Léon Danco, the pioneering family business adviser, once wrote, “The toughest thing for the entrepreneur to realize is that time is constantly running out. Most owners don’t plan because they don’t think they are ever going to retire or die.” If you don’t have an exit plan, the future of your business, your personal financial security and your employees’ jobs will all be at risk.
A disciplined, systematic approach to accomplishing your objectives will result in an orderly and successful exit from your business. Investing time now to create your exit plan will give you peace of mind.
If you choose to sell your business, plan well in advance. Keep in mind that it can take up to two years to complete the process.
Several types of buyers may be interested in your business—strategic buyers, financial buyers or private equity groups. Your marketing efforts should be targeted to buyers who will see the most value in your company.
The six value drivers
Your exit planning should be based on a solid understanding of what drives your business value as well as accurate benchmarks of the value of your company. Value drivers are the characteristics that reduce the risk of owning the business or increase the probability that the business will grow in the future. If these characteristics are present in your company, a buyer will pay a premium price.
• Management team: Too many business owners make the mistake of retaining complete control, which makes it hard to separate them from the business. Designate a manager or assemble a management team that is capable of running the company now and after your departure.
• Systems and procedures: Like a strong management team, reliable systems and well-documented procedures will help sustain the growth of a business and ensure a smooth transition to a new owner. Write a formal business plan, create written job descriptions, develop a systems manual and organize customer and supplier files. Consider investing in technology and software tools that will help streamline current procedures.
• Customers and suppliers: To protect yourself from the loss of a single customer or dominant supplier, diversify your customer and supplier base. No one customer should account for more than 20% of your total sales. This may require you to invest in additional capacity that will allow you to broaden your customer base. Taking the time to investigate your suppliers is a prudent strategy and may also reduce your cost of goods.
• Facilities and equipment: Make sure your facilities are up to code and convey the image you want to project. Invest in new equipment and maintain service records.
• Financial discipline: Bus-inesses are valued based on the health of their historical income statements as well as five-year projections that are substantiated. The existence of financial controls supports an owner’s profitability claims. It is extremely important that your company’s financial records be accurate and verifiable. A potential buyer or lender will want to carefully review them.
• Growth strategy: Your ability to demonstrate a realistic growth strategy is vital to the perceived value of your business. Creating a pro forma statement with projected discretionary earnings is the best way to communicate future opportunities. Make sure to document your assumptions and clearly outline new products, marketing efforts, increased demand, industry dynamics and other factors that affect growth.
It is imperative that you have an updated business valuation performed before placing your company on the market. This will help you set a realistic, defendable asking price. A business valuation is a data-supported document that benchmarks the current market value of your business. To avoid the potential use of an unreliable valuation approach, we recommend you use an unbiased and certified business valuation firm. If the valuation proves insufficient to support your long-term financial objectives, you should devote significant effort to improving the key value drivers. If the valuation is in line with your expectations, you should take steps to preserve your business’s value and occasionally have it revalued. Industry dynamics and the health of the economy are external factors that can greatly alter the market value of your business.
Profitability analysis
Once you understand what your value drivers are, and you know the value of your business, your next step should be to analyze your company’s profitability. Begin the process by conducting what’s known as a SWOT analysis. Identify the company’s true strengths, known weaknesses, growth opportunities and any threats to the future of the firm. Strengths and weaknesses are internal factors. Opportunities and threats are external factors.
For example, strengths could include a new, innovative product or service, the location of your business, or your marketing expertise. A weakness might be undifferentiated products or services or a damaged reputation. Opportunities could include a developing market, such as Internet customers, or a strategic alliance. A threat could be a new competitor in your home market, price wars or legislative action that negatively affects your industry. Make sure you are realistic and very specific when performing your analysis. Your SWOT analysis should distinguish between where your organization is today, and where it could be in the future.
Next, you should determine your company’s profitability drivers. This starts with understanding where you make and lose money. It’s easy to equate growing revenues with making money, but unless your operating margin is keeping pace with your revenue growth, you might actually be facing a decline in profitability.
To understand the profitability picture, you must analyze the cost structure and contribution margin of each business component separately. A component may be a brand, product, channel or customer.
One common mistake that companies make is to allocate a large percentage of their cost structure to “shared costs.” If all costs are not directly attributed to individual components, profitability is likely to be overstated in some areas and understated in others. This could cause management to make poor business decisions, such as increasing sales to a high-volume customer when the company should be growing its business with lower-volume, higher-profit customers.
Consider the following initiatives once you have determined profitability drivers:
1. Re-evaluate all products and services. Consider dropping low-volume products or services. Keep them only if their customer reach is strategic in terms of loyalty, satisfaction and relevance. Compare their contribution margin to that of all other products and services. Evaluate their system-wide operational impact on manufacturing and distribution -productivity.
2. Realign customers. Renego-tiate pricing or completely eliminate unprofitable customers to improve the low-cost/high-cost mix. This may allow for consolidation of facilities, reduction of manufacturing lines and more efficient distribution. Focus resources on profitable accounts with high growth potential.
3. Set long-term strategy. Share your findings with your leadership team so that all future decisions will be based on true costs, system-wide impact and the most favorable profitability strategies.
Action plan
After completing the steps suggested above, create a list of action items, with projected completion dates, that will maximize your business value and increase your profitability. Careful planning will allow you to transition your company without jeopardizing either near-term performance or future growth. Your goal should be to move from a revenue culture to a profit culture and to strengthen the business in the areas of the six value drivers.
Set aside time to review your action plan twice a year and compare your progress against your short-, mid- and long-term objectives. Make adjustments and work with external advisers to stay on course.
Keep in mind that the sale of a business can suddenly create significant liquid assets for the owner. Without a wealth management plan, there can be unwanted consequences. Tax and estate planning should also be essential elements of your exit plan.
Brian Mazar (mazar@fortunebta.com) is managing director/CEO of FORTUNE Business Transfers & Acquisitions, a firm providing business sales and acquisitions, business exit/succession planning and certified business valuations.