When the business is the owner: what a buyer, a lender and a successor see

Written By Corinne Kirk

Many owners describe their business as a team. In many cases it is one person with helpers. Every price is set by the owner, every important customer telephones the owner, and every difficulty finds its way to the owner's desk. The business earns well, and the owner is rarely at fault for having built it this way. It is how most businesses begin.

The difficulty appears at a particular moment, when someone is asked to rely on the business without its owner. A buyer is asked to purchase it. A lender is asked to advance against it. A successor is asked to run it. Each asks the same question: what remains when the owner is absent?

Earnings and value are different things

A business can produce a good income for its owner and still have little to sell. The difference lies in where the earnings come from. Some profit is the return on a system — customers who stay because of the product or the contract, staff who deliver without supervision, procedures that run the same way on any day. Some profit is the owner's own labour, recorded as business profit because the owner has not been remunerated at a market rate for it.

A buyer separates the two. The usual approach is to restate the earnings as if a manager had been engaged to do the owner's work at a market salary, and to value what remains.

Consider a distribution business that reports a profit of $400,000 before any payment to its owner, who works most weekends. A manager capable of doing the owner's job would cost $180,000 a year. The earnings a buyer assesses are therefore $220,000, not $400,000. The accounts were accurate. They answered a different question from the one the buyer is asking.

Where dependence hides

Dependence is seldom a single weakness. It tends to sit in four places.

Relationships. The customers know one name. The supplier terms were agreed in conversation with one person. A buyer cannot be certain that either survives a change of owner.

Knowledge. The pricing logic, the history of the largest client, the reason one machine is always run first — all held in one memory and recorded nowhere.

Decisions. Nothing proceeds without the owner's approval. To an outsider this suggests that no one else has been trusted, or trained, to decide.

Numbers. Where the owner alone prepares, or understands, the management reports, the business has no financial voice of its own. Both a lender and a buyer read those reports, and neither can rely on a business whose numbers only one person can explain.

What changes the picture

Dependence is reduced by decisions taken years before a sale, not by preparation in the final months. The work is ordinary. Decision rights are written down and delegated, with limits. Procedures are documented by the people who carry them out. The principal customer and supplier relationships are shared with a second person and, where practical, recorded in a contract. Monthly financial reports are produced to a fixed timetable and read by someone other than the owner. A second layer of management is built and given real authority.

None of this makes the business less the owner's. It makes the owner optional, which is a different condition, and the one a buyer, a lender or a successor is able to assess.

When the owner does sell

The tax system treats the sale of a small business as an event with its own rules. Four small business CGT concessions allow some or all of a capital gain on an active asset to be reduced, disregarded or deferred: the 15-year exemption, the 50 per cent active asset reduction, the retirement exemption and the roll-over. Each depends on conditions tested at the time of the sale. The basic conditions include either aggregated turnover below $2 million or a pass of the maximum net asset value test, and an asset that meets the active asset test.

The 15-year exemption disregards the whole gain where the asset has been continuously owned for the 15 years before the sale and the owner is 55 or over and retiring, or is permanently incapacitated. The retirement exemption disregards gains up to a lifetime limit of $500,000; the owner need not leave the business to use it, and where the owner is under 55 the amount must be paid into a complying superannuation fund.

These concessions apply to a business that exists as an asset which can be sold. A business that cannot operate without its owner leaves less to sell, and the concessions then reduce tax on a gain that may be small or may never arise.

The principle

The value of a business lies in what continues when its owner is absent. That condition is built over years, in decisions that are unremarkable when taken and decisive when tested. It is seldom assembled in the months before a sale, a loan application or a retirement.

The owner's skill is not the difficulty. It is the reason the business exists. The question is whether the business has been taught to do without it.

If you would like to review how much of your business depends on you — and what a buyer, a lender or a successor would find in your absence — we welcome the conversation.

Corinne Kirk
Partner, Accountant

1300 102 542 | 0405 106 401
corinne@egu.au

 

Sources

 

This is general advice. It does not take account of your objectives, financial situation, or needs, and is not a substitute for advice that does. Before acting on anything in it, consider whether it suits your circumstances, and consider the relevant Product Disclosure Statement.

Corinne Kirk
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