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Small Business Exit Plans Are Broken | Episode 488 — Leadership Powered by Common Sense with Doug Thorpe
Introduction
Well, hello again, everyone. This is Doug Thorpe, and you are listening to Leadership Powered by Common Sense. I’m excited today for two reasons. I’ve got two guests with me, Mark Willis, who you might have met in a recent episode, but also his colleague and co-author of a new book. The gentleman’s name is David Barnett. And David in particular is all about buying businesses, buying or selling businesses. And I know he’s got some great ideas and things to share with us. And, Mark, as you may recall, I spoke a lot about personal wealth management and some very key strategies that are widely known. And so we’ll get into a little bit of that. But first, David, let me welcome you to the show.
Thank you. Thank you very much.
And Mark, welcome back.
Thank you. Thanks so much for having both of us. Back for round two.
Yeah. You bet.
The Business Buying Opportunity — And Why It’s Trickier Than It Looks
You bet. Well, let’s tee up on the business buying idea. David, as in the background, you’ve got a great poster that says buying versus starting. And that’s a topic near and dear to my heart. The incredible opportunity that’s out in the market right now. There are trillions of dollars of value in the market with small, privately held businesses that could be up for sale. Typically baby boomers who might have started those businesses 15, 20, 25, 30 years ago are ready to cash out and move on. They’re healthy, cash flowing businesses and opportunities. And there’s some intriguing financing options out there that potential buyers can take advantage of. But David, let me start with a question. How do you see the market right now?
Well, it’s an interesting question because I actually get asked this question quite often. And the reality is, is that there’s actually no such thing as a market for small businesses because every business is very unique. And so a person with a background in process engineering from a manufacturing background is never going to buy an extremely profitable flower shop because it just doesn’t take advantage of their skills or knowledge.
And so it’s a very disjointed and non-transparent market, because it’s also a secret market where businesses are put up for sale without being publicly advertised. And when they are, it’s in a confidential fashion. So it’s really difficult for the market to function. And it is a lot of work to find a good opportunity.
You know, you opened by talking about how all the baby boomers’ businesses are going to be sold. That’s a very common narrative. But here’s the reality: about 80% of businesses that are put up for sale never sell. And the reason is, is because they’re not worth owning.
There are a lot of businesses out there that cash flow perfectly well for their current owners, and they provided well for those people. But if you take a look at that business and you were to acquire it, take on any amount of financing and then add debt service on top of that deal, it just doesn’t work. And so unfortunately, one of the big things that I have to do, as part of my work, when I’m talking with someone who owns a business, I might want to bring it to market — I show them what realistically their business could fetch in the marketplace.
And sometimes they’re very disappointed because of the things that they’ve been doing and running their business.
The Invisible Market: Why Seller Expectations Are Often Way Off
I could not agree more. I’m glad you called that out and you packed a lot in there, starting with the number that 80% of the businesses that may want to be sold are never going to be sold. And you’re absolutely right. And that, in fact, is a lot of the work that I do with entrepreneurs — making them ready for sale. There’s a long, long list of reasons that they’re not going to fetch the multiple they hoped for.
Here’s one of the other problems related to the invisible market you talked about. And I really like that idea because it is so convoluted. Typically these owners, they may go out and go on a hunting trip or a golf trip with a bunch of their buddies who are in similar positions, and they start chatting up the idea of selling the business, and they’ll get this proxy that says, oh, yeah, yeah, your business is worth 5 million or 7 million or 10 million.
And they might sign up a broker and say, that’s what they want. And there’s a lot of brokers that are going to accept that number and put it in the listing. But that’s not a lot different than the person wanting to sell their house, and the market around them might go for 140–150 a square foot, but they’re asking $300 a square foot for their house. And no good real estate broker that I know is going to let them do that. They’re going to try to talk them back to level with a competing bid — maybe a little higher than the market, but not to exit the market.
Shopkeepers vs. Dentists: The Two Types of Business Brokers
Yeah, absolutely. And this is one of the reasons why I am no longer a business broker, because in the world of business brokerage, if there’s a competitive marketplace where there are many brokers operating in the same city, for example, they all kind of default to the same sort of marketing, which is: I have the secret sauce that can sell your business for more.
And the reality is that when you go to buy a house, you need to qualify for a mortgage. That mortgage is going to be based upon your own earnings as an employee or business owner, whatever it is. But when you buy a business, the ability to obtain financing on the business is going to be tied to that business’s cash flow. And so that business’s cash flow is the limiting factor.
And I group business brokers into two categories. I call them shopkeepers or dentists. And so a shopkeeper is going to agree with you, say whatever they need to please you, to make you happy in the moment, to get that listing. And then they’re going to put your business up for sale like a piece of inventory in a store. And when it doesn’t sell, they’re going to then start telling you that we need to reduce the price.
Whereas the other kind of business broker — who I describe as the dentist — I mean, you go into a dentist with a toothache and you say, my tooth is hurting, and they say, yeah, you’ve got a bad cavity there. We’re going to have to do a filling. And you say, geez, I don’t like the drill. Can you just polish it instead? The dentist is going to say no, that’s not going to solve your problem. You need a filling. And the dentist is going to hold you to the truth and give you the tough love.
That’s the kind of business broker that people really should want to work with. The problem is that a lot of people just don’t know how to go out and measure that relationship, to figure out who is the right broker for them.
From Broker to Consultant: A More Honest Model
About 15 years ago, I switched from being a broker to a consulting model, where today I work with buyers and sellers. The way that I work with them is that I help them either evaluate their business that they want to sell, or evaluate one that they’re going to buy. And I don’t have any benefit or outcome that comes out of the transaction. I’m simply doing the consulting work and charging them for that work.
And so I don’t have an incentive to try to inflate their idea of what their business might sell for. I try to be realistic. One of the topics you just repeated was that 80% of businesses that go for sale don’t end up selling. That’s one of the things that we talk about in the book that Mark and I wrote together, The Business Fortress.
Because what we argue — or one of the big things that I argue all the time — is that the meat of business ownership is not in the exit. And this is an idea that we get, I think, a little bit out of these Silicon Valley stories, like when Mark Zuckerberg sells stock in Facebook, he is cashing out because his stock went from zero to being worth millions of dollars. But the reality is that most small business owners operate in industries where the valuation multiples are quite low and their businesses are probably earning them under half a million a year, which is another factor that makes the multiple quite low.
And when I show most people what their business is going to sell for, almost all of them are a little bit disappointed, and they’ll say something along the lines of, wow, well, I could just run it for the next few years. I would have the same money and I would still own it. And they’re absolutely correct.
The Real Reason to Sell — And Why the Exit Isn’t the Big Payoff
The reality is that a good, profitable small business that provides for your family could very much be an asset to you and worthwhile. The reason you’re going to sell it is not to cash out. It’s because you’ve got some kind of pressing, personal thing that is forcing you to get out of it, whether that’s a matter like divorce or poor health. Or maybe you do decide to retire finally and you want to stop running the business. And at that point, you’re now trying to say, hey, instead of closing this business, I’d like to sell it, and I want to try to get some kind of value out of it.
So the meat is not in the exit — the meat is in the operation. By fine tuning your business and making it as profitable as possible, as well run as possible, you get to benefit each and every year that you own it. It will actually enhance the value upon exit. But if you’re never able to exit, with higher profitability, you’ll be able to engage in some other kind of retirement planning, much the same as any other employee would do.
You know, you get some retirement savings of some kind through different investment vehicles, and you’re going to perhaps be able to build the balance sheet of the business so that even if you end up closing it, you’re going to be left with assets within the business that will ultimately be transferable and help you with your net worth and retirement.
The Pinch in the Hourglass: When the Business Can’t Run Without You
Right. And I think one of the stumbling blocks — and you alluded to it — is that too often these owner-founders are the pinch in the hourglass model. Everything flows through them. And if they go away, the business goes away.
And that’s one of the biggest hurdles in the notion of optimizing what you’ve got. I argue that the first thing you’ve got to do, if your fingerprints are on everything in that business, is figure out how to change that immediately. Delegating to other team members. Hiring an operations head or something that is going to get you away from it. And the classic barometer that I use is I ask these owners: Could you go away for two weeks or a month and the business still survive? And 99% of the time, the answer is no, it wouldn’t.
Documenting Your Business: The Key to a Bigger Buyer Pool
What I like to do is give an example to people. So if you think about a roofing company that has several crews — the owner maybe is doing the quoting, they’re ordering materials, they’re coordinating with their site foremen to get people and material on site at the right time. And if they have no written processes or methodologies for anything that they’re doing, that could still, if it’s a profitable business, be sellable. But it’s only going to be sellable to someone from the roofing trade — someone who already understands what the owner is likely doing, and with a little bit of coaching from that seller, they’ll be able to kind of pick up the pieces and carry on.
And so in a given city or marketplace, that could be just a small handful of people that are qualified and capable. Whereas if everything is documented properly and you’ve got Excel calculators for doing quotes and you’ve got SOPs and checklists and operating systems and all that kind of thing, well, now you can sell it to someone who hates his job at the post office, right?
Because that person can come in, you can show them the documentation you’ve created about how everything runs. And that person can then have the confidence that they’ll be able to come in and take over and run the business, because they can see how they’re going to be able to learn this.
Right. This is the IMF.
It’s exactly the IMF. And buyers are always worried that there’s a special secret that they won’t be able to learn or master. And the reality is that anyone who started a new job has gone through the same kind of learning curve where you just have to learn all the stuff and learn the product details.
When the Business Goodwill Lives in the Owner: The Architect Example
And how do we talk to customers and what our policies are. And so it is well worth people’s effort to go through this, if there really is something personal driving the value of the business. And the other extreme example I will use is the award-winning architect, right, who’s got an architecture firm, but they’re the ones who get featured in the local real estate magazine. They’re the ones who’ve won the awards that are on the shelf for different designs that they’ve built. People who hire that firm want to work with that person.
And so in that case, what you’ve got is a business with financial statements. But the goodwill of the enterprise is literally within the body of that individual owner. And so that person has an even bigger challenge because a buyer is going to realize, hey, if I just buy this firm, I’m not the award-winning architect.
Those architects, when they want to sell in that kind of example, they’re the ones who get tied into multi-year commitments where they have to stick around and they have to go to the golf tournaments, and they have to go to the banquets and they have to go to the events along with the new owner, so that people in the marketplace begin to see the two of them as peers.
Some sort of emeritus situation, right? Yeah. Like, give that guy an installment sale for ten years and keep him on as an employee of the business you just bought.
Exactly. And it’s only when people kind of see the two people as being on par that the goodwill created by the first person will kind of transfer on to the next. And those are the really challenging situations. I’ve actually had people say, wow, that sounds like a lot of work. I’m not doing it. And then they literally think, what’s plan B? And then plan B is an examination of what they’ve actually built over the course of their life — or worse, there is no plan B. And this is why you find so many 75-year-olds running a business.
A Cautionary Tale: The Veterinarian Who Got Zero
Yeah, I’ve got a similar story. I’ve got a dear friend that was a lifelong veterinarian, and he decided he wanted to retire, and he kind of put his vet shop up to the market and got zero response on it because they said, yeah, but you’re the doc. And he says, no, but I’ve got this list of clients.
And it’s like, no, those clients are going to find other docs. You know, they’re not going to come here necessarily — there’ll be this immediate runoff, even if a new doc shows up, until he’s able to build the relationships. There was a fear that it’s a zero value. So my friend basically closed. He did close his shop, let his team go and sold his equipment for scrap, basically.
The Business Fortress: Why the Balance Sheet Matters More Than the P&L
This is one of the themes of the book — The Business Fortress that I wrote with Mark. Hey, why don’t we take a more intentional pathway in owning and operating the business and think not just about profitability. Everyone wants to talk about profitability. They all want to look at the income statement or the P&L.
And the problem with that is you can have ever-increasing profitability in your business, ever-increasing revenue. But what do you do with the profits? If you keep taking the money out and spending it, you’re not doing anything to build the long-term prospects of the business.
And so in the book, we try to make people look a little bit at the balance sheet, which is one of the financial statements that a lot of small business entrepreneurs just don’t spend any time at all looking at. But it’s where you actually see the change over time in just how sturdy the foundation is for your business and just how resilient it can be to market downturns or changes in the credit cycle.
We talk in the book about how if people focus on the balance sheet early enough in their business career, not only do they get a stronger, healthier business, they create opportunities for themselves to take advantage of other people’s weakness when there are downturns in the economy. But they also build in this massive Plan B when it comes to retirement, in that they build stronger assets within their business.
Lessons from Banking: 64 Consecutive Quarters of Earnings Growth
Yeah, every time I think about that, I go back to an early chapter in my career as a banker. The organization I joined — and I stayed there for 20 years — had a discipline on financial management as a company, and we ran off 64 consecutive quarters of earnings growth. That’s a balance sheet line item. That’s not an income statement line item. You know, when you’ve got the earnings growth, you’re building that tremendous nest egg, if you will. And that’s what got recognized in the market and drove our stock value, etcetera.
So I want to — with the time we’ve got left — touch on an option that is not talked about enough. That is the idea of the owner refocusing their intent and maybe, with the help of a consultant, creating a blueprint for how to maximize the profitability of the business and then take that extra margin they might generate and do something else towards personal wealth building.
And, Mark, we’ve had you on the on-deck circle the whole time here. Maybe you could pick up on that idea.
Building the Castle: Mark’s Business Fortress Metaphor
Well, you know, I think it’s important what David has said. He’s got such wisdom. I mean, David, you’ve worked with how many thousands of entrepreneurs and business owners. So you’ve seen the ugly truth. And anybody listening to what David is saying — this is not a future that you want when you’re faced at age 75 or 80 years old and you’re still turning the crank of that business.
So you’re right, David, the unspoken report in your QuickBooks software as a business owner is the balance sheet. And where you keep your profits is so important. So many business owners just scrape it all out of the business or, worse, reinvest it into things that tie themselves deeper into that business again.
Think of a medieval castle for a minute. The walls — that’s the structure, that’s the protection, that’s the balance sheet. It’s all the inventory, the goodwill, the cash in your policy, the equipment, all the things that create resiliency when economic hard times come.
Then there’s the moat. The moat is sort of like your liquidity. Where’s the liquid access to your money, where you can protect yourself from the onslaught of Vikings that may be attacking your castle, right? The competitors, the economic headwinds coming at you, the higher interest rates, the banks that are trying to suck you dry.
Then there’s the castle keep — what’s inside your business. If we open up the doors and look inside, is there any treasure in there at all? Or are you putting all of your money right back into illiquid business ventures or marketing schemes that never pan out? Or are you building assets, current assets on the balance sheet of your business that can double as a retirement fund?
Where Should Entrepreneurs Park Their Profits?
You know, so many people think they hear their financial advisors say to them, hey Mr. Entrepreneur, you have a very high-risk business here. Let’s go put money over here in this stock market account. Let’s set you up with a SEP IRA or a 401(k) through your business. And many financial advisors get paid a hefty fee for setting all these up.
But does that really help your business thrive when you pour money into Apple and Microsoft and any index fund the advisor might recommend? Does that help your business? Or is it siphoning energy and money away from your business into the rest of the overall stock market?
Yes, it helps with diversification to do something like that, but what do you really understand and control? If you’re like most entrepreneurs I talk to, you get your business way more than you get what the stock market might be doing. So are there ways we can park money in something that you have liquid access to? Building the moat around your castle that you can draw on when economic headwinds hit you — or the Vikings maybe attack you — and then you have ready access to both an asset now and also potentially a retirement plan.
If you cannot sell that business for a hefty price, there are financial tools and accounts — and we get into it in the Business Fortress book — that help the entrepreneur both now and also in retirement time when the days come.
The Entrepreneur’s Mindset Around Risk and Outside Investments
Yeah. I mean, I don’t work in the world of personal finance like Mark does, but I know that in the conversations I’ve had with business owners over the years, most of them really realize that their own business is a risky vehicle and that they are quite invested in it. So I’ve often found that a lot of entrepreneurs, because they understand they’re taking a lot of risk in their own business, when they do make investments outside their business, they tend to go for things that are very lower-risk.
They don’t want to seek bigger risk — high-flying tech stocks or something like that. They’re looking for something that’s more secure, because they’ve probably seen some of their friends in business have hard times or maybe even have their businesses close.
And they’re aware that their day-to-day is riskier than that guy we talked about earlier who works at the post office.
When the Owner Just Wants Out — The Cautionary Tale of Running Out of Gas
Yeah. One thing I want to touch on — and I’ve had this happen a number of times — the owner-founder is getting up in years and wants that exit. And that’s really their focus. And David, as you mentioned, so often it’s a little bit of a sad and cautionary tale. Maybe it’s a health issue. Maybe it’s a family issue. And they really have a significant driver wanting to get them out of there.
And if you start talking about, well, if you could just hang on another year or two and make these adjustments, you will have a higher value — they will come back with, I don’t have the energy to do that. I’m not interested in spending the emotional and mental energy to do that. I just can’t. And even if their outside influence is not so dramatic, they just want out. A lot of times that’s the answer I hear: I’m just not interested in doing that anymore.
The “Live Forever” Exit Plan Trap
I’ve heard that too. I actually had a case last year where somebody who kept saying that they were going to come to me to get their business value, to try to get an idea of what their exit might look like — kept putting it off, putting it off, almost for ten years. Then they called me up saying they received an offer. So I said, okay, send it over and send me your latest financial statements. And I called them back and I said, look, with a little bit of work and two years of improved statements, which I know you can create, you could probably get like another 100 grand. And the response was: I’m kind of tired. So.
So I will caution business owners out there against what I call the Live Forever exit plan, which is that they don’t actually ever work on their exit or making a plan because they think that they’re just going to work forever.
And I just turned 50. And I can tell you, I am feeling now that I don’t have the same energy that I did at 45, and I can only imagine that when I hit 60, there’s going to be maybe another notch down. What happens is you’ve got people that get into their 40s and 50s who still feel invigorated and excited about their business. They think that that level of energy is going to carry on forever. And at a certain point, you start to lose the interest and the motivation.
Get a Valuation Before Making Big Business Investments
And if you have not taken steps to really understand what are the value drivers in your business, then you can end up in one of these positions that you just described where you end up selling for less or not having an opportunity to exit.
The other trap that I’ve seen, Doug, is people who will be approaching large investments in their business. So let’s say you have a business that has a big piece of equipment that costs half a million dollars — they will just not even think about it. They’ll go and they’ll buy a new one or replace one or whatever, and they’ll make this big commitment with a lease or a loan.
I always say to those people: if you do a business valuation beforehand, find out what your business is really worth. Then from that, we can actually extrapolate a couple of years in the future and look at what the impact of that investment will be. Oftentimes, if the business isn’t as good as you think it is, if it isn’t as valuable as you think it is, it can make more sense not to do the reinvestment, but instead direct those funds into some kind of wind-up — you could actually end up with more than ultimately you end up selling for.
And that’s not a strategy that people like to hear about. Everyone likes to hear about these multiples of cash flow and millions of dollars of sale value and all this kind of thing.
The Hidden Truth About Business Sale Terms
The thing that I would caution people about is: when you’re at the golf course and you hear that a certain guy sold his business for so many millions of dollars, the one thing nobody ever asks is, what were the terms of sale? Nobody ever says, oh great, $2 million — how much did you get on closing? Do you have to hold a seller’s note on that? Are there any offset clauses on that seller’s note if certain results aren’t achieved in the next five years?
That’s the reality of selling a business. But people don’t ask those questions. They just get caught up with the headline numbers. And that’s part of — as you referred to earlier — part of what skews expectations on the part of business owners.
The Tax Impact Nobody Talks About
Well, and all of that, plus not to mention the tax impact if the deal is not structured optimally.
Yeah.
You know, that big bogey you see as a number floating around might be what your golf buddies told you, but your cash in pocket when you finally walk away is substantially less. And by the way, just for the record, I chuckled while you were talking about turning 50 and projecting 60. Wait till you get to 70. I have stories, but no — it is all true. And it is specifically back to what I was talking about. When you see these older owners and they’ll tell you, I’ve just run out of gas. I thought I was going to live forever, and I’m not. At least not related to the business.
When the Owner’s Energy Fades, the Whole Business Feels It
And if the owner is saying that — if the owner is running out of gas — imagine how their employees are showing up to work every day. And then, David, you’ve taught me this, and it’s so true. It’s obviously true. When you’re showing up run out of gas, the employees are not doing their best work. What’s happening to the valuation? It’s a downward spiral to nothing.
Absolutely right.
Small, personally owner-run businesses are driven off the vibrations of the owner — the energy, the attitude, the twinkle in your eye or whatever. That has an impact on how the employees behave and how they treat the customers and how quickly someone replaces a burnt-out light bulb. Like all those things.
Broken window theory is real for the business, you know? And not to stretch the metaphor too far, but hey, we did write a multi-chapter book on the metaphor. The knights in your castle are crucial. And bringing them into this discussion — possibly an ESOP, for example, an Employee Ownership Plan, or some sort of buyout from the employees — can be the difference.
They’re the most readily capable, but do they have the funds to buy you out? Maybe there should be discussions around building retirement benefit solutions for the employees — at least the key people that make your business run.
Involving Key People in the Sale Process
Yeah. Well, in the scenario where the owner is trying to tee the business up for sale, one of the due diligence questions I encourage buyers is: Can I meet your key people? And often the answer is no. You know, I don’t want to let the cat out of the bag.
And my argument on that answer is: that’s a big indicator of the trust the owner has been able to build in his team. And if the trust factor is low, you’re going to say no to that exposure. But if the owner has already been talking about this for a while and encouraged people to hang in there — that he or she will be diligent in finding a compatible owner — then that’s a different discussion.
And I’ve been in situations where that happened and it was a great success. You know that transition. All critical elements of these things.
Closing Thoughts
Well, Mark, I know you’ve got to exit. And, David, I think we are about up on time here. But any last words you’d like to give us — the final “so what”?
Well, I think if anyone out there is a business owner, regardless of your age, I think you should check out the book. It’s been out for about a year now. We’ve gotten plenty of positive reviews. The Business Fortress — available on Amazon. And it’s filled with actionable ideas and new ways to probably look at the business that you think you know pretty well.
We spend a lot of time showing people how bankers and landlords, for example, will look at your business when they’re doing business with you. And how that perspective can actually help inform the way you might want to start thinking about certain aspects of your business, too.
Very good. Well, David, thank you for sitting in with us. And Mark, thank you again for joining back in and introducing us to David.
Yeah. And I’d say if folks want a little taste of the book, you can find the first chapters, some book reviews and some video discussions — David and I at NewBankingSolutions.com. That’s NewBankingSolutions.com.
Wonderful. And David, if folks do want to get in touch with you, how do they do that?
My website is DavidCBarnett.com. But if you’re interested in just discussions about buying, selling, financing and managing small businesses, if you just look up David Barnett anywhere on YouTube or any podcast platform — I just celebrated 12 years on YouTube, so I’ve literally got like 800 podcast YouTube episodes out there. It’s all videos, mostly driven by questions submitted by people in your audience. So it’s just me talking to people about deals or answering people’s questions about deal making and doing transactions.
That’s great. Well, folks, we will have specific links to that in the show notes, as always. And I do want you to remember — we too have a video version on our YouTube channel by the same name. Leadership Powered by Common Sense. Hop over there, give us a comment, let us know what you think, and if you’ve got any ideas for future episodes, we’d love to hear from you! For now, I’m going to sign off. Say goodbye. Go out there. Make it a great day.
Meet Our Guest
David Barnett is a life-long entrepreneur and former small business finance and business broker.
He spends his time on consulting projects with buyers and sellers of small businesses and educating the public on small business deal making and operations. He also does work as a small business and Certified Machinery & Equipment Appraiser.
He’s the author of many small business books available on Amazon and maintains a YouTube channel with over 800 videos on these topics.
He also appears regularly at conferences and other small business events.
Link to David’s Book: Business Fortress
David’s LinkedIn: https://ca.linkedin.com/in/davidbarnettmoncton
David’s Website: https://www.davidcbarnett.com
Connect with Doug Thorpe
