Good preparation and risk reduction create better options.
If you’re a Baby Boomer who plans to sell or transition out of your business in the next 10 years, you’re not alone. And that’s not good news.
The Pepperdine School of Business predicts that 67 percent of business owners are planning some sort of ownership transfer in the next 10 years. A report in Inc. magazine forecasts that 65 to 75 percent of U.S. small businesses—nearly 10 million—will be put up for sale in the next decade.
“With such a large supply on the market,” writes Carey McCann of SME Research, “there will surely be a downward pressure on pricing.”
In such an environment of likely higher interest rates, more regulation and competition; developing an exit strategy assumes an even higher importance. Companies that have planned properly will typically command a higher price and find it easier to execute a transition. Frankly, those who don’t plan (and execute) may be in big trouble in the crowded marketplace.
Even if you don’t have immediate plans to sell, it’s a good idea to start thinking about it now. Deliberate planning and execution usually takes several years and sometimes more to successfully accomplish. Plus, the act of planning and successful execution will help you improve your company’s performance and even future access to credit.
Improve Performance and Corporate Value by Reducing Business Risk
One of the most important concepts to understand in exit planning is that risk reduction significantly increases corporate value.
Most business owners understand the benefits of improving their compound annual growth rate and increasing their EBITDA. Many, however, fail to understand how perceived future business risk can affect business valuation, potential sale price and the quality and quantity of your options for transition. That’s true whether you’re considering an external sale, an inter-generational transfer, a management buyout or an employee stock ownership plan.
Even if you are not interested in exiting your business in the near future, optimizing your business value through risk reduction has huge benefits.
For example, when you attempt to increase your borrowing limit, your bank will not only look at your past performance, it will typically consider what its risk is in the future performance of the company. They will examine the risk factors going forward in areas such as leadership, people, planning, sales, marketing, operations, finance and legal.
According to research from Morningstar and Corporate Value Metrics, lower middle market companies can increase their value up to 70 percent over a three- to five-year period through business risk reduction.
What’s the best way to reduce risk and enhance corporate value? There are many approaches, but from our experience, the most successful outcomes have employed a formal process.
A 4-Step Transition Plan
The best way to proceed is to use a four-stage transition process that combines a team approach that may include consultants, accountants, attorneys, investment advisers and insurance professionals:
Stage 1: Discovery
What are the ownership’s personal needs, goals and timeframes regarding transition? What is the current state of the business on its lifecycle and the risk factors in its functional areas described above?
Stage 2: Options Assessment
Given what was learned in Stage 1, what are all the potential ways to meet the ownership goals? Many times inertia sets in, and it is easy to have blinders on. It is critical to examine all potential paths with their pluses and minuses and to not arbitrarily pick one. The impact on all stakeholders should be measured.
Stage 3: Pick A Path
This includes formal road map development; acquisition and development of internal and external resources; and a real commitment to both value enhancement and business risk reduction. Some specifics that can be addressed to reduce future business risk include customer and/supplier concentration; geographic, horizontal and vertical scalability; good financial controls; recurring revenue; product/service exclusivity; customer satisfaction and strong, deep leadership with a motivated workforce.
Stage 4: Plan Execution
This covers formal milestones, formal and timely reassessment of goal achievement and a method to reward for goal attainment.
Every business owner should have a goal of successfully transitioning out of their company in the future. To that end, it is critical to understand that the execution of a formal plan including business risk reduction and value enhancement will greatly improve the probability of reaching your goals. This is even more important given baby boomer demographics and the challenges in the debt markets in the years to come.
So, even if a transition is not imminent, it is much better to begin the planning and execution of a formal transition process earlier rather than later. With a good process, it is easier than you think.
Dave Raden
Joe Kessinger
Joe Lieberman