Exit Planning Tools for Business Owners

Exit Planning

20 Red Flags to Look Out for When Buying a Business

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Buying a business is an opportunity to skip the growing pains of launching a startup. It’s a chance to start with a proven model with customers and cashflow. How can you tell if the prospective business is a genuine investment opportunity or a disguised escape route for a burnt-out owner?

The following is a list of the top five things to consider when prospecting a business purchase – and some red flags for each category so you can recognize trouble a long way away. This list is no way exhaustive and there are many other issues to consider when buying a business. However, nailing these will tip the odds of success in your favor. Here are 20 red flags for buying a business you should look out for.

1. Why the Business is For Sale

Before you fall in love with a business, make sure you understand why it’s for sale. You’ll want to interview the owner about their experience with ups and downs, their efforts to course-correct, and what tactics have been most successful.

Above all, you should be checking to see if you have what it takes to take the business to the next level and why hasn’t the previous ownership attempted this course. It’s not just about if the company could be a profitable investment– it’s about verifying the fit with your skills and resources.

Red flags:


The owner is burnt out or seems to be filling multiple roles
A toxic culture and/or high employee turnover
A poor business plan that can’t compete with costs or competition
An industry that is contracting or being disrupted by technology.

2. Perform Due Diligence

Due diligence will occur after your Letter of Intent has been accepted. It’s a comprehensive process, taking anywhere from 45 days to 9 months. This is the most critical step in the acquisition process. This is your chance to get “under the hood” and see how the business operates and to validate what you have heard from the owner in the prior discussions.

Due diligence includes:

Verification of sales and cashflow
Key employees
Concentration risk – clients and key suppliers
Financial/Tax Review
Asset Consideration
Legal Review
Operational Efficiency
Company debt
Real Estate status – lease expiring, property owned by the owner.
Inventory – obsolescence, turnover
Environment Concerns

Red flags:


Findings are significantly different than similar companies
The business model is overly complicated
Report results seem unlikely
Cultural concerns

3. Financial Review

Although briefly discussed in the previous section on due diligence, this is where you will determine what the financial opportunity of acquiring this business will be. It’s critical to partner with an independent and qualified CPA / financial professional to ensure that the story the numbers are telling are accurate. It is your responsibility to verify the results being provided to you.

You’ll want to dig into:

Profit and Loss (P&L) Statements
Balance Sheet
Cash Flow Statements
Tax Returns
Accounts Payable
Accounts Receivable
Sales history

Red flags:


The owner claims that the company makes more than the books reflect
Customer concentration
Equipment will need to be replaced soon (significant early expenses)
Account receivable and Accounts payable aged past 90 days Lack of budget and rolling 13 week cash forecast.

4. Get Clear About the Industry’s Future

You’ll also need to research the future of your new company. Is growth likely? What are the barriers to entry? Competitive landscape? Is the industry fading in relevance, being disrupted by technology, requiring significant product development to stay alive?

Access to industry research and speaking with industry experts is important. Talk with future competitors under the guise that your are considering becoming an investor in the industry. Seek out recent transactions and what the multiples are. How have the new owners faired post-acquisition.

Red flags:


The owner claims to have little competition
Inability to adequately explain declines in sales or margins
The owner reports having a hard time keeping up with established competitors
The owner mentions continuous new competition
The industry isn’t flexible to modern innovations

5. Reputation Matters

A good reputation isn’t just nice to have– its value is measured in dollars. Companies with a good reputation benefit from higher profits, free marketing, and better hiring ability.

Clean branding has never been more critical in an age of consumer determination to buy socially, ethically, and environmentally friendly. With social media and reviews in the driver’s seat, it’s crucial to work with intact brands.

Remember, brands don’t get a redo just because ownership changed.

Red flags:

Poor social media or news coverage
Significant poor reviews
Mistrust in target consumer base

Joe Gitto, CEPA is an accomplished senior Finance, Sales and Operational Executive, Entrepreneur, Coach, Thought Leader, and Board Member with more than 25 years of success in various industries. He is the Managing Member of Blue Sky Exit Planning Services.

Owners are a Minority

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When it comes to careers, business owners are a minority of the population. In conversations this week, I mentioned the statistics several times, and each owner I was discussing it with was surprised that they had so few peers.

According to the Small Business Administration (SBA), there are over 33,000,000 businesses in the US. Let’s discount those with zero employees. Many are shell companies or real estate holding entities. Also, those with fewer than 5 employees, true “Mom and Pop” businesses, are hard to distinguish from a job.

The North American Industry Classification System (NAICS) Association, lists businesses with 5 to 99 employees at about 3,300,000, and 123,000 have 100 to 500 employees (the SBA’s largest “small business” classification.)

Overall, that means about 1% of the country are private employers. Owners are a small minority, a very small minority, of the population. Even if we only count working adults (161,000,000) business owners represent only a little more than 2% of that population.

So What?

Where am I going with this, and how does it relate to our recent discussions of purpose in business exit planning? It’s an important issue to consider when discussing an owner’s identity after transition.

Whether or not individual owners know the statistics of their “rare species” status in society, they instinctively understand that they are different. They are identified with their owner status in every aspect of their business and personal life.

At a social event, when asked “What do you do?” they will often respond “I own a business.” It’s an immediate differentiator from describing a job. “I am a carpenter.” or “I work in systems engineering,” describes a function. “I am a business owner” describes a life role.

When asked for further information, the owner frequently replies in the Imperial first person plural. “We build multi-family housing,” is never mistaken for a personal role in the company. No one takes that answer to mean that the speaker swings a hammer all day.

Owners are a Minority

We process much of our information subconsciously. If a man enters a business gathering, for example, and the others in the room are 75% female, he will know instinctively, without consciously counting, that this business meeting or organization is different from others he attends.

Similarly, business owners accept their minority status without thinking about it. They expect that the vast majority of the people they meet socially, who attend their church, or who have kids that play sports with theirs, work for someone else.

There are places where owners congregate, but otherwise, they don’t expect to meet many other owners in the normal course of daily activity. This can be an issue after they exit the business.

You see, telling people “I’m retired” has no distinction. Roughly 98% of the other people who say that never built an organization. They didn’t take the same risks. Others didn’t deal with the same broad variety of issues and challenges. Most didn’t have to personally live with the impact of every daily decision they made, or watch others suffer the consequences of their bad calls.

That is why so many former owners suffer from a lack of identity after they leave. Subconsciously, they expect to stand out from the other 98%. “I’m retired” carries no such distinction.

John F. Dini develops transition and succession strategies that allow business owners to exit their companies on their own schedule, with the proceeds they seek and complete control over the process. He takes a coaching approach to client engagements, focusing on helping owners of companies with $1M to $250M in revenue achieve both their desired lifestyles and legacies.

The House of Gucci Succession Plan

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By now, you may have seen the movie House of Gucci. Lady Gaga and Al Pacino star in the true depiction of the Gucci family.

The Gucci brand started with two brothers who own the family business equally. Each brother had a son, and each son was to inherit the empire. One of the sons was a ne’er-do-well, who always attracted and found trouble. Despite nobody ever giving him a chance, the viewer could tell his successor ownership was doomed. The other son married the woman who was played by Lady Gaga. The story progresses through time as one of the fathers die and the other goes to jail while the wife rises to power and greed. To complicate the succession plan, lavish lifestyles, poor business decisions, children and divorce ensue.

The Gucci brand has always been iconic, and it remains so today. The movie describes the struggle between the two brothers and their ideas on how to grow the brand. One brother wants to expand into shopping malls across the world, while the other brother believes the idea of having a Gucci store in a mall is despicable. The two brothers who have these opposing views show how difficult it is running a family business with 50-50 ownership.

The two sons are the on-again/off-again heir apparent to the fortune, and eventually they will run or have a hand in running Gucci. The ne’er-do-well son struggles and is really off-base with his ideas, which are very inconsistent with the brand, and he lacks any sense of training or sense of how to run a business. Subplots in the movie describe how the other stakeholders attempt to circumvent his ownership and ultimately the rest of the family.

The other brother is smart, but he has a blind spot in that he has never had to struggle financially. He has never had to know what it was like to lack resources. His approach to management and growth are flawed because of the company culture and his paradigm. The influence of his wife and others around him also taint the management and success of a family run business. He lives lavishly, incurring personal expenses that he funds through the company.

Subterfuge and infighting ultimately become the demise of the family. The business survived but it was sold off for pennies on the dollar and was turned into a publicly traded company and as a result, the family no longer owns the business.

Clearly, the Gucci’s would have benefited from a team of exit planning advisors to help them navigate these waters! Indeed, there was no training of the sons, there was no alignment by the brothers, there was no dealing with the other stakeholders in the family. There was no financial planning, nor personal planning. Other than the brand quality, there was no development of cultural consistency or business attractiveness. There was a lack of management succession, planning and delineation of who does what. Sadly, there are many family run businesses that much less well known, but who lack the kind of exit planning that is needed to successfully pass along the business to the next generation.

House of Gucci illustrates how important it is for families to pay attention to succession and exit planning. I give this movie two thumbs up for the entertainment value of the movie, but two thumbs down on exit planning!

Mark Hegstrom is Certified Exit Planning Advisor and helps business owners to plan for what may be their single largest lifetime transaction: the transfer of their business. Get started by completing an exit readiness Assessment for yourself. Mark is Managing Partner at Business Owner Succession Strategies (BOSS). He currently serves as President of the Exit Planning Institute -Twin Cities Chapter.
 

Why You Can’t Sell Your Business Overnight

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So why can’t you just sell your business in a couple of months?

Business owners are often told they need to get ready to sell their business, why can’t they just up and sell it? The short answer is that they are unlikely to sell it. Listing the business may be easy, getting someone to buy it, that’s the hard part. According to the Exit Planning Institute, only some 20-30% of businesses sell today.

You might be asking yourself, what actually makes a business part of this group who does sell?

Of course, there may be many answers to this question, but I think the biggest reason can be summed up in a single word: Risk. A business buyer is going to look at several factors when determining if they will buy. These factors lead them to conclude a risk level and they compare that with their tolerance for accepting risk. The higher the perceived risk, often there is a direct correlation with a lower multiple of EBITDA, and thus a lower selling price. In some cases, the risk perception may be so high that the buyer decides there is no price they would pay to accept that risk.

What are some of these perceived risks?

I think for a lot of small and lower middle market businesses, the challenges for a successful sale to an outside party are greater than for larger companies. Larger companies are larger because they sell more products – they need more inputs to sell a larger amount of their product. They need people, processes and management. Usually in a larger organization, the owner is not participating directly in the production or sales of the product, they have an organization that does this. Contrast this image with a smaller company where the owner is directly involved in the production of the product or sales – the greater this involvement, the greater the perceived reliance on the owner. We call this “owner centricity.” The higher the owner centricity, the riskier the proposition is to an outside buyer.

If the current owner is deeply active in production, sales or the management of the firm, then an outside buyer will have to replace those functions – they may conclude they will have to do these activities, and there is the rub. They may or may not want to do them, but perhaps more important, they may not perceive that they are able to do those functions. An owner who knows all his customers, an owner who is a gregarious personality and is responsible for attracting new business, an owner who has been at it for decades and knows the industry, the suppliers, the competition – those are all critical owner functions – the problem is that a new owner may not be able to see themselves doing those activities with the same success as someone who has done it for years. If the prospective buyer can’t see themselves as being able to do these functions as well, then they will question whether the business can repeat the sales and profits earned by the original owner. The degree to which this idea is challenged is risk.

A way to reduce this risk might be to reduce the level of owner centricity. To reduce the level of owner centricity, an owner would assess the critical functions of the business and measure the extent of their involvement. Once measured, the owner would undertake the process of implementing a management succession plan to develop written procedures, systems and policies, and begin the methodical process of handing over or delegating the owner’s responsibilities.

I like to think of a business as a mental model that fits inside of a shoebox. The box has systems, policies and procedures, that runs itself. It produces a repeatable process of making money. Imagine that one could reach inside that box and pulls the owner out! Now the owner owns the box that produces the repeatable product and earns a predictable profit. I recently met with a business owner client who shared that he had taken our advice and told his staff that he is no longer coming into the office. (His words were “only call me if someone dies”!) What he found was that the business ran without him, it produced recurring and repeatable revenue and profit streams. A new buyer might perceive that they can own that box, and they may then perceive it as less risky.

Exit, succession and continuity planning is about this process. Reducing owner centricity is one thing an owner can do to prepare for a sale or exit. This is not a quick fix, this takes time. Those who develop and implement an exit and succession plan over time may be able to reduce the perceived risks to a new buyer. You might say, those with a plan have a better chance of selling their business than those without a plan.

Mark Hegstrom is Certified Exit Planning Advisor and helps business owners to plan for what may be their single largest lifetime transaction: the transfer of their business. Get started by completing an exit readiness Assessment for yourself. Mark is Managing Partner at Business Owner Succession Strategies (BOSS). He currently serves as President of the Exit Planning Institute -Twin Cities Chapter.
 

Purpose After the Sale

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Purpose after the sale is one of the biggest challenges for an exiting owner.

Purpose – “Having as one’s intention or objective.”

Many exit planning advisors discuss the three legs of the exit planning stool – business readiness, financial readiness and personal readiness. In our previous two articles, we focused on two of the “big three” components of a successful life after the sale, activity and identity. The third is purpose.

So many advisors point to the 75% of former owners who “profoundly regret” their transition, and say it’s because they didn’t make enough money. To quote Mr. Bernstein in the great film Citizen Kane, “Well, it’s no trick to make a lot of money…if all you want is to make a lot of money.”

I’ve interviewed hundreds of business founders. When asked why they started their companies, by far the most common answers are about providing for their families and having control of their future. Only a very small percentage say “I wanted to make a lot of money.”

Decades of Purpose

So what kept them working long hours and pushing the envelope after they had reached primary, secondary and even tertiary financial goals? Non-owners often chalk it up to greed, but Maslov’s hierarchy of needs drifts away from material rewards after the first two levels. Belonging, Self-Esteem and Self-Actualization may all have a financial component, but money isn’t the driver.

For most owners, the driving motivation is this thing they’ve built. The company has a life of its own, but it’s a life they bestowed. They talk about the business’s growing pains and maturity. Owners are acutely aware of the multiplier effect the success of the company has on employees and their families. In a few cases, that multiplier extends to entire towns.

That’s the purpose. To nurture and expand. In so many cases every process in the business was the founder’s creation. He or she picked out the furniture and designed the first logo. This aggregation of people breathes and succeeds on what the owner built.

That’s why so many owners still put in 50 or more hours a week, long after there is any real need for their constant presence. This thing they created is their purpose.

Purpose After the Sale

It’s no surprise that so many owners find that 36 holes of golf each week, or 54, or 72, still isn’t enough to feel fulfilled. You can get incrementally better, but it doesn’t really affect anyone but you. Building a beautiful table or catching a trophy fish brings pride and some sense of accomplishment. Still, it never matches the feeling of creating something that impacts dozens, scores or hundreds of other human beings.

That’s why we focus on purpose as the third leg of the personal vision. In the vast majority of cases, it involves impacting other people. Any owner spent a career learning how to teach and lead. Keeping those skills fresh and growing is a substantial part of the road to satisfaction.

Purpose may involve church or a community service organization. It could be serving on a Board of Directors or consulting for other business owners. It might be writing or speaking. Purpose after the sale doesn’t require a 50-hour week, but it does require some level of commitment, and the ability to affect the lives of others.

John F. Dini develops transition and succession strategies that allow business owners to exit their companies on their own schedule, with the proceeds they seek and complete control over the process. He takes a coaching approach to client engagements, focusing on helping owners of companies with $1M to $250M in revenue achieve both their desired lifestyles and legacies.