THE ROLL-UP
You can sell to a roll-up firm, also known as an aggregator. Say you have $1 million in EBITDA. For a firm that size, you'll likely get a P/E of 6 or so. You sell 80% of the firm to the aggregator and 20% to your key employees at a 20% discount to keep them on board.
Assuming you have zero basis in your firm and a P/E of 6, your capital gain is $5.76 million (0.8 x $6,000,000) + (0.2 x $6,000,000 x 0.8) = $5.76 million). This results in federal and state taxes of about 20% (or more), and rates could rise in the future. After the tax dust settles, you'll have about $4.6 million in your pocket ($5,760,000 x 0.8 = $4.6 million).
Given current investment returns, assume you can draw 4% forever or 6% for the next 20 years. That amount ranges from $184,000 to $276,000 annually, a pretty good chunk of change, but only 19% to 28% of what you were making previously.
DIE AT YOUR DESK
The second choice? Take the $1 million in profits again. Assume you give 20% to your key employees and keep $800,000 for yourself, until you drop dead at your desk. Based on surveys I've done, that annuity stream scenario is what roughly 25% of all small business owners expect.
Most financial planners, though, would see the poor planning in this tactic and a tremendous lack of concern for all the stakeholders, including clients and staff. You can call this outcome the train wreck scenario. If you decide to do this, your staff - the folks who own 20% of the firm - will figure it out and likely defect with clients before the company implodes.
SELL TO YOUR STAFFERS
Consider a third scenario: Sell the entire firm to your valued, loyal employees. They may already own a piece, but that stock is not likely bankable. In the current lending environment, private stock has little value as a security. Banks require you to personally guarantee their loans.
Thinking you can strike a better deal, you offer the employees a 20-year note at 7% with nothing down, which means they have to come up with about $152,000 each quarter, or $608,000 a year. If they give up about two-thirds of the cash flow for 20 years, that's a good deal for you, right?
Other than the impractical nature of this transaction, who would be willing to put former employees in charge of a firm and watch from the sidelines, shouldering the financial risk for 20 years or more? Most sellers, including the individual who offered me the Monitor Group 13 years ago, would not do that. That man demanded two-thirds of the total sales price in cash and took back a seven-year note on the last third. I paid the note off in five years, but a significant down payment isn't something most employees can make.
Still, selling to employees seems easiest for many owners because it retains clients and gives founders a sense of continuity but, to work, it has to be a windfall for employees. Why?
For employees to pull it off, there must be: A minimal down payment coupled with a very low interest rate; a very low price; or a payback period that looks like a 30-year home loan. If these conditions aren't present, the company won't have sufficient cash flow to pay the seller and grow. Nice for employees, but not so good for you.
THE NEGOTIATION
As I mentioned in my previous column, I talked to Mark Tibergien, CEO of Pershing Advisor Solutions, about business succession. He recommended merging with a firm that has a solid management structure run by folks younger than I.
Fortunately, seven years ago I joined a business consortium of like-minded wealth management firms spread across the country and Australia: the Zero Alpha Group. The organization shares intellectual capital, including best practices and financial data for benchmarking. Over the years I've come to know all the firms and their founders well. These are among the best-managed firms in the country and the combined intellectual base of ideas, experience and strategic thinking is unparalleled in our industry.
