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3 Surprising Reasons to Offer a Subscription

By Mark Tepper

April 27, 2017

You can now buy a subscription for everything from dog treats to razor blades. Music subscription services are booming as our appetite to buy tracks is replaced by our willingness to rent access to them. Starbucks now even offers coffee on subscription.

Why are so many companies leveraging the subscription business model? The obvious reason is that recurring revenue boosts your company’s value, but there are some hidden benefits to augmenting your business with a subscription offering.

Free Market Research

Finding out what your customers want is expensive. By the time you pay attendees, rent a room with a one-way mirror and buy the little sandwiches with the crusts cut off, a focus group can cost you upwards of $6,000. A statistically significant piece of quantitative research, done by a reputable polling company, might approach six figures.

With a subscription company, you get instant market research for free. Netflix knows which shows to produce based on the viewing behaviour of its subscribers. No need to ask viewers what they like, Netflix can see what they watch and rate.

For you, a subscription offering can allow you to test new ideas and gives you a direct relationship with your customers so you can see what they like first hand.

Cash Flow

Subscription companies are often criticized for being hungry for cash. Many charge by the month and then have to wait months—sometimes years—to recover the costs of winning a subscriber.

That assumes, however, that you’re charging for your subscription by the month. If you’re selling your subscription to businesses, you may get away with charging for a year’s worth of your subscription up front. That’s what the analyst firm Gartner does, and it means they get an entire year’s worth of cash from their subscriber on day one. Costco charges its annual membership up front, which means it has billions of dollars of subscription revenue to float its retail operations.

Loyalty

Customers can be promiscuous. You may have a perfectly satisfied customer but if they see an offer from one of your competitors, they might jump ship to save a few bucks. However, if you lock your customers into a subscription, they may be less tempted to try a competitor since they have already made an investment with you.

One of the reasons Amazon Prime is so profitable is that Prime subscribers buy more and are stickier than non-Prime subscribers. Prime subscribers want to get their money’s worth, so they buy a wider swath of products from Amazon and are less tempted by competitive offers.

The obvious reason to launch a subscription offering of your own is that the predictable recurring revenue will boost the value of your company. And while that’s certainly true, the hidden benefits may even be more important.

Avoiding Disasters in Insider Transfers

By Mark Tepper

April 19, 2017

Steve Smith was no different than millions of other baby-boomer business owners in that the thought of leaving his business was never far from his mind, no matter how far away his exit might have been. He daydreamed about transferring the business to his oldest daughter and perhaps to a member of his management team, yet he couldn’t gauge their passion for owning a business and hadn’t tested their management skills.

And, of course, they had no money.

Steve’s company was his economic and financial lifeline. Without its income, his ability to use the business to accumulate wealth, the ability to sell his interest to a buyer who had cash, and a plan, Steve’s wishes would never come true. To Steve, it was obvious that if he ever wanted to exit his business in style, he needed to wait for a white-knight buyer to appear on his doorstep bearing saddlebags of cash. So, Steve did what many other owners in his position do: nothing.

If you think that transferring your business to your children or management team is inherently risky, you are right.

Insider transfers are risky for three reasons:

  1. Insiders have no money
  2. Successors’ management/ownership skills and commitment to ownership may be untested
  3. Owners lose control of the business if they make the transfer before they are completely cashed out.

On the other hand, the possible benefits of an insider transfer include the following:

  1. Keeping the business in the owner’s family or extending the owner’s legacy through his or her hand-picked management group.
  2. Motivating, retaining, and rewarding key employees.
  3. Reaping more after-tax money than a third-party transfer.
  4. Retaining control until all, or most, of the purchase price is received.
  5. Remaining active in the business while gradually reducing day-to-day responsibilities.
  6. Providing time for owners to build up personal assets (via distributions of cash) before their exits.

The trick is to design a plan that minimizes risk so owners can reap all of the potential benefits. Let’s first look at how that might be done.

1. Insiders have no money; therefore, it is too risky to sell to them. That’s true if owners don’t design a transfer strategy that puts money in the insiders’ pockets as they increase the value of the company. Owners have to work steadily and effectively to build cash flow (the source of all cash outs) through (a) the installation of Value Drivers and (b) careful planning to minimize taxation years in advance of the transfer.

Unless owners carefully plan to avoid it, cash flow can be taxed twice. This double tax, sometimes totaling more than 50% of the total payout, can spell disaster for many internal transfers. However, through effective tax planning, much of this tax burden can be legally avoided.

Finally, owners and their advisors, including a certified business appraiser, should use a modest but defensible valuation for the company. By using a lower value as the purchase price, the size of the tax will be correspondingly reduced. The difference between what owners will receive from the sale of the business at a lower price and what owners want to be paid after they leave the business is “made good” through a number of different techniques to extract cash from the company after the owner leaves it.

2. Successors’ management/ownership skills are untested. If the successors’ ownership skills are untested, owners should create a written plan to systematically transition management and ownership responsibilities to their successor(s), beginning today. The transition period, during which owners test both their assumptions and their successors’ skills, usually takes several years to complete.

3. Losing control before being cashed out. This only happens if owners and their advisors fail to implement a transfer strategy designed to keep the owner in control until he or she receives the full sale price for the business. In a properly crafted plan, owners keep control through a well-designed and incremental sale of the company based on improving company cash flow over time.

There are four keys to reducing the risks of an insider transfer:

  1. Plan the transfer well in advance of your desired exit date. Executing an insider transfer takes longer than executing a sale to a third party.
  2. Implement value-building activities, which are just as—if not more—important to an insider transfer as they are to a sale to a third party.
  3. Design the plan to be tax-sensitive.
  4. Write the plan down and hold advisors accountable.

We have the experience and know-how to help you implement those keys and unlock the doors to your successful exit. Please contact us today to get started on your insider transfer today.

Elements of a Plan to Sell to Insiders

By Mark Tepper

April 9, 2017

Today, we discuss the essential elements of a plan owners use to transfer a business to insiders that keep the owner in control until he or she is paid the sale price. If you suspect that the children, key employees, or co-owners you would pick to succeed you do not have the funds to cash you out, consider the following 10 elements that make insider transfers successful.

Element 1: Time

A transfer to insiders takes time: time to plan, time to implement, and time for successors to pay the departing owner. Typically, the more time owners take to transfer the company, the less risk they incur and more money they receive from the new owners.

Thus, the first question an owner must answer is, “Am I willing to take time (typically three to eight years) to execute and complete an insider transfer (while maintaining control)?” If the answer is no, then it is probably best to consider other Exit Paths.

Element 2: Defined Owner Objectives

If owners are willing to devote the time necessary to transfer the business to insiders, they also must define and/or quantify their objectives. These may include the following.

Financial security and independence.
Departure/retirement by a chosen date.
Keeping family legacy or company culture intact.
Rewarding key employees.
Taking the business to the next level on someone else’s dime.

In a well-designed transfer plan, these objectives are met before control is transferred.

Element 3: Cash Flow

Healthy cash flow is critical to any sale. No buyer, whether outside third party or insider, wants to buy a company with anemic cash flow. However, in a transfer to insiders, cash flow assumes gargantuan importance, because initially, it is the major, if not sole, source of an owner’s sale proceeds.

Element 4: Growth in Business Value

Like healthy cash flow, buyers look and pay top dollar for companies that have the potential to grow in value. In transfers to insiders, ownership transfers generally occur only if cash flow continues to grow. Thus, it is vitally important that owners contemplating an insider transfer install and cultivate Value Drivers before and during their exit transition. (For a quick refresher on Value Drivers, please contact us for one of our Value Drivers white papers.)

Element 5: Capable Management That Desires Ownership

Having a motivated management team capable of replacing the owner is hugely valuable to any buyer, especially when that buyer is an insider. The management team that succeeds the owner must desire ownership and be willing to sign personally for any acquisition financing or ongoing company debt. Owners often assume that their management teams want to own their companies, but sometimes, management teams balk when they realize that they have to pay for ownership. Thus, assuring that the management team not only desires ownership but is willing

Element 6: Minimize Taxes

Most owners don’t want to pay any more taxes than they are legally required to pay. Owners who are contemplating insider transfers must take special care to minimize taxes. In an insider transfer, it is imperative that owners and their advisors structure the sale of their businesses to minimize taxes on the company’s cash flow (pre-tax income), because without planning, cash flow is taxed twice: (a) once when the insider receives it (as the new owner) and then pays taxes before paying the owner to purchase the company and (b) when the owner pays taxes on the proceeds received.

One goal of tax planning is to subject the company’s cash flow to taxation only once. Accomplishing this feat takes considerable planning, but it’s worth the time and effort to save a third or more of the company’s cash flow from this type of double taxation. One-time taxation means owners receive more money more quickly and thereby reduces the risk that the exiting owner will not be paid in full.

Element 7: Regulate an Incremental Transfer of Ownership

One of the most important advantages of a well-designed insider transfer plan is that it gives the owner the ability to regulate how ownership is transferred, when it is transferred, and how much ownership is transferred. If company performance falters, employees stumble, or the owner chooses instead to sell to a third party, a well-designed insider transfer Exit Plan keeps the owner in the driver’s seat.

Element 8: Increasing Control Means Decreasing Risk

While business owners take risks every day, they don’t relish risking their own and their families’ future financial security. Therefore, we use strategies to keep voting and operational control in the hands of the owner. This shifts operational business risk from the exiting owner to the incoming owners so that exiting owners stay in control of their companies until they receive the entire sale price. (If you’d like to talk about the many ways we accomplish this for our clients, give us a call.)

Element 9: Written Road Map With Deadlines

To succeed, we believe that owners must put their transfer plans in a written document and communicate it clearly and regularly to the eventual owners. If the plan is not in writing, it simply is not credible, and neither the owner nor his or her employees will take it seriously. More importantly, the written plan is the playbook for owners’ exits. Owners will use their written plans to coordinate their actions with those of their advisors, thus reducing delays and costs. The plan should include a timeline and provide accountability (i.e., who will do what, when) for all participants, including the owner. Without incremental, staged checkpoints, it’s nearly impossible for owners to exit on their terms. You’ll never finish a marathon if you don’t have mile-by-mile goals to meet.

Element 10: Owner Education

Owners need to understand the ins and outs of insider transfers because, unlike sales to third parties, they will control their businesses and the Exit Process until they’ve been paid in full. That education begins as you read this newsletter.

We would love to teach you more about the ins and outs of insider transfers, and share our experience and proven success in addressing these elements with you. Please contact us today to begin addressing the elements of an insider sale or to learn about which strategies we can help you implement to assure that you exit your business on your terms.

The Anatomy of a Successful Exit

By Mark Tepper

March 29, 2017

Stephanie Breedlove started Breedlove & Associates in 1992 as a way to pay her nanny. The big payroll processors weren’t interested in dealing with one person’s wages and doing it themselves was complicated and time-consuming, too much for the then overwhelmed Breedloves.

Breedlove saw a business opportunity and started a payroll company for parents who needed to pay their nannies. By 2012, Breedlove & Associates had grown to $9MM in revenue and then she received a $54MM acquisition offer.

To give you some context of how incredible it is to sell a $9MM business for $54MM let’s look at the numbers. At The Value Builder System™, more than 25,000 business owners have completed the Value Builder Score questionnaire, part of which asks about any acquisition offers they may have received. The average multiple offered is 3.76 times pre-tax profit. Even the best-performing businesses, those with a Value Builder Score of 80+, only get offers of 6.27 times pre-tax profit on average. Breedlove got close to six times revenue.

What did Breedlove do right? We’re going to look at the five things Breedlove did—and that you can do—to drive up the value of a business.

1. Sell Less Stuff to More People

When Breedlove hit $30K per month in revenue, she quit her job at Accenture (formerly Anderson Consulting) and devoted herself to Breedlove & Associates full-time. To grow, she had a choice: sell more to her existing customers (e.g. busy couples often need lawncare, house-cleaning, or grocery-delivery services) or stick with her niche of paying nannies. Most consultants and experts would say it’s easier to sell more to existing customers (and they’re right), but it doesn’t make your business more valuable. Breedlove decided to stick to her niche and find more parents who needed to pay their nannies, and that decision laid the foundation for a more valuable business.

Investors from Warren Buffet look for companies with a deep and wide competitive moat that gives the owner pricing authority. When you have a differentiated product or service, we call it having The Monopoly Control and companies with a monopoly get significantly higher acquisition offers.

Rather than selling existing customers generic services in commoditized markets, Breedlove focused on selling one thing to as many customers as she could find.

2. Strive for 50%+ Net Promoter Score

One feature that interested acquirers look for is your customer satisfaction levels. Increasingly, they are turning to the Net Promoter Score (NPS) as a measure of this. NPS was developed by Fred Reichheld and his team at Satmetrix, who discovered that your customers’ willingness to refer you to their friends or colleagues is highly predictive of your company’s future growth rate.

The NPS approach is to ask your customers how willing they would be to refer your company to a friend or colleague, on a scale of 0 to 10. They are then categorized into Promoters (9s and 10s), Passives (7s and 8s) or Detractors (0–6s). The NPS is calculated by subtracting the percentage of Promoters from the percentage of Detractors. Most businesses achieve an NPS of 10% to 15%, while the very best companies (think Apple and Amazon) get scores of 50% or more.

Breedlove obsessed over her company’s NPS and realized the key to driving it up was perfecting the first few interactions with a new customer. When you call a big payroll company looking for a service to pay your nanny, the response can be underwhelming. With only one person to pay, you are often relegated to the most junior staff member and even they would rather be dealing with a larger client.

When you call Breedlove, by contrast, you get a team of professionals totally focused on setting you up. You’re not an afterthought. You’re not passed on. Instead, you get the best onboarding talent the company has to offer.

This set-up team was a big part of how Breedlove achieved an astonishing 78% NPS.

3. Create Recurring Revenue Streams

The third thing that made Breedlove’s company attractive was recurring revenue.

Regardless of what industry you’re in, recurring revenue models give acquirers more confidence that the business will keep going strong after you leave.

By 2012, Breedlove & Associates had grown to $9MM and, given the nature of the payroll business, 100% of their revenue was recurring.

4. Reduce Reliance on Customers, Employees and Suppliers

Breedlove’s company was also attractive to buyers because she had a highly diversified customer base with no single customer representing even close to 1% of her revenue. If more than 10% to 15% of your revenue comes from one buyer, you can expect prospective acquirers to ask a lot more questions.

Customer concentration is one of three factors that make up The Switzerland Structure Module. The Switzerland Structure measures your business’ dependence on a single customer, employee or supplier.

5. Find an Acquirer You Can Help Grow

By 2012, Breedlove & Associates was growing 17% per year, which is good but not blow-your-mind good. So how did she attract such an incredible acquisition offer? The trick was showing her acquirer how they could grow.

In Breedlove’s case, she sold her company to Care.com. Think of Care.com as the Angie’s List of care providers (e.g. child care, senior care, etc.). If you need someone to care for your kids or an elderly relative, you enter your address into their website and Care.com will give you a list of vetted caregivers in your area.

At the time of the acquisition, Breedlove had 10,000 customers and Care.com had seven million members. Breedlove argued that if just 1% of Care.com’s members used Breedlove’s payroll service, it would equate to 7X growth in Breedlove & Associates almost overnight.

In 2012, Care.com acquired Breedlove & Associates for $54MM—an outstanding exit made possible by Breedlove’s focus on what drove her company’s value, not just their top-line revenue.

Are You and Your Company Candidates for a Third Party Sale?

By Mark Tepper

March 22, 2017

If you think that planning for the biggest financial event of your life is a good idea and prefer an approach other than “wait and see,” what can you do to make sure your company is ready to sell when you decide the time is right?

Step One: Define your Exit Objectives:

How much cash you need to fund a financially secure post-exit life.
When you want to leave.
Which kind of buyer you prefer (third party or insider).

Step Two: Convert your impression of what your company is worth into an objective valuation.

Step Three: Build needed value into your company by making yourself an Inconsequential Owner.

Step Four: Sale to a third party.

Generally, owners are attracted to a third-party sale (rather than a sale to insiders, such as family members, co-owners, or employees) for one or more of the following reasons:

  • When the market is favorable and strategic buyers are active in the marketplace, a sale to a third party can yield more cash.
  • A sale to a third party usually is less risky than one to insiders.
  • Sellers get their money more quickly than in a transfer to insiders.
  • Insiders (children, co-owners, and employees) don’t have what it takes (usually cash and sometimes desire) to buy the company.

If these statements apply to your situation, your next step is to ask the following:

  • Am I personally and financially ready to exit?
  • Is my business fully prepared for my exit?
  • Is the mergers and acquisitions (M&A) marketplace favorable for sellers?

To optimize the likelihood of a successful sale, owners should embark upon the sale process only if they can answer each of these questions with a confident “Yes!”

Owners should seek answers and resolutions the moment doubts about whether to exit occur. They should not wait until they are burned-out, the M&A market declines, or an unexpected event forces their hand.

  • Owners should begin their own process today to assure that they take their businesses to market only when they, the business, and the market are ready. They should seek out the advice of experts and read more about the entire sale-preparation process.
  • Owners should start to assemble their Deal Team by interviewing prospective advisors. Depending on the size of the company, the transaction intermediary may be an investment banker or a business broker. Owners will need to find an attorney skilled in transaction work, but if the owner’s current CPA is skilled in tax-minimization techniques, he or she may be able to work on the Deal Team. Remember, while these advisors will cost money, they should make money as well. Asking them all how they plan to do that is critical.
  • Using the expertise of the Deal Team can help owners create a plan that does the following:
    • Minimizes the tax consequences of the deal.
    • Accounts for an owner’s willingness to remain active in the company once the deal closes.
    • Determines whether the transaction will best be conducted as a controlled auction or negotiation.
    • Specifies which kind of payment owners will accept.
    • Includes a strategy that allows owners to focus on their companies’ profitability while the transaction occurs.

The Deal Team should also help avoid the all-too-common traps that await selling owners, including not minding the store, information leaks, prematurely rushing to market, and running off with the first buyer.

John Brown, the CEO of BEI (our Exit Planning resource partner), gives owners an important piece of advice: “Whether your company is small or large, selling it to a third party is the biggest challenge—and opportunity— of your business life. I urge you to grab hold of this opportunity. Refuse the role of bystander or bit player. Instead take center stage as an active and full participant in the sale process and you will add value and minimize uncertainty and risk.”

We'd like to add our experience and knowledge to your Deal Team, and we can help you screen candidates for other seats at the Deal Team table. If you would like more information to help you determine whether your business is a candidate for a third-party sale or your next steps in the third-party sale process, please contact us today.