Successor

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.

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.

Successor Insights: The Need for a Sounding Board

There’s no question that a successful business owner knows his or her business better than anyone else. And as a consequence, there’s no one better to help a successor learn the business. But there are potentially several problems that occur when an owner is the only one to help a successor develop.

The first issue pertains to leadership. Learning the mechanics of a business doesn’t really help hone leadership skills. Although people generally do respect a leader’s knowledge and technical skills, that degree of respect only goes so far.

For people to fully trust and respect a leader, that leader needs to earn that trust and respect. Trust and respect aren’t automatically given because of someone’s title.

In order for a leader to earn trust, he or she needs to demonstrate that they have integrity. In other words, they do what they say they’re going to do and are the kind of person they claim to be. And, in order for a leader to earn respect, he or she needs to treat people with respect in both word and action. For example, a leader needs to treat people like people rather than like things. And they need to treat adults like adults instead of like children.

The second issue pertains to strategic thinking. Knowing how to do things really well simply means a successor has mastered the mechanics – the systems and tactics – of the business. If they don’t learn to think strategically, then several things tend to happen.

One result of not thinking strategically is that improvements will tend to be small, resulting in only modest gains. A second consequence is that a successor will tend to develop tactics that they feel are “strategies”. This also produces results that are mediocre. But the third consequence is the one that is most detrimental. They will develop strategies to address symptoms rather than underlying problems. The result of addressing symptoms instead of problems is that it almost always creates more challenges that cause a decline in revenues and profits.

The third issue pertains to blind spots. If a successor only gets guidance from an owner, they tend to end up with “group think” along with the blind spots that accompany it. Group think is what happens when people think “this is the way we do it around here”. The problem with having blind spots is that a successor can’t see what he or she is missing. Regardless of experience, intelligence or education, we all have these blind spots.

Typically, the only way to eliminate blind spots is to get outside perspective. Someone needs to point them out to us. If we don’t get past our blind spots, we miss opportunities and make poor decisions.

The solution to improving leadership competence, enhancing strategic thinking and eliminating blind spots is to have an unbiased sounding board. Someone who can offer outside perspective and help develop the needed competencies.

The Successor Litmus Test

A well-prepared successor is essential for a smooth transition and is critical for continued growth and profitability. The question then, is how do you determine whether a successor is ready to take over? What is the “Litmus Test” that will reveal their degree of readiness?

The answer is that there is none.

There is no one “test” that will reveal their preparedness. Rather, there are several things (you can call them tests if you like) that will reveal just how competent they really are. Here are a few suggestions you can use to evaluate your successor:

Vision: Ask your successor what his or her vision is for the future of the company. Do they talk about maintaining or do they talk about growing? Do they talk about changes they’d make? Do they talk about the company’s culture? Do they have an eye on the customer and the competition?

Any and all of these issues can and should be an essential part of someone’s vision for the future of the company. By listening to what they talk about and listening for what they don’t talk about, it will reveal whether they’re beginning to think like an owner.

Strategy: When an issue arises within the company, ask your successor how they would resolve it. Help them to differentiate between problems and symptoms. Help them differentiate between strategies and tactics.

If they attempt to “solve” a symptom, the solution almost always makes the situation worse. Help them to understand that before a strategy can be developed, the underlying problem must first be identified. Once the true problem is uncovered, the best strategy almost always presents itself. Helping them understand these insights will help keep them from developing poor initiatives.

Decision-Making: Making sound business decisions is key to the future of the business. Good decision-making requires business savvy, sound judgment, and the ability to see the bigger picture.

Have your successor start by making less critical decisions. As he or she demonstrates competence, allow them to participate in decisions that have a greater impact on the company. Coach and mentor them on how to make better decisions. Only by helping them make course corrections can you hone their decision-making abilities.

Judgment: There’s only one real way to test their judgment. The one true test of judgment – after all the other development has taken place – is to leave.

Ask yourself how long you’d be comfortable being away from the business. And then leave. At first, it may be for a few days. Then a week. At some point, it may be that you can stay away for two weeks or even a month. The truth is that at some point, when you retire, you will be away from the business all the time.

If you’re not comfortable with staying away for an extended period of time, it’s generally due to one of two things. Either your successor isn’t yet ready to take over, or you aren’t prepared to let go. Either way, something needs to change if you want a smooth and successful transition.

If you’d like help preparing your successor, please give us a call. We specialize in successor assessment, successor development, and successor recruiting.

How Owners Think Differently

Up until a successor takes over as an owner, they have typically only ever been an employee. Therefore, it is critical to help them begin adopting an Owner’s Mindset prior to handing over the keys.

Owners and employees generally think differently. I remember when I first became owner of a company. I co-owned a restaurant development company, where developed our own restaurant chain and also developed a territory for a national franchise.

Suddenly, every purchase felt like (and was) coming out of my own pocket. I spent a whole lot more time justifying expenditures that I did as an employee. And while before, my focus was on doing my job well, now, everyone’s job became my concern.

Employees typically are focused on getting their work done, while owners, in contrast, need to anticipate problems, develop strategies, and plan for growth. And while employees are concerned with their paycheck, owners are concerned with paying the bills. All the bills.

As I soon learned, owners also need to see the bigger picture – both internally and externally. An effective owner needs to be aware of the economy, the marketplace, and the competition. It will influence how they develop strategies to grow the company. (Employees tend to focus on the here and now.) Additionally, an owner soon realizes that most decisions impact almost every aspect of a business and therefore require more thought (and forethought).

I also remember that when I was an employee, I often gave thought to what other opportunities might be out there. You see, if a business doesn’t do well, or you (as an employee) become dissatisfied at work, you simply find a new job. Owners, on the other hand, understand that there is no “Plan B”. The company is their future. The future now rested on my ability to grow the company and its profits.

In short, for a new successor to succeed, they need to adopt an Owner’s Mindset. Not doing so will almost certainly lead to missteps and setbacks. Our Successor Development program helps prepare a successor to become an Owner.