Finishing or Finishing Well? – Leadership and Business Value

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For several years we’ve worked closely with owners as they put together their business transition plans. During this time we’ve observed some interesting – and consistent – trends, most of which have been substantiated by a survey performed by Harris Interactive.

Observation One:

Many owners are not ready to “slow down.” In fact, we know several who obtained an equity position in a new business venture after they sold their company. These “serial entrepreneurs” are staying active and for them, the challenge of building a new enterprise is more appealing than the challenge of lowering their handicap.

The Harris survey supports this by noting:

  • 38% view their transition as the start of a “new chapter” in their life;
  • 40% expect to continue their life as in the past;
  • Fewer than 25% agree with the idea of relaxing and doing nothing.

Observation Two:

After selling their business, most owners want to continue working in some capacity, even when they don’t need the money. We’ve noticed many owners are similar to lifelong athletes. Both have found that competing against others and against themselves, completing difficult challenges, and accomplishing important milestones are deeply satisfying. By continuing to contribute, owners get to “stay in the game.”

The Harris survey found:

  • 95% expect to work in some capacity in their retirement – and for most, money will not be the primary reason for doing so;
  • 50% plan on working whether or not they get paid.

Observation Three: 

Those who have prepared for the financial realities of retirement are more satisfied than those who have not. For owners and partners, financial planning includes a realistic assessment of the “street level estimate” of the value of the business, as well as an objective determination of its salability. This should be one of the first steps completed in the planning process since for most (up to 70% of all owners) the business or practice represents more than one-half of the owner’s personal wealth.

On this Harris made two important observations:

More than 60% of those who said they had more than adequate resources to support themselves in retirement were extremely satisfied with their post-business life;

  • However, only 46% of those who had to “cut corners” after they sold their business indicated they were satisfied.

Observation Four:

Most owners are not receiving enough from the sale of their business or practice to fund their post-transition lives. In fact, we’ve found that without adequate preparation a significant amount of the potential value of the business is lost. Furthermore, owners need to know that less than 10% of all companies actually sell as an ongoing business!

After interviewing more than three-hundred business and practice owners who sold their companies, another study found that:

  • 75 % felt the sale did not accomplish their personal or financial objectives.

Clearly, it is important for owners to understand the issues impacting the value and salability of a business. This understanding starts with the owner, and how he or she is building and running their company.

Two Dimensions

Owners typically build a business or practice from strongly held preferences on two key dimensions. It is important to understand these preferences – particularly when selling to a third party – since they impact business value.

The Dimension of Team. The first dimension addresses the owner’s ability to build a business or practice with others. Consisting of an effective “team” or teams, business success is usually described in terms of what “we” did. As a result of the team’s clearly defined responsibilities, shared accountabilities, and fair distribution of rewards, the value of the company increases since prospective buyers are usually willing to pay more for this type of business; particularly if the team come with it.

Other owners, for whatever reason, have not been able to embrace this “team” concept when building a business or practice. Instead they operate independently of others and, as a result, are naturally viewed as the cause of business success. Prospective buyers are reluctant to buy the company; particularly when the owner is unwilling to stay after the sale.

The Dimension of Time. The second dimension addresses the time-frame owners take when growing their business wealth. Some have a strong desire to create and implement future oriented strategies requiring continued investment in the business or practice.  They are willing to defer (to some extent) immediate rewards in order to improve operations, pursue new markets and enhance the long-term value of the business.

As you can guess, others are reluctant to do so, even when the investment in the business or practice is actually an investment in their own future. These owners prefer to take their “winnings” today, believing – or at least hoping – that tomorrow will take care of itself.

Four Types

By combining these two dimensions (Team and Time) we can identify four preferences owners have when starting and building their company. Borrowing from David Maister, I would classify these as one of four different types of animals.

FinishingWellChart

mountianlion150Type One: Mountain Lion

The first type is the owner who values independence, chooses to make minimal investments for the future, and is willing to bet on his or her ability to catch fresh meat each and every day. The solo operator (or sole practitioner) is primarily interested in receiving the immediate rewards for today’s results.

 

wolfpack2-150Type Two: Wolf Pack

The second type prefers to act in coordination with others, but doesn’t like to invest (or defer gratification) too much. He or she believes the business will do better when everyone works together, however after a good year most of the profits will usually be distributed as salaries and bonuses.

Both Type 1 and Type 2 owners are reluctant to invest or “bet” on the future. There may be a number of reasons for this, including their aversion to risk.

 

beavers150Type Three: Beavers

A number of owners want to be independent, but are also interested in building for the future. They do so by investing time and resources to grow the business and its capabilities. Similar to “beavers” who build dams to provide for their own family, these owners will also tend to diversify their holdings so as to lessen the influence of business value on their total personal worth.

 

ants150Type Four: Ants (or Bees)

The last type describes owners who want to be part of something bigger than what they can accomplish on their own, and through patience and discipline invest in the well-being of the entire organization; not just their personal goals. In many respects these owners are fulfilled when their work benefits the entire community.

 

Grading the Impact on Value

Left unchecked, owners will usually build a business or practice that corresponds to his or her preferred type, whether they are a Wolf Pack, Mountain Lion, Beaver or Ant. Although profitable companies can be led by any type of owner, some approaches contribute more to business value than others. Consequently, in order to complete their business transition plan, owners should give themselves time to review and – if necessary – adopt a more promising model.

Ants: Grade A. It is easy to see how Ants (Type 4 owners) naturally build businesses that are graded high in terms of its overall value and salability. Over the years the owners regularly invest in the growth and strength of the business while building the necessary teams to run it. Prospective buyers quickly learn that the company’s management team is largely responsible for its success, and that its equipment and processes are up to date. Together, this reduces the risk for the buyer who may then pay a higher price for the business.

This happened to a business led by one of our senior advisors. After the owner of a manufacturing company in the Pacific Northwest died, the family hired him away from the bank to serve as its CEO. Under his leadership the business and its culture transitioned from Type 1 (Mountain Lion) to Type 4 (Ant Farm). He aggressively reinvested profits back into the company; incorporated lean manufacturing throughout its operations; and improved the overall balance sheet. Eight years later the company was sold – at a premium – to a national corporation.

Wolf Pack: Grade B Owners who build effective “companies” can expect to sell their business or practice for more than those who build a high paying job. When reviewing a business or practice, prospective buyers consider its income and profits while trying to determine whether or not they will grow after the sale. Buyers are willing to pay more for a business when its success is built upon the key managers and employees who agree to stay with the company, and not just the owner who is leaving.

With a strong team in place, Type 2 owners might still find a willing buyer, even when the odds of doing so are considered low. Contractors, for example, usually have a hard time selling their companies to third party buyers. We are working with one, however, that will undoubtedly become an exception. Over time, the owner has built and retained one of the most effective teams in the industry. Every year they find a way to do more business, increase income, and improve profits. They continue to do larger and more challenging projects and, as a result, have become the largest company of its kind in the four states it does work. Although the owner provides the strategic direction and leadership for the company, he recognizes and cites the contributions others make to its overall success.

Beavers: Grade C. Both Beavers (Type 3) and Mountain Lions (Type 1) will have a hard time capturing business wealth if they decide to sell their company or practice. Because the owner holds most, if not all, of the key positions in the company and is responsible for most, if not all, of its key relationships, buyers may be unwilling to invest in business since it appears to carry a high degree of risk. In a capital intensive industry, such as manufacturing, Type 3 owners may find more interest from those wanting to buy their equipment (since it may be up to date) than their business.

Given enough time Type 3 owners do have some options. First, they can build (or hire) an effective management team and transition critical responsibilities to them. This usually involves a revised salary and bonus structure, as well as some type of deferred compensation and/or incentive plan to retain key managers until the sale is completed. Before choosing this option independents (Type 3 and Type 1 owners) need to consider whether or not they are capable of changing their lifelong management style.

If they can’t, they could choose a strategy similar to one used by one of our clients. After reviewing several transition options, we reassessed the owner’s goals and determined they could be reached through an aggressive “value-depletion” strategy. Over the next few years he will run his business with one primary objective: withdraw as much money from the practice as possible and transfer the funds to other (more passive) investments. Then, after reaching his financial goals he will unload his business for whatever the market brings.

Mountain Lions: Grade D. Independent operators who fail to invest for the future end up paying themselves a high salary struggle to create transferable business value. Essentially, the business has become so dependent on its owner that buyers are unwilling to pay for what they believe is a risky investment. This can be disappointing for owners who are anxious to leave their business.

We saw this first hand after reviewing the operations of a manufacturing company in Idaho. The Type 1 owner told us that after working sixty hours a week for fifteen years, he was feeling burnt out. During our initial assessment (to determine the Street Value of the business among other things) we found that the company did not have any key managers, had no marketing plan or sales people, received over eighty-percent of its business from one customer, lacked effective processes and systems, and relied on equipment that would soon need to be replaced.

During our frank review we discussed these (and other) challenges needing attention, recommended specific steps to recapture some the company’s lost value, and created a critical path showing how he and his wife could transition from the business.

In response, the owner reminded us of his high salary. He wanted out, sooner rather than later. Against our advice he listed his company with a business broker and ended up in a lawsuit when the broker sued him for commissions. Even though the company never sold.

Four Types, One Outcome

In time, all owners will leave their company. A large number will do so by attempting to sell their business or practice to a third party in the hope of transferring the value of their business and investing it in other places. By understanding their preferred way to build and grow a business, as well as the impact made on its value, owners should be able – with enough time and courage – to design an effective plan that will support his or her post business life.

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