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 - 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 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.
So what should business owners be thinking about with regard to their 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 their lifetime, clients need to really know and understand how much they 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, model it different ways: Sometimes it could involve running a worst case scenario which only includes cash upfront. Then run another scenario with the earn-out, salary continuation, and other contingencies of the offer. The point is providing the various range of outcomes can help them become more comfortable with their minimum retirement funding requirements and, as a result, have a lot more confidence and intentionality during the sales and due diligence processes.
2) What are the most common mistakes business owners make when selling their companies? Business owners should be commended for successfully growing their businesses, but selling a business is a whole different sort of challenge; most often it is one they haven't faced before. So why not learn from the most frequent mistakes others have made in order to avoid the same pitfalls?
Seventy-five percent of entrepreneurs have never tried to exit a business. Understanding the perspective of potential buyers is really crucial in properly preparing for sale and maximizing the value of the business. Here is a summary of the most common mistakes made by first time sellers.
3) 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 do 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?
This discussion around the mechanics of income creation is incredibly important. Whether it involves visual depictions of various buckets or more traditional allocation pie charts, this is an advisor's opportunity to explain how income is going to be derived in order to create their "paycheck".
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. In talking with a number of investment bankers over the years, this is a big reason why deals fall apart. The business owner is not emotionally prepared for life after the sale.
Here is where, as advisors, we need to be careful about the words we use. Quite a lot of business owners say 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.
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 the owner's 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 untimely exit - force the owner to ask himself or herself a difficult question. How do I make myself less consequential to the daily operations of this business?