Replacing the Big Dog

By Dennis Boone

In some ways, it is the typical small-business succession story: After a decade of building a start-up with a relative handful of employees into a leader in its field with more than 150 on the payroll, the chief executive is ready to turn the reins over to the next generation of leadership. So he does his diligence, brings on board someone prepared to take the organization to even further heights, and prepares to step out of the limelight.

In other ways, Joe Ratterman’s exodus at BATS Global Markets is not at all like any succession strategy most small businessmen will contemplate. Although he’ll remain affiliated with BATS as chairman after Chris Concannon succeeds him as CEO this month, the company Ratterman has built is now the nation’s second-largest equities trading platform, and the largest of its kind in Europe. Rarely does that kind of success come to an organization so small in numbers, but after eight years of sending seismic shocks through equities markets worldwide, Ratterman was ready for something else.

“I came to the board last July and said ‘Hey, ‘I think it’s time we start to figure out how to  appoint my successor, and I want to do that in a methodical way; I’m not going anywhere—it was just time to make a transition,” Ratterman said. He wanted to make the hand-off before someone asked him to, noting that after periods of high growth, executives naturally drift toward a focus on risk mitigation and protecting what they’ve built, rather than driving that continued growth.

Those are the same kinds of issues—and challenges—that millions of other U.S. executives will be contemplating over the next decade

It’s the same kind of issue that millions of other U.S. executives will be contemplating over the next decade. Fueled in large part by the retirements of business-owning Baby Boomers—10,000 are reaching retirement age every day, and the oldest Boomers are pushing 70—activity is already surging among local business brokerages. Factors like low interest rates, private equity firms that are brimming with cash, a broadening economic recovery and a revival of business valuations to pre-recession levels—or better—have made this an ideal time to sell, area business brokers say.

“It’s very much a seller’s market ac-ross industries in 2015,” says Tim Skarda, managing director for Allied Business Group in Overland Park. “In the last six months, and particularly in the past three months, we have seen a tremendous amount of interest and activity. I’ve heard a lot of people say, for whatever reason, that it feels like 2015 is the year to do a deal.”

Under the best of circumstances, such a deal might ensure that a family business survives into a new generation, that management transition is fluid, that tax consequences are minimized and that an owner’s equity—in dollars, tears and sweat—is maximized. But a surprising number of business owners won’t be
negotiating under the best of circumstances.

That’s particularly true of the Baby Boomers, who account for the largest number of businesses likely to be in play. A great many of them, Skarda says, were nearly ready to make the move as 2007 approached and the wheels came off the economy. “But when the downturn happened, it took them time to rebuild their companies and get them where they were marketable and where the market was prepared to pay them a premium,” he said.

Some have used the time wisely, and have recovered at a good time. Combine the cash stores of private equity firms and strategic buyers with lenders who are more aggressively making deals, “and you have all the dynamics for a seller’s market,” Skarda said.

And that market could get even hotter.

“There is some amazing data out there,” says John Hense, managing director at CC Capital Advisors. “It’s hard to get a handle on the true numbers, but we have seen data suggesting there are roughly 10 million companies with more than one employee where Baby Boomers account for 60 percent, even as high as
70 percent of those companies.”

Other data, he said, showed that 65 percent of the privately held companies sold in the final quarter of 2014 were owned by Boomers, who could exit more than 4 million companies worth more than $10 trillion before they’re through. “Those are huge numbers,” Hense said. “That’s a factor that is going to weigh heavily on M&A over the next 10 years.”

Succession Fundamentals

Even before the recession set in, the dam was near a bursting point. MassMutual’s American Family Business Survey in 2007 showed that 40 percent of business owners expected to be retired by 2017. Many of them had to defer those plans, but slightly more than 30 percent said even then that they had no plans to retire—ever.

For some in the latter group, it was a matter of personal preference—they’d rather work than contemplate life on a golf course. For a great many others, the focus on day-to-day management of their companies had taken their eyes off the wealth-creation ball: More than a third had no regular formal valuations of the worth of their business, and many who were compelled to sell since then have left considerable sums of money on the table because they failed to take steps to maximize the company’s book value.

“A general rule of thumb for us is that about a third really do their homework,” said Hense. “About two-thirds of those we meet with who are contemplating a sale of the company just started thinking about it in the past three to six months.”

One reason for that, brokers say, is that valuations have finally recovered to pre-recession levels.

“Since the bottom of things in ’08-’09, they’re up at least 20 percent,” said Michael O’Malley, of O’Keeffe & O’Malley, a firm that specializes in M&A deals. “That’s assuming they have the same earnings; if earnings have increased, the valuation for that has gone up, too.”

Among the sectors where owners are capturing that value, brokers say, are technology, agriculture, and health care. So strong has been the valuation pop, said Skarda, that “we don’t expect them to get any higher than where they are at right now.”

That was Hense’s perspective, as well: “I think we’re definitely seeing a potential peak in valuations,” he said. “They could go up a little more, but a lot of what’s driving this is debt levels have continued to increase—the more debt you can put on an acquisition, the more you can pay for a company.”

The potential for a peak raises the question of whether more owners should be exploring ways to capture that value now. “It speaks toward timing, the risk of waiting too long, all those factors,” Hense said, but a lot of owners will continue to defer for two main reasons.

“First, some companies are just now recovering from the recession,” he said. “Now the owners are saying ‘Hey, it’s not so bad now, and I’m kind of enjoying it again.’ The other factor is, what do they do with their capital, with their liquidity? Right now, they can put it in a 10-year Treasury at 2 percent, and if they do that, they will not be able to replicate the income they’re taking out of the company right now. That is weighing heavily on the lack of exits that normally would be expecting from those owners at this point.”

Timing and Strategies

For the short term, brokers say, owners who do plan to sell outright or transition the business to a next generation can generally count on a strong market.

“I don’t think people have reached a point where they feel like they have to do this now or risk missing out,” said O’Malley. “There’s so much demand, especially with larger businesses and private equity groups.”

Smaller deals, he noted, tend to be harder to execute, even in this environment. “It’s always been a struggle with those below $2 million in value,” O’Malley said. “Some businesses are just too small for the larger investment groups, and the ‘tweener range of $2-$6 million is too big for the individual investor. Those in the middle sometimes aren’t getting the high multiple that others would be.”

That, said Jim Betterman, a wealth-management and succession planning specialist for Lathrop & Gage, is where creative approaches can come in.

“If there’s a business that somebody’s going to buy or sell, one way it’s done is the buyer will buy a controlling interest, 65 percent or so, and the current owners retain the other 35 percent,” he said, and increasingly, clients are taking such an approach.

“It takes a real ability to match cultures and business plans, because the sellers are thinking about getting out altogether,” Betterman said. “The idea of retaining 35 percent is so that they get a second opportunity to sell, and the hope is that with the combined entity, if it does well, the seller will have  even better liquidity on the second round.”

Allowing the buyer to pay over time, O’Malley said, can also produce a deal that otherwise might be out of reach.

“If the right buyer comes along, they may be willing to pay a higher price, but on terms, with the seller carrying paper, or a piece in the form of an earn-out,” he said. “If the seller can help drive that value and the trend continues, the buyer will pay over time.”

Sellers, he said, could thus “call the shots and name their price if it’s sold to an employee or to somebody who is under-capitalized, and that seller is willing to sell over time and finance a big portion themselves.”

Getting the deal done, even at a higher price, can come with higher risk.

“We see that working,” says Betterman, “but it has to be the right business strategy and the right culture for both sides of the deal. It is very effective if you have the right mix and match of people. With succession planning, it’s really interesting to see that as a way to attract and retain that younger group of leaders.”

Being Prepared

No matter what the strategy or the timing, brokers say, maximizing the value of a business at the time of a sale calls for a long-term vision undeterred by daily distractions.

“As a whole,” said Skarda, “business owners tend to delay these big strategic decisions because they’re pretty well immersed in the daily business. In a lot of cases, if owners did more planning, sought out a little bit of advice two, three, even as much as five years prior to a sale, they could sell the businesses for substantially more.”

Somewhere between two-thirds and three-fourths of the business owners he’s observed have failed to do just that, he said.

“This kind of stuff isn’t fun,” Skarda said. “Fun is chasing the deal down, getting that new order or new contract, buy new equipment—that’s their business. They’re good at it, but this isn’t what they do. That’s not to say anyone has a magic potion that can make their business 50 percent more valuable, or 100 percent, but if you can move the needle 10 or 20 percent, a $5 million business can be worth $6 million, or a $10 million business can be worth $12 million, and that’s huge.”

And if it’s not done? So much the better, perhaps, for the buyer.

“That,” said Skarda, “is why they can pay what they do: They’re going to capitalize on the things that the seller left on the table.”