John Dini Archives - Your ExitMap

Purpose – Life After the Sale Part 3

January 3, 2025 by John F. Dini

The third component of life after the sale is 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? Sure, non-owners may 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 presence. This thing they created is their purpose.

Life After the Sale

Unsurprisingly, 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 in your life after the sale 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 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.

Private Equity Reputation

December 2, 2024 by John F. Dini

We began this series by saying that Private Equity reputation is as the Great Satan to some, and a savior to others, depending on the personal experience of the speakers. In fact, both reputations are well deserved, but neither can be universally applied.

The “Great Satan” Private Equity Reputation

PEGs buy companies for the express purpose of improving their performance. That often comes with considerable pain for employees. A Searchfunder I know said recently “I’m looking at this acquisition because the owner thinks he is running an efficient company, where I see at least ten points that could be dropping to the bottom line.”

Efficiency is good, but too often it flies in the face of what made a company successful. In one example I recall, the PEG principals spoke to the assembled employees the day after closing on the business. They said “We bought this company for its culture and its people. Those are the most important assets to us.”

The cuts started coming the following Monday. Thanksgiving turkeys were “outdated.” Gone. All bonuses would be performance-based, so extra bonuses at Christmas would be discontinued. Season seats for the local sports franchise – gone. (Most of those went to customers.) Weekend overtime – gone. Schedules would be rearranged so that weekend workers were now scheduled for Saturdays and Sundays and got fewer hours during the week to make up for it.

Employee discounts on the company’s products – gone. Partial subsidies for family health insurance, well by now you are getting the gist. The flood of cuts was shocking and seemed unending. The flood of resignations started soon after.

By the way, the PEG missed its planned flip date (when they were supposed to sell to a bigger PEG) because of poor results and eventually took the company into Chapter 11.
I wish I could say that this type of result was unique, but it happens in far too many cases.

The “Savior” Private Equity Reputation

There is another reality. About 50% of all the privately held employers in the United States are Baby Boomers. The youngest of these are now turning 60. Many have built substantial enterprises whose value is far beyond what a younger entrepreneur can afford.

Private Equity has morphed into a many-headed creature, capable of acquiring almost any size business with value. It will never be for the mom-and-pop businesses that merely earn a living for the owner. As Doug Tatum says in No Man’s Land, they have grown to a level where they provide “wealth” to the owner equivalent to three salaries. Unfortunately, the owner must hold down three jobs for it to work.

But businesses with real cash flow, from a few hundred thousand dollars to a few hundred million, can find a tranche of PEGs who will consider their acquisition. Some specialize in minority ownership, or in funding the transition to a new generation of owners. Like it or not, these will be the saving of an entire generation who became successful by building a illiquid asset.

The latest estimate (from the Exit Planning Institute) is that these owners have $14 trillion dollars locked up in these illiquid assets – their companies. It that was an economy, it would be third in the world behind only the USA and China.

Reputation Counts

Many business owners are dazzled by the money a PEG has. With 17,000 of them out there, “We have money” is no longer as impressive as it once was. If a PEG comes calling, sellers (and their advisors) should carefully research their track record. If they lead with a guy “just like you” who owned a previous acquisition, be cautious. In most cases, he or she is compensated for adding to their portfolio.

Instead, talk to other owners who were acquired previously and are no longer active in the business. Look carefully into the acquirer’s experience in your industry. Unfortunately, “We have money” sometimes dazzles the PEG too. They begin to think financial manipulation is the only thing needed to make any business more successful.

Private Equity reputation is important. It will help you decide whether you should be discussing “show me the money” or “show me the future.”

Private Equity Leverage

November 11, 2024 by John F. Dini

Private equity leverage can dramatically increase ROI, but it can also be a trap. In our previous article, we discussed the general structure of Private Equity, how it works, and the types of Private Equity Groups (PEGs). They have grown rapidly as an alternative investment that produces far better returns than Treasury Bills or publicly traded equities.

The Power of OPM (Other People’s Money)

How do they provide these enviable 18% to 25% returns on an investment? The simple answer is leverage. An example most business owners can easily comprehend is a real estate mortgage. You put down $100,000 on a $500,000 building. The mortgage, especially in the first few years, is largely interest expense. You lease the building for a rental rate that covers your mortgage payment and expenses. Two years later you sell the building for $700,000. How much did you make?

The obvious answer is $200,000, but what is your Return on Investment (ROI)? If you said 40% you’d technically be correct. You made a $200,000 profit on a $500,000 investment. But what was your cash-on-cash return?

That is 200%. You actually invested $100,000 of your own money and used the building to secure a loan for the rest. Your profit was $200,000 on a $100,000 investment.

Private Equity Leverage(Other People’s Money)

Extend this example to buying a business. The business makes about $2,000,000 a year. (For the sake of simplicity, we won’t discuss here the differences between cash flow and profit.) The agreed-upon acquisition price is $10,000,000, or five times the profits. The PEG contributes $2,000,000 as a downpayment and finances the remaining $8,000,000. The cash flow of the business must cover the loan payments and leave enough working capital for operations.

A 5% loan amortized over 20 years requires a payment of about $53,000 a month or $636,000 a year. The remaining cash flow ($1,364,000) produces a return of 68% annually on the purchase.

Of course, the Limited Partner investors don’t get all 68%. Some must be kept as working capital for expanding operations. The PEG receives substantial fees for creating the deal and overseeing the investment.

In fact, the 25% return to the investors is only part of the story. If the PEG can double the company to a $4,000,000 profit level, even the exact same 5x multiple on exit could produce a $20,000,000 sale, or an $18,000,000 return on the original $2,000,000 cash outlay. That’s a 900% ROI.

Leveraging the Leverage

Buying a middle-market business with the structure outlined above would be lucrative enough, but of course, as professionals, the PEG would like to maximize their return. They frequently cut expenses dramatically upon acquisition (more on this in the next article.)

Often, they will line up a secondary loan, using the company’s cash flow to reduce or eliminate their downpayment exposure.

Private equity leverageDuring the low-interest environment of the last decade, PEGs could negotiate even more favorable terms. If you replace the 5% loan with a 2.5% loan, the annual cost is reduced to $509,000 annually, leaving a 75% return to work with.

Traditionally, most of the loan terms in private equity purchases reset after a few years. Refinancing at 9% raises the loan cost to about $865,000. Still, a 57% ROI is acceptable, if the business is thriving and the other expenses are kept under control. If the cash flow is covering a secondary loan at an even higher rate to replace the downpayment, or it’s been pledged to cover other debt outside the business, the picture might not be as rosy.

Private Equity and Privately Held Businesses

October 28, 2024 by John F. Dini

Depending on who you are talking to, Private Equity is either the Great Satan or the savior of small and mid-market companies in the United States. The stories depend a lot on the personal experience of the speakers.

Once a vehicle for high-risk investment plays in corporate takeovers (see Bryan Burrough’s Barbarians at the Gate,) Private Equity has morphed into tranches where specialists seek opportunities in everything from a Main Street entrepreneurship to multi-billion-dollar entities.

What is Private Equity?

The term itself is relatively generic. According to Pitchbook, there are currently 17,000 Private Equity Groups (or PEGs) operating in the US. The accepted business model for our purposes is a limited partnership that raises money to invest in closely held companies. The purpose is plain. Well-run private businesses typically produce a better return on investment than publicly traded entities.

The current Price to Earnings (or PE – just to be a little more confusing) ratio of the S&P 500 is about 27.5. This is after a long bull market has raised stock prices considerably. The ratio is up 11.5% in the last year. That means the average stock currently returns 3.6% profit on its price. Of course, the profits are not usually distributed to the shareholders in their entirety.

Compare that to the 18% to 25% return many PEGs promise their investors. It’s easy to see why they are a favorite of high net worth individuals, hedge funds and family offices. As the Private Equity industry has matured and diversified, they have even drawn investment from the usually more conservative government and union pension funds.

Private Equity Types

Among those 17,000 PEGs the types range from those who have billions in “dry powder” (investable capital,) to some who claim to know of investors who would probably put money into a good deal if asked. Of course, which type of PEG you are dealing with is important information for an owner considering an offer.

The “typical” PEG as most people know it has a fund for acquisitions. It may be their first, or it may be the latest of many funds they’ve raised. This fund invests in privately held businesses. Traditionally PEGs in the middle market space would only consider companies with a free cash flow of $1,000,000 or greater. That left a plethora of smaller businesses out of the game.

For a dozen years I’ve been writing about the pending flood of exiting Boomers faced with a lack of willing and able buyers. I should have known better. Business abhors a vacuum.

Searchfunders

Faced with an overabundance of sellers and a dearth of capable buyers, Private Equity spawned a new model to take advantage of the market, the Searchfunders. These are typically younger individuals, many of whom graduated from one of the “EBA” (Entrepreneurship By Acquisition) programs now offered by almost two dozen business schools.

These programs teach would-be entrepreneurs how to seek out capital, structure deals, and conduct due diligence. Some Searchfunders are “funded”, meaning they have investors putting up a stipend for their expenses. Others are “self-funded.” They find a deal, and then negotiate with investment funds to back them financially.

Both PEGs and Searchfunders seek “platform” companies, those that have experienced management or sufficiently strong operational systems to absorb “add-on” or “tuck-in” acquisitions. The costs of a transaction have bumped many seasoned PEGs into $2,000,000 and up as a cash flow requirement. Searchfunders have happily moved into the $500,000 to $2,000,000 market.

In the next article we’ll discuss how PEGs can promise returns that are far beyond the profitability of the businesses they buy.

My Interview with Jerry West on Management

August 29, 2024August 29, 2024 by John F. Dini

I once had the thrill of interviewing Jerry West on management. He was “The Logo” for the NBA, although back then they didn’t advertise him as such. Only the Laker followers knew for sure.

In 1989 the “Showtime” Lakers were coming off back-to-back championships. Pat Riley was a year away from his first of three Coach of the Year awards. Jerry was the GM. Many people don’t know this, but starting when Jerry West was drafted in 1960 until he stepped out of the GM role in 2002, the Lakers only missed the playoffs twice. Those seasons (74-75 and 75-76) were the only two seasons out of 42 that West was not on the Laker payroll.

In 1989 I was enrolled in Pepperdine’s Executive MBA program. Our class assignment was to interview a top executive with whom we had no previous relationship or introduction about his management style.

Mr. West Returns the Call

I was an avid Laker fan, and I thought “He can only say no.” So I called the Forum, asked for West’s office, and left him a voicemail. A few hours later our receptionist called me and said “One of your friends is goofing around on the phone. He says he’s Jerry West.” Obviously, I took the call.

We met in his office underneath the stands in the Forum. It may have been 12 x 12 feet, but the magnetic boards lining the wall made it seem much smaller. Each board had an NBA team’s name on top, and magnetic placards for every player currently on that team.

I asked Jerry about how he approached the management of the Lakers. He gestured to the boards. “My job as General Manager is to put the best team on the floor that I can. I look at these boards every day and think who might be better on the Lakers? Then I look at other teams and think who they might have that will convince the team with the player I want to give him up.”

He went on to say that he was sure that business executives weren’t as singularly focused as he was. He thought about the Lakers from the moment he woke until going to sleep at night. I didn’t try to convince him that he matched the profile of many small business owners.

Jerry West on Management

As a manager, Jerry said that he believed that if you hired someone to do a job, then you needed to step back and let them do it. Pat Riley was a broadcaster with no coaching background. Jerry said that the problem with experienced coaches is that they had already been fired once. West took a flyer on Riley, but to appease the media he agreed to sit on the bench to lend advice.

“It was crazy. Riley had no idea what he was doing. He’d call to put guys in the game that we had cut the week before or to sub in guys who were already on the floor. I lasted about three games on the bench. I had to go to my office and let him learn on his own. The alternative was that I’d kill him.”

One poignant moment was when he discussed his family. I can’t imagine the burden being in the public eye brought with it. He talked about his children being bullied on the playground because the team was on a losing streak. Even worse was having his wife accosted in the supermarket aisle by a fan who was incensed over a trade.

One of his greatest tips was when we discussed keeping things in perspective. He showed me two file folders in his desk drawer. “One of these has the most complimentary of the letters I get when the team is doing well. They tell me I’m a genius. The other folder is the worst letters I get when the team is doing poorly. You can guess what they think of me.”

“Whenever we are on a streak, good or bad, I pull one of the letters from the file when we were doing the opposite. It reminds me that it wasn’t always the way it is today, and it will swing back sooner or later.”

Looking to the future

I wasn’t supposed to discuss the Lakers, but the fan in me couldn’t help it. Jerry had just drafted a guy from Yugoslavia that no one had heard of. This was well before European players dominated the top draft picks. I had to ask him about his choice.

“Wait until you see him,” West said. “Seven feet tall and he can pass the ball like Magic.”

He became the starting Laker center for the next seven years. Then Jerry West traded Vlade Divac to the Charlotte Hornets on draft night of 1996 to get the 13th pick, a teenager named Kobe Bryant.

Always looking at those boards.

We’ll miss you, Jerry.