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Internal Transfers: Legacy vs. Lucre

June 11, 2020September 13, 2017 by John F. Dini

Lifestyle vs. Legacy

Why would I refer to the results of an internal transfer as “lifestyle vs. lucre?” Lucre is a pejorative term. While it is technically just a synonym for money, most dictionaries draw the parallel to its use in “filthy lucre;” money that is ill-gotten or otherwise dishonorably obtained.

I was honored to present at the Exit Planning Summit this past weekend. One of the things I discussed was the need to help business owners determine whether their personal vision for their company’s future was based on lifestyle or legacy. That’s how I normally term it, and there is no negative connotation attached to either term.

That “lifestyle vs. legacy” decision, however, usually designates the difference between selling to a third party for full market value (lifestyle) and selling to employees in order to preserve the culture and quality of the organization (legacy.)

Legacy vs. Lucre

“Legacy vs. lucre” is my term for the differing motivations in an internal transfer, and it is fully intended to be pejorative.

For a business owner, the greatest appeal of an internal transfer is control. He or she gets to pick the new owners, their timeframe for taking over the company, and how much they will have to pay.

Sometimes, that avenue to exit is chosen because the owner knows he or she can’t get a satisfactory price in the open market. The company just isn’t worth what he wants for it.

So selling to employees becomes a vehicle to get more than fair market value. Of course, no third-party lender will touch a deal for more than the business is worth, so almost by definition such transactions have to be seller-financed.

That is one of the reasons we hear horror stories about selling a business to employees for a note, and having to take it back when they default. Their failure may have been due to a lack of training to run the business, or an unsupportable price. Either way, they were set up for failure by an owner who was more interested in getting a check than in what happened down the road.

Legacy Requires Win-Win

Selling to a third party is an arms-length transaction. Both parties have their own agenda and advisor team. The buyer is perfectly cognizant of Caveat Emptor. The seller wishes to maximize the proceeds, the buyer to minimize his cost. The result is usually something in between.

When selling to employees, the playing field isn’t even. The employees have followed the seller’s direction for a long time. They are accustomed to doing what he says. It’s when the owner takes unfair advantage of his status that legacy turns into lucre.

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The Right Price for Your Business

June 11, 2020August 20, 2017 by John F. Dini

“If someone offered me the right price, I’d sell in a minute!” Exit planners and business brokers hear it all the time. “Anything is for sale if the price is right!”

What is the “right” price? Of course, you can fantasize about a windfall from a buyer who has far more money than brains. Some of the fast-talking “business brokers” (the ones who get more revenue from preparing offering books than actually selling companies), will pitch their secret list of buyers in Europe and Asia who routinely overpay for businesses.

In case you didn’t know, the largest advisory firms in Europe and Asia are the same ones we have here. The same accountants, the same attorneys, the same investment bankers and the same consultants. It’s unlikely that they give their wealthy overseas clients lesser quality advice than the ones in North America.

Barring purchase by a lunatic, your business is likely to be priced around Fair Market Value; the arms-length amount that an independent buyer will pay an independent seller.

Beauty is in the Eye of the Beholder

You are the seller, and your company is what it is. Buyers, however, come in a variety of sizes and flavors. Understanding why companies have different values to differing buyers is critical if you plan to maximize your proceeds.

Here is a 2 1/2 -minute video on valuation from our website of free tools for business owners at www.YourExitMap.com.

These are the typical ranges for “fair market value.”

If you are earning less than $500,000 in total salary, profits and benefits from the business, your likely price is between 2.5 and 3.5 times the SDE (Seller’s Discretionary Earnings.) These are “Main Street” businesses; typically sold to individuals.

Once you exceed $1,000,000 in Earnings before Interest, Taxes, Depreciation and Amortization, or EBITDA (but not counting your personal salary and benefits) you are a target for professional investors. These include private equity groups and family offices. In this market, valuations between 4 and 6 times earnings are common. If your EBITDA is over $2,000,000 it could be substantially higher.

Strategic and industry buyers (who may be the same) could pay more, but those transactions are very specific to the situation. In simple terms, the right price is whatever you can get. If the acquirer has a plan to plug your business into an existing customer base and grow it substantially, earnings often become a secondary issue.

The Neutral Zone

The “neutral zone” contains those companies who earn more than $500,000 (SDE) but generate less than $1,000,000 EBITDA. This is a fairly broad range.

Let’s use an illustration. An owner takes a $400,000 salary along with another $250,000 in benefits, and shows a pre-tax profit of $700,000. Clearly that is a healthy small business. In the “Main Street” market the company could value at between $4 and $5 million.

An individual buyer would need at least 25% down ($1,000,000 cash) plus working capital, and be able to guarantee loan payments of about $500,000 a year. That’s well beyond the range of most individuals.

Yet unless this business has a unique product or intellectual property, it is likely of no interest to professional, industry or strategic buyers.

Many of these companies are choosing a staged sale to their management teams. Others choose to kick growth into a higher gear in order to reach the next stratum of buyers and valuation. Either approach will usually take at least five years.

Controlling the Right Price

Some owners are choosing both approaches. They use ownership as a management incentive to achieve growth targets. If the company makes the leap into a buyer market with higher valuations, both the owner and the management team win.

If the company doesn’t attract the target buyers, the owner still has a solid exit strategy from a more valuable company. Getting the right price requires the right plan.

“Read” my new book in 12 minutes!

After the Exit; “Nothing Will Change”

June 11, 2020April 27, 2017 by John F. Dini

“Nothing will change.” It is almost de rigueur for an acquirer to include that in his or her opening comments to the incumbent staff of a just-purchased business. Sometimes it is the seller’s attempt at making folks feel better. “Don’t worry. They promised me that nothing will change.”

In the moment, it seems like a calming thing to say, a confidence builder for the employees who have just been informed that they have a new boss. In the long run, it can cause more problems than it solves.

Everything Changes

In any company, change is ongoing. Employees are asked to learn additional skills. Systems are upgraded. Procedures are rewritten. People are promoted or terminated. Customers leave, or (hopefully) big new accounts with new requirements are landed.

No experienced business owner in his or her right mind would ever promise employees that “Nothing will change.” Change is part of the landscape, and adjusting to it is inherent in keeping the business growing and relevant. Employees accept that fact unconsciously, because it’s always been part of the landscape.

Of course, when an acquirer says “Nothing will change,” he means today. There will be new procedures. New reporting relationships will have to be worked through. Software will be modified, or even discarded for the acquiring company’s preferred systems. And eventually, some employees will be promoted or terminated based on their ability to accommodate those inevitable changes.

“Nothing will change” is a license for employee dissatisfaction. They have to learn a new telephone system. (“He lied. This is a big change.”) All invoicing will be done through the central office. (“She lied. This is a massive change.”) Job descriptions and incentives will be adjusted to match the parent company’s. (“He lied. Everything is changing!”)

Demystify Change

The appropriate soother for acquisition anxiety is the truth. “I know this is a big change. You’ve faced great changes in this company before (get some examples from the seller) and your ability to adjust and succeed is what makes us so excited to be teaming up. We’ll take things slowly to start, and work with you so that our integration will be as painless as possible.”

There are no magic words that can completely eliminate employee concern. Dealing with it by promising something that isn’t true is just incurring a long-term cost for a very short-term benefit.

Stop Managing

January 29, 2017 by John F. Dini

Why would anyone advise business owners to stop managing? Management is a proven science. From the time and motion studies of Frederick Winslow Taylor in the late 1800s, to Matthew Kelly and Patrick Lencione’s Dream Manager, we are constantly in search of ways to make employees more effective.

Management trends (some say “fads”) come and go. Wikipedia lists a number of major theories since the 1950s, including Management by Objectives, Matrix Management, Theory Z, One-minute Management, Management by wandering around, Total Quality Management, Business process reengineering, Delayering, Empowerment, 360-degree feedback, Re-engineering and Teamwork.

You could probably throw in a couple of offshoots like ISO 9000, Open Book Management, Six Sigma, Balanced Scorecards and Net Promoter Score. All have metrics (Key Performance Indicators) to measure their effectiveness.

In the 125 years since Taylor, after the introduction of automobiles, telecommunications, manned flight and the Internet, we are still working from the basic framework of time and motion studies. We try to empower people, but that often just means having them track their own production rather than have someone else do it for them. (Delayering)

That leads us to one of the Catch 22s of many business owners’ reality. Once you have grown an enterprise large enough to require management, you’ve outgrown the skill set that made your business successful.

Small businesses become bigger businesses through their owners’ leadership and creativity. Time isn’t a fungible commodity, you can’t save it or get more of it. In a zero-sum equation, any increase in one factor means a reduction in others. The more time you spend managing, the less there is left over for leading and creating.

Stop Managing, Start Creating

Last week, I sat in on a panel of three successful business owners who were discussing the value of a second in command. Each mentioned how delegating the management tasks of daily operations had freed them to focus on longer-term objectives, develop new ideas, and improve their personal quality of life. (In case you’ve forgotten, that’s why we own companies.)

A second-in-command to manage the business can’t be undervalued. I recommend Gino Wickman’s Rocket Fuel for a terrific examination about the relationship between a visionary and an implementer. If you haven’t read my own Hunting in a Farmer’s World, subscribe to Awake at 2 o’clock (to the right) for the chapter “I’m a little bit ADD” and see if you recognize yourself. (If you already subscribe, don’t worry. We don’t send duplicate emails.)

There were a number of owners from smaller businesses in the panel’s audience. Their comments were not unexpected. “I can’t afford a hire really top-flight manager.” “What if I get dependent on someone and he leaves?” “How can I find someone who knows as much about the business as I do?”

Those observations are being made by looking through the wrong end of the binoculars. The real question to ask is “What would happen if I had more time to do what I do best?”

The average business owner estimates that about 20% of his or her time is spent in business development, the long-term creation of new products, services, systems and relationships. If a second in command can take just 30% of your duties, you could increase your business development effort by 150%.

What will happen if you stop managing, and devote 2 1/2 times the effort to growing your business? That’s how much a good manager is worth.

Are you over 50 years old, or do you advise business owners who are?

Exit Planning: Telling Secrets

June 11, 2020January 8, 2017 by John F. Dini

Planning your exit from a business is a process of telling secrets. For many owners, it is the most terrifying part of selling.

A rancher in South Texas once said to me, “I’m going to tell you a secret, and you have to solemnly swear not to tell anyone. When you do, you have to make them swear the same thing.”

Most business owners are very cautious about with whom they share their exit plans. The logic is intuitive. The more the information is shared, the bigger the chance is that someone will use the knowledge against you.

telling-secrets Competitors will tell customers, insinuating that your company will no longer be a dependable supplier. Employees might begin looking for greater security in other jobs. Vendors may seek another distribution channel. Your bank could start tightening your credit.

Yet your buyer wants to verify due diligence information. He wants to talk to key employees and customers. Lines of supply and the solidity of relationships have to be confirmed.

Some owners are unduly afraid of letting anyone know their plans. Sooner or later everyone will know, but when they should be informed is an important part of your planning. Controlling the distribution of information might have dramatic impact on the value of your business.

Those who should know about your plans can be placed in three groups.

Round One

Key employees: Whether they are slated to be the next generation of owners or not, key employees should be the earliest group informed of your plans. Of course if you are contemplating an internal sale, their willingness and ability to buy the company requires disclosure. If you are planning an external sale, their cooperation in preparing the company for a buyer’s due diligence will be critical.

Consider having the employees sign a new non-disclosure agreement. Even if you have confidentiality provisions in your employment contracts or policy manual, it serves to emphasize the sensitive nature of exit planning information.

Round Two

Going outside your trusted inner circle is a big step, but you should consider it once you have a solid buyer in place. Sharing earlier, rather than later, makes due diligence easier.

General Employees: Employees can usually be informed fairly early in the sale process. Explain that the transition of the company is a normal part of its lifecycle, and that you are taking steps to ensure that it is done with an eye to their continued employment. That will go a long way to making them feel more secure. If you treat it like a dark secret, they will have greater concerns about the inevitable rumors.

That’s why I suggest you inform the employees before you tell vendors and competitors, from whom they are likely to hear it anyway. Bringing them “in the know” will also help forestall any hiring attempts by other businesses. Inertia is a powerful force. Usually after a few weeks with no major disruption, the employees just accept your exit planning as a fact of life.

Critical vendors. If you have an exclusive distribution or supply relationship with some larger companies you may already be fielding requests for a documented succession plan. Many suppliers appreciate the forethought of exit planning because it ensures the stability of their distribution chain.

One area of caution. Watch out for a vendor’s loose lipped salespeople, who may regard news of your pending departure as hot gossip for the rest of their customers.

Round Three

Customers: Most customers should be told as late as possible before the transaction closes. If informed of a fait accompli, they are likely to stick with the relationship long enough to gain some experience with the new owners. If informed too far in advance, customers will logically begin to look for alternative sources of supply.

Lenders: While many bankers and other lenders will say that they ought to be informed as early as possible in the process, it is often not a great idea. They may seek the opportunity to finance a transaction, and certainly would like to begin a relationship with any new owner as soon as possible, but they also have a primary responsibility to protect the assets of their institution.

That means they have to worry about the security of your personal guarantees, and whether they see any risk to their capital in your business. Discussions with your bank should include details about the future of your banking relationship.

Due diligence is only one step in the process of telling secrets. Lots of other stakeholders will need to be informed. How and when you do that should be a formal part of your planning process.

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