By Mark Tepper
March 8, 2017
We attempt to dismantle the most common objections owners have to undertaking the planning necessary to exit their companies successfully. Excuses to avoid Exit Planning include the following:
- The business isn’t worth enough to meet my financial needs. When it is, I’ll think about leaving.
- I will be required to work for a new owner for years.
- I don’t need to plan. When the business is ready, a buyer will find me.
- This business is my life! I can’t imagine my life without it!
Assuming we are successful in persuading you that Exit Planning not only helps your business while you are in it but also is the best way to leave the company to the successor you choose, on the date you choose, and for the amount of cash you want, you might ask, “How do I, as an owner, jump into Exit Planning?”
Let us suggest that one of the best places to jump in is to take some measurements.
First, owners should retain a valuation expert to perform an estimate of the company’s value to find out what it is actually worth. (If you plan to sell to a family member, co-owner, or employee, retain a certified business appraiser. If you foresee a sale to a third party, ask a business broker or investment banker for a “sale-price estimate.”) The transaction advisor an owner chooses (an investment banker if the company’s likely value is at least $5 million and a business broker for smaller businesses) should be able to give the owner a range of value for the business in today’s mergers and acquisitions (M&A) marketplace. Regardless of the state of the M&A market, though best guesses and educated opinions are nice, they are weak foundations for Exit Planning.
Second, owners should sit down with their financial advisors to figure out how much cash they will need to meet their financial goals. Tapping into the expertise of a financial advisor to help objectively analyze an owner’s future needs and make realistic, risk-sensitive assumptions about investment rates of return is paramount.
To illustrate how assumptions, rather than objective measurements, can lead owners astray, let’s look at Sam Reed, a hypothetical business owner who went into a transaction armed only with assumptions.
When Sam Reed began thinking about selling his business, he started paying close attention to what competitors were getting for their companies. He applied his industry’s rule of thumb to his company, compared his company to others, and figured that his company was worth about $20 million. He calculated that he’d take home about 75% of that after taxes. Since he needed $6 million to pay off business debt, he thought he could cash out for $9 million.
Sam hadn’t put a lot of thought into what income he’d need for a comfortable post-exit life, but figured that at his age (50), $9 million, yielding 8% per year ($700,000+ annually), would be an adequate replacement for the $850,000 salary and distributions he currently took from the business.
With the stars seemingly aligned, Sam put his company on the market. Unfortunately, Sam’s telescope was out of focus: His idea of business value was unrealistically high, given the flatness of his company’s cash flow and the state of the M&A market. The best offer on the table was $14 million, of which $11 million was in cash, leaving him with about $2 million net at closing (after taxes and debt payoff), and another $3 million in future payments.
When Sam learned from his financial advisor that the realistic return on the net proceeds ($2–5 million depending on whether he actually received the $3 million in future payments) was 4–5%, he had no alternative but to back out of the sale process.
Sam made two critical mistakes: He miscalculated the proceeds he’d receive at closing and unrealistically overestimated the rate of future investment return. He would have saved time, effort, and money if he had (1) gotten a sale-price estimate that allowed him to realistically estimate how much he would net from the sale and (2) forecasted a realistic, risk-sensitive rate of investment return (as part of a financial needs analysis). With these two pieces of information in hand, Sam could have made a more informed decision.
Many owners don’t have the luxury of time. We suggest that you at least stick your toe in the Exit Planning pool by obtaining these two simple measurements. Test your assumptions: You may be surprised by the results.
We can help you get started on a plan that can make your company more valuable today and help you achieve the future exit you desire.
By Mark Tepper
February 27, 2017
Are you tempted to re-sell someone else’s product to boost your topline revenue?
On the surface, becoming a distributor for a popular product can appear to be a simple way to grow your sales—simply find something that is already proven to be successful elsewhere and negotiate the rights to sell it in your local market.
While distributing someone else’s product may be a relatively easy way to grow your topline, all that revenue growth may do little for your company’s value. A typical distribution company will be lucky to sell for 50% of one year’s revenue, whereas if you control your product or service—and the brand that embodies them—you should be able to do much better.
How Nike Became One of the World’s Most Valuable Companies
For an example of the dangers of not owning your own products, take a look at the evolution of Blue Ribbon Sports into Nike Inc. As Nike co-founder Phil Knight describes in his recent autobiography Shoe Dog, the company started off by negotiating the exclusive rights to sell Tiger running shoes in the United States. Knight’s company was called Blue Ribbon Sports and he imported the shoes from Onitsuka, a Japanese company.
Despite their exclusive agreement with Blue Ribbon, Onitsuka started to court other American dealers. When Knight protested the obvious breach of their contract, Onitsuka threatened a hostile takeover of Knight’s business or to shut him down outright. Knight’s company was tiny at the time and so deeply reliant on Onitsuka for supply, he could do virtually nothing to enforce their agreement.
Given its dependence on Onitsuka, Knight’s company would have scored close to zero out of a possible 100 on what we call The Switzerland Structure, a measure of your company’s reliance on a supplier, employee or customer. The Switzerland Structure is only one of eight value drivers we measure, but abysmal performance on any one factor can be a significant drag on the value of your business.
Onitsuka’s snub became Knight’s impetus to start Nike, which gave him control of his marketing, supply and product development. Instead of simply re-selling someone else’s shoes, Nike developed their own designs and contracted the manufacturing of their products to other factories. By owning its own products and brands, Nike has become one of the world’s most valuable companies and regularly trades north of 20 times earnings.
To see how your business performs on The Switzerland Structure and the other seven factors that drive your company’s value, take 13 minutes and complete the Value Builder questionnaire now.
By Mark Tepper
February 22, 2017
In all likelihood, you are absolutely critical to the success of your business. Without you, there is no business.
We want to fix that.
With a little luck and a lot of hard work, we can help you become an Inconsequential Owner.
At some level, all owners understand that they will someday leave the businesses they have created. Let’s assume for a moment that you leave your business permanently tomorrow. If you are an Inconsequential Owner, your exit will have no impact on the business, and that’s good for business value. Buyers pay for business value, not for the departing owner.
If you constitute a significant part of your company’s value (i.e., you are a Consequential Owner) and you have left the scene, there likely will be few buyers interested in your company, and those who are interested likely will pay significantly less than they would had you been an Inconsequential Owner.
Exit Planning is a process you can use to transform yourself into an Inconsequential Owner for your sake, your family’s sake, and your company’s sake. While perhaps not the most flattering label, becoming an Inconsequential Owner not only increases your business’ value but also probably aligns with what your friends and children have been calling you for years!
All Exit Plans should answer this question: “What has to happen in my business by the time I leave it to (1) enable me (and my family) to achieve financial security and (2) allow me to move forward with the rest of my life, confident that I have been a good steward of the business?”
The details that constitute “what has to happen” are discussed in myriad newsletters, books, and white papers that we can share with you. For most owners, one of the first and most important things that “has to happen” after figuring out where they are (i.e., current business value) and where they want to go (i.e., Exit Objectives) is to create and sustain business value.
When we talk about value in the context of Exit Planning (Step Three of The Seven Step Exit Planning Process™), we divide the discussion into three areas: building value, protecting value, and minimizing income taxes. The following is a summary of each area.
When considering building value, we first will ask, “What do you, as the owner, need to do to create a successful company that can operate without you?” Topics include developing a market focus, creating a top management team, and adopting a proper financial focus and corresponding policies.
Second, we ask, “Which characteristics will buyers pay handsomely for?” We call these characteristics Value Drivers, and they include (but aren’t limited to) the following:
- A stable and motivated management team.
- Operating systems that improve cash flow sustainability.
- Understanding and nurturing the company’s competitive advantage.
- A solid and diversified customer base.
- A realistic growth strategy.
- Effective financial controls.
- Good and improving cash flow.
Protecting value relates to both internal and external threats. Instead of handling these threats as they occur, owners must identify threats and know how to avoid them before they happen. Some examples include protecting propriety information and trade secrets; preventing employees from doing harm to the business when they leave by taking customers, employees, and business relationships; and anticipating and evaluating outside threats to owners’ companies.
Minimizing Income Taxes
The lifeblood of every business—and therefore the best indicator of value—is cash flow. Our discussion includes how to preserve cash flow and value from income taxation (legally, of course). Income taxes collected on the sale of a business interest can range from 0 to over 50%. Of course, each tax-efficient design and the tools used to implement those designs usually have disadvantages along with their advantages. However, to date, we have not identified any upside to paying more than necessary to your silent partner, Uncle Sam.
As you read articles about The Seven Step Exit Planning Process, we hope you begin to appreciate that while planning and preparing yourself and your business for your ultimate exit may seem to be a daunting task, it does not need to be. Indeed, if you approach the task systematically, you will use only small chunks of time and effort for a potentially enormous payoff.
If you would like more-detailed information about Value Drivers, please contact us today, and we will provide you with guidance and literature on how to install and maximize the effects of Value Drivers in your business.
By Mark Tepper
February 8, 2017
For many owners, the answer to one question determines whether they can leave their companies: “How much money will I get when I sell?”
This question is critical, and answering it is Step Two of The Seven Step Exit Planning Process™. Realistically, you can’t exit your business unless you achieve financial independence, and the primary source of that independence is likely to be the funds you receive for your business when you leave.
Let’s look at fictional owner Ron Nee, the owner of Landscaping Supply Company, to see why getting a valuation well before your exit date is so important.
For years, Ron figured he could sell his business for more than enough money to retire comfortably. He based that belief on his understanding of his industry’s valuation rule of thumb: a percentage of gross revenue. Using that rule, Ron calculated that his company was worth about $2 million—more than enough to finance his post-exit life.
When Ron decided that it was time to sell and met with a transaction intermediary, he learned that the rule-of-thumb approach didn’t apply. Ron discovered that buyers for the company would base their offers on cash flow rather than on revenues (the basis for Ron’s estimate).
Because Ron relied on an incorrect assumption about the value of his business, he had wasted valuable time coasting along to his exit date. Had he retained a professional to estimate value or provide a range of likely sale prices before he was ready to exit, he could have spent his time focused on increasing the value of his business.
How Can Owners Avoid Ron’s Predicament?
Ron Nee failed in a critical aspect of ownership: knowing the value of his business. By not getting a professional valuation or estimate of value, he never knew how far away he was from exiting. He had no accurate information on which to base a plan to grow value.
Benefits of Valuation
An accurate valuation of the business does the following.
- It objectively tells owners how much value they need to add to the business.
- It gives owners the ability to monitor their progress toward their ultimate financial objective. For example, if Ron had discovered that his business was worth $1.5 million (pre-tax) instead of $2 million, he could have created and implemented a plan to increase the business’ value to $2 million by the time he wanted to exit. His plan could have included interim goals and laid out strategies to achieve each interim goal.
- It determines whether and when owners can reach their Exit Objectives.
- It provides a basis for estimating and minimizing tax consequences of Exit Path alternatives.
Whether owners are ready to exit their businesses today, tomorrow, or in 10 years, they need more than a thumbnail sketch (i.e., a rule of thumb) of value. An experienced appraiser should be able to answer the question, “Can my company be sold today for enough money, after tax, to allow me to reach all of my Exit Objectives?” If the answer is no, owners can use that knowledge as the basis for a plan to build business value.
The scope and cost of hiring an appraiser or business intermediary varies substantially. For example, if an owner is several years away from a transfer of ownership, a full-blown valuation may be unnecessary. Instead, that owner needs a value approximation (or range of likely sale prices). If an owner is ready to exit and plans to sell to a third party, a transaction intermediary can prepare a range of likely sale prices. If that owner plans to transfer the company to employees or family members, a certified business appraiser can prepare a “calculation of value.”
Estimates of value, thorough valuations, and marketability appraisals all have their places. Don’t skimp on obtaining the valuation you need, but don’t secure a more precise valuation before you need it.
Finally, let’s return to Ron’s situation: What might have happened had Ron obtained a business appraisal and learned—well before his target exit date—that his company would likely sell for a price that would meet his financial objective? Should he have taken immediate action to sell? What would you do if you learned that you could exit your business today for an amount of after-tax cash that would meet all of your financial objectives? How would knowing that your business’ value is 60, 75, or 110% of what it needs to be affect your actions? Life offers no guarantees regarding your health or longevity, and volatile economies can provide an excellent reminder that there are plenty of circumstances beyond your control. For all of these reasons, knowing the value of your company is a fundamental, indispensable element of sound decision-making.
For more details about how we can help you value your business, contact us today.
By Mark Tepper
January 25, 2017
If you have resolved to make your company more valuable in 2017, you may want to think hard about how your customers pay.
If you have a transaction business model where customers pay once for what they buy, expect your company’s value to be a single-digit multiple of your Earnings Before Interest Taxes, Depreciation and Amortization (EBITDA).
If you have a recurring revenue model, by contrast, where customers subscribe and pay on an ongoing basis, you can expect your valuation to be a multiple of your revenue.
Breedlove & Associates Sells for 6X Revenue
In 1992 Stephanie Breedlove started a payroll company to make it easier for parents to pay their nannies on a recurring basis. It began small and Breedlove self-funded her growth, which averaged 20% per year.
By 2012, Breedlove & Associates had hit $9 million in annual sales when Breedlove accepted an offer from Care.com of $55 million for her business—representing an astronomical multiple of more than six times Breedlove’s revenue.
Buyers pay up for companies with recurring revenue because they can clearly see how your company will make money long after you hit the exit.
Not sure how to create recurring revenue? Here are four models to consider:
Products That Run Out
If you have a product that people run out of, consider offering it on subscription. The retailing giant Target sells subscriptions to diapers for busy parents who don’t have the time (or interest) in running to the store to re-stock on Pampers. Dollar Shave Club, which was recently acquired by Unilever for five times revenue, sells razor blades on subscription. The Honest Company sells dish detergent and safe household cleaning products to environmentally conscious consumers and more than 80% of their sales come from subscriptions.
If you’re a consultant and offer specialized advice, consider whether customers might pay access to a premium membership website where you offer your know-how to subscribers only. Today there are membership websites for people who want to know about anything from Search Engine Marketing to running a restaurant.
If you bill by the hour or the project, consider moving to a fixed monthly fee for your service. That’s what the marketing agency GoBrandGo! has done to steady cash flow and create a more predictable service business.
Ask yourself what your “one-off” customers buy after they buy what you sell. For example, if you make a company a new website, chances are they are going to need somewhere to host their site. While your initial website design may be a one-off service, you could offer to host it for your customer on subscription. If you offer interior design, chances are your customers are going to want to keep their home looking like the day you presented your design, so they might be in the market for a regular cleaning service.
If you offer something expensive that customers only need occasionally, consider renting access to it for those who subscribe. ZipCar subscribers can have access to a car when they need it without forking over the cash to buy a hunk of steel. WeWork subscribers can have access to the company’s co-working space without buying a building or committing to a long-term lease.
You don’t have to be a software company to create customers who pay you automatically each month. There is simply no faster way to improve the value of your business this year than to add some recurring revenue.