For many financial advisors, business transfers have created most their clients’ investable assets. Aging, Pandemic fatigue, fear of a rising capital gains tax, and a glut of Private Equity money were expected to push a bulk of Baby Boomer business owners to consider selling their companies. That, in turn, was expected to boost the fortunes of wealth management professionals. How have these expectations played out in reality? I asked that of Rob Slee, Founder and Managing Partner of the investment banking firm Roberston & Foley, and author of the book, Private Capital Markets: Valuation, Capitalization, and Transfer of Private Business Interests. Here is Rob’s response:
The pace of transactions seems to have accelerated at an historic rate but there’s a real dichotomy in the market. Probably 90% of Boomer business owners are trapped in their own business because they haven’t created enough value to sell to a third party.
Then there’s the owner - market value gap. Almost every owner I've ever met thinks their business is worth about twice what the market is willing to pay. I call it owner value versus market value. What owners tend to do is they come at it from a point of, “What do I need it to be worth after taxes?” Unfortunately, the market could care less what you need it to be worth. The amount of money that's looking for these companies to buy is probably 10x what it was 20 years ago. However, private equity is only able to act on maybe 2% of those Boomer businesses because the owners haven’t structured them to be saleable.
The option of transferring the company to the kids has shifted. Boomers’ adult kids saw what the parents went through to build those companies, but they rarely buy the company because they don't want the same headaches that plagued their parents. They want the money, but they don't want to have to do what it takes to build the business back up again. I'd say of the last 25 businesses I've sold where the kids were in the business, not one of them was bought by the owner’s children.
Usually, the sellers haven’t thought through their financial end game ahead of time. They haven’t considered how they're going to construct their exit transaction for maximum value or how they'll manage the money afterwards. It’s purely an afterthought unless they’ve had a good financial planning team working with them ahead of time which may happen when true generational wealth has been created.
Boomer business owners think that as soon as they start talking about exiting their company, it's the first step toward the elephant graveyard. They really don't want to talk about it until somebody knocks on the door with an offer but by that point many of the good planning opportunities are gone.
At the start of every conversation about selling a Boomer business there are two things I hear: “I want to take care of my employees,” and, “I want to give a large amount of money to establish a charitable foundation.” Often, those good intentions take a back seat once the owner sees the after-tax and after transaction-cost proceeds. There's not enough money. Or, if by the time they get to me, they already have a letter of intent, it's too late, legally to be doing some things like a charitable remainder trust.
The Business Transfer Cycle
When Boomer owners are considering selling, they need to keep the ten-year business transfer cycle in mind. Looking back 150 years across American business history in the middle market, you have these periods every ten years when it’s smartest to sell. Normally our transfer cycle would have ended at the top of every decade but because of COVID and $10 trillion of federal investment in pandemic relief have extended the transfer cycle a few years into this decade. Soon, though, that window will close and then Boomer owners will be trapped for another six or eight years, until the next the next decade.
Every time I've had an owner pass up a market value deal cash or cash market value deal, within 24 months that business either went bankrupt or the owner was dead. It's like I can predict it with great accuracy because the market is a jungle. When it says it's time for you to go you either go or the jungle takes you out. The jungle doesn't give you a second chance - the competition will run you out of business. You’ve got one chance at the brass ring and a fair deal so you would be wise to take it. Market value is market value.