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Exit Planning

The Advisor’s Job: Creating Transferable Business Value

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If you are an attorney, CPA, banker, transaction intermediary or financial advisor, helping your clients build business value is likely far outside your professional expertise. Yet, in our experience, the fundamental obstacle facing the owners all of us work with is transferable value.

Business value becomes transferable when the current owner is no longer indispensable to the operation and well-being of the company.  A business with transferable value can be sold or transferred to another with minimal disruption to cash flow-even after the owner leaves the company.  The owner, in short, is dispensable.

Most owners are not able to exit their companies when they wish or with the financial independence they need because they are indispensable to cash flow and value creation.  Consequently, their businesses lack adequate transferable value.

They cannot sell or transfer their companies for enough cash to ensure their post-exit financial independence. So, no matter our area of professional expertise the challenge for us as owner advisors is: How can we help owners build transferable value in their companies?

As you consider this question, bear in mind two considerations: First, if you don’t reach out to owners it is likely that no one else will.1 Second, taking the lead role in helping owners develop greater value doesn’t mean you need to turn into a valuation consultant. You need simply to understand the value creation process and recruit the proper consultants to develop value.

Ken A. Stiefler, a Certified Exit Planner and President of eXITSTM, LLC, agrees. “When I meet owners I tell them that, in construction terminology, I’m like a general contractor, and that I depend on the expertise of my subcontractors. Over the years, I’ve developed a stable of skilled consultants so I can match the value-creation needs of an owner with the expertise of the consultant.”

The approach Exit Planning advisors use to create value is, in turn, based on three considerations. First, they understand what buyers look for in targeting acquisitions. Buyers’ value expectations are the most objective standards of valuing a company for transfer purposes.

Second, Exit Planning advisors share what we know about buyers with our owner clients.

Third, all advisors involved in the Exit Planning process must be prepared to represent their owner clients in enhancing and protecting value to the extent practical within each of our professional disciplines. There are many opportunities to do so during the planning and execution of each owner’s Exit Plan. (We’ll explore these opportunities in some depth in future articles.) These opportunities do not exist however, unless you show owners that they must create additional transferable value if they are to exit successfully.

What owners need to know about building transferable value

We suggest that the first task in helping owners to grow value is to communicate to them that transferable value is what a business is worth, to someone other than the owner, without the owner at the helm.  This rule applies no matter which exit path an owner chooses. Transferable value is the single, common determinant of a successful exit.

  • Insiders (co-owners or key employees) won’t be willing (nor should owners be) to acquire a company by pledging personal assets if they can’t run the business without the owner.
  • Passing on the business to the owner’s kids is a recipe for disaster if it can’t continue successfully without the parent.
  • Third-party buyers know that owners will leave the company when they sell so if the business is owner-dependent, what are they buying? That question is just rhetorical because buyers won’t make offers on owner-dependent businesses.
     

Value Drivers

Again, no matter what exit path an owner chooses, transferable value is the prime determinant of a successful exit. The factors (or business characteristics) that drive transferable value are “value drivers.”

Looked at from a buyer’s perspective, strong value drivers are what make a company a desirable acquisition. When value drivers are present and functioning well, buyers will pay top dollar for them because they result in increased cash flow (and EBITDA). Generally speaking the greater the EBITDA the greater the multiple buyers will pay for the cash flow. For example, increasing cash flow from $1 million to $2 million also tends to increase the EBITDA multiple:

       $1 million x 4 = $ 4,000,000

       $2 million x 5 = $10,000,000

       But as hucksters say, “That’s not all, folks!”

A company with strong value drivers will also tend to demand a higher multiple on the same amount of EBITDA than a company with average value drivers.

As you read through the list of value drivers below, remember that it contains only standard value drivers. Depending on what a company does, it may have other drivers that create and increase transferable value.

The listed value drivers are the ones that transaction intermediaries and private equity groups (professional buyers) tell us they use to assess business value.

Standard value drivers include:

  1. Best-In-Class Management Team
  2. Operating systems demonstrated to increase sustainability of cash flows
  3. Diversified Customer Base
  4. Proven Growth Strategy
  5. Revenue that is recurring sustainable and resistant to “commoditization”
  6. Good and Improving Cash Flow
  7. Demonstrated Scalability
  8. Competitive Advantage
  9. Financial Foresight and Controls

Before we discuss these and many more characteristics of a company that build value and attract buyers, let’s establish five working fundamentals.

Fundamentals of Value Drivers

First, while it is the owner’s job to create transferable value in the business prior to a sale, advisors and the owner’s top management are invaluable as owners work to increase cash flow.

Second, buyers—specifically Private Equity Groups (PEGs)—are the arbiters of value. That’s important even to owners who may plan to transfer their businesses to insiders or sell to a strategic buyer. PEGs (generally financial buyers) are the gold standard because, unlike insiders, PEGs evaluate and set purchase prices for lower- and mid-market companies based on their experience, competition with other experienced buyers, and a thorough examination of a potential acquisition. PEGs are sophisticated buyers whose continued existence relies on making the right decisions, time after time, about the growth potential of companies. In short, they know what qualities to look for in acquisition candidates. These qualities are what we refer to as “value drivers.” Bringing these value drivers to the attention of the owner, and explaining their importance, is one of the first steps advisors can take to engage clients in any type of a value building process.

Third, the sooner you help owners to improve their company’s value drivers, the greater the potential to reap ongoing and future benefits for both owner and his or her company. Again, this principle applies whether owners plan to sell to a third party, transfer to insiders, or keep the business indefinitely.

Fourth, if owners wait to begin building transferable value until they are emotionally prepared to leave the business:

  • They will still have to do all the same work necessary to build value. That work will take just as much time as if they started today, but because they are already emotionally ready to leave, there’s a high probability that they will have lost the passion and interest they have today. Once that happens and the entrepreneur is no longer a driving force, the energy and growth of the business suffers.
  • Owners who wait forfeit years of increased cash flow (as well as a more pleasant ownership experience), because the heart of value building is making the owner replaceable while increasing cash flow.
  • Owners who wait have fewer options when they exit than do owners who tackle building value well before their departures. Further, the obstacles they do encounter will be more difficult to overcome because you don’t have the time to create and initiate alternative growth strategies, replacing non-performing management, etc.
     

Your job is to show owners that acting to drive value upward is vital and, since they have to do it anyway, why not start today?

Finally, even if owners assume that their companies are too small to attract the notice of a PEG or strategic buyer, keep in mind that every buyer wants the same qualities in a business that professional buyers require.

For the reasons described here, we suggest that you strongly (and continually if need be!) encourage your clients to create an action plan to grow transferable value as part of their Exit Planning. If they do so it will (of course) create more work for you and other advisors. But the most important reason to urge owners to build value is that unless they do so, they will not be able to exit their companies when they wish or with the financial independence they need. Once owners understand the truth of this statement, you and your owner-client can begin, well in advance of an owner’s planned departure date, to enhance value drivers and thereby increase transferable value.

References
1. When we asked owners (in BEI’s North American Business Owner Survey) who they had talked to, at least once, about their plans to exit their businesses, responses were: 22% to their spouses, 13% to their attorneys 12% to their CPAs 9% to their children 9% to their financial advisors, and 3% to their insurance advisors.
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