A buyers’ market is looming in the financial services industry, making a succession strategy an integral part of every business plan.A business owner needs to a make an exit plan the day he incorporates his business, said Tom Deans, author of the book, Every Family’s Business, a guide to succession planning for business owners. “If you don’t, you’ll be running a random business. Every decision you make should be made knowing how it will shape the sale of your business down the road.”
“There are now 40,000 life insurance brokers in Canada and their average age is close to 60,” said Geoffrey Morphy, senior vice-president at Klein Farber Corporate Finance Inc. in Toronto. “In five years, there’s not going to be the number of buyers coming along with the money and the skills to buy businesses that are not packaged properly.”
But that hasn’t happened yet, said Helen Mallovy Hicks, Toronto-based partner and national leader of the valuations, forensics and disputes practice at PricewaterhouseCoopers LLP. “Entrepreneurs are still reluctant to retire and sell. Their business is their baby.”
For many businesses, there is still time to get them in shape for sale – which can take up to five years. “Only the best-prepared businesses are going to get noticed down the road,” said Mr. Morphy, who holds the Certified Exit Planning Advisor designation conferred by the Exit Planning Institute in Chicago. “Owners need to make them look as attractive as possible. If a prospective buyer has any reservations, he’s likely to move onto another business.”
He starts off the exit-planning process by having business owners define their goals. “We put them through an extensive questionnaire process that not only asks questions about the business, but also about the owners themselves. What do they want? A lot of people regret selling afterwards and this is unfortunate. We want to help them set realistic expectations from the outset and to structure a transaction that addresses their primary business and personal requirements. Do they want to continue working in the business as employees or advisors? Is their objective to get top dollar or is legacy – the continuation of the business name and its role in the community – important?”
Valuing a business
Valuation multiples, such as a percentage of annual recurring revenue, have traditionally been used to put a price on a business. “If a business’s trailer fees are $100,000 a year, the business could be valued at $400,000,” said Brian Keough, president of Keough & Associates, a Halifax-based business valuator. “A life insurance business could have a higher value because life insurance has a higher rate of retention.”
Cameron Jacox, president of Toronto-based Jacox-Hilton Advisor Consulting Inc., likes to use the last three years’ average trailer fees. He said there’s only so much goodwill that can go into valuation in the financial services industry: “Your business may be a fixture in the community, but everyone in town knows that John Smith is leaving it and the business’s name will no longer hold the same value.”
But Mr. Keough said rule-of-thumb valuations should be just guidelines. “You also have to take the quality of your book into consideration. If your clients are in their 30s and 40s, the book has more value than if the clients are in their 60s and will soon be using their assets to finance their retirement.”
Remember to capture normalization adjustments, such as bonuses taken by the owner, when presenting financial information to the buyer, said Brooke Valentine, Calgary-based managing director of corporate finance at PricewaterhouseCoopers LLP. “Add back these costs to the profit to form a true valuation of the business because the buyer will no longer have to pay you these bonuses when he buys the business.”
Aspects of a business can be enhanced during the pre-sale period to increase its value.
“A prospective vendor should have his accountant ensure that the business has a clean balance sheet,” said Mr. Keough. “You don’t want to have superfluous assets on the balance sheet, such as ancillary businesses that wouldn’t interest a buyer. And you need proper tax-planning advice.”
Mr. Jacox closely analyses an owner’s book of business. “Changes in insurance markets over the past decade mean a range of potential problems exist within your client book. “We’ve found that roughly 25% of the policies in any book have problems, such as clients who’ve taken out loans against their policies that imperil their viability.”
Mr. Valentine suggested some other strategies for enhancing a business:
Consider timing. “It’s always an advantage to sell a business when the trailing 12 months have been strong and the coming 12 months look strong,” he said. “This can’t always be controlled because life events often force owners to sell. And it can challenge human nature because we tend to hang on when times are good and want to sell when times are bad.”
“Transfer client relationships to other advisors or agents in the firm,” he added. “This is especially important if the buyer comes from outside the industry or is looking to expand horizontally into the niche you offer. It will also attract companies in the business of buying and selling businesses.”
Mr. Morphy noted that owner-dependent businesses can be a stumbling block for buyers. “Business owners who can’t delegate may think the business has real value, but the value is only in the person who’s leaving. Someone’s going to want to buy that business – not its owner. We consult with business owners to bring about changes that not only make the business more saleable but also at the same time enhance the overall value of the business. It is a double win for the business owner.
Look at cost-cutting wherever possible, and updating the IT system, advised Mr. Valentine.
Many owners have a sense of who their potential buyers are, Mr. Valentine said. “But their view is often much narrower than it should be. It usually takes into account strategic buyers – those that see buying a business as a way to acquire elements that fit with or enhance their existing businesses – especially those who’ve already approached them. They tend not to be familiar with financial buyers, those who are in the business of buying, growing and selling companies. A firm like ours would increase the vendor’s options to look at companies that want to expand or get into other markets.”
Try to increase tension by having more than one buyer at the table, Mr. Keough said. “This may be easier in a big city than in a small community, and the best way to do it is by hiring an intermediary to prepare a package and scout out buyers. When you’re running a business, you don’t have time to do this yourself.”
Owners need to understand buyers’ needs and align themselves with those needs, Mr. Valentine added. “If you are an insurance business with high-net-worth clients, and a prospective buyer specializes in other products, it’s in your interest to explain that your client base has great potential beyond what you’re offering it.”
He advises working with potential buyers in the same positive way that you do with clients. “Try to find a win-win solution. Don’t treat buyers as adversaries, which will undermine the success of negotiations and the transition process.”
Keeping a business in the family may be a priority for some business owners, but Mr. Deans warns against gifting a business to a child. “Founders risked their time and money starting their businesses. Gifting denies children the opportunity to risk something themselves and follow their dreams. They’ll lack the passion and commitment they need to make the business fly,” he said.
“If a child really wants the business, have him borrow money to buy it. Or gift equal amounts to each child, and have the one who wants the business give it back to you in return for company shares or assets. That way, you’ll avoid a situation upon your death in which your children receive equal company shares, forcing them into partnership with one another and undermining family relationships.”
Selling a business to a family member is usually a different kind of deal than selling to an outsider, Mr. Valentine said. “The buyer is usually unable to fully finance the purchase and negotiates a vendor-takeback arrangement. If a business is selling for $5 million, and the buyer has $1 million to put down and gets a bank loan for another $2 million, the remaining $2 million will be paid back to the owner over time from the business’s profits.”
Sale and transition
Mr. Jacox likes to set up an advance agreement between vendor and buyer, detailing the terms of the sale a specified number of years down the road, and outlining what would happen if the owner dies or becomes disabled before then. “As the retirement date approaches, we come in again and survey the book for quality. And we hammer out payment plans, which could mean taking a lump sum now and $100,000 a year for the next 10 years.”
Most buyers want the vendor to remain on board in some capacity for a certain length of time to help with the transition process. This needs to be included in the sale agreement.
Introducing the successor to clients is an important part of transferring the business. “It’s a rare client who doesn’t wonder what will happen to his portfolio when his advisor retires or becomes incapacitated,” said Mr. Deans, “so it’s important for the advisor to address this subject with clients, letting them know there’s planning in place to protect their interests. And it’s a great way to segue into discussing the client’s own plans. The advisor who’s done his own work is in the position to help the client with his own succession, and the client will then turn to the advisor to invest the proceeds of the sale of his business.”
Jonathan Reimer, president of Dynasty M&A Consultants in Vancouver, said a confidentiality agreement should be in place while the deal is negotiated. “People are afraid of change,” he said. “The staff may leave, and clients will be more inclined to look at proposals from other firms. Announce the sale to staff and clients when it’s a fait accompli.”
He suggests that the vendor announce the sale to staff in the morning and spend some time talking to them. “Then the purchaser can join them and everyone can go out of lunch. This way, staff won’t stew about it overnight, fearing the unknown.”
Clients should find out about the sale directly from the vendor, he added. “Arrange for top clients to meet in person with the owner and vendor.”
