Exit Planning Tools for Business Owners

business strategy

Is Your Business Built on Individual Heroics?

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Great employees are a wonderful gift, but individual heroics aren’t healthy for your business.

Someday, you will start thinking about leaving the business. Perhaps you already do. When you begin planning for your transition, what will your company systems sound like when you describe them to a critical buyer?

“Yes, we have a process for that. It hasn’t been updated, but Martha knows it like the back of her hand.”

“We really don’t have anyone cross-trained on that machine. Bucky likes to work alone, but it’s okay because he hasn’t taken a vacation in three years.”

“We always use Andy on that route. There are lots of traffic snarls, and he’s the only one who seems to be able to finish on schedule.”

You are getting the point. When an employee is especially productive or reliable, it’s easy to become dependent on his or her individual heroics. It’s one fewer function of the business that you have to watch.

heroic workersIt is ironic that the very behaviors that make your life easier appear to be threats in the eyes of a prospective buyer. You know that they could pose a problem, but they haven’t so far. Why fiddle with what’s working?

The answer is because individual heroics discount the value of your business. A buyer worries that key workers might not like his or her management style. As a new owner, he might be immediately approached for pay increases. Worst of all, if one of your heroes’ performance heads south, he may not be able to fix it, or even know what is happening.

For just a moment, look at your best employees as threats. Do you have a contingency plan for each? Can Martha’s process be documented so anyone can do it? Is Bucky just a loner, or is he trying to make himself irreplaceable? Can Andy’s mental map be duplicated by routing software?

And in case you didn’t realize it, “I can do any of those jobs myself. ” is the worst of all possible answers. Those kind of individual heroics will send the buyer towards the exit instead of you.

Dependable high performers are invaluable, but they are frequently protective of their status. Recognize them, but make it plain that that their work needs to be duplicable. (Although, “Of course, not at the level you perform.”)

If you don’t, start looking at them as liabilities rather than assets.

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Good Customers Can Be Bad

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When can good customers be bad? What could be wrong with a customer who buys a lot, pays promptly, and never has a service problem?

They might be buying too much. No matter how strong or comfortable a sales relationship is, it could end. You may be confident that the customer is yours for life, but therein lies the problem. Someone who buys the business doesn’t have the same level of confidence that the customer will be around for a whole new ownership lifetime.

Many mid-market companies rode one horse to success. There were bringing in a few million dollars in revenue when the landed “the big one.” Perhaps they had to scramble to add capacity and ramp up talent, but the seized the opportunity and met the challenge.

As these companies grow, the owners always say the same thing. “I know that it’s bad to have my eggs in one basket. I’m going to find other customers to even things out.”

big and little businessmenBut the good customer keeps buying more. They are twenty times your size, and an increase of 2% for them translates into 40% more for you. Businesses in this situation aren’t necessarily complacent. They are just scrambling to keep up.

This good customer brings many other benefits along with its dollars. They ask for plans and budgets, so you develop capabilities to meet their requirements. They coordinate packaging a shipping, so you learn more about logistics. They ask for detailed reporting, so you upgrade your tracking systems.

Your company’s increased capabilities translates into more business with large customers. You can show your ISO certification or online reporting. You deliver specifications or scope of work statements as professional as those of much larger competitors.

But you never quite catch up. You are like the dog that caught the pickup truck. You don’t have any control, but you can’t let go, either.

There is an obvious risk of good customers having a change in management or strategy, but for the most part the relationship is favorable. The problem arises when it is time to exit your business.

This issue is specific to mid-market companies. In a Main Street sized business, an entrepreneurial buyer (one who is purchasing a job) will often look at the steady income from a large account favorably. If you’ve grown large enough to attract a professional buyer, however, the “Quality of Earnings” audit will bite you.

Quality of earnings analyses are done by larger accounting firms for mid-market buyers, particularly private equity groups. Those firms typically charge between $20,000 and $60,000 for the audit. Not surprisingly, the client wants a return on that investment. That comes by way of discounting profitability associated with the “risky” business.

If the letter of intent is offering five time earnings, the price reduction is of course on a 5:1 ratio to the profits. Not to belabor the math, but if a $40 million company had $4 million in profits, and 40% came from one account, a 35% discount for that account alone would be $2,800,000 off the purchase price.

That’s when good customers can be bad.

Do you know an owner who would enjoy Awake at 2 o’clock? Please share!

The Immortal Business Goes on Forever

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Do you run an immortal business? I hope so. If you answered “no,” or even hesitated to be sure of your response, then you don’t think of your business as immortal.

So when do you plan to shut it down?

Most owners react viscerally to that question. They’ve invested too much time and too much sweat to watch their companies become a memory. They care too much about employees and customers to entertain the idea of  abandoning them.

ForeverFor many, the business is a part of them. Shutting it down would be like having a piece of you die.

Ironically, we play mental gymnastics in our heads every day. We think we have an immortal business. We know we aren’t immortal (on this plane of existence, at least.) Yet, I talk to owners every day who want to pretend that either they will run the business forever, or that it will find some magic way to continue without them.

Anyone who works in exit planning knows the standard answers to the question “What is your exit plan?”

  • “I intend to look for a buyer in about 5 years.”
  • “I still enjoy my business. Talk to me after I get tired of it.”
  • “I’ll sell anything for the right price if someone offers it.”

Each of those answers is a version of “I haven’t thought much about it, and I really don’t want to.” I wouldn’t be much of a consultant (or at least I’d be an impoverished one), if I didn’t have some counter arguments ready.

  • “I intend to look for a buyer in about 5 years.” That’s fine, but five years is about the minimum time you should allow for any serious tax planning. If you are going to take a subchapter S election, create a new entity, or change your  depreciation methods, it will take some time to have the desired effect. Of course, the Internal Revenue Service already has a plan for how they would handle the proceeds, so you could just go with theirs.
  • “I still enjoy my business. Talk to me after I get tired of it.” That is clearly too late. Whether you are selling to employees or family, or marketing the company to third parties,  the business needs to be running well to survive a transition to new ownership. Once you start losing interest, it gets much tougher.
  • “I’ll sell anything for the right price if someone offers it.” Sure but what is the “right” price? Is it based on industry metrics? Is it some multiple that a guy from a vendor told you a competitor sold for? Is it a number you need for retirement that has little to do with market value? If you received an offer tomorrow, how would you know if it was the best offer you might ever see?

The most important thing to remember is this: Planning is only planning. Implementation is a different activity in the management cycle. Just because you have a plan doesn’t mean you will use it today or tomorrow, but it will still be there when you choose to put it into action.

If you own an immortal business, you have an obligation to the folks who depend on it. Part of that is to know how they will be able to continue depending on it when you aren’t there.

If you know a business owner who would benefit from “Awake at 2 o’clock,” please share!

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Selling Your Business: Money isn’t Everything

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When I was a kid my mother said “Money isn’t everything” in response to every envious glance at another kid’s stuff. As I became successful enough to afford things for my children, I reversed the meaning. “Money isn’t everything” became my reminder that their possessions didn’t make them better or happier than others.

The same holds true for companies. An entrepreneur who is struggling to generate sufficient working capital is an unlikely prospect for a lender, let alone an investor.

I regularly receive approaches from business owners who have a great ideas, but have run out of capital without generating cash flow.  They usually have trouble understanding why I don’t want to represent them in their investment search (for a fee contingent on only my success, of course.)

“But everyone says there is plenty of money looking for deals,” they say. It is true. There is always more money available than good investments. That’s why so many investments lose money.

Once your business approaches $1 million in annual earnings, the whole capital landscape changes dramatically. If you are scalable (meaning you likely have around 100 employees or more) your deal is attractive to financial investors such as private equity groups. There are currently about 7,000 such buyers in the US, pursuing the 17,000 or so companies who meet their criteria.

These buyers range from Search Groups (who have investors lined up if they find a company), to investment funds with a billion dollars or more in “dry powder” (cash in the bank).

If you are smart, and clever, and tenacious, and lucky, you can reach the point where there is plenty of money to buy you out. In fact, money is probably chasing you. Most sellers, however, come to realize that money isn’t everything.

shark with dollarThe M&A world abounds with horror stories of financial buyers who stripped the employee benefits from a company and drove off its key personnel. Others pulled their capital as soon as they had control (to leverage it in another deal) and left the business staggering under the debt replacing it. Still more inserted a Hired Gun executive from another industry whose inexperience quickly ran the business on the rocks.

That might not be your concern if you walk away with a terrific multiple, but if the deal (like many) requires you to leave a substantial amount on the table for a few years, it’s critical.

I work with business owners in their exit planning. Although I haven’t brokered in years (meaning list and market businesses for sale), I regularly advise owners who are dealing with an approach from financial buyers. Here’s my mental checklist for vetting a financial buyer:

  1. Do you trust them? Can you see working side by side with them as your partners?
  2. Do they understand your business and your customers, or are they just looking at your financial statements?
  3. How important to you is the future of your employees and your reputation?

Notice that the questions don’t include “How much money do they have?” If you are attractive to one financial buyer, you are probably attractive to a lot more.

Many of my clients, when they examine the non-financial aspects of selling, choose alternative exits. They arrange for the employees to buy the business, or merge with a friendly competitor. They may not make quite as much, but money isn’t everything.

If you enjoy Awake at 2 o’clock and know a business owner who would benefit from reading it, please share. Thanks!

Selling to Employees: Is Your Exit Strategy Right in Front of You?

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When I interview a prospective client for exit planning assistance, we usually explore selling to employees. The first reaction is always “That won’t work. They don’t have any money.”

If you have a company with reasonable cash flow, a talented management team and sufficient time, selling to employees is not only a realistic option; it may be the best way to get value from your business. I’ll define those parameters for you in a minute.

If you haven’t read my eBook Beating the Boomer Bust, follow the link for the free download. My research shows that the hard numbers will inevitably translate into a hard market. There are 3,000,000 Baby Boomers (over 50) who own businesses with employees. Over the next 20 years, that’s an average of 150,000 owner retirements per year. Intermediaries (brokers, private equity and M&A) account for about 9,000 transactions a year.

That leaves a lot of folks looking for a way to cash out. Selling to employees is a process that lets you keep control until retirement. By structuring the sale correctly, you can leave with the proceeds in the bank, not in a promissory note.

How does that work? It requires a bit of mental gymnastics. First, any owner has to accept that the only source of funding for any transaction is the cash flow of his or her company. If a buyer pays cash, he expects that cash flow to pay him back. If a bank finances the acquisition, they expect the cash flow to service the debt. If you finance it, you are the essentially the bank.

Selling to employees is the same. You use the current cash flow to help employees buy stock. In return, they qualify by working to increase the value of the business until your final return is equal to (or more than) what it was when you started.

Think of it as taking a note for 30% of the purchase price while you are still in control, so that you can get a 70% cash down payment when you leave.

Now, let’s discuss the parameters.

Cash Flow: Your company has to be earning more than just your paycheck. My rule of thumb is that around $500,000 a year after owner’s compensation gives enough to work with. More than that doesn’t change much, since then we are usually looking at a higher purchase price. Less than that is doable in a longer time frame, or if the owner is willing to subordinate some debt to the bank.

Management Team: You need at least one decision maker who does more than just go through the operational motions. Any third-party lender wants to be comfortable with company leadership when you’re gone. A large portion of our planning surrounds transfer and documentation of management capability sufficient to satisfy a lender.

Time Frame: Many business owners tell me “I’ll think about exiting in five years.” That’s fine, if your plan is to retire in fifteen years. Generally speaking, the longer you have, the more lucrative an internal sale can be. I’ve done three year plans, but five is much more comfortable, eight years is even better, and we regularly work on transitions of ten years and longer.

all for one one for allSelling to employees requires legal agreements, specialized compensation plans and a willingness to run the company transparently. The return is a team that is committed to the long term, highly motivated, and all on the same page when it comes to growing the business.

Why should you consider selling to employees?  Because your company lives on with the culture you created. Because you can choose the value, not negotiate it. Because your employees aren’t comparing your company with other investments. Because you control the timing of your exit.

Because it is probably the biggest financial transaction of your life.

Do you know an owner who would benefit from reading Awake at 2 o’clock? Please share!