In the prior post, Transferable Business Value And What Drives It, I described value drivers—business characteristics that buyers demand if they are to purchase your business. Value drivers are critical because they can create transferable value.
Transferable value is what your business is worth, to someone else, without you.
An easy way to determine if your company has transferable value is to ask, “If I permanently leave my business today, will it continue with minimal disruption to its cash flow?” An obvious follow-up question is, “Who is going to be responsible for running my business without me—and with minimal disruption to cash flow?” The answer can only be, “My company’s management.”
Perhaps less obvious than management as responsible for future performance is management as instrumental in growing cash flow—business value—beyond your capabilities. Next-level management is, indeed, the mother of all value drivers. The father of modern management, Peter Drucker, says this about entrepreneurial management, “It requires . . . building a top management team long before the new venture actually needs one and long before it can actually afford one.”
As the name implies, next-level managers are typically those who have worked in companies that are larger, often much larger, than yours. Next-level managers know how to grow your company at least to the level of the larger companies they’ve worked for. They have experience and skill sets appropriate for the company you want and need it to become.
This I believe is part of Drucker’s message to entrepreneurs: to grow a business significantly requires management that knows how and what to do—indeed has done it before for a larger company.
Three Tasks For Owners
To help your company move forward in developing and retaining next-level management you have three ownership tasks.
Task 1. Attract and retain next-level management. This may involve training and coaching existing management to the level needed, adding next-level management, and replacing or transferring underperforming management.
I appreciate that making the decision to replace existing management is not easy. Owners usually have a gut feeling when doing so is the right decision, but that intuition butts up against loyalty, friendship and the obligation they feel toward long-time managers.
In considering whether to replace part or all of your management team realize that doing so is normal for rapidly growing companies. Next-level management, in large part, causes that growth. Eventually, the first set of next-level managers may also be replaced.
Hiring next-level management does not mean casting out your management with six weeks of severance pay. Members of your current management team may still be very valuable—just in different roles. Often they can remain employed and perform well and responsibly, but in a sphere more appropriate to their experience level.
Task 2. Engage management consultants and outside resources to spur growth. Retain consultants to assess, train and coach existing management.
Ken A. Stiefler, CExP™, describes how he worked with one of his Exit Planning clients. “This owner brought me in when he recognized two things about himself: too much of the business revolved around him, and he wasn’t capable of taking the business to the next level. In an effort to change his role, the owner began planning to replace himself by: 1) bringing in a new general manager (instead of simply delegating to existing management), 2) creating a plan to delegate his responsibilities, over time, to others in the company and 3) looking at outsourcing some tasks.”
Exit Planning advisors like Ken have resources and a stable of outside talent on call to resolve issues that existing management or advisors cannot.
Task 3. You must provide the leadership and motivate top management to achieve the goals you’ve described in your growth plan. Providing strong incentives to management is one of the key components private equity firms create for newly acquired companies.
As an owner who is building transferable value you must add this component: When designing incentive plans for your management team, be mindful of the need to retain management beyond your departure as active owner.
There are two parts to this component. First, when you provide top managers financial incentives designed to grow cash flow or business value they are motivated to help you to achieve your exit goals. Second, these incentives can also motivate management to remain after you exit, and management must stay in the business when you leave if it is to continue to thrive. If your company fails to thrive after you leave it, you are not likely going to achieve your values-based goals. And, it’s unlikely you will receive the balance of the purchase price you were expecting after you sell the company.
Incentive Plans Motivate Key Employees
Perhaps the most common tool used to motivate management is a “non-qualified deferred compensation plan,” or NQDC Plan. For the sake of brevity, the NQDC Plan includes two elements, a benefit formula and a vesting schedule.
The benefit formula typically contains a performance benchmark that motivates participating key employees to increase the profitability or cash flow goals of your company. The employees usually receive a cash award. Usually about half of the award is paid in cash each year if cash flow or profitability reaches or exceeds the pre-determined benchmark. The remaining half of the award is deferred and subject to vesting. Unless the business or key employee reaches the benchmark, the key employee receives no award. These plans are designed to encourage your management team to achieve the very growth goals necessary for you to reach your financial security goals.
The vesting schedule is similar in concept to the vesting schedules used in many qualified retirement plans such as 401(k) or defined benefit plans. Like many qualified plans, a key employee is vested in the benefit over a number of years. If that employee leaves before becoming fully vested, they forfeit part or all of the accrued benefit.
Incentive plans for key employees (management) are widely used in Exit Planning. (Examples and additional explanation to follow in future posts.) Their near- universal usage is understandable: To create transferable value, someone other than you needs to be similarly motivated to grow value and the cash flow necessary to achieve your exit goals and continue the company beyond you. That “someone” must be, can only be, your management team.
Look again at Peter Drucker’s recommendation. Unless you “build a top level management team before [your company] reaches the point where it must have one” your company will not be the great, durable enterprise it must be to enable you to exit it when you want, for the money to need, in the hands of the successor of your choice.
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