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Plan for the unexpected

Many things can and do go wrong during succession planning, but here are the top 3 we at Gibson’s see during succession planning:

  1. The owner is not mentally prepared. The mind dictates clearly that it is time to hand over, but the heart does not want to let go. It is one of the key tasks of a supporting consultant to prepare the owner for the exit. If the owner is not ready to let go, progress will slow down and can even stop, and the succession ends up in the “too hard” basket.
  2. Waiting for better times. If during the succession planning the business does not perform as hoped, progress can come to a halt. Especially if external circumstances such as market decline or currency exchange rates impact business results, companies tend to put their succession plan on hold and wait for better times.
  3. Different understandings of the same terminology. A classic example is the offer of a multiple (to the profit) for a company. For some, this means all the assets and goodwill, others understand this includes stock, work in progress, etc. The same is true if a business broker is involved: commission on sale price includes for some business brokers, also the value of the owner’s stock. It’s important to be clear about terms and meanings from the start.

You only get to exit your business once, so it pays to get it right. Most owners are very successful managers but have very little experience in selling a business. Bringing in an independent business consultant with the experience and knowledge – one who has no agenda and who doesn’t act as a business broker or legal or financial advisor – can help define the best fit succession plan for the owner and achieve the best overall result.

Putting yourself in the buyers’ shoes

To get a great result on the sale of your business, you need to start thinking like a buyer, rather than a seller.

As a business owner who has decided to sell, this can be a difficult thing to do. But if you can successfully put yourselves in prospective buyers’ shoes and ask ‘what’s in it for them?’ you’ll be much more likely to achieve an optimum result.

So, ask yourself: Who are the buyers? Where do they come from? People buy businesses for many reasons: they may be dissatisfied with their current job, laid off, looking for a family investment or just have a burning desire to have more control over their lives.

No matter what their motivation, all buyers have one thing in common: a desire to see the numbers! Buyers want to see income and expenses and assess the pros and cons of the business.

To present this information, you’ll need to develop an Information Memorandum, a formal document that contains the information a potential buyer will be interested in. In principle, this document is your sales brochure! It must provide enough high quality, convincing information for the potential buyer to decide to make a non-binding offer and move forward to the due diligence phase.

The Information Memorandum must explain:

  • The past business performance
  • The forecasted business performance for at least 3 years
  • A good understanding of the assets and the liabilities of the business
  • Reasons why the business is better than its competitors.

So, what’s the best way to put yourself in the shoes of potential buyers? Simply, to seek advice from people who buy businesses. They know what is important for a potential buyer and what is not.

At Gibbons we work with hundreds of buyers and sellers, and know the potential pitfalls. A top tip from one of our Succession Planning Consultants is ‘Be very careful about what you disclose before the deal enters the due diligence phase. Your customer list and their sales, for example, should not be discussed before due diligence formally begins’;

When developing your comprehensive Information Memorandum, remember to ‘think like a buyer’ or seek help from someone who knows how buyers think!

The real value of your business?

Because business owners have built their company over decades and invested their hearts and souls into it, they’re often tempted to measure value more with their emotions than with a clear logical mind.

To avoid this, calculation methods can help determine the value of a company, with the most applied being:

  • Income approach: Starting point is the gross profit of the next 3 to 5 years, discounted to today’s value. A simple approach often used for small companies.
  • Discounted Cash Flow method: Future cash flows are calculated and discounted to today’s value. This approach is more suitable for medium size enterprises.
  • Comparative data approach: Based on transaction in the past within the same or similar industries the potential sale price is estimated. This requires access to a very large and up-to-date database to get reasonable results (e.g. CoreValueTM).
  • Fixed assets method: Especially if future income is not given or unpredictable the existing assets minus the current long and short-term liabilities are the base for this calculation.
  • Mean Value method: This is a mixed method which considers both, the income and the current assets. Often both a weighted with a different ratio.
  • Strategic method: In some rare cases the value is based on access to patents, markets, etc. There is in principle no generic calculation for this case available.

At the end of the day, it’s important to remember that the value is driven by the market. As Publilius Syrus wrote in 1st Century BC: “Something is only worth what someone is willing to pay for it”.

 

Your role as an owner

There’s a saying amongst business consultants that some business owners aren’t looking for a successor, they’re looking for a monument conserver!

Understandably, leaving behind the business you’ve built up through your hard work is an emotional one. You need to remember however that you’re selling the company, not yourself. When owners are having difficulty letting go, they can send conflicting signals that compromise credibility and create confusion and doubt in the minds of potential buyers.

As the current owner, ensuring your house is in order and that you, your advisers and your team are pulling in the same direction and presenting the business well, is critical.

The first step is changing the way you see yourself – no longer as an operational owner but as a managing director of a strong management team. In many companies the owner wears many hats from General Manager to CFO to Sales Manager. Although this is often for good reasons, it is a big hurdle to overcome in succession planning. The value of a business is enhanced if the owner is not required to run the business. To get your business ‘sale ready’ you need to hand over any unique knowledge, such as customer contacts, special production or product knowledge, to the team that will remain when you leave. Without this, the business is worth far less.

Often it goes ‘against the grain’ to hand over control. But when you are planning to exit your business, you need to find ways to delegate responsibility to streamline the management of the business so that you as the owner are not tied to running every major aspect of the business. For now, you might control of some critical tasks, such as hiring of new staff, sales reviews and cash flow checks, and keep sensitive information such as company profit and employee salaries to yourself. But having a strong management team in place for all day-to-day activities is much better place for a successful succession plan. After all, you will need your employees’ help to prepare the business for the transition and then to make that transition successful. And while you negotiate the sale, you need to know that the on-going management of the company is running smoothly so that no surprises crop up at a critical point in the sales process.

While there is no one-size-fits-all approach to managing the challenge of simultaneously overseeing a successful business and managing a sales process, careful preparation and ensuring you have a strong management team is vital. Employees feel empowered and informed, you are freer to focus on succession planning and the sales process, and the new owner gains a thriving business. In that scenario, everybody wins!

Timing is key

“Retirement timing is always a tricky thing. I think it’s different for everyone. How you say goodbye to the thing you have really focussed on that much is a tough one. I’ve always intended to leave in good shape, to exit on a high note”. – Damian Woetzel

Business owners will inevitably move on from their business, yet the data shows that succession planning is typically last on their list of priorities. Business leaders are usually focused on building the business, and don’t like to think about the day they will leave it behind. But the reality is that planning for the sale or succession of your business is one of the most important decisions you can consider, and that proper succession planning will deliver the optimum results for you, your employees and the new owner.

To understand basis for succession planning, take yourself forward in time and imagine what you want to put on the table for potential buyers. You want to show them:

  • A successful business with a steady sales growth over the last 3 years
  • A stable management team which has demonstrated their management skills over many years
  •  A stable cash flow over the last 3 years, and a strong financial position
  • A predictable future income for the business, ideally supported by long term contracts
  • No legal disputes
  • A stable and engaged work force
  • A very presentable premises with well-maintained assets
  • A managed business that does not rely on the current owner for its success.

When a business can tick all these boxes, a succession plan can be implemented quickly, but unfortunately this is not often the case. This timing can make an enormous difference in what you take away from the closing table.

Succession planning should ideally start more than five years ahead of the business sale, with more detailed planning over the three years before the planned exit. If your circumstances allow you proper time to plan, you will be able to turn your attention to critical issues that need to be addressed before the sale. Depending on the business these types of issues might be:

  • The owner is heavily involved in operations. When they leave, production, sales or other areas will struggle.
  • The product portfolio is at the end of its life cycle or under threat of cheaper Asian imports.
  • Other key members of the management team will also leave once the owner leaves, and the business depends heavily on single individuals because of their knowledge or skills.
  • The company has no sales plan and a very unstable sales history

Within a reasonable timeframe, most issues are fixable – although one of our Gibsons Consultants fondly remembers a client who stated “I am 73 years old and want to get out of the business by the end of the year”.  Succession planning in this environment is obviously challenging and reduces the options on the table. In succession planning, timing is everything!

 

The key to successful succession planning

Whether or not you like to think about it, it’s inevitable that one day you’ll leave your business. It may be that you decide to sell up and enjoy the fruits of your labour in retirement, or you have to exit the business due to health reasons. Whether today or far in the future, the time will come when you, as a business owner, have to answer: Who will continue to run my business?

The key to successful succession planning is to ensure you are not asking this question too late! Leaving it until you have reached an age where you are no longer healthy enough to work, or when the enthusiasm that drove your business to success has disappeared, will devalue your business.

You could decide, or need, to sell at any point in time – but it takes time to have the business in a state to maximise the sale value. The reality is that planning for the sale or succession of your business is one of the most important decisions you can consider, and that proper succession planning will deliver the optimum results for you, your employees and the new owner.

Succession planning has a time horizon for the next ten years and allows you to plan ahead all the necessary changes for an optimal handover. A succession plan answers two basic questions:

  • Who will own the company in the future?
  • Who will run the company in the future?

For many SMEs, the owner is heavily involved in the daily business, so essentially the owner and the managing director are the same person. A Succession Plan might split these two roles, with a potential scenario being that the owner first steps back from operations while remaining the owner, and a certain amount of time, transfers the ownership.

But first, the current owner has to answer some fundamental questions:

 

1. What is my target for the transition?

  • Maximum upfront money
  • Legacy for my family
  • Protection of my brand name
  • Shortest transition period
  • Job security for my staff
  • Monthly income for the retirement

2. How much do I want to be involved after the transition?

  • A day or two per week
  • Consult to the business for some years
  • Bye, gone fishing

3. When do I want to step out?

  • Next 3 to 5 years: Plenty of time to make the company really attractive, optimise the product portfolio, clean up structure, train internally or hire required key positions
  • Next 2 to 3 years: Sleeves up, clean up fast, fix broken processes, prepare accounting
  • Less than 2 years: Doable, but no time to waste. Some transition models might be already gone, avoid a simple fire sale

The answers to these questions will guide your timeframes and approach.  It’s all about having choices. If you have a plan or strategy in place, then you can choose what you really want to do, at the time when you want to do it. And isn’t that what success is all about?

 

Is it time to exit your business?

In the challenging economic climate since the GFC, many SME business owners have asked: Is now the time to exit my business?

According to the Australian Bureau of Statistics (ABS), from 2009 to 2013, increasing numbers of business owners answered yes to that question and did exit their business. And despite a drop in the exit rate in 2013–2014, many business owners are still considering their options.

Fin year Entry rate % Exit rate % Variance %
2009–2010 16.7 13.1 3.6
2010–2011 13.9 13.5 0.4
2011–2012 13.5 13.1 0.4
2012–2013 11.2 14.1 -2.9
2013–2014 13.7 12.7 1.0

Entry rates versus exit rates of Australian businesses 2009–2014
But you don’t need to wait for desperate circumstances before you develop an exit strategy for your business. In fact, developing an exit strategy can help both to prepare your business for sale and/or to make your business more competitive.

If you want to continue to operate your business, how can you safeguard your business into the future and avoid being one of those exit statistics?

To be competitive, SME business owners must be outwardly focused. In addition, you need to know what is driving the value within your business, and what is not driving value. This means capturing not only financial information and tangible sources of value but also intangible drivers such as market share, brand, point of differentiation, margin and customer satisfaction.

Alternatively, if you want to sell your business, you will need to provide the buyer with proof of the value of your business and reasonable assurances of future profitability. The intangible assets mentioned above are crucial to the competitive advantage and future earning capabilities of an SME business.

But how do you identify and measure those intangible assets and drivers? In many SMEs an information gap exists in this area, which consequently can impact the value of the business and make a business more difficult to sell.

Whether you eventually decide to stay and forge ahead or to exit your business, an important starting point is to know the value of your business.

Do you know the value of your business?

You might be surprised, as a US-based survey found that 95% of business owners thought that their company was worth more than it is in reality.

Dr Ralph Bradburd, Professor David Wells and Chuck Richards, CEO of CoreValue, in their white paper ‘Transferrable Enterprise Value – The importance of quantifying intangible value drivers in SMEs’, stated that enterprise value (EV) tries to measure the ‘true worth’ of a business. It is often referred to as the takeover value.

For publicly traded companies, EV can be derived from shareholder reports, financial statements and other metrics, but for smaller businesses most of this information is not available and the information gap can make it very difficult to acquire. This information gap includes personal relationships with suppliers and customers, often poorly documented operational information and processes, and the fact that smaller businesses tend to operate in narrow markets with specialised products and/or in specific geographical areas which limits comparisons with like businesses.

Gibsons can now help you to develop a comprehensive assessment of the value of your business using CoreValue. CoreValue is a software application that analyses where the value is being driven from within your organisation and then provides you with practical and achievable action plans to address the issues that impact on the value of your business.

By using the CoreValue valuation tool, we can help you find out what are the value drivers within your business. From there we can help you to build on that existing value.

For more information on how to create a business exit plan or specifically how CoreValue can assist your business, contact Gibsons and speak to one of our experienced business consultants.

Thanks to Steve Bryant from QMI Solutions for providing information about the CoreValue database and software that is included in this article.