Today, there are more than 12 million women-owned businesses in the United States, employing over one in five working adults, generating almost $1.9 Trillion in annual revenues and growing at twice the rate as their male counterparts. Yet, nearly two-thirds of women business owners have no succession plan in place, including more than half of those over age 65. And few grasp the value of their business, with just 18% of female entrepreneurs saying they have had a formal appraisal. This means that increasing the value of women-owned businesses is broadly relevant, generally overlooked, and often, too little, too late.
Moneyweave® Academy Board member Regina Barr and Mary Quist-Newins recently spoke with attorney and business transaction expert, Susan Markey, about these issues.
In your practice as a tax and legal expert, when should a business start preparing for sale?
SUSAN: I am a big fan of the traditional answer, which is three years in advance of sale. Why? Purchasers want to review your financial statements for at least the three years prior to the sale. That means you need clean, good-looking financials for at least three years. You want to make sure you have done everything you can to present your business in the best possible light. Many business owners don’t know that the sale of the business can take a year or longer — depending on the size of the business and the due diligence involved. You should also be looking at it from the personal financial planning side of what you need to get out of the business to live the life that you want to live.
MARY: I’m glad you brought up the concept of quantifying the value of your business for your personal finances. I’ve found most business owners never do this and very often their business is their number one asset. From a financial planning perspective, it’s never too early to start thinking about preparing for a successful exit, but very few business owners do that.
What are some of the common mistakes in business valuation that you run into?
SUSAN: The thing that is really important is to balance your short-term versus long-term goals. Many business owners — usually at the end of the year — make decisions that suppress their income to lower their income taxes. That’s great from an annual taxpayer perspective, but it’s not great when those numbers are used to calculate the value of your business.
For example, you might have a lot of semi-personal expenses that are being run through the business. Those can help you reduce your income taxes in the short term but when your business is sold, it’s not a useful strategy because business valuation is generally based on a multiple of revenue or EBITDA (Earnings Before Interest, Taxes, and Depreciation). Many business owners run their car payment through the business, but if you’re reducing your purchase price, by say a multiplier of 10 times of that expense, that’s not a good long-term decision.
Another common mistake I run into is failure to correctly time large expenses. If you can avoid having a large or recurring expense within three years of sale, avoid it, because it maximizes your revenue, increasing the amount that you are paid for the business. Entrepreneurs are so worried about the day-to-day dollars in and dollars out, they sometimes lose sight of the time and capital they have invested in the business which matters much more when they sell, not their annual distributions and pay.
MARY: Your points on the tension between short and long-term aspects of business decisions and stepping back to plan are excellent. With those in mind, research also shows that over three in four businesses do not survive past their founder’s exit. Put another way, just 25% of businesses have any value at the end. How sad.
Tell us about how, and when owners should think about getting an appraisal for their business.
SUSAN: My perspective is that if we are right at the time for sale, it’s not the right time for an appraisal because your business is worth what someone will pay for it in the market. As part of the due diligence process, you would have to disclose any appraisal that you have obtained. Generally, if the appraisal is lower than the negotiated purchase price, purchaser often tries to negotiate downwards from the appraised value. Be planful about when you obtain a valuation when preparing for sale. If you contemplate a sale in the next three years, think twice about a formal valuation. However, if you are thinking about bringing on investors to grow the business a formal valuation can make a lot of sense.
Work with a good broker to help you with selling. They will tell you appropriate valuation of your business and will consider market factors. For example, the market is very frothy right now. I have clients that had appraisals last year but the appraisal is no longer valid because it does not reflect what the market looks like today. Here is that tension again, where you have to disclose this appraisal, but it might say that the business is worth significantly less than the market says that it is worth today. That is why it is critical that an appraisal is part of a comprehensive plan.
REGINA: There are planning and action steps that business owners should also do at the front end that might help them longer term. For example, I chose not to use my name in my business with an eye towards perhaps one day wanting to sell.
What advice would you give to someone who is starting a business and plans to sell it one day? What are the strategies they might consider doing at the front end?
SUSAN: One of the biggest concepts that I share with my clients – operate your business with a dependency on processes rather than on people. For example, you might have Mary working in your business, and she is a great employee and you rely on her for everything. That’s not a saleable business concept because there is only one Mary – she might get a new job, retire, fall ill, or worse.
But if you have created processes for someone who has Mary’s role to follow, you’ve created something that’s transferable and saleable. Many proprietors greatly underestimate the vital role processes play in making their business more valuable.
Having the right players in the right seats is key. Even more crucial is formalizing documented processes between those individuals. This shows the purchaser that the underlying infrastructure and operation of the business can be replicated so they can realize a smooth transfer and rapid growth.
A very dangerous practice for many entrepreneurs is that they want to work so much in the business that they forget that their role is to work on the business. Just because you have the skill and the competency to do everything within your business, that is not leveraging and creating equity, that is creating a job for yourself. If you need to do everything, you have not maximized your business’ value or made it as big as it could be.
REGINA: I’m famous for telling people to “delegate or die trying,” because otherwise, you get burned out. There are many tasks that can be delegated. When you have repeatable, documented processes in place they can be replicated by others. The more we can get down on paper, the better off we’ll be. Let’s focus a little more on the front end of valuation planning, especially regarding Intellectual Property.
Whether we’re starting a business or have one up and running, how should we go about setting up or protecting Intellectual Property, especially if we might want to sell or leverage it in the future?
SUSAN: The same analysis related to real property can also be applied to intellectual property. However, lawyers generally advise that it is smart to hold your intellectual property in a separate entity, and then lease it to your operating entity. The reason for that is it shields your intellectual property from creditors and plaintiffs that sue you about something related to the operations of your company. The other reason is that often, the magic in your business is your Intellectual Property, along with your know-how, your processes, and your techniques. That’s your secret sauce.
Having intellectual property outside of the operating business also gives you the opportunity to lease it to multiple people. For example, you might decide that you want to sell your operating company but retain the intellectual property. This enables you to lease it to the purchaser and maybe even lease it to other people in the market. It gives you the potential to engage in a franchising type relationship. In these ways, you would continue to reap benefits even after your core business is sold. The other reason why separating it out is that while Intellectual Property is notoriously hard to value, it’s often the crown jewel of your business — the most important part.
It is easy for the value of intellectual property to be overlooked when you’re selling an operating business as just something that’s thrown in. But if it is in a separate entity, a separate value has to be allocated to it. As a result, it forces you to go through that discussion and it can also create some tax efficiencies to do it in that way.
It is also important not to commingle personal and business assets. Have good separation and a good definition of who owns what. I often see that at the beginning of a business, there are no agreements about intellectual property and who owns what. Owners hire employees or retain contractors without agreements in place. Then later the intellectual property created by the employees or contractors becomes hugely valuable. As a result, I see lawsuits where someone says, “Well, I created part of this code, so I own this intellectual property because you didn’t have a work for hire agreement in place.” This can create huge problems. I know that entrepreneurs at the beginning stages want to keep their legal spend down but this is an area where you want to invest because it is probably the most valuable thing you create in your business.
MARY: It’s great that we’re talking about how to grow and preserve wealth, not just income in from your business. That’s especially important for female business owners since we’re often wealth constrained.
Let’s talk about the practicalities of obtaining good tax, legal, and valuation advice. How does someone go about doing that?
SUSAN: First, credentials are very important. You need to work with people that have the right qualifications to be able to provide you with sound advice. For example, your accountant for a business sale should be a CPA. The person who has done your books and taxes are likely not the right advisor for strategic transactions. You need to seek people out that have experience in this area. In the same way, if your corporate counsel does the day general day-to-day work for businesses, they’re not necessarily the right counsel for a business sale.
It’s also essential to talk with each of your advisors about how many transactions they have done in the past couple of years and what was the value of those transactions. If you tell me you’re selling your business for $100 million, you need someone that focuses on that part of the market. Or, if you say that you’re looking for $500,000, there are specialists that do that. Find the right person for different tiers of sales.
And finally, it’s essential that all of your advisors understand your goals: Why are you selling your business? What do you want to do next? This influences how they structure the sale. Sometimes entrepreneurs are so excited about the sale of the business that they forget to talk “the why.” This affects how we negotiate a transaction. For instance, if you tell me, “I want to pay for my grandson to go to college, and then after that, I’m downsizing.” as opposed to “I want to buy a giant ranch in Wyoming tomorrow”, we will negotiate very different terms for those two sales.
REGINA: You’ve shared outstanding insights about things to consider, advisors to retain, and actions to take leading up to the sale of a business.
How do you know when it’s the right time to sell the business?
SUSAN: The epiphany answer I give people is when you’re not having fun anymore. I don’t mean just a bad day. I mean when overall, you don’t look forward to this anymore and you don’t want to keep growing it. That’s when you know that you’re done from an emotional sense.
From a practical, legal, and technical sense, you want to sell when value is high and lock in that profit. The hard part is analyzing when the value is high and weighing that against any future risk. So, if you’re aware that there is a lot of future risk that can create instability in your business and you have a lot of value locked up in the business, that may be a good time to sell.
The other thing I would say is when you’re at a point in your life where you cannot give the amount of time and oversight that the business needs to grow. Sometimes people hang onto their business too long and wait and disengage because they say, “Well, I’m the owner. I can create a nice schedule for myself and spend more time with my family.” That’s true. You can do all of those things, but if you do it so much that the profitability of the business goes down, you did not help yourself. Right? You could have sold the business when the profitability was high and invested that, and then use those proceeds to invest in the lifestyle you want. Those are the kind of factors to consider if it’s time for valuation, whether or not you’re enjoying it anymore, and what’s happening in the market.
One last question, if there was only one thing you could ask people to walk away with from our conversation today, what would that be?
SUSAN: The big overarching thing is to remember that you create equity by using leverage, processes, delegation, and not creating a job for yourself. Your goal is to grow value and create equity. Don’t create a business that’s dependent on you and the things that you alone can do.
No matter what stage you are at in your business, there are strategies you can take right now to grow the value of your business. The key? Educating yourself and securing the right team. And remember, it is never too late.
For more information about Susan Markey, JD, ESQ and Maximizing Business Value, visit our website for her biography, podcast and class.
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