What, You Only Have Six Customers?

For the foreseeable future once a month this memo will be on a topic to increase value in a business, which is exactly what business owners should want and is definitely what business buyers are looking for.

I’ll start with one I’ve seen a lot of lately, customer concentration. Here are three examples:

  1. Seventy percent of sales to one customer.
  2. Seventy-five percent to three customers.
  3. Eighty percent to three customers (one being a middleman buying for their clients).

This should scare owners, but usually they feel their relationship is so tight all is okay. To a buyer, with acquisition debt payments, it scares the bejeebers out of them. To spin this around, I’ll repeat something I wrote about years ago because vendor concentration can be as deadly as customer concentration. A past client had about 70% of his sales from one vendor, he lost the line, built up his business, and again was with one vendor at 65%. Lost that vendor when the vendor’s competitor took sales in-house and his vendor went to my past client’s larger competitor.

This stuff happens, all the time. It’s not make-believe or fantasyland. I talked to an owner recently who lost his top customer. Why? Because his salespeople (I’m using the term loosely) made contact once a year. The rest of the year they took orders and cashed commission checks.

So, what happens when it’s time to sell? One recent deal had a price 30% of what it would have been three to five years ago, which was before the top customer changed focus and sales reduced significantly. One of the examples above is a company close to selling and the facts include:

  • The price is 50-60% of what it would be if there was no customer above 10% of sales.
  • There’s a claw back provision for 20% of the price (if sales drop below certain levels).
  • The seller has to stay for (at least) one year to maintain the relationship.

So much for exiting with style, grace, and more money.

The real problem is no matter how often their CPA, banker, consultant, and M&A professional tell them to fix this problem the owner is “fat, dumb, and happy” riding the top-customer wave. It’s why the Wall Street Journal published statistics showing 90% of small to mid-sized businesses are not ready to sell for maximum value.

“There is more stupidity than hydrogen in the universe, and it has a longer shelf life.” Frank Zappa

Fussy Buyers & Naive Sellers

My friend Dennis Hebert with CFO Selections called recently regarding a client of his who is thinking of selling to his COO/GM. The holidays got in the way and then Dennis told me he felt they didn’t have a good understanding of what it takes to do a deal, so he gave them a redacted purchase and sale agreement. It caused them to pause and think.

Business sellers often underestimate the complexity of what’s involved in selling a company. It’s their cute little puppy so they think everybody will think it’s adorable. Even when others find it adorable there’s still a lot of work. The amount of detailed information requested by the buyer, bank, and attorneys can be overwhelming. Deal fatigue is common.

Most business people are optimistic, it’s a necessary trait, and sellers are no different. The complexity of a buy-sell deal can be extremely high and reduce optimism. It’s not like selling or giving away a cute puppy.

On the flip side, most business buyers are too fussy. I remind all buyers there are no perfect businesses and no perfect deals. Watch out for anything that looks too good.

No small business saves the world or changes western civilization. But these businesses do create jobs, wealth, and a lifestyle, for both the employees and the owner. In fact, boring is often best. Buyers need to answer the following three questions:

  • Can you see yourself going in there every day?
  • Can you add value?
  • Is it a viable business model that doesn’t violate your values?

The rest is analysis, due diligence, negotiation, etc. And, on the flip side to the seller underestimating the complexity of the process, the buyer needs to realize they can always ask another question, and they need to get over that impulse, and make a decision. As I write in the preface to Buying A Business That Makes You Rich, buyers will make a leap of faith and it needs to be off a chair not the roof.

“How desperately difficult it is to be honest with oneself. It is much easier to be honest with other people.” Author Edward E. Benson

The Five Types – Buyers, Owners, Employees

I’ve been in my industry for about 25 years. I’ve seen a lot of business owners, business buyers, wannabes, employees; meaning people of all types. I’ve concluded there are five types, whether they’re business buyers, owners/sellers, or employees. When it comes to buyers this analysis is after I determine if the person is an offensive or defensive buyer. Defensive buyers rarely do a deal. They’re too worried about any and everything including the economy, the industry, the debt, the weather, and especially (although they won’t admit it) their own abilities.

All of these types have beneficial traits, and some have more detriments than the others. It depends on the person and their objective. And, it depends on the life phase the person is in at the time.

Driven by money– everybody is driven, to some extent, by money. Even the homeless, which is why there’s so much crime near homeless encampments.

The business buyer in this category probably has significant assets but wants more. He’s worried he won’t have enough in 20, 30,40 years. He wonders if the company he buys can scale from $1 million in earnings to $5 million and how fast it can be done.

When this is a business owner/seller, employees and buyers need to be careful. This is the person who tilts the pension plan to 90% to owner and 10% to the few dozen employees. She pays as low a wage as possible, provides skimpy or no benefits, and is extremely aggressive as she blends her personal and business checkbooks (deducts personal expenses on the business’ tax return thus cheating the IRS).

Employees in this category are often in sales. Sell more, make more. Others climb the corporate ladder just for the pay. Seventy-hour weeks, no problem because they’re making more than their friends.

Driven by accomplishment– Offering a broad-based opinion, these people make great buyers, sellers and employees. They want a great income but it’s not the top (or only) motivating thing.

The success driven buyer wants to grow and expand, create jobs, innovate, and feel good about what they’re doing. They’re the owners (I know many like this) who will say something like, “Our earnings are $2 million a year but I still take only $20,000 a month in salary and reinvest the rest in the business.” He’s focused on the end game.

Owners like this are often most concerned with legacy. When selling, it’s take care of my employees, do good by my customers, etc. because I want to take my grandkids here in 10 years and see how well you’re doing.

Success driven employees are what you want. While looking for career growth, they want to be part of a successful team and see the results of their work. Many become owners later in life.

Life Balance– here we can lump all three categories together. They want to work a normal work week, be productive, earn a good living and still have time for family, hobbies, non-profit work, etc. These people don’t accumulate vacations because they want to work more. Owners in this phase are often “coasting,” working hard enough to make their great living but not wanting to grow too much.

Lifestyle– This is where it gets interesting because what on the surface seems like a great thing, it’s something that drives buyers nuts.

The buyers not driven nuts by this are ones often featured in articles about franchises, main street (mom & pop) stores, etc. They want something they’re passionate about, with reasonable income. But most buyers are in the above three categories not this one.

Here’s what I mean, via the combination of a few real-life examples. The owner said they work from 8-4, make enough money to get by, get done what they get done, and there’s always tomorrow. No urgency, no emphasis on the customer, and surely no career path for the employees. And, not much value to a buyer who will figure they’ll lose the employees when they come in and want to grow the business.

Employees in companies like this tend to be ones with bumper stickers like, “A bad day fishing is better than a good day at work.” It’s a means to an end to them. In a book I’m reading, “Invisible Influence” by Jonah Berger, he says it’s tough for those who want to be successful to relate to these people as there’s not much commonality.

Hate the boss– some people just hate authority, no matter who it is. My thoughts are when these people get so sick of working for someone else, they buy or start something that’s a job and nothing more. Route sales fall into this category as does anything else where the job is task driven and there are no employees, because they probably (would) hate employees as much as they hate a boss.

Employees like this can’t wait to leave (every day, especially Friday, and eventually for good). They’re the bad apples that make the culture rotten and if they ever inherit some money they’re probably gone, into some business described in the preceding paragraph.

Conclusion

In my day-to-day goings on I see, and want to see, mostly success driven and life balance people. I see quite a few money driven folks, nothing wrong with them especially if they also take care of their team, and if I was in the private equity world I’d see a lot more of them. The lifestyle owners and buyers don’t cross my radar and I stay away from the last type.

Think of your clients, your employees, your customers, and others. I’ll bet you’ll find you have a lot of them with the same traits you have.

When “Word of Mouth” Isn’t Enough

I’m talking to an owner who’s pretty darn proud of the fact he doesn’t do any marketing or have any sales effort because it’s all “word of mouth.” He tells me this knowing I know his friend (with the same type of business) in a noticeably smaller market that has two to three times the revenue he has.

My first thought was, maybe if you did some marketing, you’d be making more money, and more importantly, have a more valuable business. By his own admission, this owner spends a good amount of time working “In” the business. He’s working well under his pay grade when he does this and probably works more hours than he would if he grew the business.

Word of mouth is great, especially for businesses like mine where referrals are the platinum standard. But those referrals only come as the result of marketing. But for a more traditional B2B or B2C firm (like this one that sells to businesses, government, and consumers) there needs to be marketing plus some sales effort.

A salesperson should be calling on the businesses and government buyers letting them know about new offerings, building the relationship, etc. As consumers, what’s the first thing we do when we need a new product or service? Right, we Google it. Some SEO or AdWords is sure worth a try.

Marketing is what creates customers, which creates buzz, which leads to the word of mouth phenomenon, and even more customers.

“I don’t always follow my own advice.” Edith Wharton

Getting Culture Right

In November I had the pleasure of attending the all-staff dinner as part of the Farallon Consulting retreat (Farallon is an environmental consulting firm on whose board I serve). It was an exhibition of culture at its best.

While I only heard reports about the day’s activities (and happy hour) I witnessed a group of people on the same page. While there’s an endless supply of “bad” stories about managers, culture, etc. a good way to start the new year is to consider what a good culture means, whether you have a few employees, dozens, scores, or hundreds.

  • Realize even companies with the best culture still have issues, but those issues are at the other end of the spectrum from the shenanigans on The Office. It’s simply because people are people.
  • A good culture means better collaboration to achieve goals, whether it’s increased revenues, better productivity, reduced costs, or anything else. When employees work well together the boss (business owner in small companies) spends less time refereeing and more time strategizing.
  • When employees enjoy their work environment they want to work there, will do extra, will not be job switching and that means higher employee retention. Given the costs of replacing someone, this is huge.

There are a lot of people who help companies improve their culture, and it’s worth it (when done correctly). This month is a good time to assess your culture and do what it takes to improve it.

“Every day on Earth is another chance to get it right.” Steve Earle

How to Ruin a Deal

As part of Jessica’s training I went through my folder of old articles and other industry materials. I came across something from a business broker and while it’s probably 20 years old it’s as viable, and valuable, as ever.

Here are five points with my insights on how they apply to all businesses, not just the buy-sell world.

Don’t make friends– It starts with the line, “People want to do business with people they like.” Customers who don’t trust a salesperson won’t buy from them. I’ve been saying for 20 years, “Nobody will buy from or sell to someone they don’t like.” Relationships are the most important factor.

Hide the flaws– Full disclosure, open Kimono, no secrets. It doesn’t matter what phrase you use, don’t hide things. In buy-sell deals the due diligence process is for confirmation not surprises. In everyday business it means being honest about what your product or service can do, what it can’t do, etc.

Don’t listen– In the class I teach at the Seattle SBA I say sales is asking questions and listening. It’s not smooth, persuasive talk. Your prospective and existing customers will tell you what they want and/or need. If all you’re thinking about is your next statement, you’ll miss important clues.

Ignore the marketplace– The buy-sell world has ranges of value/pricing. Almost no business is so special it defies those ranges (as super-motivated buyer is most likely the one factor causing a higher than normal price). It’s the same in most industries, unless you’ve carved out such a strong competitive advantage you stand out from any competition. It’s tough to do with widgets and much easier to do with software, which is why software has such high margins.

Statistics prove my point– The author used statistics to show sellers who priced their business well above the professional’s estimate of value sold for less (than the estimate) because the buyer picked apart everything, because the price made no sense. Use statistics whenever you can. For example, our process increases donations by 37% or our sales training shows a 24% increase in sales and 5% increase in gross margin. A tour company owner told me how the most successful guides (those who get the biggest tips) use statistics about the area because customer soak up that information like a dry sponge soaks up water.

There were some other good ones, including “Don’t put it in writing,” “Delay” (meaning you should show urgency), and “Take unreasonable positions.” My conclusion is, these things are universal and I’m sure you have industry rules that apply to most other industries. The key is to follow them.

Confirmation Not Blind Belief

As part of Jessica’s training we are reviewing one chapter a week from Russell Robb’s book, Selling Middle Market Companies (which is really about selling non-micro but still small to mid-sized businesses). Chapter four had a few topics near and dear to me.

  • It started with the topic of preparing a business for sale. He strongly said sellers should not take on any big, new projects or purchases (that will hurt short-term performance but has long-term potential). In my book, If They Can Sell Pet Rocks Why Can’t You Sell Your Business (For What You Want?), I say owners should run their business on a day-to-day basis as if a sale won’t happen. And, to discuss any big plans with their advisory team before just doing something.
  • Next was his explanation of how buyers will look at EBITDA and how smart ones will factor in upcoming capital expenditures. He calls it EBITDA-CAPX and discusses this to warn sellers they can’t skimp on replacing assets that need to be replaced. For example, if a company normally replaces two vehicles a year but stops getting new ones a year or two prior to selling the buyer will factor into their valuation the cost of more new vehicles than normal.
  • Finally, he warns sellers not to delay paying their bills (accounts payable) in order to pay off long-term debt. He states sharp buyers will peg a working capital amount that will stay in the company and therefore won’t be fooled by this tactic.

One of the pieces of good news from our weekly study is Jessica is always saying things like, “I’m familiar with this because it’s just like in your books.” Continuing education is necessary, especially in industries like mine where things are so different than they were in years past. It’s good to have multiple sources of information to get both different viewpoints and confirmation of the basics.

“You can only hold your stomach in for so many years.” Burt Reynolds