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Business Exit Strategies

For Sale: The Next Step - Planning for Your Future

 

The next step – planning for your future

I'm often asked "What do you do besides help people buy businesses?" I reply "I also help business owners prepare their business for sale and formulate an exit strategy."

"What does it mean to prepare a business for sale?" The person that asked me said they have heard the phrase "preparing a business for sale" before but didn't understand what the process involves.

My answer was that there are three main functions when preparing a business for sale (and lots of subsets of these functions).

  • The financial systems and statements must be in order.
  • There should be a proven marketing plan that has been successfully implemented.
  • Systems should be in place to improve efficiencies and reduce the role of the owner.

However, we need to backup a bit. While it is wise to prepare and plan for (just about) everything in business and in life you have to make sure you are planning for the right event.

What is your next step?

In November 2007 the following topics along with some related statistics were in “Want to Buy a Business? Your Timing is Right” by Matthew Mogul, Associate Editor, The Kiplinger Letter

  • Expect a glut of firms to go up for sale as thousands of baby boomers retire.
  • Most firms will sell to strangers.
  • Owners without an exit strategy will likely sell at a discount. 
  • Expert advice is a must.
  • One option that's growing more popular is selling to employees.

Before you prepare you have to know what to prepare for and in this context we define it as “Succession Planning.” The first step is to assess the current situation and the likely alternatives. Is your business one that an outside buyer will be attracted to? As the above states, it appears there will be many businesses on the market in the next decade. Even though Mogul states many will sell to strangers (individuals, competitors, equity groups, etc.) you have to know if your business will be attractive to these buyers – especially in comparison to all the other businesses you will be competing with. If yes (it will be attractive to outside buyers), then proceed with your planning concentrating on the three areas mentioned above.

If no, you need to assess why. Some reasons why an outsider may not want to buy your company are “fixable” and others are not. If it’s because your industry is not healthy, your industry is too “scary” (to an outsider) or something similar, you may not have as many options as you hoped. But what if the reason outside buyers are apprehensive is because you, the owner, are a “control freak” and all of the most-important functions of the business are dependent on you? Well, that can be fixed. It won’t be easy, but it can be done. What if it’s because you don’t want to put out the effort or take the risk to grow the business but you know it can be done (perhaps your income and life balance are so good you don’t want to work any harder)? That can also be fixed (see below). You will have to do what needs to be done to prove the business is not stagnant.

Outside buyers typically pay a lower price than management or family. However, they usually offer better terms. Management buyouts and sales to family often have a higher price with much more seller financing. If you can live with an annuity type payout and you trust the internal buyers it can be a win-win. Keep in mind, according to Mogul, only 15% of businesses successfully make it to the third generation. Actually, I was surprised the percentage was this high as I see so many companies that never make it to the second generation. As a seller, you have to be positive your children have the skills and the desire to run your business. I can think of very few people I know whose children go into the same profession they are in and very few people who go into the same profession as their parents. We all are born with different skills and interests so you don’t want to force a (potentially bad) situation just to have your family take over your business.

Prove your business can (profitably) grow

Recently I worked with a client who wanted to sell his business. After I interviewed the owner and reviewed the company's financial statements I told him nobody would buy his company. Profits one year were wiped out by even bigger losses the next. A graph of the annual profits/losses looked like a sine wave.

We determined that the erratic profits were a function of volatile sales and the sales were a result of inconsistent marketing. We put in a rudimentary sales and marketing plan, and most important, made sure the owner and the staff implemented the plan and monitored the results.

We started in July. By the end of the year, sales for the last six months of the year were 50% above the amount projected on June 30. These profits continued the next year and the years thereafter. Sales and profits have been more consistent and the company still has the same owner. There is/was a lot less motivation to sell when things are going well.

A good first step in preparing a business for sale is to:

  • Have a sales and marketing plan
  • Implement the plan
  • Monitor results and document what worked and didn't work.

Too often business owners say that someone who is good at marketing will be able to easily grow the business. Is it true? Who knows? A buyer worries that every marketing technique available was tried and very little worked.

Are the financial statements true and correct?

Let's start with the Balance Sheet and some basic questions. Are the accounts receivable collectable? Is all the inventory usable and salable? What about the fixed assets? What is the life expectancy of those assets and what will cost to replace them? Having these items under control gives a buyer confidence.

Moving to the Profit and Loss statement, everybody knows that one of the best advantages of business ownership is using pre-tax dollars for expenses for which an employee must use after tax dollars. A buyer wants to know what profit truly is. When speaking to groups I often tell owners to ignore their CPA (lots of great facial expressions, especially from the CPAs in the audience). I go on to say ignore your CPA and pay high taxes because that means you are profitable. Buyers and bankers like to see high profits on the tax return.

It comes down to, "What is the free cash flow of the business?" Free cash flow is what is left after all legitimate business expenses, allowing for capital expenditures and having assets accurately reflected. This is money the buyer can use to pay him/herself, put in their pension, pay off their acquisition debt, grow the business, etc.

A buyer client recently passed on a company because the accounts receivable were in such a state of disarray. He wouldn't take the risk of buying that history and the culture of not collecting monies due in a timely fashion. Another client had the price of the business drop by one-third after the inventory and work-in-progress were adjusted to correct levels.

Good financial statements are a big part in a smooth sale at the price fair to the seller and buyer.

Systems are important

Systems and procedures make the business less and less dependent on the owner. To use a sports analogy, some teams are always known as "over-achievers." The coach has a system and style of play that allows good players to play great (together). That's what I am alluding to. Having systems that allow you to add or replace good people without causing stress. To have the day-to-day operations run without micro-management.

I once worked with a client who felt that too much profit was, "Slipping through the cracks." He had a growing and successful business and also had a "feel for the business" that told him he was not maximizing efficiency.

One of the things we did was facilitate a management team exploratory session, without the owner. We put the half-dozen managers in a room for four hours and probed them on what they did, how they did it, where they felt lacking, etc.

At one point, in discussing operational procedures and job tracking between departments, two managers looked at each other and at just about the same time said, "You do that? We do that too." In other words, they both used time and resources to create the same "report." Coordinating those efforts alone meant saving thousands of dollars a month in efficiencies.

A good first system is to define roles (an org chart, for example, is needed even if some of the people have their names in multiple boxes). Once everybody knows their job and their duties, who they report to and who they supervise they can communicate better. It sounds simple but is too often overlooked. Much more often than not this has to be created when working to improve a company or devise an exit strategy.

Having rules, or procedures, and sticking to them does not have to be complicated. For example, a "system" for one client was having the sales and project teams meet before every job started. This eliminated the project team being in the dark and following instructions from the sales team to do the job as it had sold even if the project team knew from their on-the-job experience that there was a better way to get the product installed.

One of my clients is preparing to make an offer to buy a company. This firm was doing okay until two years ago when they hired a COO. Since then sales have grown at a slightly higher pace, margins have grown slightly and expenses have dropped. My client stated that the COO put in systems. Given that his wife and he are "engineering types" this is good. He wants to take over a system, not just a business.

Conclusion

Business buyers are by nature a skeptical lot. They hear a lot of "pitches" and see a lot of clever disguises. A business owner who has taken the time (six months to a few years) to do what it takes make the business be what a buyer wants it to be is way ahead of the competition.

In January an article in the Wall Street Journal stated that 70% of mid-sized business will sell in the next decade and that 90% of them will be unprepared for a sale. Those owners face the prospect of being in a market glut and behind the leaders. Well-prepared companies will sell faster, sell with less hassle, be financed easier and, most importantly, be a safer purchase for the buyer. All of this means a higher price and better terms for the seller.

Preparing a business for sale is not the same as an exit strategy. It is part of an exit strategy. An exit strategy is the plan for when to leave the business, it is calculating the money the owner needs to get from the sale of the business and how to get to that point.

Preparing it for sale is the tactical implementation of that strategy. It starts with creating a great first impression (clean offices and/or plant, sharp looking people, etc.). It's reviewing and cleaning up the financial statements and accounting system, implementing and tracking the results of a marketing plan, cleaning up all disputes (legal, customer issues, employee or union issues, etc.) and having all the information a buyer will want for due diligence in a logical order.

Last but not least it is having an advisory team (legal, tax and financial advisor plus their intermediary) and letting any management and employees who need to know what the owners future plans are be part of those plans. If you, as an owner, don't want to tell any of the employees that you plan to exit then drop hints like, "Retirement sure sounds good," or "I wish my vacation could last two months." Then they won't be surprised when a sale is announced. They'll be thinking, "Yes, the boss has been hinting at getting out."

 
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