For Managers: Best Practices

FOR MANAGERS
Best Practices

Exit Strategies: Part II
Key step is finding the right buyer

By Ronald A. Schmaedick

In this second of a two-part series on how to bring your successful real estate career to a happy and profitable close, REALTOR®Ronald A. Schmaedick, a consultant in the field of buying and selling real estate companies, tells you where to look for buyers, how to allay their fears, and where to get expert help.

Finding successors is the key step in a successful exit strategy.

Most owners have put so much of themselves into the business that keeping it in the family is their first choice (see sidebar on page FM2). The biggest problem with that is, most young family members don’t have the financial resources to pay any serious up-front cash. The next question is, do they have the ability, experience, and tenacity to stay with the business and pay for it out of earnings?

One owner of a 40-person company set up the corporate stock so that he and his wife could gift the shares to their children, including the successor son, as much as the federal income tax law would allow. Then the son bought the remaining shares plus his siblings’, since they had no interest in the business. Incidentally, the son quickly moved the business to profit levels far in excess of those of prior years, so the buyout was done with ease.

More potential buyers
Other potential successors or buyers include managers or salespeople currently with your company or with competing companies; local companies in a growth mode; companies in nearby markets that want to expand to your market; and large building and development companies in your area that want to own a “marketing arm.” Builders and developers find themselves paying lots of real estate fees and may feel they could provide a better service at less cost; since they often control significant real estate inventory, owning a real estate company in some cases is a natural extension of their enterprise.

Insurance agencies and other financial services companies with the potential of cross selling integrated financial services are potential buyers and have had on-again, off-again romances with the real estate business. Many of the old-line real estate companies were born out of local insurance companies. Today a few mortgage lenders are stepping into real estate brokerage directly and indirectly.

If the Real Estate Settlement Procedures Act regulations are redefined to encourage one-stop shopping and cross sales of real estate andfinancial services, you'll see even more interest from those local financial institutions. This interest will accelerate as the regional and national real estate companies and franchises bring integrated services to your town. Local companies will develop local affiliations to compete and maintain market share.

What if the buyer hesitates?
Most real estate companies of any significant size are sold with the downpayment up front and the balance paid over time. Frequently, the installments are based on the future revenues of the company. Therefore, it’s important to the seller that the new owners be successful.

The single most important concern of those buying a business is the risk of its collapse as a result of events they can’t control, for example, an economic downturn. In a real estate brokerage, the biggest concern is focused on the question, will the productive salespeople stay with us?

There are no guarantees they will. But you can allay that fear by sharing risk with the buyer. The best way is to structure a transaction wherein a significant portion—20 percent to 50 percent—of the purchase price is paid in installments based on gross commission income (GCI) over a two- to five-year period. The size of the installments is a percentage of the company's revenue during the installment period.

As a simplified example, let’s assume that Betty Broker is selling Able Realty's assets for an estimated $580,000. Her company is a well-managed brokerage in a niche market earning 8 percent of GCI before paying interest and taxes. The sale is based on the following pricing:

Current listing inventory—Twenty percent of Able Realty's net income (listing side only), after paying co-op offices and salespeople, will go to Betty on all listings on the books that sell and close within one year of the company's sale. Estimated cash to Betty from the listing inventory is $80,000. This cash will be paid as the transactions close.
Current pending inventory—Eighty-five percent of Able Realty's income on transactions signed on both sides by the date of the sale of the company, after paying co-op offices and salespeople, will go to Betty. Estimated cash to Betty as the selling broker is $200,000. This cash will be paid as the transactions close.
Furniture, fixtures, equipment, and goodwill—The estimated value of $300,000 will be paid as follows: $150,000 cash downpayment (50 percent) and the balance of $150,000 (50 percent) paid in installments over three years.
Bottom line—If Able Realty's GCI is about $1.8 million annually, that’s $5.4 million over three years; $150,000 (50 percent) divided by $5.4 million is 2.78 percent. Therefore, Betty will receive 2.78 percent of the company's GCI for the three years. The ratio is fixed. If the GCI goes up or down, so does the size of the payment to the selling broker. In most cases, the energy and excitement brought in by the new owners will increase the GCI. The GCI is chosen because it’s the most verifiable number and the most difficult to manipulate.

Under these circumstances, a buyer can be comfortable paying Betty more because Betty shares some of the risk.

Getting help with the buy
Where do you get assistance? In-house accountants and attorneys can aid you with the final details of the income tax and legal aspects of a succession plan. However, when you begin exploring your options, establishing a price, and, if necessary, searching for a buyer and entering into initial negotiations, expert help could put more net dollars in your pocket.

An outside consultant can help you analyze what the company's true profits are and determine a reasonable price. An outside consultant's formal appraisal can expedite negotiations between buyer and seller. The consultant can facilitate negotiations by being more objective and less emotionally involved. The experienced creative consultant can find ways to help both the buyer and the seller attain their goals.

Consultants come in two flavors. One is a generic business consultant who can be found in most cities with a population of 250,000 or more. The other is a consultant who specializes in the real estate industry. They can be identified by contacting the Real Estate Brokerage Managers Council of the REALTORSNational Marketing Institute® at 800/621-8738, or, if you're a member of a franchise, its regional or national headquarters may be able to refer you. One precaution—some “consultants” in our industry are currently so committed to the “bigger, better, best” syndrome that if you aren’t a mega-operation, they tend to expect you to put up the white flag and sell out for pennies on the dollar.

And that’s about it
The key to a successful exit is thorough planning on several levels, which allows you to identify, prepare for, and overcome the major hurdles that block the best intentions.

With your plan in hand, someday you'll be able to leave your business with a warm heart, a smile on your face, and money in your pocket, confident that you did the right thing for your family, yourself, and the people who supported you over the years.

Ronald A. Schmaedick, CRB,is president of Schmaedick & Associates Inc., Eugene, Ore., and a consultant in the valuation and buying and selling of real estate companies. He's also an active associate broker of the commercial department of Realty Executives, the company he sold to his daughter in 1996. You can reach him at 541/465-1704.

All in the family
Many owners who decide to get out of the business want to pass their company on to a family member. That’s not always an easy choice, says consultant Ronald A. Schmaedick.

Answers to the following questions could provide you with some guidance.
How can I treat all my children fairly?
Who should own the business?
Who will be CEO?
Who will have voting control?
How much money will I get for the business? When?
How long am I prepared to personally indemnify—or guarantee—the creditors or the company?
What are the income tax ramifications of my plan?

For more information on succession plans for family-owned businesses, Schmaedick recommends nationally known consultant Dr. Patricia A. Frishkoff, Family Business Program, Oregon State University, College of Business, Corvallis, OR 97331–2603.

ONLINE
If you missed the first part of this series, you can find it in our article archives on REALTOR® Magazine Online at One Realtor Place® (REALTOR.COM).

If your company is unusual in its marketing, philosophy, staffing, or other area, let us know. Write an explanation, using the format above, of how your company is unique and fax to 202/383–1231, or E-mail it to lsalvant@realtors.org.

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