Have you set up a Triple Option for leaving your business?
The Succession Planning and Exit Planning fads seem to have crested and receded in recent years, but the need for preparing your business for its next stage is as important as ever. The real problem that was never truly addressed by the Exit Plan gurus (and remains unsolved for most business owners) involves building a business model that affords multiple options for transition and presents an attractive profile to each option.
Bo Burlingham, of Inc. Magazine fame, addressed this issue in his forward to John Warrillow’s book, Built to Sell. Here is Bo’s commentary:
Among the many things I’ve learned from them has been the fundamental paradox that lies at the heart of company-building, at least as it is practiced by the smartest entrepreneurs: You should always run a company as if it will last forever, and yet you should also strive constantly to maximize its value, building in the qualities that allow it to be sold at any moment for the highest price buyers are paying for businesses like yours….
And it’s the philosophy of John Warrillow. John, in fact, refers to this approach as having an “options strategy,” as opposed to an “exit strategy.” The idea is to have as many choices in the future as possible. When you follow an options strategy, he says, you build systems and a management team around you so that if a buyer comes along, or you decide it’s the right time to get out, you have a sellable business. Or so that you can install a president and move into a chairman’s role, which is a kind of quasi-exit. Or so that you can stay involved day to day and work on building an enduring company that can go on without you.
While I agree with Bo’s assessment of the options that should be cultivated within a healthy company, my experience with small business presents a slightly different version of theTriple Option. A truly healthy small business should be prepared for three possible exit options (alongside the obvious option of continuing within the business).
Option 1 – Third Party Acquisition
Preparing your business for sale to a third party should be the first and primary option to develop. There is a very simple reason for this priority. Third party sales are dependent upon consistent and sustainable earnings. Focusing your attention on developing consistent and sustainable earnings pays dividends both immediately and in the future when you actually sell your company.
There are several value drivers that need attention for this option, but three stand out as a constant struggle for small business owners.
Management. Most small businesses are first-generation businesses that were built around the skills and personality of the owner. Consequently, the business is very much dependent upon the owner. We describe this situation to clients as “owning your job.” When the company is totally reliant on you, as the owner, then you are not free to invest your time and energy elsewhere. You are your own employer, not at all unlike being an employee for someone else. The solution to this dilemma is to conscientiously build a management team and structure that allows you to spend more time in the board room (or on vacation) and less time on the shop floor or even in the front office. If you can take a 30-day vacation during which you have no contact with your company without any adverse effect on operations or profitability, then you likely have a management structure that makes your business both valuable and sellable.
Diversification. Many small businesses struggle with over-dependence on a key customer, a key employee or a key supplier. There are many reasons for this, as well as many reasons why it should be avoided. Suffice it to say that a buyer will give a higher risk score to a company that could not survive the loss of any one customer, employee or supplier. Every small business owner needs to proactively work toward relationships with customers, employees and suppliers that keep the company sustainable and profitable even if any one customer, employee or supplier disappears on any given day. Conducting regular “fire drills” by asking what impact the loss of any one customer, employee or supplier might cause is one way to constantly watch for a dangerous dependency.
Industry. Most small businesses spend far more time on the Strengths and Weaknesses portion of a SWOT analysis than on the Opportunities and Threats. There is a simple reason for this. The Opportunities and Threats are part of the larger industry and are generally not susceptible to the business owner’s control. The fact that owners cannot control their industry or its trends, however, is precisely why it is so important. We have recently been working in two related but totally different industry segments: Commercial Printing and Flexible Packaging. Our work with a couple of companies in the Commercial Printing industry reveals that even relatively healthy businesses in this sector struggle to find buyers because the industry as a whole is in decline and banks are avoiding lending due to the risk. Our work with a company in the Flexible Packaging industry reveals that this segment is white hot in terms of buyer interest, but companies in this segment need to be focused on capital investment in the right equipment as well as in differentiating the company from other competitors in within the segment. The wise business owner is constantly monitoring developments within the industry to identify opportunities for differentiation, internal investment and industry re-positioning.
Option 2 – Key Employee Succession
The second option that deserves attention is an internal ownership transition to a key employee or management team. There are at least two reasons why preparing for a Key Employee Succession makes sense both immediately and long-term.
Management Development. As noted above, a key deficiency in most small businesses is the absence of an effective and sustainable management team. The business owner that prepares for a Key Employee Succession will necessary address that concern by developing a management team that can continue operating the business after the owner is gone. The other benefit of planning for a Key Employee Succession is the retention of those key employees. Using retained earnings strategies and other tools, a business owner can create a savings plan that will provide the initial cash investment needed for the Key Employee Succession as well as providing an incentive to those key managers to stay with the company. Finally, preparing for a Key Employee Succession will necessarily require the owner to invest in training and delegation of responsibilities, two areas that are notoriously difficult for most small business owners.
Low-Cost Transition. In a typical Third Party Acquisition, the business owner will pay fees to two or three professional advisors. Attorneys and accountants will bill at their normal rates for the work that needs to be done leading up to closing. Additionally, a business intermediary will generally charge a success fee which is a percentage of the ultimate sale price. While these fees are generally money well-spent in a Third Party Acquisition, a Key Employee Succession allow the owner to pay fees over a period of years with far less costs associated with the ultimate transition of ownership. There is also a lower risk cost in a Key Employee Succession because the new owners already have relationships with all the key players and are intimately acquainted with all the key operations.
Option 3 – Family Succession
The last option that owners should prepare for is a Family Succession. This option is generally the most risky and can be the most costly in terms of overall value lost. There are three issues that need to be addressed in preparation of a successful Family Transition.
Skills Development. Just because Junior has worked in the company for several years does not mean that Junior has acquired the skills needed to run the company. You don’t have to look very hard to find examples of companies that failed under second or third generation leadership because the heirs were ill-equipped to run the business. For a company to survive a Family Succession, the next generation needs to be intentionally and systematically trained and groomed to possess the skills required for running a company rather than simply performing one of many operational functions within the company.
Character Development. A corollary to Skills Development is the development of the character traits needed to be a successful business owner. Successful business owners must have a vision and the ability to see options and possibilities in the abstract. Successful business owners must be able to cast their vision and persuade the team members to buy into the vision in order for that vision to become reality. Successful business owners need to have a well tuned intuition in terms of developments within their industry and the larger marketplace. Quite often, the first generation owner possesses these traits, but the second generation is only capable of holding the course set by the first generation while the company loses momentum. By the time the business is ready for transfer to the third generation, it has consumed any real value created in the first generation and is facing extinction. One way (and likely the best way) to avoid this common fate is to require the next generation owners to spend some time (at least two years) working outside the family business. The experiences gained from exposure to a different culture and management philosophy will provide insights and context for the next generation as they shape the business and encourage evolution within the business beyond the original vision of the founders and toward the developing opportunities within the industry and the larger marketplace.
Capital Development. Finally, the most practical problem facing most Family Successions is the lack of liquid capital available for the transition. There are many strategies available for current generation owners to realize an annuity stream of payments from the transition, thus reducing the need for large sums at the point of transition. However, many exiting owners could benefit from some up-front cash to fund retirement plans, retire debt or buy that house in Florida they have been dreaming about. Planning ahead by using deferred compensation and other strategies can help provide a “nest egg” for the next generation to use when the time comes for buying out the current owners.
If you have a “family business” in which family members are in line to take over the company, it is in your best interests to develop a Triple Option Strategy. Not only will the development of all three options give you the most flexibility and value when you finally exit the company, it will also maximize the actual value of the company for your successor (no matter who that successor happens to be). Building a truly healthy business that is attractive for Third Party Acquisition will always may a Key Employee Succession and a Family Succession that much more possible and viable.
The moral of the story is simple: Keep your options open!