Michael Beck

The Cost of Inaction

Many owners (if not most) wait until they’re ready to retire before they get serious about the planning of a transition. That timeframe is usually about 6 months before they want to sell the business. And while it’s true that most deals can be completed within 6 months, getting a deal done and getting the price and terms you want can be very different things.

There’s a cost to waiting until the last minute to plan an exit.

EXTERNAL SALES

Typically, when an owner plans to sell his or her company to an outside buyer, they’ve imagined a scenario where an advisor reviews their company, puts a value on it (which ends up being equal to what the owner feels it’s worth), and goes about finding a buyer. Once the buyer is found, they come in, look over the books and the operations, and write the owner a check for the value of the business in exchange for the keys.

But it rarely works like that…

More often, one or more issues related to price or terms surfaces and can even derail the plan.

Value Less Than Desired
When a formal valuation is done, sometimes the value is higher than expected, but often it is lower. Transition experts can help an owner increase the value of their company, but it takes time. Once changes are made and the improvements generate greater growth and profitability, that increased performance needs to be demonstrated for at least a year or more to properly boost the value of the business.

If an owner waits to address this, he or she will be forced to accept a lower value. There is a cost to inaction.

Actions to Take and The Benefits:
There are several steps an owner should take a year or more in advance of a sale to avoid surprises and to maximize value. A formal business valuation should be conducted to establish an unbiased value for the business. In addition, a preliminary Quality of Earnings evaluation and a Quality of Leadership assessment should be done to uncover any potential issues that could negatively impact value. Once the valuation, Quality of Earnings and Quality of Leadership are done, any shortcomings can then be addressed to mitigate problems and maximize value.

Price Less Than Desired
Generally, the price a buyer will pay for a company is close to the formal valuation figure. And that price is often a multiple of EBITDA. But as the wave of Boomer-owner retirements builds (it started in 2021), there will be a growing surplus of businesses on the market looking for a buyer. And with a growing surplus comes falling multiples. In other words, where the price might have been 6 times EBITDA, it may well drop to 4 times EBITDA.

If an owner waits too long to sell the company, he or she will be forced to accept a lower price due to the surplus of sellers on the market. There is a cost to inaction.

Actions to Take and The Benefits:
The Boomer owner retirement wave has begun (2021), the surplus of sellers over buyers will consistently increase over the next 3-4 years, and the surplus will persist for another 8-10 years after that. Given the dynamics of the marketplace, the best way to ensure a high multiple (and therefore a strong price), is to put an exit plan into action sooner than later.

Less Desirable Terms
Another consequence of a growing surplus of sellers, is that buyers can become more demanding and may require terms that an owner may find undesirable. They may demand a significant earn-out, where the owner must “earn” part of the purchase price based on the performance of the business following the acquisition. Or buyers may demand that the owner stay on for an extended period (1-3 years) to ensure performance. Or there may be any number of other demands that the owner may not like, which could be deal breakers.

If an owner waits too long to sell the company, he or she will be forced to accept additional terms because they’ve lost their leverage due to the surplus. There is a cost to inaction.

Actions to Take and The Benefits:
The same advice to maximize multiples holds true for deal terms. The sooner an owner acts, the more leverage he or she will have over the terms of the deal.

INTERNAL SALES

Just as with an external sale, an owner who plans on having a successor take over has also imagined a scenario. They imagine that when the time comes to retire, their chosen successor will be ready and willing to take the reins of the company and will successfully lead it into the future. The business will continue to grow, profits will continue to grow, employees will be happy, customers will be happy, and of course, all the buyout payments will be made.

But it doesn’t always happen like that…

Choosing the right person and properly preparing them to take over is essential to the success of an internal sale (succession). But many times, one or more issues exist and – if not addressed in advance – can cause major problems. There is a cost to inaction.

Lack of Preparedness
Preparing someone to take over the business is essential to the success of an internal sale. But grooming them in the mechanics of the business does not necessarily develop their ability to lead effectively, their ability of think strategically, nor their ability to make good decisions.

The result of an inadequately prepared successor can be employee turnover, loss of customers, declining revenues, diminishing profits, and missed buyout payments. There is a cost to inaction.

Actions to Take and The Benefits:
It’s very difficult for an owner to be objective about their successor. Therefore, it is essential to the success of a successor that an objective assessment be conducted and they get outside, objective coaching. It generally takes 6-12 months of coaching to develop the competencies needed for leadership and ownership success.

They’ll become a more effective leader, they’ll develop smarter strategies, and they’ll make better decisions.

Choosing the Wrong Person
Sometimes, no matter how much an owner and/or an executive coach grooms and mentors someone, they still won’t be effective at leading the company.

The problem, however, is that those shortcomings often are not evident until the successor takes over. And of course, by then it’s too late. In fact, often the shortcomings themselves aren’t apparent, but rather manifest themselves in declining business performance. Obviously, waiting until there’s no turning back is a mistake. There is a cost to inaction.

Actions to Take and The Benefits:
An objective assessment can reveal many of those shortcomings. But identifying a successor’s strengths and weaknesses is only part of what needs to happen. Having a successor work with an experienced executive coach can reveal lapses in judgment, gaps in interpersonal skills and blind spots. Usually these can be determined within about 3 months.

If it becomes apparent that the successor is the wrong person, a new successor can be recruited and groomed. The process of finding that right person can be completed in about 3-4 months. And at least another 9-12 months should be allowed to allow the successor to prove him or herself prior to the owner retiring.

Having to Choose Among Several People
When there are several potential successors, owners often put off choosing one as long as possible. They either can’t make the decision, hope that one will rise above the others, or fear the fallout that may come from one being chosen over the others.

But of course, procrastinating doesn’t resolve anything and more likely, will create even more problems and anxiety if done at the last minute. There is a cost to inaction.

Actions to Take and The Benefits:
The best way to make a decision that will be the least upsetting to people is one based on objective assessments. They will provide an unbiased picture of each person’s strengths and weaknesses. The results will allow an owner to either choose one over the others based on their strengths or split responsibilities based on their strengths. The objectivity removes a good deal of emotion from the decision process.

BOTTOM LINE

The bottom line is that, regardless of whether an owner plans to sell their company to an outside buyer or an internal buyer, waiting until months before the event usually produces less than desirable results. Taking action well in advance of a sale will either uncover issues that can be addressed (so the business is attractive to buyers), or will prove that everything is in order and will allow the owner to sleep at night, knowing their future is secure.

Why Business Owners Procrastinate (and How to Get Them to Act!)

As I network around the country, I frequently hear advisors talk about business owners who procrastinate about taking action on their transition plans. Clearly, the owners are thinking about transitioning, otherwise they wouldn’t have met with an advisor. And it seems like they’d be ready to act on their advisor’s recommendations. But often, they don’t. So, it raises the question, why do they procrastinate? Why do they avoid taking action?

The truth is that most owners procrastinate for one reason – fear.

For the most part, these fears are unspoken. And the result is that their fears cause an owner to keep “kicking the can down the road”.

The key to moving past these fears is to first uncover any unspoken fears and then to offer perspectives or solutions to address them. If you’ve ever had an owner procrastinate, you already know presenting a logical argument rarely moves someone to take action. The reason is that people “buy” emotionally, rather than logically. It doesn’t matter whether you’re selling TV’s or cars or ideas or strategies. People buy into it emotionally and then rationalize their decision logically.

The process of allaying an owner’s fears about a transition and helping them feel good about moving forward starts with uncovering those fears. Once you’ve identified the issues that are creating anxiety, you can then make suggestions to help alleviate them.

The most effective means of uncovering these unspoken fears is by asking “good” questions. A good question is one that doesn’t cause them to become defensive and gives you insights into their perspectives and their thinking. It may require you to ask a number of questions about a particular issue in order to get the insights you need to help them, but once you have those insights, you’ll be able to offer just the right perspective or solution they need.

Here are the most common fears that owners have, along with some sample questions to ask. The key is to ask questions about each of these issues to determine whether that fear exists.

GENERAL FEARS RELATED TO A TRANSITION:

>> The fear that their company won’t be worth what they had hoped for
They’re afraid of being disappointed and having to alter their retirement plans

Questions:
● What do you think your business is worth?
● How much would you like it to be worth?
● What if the value turns out to be lower?

>> The fear that they don’t know whether to sell to an outside buyer or an inside buyer and they don’t know how to make that decision

Questions:
● Would you rather sell to an outside buyer or a successor?
● How will you decide?

>> The fear that their transition experience will be poor
Just like another owner they know or have heard about

Questions:
● Do you know anyone who transitioned out of their business?
● How did it go?
● Why do you think that happened?

>> The fear that the transition process will take up too much of their time so, they feel they need to wait until things are slower

Questions:
● How long do you think a transition takes to execute?
● How much of your time do you think it will take will it take?

>> The fear that their identity is tied to the business
And they will lose their purpose, prestige, and identity when it sells

Question:
● What will you do after your business sells?

FEARS RELATED TO AN EXTERNAL SALE:

>> The fear that they won’t find a buyer
And they’re not sure what they’ll do if that happens

Questions:
● What if you/we can’t find a buyer?
● What will you do if that happens?

>> The fear that an advisor or a buyer will find flaws or shortcomings with their business and they won’t be able to fix/address them

Question:
● What if a buyer finds shortcomings that we’re unable to fix/correct?

>> The fear that they aren’t as profitable as others in their industry
And therefore, their business will be less desirable and/or worth less

Question:
● Are you as profitable as others in your industry?

>> The fear that they’ll have to agree to terms they don’t like
Such as a long payout or the requirement to stay on for one or more years

Questions:
● Are you OK with possibly getting some of the money up front and the rest over time?
● How do you feel about the possibility of staying on for a year or two after the sale?

FEARS RELATED TO AN INTERNAL SALE:

>> The fear that their successor is not yet ready to take over
And may never be…

Questions:
● Do you have a successor in mind?
● Are they ready to take over?
● How do you know?
● How long are you comfortable being away from the business and leaving them in charge?

>> The fear that they need to choose one successor (child/exec) over another, and don’t know how to choose. Plus, they’re afraid of the fallout once they do choose.

Questions:
● Is there more than one possible successor?
● How will you choose?
● What will happen to the one (or ones) you don’t select?

>> The fear of the fallout that will occur when someone (child/exec) wants to take over, and they find out they’re not being considered.

Questions:
● Will you need to reject anyone as a successor?
● What will happen when you don’t select them?
● How will you go about finding a successor?
● How will you keep a successor on board until you feel they’re ready?

Once you’ve determined the various emotional issues an owner is wrestling with, you’ll be able to offer useful perspectives and solutions, including bringing in experts to help with specific problems. Addressing their fears, and providing solutions and perspectives, will establish you as an insightful, thorough, and caring advisor. And it will get them to act sooner than later, thereby helping them maximize their results.

Three Questions Interview

Doug Marshall, an expert at Business Valuation and Value Protection, spent a few minutes with me to ask three good question about finding and developing successors.

The 5 Most Common Successor Development Mistakes

Most business owners know that a well-groomed successor should have at a working knowledge of operations, sales and marketing, customer service, administration, and finance. But this knowledge, although necessary, is not sufficient if a successor is to effectively lead a company into the future. In addition to having a firm grasp of the mechanics of the business, a successor must become an effective leader, think strategically and have good judgment, have vision, and adopt an owner’s mindset.

Mistake #1: Not Developing Effective Leadership Skills
The effectiveness of a person’s leadership is determined by how they are viewed by the people they lead. A leader who is not respected or trusted can’t be very effective. In contrast, a leader who people trust and respect will always get better results.

People decide how much they trust and respect a leader based on how that leader acts and how they interact with others. When a leader demonstrates that they do what they say they’re going to do (acts with integrity) and demonstrates that they are the kind of person they claim to be (acts in integrity), people learn they can trust him or her.

When a leader interacts with people in a manner that shows they respect and value them, the leader will earn the respect of those around him or her. Leaders accomplish this by treating people like people (rather than like things) and by treating adults like adults (rather than like children).

Mistake #2: Lack of Strategic Thinking
The ability to think strategically is essential for a leader guiding an organization. Without an understanding of what a strategy is and how to develop one, leaders will often focus on goals and tactics. In the absence of a true strategy, these goals and tactics are often misguided and usually result in new challenges.

A goal is not a strategy. It’s just a metric to measure progress in the execution of a strategy. Plus, it has no emotional or inspirational component. Tactics are not strategies either. Tactics are the means by which a strategic initiative can be achieved. Tactics – like goals – also have no emotion or energy behind them. They are simply the mechanics of how things will get done.

A good strategy (in contrast to platitudes, goals or tactics) addresses a problem or takes advantage of an opportunity and provides direction for the company. Additionally, a good strategy inspires people to achieve it. By developing a true strategy, excellent results can be achieved, and the desired financial goals realized.

But an effective strategy also needs buy-in from the team. Without buy-in, a leader simply gets compliance, and compliance is not the same as commitment.

Mistake #3: Lack of Vision
For a leader to guide a company, it is essential to develop a vision for the future of the organization. A vision imagines a future which is better, different, and/or larger than the current state. Without vision, a leader will simply continue to execute the existing business model, often getting left behind as the economy shifts, customer/client preferences change, and competitors adapt.

The ability to develop vision can’t be learned from a book. It arises from within and it requires a leader to have passion and purpose for what they do. A passionless leader can only develop goals – which are uninspiring by their nature. If a leader wants to engage his or her organization, he or she must create a future that inspires people.

Mistake #4: Not Developing Good Judgment
A successor needs to develop sound judgment and become business savvy in order to make good decisions. Good judgment comes from our ability to recognize when our emotions and biases cloud our decision-making. When we allow emotions to cloud our judgment, we make decisions that are misguided. Having sound judgment – unbiased by emotions – allows an owner to make good business decisions.

Business savvy is developed by thinking broadly about all aspects of the business, by being aware of what’s going on within the company, within the economy, with customers, and with the competition. (It also helps to develop an understanding of human nature.)

Mistake #5: Not Developing an Owner’s Mindset
Up until a successor takes over as an owner, they have typically only ever been an employee. There are several differences between the way an employee thinks and the way an owner thinks, and if this shift doesn’t take place, problems will arise.

Employees tend to think narrowly. They usually focus on the task at hand and/or on their specific domain of responsibility (operations, finance, engineering, etc.). In contrast, an owner needs to consider the bigger picture and how his or her decisions impact each aspect of the business.

Employees tend to think short-term. Their focus tends to be on current matters, current revenues, current expenses, and current profits. On the other hand, an owner needs to consider both the short-term and the long-term success of the business.

Employees tend to focus on doing good work while at work but generally don’t take their work home with them. On the other hand, owners learn that the business becomes their lives, and they think about it all the time.

And finally, employees know that if they make poor decisions, the business doesn’t do well, they become dissatisfied, or they lose their job, they can always find a new job elsewhere. Owners understand that failure is not an option. Generally, there is no “Plan B.” They understand that the business is their only future, and this understanding colors their decisions and actions.

One Final Issue…
There’s one more issue that needs to be considered:
It’s nearly impossible for an owner to effectively develop their own successor!

Here’s why:

Interpersonal Dynamics – In order for meaningful improvement to occur, open and honest conversations with the successor must take place. But it’s virtually impossible for a successor to be completely open, honest, and vulnerable when those conversations are with the owner.

Blind Spots – Regardless of the number of years of experience we have, our level of intelligence, and the amount of education we’ve had, we all have blind spots. We can’t see what we’re missing. Owners have blind spots.

Objectivity – Virtually everyone around a successor has an agenda – their co-workers, their spouse and especially the owner. They either want things to change or they want things to stay the same. In order for a successor to hone their thinking and judgment, they need an unbiased sounding board. An owner can’t be unbiased.

Time Constraints – There’s a reason it’s called successor development and not successor training. The growth that needs to occur happens over time. It won’t take place simply by attending a workshop or reading a book. And most owners simply don’t have the time.

Skill Set – Successful owners are expert at the business of their business, but the skills that got them where they are aren’t the same skills required to effectively coach and mentor a successor.

It’s critical for a successor to be properly developed so that the business thrives after the owner leaves and all purchase payments get paid. The risk of handing your company over to a poorly prepared successor is too great to leave their development incomplete.

Every Owner Has a Plan Until…

Mike Tyson, the heavyweight boxer, was quoted as saying, “Everyone has a plan until they get punched in the mouth.” Regardless of what you may think of him as a boxer or a person, it was a great observation.

It doesn’t matter whether we’re talking about boxing or business, the truth is that owners all have a plan for a transition until they get hit with a setback. Some will give up after being derailed, but others will take a step back, correct their course of action, and find a way to succeed. Giving up on a course of action is not the same as giving up on a goal.

Having a strong attachment to the process with which to achieve a goal often undermines our success.

Let’s look at the typical transition options, the potential setbacks, and how to recover from a setback.

Typical Transition Options:
Generally, owners have two practical options – an External Sale (Exit) or an Internal Sale (Succession). (The other option is to close the doors and sell the assets.) An Exit is generally a sale to an Individual Buyer or it’s some form of Strategic Acquisition (M&A/Investment Bank/Private Equity). In contrast, a Succession is a sale to a Family Member, a Key Executive, or via an ESOP (Employee Stock Ownership Plan). A number of these options can be the right path for an owner, depending on the nature of the business and the needs of the owner. The problem is that many times, things don’t go as planned.

Potential derailers for a planned External Sale
Circumstances that can derail an Exit include:

Can’t find a buyer or attract capital – This can be due to a surplus of businesses for sale or to the nature of the business. The greater the surplus of sellers, the more selective buyers can afford to be. Additionally, the more dependent on the owner and his/her relationships, the less attractive the business.
Price too low – This can also be due to a surplus of businesses for sale or it can be due to business valuation issues like customer concentration, weak leadership, market concentration, etc.
Unacceptable terms – Sometimes buyers require an owner to stay active in the business for an extended period of time and or defer payment of monies pending performance.
Health issues (yours or a family member) – Clearly, this situation is unexpected, and a sale would be undertaken under pressure, which would result in a loss of leverage.

Potential derailers for a planned Internal Sale
Circumstances that can derail a Succession include:

No qualified or interested successor – Either the person you had in mind to take over the business doesn’t want to, or you don’t have confidence in the person who wants to take over.
More than one interested family member or executive – You have more than one person who wants to be the successor and it creates conflict – sometimes significant conflict.
Too small for an ESOP – You like the idea of creating an employee-owned company, but the cost is too high and/or there aren’t enough savvy leaders to take charge.
Health issues (yours or a family member) – Clearly, this situation is unexpected, and a transition would be required before a successor is ready.

How to Reduce the Chance of Your Plans Getting Derailed:
The best approach to planning a transition is to be proactive, well in advance of your anticipated departure. Start by pulling together a team of professionals sooner than later. Their expertise can help you choose the best exit strategy for your situation, identify and resolve potential issues, and refer you to people with any additional expertise if needed.

• Wealth Manager
• Tax Planning Attorney
• Successor Recruiting
• Successor Development
• Succession Attorney
• Private Equity Firm
• M&A Advisor

• Investment Banker
• Exit Planner
• Executive Coach
• Estate Planning Attorney
• Commercial Banker
• Business Broker

If your goal is an external sale, consider having a preliminary Quality of Earnings Report done along with a Quality of Leadership Report. These two reports will highlight any shortcomings and/or impediments in advance of a sale so they can be addressed before going to market. Additionally, consider selling sooner than later to avoid the surplus of Boomer-owned businesses coming to market and/or to avoid being forced to retire due to health issues.

If your goal is an internal sale, ensure you’ve identified your successor well in advance and make sure they want the role. (If there is no one, then start the process of recruiting a potential successor as soon as you can.) Once that’s done, start working on developing that person. Develop their business savvy, their leadership effectiveness, their strategic thinking, and their owner mindset. If more than one successor will be involved, objectively assess them and decide how to split/share responsibilities.

How to Recover from a Setback on an External Sale:
Basically, there are two paths to recovering from a setback on an external sale. Start by attempting to make the business more attractive. If possible, address the issues that caused the business to be less attractive, caused it to be worth less than you hoped for, or caused the terms to be undesirable. If that can’t be accomplished, then switch to an internal sales solution by choosing or finding a suitable successor and grooming them to take over.

How to Recover from a Setback on an Internal Sale:
If your plan to have a particular person take over the business fails, re-evaluate and assess alternative successors and/or start the process to recruit a successor from outside the company. Once you’ve chosen someone, begin grooming them to take over.

By the way, if you want to accelerate the development of your successor, consider bringing in a professional executive coach. Having an objective, confidential sounding board can help them gain new perspective and develop the skills they need to succeed.