Apr 03

Bunch on Business

Begin with the end in mind.

Some entrepreneurs find themselves in unenviable situations when they are ready to sell their dream business. I am talking about business perpetuation. Every business needs to have a perpetuation plan that allows the founder to monetize or transition their business to the next generation of family or outside owners.

Monetizing or selling the business requires current ownership to be cognizant of how their business gets valued, common deal structures, potential buyers, transferability, and due diligence requirements.

What is the valuation method for your business? Many companies are valued at multiples of EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization). Some companies are valued by gross or net revenue multiples based on appraisals or some industry-specific methodology. Business owners need to know which valuation method to apply to focus their efforts in areas that build shareholder value.

Common deal structures include cash, earn-outs, employment agreements, non-compete clauses, and owner financing. It is important to understand how your industry transitions ownership so you can be prepared to negotiate accordingly.

Private equity buyouts have grown recently. They offer competitive values, but with strings attached to earn out the full offer. They often require current owners to work for the new ownership during a transition period from one to three years.

Internal employee perpetuation can work in smaller businesses but is more difficult as the organization becomes larger. Are you mentoring the next owner? Will the employee have the capital to buy you out or are you willing to owner-finance the transition? Do you have a signed agreement outlining the value and terms for a future transition date?

Family members who are not actively engaged or competent to operate the business should not be considered as viable new owners. Studies have shown that family-owned businesses decline in the second and third generations. Competitors may be your best solution for a sale, so be courteous to those you compete with since that could become part of your perpetuation plan.

Taking a company public through an IPO will require stringent financial reporting, audits, public relations, and formation or hiring of a team to navigate the regulatory environment. If an IPO is your future, you need to plan and implement these preparatory steps before initiating your filings.

If you are involved with partners, it is best to have pre-negotiated buy-sell agreements that are funded with company-owned life insurance policies. These agreements automatically buy the shares from the estate of a partner who unexpectedly passes away. You should also consider negotiated buyout language to deal with a disengaged partner or those wanting to exit the business.

Failing to understand the complexities of perpetuating a business ahead of time can leave owners with unsellable assets, lower valuations, limited options and liquidity. So, like so many other facets of business, your end game begins when you form your company.

Richard “Gordy” Bunch is the EY Entrepreneur of the Year® for the Gulf Coast for Products and Services. He is also the founder, president, and CEO of The Woodlands Financial Group based in The Woodlands, Texas. You may submit suggested topics for future business columns to him at or through the editor of this publication.

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