're waiting multiple years to cash out the rest of your equity that rollover piece and a lot of things can happen during that period and so if you haven't done the financial planning around what happens if i only get the upfront amount then you're doing yourself a disservice because there's real risk in that ongoing piece um and then and then structure is important as well because there's risk and structure typically the buyer the new owner the financial buyer private equity group is going to have some sort of preferred return over time and they probably have some sort of preferred or some sort of preference in their cash out at the end and so they're going to need to get all of their money back plus some return before you get paid and there's risk in that and and those are things that just need to be understood and i'm not saying that this is a bad way to go in fact this is a way that that many many businesses sell today and it is incredibly successful for the vast majority of the sellers but it's not successful if the seller goes into it without understanding the risk without understanding their responsibilities without understanding the economics of the transaction yeah so it's really a personal decision and that's why the planning is so important because it takes time to go through all these and all the considerations to determine what's going to be best for you and your family and everybody so good points bob all right let's move on to key takeaways we covered a lot especially you covered a lot in that last slide bob so yeah i i i get i get going on these topics and uh sometimes i i i run a little too long oh it's great you have so much knowledge that it's great to hear you expand on all of that so but we do have three main points that we want people to walk away with so let's go for those yeah and they're the points that i've hit on almost every slide understand your needs and understand them early and not just understand your needs but understand how different alternatives meet those needs and those needs aren't all financial some of those needs are non-financial they're emotional and not economic and understanding and planning for them very early creates higher likelihoods of success later because if you wait until someone knocks on the door and you don't really understand what you're getting into the likelihood that you're going to look back 5 or 10 or 15 years later and regret something that you've done is much higher than if you start early think through what the alternatives are understand how each one meets all of the needs that you have and all of the objectives that you have and then pick the path that is most likely to be successful for you the other thing here is is financial buyers could provide the highest value over time but there's risk in that value and so when you're thinking about doing a sale to a financial buyer particularly a private equity type buyer it's important to think through who your partner is going to be and whether or not you can reach that end goal of the second payout a lot of people [Music] a lot of people i've worked with in the past have made it and a couple haven't because after year one or year two they just can't move forward with their new partner as their boss doing things that they didn't really understand they had to do and so they walk away from a big chunk of of that liquidity that um they potentially just leave behind yeah that could be a big challenge bob if you've been your own boss for years or decades and then all of a sudden someone else is your boss that's a that's a big big difference in how you operate yeah and that not only is someone else maybe your boss but but maybe your role is different right before you were you were making decisions um in a way that that was down one path and now the new buyer really wants to grow in a way that you weren't prepared for and your role is now sales instead of management and the reason it sales is because you have the relationship with all of your customers and you can bring in new customers and expand those relationships and you weren't ready for that that can really be a traumatic event in a sale definitely all right we're going to take a few questions now from our viewers uh the first one is from iran and this is a question from a client the question is what happens to my management team and employees with these types of transactions so that's a that's a great question and a lot of people when i when i'm talking to business owners one of the the main concerns they have in any transition is their management team and their employees frequently these people have been with them for years maybe decades and have become like family and they're very concerned about their their employment and safety and and financial safety going forward typically with this kind of a transaction the private equity firm that's buying the company the buyer the financial buyer is actually buying the management team they want that management team to stay in place and so those management teams are not only generally pretty safe unless unless they're just not effective in which case the company wouldn't be interested in buying your business in the first place but they're generally pretty safe in their in their positions in fact oftentimes the management teams get some sort of equity incentive to help expand that business and grow that business and so they'll actually participate in that second sale in a way that they might not have otherwise and so management teams are generally pretty safe employees are generally pretty safe as well unlike a sale to a strategic buyer where the buyer probably has a lot of overlap in their employee base and their management base and so in those strategic sales they come in and they cut and they eliminate that duplication in a in a financial sale um the buyer really doesn't have that right they're buying this business as a standalone sometimes they have other businesses in the same industry and they're doing what's called an add-on transaction and in that case management teams and employees might be a little bit more at risk but they still need someone to run the company and they still need people to to do the everyday line tasks so generally speaking they're fairly safe in this kind of a transaction all right one more question here uh this is from james question is how do financial buyers value my business differently than other types of business so another another good question and i get this all the time the way financial buyers value a business is based on a rate of return they need to achieve and so they they can do a financial analysis that looks out into the future um and says we're going to grow at x rate we're going to assume we're going to grow at this rate and it's going to take a certain amount of money to get there we're going to have to make investments either capital investments or other investments and the return i need on those investments is x percent and the reason they do that is that financial buyers are actually big pools of investable cash and they have people who have provided that money for them and they have to make some return on that money in order to return it to the investors and make a profit for themselves and so they have a benchmark they know the return that they need and they know the time frame that they're going to invest for and they'll back into what they have to get the kind of growth they have to get to get that return and so when they're valuing a company in order to get that return on the growth that they expect they can pay a certain amount of money i mean it's fairly simple math and so that's different in in the way some other companies will value your business in that other companies may have some synergistic value and so they're not looking at just your company as a standalone and the growth that it provides them and the return it provides them they're looking at some additional return that they might get by owning your business or or capturing your client base maybe they can sell them something else and so while the process is the same the thought um around that process is different and so private equity firms just sort of naturally look at businesses in a somewhat different manner than other types of buyers okay we have another question here from jonathan and the question he says another question that we hear from clients what happens if i decide to leave the company after i close a transaction with a financial buyer that requires me to stay now you touched on this that you people may have i don't know what would it be called seller's remorse once they start working and then think oh this is not for me what happens so two two things i want to say one is is plan ahead and and when you're thinking about a financial buyer especially if you're running a process to sell your company choose your partner before you choose the economics of the transaction make sure it's a partner that you want to work with and that you can work with going forward because they're going to be some economics that depend on your ability to do that what you get if you leave early is all dependent on what you negotiate and so sometimes if you won't walk away before that secondary transaction you don't get anything and sometimes you you just have to wait and you'll get some portion and sometimes um you'll get you have a right to exit at a certain point in time for some discounted value so it's important to to really think through protecting yourself in the event that you can't stay until the end until that that new owner sells the business and negotiate a deal a transaction that provides you an out in the event that you can't stay now again with that said don't enter a transaction like this thinking that you're going to leave early right these are transactions that they want you to stay the buyer wants you to be there and they provide all kinds of incentive for you to be there that's the whole point of an equity rollover is that you have skin in the game going forward and so don't enter a transaction even though you've protected yourself with the idea that well if i don't like it i'll just leave um make sure that you're entering these transactions with your eyes wide open and full knowledge of what will happen but also with enthusiasm and the idea that you're going to stay and do what needs to be done to get this business to the next level so that the new owner can sell it at a a profit that gets them the return they need okay all right good stuff bob uh one more question this is kind of a basic one but just simply what should i look for in a financial buyer let's say you're just starting the process and the idea of a financial buyer that appeals to you what are the basics that you need to look for early yeah so so like i said make sure it's it's somebody that you can work with make sure they have a vision that you buy into when they when they sit down with you and say hey we'd like to own your company and here's why we'd like to own your company here's what we think we can do with it here's how we're going to do it make sure those are all things that make sense to you because if it doesn't you'll be in that situation where you're hoping that you protected yourself well enough in the in the transaction documents because you're going to want to leave early the other thing to look for is is what kind of management do they have what kind of capital do they have and are they willing to bring and what's their growth plan and what's their historical success rate right if it's a brand new private equity firm make sure that they have people who are operators who understand your business right if if you are a distribution company and the private equity company that's buying you is got expertise only in food service maybe there's a disconnect and so when you're thinking about who to go to um make sure that it's it's someone you're comfortable with and that puts a plan together that you believe is executable with your uh participation and you're willing participation okay bob as we wrap things up here any uh final thoughts that you'd like to share you know um there are lots of ways to transition out of your business and uh financial buyers is is just one of many you know the final thought i think for everyone who owns a business is i know you're thinking about it everybody's thinking about transition or you should be thinking about transition start talking about it there's people out there who can help you there are people out there who've done this and don't have any agenda they just want to help you understand what your alternatives are so that you make the best decision uh and and starting early and combining that planning with personal planning are really the keys start now and make sure you're doing personal planning along with it all righty we have a slide that has your information on how to contact you bob so our our webpage for you is commercial.com business transition and that's a way where you can read bob's content and learn more about transition planning and also there's a way where you can contact bob if you have any questions for him directly so i wanted to thank everybody for watching our linkedin live really appreciate it and bob appreciate you being here again with us and sharing all your expertise and your knowledge happy to do it thank you susan all right thanks have a great day everybody bye you