I wrote a post about the real (nay, ONLY) succession plan for any small business: sell it!
But, Steve asks about the alternative:
What if you don’t plan to leave? I mean, Maybe the plan is to run it till you can’t any longer, then the wife runs it till she is ready to sell, or pass to the kids(if they are even interested in that type business). My idea is to find Businesses that provide (mostly Passive income) where you don’t need to spend much time at the shop daily. Where your biggest job is probably gonna entail paperwork.
This is the ‘pipe dream’ of many a small business owner – and, was certainly my father’s ‘dream’ … bring the kids into the business and then pass it on to them. After all, look at the advantages:
– Continuing ‘passive’ income … your kids will eventually run the business and look after you
– You’ll be smart enough to keep a chunky % of the business for yourself to ‘guarantee’ a healthy share of the ongoing profits
– No issues around selling the business, finding the right buyer, or handing it over
– It’ll keep the kids off the streets (probably, my father’s greatest motivation)
And, that’s certainly the central theme of a book that I reviewed some time ago, called Get Rich, Stay Rich, Pass It On: where the authors suggest that the ONLY way to ensure that your wealth carries on through the generations is to have roughly 50% of it in “continually innovative enterprise/s” a.k.a. a business:
What we mean here by a continually innovative enterprise is one that either offers a product or service that breaks new ground or changes a traditional product or service so much that it becomes virtually new.
As I said in my review: “that is something that you do before you retire so that you can retire rich … you take risks, you innovate, then you sit back and reap the profits (or sell)”.
But, there’s a serious flaw in this logic: 99.9997% of small businesses are inextricably tied to the owner; large companies know this, that’s why when they buy a small business, it usually comes with an employment contract to tide them over until they can ‘wash out’ the Owner/Founder Effect:
This is the truism that the business IS the owner/founder and the owner founder IS the business!
The reality is that owner/founders and their businesses cannot be parted so easily and these large companies should NEVER buy small businesses because of the Owner/Founder Effect … inevitably, the owner falls afoul of the new management, leaves disappointed [AJC: hopefully, with bundles of cash in her pocket to help console her 😛 ], and the business goes downhill thereafter.
Eventually, the business becomes ‘absorbed’ in the overall enterprise and they conveniently ‘forget’ that they totally stuffed it up … and, more often than not the old owner eventually buys back his own business for 25 cents in the dollar.
Friends of mine started a computer company and sold/bought it three times … each time selling high, buying low and making a heap on each subsequent sale 😉
Do you think it’s any different, Steve, when you ‘sell’ your business to your wife and/or children?
Because that’s exactly what you are doing: selling it to the least qualified purchasers; you may be able to teach them some of what you know … perhaps even a lot … and, there’s a VERY slight chance that you will be able to teach them (assuming that they have the will and ability to take on what you teach) 98% of what you know …
… but, you can NEVER pass on that last 2%: the Owner/Founder Effect ‘magic’ that made your business one of the few small-to-medium business success stories.
That’s why I called the book’s concept of encourage people to start/buy, then keep, these innovative enterprises “the most dangerous idea in retirement planning that I have ever read”, because that last 2% – the bit that is IN you and ONLY in you – is the bit that you CANNOT pass on and will eventually send your family broke.
Of course, there’s at least (my best guess) a 0.0003% chance that your business COULD become the next Walmart and pass on to at least ONE more generation, but I wouldn’t be willing to bet my family’s financial future on that.
So, instead of trying to fit your business into your Life, here’s what to do:
1. Find Your Number, the one that allows you and your family to live their Life’s Purpose
2. Apply a FULL 100% of YOU to molding the business into something that can be sold for at least Your Number (LESS the value of any investments that the excess cashflow that you truly outstanding business has been able to fund)
3. Spend your free time TEACHING your kids how to fish for themselves
… that’s what I’m doing for you, and that’s what I suggest you do for them 🙂
Bingo!!! Just about the smartest advice I have read on protecting/preserving the retained earnings in a business. You echo my sentiments on how to pass generational wealth –never gift an operating business — always sell. Every business must always be for sale and must always be sold. Every person, product and service has a life-cycle. Understanding where a company is in its lifecycle is the first step in probing the market for the peak of its enterprise value. Businesses are merely an instruement of wealth creation. When owners try to make them more –make them a family project — or try to pursue their longevity — they destroy value and family relationships and almost always in that order.
Ardian,
Here is what I think is a good “fishing” question that I’ve been wondering about that could be a useful future post:
What are good use cases for different types of corporations, i.e. When should I choose an LLC over a sole proprietorship, S corporation or other legal structure.
-Rick Francis
@ Thomas – Beautifully said … I’m going to reverse this and make your comment my post, and make my post the comment 🙂
I really like this line: “Every person, product and service has a life-cycle” … something for EVERYONE to keep in mind.
@ Rick – I’ll never answer that one myself because I am not an attorney, but if any of our readers is an attorney, I’ll happily take a guest post?! Great question, though.
Also, in the US, the entity that you choose, may vary by state due to the differing laws, I believe?
@ajc- Great post. In what circumstances would you actually recommend an indiviual buy a small business over starting one?
Also, when I read the title of this post, I thought it was going to be about you not wanting to stop making deals. I’ve been assuming that you have already reached your “number”, am I right? If so, have you stopped taking larger than needed risks?
Excellent Post.And(Salamat Po)Thanks for the helpful Ideas.
Ryan makes a wonderful point here. So have the businesses your in become more of a hobby ,since we all assume you’ve reached your number by this point?
Whats to say,if you sell your business ,it won’t go under in a few months/years ,since you pointed out that that 2% of you can never be taken out.Or ,maybe its not for us to care at that point ,since we have reached our number,and sold to do the things we were hoping to do at that stage in life.
@ Ryan – Yes, part of my Life’s Purpose is to ‘travel intellectually’ … one of the ways that I like to stimulate my intellect (what little there may be) is by starting businesses. I always wanted to be a VC … not for the money, so much as for the challenge/fun/creativity.
But, you are right, I don’t want to risk too much of my Number … fortunately, I live by my words and have set up a partnership with a s/w development firm. I figure that we can start 10 ‘internet businesses’ for around $500k of my cash total. Who knows, I may even get lucky (again) 😉
Adrian, I was reading about property investments. Wonnder if you could expand and talk about this a bit more,so we can all learn more about this (see article below)
Debt Service Coverage
For real estate loans, the debt service coverage ratio is Projected Net Operating Income (ie, rents less operating expenses)/Debt Service (principal plus interest). When making income property loans, a debt service coverage ratio of 1 is the minimum required to ensure the property generates sufficient income to cover the debt. Indeed, most lenders will require some cushion and demand a debt service coverage ratio of 1.25 or better.
@ Steve – I will be doing some more articles on investing in RE, but I have built up a multi-million dollar investment portfolio and I can’t even spell D E B T S E R V I C E C O V E R A G E 😉
In the meantime, all you really need to know (because this is all I know about investing in RE … really) is in this series of posts (follow the backlinks to get back to article # 1):
http://7million7years.com/2009/01/05/anatomy-of-a-commercial-re-investment-part-3/
Can’t spell it? you did fine there adrian 😉