Exit Planning Tools for Business Owners

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The Third Entrepreneurial Sin — Sloth

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This week we begin discussing the tactical sins. They are those habits of a business owner that impact day-to-day operations; Sloth, Wrath and Greed. To read this series from the beginning, start here.

Few business owners would acknowledge that they suffer from Sloth. Most work very hard. To paraphrase an old New Yorker cartoon, “The thing I like best about self-employment is that I can make my own hours. I’ve chosen to work 24 hours a day.” (Also, see Lust.)

good enoughSloth in your business isn’t a disinclination to put in the effort. It’s the sin of settling for “good enough.”

If your sales are flat, margins are shrinking or you never experience employee turnover, you may be suffering from Sloth. If you accept financial reporting that is late (after the 15th of the following month), or worry that you wouldn’t know what to do if a major customer defected to a competitor, you are definitely guilty.

There are things you say to your employees that indicate Sloth. Listen for these clues:

  • “I know the order isn’t complete, but we are late already. Ship what we have.”
  • “Yes, that’s Bob’s responsibility, but I’d rather you handled it.”
  • “The bank wants to see our financials. When should I say they’ll be ready?”
  • “I think we are making a good profit. We are paying the bills.”

Managing your business isn’t a matter of finding the lowest common denominator. Just because you aren’t going broke doesn’t mean you are running a great company.

The “Business Virtue” that counters Sloth is Benchmarking; the ability to measure your results against a standard. Various management approaches extol Balanced Scorecards, and Key Performance Indicators. “Manage what you measure” is an axiom that is frequently quoted, but far less applied in day-to-day operations.

Benchmarking your company requires that you know how others in your industry or market fare. It doesn’t require industrial espionage. Trade associations, banks and accounting firms have statistical reports with financial metrics by industrial code and company size, most of which they will share on request. Knowing where you stand against other who run businesses like yours is a first step in knowing whether you are doing well, or just surviving.

At the very least, know where your company stands against itself. I’m surprised by how many business owners can’t tell me how their ratios look compared to last year, or the direction of their margin and expense trends.

Internally, Benchmarking requires that you set measurable standards of employee performance. Are your expectations made clear via goals and objectives with concrete deadlines? Is advancement tied to achieving these, or do raises and promotions come because someone is good enough? When was the last time you terminated someone for not improving?

I knew an owner who reviewed a lower-level employee. The worker had a specific job that only he did. He had production goals, which were met in the previous year and qualified him for a raise. The owner congratulated him, and then said “Let’s look at what could be better, so we will know whether you have earned your next salary increase.”

The employee exclaimed “You people are never happy. I quit!” and walked out. He spoke the truth, but the business was in the top 1% of profitability in its industry. They didn’t get there overnight. It took many years of looking for (and measuring) what could be better. Their quest for improvement would not be abandoned for an employee who felt that he was already “good enough.”

Sloth isn’t laziness. It’s the insidious creep that begins when an owner has too much on his or her plate, and lets slide the things that aren’t an immediate problem. Left too long, it may be the most difficult sin to root out of a company’s culture. That’s why we first discussed the sins that affect an owner’s personal performance, Lust and Gluttony. Only after you have tuned up your own efficiency can you begin to work on the issues surrounding you.

I hope you enjoy Awake at 2 o’clock? Please share it with other business owners.

 

The 7 Deadly Sins of an Entrepreneur

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The Seven Deadly Sins are alive and well in small businesses today. Far from being a hoary religious holdover from the Dark Ages, they are practiced assiduously by entrepreneurs everywhere.

devil dancing in suitThere is something to be said for any concept that catches the public imagination for fifteen centuries. First postulated by Saint John Cassian around 400 AD, the sins were codified by Pope Gregory the Great in the late sixth century, and popularized by Dante Alighieri in “The Divine Comedy” in 1315. They remain present on a daily basis in many businesses  through the 21st century, 700 years on.

The Seven Deadly Sins are Lust, Gluttony, Sloth, Wrath, Greed , Envy and Pride. In a business, they can be divided into Operational, Tactical and Strategic sins.

The Operational Sins are Lust and Gluttony. Lust is present when the owner uses his or her power of position to pull the business in any direction he or she chooses. Gluttony is a tendency to hoard all authority and decision-making for yourself.

The Tactical Sins are Sloth, Wrath and Greed. Sloth in business is settling for “good enough,” when a bit more effort would produce a far better result. Wrath is using adrenalin to replace critical thinking, and reacting to problems by ratcheting up your emotional drive. Greed presents itself as the belief that every issue in the business could be solved by “just a little more.”

The Strategic Sins of Envy and Pride stem from the owner’s personal belief structures. Envy is the belief that no one has the same problems as you do. Pride is a conviction that the company can’t survive on a day to day basis without your special talents.

Christianity, of course, has corrective actions for the Seven Deadly Sins. Each sin has its counteracting virtue. For Lust there is Chastity. For Gluttony; Temperance. The sin of Sloth is counteracted by the virtue of Zeal, and that of Wrath by Kindness. Greed is foiled by Generosity, Envy by Love and Pride by Humility.

When applied to business ownership, the Entrepreneurial Sins also have corresponding “virtues” that can reduce or eliminate their negative effect on your business.

The Operational Sins require behavioral changes. The counter to Lust comes with having a Personal Vision. Gluttony is defeated with Delegation.

The Tactical Sins dissipate in the face of internal organizational  practices. Sloth can be overcome by Metrics; the use of clear goals and objectives. Wrath is far less of a problem in the presence of Planning. Greed lessens when there is objective Budgeting.

Strategic Sins are those that can be defeated with more long range initiatives. Envy falters in the face of Knowledge about your industry and your markets. Pride dies a natural death when you engage in Exit Planning.

The Seven Deadly Sins of Entrepreneurs is a fun way to look at much of what we do in our business. I’ve presented it a number of times as a workshop for local and national business groups, and the idea is catchy enough to have landed me an Easter Sunday television interview a few years ago.

You may not be inclined to New Year’s resolutions (I’m not, myself) but most of us start a fresh calendar with some level of intent to “do better.” We’ll spend the remainder of January examining the indicators of these sins in your business, and what you can do about them.

If you know a business owner who might benefit from correcting one or more of the Seven Deadly Entrepreneurial Sins, please forward this column so he or she can subscribe. Thanks!

 

Is Your Business in the “Neutral Zone?”

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As Baby Boomers business owners approach retirement (the youngest of them turned 50 this year) they face a unique challenge. The market for small businesses is increasingly a buyer’s smorgasbord A shrinking middle-aged population, corporate competition for talent and less interest in the long hours associated with many traditional small businesses combine to make selling many Boomer enterprises a more difficult proposition.

The best-of-class companies on both the smaller and larger end of the spectrum will still stand out as appealing propositions to buyers. On the main street side (companies selling for less than $3 million or so) there are still plenty of aspiring entrepreneurs who seek a lucrative opportunity.

The mid-market (companies with over $1 million of pre-tax income) has more money chasing fewer target prospects. Current estimates calculate over $1.6 trillion (about the GDP of Japan) allocated by Private Equity Groups and corporate M&A departments for purchasing those businesses.

stuck in betweenWhat about the companies in the middle? As in the Star Trek “Neutral Zone,” the place where neither the Federation nor the Romulans travel, these businesses have a special challenge when their owners seek to transition, and especially when they want to exit with the value of what they’ve built.

A generic history of these Neutral Zone companies applies to thousands of them. A Boomer entrepreneur bootstrapped a business thirty years ago. Badly undercapitalized, he or she struggled for years to make a decent living. As time passed, a four decade long expanding economy, driven by the influx of workers and consumers from the same generation, helped to grow the business until it provided a comfortable living.

Now in their 50s or 60s, those owners have achieved their life goals. Their labors have resulted in an enterprise that employs between 15 and 50 people, and puts between 300,000 and a million dollars to the bottom line above and beyond their own salaries. Compared to 95% of Americans, they are “rich.”

But they are too big to sell easily in the small business (main street) markets, and too small to attract mid-market buyers. They are in the Neutral Zone.

In main street sales (as I’ve explained here before) solid companies sell for an upper limit of around three times the pre-tax profit combined with the owner’s salary and benefits. As that pricing exceeds $3 million, and certainly above $4 million, it becomes difficult to find an individual entrepreneur who can leverage that purchase price.

In the mid-market, where the cost of a transaction limits targets to those with $1 million and more in EBITDA, many Neutral Zone owners would have to grow the business by 30% to 70% just to make the entry level numbers.

A Boomer entrepreneur who is in the “harvesting” phase of business ownership; enjoying the benefits that come from decades of dedication to the business, is often not interested in another big push. It may require more investment, more risk, and probably a lot more effort.

He or she built the company with a belief that it would fund a certain post-business lifestyle upon sale. Now they are finding out that a well run organization with solid and sustained profitability may not be enough.

I typically work with between 15 and 25 of these owners at any given time. For many, the solution can be to “hire a buyer.” Their companies are financially capable of recruiting top management talent. That talent should first be capable of taking the day-to-day management duties from the owner, but in addition, be entrepreneurial enough to eventually assume ownership in turn.

The secret to realizing the full value of a Neutral Zone company may not lie in bringing it up to another level (or, perish the thought, down to a lower level) of prospective buyers. Instead, consider using the organizational strength and profitability you’ve created to engineer an internal sale on your own terms, in your own time, and under your control.

 

Do you enjoy “Awake at 2 o’clock?” Please share it with other business owners.

Owners Live in Two Different Worlds

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Business owners live in two different worlds. If you are a Baby Boomer, the title of this column might bring memories of any one of the many covers of the song by the same name. (Everyone from Nat King Cole to Roger Williams, and from Jerry Vale to Englebert Humperdinck recorded it.)

My application of it in business refers to the chasm between those owners who plan to sell a business valued at less than $3 million, and those who have companies valued at more than that. In M&A parlance; “main street” and “mid-market” businesses.

business presentationSome background is in order. I spent the week at two conferences. At the Business Enterprise Institute’s Exit Planners’ Conference we talk mostly about the complexities and structures of mid-market transfers. From there, I attended The Alternative Board’s International Conference for advisors who run peer advisory groups and provide coaching, principally for the owners of main street companies.

At the latter, I had the privilege of being on a panel with Bo Burlingham of Inc. Magazine, the author of Small Giants and Finish Big, and John Warrillow, the Founder ofBurlingham Warrilow Dini the Value Builder System and author of  Built to Sell. It would be challenging to find three people in the country who have spent more combined time studying how small businesses sell, and what determines their value to a buyer.

Even with two audiences of savvy professionals who are focused on the flood of business owners transitioning from their businesses, in many sessions the presenters had to explain the difference between the two markets. As an owner, it’s critical that you understand what the market is for your company. Using data from the other side of the fence is only destined to frustrate you.

Mid-Market

These are companies with a value (not revenue!) of greater than $3,000,000. To garner the interests of financial buyers (private equity groups), they have to generate pre-tax earnings of at least a million dollars a year. To attract strategic buyers, they must have some real differentiation in their industry or market. Those who are truly scalable and have already grown to over 100 employees are the hottest commodity; but according to Doug Tatum, the author of No Man’s Land, they presently account for about 30,000 of the 6.5 million private employers (2-500 employees) in the marketplace.

The acquisition outlook for these companies is wonderful. The financial market is blazing hot, with 7,000 private equity players and publicly traded acquirers chasing those 30,000 businesses, or at least any among them who will still take a phone call. Valuations  are growing quickly, with multiples in the upper end of the market up over 20% in the last two years, and well over a trillion dollars of “dry powder” waiting to be spent on buying them.

Main Street

Clearly, the odds are pretty high that you are one of the 6,470,000 owners whose company does not fit the description above. Welcome to Main Street, where differentiation is difficult or impossible to quantify. (Sorry, but in all but the rarest cases,  “service” is not a competitive differentiation.) The business exists primarily for the purpose of providing financial security for the owner and the employees.  Likely acquirers include individuals seeking to purchase an income, small competitors, or if you are close to the million dollar pre-tax mark, perhaps a private equity group looking for a “tuck-in” or “bolt-on” to an existing similar acquisition.

The news for these owners could not be more starkly different than for the chosen few in the mid-market. According to Burlingham, somewhere between 1.3 and 2 million of these businesses will come up for sale in the coming decade. According to both IBBA (the business broker’s association) and the US Chamber of Commerce, only about 20% of them will successfully sell to a third party. With the much lower population of Generation X, who have little in the way of liquid savings and eschew 50 hour work weeks, the pre-tax multiples in Main Street values are contracting, and the shrinkage grows worse the farther down the food chain you are.

The message is clear. As John Warrillow said, if you are anywhere close to the magic numbers that attract mid-market buyers, the most important thing you can do is drive your company over the top. The difference can mean double, or even triple the proceeds you receive. Here’s an exercise. A company making $700,000 a year with a valuation of 3x earnings can sell for $2,100,000. If they grow to $1,100,000 in profits with a value of 5x earnings they’d get $5,500,000 at sale. That’s 57% growth in profits for 161% growth in price.

Any questions?

Even the measurement of earnings between the two types of business is different. We’ll discuss that next week.

 

 

Ageing Boomer Entrepreneurs: Fearful or Smart?

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Do we become more cautious with age?

Startups are usually associated with younger entrepreneurs. By the time they reach their 50s or 60s business owners tend to tackle fewer big new ideas. Those that do tend to be successful enough that they can segregate the risk in a way that won’t threaten their core livelihood. Are they smarter, or just more fearful of failure?

There are any number of business axioms about the value of experience. “Experience is what you get when you don’t get what you want.” or “Good decisions come from experience. Experience comes from bad decisions.” Does the caution that accompanies age come from experience, or just from a natural reduction in adrenalin?

The youngest Baby Boomers turn 50 this year. Collectively, they represent over half the small business ownership in the United States. There is an important macroeconomic issue attached to the general ageing of owners. If risk-aversion is a biologic phenomenon, then we can expect millions of small employers to drift into “harvest mode,” maintaining their businesses as vehicles for current cash flow and retirement security. They will leave growth and innovation to a younger, but substantially smaller group of entrepreneurs.

Some of their caution is due to external influence. As companies grow and founders age, they become far more conscious of their responsibility to employees’ families and children. Putting everything on the line has potential impact not only on workers, but the extended small economy that depends on their wages. Greater responsibility generates greater caution.

danger aheadWhen you are starting out, have fewer people depending on you, and mistakes have fewer consequences (see my 2014 post The Luxury of No Resources),  it’s easier to take a leap. If you fail, you’re not much worse off than you were before. But there are costs to learning by trial and error. After a while, going back to the drawing board becomes tiresome.

Ideally, the caution that comes with age isn’t from fear. It’s because you’ve come to appreciate the value of planning. It’s not because you are afraid to make a mistake, but rather you want to avoid the delays that come with making repairs every time you hit a pothole.

Every school of business wisdom extols the value of planning. When we are younger, we tend to ignore it. We scoff at Abraham Lincoln’s quote “If I had eight hours to cut down a tree; I’d spend seven sharpening my saw.” The tree is right in front of us. The saw is in our hands. We can sharpen as we go. Sometimes that works. Often it doesn’t.

Many Boomer owners will operate from a fear of failure. Their businesses will fade as the world continues to change around them and they don’t adjust. Hopefully, they’ve been successful enough in the past to exit comfortably.

Some, likely a small minority, still seek to leave a bigger legacy. They have a shorter time frame, lacking the 30 or 40 years of a full career ahead of them. They’ve learned to spend the seven hours sharpening, so that the hour spent sawing is easier and more productive. Those entrepreneurs will adjust to change on their own timetable, but  with far better results.

Their caution isn’t from fear, but from experience.