Most entrepreneurs start a business because they know something about a particular industry, its practices, its products and services, and its customers. Generally, they believe they can do whatever it takes to match or beat competitors profitably and successfully. Many new businesses don’t survive, but for those that do, the belief of the founder that he or she knows how to deliver value to customers holds true.
Initially, the business owner may do everything. He or she finds customers, prices the products or services, performs the work, handles the billing and collections, and performs all the administrative functions. Over time, as the business grows, the owner typically hires others to help, generally to assist in making the products or performing the services. Perhaps an administrative person is found to do some of the more mundane functions like billing, purchasing and recordkeeping/accounting. But the owner still maintains the primary customer relationships, continues to be the expert at production or service delivery, directly manages the employees and has involvement in all but the most basic business operations.
This arrangement can continue for decades, and it can provide the owner with a pretty comfortable lifestyle. Excess cash is typically reinvested in the business to grow, adding new products, new services, and new employees to do the work. Instead of a 401(k) or IRA, the business is their chosen investment option.
Historically, the children of business owners typically grow up in the business, starting with after-school jobs and progressing to more significant roles. Eventually one or more of the kids may wind up taking over the business after the parent retires. However, we’re often seeing that the kids have other interests and don’t actually want to be in the business long term. But the owner still needs to fund retirement, and the business is normally seen as his or her most valuable asset. He or she can always sell the business and retire in comfort, right?
In the world of mergers and acquisitions, there are two kinds of buyers – strategic and financial.
A strategic buyer is one that is in the same or related industry as the target company and seeks to buy the firm as an extension to its existing business. A strategic buyer could be a competitor. In this case, the buyer is typically looking to acquire both the customers of the target firm, as well as its production or delivery capability. For example, one HVAC firm could seek to acquire another in order to eliminate a competitor, expand its client base, broaden its product line, and obtain qualified service technicians. In the case of a strategic buyer, most of the functions the original owner performed can generally be transitioned to the acquiring firm.
A financial buyer, on the other hand, is an entity that is primarily interested in making an investment (i.e., purchasing the target company) and obtaining a cash return from that stand-alone business. A financial buyer has no particular expertise in the industry of the acquired firm and looks for the firm to be able to function independently, after the former owner retires.
In today’s market, there are a lot more financial buyers than strategic buyers, and a business owner seeking to retire should understand what it takes to be attractive to them. What seemed to work for decades – an owner who is intimately involved in all aspects of the firm’s customers and daily operations – is a big negative when trying to sell to a financial buyer.
So what’s the answer?
In a word, preparation. In order to obtain the highest value from a financial buyer, the business should be capable of operating, at least on a daily basis, without direct involvement of the owner. Ultimately, owners need to replace their hands-on involvement with some combination of processes, systems and other people. For many owners, this is the hardest transition to make.
From person to process
Much of an owner’s expertise can be embodied in a process. For example, customer acquisition is a process that could consist of some combination of relationship-building, marketing, advertising, and/or bidding. This process may come naturally to an owner but employees need to be trained to be able to perform it independently. The same logic applies to product design, project planning or service delivery.
Systems are important. Systems support processes and allow the coordination of functions among sales, production, delivery and administrative people. Accounting systems come to mind first, but many processes can be made more efficient and effective through systems. For example, the sales process could be tracked in a customer relationship management system.
Finally, an owner needs to hire and train the people to execute the processes and run the systems. This sounds expensive, but most often it’s not. In many cases, the people are already in place, but they need to be enabled to “step up” to assume greater responsibility. Having the right processes and systems in place can show them how.
Putting the right processes, systems and people in place can take time and effort. That is why we encourage our clients to start early, at least three to five years before they contemplate retirement and sale.
In fact, we recommend that owners do two things. First, they should obtain an independent valuation to establish a baseline value of their business to a (typically financial) buyer. Second, as a by-product of the valuation, an owner should obtain a “marketability assessment” of the business to determine what steps he or she should take to ensure that the business is indeed able to be sold as an entity independent of the owner.
Ultimately, all owners exit their businesses. Done poorly, the only value may be in liquidation. Done properly, and with foresight and preparation, the exit can provide a financially sound and rewarding retirement.
Frank Arcoleo is managing director, Central Pennsylvania for A Neumann & Associates LLC, a merger and acquisitions firm. Based in Lancaster, he has expertise in strategic planning, information technology implementation, process re-engineering, and financial management and planning.