"You can’t handle the truth!” Jack Nicholson’s now-famous line, which he shouted at Tom Cruise’s character in one of the final scenes in the fabulous movie ‘A Few Good Men’, was ad-libbed in the final shooting. It was not part of the original screenplay. While it worked out great for Jack, I wouldn’t suggest ad-libbing the Exit Plan for your business.
When Rita and Gary began to think about leaving their business, they didn’t know who to turn to for advice. Neither their CPA nor financial planner had ever raised the topic of Exit Planning. To their credit — unlike so many owners — the couple took proactive action. They set up a meeting with an Exit Planning advisor (CEPA®) to discuss what their company would likely sell for—in about five years. With that piece of information, they could make a decision on if and when they wanted to sell, for how much, and to whom.
During their meeting, the advisor (Miguel) looked over their financials and asked questions about the business. All was going well until he told the couple that their company had little value to a third-party buyer.
“How can you say that?” Gary asked. “We make over a half million dollars per year!”
Before Miguel could respond, Rita added, “There’s got to be plenty of buyers who would jump at the opportunity to run a company with our profit margins!”
“Your company only has that level of profit,” Miguel began, “because…
- First, you two work 60 hours a week and rarely take vacations.
- Second, you don’t pay a management team.
- Three, your systems and processes are out of date, and
- Four, there is no significant marketing.
Without the two of you present, there would be no profit, so what would a new owner be buying without you two in the business?”
“But an owner would make $500,000 per year!” Gary reminded Miguel.
“That’s true,” Miguel agreed, “if that owner had your knowledge, had the business relationships you have, and was willing to work as hard as you do.”
Miguel continued, “Private equity firms are the likeliest buyers for companies of your size. The problem here is that they focus on three primary value drivers.” These are:
1. A capable management team with members that will stick around after the business is sold
2. The company must have up-to-date operating systems.
3. Have a broad customer base.
There are plenty of other value drivers that buyers analyze, but those are typically the top three buyers’ demand.
Let’s focus on the first value driver: a reliable management team. “Today, you are the management team. Aside from that, the company’s marketing systems are not current and eight customers account for 75 percent of revenue. Unless you build a management team that can address these issues and install other value drivers, you won’t be able to sell the company for much,” Miguel concluded.
Fortunately, Rita and Gary could handle the truth. They decided to hire capable managers. They approached two candidates who were working for competitors and offered to match their current salaries and award bonuses equal to 20% of any increase in annual cash flow. The two agreed to come on board if Rita and Gary documented salary, bonus arrangements and responsibilities in employment agreements. Once the agreements were signed, Rita and Gary were elated. The exit they imagined before they met with Miguel was starting to come into focus.
Takeaways…. The top three value-driving characteristics that professional buyers require are:
- Strong management teams
- Current operating systems
- Customer diversity
Businesses that are run primarily by owners tend to lack transferable value. Owners of these businesses seldom have proactive advisors.
To truly create and gain the greatest value for your business, you should start with a strong management team of employees and advisors. That team can then focus on the other key value-driving characteristics that a buyer is looking for and make those necessary improvements. The truth is, building value in a business is a team sport.
Michael Stier is an Area President for FocusCFO based in Charlotte, NC.