“Why would I sell and invest in that?”

April 4, 2016

By Martha Sullivan, CPA, CVA/ABV, CM&AA, CEPA
Partner, Succession Planning Practice Leader

In a recent conversation, an owner of a successful business blithely remarked “Why should I sell? I can’t make this kind of money in the market!” On the one hand, I could appreciate where they were coming from. With interest rates at their lowest levels and varying perspectives on the stock market depending on your risk tolerance, the search for returns can be rather frustrating. Add to this the fact that the particular business owner was earning a nice salary, enjoying many perks and drawing nice year-end distributions, life was pretty good!

The business itself was doing well and had strong prospects for the future. There was a solid management team in place guiding a happy workforce. Client relationships were long and deep but diverse. Profits were strong. Again, while there were no succession plans in place, life was good.

Whether it was the right time to sell or not, I don’t know. The market was good and many middle-market deals were getting done. Liquidity still exists and investors are looking for quality deal-ready companies to buy. This company had a lot going for it in that regard.

But that wasn’t what this owner was focused on. They were focused on what they could get as returns in the market as income versus what they were enjoying as income from the business. I then asked them about what other investments they held and how they were doing in the market. They had other investments and had made sound choices with them. Nonetheless, one thing greatly troubled me. The business was the biggest asset in their portfolio – and not by a little amount. The business represented over 65 percent of their net worth.

Modern portfolio theory tells us that diversification is important to hedge against two types of risk. One is systemic risk – the risks that are associated with the market, the economy, global events and other element of that nature in general. Unsystemic risk is the risk that is specific to a particular investment. With a portfolio of publicly held equities, unsystemic risk is manageable within a couple days. You contact your broker and simply sell your position. When that stock is privately held, it’s an entirely different matter.
The process to sell a privately held business can take anywhere between six months to several years, depending on the business, the economy and the negotiating parties. The process can be broken into:

  • Preparation for sale
  • Identification of potential buyers
  • Preparation of offering
  • Letter of Intent and related negotiations
  • Due diligence
  • Definitive agreement negotiations
  • Closing

This takes time and resources, working ideally with a team of experienced advisors to get over the finish line. Sometimes, even after going through many of these steps and everyone’s best efforts, there may not be a market for a privately held business.
I pressed the business owner a bit further, asking him about his succession and estate plan, especially if something unexpected were to happen. Sheepishly, he acknowledged that he had been kicking that can down the road. He knew he needed to get those ducks in order, but had been putting it off because he had no idea where to start but knew there were many moving parts and pieces. Much of that income to his family could come to a screeching halt if something happened to him. With so much of their liquidity tied up in the business, did he know whether there were adequate resources to carry his family through while the business was sold under less than ideal circumstances?

Taking the conversation back to the beginning, I suggested we review his personal financial portfolio with his wife, and map out what they wanted to achieve financially and personally, after the business. From there, we would figure out the next steps together. Maybe it was a great time to sell. Maybe it wasn’t. Perhaps there were ways to diversify his portfolio by taking some of the chips off the table. It was time to sit down, talk is through. It was time to build an exit plan so that whenever the time came, he was ready to sell.

For more information or assistance on business transition strategy, call 888-556-0123, email info@honkamp.com or submit our online form.

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