Exit Planning Tools for Business Owners

Exit Strategies

Four Basics of Exit Planning 3: Know Your Buyer

by

Know your buyer? Your initial reaction to this title may be “How can I know my buyer? I haven’t even decided to sell yet!”

Nonetheless, understanding the type of buyer that your company will attract is vital. More importantly, gaining that understanding long before you go to market will impact many decisions about how to run your business between now and when you start to actively market the company for sale.

The classes of buyers are not interchangeable. I once worked with the owner of a subcontracting company. He told me “I want to find a strategic buyer. I know they pay higher multiples than anyone else.”

That’s nice in concept, but Strategic Buyers make strategic acquisitions. His business was only as good as its next bid. He had no proprietary systems, no products, no long-term customers and no contracts besides the current jobs. Strategic buyers pay for strategic differentiation. He was unhappy that I didn’t classify his self-defined “great reputation in town” as a differentiator.

Other Classes of Buyers

Your business will determine what types of buyers you should seek, how your earnings will be viewed, and the multiple of earnings you can expect.

Main Street is the generally accepted term for businesses that sell for less than $3,000,000. Entrepreneurial Buyers are most commonly an individual or partnership. Downsized executives and entrepreneurs who have sold a previous business make up a large percentage of the buyer population for these companies. These transactions are usually handled privately, or through a business broker who advertises them on the Internet.

Cash flow for these businesses is called Seller’s Discretionary Earnings (SDE), and includes all the perks of ownership (wife’s car, no-show child employment and the like.) Anything that could be applied to a debt payment qualifies. For most Main Street buyers, their ability to service loans for the purchase usually tops out around 3 times SDE.

Mid-market companies sell for between $3,000,000 and $100,000,000. Financial Buyers include private equity firms and family offices. These buyers usually seek acquisitions where the cash flow is in excess of $1,000,000 a year.

Many lower Mid-market sellers are confused by the cash flow calculations. Financial Buyers’ cash flow measure is EBITDA (Earnings Before Interest Taxes Depreciation and Amortization.) Some sellers try to include the side benefits their company pays for in EBITDA. Financial Buyers assume that any benefits you have, a replacement manager will have as well, and they will ignore many of the SDE inclusions.

Private equity and Family Offices purchase businesses that are likely to produce a predictable return. Because they have investors (or wealthy family members) to please, their purchase prices are usually in the range of 4 to 5 times EBITDA, although the recent financial markets have driven that into the 6x territory for acquisitions over $20,000,000.

The Mid-market is also where sales are made to customers, vendors or competitors. Handling these transactions requires special care with confidential information. Since buyer and seller usually know each other, a broker-type intermediary is less necessary. Many times a transaction attorney or accounting firm can handle the negotiations.

The Neutral Zone

Exit Planners provide special value to companies in the “Neutral Zone.” I define that as too small to be big, and too big to be small. Their EBITDA is healthy (usually $500,000 or more after owner compensation) but below the $1,000,000+ that the Financial Buyers seek. Yet at that level, few Entrepreneurial Buyers can handle the purchase price.

There are many options still available to a Neutral Zone company. You can choose a growth strategy to enter the realm of Financial Buyers. A Leveraged Buy Out (LBO) by experienced employees is likely to attract the interest of a lender. An Employee Stock Ownership Plan (ESOP) is a very attractive alternative in the right circumstances.

In all cases, a good planning runway will help you to know your buyer. Then you can position the business with control over the outcome you seek.

A short video on classes of buyers and the multiples they pay, along with a free calculator to determine your SDE or EBITDA are both available on our website of free tools for owners, Your Exit Map.

Four Basics of Exit Planning 2: Distance to Goal

by

Once you understand your company’s value, the next step in planning is to calculate your Distance to Goal. As the Cheshire Cat said, “If you don’t know where you are going, any road will get you there.”

“Any road” is not the way you want to approach the biggest financial event of a career. Distance to Goal calculations require an understanding of where you are now, where you want to wind up, and how long you need to get there. In both industry surveys and my own experience, the majority of business owners have (at best,) only a rough idea of the road they will take.

Calculating Distance to Goal

Where you are now is a calculation of your current liquid net worth. “Liquid” implies assets, such as stocks and bonds, that you can use for living expenses. Your home isn’t liquid. Income property isn’t liquid, but you can apply the rents to your retirement needs. Don’t include the value of your company at this stage. We’ll get to that in a moment.

Next, you need to calculate how much you’ll need for the next phase of your life. That may be  called retirement, but it also might be charitable or community work, satisfying a long-desired wanderlust, or even starting another business. A good financial planner can help you with the assumptions for inflation, longevity and future medical costs.

From a starting point (current liquid net worth,) and a target destination (financial needs at retirement) you can calculate a financial Distance to Goal. Now it is time to choose a time frame.

Add the amount you expect to save each year that you continue working to your liquid assets plus the post-tax proceeds of transferring your company at its current value. Do you reach your goal?

Navigating the Path

With this exercise, some owners are surprised to learn that they are on track, and only need to maintain their current path to realize their objectives. Unfortunately, more find that they can’t reach their destination in the desired time frame without some changes.

This simple triangulation, with a solid starting point, concrete destination and a time frame gives you a clear look at the options available to you. They might include:

  • Increase liquid assets: Do you have underutilized real estate? Will you downsize your living quarters once retired?
  • Increase savings: Can you make adjustments in your business or your lifestyle to augment what you are currently saving?
  • Increase value: Would changes in your business make it more attractive to certain buyers? (That will be post #3 in this series.)
  • Increase time frames: Could working a couple of years longer close the gap in your planning?

You can experiment by modeling different scenarios using the free Triangulation Tool at www.YourExitMap.com.

Stephen Covey made famous the phrase “Begin with the end in mind.” If you understand your Distance to Goal, you are better able to choose a road that gets you there.

 

Four Basics of Exit Planning 1: Valuation

by

There are four basics an owner should address before beginning any exit, succession, or transition plan. They are Valuation, Distance to Goal, Prospective Buyers, and Professional Team.

First, my apologies for missing a tri-weekly post. Between trips to Denver for BEI’s National Exit Planning Conference, Dallas for a client, San Antonio for our own XPX Exit Planning Summit, Nashville for the national EPI Exit Planning Summit, and St. Louis for Archford’s Metro Business Owner Summit, I kind of lost track of my posting schedule.

Here is the first of the four basic requirements. I promise not to dally in posting the rest of the full set.

Understanding Valuation

Value is the starting point for all transition planning. Any decision, any business plan, and every retirement projection (either for time frames or finances) must start with the value of your business today.

Knowing the value of your business is different from thinking you know it. I talk to many owners who say “I met a guy at a trade show, and he told me that he knows a guy with a business just like mine who sold his company for five million dollars. I think I’m a little bigger than he was, so I know my business is worth at least six million.”

Sounds foolish? How about “My accountant says that all small business sells for about five times earnings.” Or “Everyone in my industry knows that all companies like ours sell for one and a half times revenue.”

Any valuation estimate that is in the same sentence as “all,” or “everyone” is a crock. Multiples may serve as guidelines, but the value of a specific business is always unique to that business.

How much is a manufacturer of disposable paper products worth? What if they specialize in paper straws? How much does that value change every time McDonald’s or Southwest Airlines announces that they are switching to paper straws? How much is it worth if it is the last paper straw manufacturer in the USA (like Aardvark® Straws?) If you understand the value, your mental estimate should have changed with each sentence.

Every change in the above paragraph described an intangible. Events and market conditions are as important, or in some cases more important, than last year’s numbers. Valuation starts with profitability and cash flow, but the real price that someone will pay for a business lies in the intangibles.

Intangibles

There are scores of intangible factors affecting business value. Most are related to customers, employees, or systems. Ask yourself these questions (although there are many more.)

  • Customers:
    • Do you get more than 20% of your sales from one customer?
    • Is your revenue recurring (by contract) or a series of one-time transactions?
    • Is your value proposition more than just “good service?”
    • Are steady or repeat customers increasing their purchases?
    • Can you forecast their purchasing accurately?
  • Employees:
    • Do you have managers that can run the day to day operations without you?
    • Are your key employees too close to retirement age?
    • Is turnover too high, or nonexistent?
    • Are important positions cross-trained via a formal process?
    • Do you have non-competes and/or long term retention incentives?
  • Systems
    • How accurate is your budgeting when compared to historical reality?
    • Are all processes documented and followed?
    • Is equipment carefully maintained?
    • Our proprietary systems and knowledge protected?
    • Do you track the effectiveness of sales and advertising expenses?

All valuations begin with profitability and cash flow. Most business appraisals take at least a cursory look at a few of the intangibles listed above. Buyers, however, will look at all of these factors and more.

Understanding the four basics of exit planning starts with valuation. If you don’t know where you are, it’s tough to plan where you are going.

For over twenty years, business owners have asked me “What can I do to increase the value of my company?” My answer is always the same.

“Exactly what you should be doing to improve it every day.”

Do you think you know the value of your business? Try the “Sellers Sanity Check,” a free tool at YourExitMap.com

Invest 15 Minutes and take our FREE Exit Readiness Assessment. We do not request any confidential information.

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

Death, Taxes and Exit Planning

by

(This post was published in the Sageworks/ProfitCents blog earlier this week)

Understanding the Post-Ownership Void

As advisors, we understand that our business clients should be preparing for the biggest financial event of their lives – the sale of their business. However, when we ask, “How are you exit planning for your retirement from the business?” we seldom get a straight answer.

Instead, we get any number of comments like: “I still enjoy my business, I’m not thinking about it right now.” “I have a good company. I can sell it whenever I choose.” “Everything is available for the right price. I just haven’t heard it yet.”

These are all ways of evading the fact that they haven’t thought about their life after the sale of their business, and they don’t want to. Why is having the exit planning discussion so challenging? Because, like planning one’s own funeral or purchasing life insurance, it is frightening to contemplate the end of one’s professional career.

What I Do is Who I Am

Most business owners, particularly founders, find it difficult to separate their business from their own identity. The business is who they are. At family gatherings they overhear, “There’s Bob. He owns his own business, you know.”

The ownership of their business permeates their relationships. They are, “Bob Smith, the owner of Smith Manufacturing.” Not only in their business circles, but also at their church, in their children’s schools and their friendships. The business is their persona.

Contemplating life after ownership is scary. Who am I if I’m not me? Will I be treated the same? Can I command the same respect if I don’t have employees? Will my opinion still matter? Will others see me as successful without the trappings of a company around me?

Some owners have the confidence to leave a business with no concern about how others will perceive them. Most, however, associate retirement on some level with failure. While owning their business, they got a small shot of adrenalin every time they were asked to make a decision, which was usually many times a day. They fear a life without those little rewards, albeit unconsciously.

Understanding this reluctance to explore the void that retirement creates is a vital part of an advisor’s ability to serve their business clients. It’s easy to say, “Okay, I’ll be here whenever you want to talk about it.” But this alone is a disservice. Planning the most important financial event of a client’s life should be a priority, not an afterthought.

Have a Safety Net

When a client avoids the exit planning question, have a safety net. Selling a business is a competitive endeavor. No smart owner would enter a new market without knowing what his competition looks like. Just because someone isn’t thinking about an exit doesn’t mean that he or she shouldn’t do anything today. Getting the conversation started is one of the most valuable services you can offer.

Life After Exit — Time is of the Essence

by

From time to time, we share real stories about life after exit from owners who have sold their businesses. Some are great and some… not so much. The have agreed to share their experiences to help other owners prepare for both the process of transferring their companies and what comes after.

The Business

BVA Scientific, a distributor of laboratory supplies and equipment, started in Bob and Nancy Davison’s bedroom with the garage serving as the “warehouse.” Both had a background in laboratory supply sales, and they focused on building deeper customer relationships than the multi-billion dollar vendors who dominate the industry.

That approach helped the company grow with a balanced customer base. BVA has a presence in food testing laboratories, water and wastewater plants and the Texas oil fields, rather than the typical dominance of doctors and hospitals for their type of business.

Not surprisingly, BVA had attracted multiple inquiries from private equity groups. None of those came with management, however, and all wanted the Davisons to remain as employees for a long time after the acquisition. While they weren’t in a rush to get out the door, Bob and Nancy wanted a clear path to retirement

Here is how they describe the transaction

“First, let’s kill all the lawyers…”

Nancy: “We knew that the business had grown beyond what a couple of salespeople could handle well. Supply sources were moving to Asia, and I felt a bit out of step. I think the real impetus was when a general manager to whom we planned to sell the business left for, of all things, his own sign shop franchise. We hired a replacement, but we could see that he wasn’t our exit plan.”

Bob: “I’ve always been very active in our trade association. A colleague with a much larger operation had asked me several times to let him know if we would consider selling. When he repeated the offer at a conference, we decided to start talking seriously.”

Nancy: “The due diligence almost killed me. The buyer’s attorneys kept asking for more information. Halfway through the deal their lead attorney went on maternity leave, and her replacement wanted to restart the whole process from the beginning!”

Bob: “Our legal bills wound up being so much more than we anticipated. I think my biggest surprise was finding out how many adjectives could be used to modify the word lawyers.”

Nancy: “The closing date was delayed multiple times. Then our biggest customer told us privately that they were planning to shift their purchasing for high-volume items to China. It was a gut check, but we shared the information with the buyer. We had to restructure the deal with a portion tied to an earn-out, based on the level of business we maintained for a year after closing.”

Life After Exit

Bob: “Nancy stepped back pretty quickly. I wasn’t quite ready to retire, and now I have the added motivation of watching our earn-out. My role is technically sales-related, but it is just as much about keeping the employees happy through the change.”

(Note: As we approach the end of the earn-out agreement, BVA Scientific has easily reached all the goals required for full contingency payment. Nancy and Bob continue to enjoy life after exit.)

 

This story and others are in my latest book Your Exit Map: Navigating the Boomer Bust.