Exit planning for the ‘lifestyle’ business owner

You may be surprised to learn that, for the vast majority of businesses operating in the U.S. today, the method of exiting the business will be to wind down operations when the current owner ceases to be active in the business.

According to the U.S. Small Business Administration, there are over 28 million privately owned businesses currently operating in the nation. Of this total, approximately 22 million are owner-operated and have no employees other than the owners. These businesses depend their success on the unique training, skills or relationships of their owners to their clients and customers.

In most cases, these businesses will simply cease to exist once the current owner is no longer around because the relationship (“stickiness”) of the customer or client is to the individual who provides the products or services and not to the business entity through which the owner operates.

Think of the self-employed owner of a business that provides a product or service that cannot be replicated by others. Examples include an artist, actor, entertainer, professional chef or athlete. These individuals’ personal skills and talents are so unique that it is not possible to replicate them, in order to separate the owner from the business.

In most cases, the value of these businesses consists exclusively of the “personal goodwill” of that owner, a “value” that is not capable of being transferred to someone else. 

The same is true of many professional practitioners (physicians, CPAs, lawyers, etc.) for whom the client relationship dynamics drive the value of the practice.

These client relationships are not transferable in the traditional sense and, therefore, in most cases, the professional’s practice will have little or no value to an acquirer because there is no assurance that the clients will remain with the practice. 

Another example is independent services providers (physical therapists, freelance court stenographers, etc.) who contract their services through outside organizations.

The training and experience required to become skilled in these professions create high barriers to entry. As a result, these practitioners can achieve significant financial success during their working years. However, in most cases, these practitioners do not have the ability to transfer that financial success to another once they stop working, since their relationship is with the contracting organization and not with the client who actually uses their services.

These types of businesses can best be characterized as “lifestyle” businesses, by which I mean a business that has a value that is limited to its ability to maintain the lifestyle of the owner but only while the owner remains actively involved in running the business.

These businesses are generally not transferrable by sale or otherwise when the owner stops working. Therefore, exit planning in the traditional sense will not be of value for owners of these businesses.

Rather, the focus of planning will be on either extracting value from the business, while the owner is working, that can be accumulated to meet the lifestyle and other financial requirements once the owner is no longer working, or taking steps to convert the business into one that can create value (“enterprise” value) independent and in addition to that which is provided by the owner’s involvement in the business.   

Extracting value from the business while the owner is working is similar to the financial planning that is done by an employee who sets aside earnings into company-sponsored retirement savings vehicles or personal investments to help provide for financial security in retirement.

The owner of a “lifestyle” business can use many of the same types of retirement savings vehicles, including SEP-IRAs, proprietor and business-sponsored pension and profit sharing plans, etc., along with personal savings and investments to provide funding for future financial security in retirement.

Paul B. Stevenson of North Hampton provides exit planning and business valuation services for owners of privately-owned businesses. He can be reached at 603-964-3742 or at pbstevenson.com