Sir Edmund Hillary is widely known as the first man to have climbed Mount Everest. Hillary and his companion Tenzing Norgay reached the peak in 1953. There is some controversy, however, that another man named George Mallory was actually the first to reach the summit. Mallory’s climb occurred nearly 30 years earlier, but was never confirmed because he did not survive the descent.
When it comes to business planning, far too many entrepreneurs resemble Mallory’s fate. They focus intense energy on scaling the mountain – growing the business, increasing revenues, finding new customers – but precious little time on the “descent” (i.e., determining and planning an exit strategy for the business).
Yet energy spent growing a business is largely futile if it is not properly transitioned, and its value is not fully realized. In a study of 300 former business owners who recently sold their companies, only 25% felt the sale accomplished their personal and financial objectives. Undoubtedly, much of those disappointing results can be attributed to a lack of planning. Nearly two-thirds (64%) of business owners over the age of 50 have no succession plan for their business.
As a business owner, what should you thinking about with regard to your single biggest asset? Here are five key questions:
1) What does the business need to be worth in order to meet your goals?
More often than not, entrepreneurs nearing a liquidity event do not have a good answer to this question. Yet to have the confidence required to follow through with the biggest single transaction of your lifetime, you need to really know and understand how much you need to net from the sale of the business to be financially independent.
This is where ‘what if’ scenario modeling can be extremely helpful. If an initial offer has been made to purchase the business, it is helpful to have it modeled it different ways by an advisor. Sometimes this means running a worst-case scenario which only includes cash upfront. Then, perhaps, another scenario that includes different contingencies of an offer such as an earn-out or salary continuation.
The goal of seeing a range of outcomes is that it can help you become more comfortable with your minimum retirement funding requirements and, as a result, have a lot more confidence and intentionality during the sale process.
2) How do you “get paid” for the next several decades after you sell the business?
This is a potentially daunting challenge for an entrepreneur. How will you take a largely illiquid asset base and convert it into a sustainable steam of income that will last for two or three decades and keep up with inflation?
It is crucial to have a plan addressing the mechanics of income creation prior to sale. You need to understand how your “paycheck” will be created in retirement. This should be a comprehensive strategy that includes cash flow from illiquid assets such as investment real estate as well as more traditional investment accounts.
3) What are the most common mistakes business owners make when selling their companies?
Any business owner should be commended for successfully growing a business and creating wealth, but selling a business is a whole different sort of challenge; most often it is one they haven’t faced before.
Seventy-five percent of entrepreneurs have never tried to exit a business. So why not learn from the most frequent mistakes others have made in order to avoid the same pitfalls? This is the value of working with the right team of advisors.
At Brown and Company, we’ve leveraged our experience in having worked with many former business owners who have sold their companies to create our Buyout BarometerTM. It is designed to help business owners assess the relevant factors involved in transitioning to a successful retirement.
4) How will you spend your time once you are no longer involved in the business?
An entrepreneur’s emotional attachment to the business cannot be overstated. According to our conversations with a number of investment bankers over the years, this is a big reason why deals fall apart. Many business owners are not emotionally prepared for life after the sale.
Quite a lot of entrepreneurs we have worked with over the years have said they will “never retire”. This does not necessarily mean they will never exit the business; it often just means they do not resonate with the traditional notion of retirement. Go figure that innovative, action-oriented risk takers like entrepreneurs don’t gravitate toward a concept that connotes passivity and withdrawal.
The word retirement has to be redefined to something meaningful and compelling to you. It is not about what you are “retiring from” but instead what you are “retiring to” in terms of a positive vision for a whole new phase of life.
5) Who runs the business if you are no longer around?
All the previous questions assume a planned exit whereas this one is about the “unplanned” exit scenario. In the event of death or disability, continuity of the business is reliant on having appropriate legal documents (i.e., buy-sell agreements), meeting short term funding requirements (i.e., life insurance), and grooming strategic leadership and operational management to step in.
The business only exists because of the owner’s ideas, persistence, and skills. Yet, ironically, as the business grows, its value is negatively correlated to your direct involvement. This is due to the fact that a business which is contingent on one person always has more risk (and therefore less value) to a prospective buyer.
The most valuable businesses are those in which the owner has made himself or herself inconsequential. In these cases, the business is built on repeatable systems and processes that can be replicated and scaled.
Therefore, several of these objectives – maximizing business value, preparing for sale, and preparing for an untimely exit – force you as the owner to ask a difficult question. How do I make myself less consequential to the daily operations of this business?