Exit Planning Tools for Business Owners

building business value

Internal Leaders Affect the Value of Your Business

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Internal leaders may not be obvious. They may not even have a “leadership” title. Make no mistake, however; internal leaders are critical to value and attractiveness when it comes to selling your business.

In Super Bowl 55 we saw the impact of an internal leader. Tom Brady has the highest winning percentage of any single athlete in major professional sports. The Tampa Bay Buccaneers have (or at least did up until this season,) the worst win/loss record over their entire existence of any major professional sports team. Yet one man changed the culture of the organization almost overnight.

Remember, for all the accolades being heaped on Brady, he is an employee. He doesn’t own the Buccaneer enterprise or negotiates any contracts other than his own. He didn’t choose the team’s logo, uniforms, location, or coaches.

Tom Brady is paid to fill only one of 53 player positions in the organization. There are also 31 coaches on the team, whose jobs are to teach and give direction to those 53 players. Although every player will acknowledge that winning is a team effort, none will argue the impact of one strong internal leader on his 83 coworkers.

Internal leaders can be good or bad

When I was a very young business owner, I hired an experienced salesman. He was an alcoholic and began inviting other employees to his house for a cocktail after work. It took me some time (too long) to realize that he was plying his coworkers with free booze while he ranted daily about how poorly the company was being run.

I couldn’t understand why there was so much resentment among my team. They seemed to resist any direction I gave them. Finally, one person was kind enough to explain to me what was happening. Because this salesman was my top producer, I was afraid of the impact on revenues if I fired him.

He didn’t want my job. In fact, he didn’t want any of the responsibility that should go with leading. He had merely discovered one of the biggest truths about leadership. It’s easier to tear something down than build it up. People love to hear that things could be better. It’s making them better that is the tough part.

Tom Brady made the Tampa Bay Buccaneers better. Like any good internal leader, he didn’t limit his contribution to his job description as Quarterback. He helped recruit and train the people around him to build a better team.

Identify your internal leaders

An army dispatches its troops under the leadership of its lieutenants, but it succeeds on the ability of its sergeants. As a business owner, you can inspire with core values and set great goals. Whether you reach them, however, will be determined by your internal leaders.

When it comes time for your transition, they are more important than ever. If you are selling to family or employees, they may not expect to be included in equity, but they will determine the acceptance of those who are.

If you are selling to a third party, his or her achievements following the sale are conditional on the support of your internal leaders. They can prop up an inexperienced owner, or sink him without a trace.

If any part of your proceeds from exiting depend on the continued success of the business, you would be wise to identify your internal leaders and make some provision for their continued loyalty after you are gone. If they don’t buy-in, you could see the value of your enterprise (and your payout) decline substantially.

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.

Exiting a “Time and Place” Business

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“The purpose of middlemen in the marketplace is to provide time and place utility.” I remember the light bulb going on in Economics 101 when my professor said that.  Suddenly, I understood the concept of added value. Someone had to get the product to the customer.

“After all,” the professor continued, “The footwear manufacturer in Massachusetts can’t sell a pair of shoes directly to someone in California. They can’t manufacture and handle thousands of customers. It would be a nightmare, and completely unprofitable.”

The fact that Massachusetts was still known for shoe manufacturing gives you some idea of how long ago this took place. So long ago, in fact, that Zappos wasn’t even a word yet.

The independent shoe retailer gave way to the department stores. In turn their shoe business was decimated by the specialty chain retailers. In fact, most shoe departments in Macy’s and others are actually chain operations within the store. Shoe sales moved into sporting goods stores and discounters. While the industry shifted multiple times, they all still provided time and place utility.

Then came the Internet. Now the manufacturer can sell directly to consumers. In fact, they can eliminate several layers of middlemen, along with the mark-ups.

Lately my area has been swamped with billboards saying “Mattress Dealers are Greedy. TN.com.” TN.com turns out to be Tuft and Needle, a direct selling (via Internet) manufacturer of mattresses. Their pitch is based on eliminating the middlemen. They have diagrams for their supply chain (From us to you.) on the website, along with a list of the markups in the “other guys” logistic chains.

Providing time and place convenience to consumers is challenging when your competitor’s time offering is 24 x 7 x 365 and the place where they purchase is their own home. Even when you need something “right away” online vendors will deliver in as little as two hours.

Last December my wife went out early on a Sunday morning to, “Pick up a few last gifts in time to ship them.” She returned an hour later, empty-handed. “This is ridiculous,” she said. “I’m going to finish my shopping on the Internet, and have all the gifts shipped for me.”

There’s an additional issue when it comes to selling time and place businesses. Many of the new generation of business buyers, the Millennials, value their personal freedom above financial opportunity. They have little interest in coming in early to open up, or staying late to close. Skipping the Thanksgiving family dinner to prep the store for Black Friday is a non-starter.

If you are hoping that I will reveal the secret sauce for perpetuating a time and place business, I’m afraid I’ll disappoint you. There is no magic formula aside from the age-old wisdom of differentiation and service.

Beating Time and Place

My friends at Digital Pro Lab in San Antonio are an excellent example of adjusting to change. What could be more outdated than a drive-up 30 minute film developing shop? What was formerly an epitome of time and place convenience (pictures in a half hour without getting out of your car), has become almost a caricature of “old school.”

Technology has shifted from celluloid film to digital. “Developing” now consists of uploading the files from your phone to a mega-printer who mails 8×10 prints overnight for less than Digital Pro’s cost. The photo chains, Ritz Camera, Fox Photo, and Wolf Photo are all gone, crushed by those “mail order, ” or perhaps more properly “email order” houses.

Digital Pro has survived (and thrives) by their differentiation and service. The large, bright showroom is full of computers where they can show customers the effect of adjusting color balance or editing. They can print your lifetime memories on almost anything, from a key chain to a large metal panel. They can still give you prints made with permanent liquid ink, not the water soluble powder used by most printers.

In addition, they can do all of this online because they’ve invested in the technology necessary to keep up with the “convenience-based” competitors.

As the cost of digital printers fell, professional photographers invested in their own machines. Digital Pro Lab has replaced their business with consumers who want to discuss their special moments, choose how to preserve them, and hold the results in their hands before they pay.

In an industry where the number of time and place based outlets has fallen by over 90% in the last decade, Digital Pro Lab has beaten the big boys with product differentiation and service. When the time comes for planning an exit, they will have options.

Do you know a business owner who will be exiting in the next ten years? Please share Awake at 2 o’clock!

What is Your Company Worth? II

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Last week we discussed how business owners frequently use hearsay or incomplete information to estimate the value of their companies. They give the number to their financial planner, or include it on a personal financial statement for their banker, neither of whom bat an eyelash at the estimate. Having the amount “accepted” by financial experts, the owner starts to treat it as fact. How do you know whether it is realistic or achievable?

alchemistValuation of a small business is a combination of art and science. No two small companies are alike. A multiple of profits or cash flow is only the starting point. Take two small companies, each with $4,000,000 in revenues and $500,000 in profits. Each pays the same salary and benefits to the owner. One does it by having systems that control most day to day activities, recurring revenue from contracts, and long-term employees who are incented by profit sharing. The other does it with an owner who works 70 hours a week, hasn’t had a two week vacation in ten years, and makes every new sale personally. Which business would you pay more to own?

Beauty lies in the eye of the beholder. The multiples paid for businesses depend on the type of buyers they attract. Commonly, those that sell for less than $2,000,000 are considered “Main Street.” Their target buyers are individuals who are purchasing an income. They intend to work in the business, and to earn a regular paycheck by running it.

Main Street businesses are valued by a multiple of Seller’s Discretionary Earnings (SDE). The value of the business is based on the sum of the financial benefits resulting from ownership. That includes profits, salary, benefits and any of a long list of possible perquisites like a company car, travel, or insurance. (For more on calculating your SDE and selling a business in general, you can read my book, 11 Things You Absolutely Need to Know about Selling Your Business.)

Main Street pricing is typically between 2.1 and 2.8 times SDE. It is based on simple arithmetic. The closer you come to 3 times SDE, the less able a buyer is to pay both the bank and himself. You can run your own numbers here, to see how it works (registration required).

For larger companies, those that attract financial and industry acquirers, the multiples are higher, but the multiplier is lower. Those buyers anticipate paying for professional management, so the owner’s compensation is less of a consideration. They look at EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization) to calculate available cash after all the expenses of running the business (including executive talent) are paid.

Competitors will calculate the savings they might realize from consolidation, but are usually reluctant to multiply those savings in a purchase price. Private Equity Groups (there are 7,000 in the US) and the acquisition arms of large companies seldom look at businesses with earnings of less than $1,000,000. As amazing as it seems to a small business owner, their due diligence and legal processes are too expensive to make smaller acquisitions worthwhile.

Private Equity Groups pay an average between 4.7 and 5.2 times EBITDA, year in and year out. That makes sense, because they are financial buyers with a targeted Return On Investment (ROI). Large company acquisitions of smaller businesses can range from 4 times EBITA up to around 7 or 8, although in a few cases strategic considerations (competition, exclusive contracts, proprietary methods) can drive that up substantially .

All of these are real numbers, based on actual sales data and industry surveys. Sellers often confuse the terms revenue and income, or apply EBITDA multiples to SDE. They are greatly disappointed and angry when legitimate offers fall far below their expectations. Just because your planner or your banker didn’t challenge your valuation estimate doesn’t make it fact.

My new book, Hunting in a Farmer’s World: Celebrating the Mind of an Entrepreneur, is now available on Amazon in paperback, hardcover and Kindle. It is an ownership book, not a management book, and is illustrated with the stories of real entrepreneurs who faced challenges that apply to us all.