By Lisë Stewart, Owner and Founder of Galliard Group
Family business owners often ask us what they can do to increase the value of their business and ensure a fair price if and when they put their business on the market. In addition to making sure you have successful products and services, there are actions you can take to increase both the value of the business and the likelihood that you will realize that value.
- Create your own Exit Strategy: Your exit from the business will happen by design or by default. By taking the time to plan when or how you might like to leave the business, you increase the likelihood that your plans will come to life. For example, you might prefer to work hard in the business until the day that you sell. Or, you might like to ease out of the business slowly – allowing a new management team to gradually take over. You might even decide that you want to stay in the business until the day when you are physically unable to perform in the company anymore. Whatever your desired future plans, let others know your plans and put in place the mechanisms to allow this happen. Make sure that you know how much money the company needs to generate – either by a sale or through a pension plan, to finance your retirement if necessary. By doing so, you’ll be prepared for the future and will have a company that can survive beyond your tenure.
- Develop a Strategic Plan: Once you know how much money the company needs to generate to support your future, you’ll need to make sure it is in the best shape possible to achieve those financial goals. A strategic plan is a simple document that outlines how you will grow the company and meet the goals necessary to create profitability, increase your market share and develop a strong team to support these efforts. The strategic planning process adds credibility and viability to your future plans. It provides the necessary reality check – can the business actually provide you and your family with the means you need? If not, what changes do you need to make to your exit strategy?
- Develop your Bench Strength: If you are considering selling your business, but you are still the key rainmaker, innovator, sales person and problem-solver, you are lowering the value of your company. Smart business owners focus on developing a strong management team who can eventually replace him or her. This management team needs to share the vision, understand the goals and become an integral part in the growth and success of the business. In the end, the business should be able to thrive whether or not the owner is still active in the business.
- Create “Turn-Key” Tools: Potential buyers often look for businesses that are both profitable and relatively easy to run. If they know they would have to make a lot of improvements, run the operation through trial and error, and do without institutional knowledge because it hasn’t been properly documented, they will be less likely to pay the asking price. If you want to make your business look more attractive to a potential owner – make it easy for them to be successful!
- Create and Maintain Sound Financial Data: A wise prospective buyer will engage in a serious process of due diligence. The key to a successful purchase at a price you are expecting is to ensure there are no surprises. Make sure you have at least 3 to 5 years of solid financial information that really tells the story of your success. Include your budgets with variance, your Profit and Loss and Balance sheets along with your tax returns. Show a solid trajectory of growth and be prepared to explain any anomalies. Also, be honest and transparent. If trust is broken during the process, this will be used to negotiate a lower selling price – if any negotiation happens at all.
- Identify your Unique Selling Proposition: What sets you apart from your competition? How can you communicate what is truly special about your business? A useful, easy to read prospectus will tell a prospective buyer what the vision for the company is and what they can expect in the future. It will describe how the value in the business has been created, as well as how it will be maintained. It will highlight the success of previous strategic plans, the strength of the management team, the experience of the employees and the unique features of your products and services. It will clearly paint the picture for a prospective buyer of the benefits they can expect to reap as a result of investing in this business.
Remember, your exit from your business will happen by design or default – planning ensures it happens by design and you can reap the rewards of a lifetime of dedication and hard work.
By Peter J. Butler, CFA, ASA, MBA and Family Business Advisor
The title of this article doesn’t sound quite right does it? The purpose of a buy-sell agreement is to provide peace-of-mind for shareholders. In theory, these “agreements” should provide relatively easy business transitions from one shareholder to another. Often, however, these well-intentioned documents fail business owners in highly emotional times (death, divorce, disability, retirement, etc.) and provide anything but peace. The agreements frequently contain incorrect and/or confusing language and/or outdated formulas. Given these problems, there is little wonder that some of these transactions end up in litigation where business transitions are never easy and peace-of-mind is rarely attained.
There are generally three types of buy-sell “agreements”:
• Fixed price agreements,
• Formula agreements, and
• Process agreements.
Fixed price is simple enough. Upon a triggering event (such as retirement), “Mr. Shareholder will be bought out at $500,000” is an example of a fixed price agreement. Its big advantage is its simplicity, and the fact that it eliminates uncertainty in highly emotional times. However, the fixed price probably becomes out-of-date the day after it was written. Therefore, when a triggering event occurs, either the buyer or the seller will be happy, but probably not both.
A formula agreement may be written as “Ms. Shareholder will be bought out at 4 times earnings times the appropriate ownership percentage”. Not as simple as the fixed price agreement, but simple enough. Or is it?
How do you define earnings? Is it net income, earnings before interest and taxes (EBIT), earnings before interest taxes depreciation and amortization (EBITDA), operating earnings or earnings before tax, etc.? Should the earnings be normalized? Is it the latest twelve months earnings, the last fiscal year’s earnings or the last calendar year’s earnings?
In times of stress isn’t it likely that two shareholders (the buyer and the seller) may view the earnings a little bit differently. You bet! I have seen far too many buy-sell “agreements” morph into buy-litigate-sell disagreements. This is not what you or the company needs, especially during transition periods such as death, divorce, disability or retirement.
Moreover, even if 4 times earnings represents market value today, will it represent market value a year from now when a triggering event occurs? Probably not. So again, either the buyer will be happy or the seller (or the seller’s estate, to the extent possible) will be happy, but probably not both.
It is crucial for corporate attorneys and business owners to consult with business appraisers in drafting these “formulas” to eliminate as much of the surrounding subjectivity as possible. Appraisers must carefully assess each word individually, and in aggregate, to ensure the agreement is well-crafted, explicit, detailed, and irrefutable – to the extent that it is possible in business valuation to avoid costly unintended consequences.
The last type of agreement is the process agreement. The following is an example of a process agreement, “Mr. Shareholder will be bought out at the fair market value of his shares as determined by a credentialed business valuation appraiser”. Fair market value (FMV) implies discounts for lack of control and lack of marketability, if appropriate. If shareholders would rather not take discounts, this can also be stated in the agreement.
What are the disadvantages of this type of agreement? There is no known take-out price or even a known formula. We have uncertainty. Uncertainty, as previously discussed, is not a good thing.
What are the benefits? The FMV should keep up with changing market conditions. Theoretically, both buyer and seller should be happy as the price is fair. Recognizing that valuation is part art and part science, sometimes these process agreements are written where the buyer has an appraiser and the seller has a different appraiser to perform the valuation. This is OK too, but more expensive for all involved. The agreement may then call for an average of the two conclusions, or possibly to bring in a third appraiser to settle the score if the first two appraisals are materially different. Does the third appraiser settle the score so to speak or does his/her conclusion then also get averaged in? As you can see if companies are not careful, this process can get incredibly unwieldy and exorbitantly expensive.
Can a firm eliminate some (but not all) of the uncertainty related to the scenario described above? You bet! A firm could obtain a valuation at the end of every year for example. If a triggering event occurs in the next year, then the valuation conclusion would be the take-out price. If valuations were obtained every year, it would create a nice historical record of progress that all shareholders could see. If perchance, anyone had an issue or did not agree with the valuation conclusion, then shareholders could discuss it before the emotion of a triggering event is facing them.
Moreover, one of the hidden gems of any business valuation is the opportunity to understand that if your business is worth $1 million today, you may be able to see how you could make it worth $2 million tomorrow by eliminating some risks uncovered in the valuation. So, shareholders could eliminate some uncertainty and gain a roadmap to build value with more frequent valuations.
There is one other important component of buy-sell agreements that I have not mentioned yet. That is life insurance. How you handle life insurance can have drastic repercussions on the buyer, the seller and the company. That will be discussed in future articles.
Peter J. Butler, CFA, ASA, MBA specializes in the valuation of privately-held companies and assisting owners in maximizing the value of their businesses. He is also a Galliard Group Certified Family Business Advisor. He can be reached at (208) 371-7267 or pjbutler@aol.com.
By Lisë Stewart, Owner and Founder of Galliard Group
Do you work with a trusted estate or tax attorney? Have you found a CPA who speaks your language? Does your insurance agent really give you ‘peace of mind’? Many small business owners have voiced some frustration in finding and working with professional advisors. Trust is not always high and there is often a disconnect in the language spoken by advisors – whether it is the use of ‘legalese’ or financial jargon that can be confusing at best.
However, these advisors can provide very necessary and important services. For example, an experienced estate-planning attorney can provide family business owners with a range of important options for transferring their estate, including their business, to the next generation while minimizing their tax implications. They can educate you about the use of Trusts, Family LLCs and other vehicles that may well meet your needs. But, in order to do so, these advisors need to be knowledgeable about issues that the family will face and the issues that will impact the business. Often a professional advisor will be knowledgeable about one but not the other.
As you begin to explore potential relationships with advisors, remember to consider the following:
Interview more than one professional in any given field. Remember, you are purchasing services and you have a right to choose a provider who meets your needs. Write out a list of your needs and expectations BEFORE you meet with your advisor. For example, if you want to work with a CPA, decide ahead of time what kinds of changes you want to see in the financial reporting for your company. List the experiences you have had in the past that did not meet your needs and offer an alternative that you are looking for in a new relationship.
When working with an attorney, develop a draft of the key points you would like your legal document to address. Work with your attorney to make sure you understand the language in any document he or she produces and ask them to use language that you can understand. It is YOUR document and you have a right to understand what it says.
Insurance can be a very important component of sound business and financial planning. However, you will find that some agents are more interested in selling you a product than learning about your business and personal needs. Be sure to speak with your colleagues in your business community to find referrals for good resources. Ask your insurance professionals about their experiences in working with family businesses and how the type of products or services they recommend for families with businesses differs than other types of insurance products. Ask for references from other family businesses that he or she has worked with in the past.
Personal and professional financial advisors and financial planners can also be a useful part of your professional services network, although, they too can be driven by the sale of products rather than being focused on what is best for you and your business. To ensure you are getting the advice you need, look for independent financial advisors – those who can develop a plan for you for a fee, regardless of whether you purchase other services from them or not. Seek out an advisor who takes an active interest in your business and how your business planning will impact your personal planning. Be wary of financial advisors who claim you must retire with exorbitant levels of personal wealth as some may suggest an investment plan that benefits them rather than you.
Let your advisors know when you are happy and satisfied with their services – and let them know when you are not. Many small business owners feel intimidated by their professional advisors and continue to pay their fees while cursing their service. This does not need to happen. This is a very competitive market for all professional service providers and many are working hard to provide outstanding customer service, produce clear documents and to build long-term relationships. Work together with your advisors and let them know that this is a transactional relationship, one based on mutual trust and clear communication.
Finally, bring all of your advisors to the same table. It is not uncommon for one advisor to give you very different information from another. At Galliard Group, we strongly recommend that whenever you are developing important plans and documents for your business and family, that you invite your advisors to the same meeting. Don’t hesitate to invite your CPA to meet with your Estate Planning or Tax Attorney and your financial advisor or your personal banker. This process may well save you time, money and frustration. Remember, as professional advisors, we work for you! Let us know how we can meet your needs more effectively.