Transitioning the Business on Your Terms
February 11, 2020
By John Carter, courtesy of Absolute Succession
The primary goal of every business owner is to “cash in” their chips and retire from their business on their terms. Ideally, this includes selling to a larger company for huge windfall or transferring the ownership to an existing owner, the key employees or “business active children”. The problem is that most contractors and other small business owners don’t prepare their business for this all important once in a life time event…instead they “roll the dice” and hope that the chips will fall in their favor. Unfortunately, most of these transfers are unsuccessful and result in “seller’s remorse”.
The question is: how do contractors and other business owners prepare for the successful sale or transition of their business, and when should they begin the process?
The answer is: owners need to create and build “Transferable or Sellable Value” in their companies and create an exit plan that accomplishes their goals at least 2-3 years from their targeted exit date.
Building Transferrable or Sellable Value
Regardless of whether you plan to sell your business to another contractor or competitor, or transfer your ownership to other co-owner, key employees, or business active children, its critical that you have a business which can operate at a high level without your on-going involvement. By creating a self-sustainable company, the businesses real inherent value, as a “cash flow machine”, can be replicable and transferrable to your targeted successor.
Creating “transferrable or sellable value”, which is converted to dollars upon the sale or transfer of your business, results from the implementation and on-going support of the following “value drivers”. Each value driver works independently to increase the likelihood that your business can continue to grow, improve market share and increase cash flow after your departure.
The first and most important value driver is the development of a well-trained and motivated successor management team. The team should be comprised of “key employees” who are responsible for setting the company’s objectives, monitoring activities and company performance and managing and mentoring the other employees. Each team member brings unique skill sets and collectively they work together to build a championship organization. Buyers and targeted successors (perhaps the key employees) will pay a huge premium for a strong successor management team that has a proven track record. Likewise, failing to identify, train or motivate a successor management team gives the buyer or successor the sense that you’re running a “one-person band”, which can’t be sustained after you leave.
The second critical value driver is having documented and applicable operating systems which can create re-occurring revenue and help the company weather inevitable economic downturns. Having systems which have been “tweaked” and refined for success, and which are documented and replicable (by your successor management team), enhance the value of your business and help ensure that your successor will be able to continue and grow the business. Documented systems which address product or service delivery, product quality and reliability, pricing and cost management, business development and customer relations increase the inherent value of your business and allows the buyer to increase the company’s operational performance and profitability.
Next, make sure that your customer base is well diversified and that your business does not generate more than 15% of its revenue from any one specific source. As contractors, most of your business comes from a limited number of sources, however its important to determine if new products and services, or modified versions of your current offerings, can be “upsold” into your current customer base, and how you can market existing offerings to new customers or your existing customer’s contractors and suppliers.
In addition, it’s critical that your business utilizes established “financial metrics”, such as audited financial statements, from reputable third parties, and has properly safeguarded all of its proprietary trade secrets, IP and customer and supplier relationships. Being able to validate your transferable value through prior year net earnings, and ensuring that your customers will continue to buy from your business after your departure, is mission critical to transferring your business and maximizing your financial return.
Selecting the Right Transition Strategy
Once you’ve maintained a constant level of transferrable value, its time to determine which transition strategy is right for you. Generally, owners look to sell and transition their business to a larger or comparable customer or competitor (a “strategic buyer”), or to transfer their ownership to a “co-owner”, “key employee or key employee group” or one or more “business active children”.
If you don’t have the luxury of someone internal to transfer the business to, or if your goal is to “maximize” your payout at the time of sale, then creating an exit strategy for a “strategic sale” will make the most sense. However, to attract the ideal buyer and maximize your purchase price, you’ll have to be able to prove that you’ve created transferrable value by implementing the above value drivers and that your absence from the business will have no bearing on its future cash flow and growth. The pre-sale and acquisition process will consist of multiple “ups and downs” as you go through “due diligence” and the negotiation process. Ultimately, your goal is to minimize the buyers future risk by providing it with a business which is self-sustainable, replicable and which can create re-occurring revenue after your departure.
For those of you are fortunate enough to have co-owners, key employees or business active children in the business who are motivated to continue growing the business and provide you a platform for retirement, then there are numerous internal transition strategies.
Generally, the “Shareholder or Operating Agreements” will dictate the “buy-out” terms and valuation metrics in the event a co-owner elects to buy you out when your ready to leave. The challenge is to periodically update those terms and conditions so that they reflect your specific transition goals and objectives. Unfortunately, most owners don’t continuously amend these terms as their needs change or after they decide on a course of action. Annual reviews and revisions are a must.
As mentioned, developing a key employee successor team serves multiple purposes…primarily it provides you with a “ready-made” buyer. If done properly, transitioning your ownership to key employees can prove to be best of all scenarios. It allows you to transfer the business “when you want”, to “whom you want and under what conditions” and for the targeted amount of post-tax dollars that you need to sustain your retirement lifestyle. There are many steps in this process to ensure the development and long-term motivation of your key employee successors, however it’s my professional opinion that this strategy generally yields the best results for most owners.
Lastly, many contractors with family businesses look to “gift” or “sell” their ownership to their business active children. Although this endeavor helps ensure the family’s legacy it comes with many pitfalls and risks which need to be accounted for and addressed in the planning phase. These include everything from favoritism and low employee moral to outright mutiny. However, if we’ve done a good job of creating standardized operating systems (value driver #2), including hiring requirements and employee performance standards, it’s possible to bring in, develop and ultimately promote our business active children into a leadership and successor role. As with key employees, there are various tools and techniques which need to be employed to ensure their development and on-going support of the non-family employees.
Putting it All Together
Regardless of revenue, number of employee or overall size, a successful business transition starts with an understanding of your “universal objectives”: “when you want to leave the business”, “how much $$ you need to get out of your business” and “whom do you want to leave the business to”. By answering these key questions, you can customize a transition strategy which allows you to build transferable value in your business and select the transition strategy that makes the most sense for you. By putting it all together in a comprehensive plan, you’ll be able to leave your business on your terms!
For more information regarding the contents of this article, please contact John T. Carter @ firstname.lastname@example.org. or (248) 935-7207.