Many business owners say this proudly. Nobody else could do the amazing work/come up with the brilliant ideas they do.
They may be right. But it isn’t a positive! It greatly reduces the business value.
Why is it bad?
They dream of selling up one day. The big pay off for many years of hard work. But if the business is hugely reliant on them, how can they step away? It’ll quickly fall apart without them.
Who would buy a business if it’ll fail soon after purchase?!
“But my business is still valuable, right?”
Let’s focus on the smaller end, as it’s more easily understandable.
There are plenty of businesses out there with £150k turnover. Maybe ~£15k costs, and a tax efficient ~£10k salary to the owner, leading to profit of £125k.
They’ve heard businesses are worth a multiple of profit (or “EBITDA”). Perhaps with a multiple of 4.
So their business is worth £500k, right? Sell for that age 60 and they can clear the remnants of their mortgage with a tidy sum left to live off.
Nobody’ll buy that business for £500k.
The key problem is the ~£10k salary they’re taking is NOT fair market value for their efforts. With the above numbers, £100k salary is realistic. Add in employment costs (pension, employer’s NICs), makes that £100k salary cost £120k to the business.
Suddenly the business P&L looks very different. Still £150k turnover, still £15k other costs…but now £120k employment costs. Profit is now just £15k. With a 4 times multiple, the business value is therefore £60k, massively less than £500k!
Will £60k clear your leftover mortgage, let alone give you a tidy sum to live off for the rest of your life? Plus this is before factoring in professional fees to sell, and any taxes.
“But my broker says it is worth £500k!”
Honest business brokers have early conversations with owners re sensible valuations. They set realistic expectations, which may disappoint some. But it gives a plausible chance of sale.
Less honest brokers will agree it’s worth £500k, and take a big up-front fee for listing it for sale. They’ll then act surprised when nobody’s interested!
Bigger businesses?
The situation is less clear cut for bigger businesses which already have some employees and systems in place, as inevitably at least some of the day-to-day business functioning can run without the owner.
Still, if you’re required to make every significant decision, the numbers may be very different, but you’ve got a similar issue.
The solution?
If you’re considering selling at some point, spend time and effort now to make your business “more sellable”.
This involves implementing systems and/or employees to help make you less essential to the business.
“But that’ll cost money, I do it for free!”
Yes, but it misses the point. You’re doing it for free because you’re the owner. Sell the business and you won’t get the profits anymore. We imagine you won’t be prepared to continue to do these tasks for free!
By you continuing to do them right up to sale, either:
- The buyer has to sort out systems/employees soon after sale, putting the onus and risk on them (reducing sale price), or
- The buyer has to do these things themselves like you’ve done. Now it’s not the easy, autonomous business they thought (reducing sale price).
Employee Ownership Trusts
Selling to an EOT is negligibly different from this perspective to a trade sale. Only exception is potentially you can stay on long term post sale, hence you being essential can be less of an issue.
It will however still be factored into any valuation. Plus it’s healthier for the business if nobody is that critical. People can leave businesses for a variety of reasons.
A succession plan isn’t just about what happens to shares. It’s also about who will run the business/do certain tasks when key people move on.
If you are interested in finding out more about transitioning to an EOT, get in touch with us at Go EO to see how we can help.