An estimated $3 trillion dollars will be “left on the table” by small business owners due to failure to plan their business exits

blog_mouse_pc_400_clr_2729My previous blog posting, Reconstructing Avery’s $10.4 Trillion in Business Transfers, details the assumptions and calculations supporting my estimate that the total business valuation for small businesses (which I define as 49 or less employees) is just short of $4 trillion dollars ($3.775 trillion based on my calculations).  That valuation number assumes all small business owners do whatever is necessary to prepare to have a saleable business.  We all know that is not the case.  In fact, an ROCG study of 502 respondents with revenues between $1 million and $100 million found that only 9% had a formal, written transition/succession plan.  For the businesses that interest me – 49 employees or less, I’d guess the existence of formal exit plans may be under 5%, possibly closer to 1%.

It is generally accepted that only 20-25% of small businesses ever sell.  Some would argue the true number is not even that high.  The number one reason small business are not saleable is the business owner’s failure to plan for the sale of their business.  Most owners don’t even realize the necessity to plan for their business exit.  Many think selling a business is like selling a home, but they couldn’t be more wrong.  They have no idea of the number of obstacles they might face.  In fact, in future posts, I will detail and address 66 obstacles I’ve identified that owners must be prepared to address and overcome or minimize.

So, here’s the really bad news that can be deduced from all these statistics.  Assuming only 20-25% of small businesses ever sell and the value of all small businesses (49 or less employees) is approximately $4 trillion dollars, one can deduce that 75-80% of all business owners are likely to leave a total of approximately $3 trillion dollars on the table through failure to plan for their business exits.

I am very interested in your feedback and comments.  Do you agree with the assumptions? What can we do about it?  How can we reach small business owners with this distressing information?

Reconstructing Avery’s $10.4 Trillion in Business Transfers

blog_mouse_pc_400_clr_2729In an extensively quoted 2006 report titled: “The Ten Trillion Dollar Question: A Philanthropic Gameplan”, Robert Avery, an economist and demographer of Cornell University, allegedly estimated that $10.4 trillion of net worth will be transferred by the year 2040 by baby boomers. He is also quoted as indicating the majority of boomer wealth is held in 12 million privately owned businesses. I say “allegedly” because I have tried in vain to find the report by Avery online. However, that $10.4 trillion aspect of the report is quoted extensively by numerous sources online.

I was hoping to see the details supporting Avery’s estimate. Without finding it, I decided to see if I could reconstruct the details.

My interest lies in educating business owners with up to 49 employees (my definition of small businesses) of the need to plan for the sale of their business. I want to determine the estimated total business value of small businesses in the U.S., assuming all business owners prepare to make their businesses saleable.

So, here’s how I’ve gone about it. First, I obtained the “Private Sector Firms by Employment Size of Firm – 2010” provided by the SBA (http://www.sba.gov/advocacy/849/12162). According to those records, there are almost 4.8 million privately owned businesses with 1-49 employees and only 221,660 businesses with 50 or more employees. In addition, there are about 21.7 million non-employer establishments (think: sole proprietorship with no employees). (http://www.sba.gov/sites/default/files/SBE_2011_2.pdf)

Here’s a table summarizing the data by number of employees.

Private Sector Firms by Employment Size of Firm – 2010

Employment Size of Firm

Number of Firms

Percentage of Total

Cumulative Percentage

Non-employer firms   (think sole proprietorships with no employees)          21,700,000

Not included

NA

1-4

2,810,228

56.0%

56.0%

5-9

993,757

19.8%

75.8%

10-19

615,441

12.3%

88.1%

20-49

375,647

7.5%

95.6%

50-99

117,857

2.3%

97.9%

100-249

66,196

1.3%

99.3%

250-499

19,117

0.4%

99.6%

500-999

8,802

0.2%

99.8%

1,000-2,499

5,397

0.1%

99.9%

2,500-4,999

1,943

0.0%

100.0%

5,000-9,999

1,032

0.0%

100.0%

10,000+

1,316

0.0%

100.0%

Total

5,016,733

100.0%

100.0%

Source: U.S. Small Business Administration, Office of Advocacy, from data provided by the U.S. Census Bureau, Business Dynamics Statistics (www.census.gov/ces/dataproducts/bds/). Non-employer firms source: (http://www.sba.gov/sites/default/files/SBE_2011_2.pdf)

Note that 95.6% of all private sector firms with employees have 49 or fewer employees. If non-employer firms are included in that computation, the percentage becomes 99.2%.

To continue reconstructing Avery’s $10 trillion business value number, I used the above SBA data, then estimated the value of businesses. (My calculation chart is displayed below.) For those under 49 employees, I used the mid-point of the range of number of employees and multiplied that number using a valuation average of $75,000 per employee, then multiplied by the number of firms. The valuation estimate of $75,000/employee was based on the businesses I’ve sold over the years. My business sales ranged from $100,000 to $5,000,000 and averaged about $1,100,000 (excluding real estate sold with businesses). That $75,000 may seem high to some, but I was very selective in the businesses I chose to represent and thus my findings may reflect a slightly higher number than the experience of other brokers. Throughout this article, I am assuming business owners have maximized the salability of their businesses. Under that assumption, I believe the $75,000 business value per employee is reasonable.

For those firms with over 49 employees, I assumed large firms are generally more efficient than small firms, so for those I used an estimated valuation of $100,000 per employee. I also researched that estimate and did find some support. Again I used the mid-point of the range of the number of employees and multiplied by the number of firms.

For the 21.7 million non-employer firms (think sole proprietorships), I’ve used an estimated value of $50,000 per business. That may be a little high, but as previously stated, I’m assuming that small businesses can be sold if the owner properly addresses the obstacles they face by planning for the sale of their businesses.

Before going further, I realize businesses should be valued based on their earnings – seller’s discretionary earnings for smaller businesses and EBITDA for larger businesses. There is no bigger supporter of the need to base valuation on earnings than me. I despise rules of thumb and generalizations (especially overstatement of value) when it comes to business valuations. But, I am taking on a challenging task here, and have to use “back of the envelope” estimates for the data I’m trying to develop.

My goal is to estimate the “potential” business value of all small firms, assuming their owners properly plan for their business exits. In fact, only a small percentage of businesses are saleable because owners fail to even realize the need to plan for a transfer. My estimate of $75,000/employee business valuation may be optimistic, but it assumes businesses are saleable because that’s the number I’m trying to reach.

So, here’s my chart of estimated business valuations for all privately owned U.S. businesses.

Calculating Estimated Business Values for All Private Sector Firms

Number of Firms

Employment Size of Firm

Mid-point of Employee    Range

Estimated Business Value per Employee

Calculated Total Business Value for All Firms in Employee Range

21,700,000

Non-employer firms (think sole proprietorships with no   employees)

NA

$50,000

(see assumptions)

$1.085 trillion

2,810,228

1-4

2.5

$75,000

$527 billion

993,757

5-9

7

$75,000

$522 billion

615,441

10-19

14.5

$75,000

$669 billion

375,647

20-49

34.5

$75,000

$972 billion

TOTAL CALCULATED BUSINESS VALUE – for all firms with under 49 employees, including non-employer firms (based on stated assumptions)

$3.775 trillion

117,857

50-99

74.5

$100,000

$878 billion

66,196

100-249

174.5

$100,000

$1.155 trillion

19,117

250-499

374.5

$100,000

$716 billion

8,802

500-999

749.5

$100,000

$660 billion

5,397

1,000-2,499

1749.5

$100,000

$944 billion

1,943

2,500-4,999

3749.5

$100,000

$729 billion

1,032

5,000-9,999

7499.5

$100,000

$774 billion

1,316

10,000+

10,000

$100,000

$1.316 trillion

TOTAL CALCULATED BUSINESS VALUE – for all firms with 50+ employees (based on stated assumptions)

$7.172 trillion

TOTAL CALCULATED  BUSINESS VALUE – for all private sector firms (based on stated assumptions)   $10.947 trillion

WOW! When I started with this exercise, I was unsure what results my assumptions might yield. Avery estimated that $10.4 trillion of net worth will be transferred by the year 2040 by baby boomers. My calculated estimate shows a total business value of $10.9 trillion for all private sector businesses. So, I’m feeling pretty good about my results.

Most importantly, I found the number I was searching for. The chart above shows the estimated value of small businesses (with 0-49 employees, including non-employer firms) is $3.775 trillion. The implications of that number will be discussed in my next blog posting.

I am very interested in your feedback and comments on the above analysis. What are your thoughts?

ATTN! Business Owners: Only 25% of businesses ever sell (How can we spread the news?)

figure_with_megaphone_400_clr_2276Attention, can I have your attention please? Business owners, please – your attention, please. Testing 1, 2, 3. Can you hear me? Hello, anybody out there listening? I have an important message to deliver. Please, can I have your attention?

Business owners: whether you can hear me or not, here’s my message:

Only 25% of small businesses ever sell! If you are like the “typical” business owner, you believe that 50-90% of your personal net worth is in the value of your business. But, 75% of you are not going to succeed in monetizing that portion of your net worth!

Now do I have your attention? Hello? Can you hear me? Please – acknowledge by screaming “Yes, I hear you.” (silence)

That’s my message, but nobody is listening – yet.

As I begin to blog, I find myself dreaming. In my previous blog post, I dreamt that President Obama would mention this problem – 75% of small businesses never sell – in his State of the Union Address and eliminate taxation of small business sales. It doesn’t seem like he intends to do that. But what if he changed the wording of his infamous “You didn’t build that” statement? He could say “You think your building value and equity in your business, but are you really? Only 25% of small businesses ever sell! Get some exit planning advice so you can monetize the sweat equity you have poured into your business. We need to save those jobs ….”

How can we reach small business owners with this message? Dreaming again – I’m a sports fan. I believe a lot of small business owners are sports fans. What if all MLB baseball stadium’s outfield fences had signs that read “Only 25% of small businesses ever sell!” What if the ribbon boards in NHL and NBA arenas around the country flashed three to four times a game: “Only 25% of small businesses ever sell!” How about a silent Super Bowl commercial – it only has words on the screen – “Only 25% of small businesses ever sell!”

Back to reality. How can we reach a large number of business owners with this message? More than a year ago, I did a little research using InfoUSA’s query engine. At the time, I was interested in the number of businesses (in certain SIC codes) with 3-49 employees (small businesses by my definition). That count (excluding some SIC codes that were not of interest) was almost 4,000,000 businesses. There were another 2,600,000 with 0-2 employees. How can we effectively reach those business owners with the message: “Only 25% of small businesses ever sell!”

I am soliciting suggestions. You can dream, as I have. Or you can offer suggestions within the realm of reality (such as LinkedIn Groups that might successfully reach business owners with this message.)

Let’s discuss it. Please comment below.

My Dream for Obama’s State of the Union Address (re: taxes on business sales)

tax_text_pie_graph_1843(Note: I encourage you to read the previous posting in this blog to understand the full context of the implications of Taxmageddon on business sales before reading this posting. As stated in the previous posting, I did not start this blog to comment on current affairs. The need for exit planning is timeless and, for the most part, the need to plan for a business sale is not dependent on what’s happening currently. So this will be an unusual type of posting for this blog.)

A prequel (dream) excerpt of President Obama’s State of the Union Address:

“We all recognize that small business drives our economy. Small business owners create 70% of all jobs in our national economy. I was recently provided with astounding research that indicates there are approximately 7 million baby boomer business owners, yet only 20-25% of small businesses ever sell. I’ve been informed that the onerous tax implications of a business sale are one of the major reasons that elderly business owners never transfer their business. We cannot allow 75-80% of businesses to wither away.

We cannot afford to lose the millions of jobs those owners have created. As baby boomer business owners age, there is nothing more critical than having those businesses passed to the next generation of business owners, who with their entrepreneurial spirit and drive, can not only maintain existing jobs, but grow the businesses and create new jobs.

Although I am not backing down on my call for new taxes on the wealthiest among us, I recognize the need to exempt the taxation of small business owners who sell their businesses. Those owners are the heroes of our society. They deserve to be rewarded for the countless hours of sweat equity poured into their business. We absolutely have to make sure that retiring business owners are passing along their businesses to the next generation.

I call on Congress to immediately enact legislation to completely eliminate all taxes on the sale of a business, including making an exception within C-Corporation tax regulations where the tax implications are most devastating. While we may not be able to agree on many issues in our political undertakings, this is something we should all agree on. Let’s get this done next week.”

Do you like my dream?

Taxmagedon’s Affect on Small Business Sales

tax_text_pie_graph_1843I didn’t really establish this blog to talk about current affairs such as Taxmageddon. The need for exit planning is timeless and, for the most part, the need to plan for a business sale is not dependent on what’s happening currently. Current affairs do affect the details of exit planning, but not the necessity of exit planning. So, from a content standpoint, this will be an unusual posting and much longer than what you will see here in the future.

In my public accounting career, I learned the tax regulations have more exceptions to rules than rules themselves. I was not interested in being an attorney or providing tax advice because I found it to be so tedious and boring. So, I stuck to the audit side of the business.

In my career as a business broker, I’ve had to become generally aware of the tax regulations as it relates to business sales. I am not an expert by any means, far from it. I leave all that to the tax accountants and tax attorneys that spend their days learning all those monotonous rules (and exceptions). But, let me say this, those guys are worth their weight in gold for anyone that is considering selling their business.

The tax implications of a business sale are onerous at best and can be devastating. The fiscal cliff tax implications have the potential of being destructive to small business sales. Surely, the President and congressional leaders will take into consideration the tax implications of small business sales. (Won’t they?) After all, they always say that small businesses drive our economy.

I’m a little concerned about writing this because tax law is very complicated when it comes to business sales. Those guys that are worth their weight in gold (the tax accountants and tax attorneys) may be horrified by my understanding and summary. (If tax experts see this, please feel free to correct me through comments.) All I can do is the best I can do based on what I think I know and I’m going to try my best to keep it simple. (after drafting: I tried, but it’s not easy to do.) I’m pretty sure there will be some mistakes in this analysis, but it’s the overall thought that counts (and hopefully the mistakes will be immaterial to the overall theme).

For purposes of this posting, I’m going to ignore ordinary income tax implications of a business sale, such as depreciation recapture, consulting agreements, etc.

First, let’s look at the horrific tax implications of the sale of a C-Corporation (C-Corp) under today’s tax laws (as I understand them). C-Corps are subject to double taxation when a business is sold. Most small business owners don’t realize that there is no beneficial capital gains tax inside a C-Corp. All corporate income above $75,000 is taxed at rates between 34% and 39%. Depending on many factors outside the scope of this discussion, when an owner sells his C-Corp business (as an asset sale), the corporation will probably have to pay taxes of about 35% of the selling price (not necessarily true as much depends on the actual financial statements of the C-Corp). That’s bad, but it gets worse.

The proceeds of that sale are deposited into the bank accounts of the C-Corp. An owner really wants those funds in his personal bank account. But when those funds are withdrawn from the Corporation, the business owner is taxed again on his personal tax return at a 15-20% rate depending on whether the distribution from the C-Corp is a dividend or considered capital gains. Now the owner has paid the federal government an effective tax rate of about 45-48% in taxes (because the latter tax is really only on the distribution amount which is 35% less than the selling price because of the C-Corp tax). Let’s assume the owner lives in a state with 5% state income tax. Now the owner has paid 50%-53% in income taxes on the sale of the business.

So, what does the fiscal cliff do to the poor business owners if Congress fails to act? As I understand it, these two taxes are already “baked in”: 1st) it tacks on another 3.8% investment income tax to fund Medicare and Obamacare; 2nd) I believe there is also another .9% payroll tax on high-income earners to fund Medicare and Obamacare. As I understand it, under fiscal cliff taxation, dividends (the distribution of the after-tax proceeds from the C-Corp) will be taxed at ordinary income tax rates (i.e. 31% above $142,700, 36% above $217,450, 39.6% above $338, 450), more than twice as much as today’s 15% dividend tax rate. In addition, capital gains will rise to 20% from 15%.

Let’s get back to the poor business owner. If my math is right, under fiscal cliff taxation, his effective tax rate (including 5% state income taxes) might rise from an effective tax rate of 50-53% to 56% to 63% on the sale of the business. How many business owners are going to make the decision to sell if they only keep 40 cents of every dollar? In evaluating small businesses as a business broker, I ran across a LOT of C-Corp owners who couldn’t stomach the approximate 50% tax bite on a sale of their business. Now, they are facing 60%!!! Are they going to decide to sell their business or die in their chair?

Pass-through business entities such as sole proprietorships, S-Corporations and LLCs do obtain the benefits of the 15% capital gains rate when a business is sold (ignoring all the things that are taxed at ordinary rates such as depreciation recapture, consulting agreements, etc.). It seems to me, under Taxmageddon, they may be taxed at an additional 9.7% (the 3.8% and .9% Obamacare taxes, plus the 5% increase in capital gains tax.) If that is true, the effective tax rate on small business sales (pass-through entities) is increasing by about a whopping 65% (9.7%/15%)!!!

It is worse yet. Tax rate rises to 55% on estates over $1 million, up from 35% on estates
over $5 million. Don’t die in 2013! If only that was within our control.

What if business owners continue to hold on to their business because of the ugly tax implications of a business sale? I’ve seen it often – more common than not – business owners hold on too long, they lose enthusiasm (or die) and the business begins to degrade and is no longer saleable. The business ultimately shuts down. The employees are out of a job and families are devastated (often, including the business owner’s family).

Small business drives this economy. When burned-out or elderly business owners are able to sell their businesses, it is usually to a younger generation person who can supply the entrepreneurial spirit and drive necessary to revitalize (what is usually) a stagnant business. Those new owners create new jobs and help our national economy flourish. That’s why taxation of small business sales needs an exemption (or significant adjustment ) from the current and upcoming Taxmageddon regulations.

Why I’ve Decided to Blog – 75% (or more) of Businesses Will Never Sell – That’s Why

blog_mouse_pc_400_clr_2729I am passionate about small business. I truly do think small businesses are the primary driver of our national economy. But what I really love about small business are the owners. Over the course of my 35+ year business career, I’ve met all kinds of owners. Some have great business skills, some have very little business skills, some were brilliant, some were not so smart. But all of them were living the American dream of owning a business. And, mostly, that’s what I love about them.

The “game of business” is seldom easy. In most instances, it requires significant internal fortitude and persistence to push through all kinds of obstacles – just to break even! And then the small business owner has to have the tenacity to push the business to profitability. For most, it’s a struggle that requires much more than the typical employee’s 40-hour work week. That’s what I admire most – the “sweat equity” investment required of most business owners.

So what’s that got to do with my decision to blog? Well, here’s the thing: when they are ready to end their business ownership career, almost all owners would like to cash out their “sweat equity” investment, but 75% or more will never be able sell their business to convert it to cash! And that is a crying shame.

If only owners realized they needed to plan for the sale of their business, I believe most could sell their business. My goal, as unrealistic as it may seem, is to turn around the odds of a successful business sale. At this point in time, the odds are about 3:1 against a successful sale. In conjunction with others (other authors, exit planners, business brokers, business valuators, CPAs, attorneys, personal financial planners, and other business advisors), I’d like to turn that statistic around to 3:1 in favor of a successful sale. That’s a very ambitious goal, but there is almost nowhere to go but up.

While I await the coming release of “How to Plan and Sell a Business”, I couldn’t wait any longer to get started at achieving my goal. So, this blog is born!

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