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Flexibility and creativity will be needed to transfer family businesses in 2009

Written on 18 November 2008 by Joseph Bazzano; posted by Jennifer Pooni

The aging of the Baby Boom generation, combined with today’s economic uncertainty, means there will be a rising tide of owners seeking to transfer their privately held businesses in 2009. If your exit plan involves a sale of your business, here are five trends that will help you think strategically about this important step.

1. The market will be saturated with businesses for sale. Smart family business owners approaching retirement will need to have a transition plan in place to deal with what is sure to be a saturated market for privately held businesses in the next few years. There may be enough buyers in the short term, since the weak labor market is expected to continue into 2009, releasing a stream of would-be entrepreneurs. But the stream bed will dry up, so business owners are advised to consider alternative strategies to traditional sales.

2. Alternative exit strategies will be on the rise. Many people have tied up more than 80% of their wealth in their illiquid business. Few take the time to look for the alternatives that may be available to them, or don’t understand the various options. Many will want to “cash in” to liberate the wealth trapped in their business. Yet, given the uncertainty of the current economy, a growing number of business owners will need to seek exit strategies that don’t involve straight sales.

There are many alternatives that can pull illiquid assets out of a business, including:

* A management buyout, in which the company’s existing managers (family or non-family) acquire part or all of the company.

* ESOPs (Employee Stock Ownership Plans).

* Transfer of ownership to family members in the form of a gift, a sale or a combination of the two.

3. The credit market will disqualify some buyers. The turmoil on Wall Street that has shaken up the banking and credit industries will continue to put a squeeze on lending standards. As a result, family business owners will have a harder time finding qualified buyers. For example, the market has evaporated for uncollateralized loans, a form of debt financing in which a lender funds against the borrowing company’s cash flow. As banks become less of an option for cash-flow loans, many companies are turning to private equity firms, whose interest rates are much higher than banks’.

4. Certain sectors will grow; others will shrink. Businesses in professional services, health care and social assistance are projected to thrive in 2009 and beyond, as Baby Boomers age. U.S. manufacturing will continue to stagnate in 2009 owing to globalization. That said, certain segments, like green manufacturing, still have growth potential.

5. Less favorable tax rates for businesses may be on the horizon. Business owners should start planning now for the end of the Economic Growth and Tax Reconciliation Act at the end of 2010. The act provided sizable tax benefits for business owners when it was enacted in 2001. Unless new legislation is passed to extend it, business owners can expect to pay higher estate, gift and capital gains taxes after Dec. 31, 2010.

Understanding the tax laws and how they affect any deal is crucial to the seller’s bottom line. This is even more important as a new presidential administration takes office. We are currently advising our clients to revisit the value of their estates, including valuation of their privately held business, in order to determine the exposure to the estate tax and what plan is best suited for minimizing that exposure.

 

Two key questions

Regardless of the economy, family business owners considering a transition must ask themselves two questions: “What do I want?” and “What do I need?” For business owners looking at options for transitioning ownership -- whether it’s selling now and moving to that cabin by the lake or to positioning the business for transition to the kids in five years -- the most important consideration is replacing the income from the business in order maintain the lifestyle they envision.

There are a number of choices available that can help business owners achieve that lifestyle. Obviously, supply and demand in the marketplace, the general health of the credit markets and economy, and Washington’s handling of the tax laws are all vitally important to selling or transitioning a business. But the bottom line is this: There will always be buyers and sellers of businesses. That won’t change in 2009. What may very well change are the particulars of those sales. We expect family business owners will need a lot of creativity as they look for ways to move out of their current businesses and into the next stage of their lives.

 

Joseph Bazzano (jbazzano@petransitions.com) is a Certified Valuation Analyst with nearly 20 years of experience in public accounting services, including mergers and acquisitions and business valuations and tax planning, to closely held businesses of all sizes. His company, Bloomfield, Conn.-based Private Equity Transitions LLC, specializes in providing comprehensive solutions for owners seeking the best exit strategies.