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.
By Mark Tepper
January 18, 2017
Like every owner, you will one day exit your business, voluntarily or involuntarily. On that day, you will want to attain certain business and personal objectives: The first (and usually prerequisite to all others) is financial security.
Believe it or not, most owners do absolutely nothing to consciously plan and systematically move toward the all-important goal of financial security. Anecdotally, the four most common excuses owners use to justify delaying and eventually ignoring Exit Planning are as follows:
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!
Today, let’s look at the first hurdle that prevents most owners from making the necessary plans to cash out of their businesses and move on to the next stage of their lives.
Excuse 1: The Business Isn’t Worth Enough to Meet My Financial Needs. When It Is, I’ll Think About Leaving.
This is a common and relatively reasonable assumption: Why spend time, effort, and money to plan to leave your business when you cannot do so today? Why not wait until it is at least theoretically possible to leave to begin the Exit Planning Process? Consider the following example:
At age 45, Jerry Rowling dreamed of the day he could leave his company. The past five years that Jerry had spent trimming fat, watching every dime, and developing new marketing strategies on a shoestring budget had taken their toll. Nevertheless, Jerry kept his nose to the grindstone, fully confident that if he worked hard enough, the exit he dreamed of would take care of itself.
Fast forward five more years: Jerry has remained stagnant, dreaming more frequently but doing nothing to bring about the day he could walk out the door. What had changed was that Jerry had reached his 50th birthday, a benchmark he had set years earlier as the day he’d leave the business behind.
During the five years Jerry spent working in rather than on his business, he missed the opportunity to do the following:
- Clearly establish his personal Exit Objectives and goals.
- Create an Exit Plan (based on his goals) that would identify the most productive actions he could take to create and protect value, and to do so in the most tax-efficient way possible.
- Drive up business value to the point where he could sell, pay taxes, and exit with the amount of cash necessary to achieve financial security.
What owners know to be true but often fail to act on is that growing value usually does not occur unless owners focus their efforts on deliberate actions that move their companies measurably toward their goals. In failing to act on what they know, owners don’t create or implement Exit Plans and thus are never able to exit on their terms.
Do You Have a Plan?
Avoiding planning not only puts your future financial security at risk but also overlooks your company’s need to grow in value efficiently and quickly in carefully targeted areas. Growing and protecting value is at the core of Exit Planning. To identify where and how to spend precious company resources (i.e., your time and money) to make the greatest impact is a key Exit Planning task. It is just as important as identifying and implementing strategies to minimize both current taxes and the tax bill when you transfer your company.
It makes sense to start planning for your eventual exit now, because you have to plan (and consistently take purposeful actions to implement your plan) regardless of the state of the economy. The simple reality is that most owners don’t plan; therefore, most owners are never able to leave their businesses in style.
Excuse 2: I Will Be Required to Work for a New Owner for Years.
If one of an owner’s Exit Objectives is to leave the business as soon as possible, he or she needs to direct the Exit Planning Advisor to make that a prerequisite of any sale. Some buyers require sellers to stay on after closing, but if the management team is strong, most require the former owner to remain only for short transition period, usually no more than a few months.
If the company’s management team consists only of an owner who wants to leave as soon as possible, the former owner should plan on working for the new owner for a couple of years. If the owner’s exit is still several years away, then there’s work to do.
The best way for owners to assure that they don’t become employees for a new owner is to make themselves an unnecessary expense by creating a management team that has proven its ability and motivation to make the company profitable.
Excuse 3: I Don’t Need to Plan. When the Business Is Ready, a Buyer Will Find Me.
One of the hard lessons of the Great Recession of 2008–2011 is that the timing of an exit depends on a vibrant economy with active buyers, a company with strong cash flow, and an owner ready to sell. These factors seldom exist in equal measure at the same time.
We suspect that some owners believe that waiting for a future economic tide to bring back well-financed buyers involves little to no risk. However, this type of passivity is fraught with danger:
What if a qualified buyer doesn’t show up?
What happens if, when the owner is ready to sell,
- the mergers and acquisitions market is dormant?
- the owner’s industry niche has fallen out of favor?
- a national competitor moves into the owner’s territory?
- the business and/or the economy is in decline or worse?
- the owner’s health and/or personal circumstances unexpectedly deteriorate?
What happens if the economic tide doesn’t return at all or at least not for many years?
Excuse 4: This Business Is My Life! I Can’t Imagine My Life Without It!
We all know business owners whose belly fires have gone cold and whose animating goals have grown stale. Nonetheless, they hang on to their businesses because they can’t imagine their post-exit lives without them. We also know owners who remain energized and involved with their companies until they die. Both types will leave their businesses eventually.
If owners still are passionately engaged with their businesses and happily making a difference in their lives and the lives of others, they should not exit just to exit. However, if the passion that once burned brightly has turned to cold ash, it’s time to act while there’s still time.
To start Exit Planning only when the end is near fails to exploit the majority of Exit Planning’s benefits. Exit Planning involves building business value, cash flow, and resiliency so that the business prospers regardless of who owns it or what that owner’s Exit Objectives are. Exit Planning involves protecting value and minimizing taxes, both of which are valuable endeavors regardless of an owner’s specific Exit Objectives. When departure day dawns, owners who have planned their exits are better positioned to achieve all of their business and financial objectives.
Certainly, the decision to sell the business you created and nurtured is an intensely personal one. No one can tell you when to exit your business or what to do with the rest of your life. Having worked with other owners, we can help guide you through the process of preparing for the biggest financial event of your life. We can help you consider all of the factors associated with exiting your business and help you complete your Exit Objectives.
By Mark Tepper
January 4, 2017
When a man does not know which harbor he is heading for, no wind is the right wind. –Seneca
The starting point for any type of plan is defining its goals. In the case of planning a business exit, this means knowing what it means to “exit your business in style.”
Philosophers, business owners, and successful people from all walks of life understand the critical importance of establishing goals, creating plans to attain those goals, and persevering to see their plans through to completion. Having worked with owners to create successful Exit Plans, we know that it is critical for owners to ask several questions to establish three principal Exit Objectives before moving forward with their Exit Plan.
How much cash do they need when they exit to support the lifestyle they desire? (Do they want to be cashed out when they leave the business or are they willing to receive the purchase price over time?)
When do they want to leave the company? (How much longer are they willing to remain active in the company?)
To whom do they want to sell/transfer the company? (To a child? Key employee? Co-owner? An outside party that can pay top dollar?)
Let’s look at an example of an owner who arrived at his exit date without a plan to reach his goals, as told by an Exit Planning Advisor.
Ben, the owner of a 45-employee plastic-extrusion company, had long thought of transferring his business to a son and a key employee but had done little to prepare for that transfer. However, as tougher economic conditions challenged his company and he reached his 58th birthday, he decided it was time to retire and called me.
I said, “Ben, it’s helpful that you’ve established two of the three Exit Objectives critical to all successful business exits. You’ve determined that you don’t want to work much longer in the business, and you’ve decided that you want to transfer the business to your son and a key employee. But what about the third Exit Objective: How much money do you want or need when you leave the business? Have you determined whether you need cash or can accept a promissory note?”
At this point, Ben had two choices:
He could retire immediately and try to sell the company for cash, but not to his son and key employee: They had no cash, and no bank would lend an amount even close to the amount of money necessary to close the deal. If Ben wanted to sell today and receive an amount that would support his post-exit lifestyle, he would have to sell to an outside third party with sufficient cash.
Ben could sell the company to his son and key employee but would have to wait 6–10 years to receive the entire purchase price, which was not guaranteed.
Ben’s situation illustrates why setting objectives or goals (and understanding how each affects other objectives and goals), creating a plan, and acting to reach those goals is critical to a successful exit.
If you prefer to leave your business in style (which to us means leaving your business to the successor you choose, at the time you choose, and with the amount of cash you desire), you must take time to formulate specific, consistent, attainable goals and objectives. You must determine a course of action—a plan—based on those goals, and you must persevere with that action until you achieve your goal. Without setting goals at the outset of your exit journey, you may drift aimlessly until, like Ben, it’s too late.
Don’t be an owner who is too busy working in your company to work on the most important financial event of your business life. We are happy to help you begin by providing you with more information about setting objectives and other Exit Planning topics.
By Mark Tepper
December 28, 2016
Imagine you’re a farmer and you’ve been tending to your crops all year. It’s harvest season and finally time to collect the spoils of your labor.
You start harvesting your crops only to find out that pesky rodents have been quietly eating away at your fields. You’re devastated as you come to the realization that much of what you have been working so hard to cultivate has already been taken.
Feeling like there is not much field left to harvest is what acquirers and investors are trying to avoid as they evaluate buying your business. Metaphorically speaking, acquirers want to know that if they buy your business, there will be plenty of fresh farmland left for them to till.
Investors call it your company’s “addressable market” and it is one of the main factors buyers will look at when they evaluate the potential of acquiring your company.
Business 101 tells us we should strive for market share so we can control pricing. Market share is a worthy goal if your objective is to maximize your profits. However, if your primary objective is to increase the value of your company, you want to be able to communicate that you have relatively low market share across the entire addressable market. In other words, there is plenty of field left to plough.
Consider the following ways you might expand the way you are currently thinking about the addressable market for what you sell:
Demographics involve segmenting a market by objective measures like gender, income, age and education level. Marriott is a hotel chain but they have created a variety of brands to address the various demographic segments they want to serve. Ritz Carlton is a Marriott brand that appeals to well-heeled travellers, but if all you want is a basic room, you could opt for a Courtyard Marriott. It’s the same company, but they have expanded their addressable market by focusing on different demographic segments.
Psychographics involve segmenting your market according to the way people think. Toyota produces the Prius, which gets 50 miles per gallon and is a favourite among environmentalists. Toyota also produces the thirsty Tundra pickup truck and, at just 15 miles per gallon, attracts a different psychographic segment.
Success in your local market is good but if you want to really boost the value of your company in the eyes of an acquirer, you need to demonstrate that your concept crosses geographic lines. McDonald’s has more than fourteen thousand locations in the United States but they have also demonstrated that the golden arches can draw a crowd in other markets. McDonald’s has nearly three thousand stores in Japan, two thousand in China and more than a thousand locations in each of the European countries of Germany, Canada, France and the United Kingdom.
You don’t actually have to become a global giant like Marriott, Toyota or McDonald’s to increase your company’s value but you do need to be able to communicate that your concept could work in other markets and that there is still good land left to plough.