Exit Planning Tools for Business Owners

Building Value

Exit Planning: Ripples and Ripples.

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Every stone thrown into a pond creates ripples. Every advance in technology does the same.

The late Stephen Hawking said that we were progressing too quickly. Along with other technology and science notables, he argued for a slowing down of development in Artificial Intelligence (AI).

Most current “AI” is actually machine learning. As computing speed increases exponentially, the ability of a computer to calculate, test hypotheses and weigh varying outcomes increases as well. Computers can now beat the best humans at every game ever invented. From Chess to Go, and from Texas Hold ‘Em to Ms. Pac Man, binary geniuses are sorting through billions of possibilities, and even being credited with rudimentary “intuition.”

But Machine Learning isn’t intelligence. A computer can sort through every chess move possible, but has trouble deciding what to do when a person with a bicycle steps out between two cars.  What if the correct answer is to swerve into oncoming traffic? A computer can’t make that call.

Robots on the Roads

That doesn’t mean you can be smug about what is coming. Take autonomous trucks. Clearly they aren’t smart enough (yet) to negotiate narrow city streets, bumper to bumper traffic jams or unload oddly-shaped cargo. That would require some real intelligence. But they don’t have to. They can just take care of the 80% of the easy stuff, long haul driving. Automatically driving great distances on relatively clear roads is completely feasible right now.

What if autonomous trucks were limited to driving from 8:00 PM to 6:00 AM? A few lanes on interstate highways could easily be electronically tagged for higher speed,  and robot-truck only use. They can follow more closely, having both quicker reaction times and the connected ability to “see” what is happening further ahead. A truck that doesn’t have to stop for food or sleep could cover a lot of ground in ten hours of high speed driving. Daytimes would be reserved for human-operated local delivery.

Ripples in the Pond.

How much would that affect trucking and other industries?

There would be far fewer driver jobs, although most drivers would likely be closer to home.

Traffic would be greatly lessened during the day. Good, you say? Tell that to the paving contractors, sign companies, crane operators, orange cone manufacturers, lighting and signal electricians or bridge builders. It could be decades before we have to expand highway capacity again. With the speed of technological advancement, decades could translate into “never.”

Is this good news for truck stops, all night diners, and budget motels? Heavy equipment manufacturers? Civil engineering companies? Public sector spending on highway construction is almost $100 billion every year. For comparison, that’s about the size of the whole digital/streaming TV and video industry.

Returning to the trucking industry itself, I doubt that trucks will remain as “one size fits all.”  Current testing is on models than can be autonomous, but also accommodate a human driver. The latter will go away. Robotic models can greatly reduce size, be more aerodynamic, and weigh less. They would also be more fuel efficient, and could be electric.

Uh oh. Trucks consume almost a quarter of all the petroleum products used in the U.S. That starts the conversation about the impact on oil companies, the fuel distribution network, gas dispenser manufacturers, drillers, pipeline construction, tank fabrication and installation…the ripples continue.

As an Exit Planner, I’m predisposed to look down the road, and to consider the risk in every transfer. Not all scenarios are doom and gloom, and many new industries will be born, most of which I can’t imagine.

I guess my message is that none of us should be smug about the future. If the financial community sees a threat on the horizon, expect lenders and investors to run the other way, fast. We watch the stones. They watch the ripples.

 

 

Selling Your Business – the Buyer’s Eyes

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Selling your business is much like selling a house. In order to realize the highest price possible, you want it to look its best.

The other day I passed an independent gas station/convenience store. The marquee at the curb advertised  their price for “unlead” gas. Really? Unleaded fuel has been required for new cars since 1975. Lead was completely banned as an additive 22 years ago. That means anyone who has bought a new car in the last 40-plus years, and every driver under 40 years old, has never purchased anything but unleaded gas.

What does that indicate about the maintenance of the business? If it has been decades since they updated their sign, what have they done with their refrigeration, roof, and other, more costly items of the infrastructure? Their P&L and cash flow are suspect, and due diligence will be more extensive. All because the first thing you see is an outdated sign.

First Impressions Count

In Steve Martin’s “LA Story” his girlfriend (Marilu Henner) checks her wardrobe by closing her eyes, spinning around in front of the mirror, opening her eyes, and removing the first thing she notices.

Very early in my working career I was in retail. My training manager taught me the same technique. Each day I walked out to the edge of the street in front of the business. I stood with my back to the business and my eyes closed. “Pretend you’ve never done business with us before,” he told me, “Then turn around, open your eyes, and see how our business looks to a new customer.”

I’ve used that exercise ever since. When I was actively brokering businesses, I remained acutely aware of first impressions. A parking lot with weeds in all the cracks or sidewalk seams. A front office with stacks of unfiled invoices on top of the cabinets. A conference room with six month old notes on the whiteboard. An owner’s office that doubled as storage for samples.

My favorite is the “Employee of the Month” board that was last updated years ago.

Staging for a Sale

Most small business owners seeking to sell ask “What can I do to get the best price?” Surprisingly, many pushed back on my staging suggestions. “I’m selling a profitable business, not a parking lot.” “Those invoices show that we are busy shipping product instead of filing.” “If a new owner wants to reinstate the employee of the month, the board is there and ready.”

Selling your business isn’t a joking matter. I want to do the best job I can for the client. If the first suggestions I make are shrugged off, what will happen when the client has to execute the more difficult tasks like preparing due diligence information?

Fortunately there were other brokers who would gladly list any business, in any condition. I was happy to let these brokers put in the effort. My time was too valuable to invest in a client who refused to see his business through the eyes of a buyer.

Business Buyers and Disintermediation

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In the last post, we discussed the reluctance of many prospective business buyers to deal with the regulatory burden of being an employer or service provider. You may be among the lucky few whose profession doesn’t require licensing. Even better, you may have qualified employees who are able to run the business without you.

There are other issues that concern younger buyers, however. One of these is the threat of disintermediation. That’s a trendy word for what we used to call “bypassing the middle man,” but it applies to many businesses that are being made obsolete by technology.

Disintermediated Businesses

How many business people still rent cars to attend a couple of meetings in a city? With Lyft and Uber, it is frequently easier to call a ride than leave a car in the (expensive) hotel parking for 90% of a visit. I’d be very skeptical of buying a car rental business today.

What happens when (not if) autonomous vehicles become part of daily life? Long-haul trucking will move to non-peak traffic hours, reducing the need for drivers, training schools, highway expansion, truck stops, and perhaps the number of trucks themselves.

Service businesses where the middleman lends expertise (easily duplicated by Internet research) or access to vendors are feeling the crunch already. The warning bell is sounding for mortgage companies, real estate agents, insurance and benefit brokers, employment agencies, printers, publishers, and travel agents.

These businesses won’t go away, but there will be fewer of them, and their margins are eroding.

The rise of robotics and artificial intelligence threatens even the most skilled professions. Legal databases, automated interpretation of medical imaging and free online tax filing are a few examples.

This quote is from a  February 21 essay by Rob Kaplan, President of the Federal Reserve Bank of Dallas.

As I have been discussing for the past two years, technology-enabled disruption means workers increasingly being replaced by technology. It also means that existing business models are being supplanted by new models, often technology-enabled, for more efficiently selling or distributing goods and services. In addition, consumers are increasingly being able to use technology to shop for goods and services at lower prices with greater convenience—having the impact of reducing the pricing power of businesses which has, in turn, caused them to further intensify their focus on creating greater operational efficiencies. These trends appear to be accelerating.

The Impact on Sellers

The overview of the business seller’s marketplace is straightforward. As I’ve been proselytizing for over a decade in my “Boomer Bust” presentations and books, selling a business will be more challenging, but that doesn’t mean any particular business is unsellable.

As with any other competition, the response is to create differentiation from the rest of the pack. There are a few key factors that top the list of appealing differentiators for business buyers.

  1. Build a business that can run without you. The more you work in your business, the less it is worth.
  2. Train effective management. Employees who understand how to run a profitable business are highly appealing to any prospective buyer. In addition, they can provide you with an alternative to a third-party sale.
  3. Upgrade the value-added component of your offering. If the only benefit you offer to a customer is time and place utility, you are probably toast.

There is another factor that may sound counterintuitive. Design your business so that it requires more expensive employees. If low wage workers are the backbone of what you do, you risk losing the technology arms race with larger competitors. I’ll expand on this in my next post.

The population of business buyers is younger, more technologically savvy, and less inclined to long hours than the generation that is selling. Winning in a competitive marketplace demands that you offer what business buyers want.

 

What’s Wrong with the Buyer Generations?

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Many of the upcoming buyer generations can’t or won’t run Baby Boomer businesses. This is (or should be) of concern to sellers everywhere.

“The children now love luxury; they have bad manners, contempt for authority; they show disrespect for elders and love chatter in place of exercise. Children are now tyrants, not the servants of their households.” Attributed to Socrates by Plato.

Elders have been complaining about their offspring for 2,500 years. The complaints change only in the activity bemoaned. “Chatter in place of exercise” is replaced by those damn radios, or automobiles, or television, or rock’n’roll, or cell phones or texting. It’s amazing when you realize that we’ve somehow managed to thrive through eons of generational deterioration.

The Buyer Generations

But one thing is true. Generation X and the Millennials are not attracted, as a group, to many of the businesses run by Baby Boomers. We’ve discussed the macroeconomic trends, demographics, sociographics and psychographics, at length in this column and in my latest book Your ExitMap: Navigating the Boomer Bust.

For the next few columns, we’ll talk about other forces that deplete the number of available and interested buyers, and what you as a seller can do about them. Note that I said “deplete” the number. An attendee at one of my presentations a few weeks ago raised his hand during Q&A and said “There will always be someone willing to buy a profitable business.”

That is probably true, but in any competitive sales situation the challenge is to find and attract a qualified buyer. Most of us do that by targeting our offerings to the buyers we seek, then making certain they are aware of what we are selling. The buyers we seek are those who are willing and able to pay the price we ask. In other words, we play the odds. What we are discussing here is finding willing buyers who are able to pay your asking price.

Regulatory Obstacles

One issue in selling your business is the regulatory environment. Since the 1970’s, Americans have come to accept that basic business qualifications should be legislated. Some 30% of all products and services now require some form of government permission (licenses or certifications) to operate.

When the owner of a business is the sole qualified practitioner for its offerings, he or she has a problem. Selling the business requires either continuing to work in it personally until a new owner is legally qualified, or providing licensed employees with some insurance for the new owner of their retention. (See our column on Stay Bonuses.)

This issue drives many owners’ decision to sell the business to qualified employees. You can include a few licensed practitioners in an ownership group, frequently combining them with non-licensed managers or executives who are more suited to running operations. With a few years of advance planning, an owner can exit with the sale price in hand on the day he or she gives up control.

To be blunt, if you are the only person legally capable of creating, presenting or approving the work of your company, you have a job more than a business. The first step in preparing a saleable enterprise is to make sure it can operate without you.

Employee Retention Before and After Your Exit

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In most businesses, employee retention is a material factor in valuation and transferability.

The ability of a buyer to assume control of a fully-functional organization has substantial influence on his or her perception of a company’s value. Any need to pay the seller for an extended period of training adds a redundant executive salary to the projected operating costs. Concern that key personnel may resign or be recruited away by a competitor adds a level of uncertainty to the transfer.

Of course, the basic premise of “The more you work in the business, the less it is worth.” always applies. Even if you’ve effectively delegated most of your operational responsibilities, however,  there remains the threat of an exodus of corporate knowledge.

Many exiting owners don’t believe that the problem is theirs. “These people work for me because I treat them well.” they say. “A new owner should have no problem if he or she does the same.”

True enough, but every buyer’s confidence level is greatly increased by a mechanism to support employee retention through the transfer process.

Stay Bonuses

Stay bonuses are so named (quite logically) because their purpose is to get key employees to stick around after a transfer of leadership. They can take a number of forms, but one of the most common is to escrow a portion of the sale proceeds for later payment if certain conditions are met.

The amount of the bonus can vary, but a general rule of thumb is about six months’ salary for two years of continued employment. Depending on the deal and the number of employees involved, this could be substantial. We suggest allocating about 5% of the sale price when planning such bonuses, but it could vary widely. Here are a few examples.

You sell your company for $5,000,000. Your four top executives each earn $200,000 a year. Six months of their salaries would be $200,000, or 4% of the sale.

On the other hand, if you have seven top executives at that level, $350,000 is 7% of your sale proceeds. That might be too rich a commission for your taste. The 5% guideline would make their bonuses about $35,000 or about 18% of salary.

Only you can decide whether the amount is motivational. Differing amounts based on position are normal. There is no requirement (such as in ERISA) that you apportion the funds by longevity or salary level.

Conditions of Payment

If you choose to make the bonus available, it only enhances the buyer’s confidence. Because the bonus is the seller’s liability, the new employer has no added financial motivation to keep or terminate any particular individual.

Bonuses are customarily forfeited upon resignation or termination for cause. Unlike other non-qualified deferred compensation plans, bonuses are typically not paid out in the event of the employee’s death or disability. This isn’t synthetic equity or a reward for general tenure. Qualification for payment is dependent on a specific condition being met at a specific time.

Also, unlike most NQDC plans, there is no buildup or gradual vesting of value. An employee who stays for 18 months isn’t eligible for three-quarters of a bonus. That should make stay bonuses free of claims in the event of an employee’s bankruptcy or divorce.

Employee Retention Alternatives

Employee retention is an issue in the transfer of any business with skilled personnel.  Only you can determine whether it is worth the investment of offering stay bonuses.

If you are confident in employees’ loyalty to the company, one alternative is to place some of the sale price into an escrow account, to be released if turnover remains below a certain percentage for a specific time. This still allows you to retain the entire proceeds, but transfers some of the financial risk of turnover (even for non employment-related causes) to you.

The other approach is to rely on inertia and security to maintain your workforce in place. Those are strong motivations, and are sufficient in most cases.

Regardless of a buyer’s demands, remember that no one gave you financial guarantees of loyalty. You earned it, and it isn’t unreasonable to expect a buyer to do the same.