Many business owners who plan to cash up to fund their retirement are setting themselves up for disaster, an expert in business sales is warning.
Bruce McGechan, an entrepreneur and business exit planning expert, says four out of five small to medium-sized businesses don't sell leaving many who have their wealth tied up in the business struggling to fund their golden years.
"I've seen people shocked, disappointed - and absolute worry. Not just them but their spouse, watching the plans they had fall apart."
The size of the problem has prompted McGechan to write a book about it in a bid to raise awareness of the issue which he says is not just a New Zealand one but also found in Australia and the United States.
"When you have four out of five businesses having something wrong with them in the eyes of investors such that they either won't sell, or get what seems to be distressed sale prices, you go 'there is something wrong here'."
McGechan says one of the biggest issues is lack of transferability.
"A business will be run by the business owner, the business is reliant on that owner. If the owner gets hit by the proverbial bus then the business could well fall apart."
He says owner reliance means there are unlikely to be any processes or procedures written down meaning the owner can't walk away and have the business continue to run.
"They don't have middle management that are skilled and able, they don't have manuals that a new owner or general manager can pick up and run the business."
On top of that there may be issues around customer concentration risk.
"That is where a customer makes up at least or probably more than 10 per cent of a business' revenue and if you rely on these large customers and they decide to go to one of your competitors then your company immediately drops in profit, has no profit or such large losses that it goes bankrupt."
Undisclosed legal issues that only come up under due diligence are also another red flag, he says.
"Investors look at those issues and they go: 'the risk is too great for me to invest or buy this business' and they walk away."
Buying a job or building a business?
McGechan says for many who own a business it is purely about providing a job or a lifestyle for themselves and their family.
He says there is nothing wrong with having a lifestyle business.
"I respect anyone making a good income from business, the issue comes from assuming their business sale will fund their retirement."
He says lifestyle business owners should be saving for retirement like salary earners, putting money aside on a regular basis.
While there is no official definition of a lifestyle business McGechan classifies any business that has earnings before interest, tax, depreciation and amortisation below $1 million as mainly a lifestyle business.
"Certainly less than $500k it is. Over $1m that is a mid-market company and can be a person buying a job but at some stage they have got a business that can operate not as just a job."
He says a lifestyle business owner is typically focused on the business paying out dividends but those who want to sell up need to build value and a business that is not reliant on its owner.
Building value is key to selling a business for a good price as the sales price is typically based on a multiple of two or more of its earnings.
"The multiple for a million-dollar business can be between two and 10 times. The multiple range varies so much because of the intangible value in a business which usually makes up 80 per cent of its value."
That intangible value comes from its customer capital - recurring revenue from customers, human capital - good middle management, structural capital like IT systems, processes, procedures and manuals, and social capital which is the sum of everything from the buzz of working for the business and its brand.
"As you build those up the multiple increases."
McGechan says making a business independent of its owner means the owner should be working on the business not in it.
"They need to have good managers in place, good procedures and processes."
The other side of the process is business owners seeing a financial adviser to work out what kind of income in retirement they want and how much they need to sell their business for to pay for it.
"That will tell you your wealth gap - the difference between your personal net worth now and what you need the business to sell for to live the lifestyle you want in retirement."
He said a business exit adviser or investment banking expert could then give an idea of what the business was currently worth and could sell for.
McGechan urged those planning to sell their business to fund their retirement to start working on it at least three to five years in advance as it often took around a year to 18 months to prepare and market a business for sale.
He said business owners should also make plans for what they will do post-retirement.
"Most business owners are spending 60 hours in a business, many of them weekends. Business is family, family is the business often the children are involved, certainly the wife and husband are involved. They have been spending all this time on something they love, their baby, their business and yet when they retire they have now got 60 to 80 hours a week.
"There is only so many hours in a week you can play golf or do gardening. A retired person who has been an active business owner needs to know when they sell their business they are going to have a fruitful retirement. That is the major reason many businesses don't sell because the business owner has a contract in front of him or her and they go: 'what am I going to do?'."
He said getting advice from a financial adviser was key.
"They need to have someone on their side to work through their goals and how they are going to fund it and work back to the business exit.
"If you don't do that and don't have a reasonable expectation as to the business being able to be sold in the first place your retirement is going to be a disaster."
*McGechan's book, Selling a New Zealand Business with "No Regrets" went on sale on April 1.