In football there’s a flexible pylon four inches square and 18 inches high on the end of each goal line, it’s in-bounds and where the goal line meets the sideline. If a player dives, runs or pushes the ball through the pylon it’s a touchdown – as long as the player took off from the playing field (not from out of bounds).
Now, players don’t dance up to the pylon and tap the ball on it. They don’t plan their run to stop at the pylon. They go full speed through it. They attack it and violently go through it.
Business owners, you also need to violently attack the pylon when it comes to planning your exit.
I recently met with a wealth manager who told me that in his humble opinion nobody in the buy-sell industry cares about helping the owner get the business ready to sell for the maximum price. They all see a business for sale and don’t care if the business is ready or not if they think someone will buy it (in it’s present state).
Why would you want to sell your business before it gets to the end zone? Why would you want to simply nudge the pylon?
Nudging vs. attacking could be six or seven-figure mistake. Your failure to take care of those things you could and should do to increase your company’s value escalate the odds you’ll be selling because of a catastrophic event. The more catastrophic the event, the more a buyers market it becomes.
Take the time, be aggressive in your planning and attack the pylon.
“We’ll try and be very aggressive, we’ll try and speed up and change gears, and we’ll see who’s going to win.” Rafael Nadal
It’s really easy to point out bad customer service and bad business practices, maybe because there are so many examples. However, every so often there’s an example of something so good you can’t help but notice it.
We were visiting our daughter in Baltimore and went out for dinner at one of Baltimore’s classic restaurants, Mo’s Seafood, Towson location. We were greeted with, “Hi, I’m Patrick, I’ll be seating you and serving you.” None of the standard, worn-out line, “My name is Kyle and I’ll be taking care of you tonight.” No, you’re taking our order and serving our food; not taking care of us.
Patrick should do waiter-training sessions. He was that good. He was upbeat, conscientious and observant. When my wife ordered a salad, he told her it was pretty big and asked if it was her entrée. When she said no, he volunteered to bring an extra plate so we could share. When he saw that my beer was 1/3 full he asked if I wanted another. I told him, “not right now,” he said he’d keep an eye on it and, sure enough, he came back when it was almost empty and asked again. Small things, but they’re the difference between average and great service.
It turns out he owned restaurants for 25 years, was burned out on ownership and just wants to work with customers. His enthusiasm showed how much he liked what he was doing. And, thankfully, he never once said, “Enjoy.”
“People have to talk about something just to keep their voice boxes in working order, so they’ll have good voice boxes in case there’s every anything menaingful to say.” Kurt Vonnegut
I was reviewing some notes for a talk and the last comment I had written was, “Use common sense.” This applies to more than just the topic of my talk, it applies to business, and life, in general.
It’s common for people to say society in general lacks common sense (pun intended). What it usually means, at least when applied to successful people (like those receiving this newsletter), is that we get too close to issues and lose perspective. It’s why outside advisors can be extremely valuable as they can see through the clutter.
A couple weeks ago a client was discussing a business, the offer he had made on it and the due diligence. This business has some nice features, it has some warts (as they all do) and as we discussed them my client said, about one of the two owners, “I just don’t trust him.”
Because he was so close to the issue this lack of trust was just another checkmark on one side of the ledger. Because I was looking at it from the outside, and with years of experience with these matters, my advice was, “Then it’s time to kill the deal,” which he did.
We all have common sense in some areas. It’s a sign of having good common sense when we know that we have to bring in assistance.
“What experience and history teach us is that people and governments have never learned anything from history, or acted on principles deduced from it.” G.W.F. Hegel
Every so often I hear the statement, “the business is so well run you can hire a manager for $50-60,000 a year to keep it running.” The implication is that the rest of any owner compensation is really profit and therefore the value (and price)* of the business should be higher.
This may make sense for a micro-business (a lot of franchises are good examples of where a non-owner manager can run it just fine), but do you really think this applies to a sizable small business? Say one with $5-7 million in sales and 10-15% profit? I’ve always found it absurd when someone insinuates that the owner of a business making well above the average profit margin could be run just as well by someone willing to work for $50-60,000 a year. You don’t get much management skill at that pay level, and even less leadership ability.
Real Life Story
Gary sold a wonderful business with the following features:
Net profit of over 25% of sales.
Profit in the very high six-figure range.
Growth of sales and profits every year during the recession.
A typical workday (for Gary) of a few hours in the office every morning to do some bookkeeping and keep an eye on things. This on the days he was actually in town, not traveling around the country or to his place in Central America.
So, could a $60,000 a year manager run Gary’s business? Sure, for a while. A very short while, after which it would start to deteriorate. You see, Gary, like a lot of owners who have been around and are “coasting,” could spot things in 10 minutes that might take a new owner or a hired COO (not a low-priced manager) a day, a week or longer to spot. He could see it in the numbers, the operations and the job flow. And he could make adjustments quickly; so quickly the untrained eye might not notice anything was done. This is exactly why the statement in the first paragraph is bogus. There’s more to it than just showing up.
I tell buyers and sellers that the transition period is the time when the seller teaches the buyer all of the little intricacies that make the business what it is. In blunt terms, these are the things that allow the seller to receive a price based on profits vs. net asset value because those profits have created goodwill.
It’s rare that a buyer will pick up everything immediately. It takes some time before you can walk in, see something off kilter and correct it quickly. The good news is, once a buyer realizes those insights and combines them with their skills and energy they can take the business to the next level.
Every business seller wants to get as high a price as possible. At the same time, the buyer doesn’t want to be swamped in debt or be under-collateralized. And the bank wants to be sure they get paid back. It all comes back to what the true value of the business is, after allowing for fair-market owner compensation.
And, on the flip side of the above, a buyer who has been making $400,000 in his or her job can’t expect to plug that salary into the valuation equation for a business that can’t justify that owner salary, which would drive the price down if used in any valuation formulas.
* There is a difference between value and price. A business’s value is a partially theoretical number based on proven and accepted methodologies and it’s called a valuation. The price is what a buyer will pay for the business based on their skills, insights and desire and is based somewhat on the valuation. Some buyers will discount the valuation because of personal factors. Others will have the opinion of my former client Craig (whose story is in my book) when he said, “I don’t care if I pay X for the business or X plus $100,000 because I know what I can do with it.”
If the only way a buy-sell deal can be made to work is because of AAA, it’s probably not worth doing. AAA stands for:
In the world of privately held businesses it is common that the owner’s goal is to pay as little tax as possible. When it comes time to sell however, they want to demonstrate that the business has more cash flow than the tax returns (and financial statements) show. Often it gets to the point of ridiculousness; I once saw a seller state that $250 of lunches were personal not business and should be considered profit.
In my world it’s common to adjust the financial statements so they look as if the seller was trying to win bragging rights for high profit instead of minimizing taxes. Some of these adjustments are easily justifiable, such as adjusting the owner’s salary to market rate or if the seller owns the real estate and pays more than market rent. But they often seem to stretch the limits of sanity and if that’s the only way the deal can work it probably isn’t worth doing.
Let’s look at the AAA of buy-sell deals.
Adjustments, as in, “you can adjust some of our operations to make more profit.” I’ve seen where the seller or their representative stated that the employee pension contributions that are $150,000 per year could be reduced to $50,000 per year. This means another $100,000 of profit (and this makes the company worth more). Never mind that employees will absolutely “love” the new owner who has just slashed their benefits.
Similarly, I once saw a deal where it was stated that if the buyer reduced the sales staffs’ commissions from 10% to 8% this adjustment would create more profit. Think slashing benefits will demoralize employees, try cutting their earnings and see how happy everybody is.
Assumptions, as in, “let’s assume X happens and you’ll make a lot more money.” Examples include:
We’re assuming that gross profit will be 42% in the future (even though it’s been 39% over the last five years and never more than 40%).
The company has too much space. We’re assuming the buyer can lease a smaller space at a lower rate (and who exactly is going to pay the exiting landlord for the rest of the lease’s term?).
There are too many employees so our assumption is the buyer will let two people go, save that money and therefore should value the business based on that higher amount of profit. In one situation, one of the seller’s reasons for selling was that she was tired of working 70-80 hour weeks. And the buyer is expected to reduce staff?
We’re assuming future growth at 12% a year for the next five years so pay us more for the business now (even though it’s been flat to 3% growth over the past five years)
All of the above are real-life examples of assumptions made to try and increase the price of a business.
Add-backs, as in, “we wrote off a lot of expenses on our taxes that really aren’t related to the business (and therefore we’ve mislead the IRS).” Now, some things are legitimate. A corporation can hold their annual meeting in Hawaii in January and write it off. It isn’t illegal but it isn’t a necessary business expense either. Other add-backs border on the ridiculous. Here are some from a recent deal (that didn’t happen, one reason being the sellers wanted the price based on the following).
Writing off (personal) Costco bills for all members of this multi-generation business.
Deducting gas, repairs, insurance and more on all family members’ (personal) vehicles.
Receiving the annual rebate from their distributor personally, not to the company (think that got reported on their 1040?)
(Supposed) personal travel, meals, etc. at such a high amount it meant that nobody did much work between trips and other entertainment.
To balance this, there are legitimate add-backs to profit and could include:
Life insurance on the seller
Rent in excess of market (when the seller owns the building and will lease it for the lower, market rate)
Adjustments to depreciation with the recent high levels of section 179 deductions (as long as anticipated capital expenditures are factored in)
Owner compensation to market rate (this could make profit higher or lower depending on how the seller pays him or herself)
AAA in the world of driving a car is pretty cheap “insurance.” And it truly can “save the day.” (Excessive) AAA in the buy-sell world is akin to “putting lipstick on a pig.” You can dress the business up but if it takes adjustments, assumptions and add backs to make the deal work, it’s the wrong deal. If it’s (sorry for all the clichés) “the icing on the cake” that makes the deal great instead of just good there’s no problem.
I was at a professional group meeting recently, we broke into small groups to discuss an issue and the first thing one person blurted out was that her personal life was a mess. This came almost immediately after receiving a reward from the group for her business accomplishments.
I’m not sure if she had feelings of inadequacy after receiving the award or if she just had to tell someone. The lesson is we can’t judge things, good or bad, based on what we see on the surface. There’s often more to the story than what we see or hear.
I tell my clients, all the time, something similar; that there are no perfect businesses and no perfect deals. Business buyers shouldn’t get too excited based on their initial impression and they shouldn’t be too down on a company because they recently read something negative on the industry. As my friend Ted Leverette used to say, there are bad businesses in good industries and good businesses in bad industries.
The same applies to business sellers as they screen buyers. Just because a skillful person has enough money to buy your company doesn’t make him or her a good buyer. Manufacturing company owners would lose all their money if they bought a restaurant and a good restaurateur would lose all their money if they bought a manufacturing business.
Delve deeper and here’s hoping your business and personal lives are in good shape.
“The most luxurious possession, the richest treasure anybody has, is his personal dignity.” Jackie Robinson
We hear a lot about word-of-mouth marketing, so, what exactly is it. Here’s an example.
In January we got a Hurom slow juicer and started making great juices at least once a day.
In February my cousin Katie, and Ross, visited from Arizona and had one of our juices. They both bought a similar juicer.
In July two of my wife’s high school friends visited her at our cabin. Both were so impressed by the juicer they ordered one on Amazon while there.
In August Katie and Ross visited the cabin and told us that three of their friends had bought juicers, after seeing theirs.
Hurom has sold at least seven juicers as a result of our initial purchase. That’s word-of-mouth marketing. Are you getting enough word-of-mouth marketing? It’s the best marketing there is.
A few times a year I teach a class at the SBA office on “Getting Your Consulting Business to the Next Level.” I always recommend the book, The Secrets of Word-of-Mouth Marketing by George Silverman (Amacom, 2001). It’s filled with great strategies and tactics to increase referrals, accelerate the sales process and more.
Of course, as with the juicer, the best thing you can do is provide fantastic service or a great product. That’s what gets people talking!
“Flattery is like chewing gum. Enjoy it but don’t swallow it.” Hank Ketcham
I was recently at a high-end resort and wanted to use the gym. There were two gyms, one in the main building, a short walk from my villa. The other was about two miles away (obviously a huge property). I was told that because I was staying in the villas I couldn’t use the gym in the main building. The reason I was told was that the company owned the main hotel building and managed the villas for the individual property owners.
Pretty silly reason in my opinion. Come on, give me a break; I can only use one of the two gyms, and it’s a couple miles away? This is a classic example of people thinking too much and putting their own wants and needs ahead of their customers.
Do the opposite and put your customers first, even if it’s a little more inconvenient for you.
It’s been a long time since I’ve experienced rain as we did at the University of Washington football game last Saturday. We were soaked under our canopies in the parking lot as we tailgated because the rain was coming down sideways. It was like a Southern rainstorm. Luckily, one of us (I’ll take credit) took along a change of clothes and waterproof gear for the game itself, as our seats are not undercover.
Everybody was wet and nobody was sitting down (because most people didn’t have waterproof pants and didn’t want to get soaked from all sides). However, the rain didn’t stop the “idiots” from making their stupid comments to show they know more about strategy and play calling than the coaches.
One of the frequent complaints in our section was because the Huskies were running the ball a lot instead of passing it. Every time a run play gained two yards or less the zingers flew. This in spite of the fact that due to the weather:
There were a combined three missed extra points (one because of a high snap).
The Huskies got a safety when a high snap went through the Arizona’s punter’s hands.
The Huskies run a precision passing game that requires a lot of quick, accurate throws. Those are hard to make when the quarterback is worried about just handling the snap and holding on to the ball.
The topper to all this nonsense was when, late in the game, there was a penalty of some sort and after it was all settled there was some booing (as always). The gal in front of us broke away from her conversation and started loudly booing, oblivious to why she was booing.
The lesson here is, stick to your game plan, don’t let uninformed outside forces influence you because you’re the one who knows what you’re doing better than they do. Go with your strengths and in this game it was the Huskies offensive line and running game.
“People striving for the approval from others become phony.” Ichiro Suzuki
Pre-Great Recession - banks competed for business acquisition loans and I remember one client’s summary that had eight banks, eight approvals, seven banks using the SBA loan guarantee program (called SBA loans from now on) and my client took the non-SBA offer. Why? Because the fees were noticeably lower (a low fixed fee vs. the SBA fee of about 3%) and the terms were about the same (10-year SBA term versus a 5-year note with a 10-year amortization, the same interest rates).
2009 - Were there any business acquisition loans?
2013 - it’s hard to find a non-SBA acquisition loan on a deal that meets the SBA qualifications.
Who benefits? Buyers, banks and especially sellers!
Buyers - new markets open up for buyers because of SBA loans. They can now buy larger and better businesses than they could with a conventional loan that requires larger down payments and five-year versus 10-year terms,
This is great news for the economy because the majority of these buyers are executives who have built their skills and capital in the corporate world and are poised to grow their acquisition, which is often a coasting business. These buyers want to soar, not coast. It’s much better for them to buy a larger business with systems, processes and a management team instead of an owner-operator business-and they can do so easier because of the SBA program.
Banks - the guarantee portion is great for banks. They get a guarantee from the SBA for at least 75% of the loan amount (this is collateral). In addition, smaller banks will sell off these loans at a premium (20% the last I heard) to increase their capital. What this means is, investors get a government guaranteed rate of return of about 4%, which is higher than T-bills and similar.
With banks having been tight on credit and many businesses not wanting to take the risk of borrowing, acquisition loans are a great way for banks to get their deposits working. And, SBA loans are much safer than many other kinds of loans and, because SBA loans are considered “cash flow loans” (not requiring full collateral), they have better approval considerations.
Sellers - however, the biggest beneficiary of SBA acquisition loans are the sellers, and it’s not even close! Sellers are getting prices they would never dream of under any other circumstances and with more cash at closing. Let’s look at an (fictional) example.
Buyer cash for downpayment – $500,000
Net profit (after owner salary) – $500,000
Tangible assets – $100,000
Criteria Without SBA With SBA
Financing with a conventional
5-year term* ~$1,500,000
Financing with an SBA
10-year term** ~$2,500,000
Possible price *** ~$1,950,000 ~$3,000,000
* 5-year term, 5.5% interest rate, 1.5:1 debt coverage ratio and with tangible collateral requirements.
** 5-year term, 5.5% interest rate, 1.5:1 debt coverage ratio and with cash flow considered a form of collateral (doesn’t require 100% tangible collateral).
*** Buyer down payment plus maximum (assumed) financing and not a reflection on bank credit policies, valuation, non-financial factors, etc.
If we assume the business (in this example) is worth 4-5 times net income, then the buyer market (that is willing and able to pay this amount) for the seller opens up from buyers with about $1 million in cash for a down payment to buyers with as little as $400,000. And obviously, there are a lot more buyers with $400,000 than $1 million (and more with $1 million who prefer to invest much less). Then it becomes a matter of supply and demand and the more demand the higher the price will be.
SBA guaranteed loans are one small cog in the big wheel of economic growth and our economy still needs help. Good businesses, bought by great buyers with fantastic financing is a super package. Let’s face it, it’s one of the few things the government does that makes sense and gets positive results. Plus, it benefits all involved parties, especially sellers.