Even Adults Need Adult Supervision

Running a small business is easy. Having a small business as an absentee owner is a piece of cake. The employees can operate the business without adult, i.e. owner, supervision. 

The above are all myths of small business and here’s an example:

In the mid-1990’s at a Chamber of Commerce meeting I met the owner of a new auto service center in Kirkland. We hit it off, started taking our cars there (as did numerous family members and friends), got great service, honest pricing, etc. They did little things right like saying you’ll need brakes in about six months versus wanting to do them immediately. Or giving the car a once-over look for no charge.

Unfortunately, the owner died a couple years ago. His wife sold the business to a technology executive who bought it as a passive investment. I hope the wife got paid in full at closing.

We started noticing little things like the phone not being answered and messages not returned. Our only needs were oil changes, the (recently promoted) service manager knew us, and all was good (for us). But obviously not for other customers and definitely not for the employees. It went from a family-business culture to one where the manager said to my wife, “It’s now just a job. I work my hours and go home.”

Guess what? Now the phone isn’t answered at all, the blinds are down, and the doors are locked. About five years ago I started using the term “adult supervision” to describe what an owner needs to bring to the business. This business used to have adult supervision and thus the employees were happy, the customers were happy, and the business thrived.

Don’t think this only applies to very small, consumer businesses like a garage. I’ve seen business with sales of $5-15 million suffer similar issues when the owner decided to take his or her eye off the ball, spend more time vacationing than working, or just clipped coupons (taking a huge salary or distribution as the business grew stagnate).

“The universe if full of magical things patiently waiting for our wits to grow sharper.” (Author) Eden Phillpotts

Growth by Acquisition Isn’t for Everybody

This was originally written for the blog on www.ibainc.com.

An interesting title of an article about how the author helps his company’s clients, isn’t it? Immediately telling readers the subject might not be for them. It’s because I’m not a salesperson, one size doesn’t fit all, etc. In fact, I start out speaking engagements on buying a business by telling the audience (usually management and executive level people0 there’s a good chance it’s not for them.

But when it is for you, be sure to do it correctly. And that means don’t jump in without a plan and when it comes to growth by acquisition that means know why you’re doing it.

In my book, Company Growth By Acquisition Makes Dollars & Sense I have a list of 19 reasons to consider growing by acquisition. I’ll list them here and go into detail on six of them.

The cake – 16 solid reasons (in alphabetical order)

  • Acquire great talent, including the seller
  • Assets are cheaper as a package
  • Competitive Advantage (fill a weakness)
  • Dependencies reduced
  • Diamonds in the rough
  • Diversify your product offerings
  • Easy money
  • Integration is easier
  • Location, location, location
  • Make a competitor go away
  • Psychology – Employees like to be part of a winner (growing firm), just like sports bandwagons
  • Risk, it’s a lot lower
  • Overhead the same, volume higher 
  • Synergy
  • Technologies
  • Vendor relationship strategies

The icing – the top three

  • Customers (efficiency vs. make more calls)
  • Yes, we can!
  • The bigger you are…the better

Acquire great talent

Good employees are hard to find and often are not in the job market. Just talk to any executive recruiter. While all buyers want capable employees, most strategic buyers (that’s you) also prefer to see a solid management team in place.

Great employees with industry knowledge and experience are in the job market even less. When you are looking for great salespeople, I believe this is amplified. They won’t change if they’ve got a good thing going. Here are some statistics from an executive recruiter, which explains why it’s tough to find good people.

  • 82% of people aren’t searching for a job.
  • Leadership, or the lack thereof, is the top reason management people switch jobs (not money).
  • 46% of millennials left their last job because of the lack of career growth.

If you acquire their company and create an atmosphere of growth, those employees will want to stay. While I can’t comment on the culture in all companies, I do know that many small family-owned businesses have owners who are coasting. They are doing very well, they aren’t working too hard, and they don’t want to disrupt the nice moneymaking system they have. 

Dependencies reduced

Dependencies are a huge issue in most small businesses. By being larger you can reduce most or all of the following:

  1. Customers
  2. Employees
  3. Management abilities
  4. Product
  5. Owner

 Not too much explanation is needed. More customers over your expanded revenue base, more employees, deeper management, less product concentration, and most importantly, there’s more talent to take a load off the owner. And an owner dependency is often the brightest red flag for most profitable small businesses. Of course the owner has to be willing to take advantage of the deeper bench by delegating to them.

Psychology – Be part of a winning team

Employees want to be part of a winning team. They want to feel they’re contributing to a winning effort. It’s very much like sports, the more the team wins, the greater the number of fans it has.

I’m thinking of a young man in his early 20’s whom I know. He took a while to figure out some things in life and is now steadily employed and has been for the last few years (with the same company). He’s proud of his job, his contribution, and showed disdain when a new, younger employee (whom he called “the kid”) flaunted the rules and wasn’t dedicated. (But let’s be honest, some employees at this level don’t care, but they’re not the ones who are important anyway, like “the kid.”

Now elevate this to the more experienced people including the management team. In one company there was some doubt about the general manager accepting new ownership. However, this doubt was unfounded as he’s leaped at the chance to implement quality controls, better processes, and accountability. 

The icing – the big three

Now here are the top three reasons to grow by acquisition.

Customers

“This would be a great business if it wasn’t for those darn customers” was a semiserious comment someone made to me years ago. Of course it’s the annoying (bad) customers he was referring to. It’s good customers we all want more of—customers who are loyal, steady, in good financial shape, growing, pay their bills on time, appreciate the value you offer, and consider you part of their team.

An ideal situation is where there are some overlapping products, so there is some continuity and synergy to be achieved. The figure below shows this. Your salespeople now have an easy transition to discussing, and selling, their products, and their salespeople have an easy transition to discussing, and selling, your products.

A picture containing electronics, compact disk

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In simple terms, if your primary motivation is acquiring a customer base, you are acquiring market share. You may have many other reasons (above), but the bottom line is you are buying customers, and that means top-line growth.

Yes, we can!

This is not about ego; it is about building an exit strategy in order to get a higher selling price. Buying another company, assimilating it into your operation, and showing that the combined profits are greater than the two individual companies’ profits demonstrates to potential buyers that this can be done. It proves you have the team that can integrate one operation into another.

This integration could be their assimilating your firm into theirs or it could be a signal that growing your business (or now a division of theirs) is possible by further acquisitions. A management team that can successfully integrate other firms without major disruption and with immediate efficiencies is a valued team. Too many big mergers and acquisitions fail. Up to 95 percent of public mergers do not live up to expectations. A savvy buyer will appreciate this talent and experience associated with past integrations.

Why larger firms sell for more than smaller ones (all other things being equal)

The bigger your business is, the more it will sell for, all other things being equal. A $50 million (revenue) company with 10 percent earnings will sell for a higher multiple (of profit, earnings, free cash flow, or whatever metric you use) than a $25 million company with 10 percent earnings, which will sell for a higher multiple than a $10 million company, and so on.

There are generally accepted ranges for multiples of earnings based on the range of companies’ revenue. However, too many small business owners see in the Wall Street Journal that a $300 million company in their industry sold for ten times earnings and assume their small business will also sell for ten times. That won’t happen; there’s more risk in smaller businesses than larger, so the desired return on investment is higher.

The fastest and safest way to grow from $5 to 15 million is by acquisition. Buy another firm in your industry—a supplier, customer, or unrelated company that provides diversification—to have an immediate revenue increase and a larger platform from which to grow organically. See more profit and a higher multiple when you exit.

“It’s not bragging if you can do it.” (Dizzy Dean, 1934)

A lot of business owners talk about their company’s potential or the growth that will occur if the buyer just “does some marketing.” Of course, most of this is just talk. Business buyers of all types and sizes are a skeptical lot. When buyers hear too much about potential they think the seller has tried every conceivable way to grow and can’t.

So prove you can do it. Grow organically and also go out and buy another company. Show that you can integrate the people, processes, financial systems, customer service, and everything else into your operation. Private equity groups and large corporations make multiple acquisitions. If you can buy another firm and successfully assimilate it, you become more attractive to these buyers. They will assume you can do it again and that your management team is capable. Strategic buyers and equity group buyers highly value management teams—it can even increase the multiple (compared to having the same size company that has not made acquisitions).

We’ve covered just six of my 19 reasons on why it makes sense to grow by acquisition. I realize most may not apply to your business. It’s the few that do apply that are the reasons why this strategy may make sense. Heck, your catalyst may be a reason not mentioned here. The point is this has worked for many companies and you should always have your eyes open looking for opportunities as there are a lot of good reasons to do so.

At the same time I must acknowledge there are pitfalls you need to avoid, but they can be avoided if handled correctly. How you handle the cultural integration makes a huge difference. Letting (most of) the employees, with both companies, know their jobs are safe is important, as with any acquisition. And you will be taking on debt, but this debt comes with good things like customers, good margins, cash flow, etc. If it makes sense to buy another company these pitfalls are easily overcome. As a very wise executive once told me, “Growth hides a lot of operational warts.”

Politicians, Businesspeople, and Rotary’s 4-Way Test

As we experience the holiday season with Peace on Earth, Goodwill to All, Thanks(giving), and the meaning of all this, I want to share my thoughts on what I consider to be one of the best codes of ethics around. It’s Rotary’s 4-Way Test and how I see it applying to politicians and businesspeople.

The 4-Way Test is:

  • Is it the truth?
  • Is it fair to all concerned?
  • Will it build goodwill and better friendships?
  • Will it be beneficial to all concerned?

Is it the truth?

Politicians – I think I could stop here because we all know they all lie, about everything. We have a President who sets the standard with over 12,000 verified false or misleading claims. Politifact states Obama made about 14% the number of “pants on fire” lies as Trump (yes, Democrats and Republicans, they all lie). Here in Seattle a Seattle City Council member, on the Berkeley “ban natural gas” bandwagon, stated a natural gas stove poisons the air in the house. A University of Washington scientist debunked that one pretty quick.

Business – My experience is most businesspeople are pretty truthful, other than owners who blend their business and personal checkbooks. They may write off some personal expenses but do report their income. When it comes time to sell, most care about their legacy (they want the buyer to succeed) and really care about their employees thriving with the new owner.

Is it fair to all concerned?

Politicians – Again, pretty simple as they only care about getting re-elected and the people who can help them accomplish that. This means donors and lobbyists not you or me.

Business – Most really care about their employees and customers. Yes, some (way less than 50%) are greedy, pay low, don’t provide benefits, etc. One telltale sign is often the retirement plan. If it has 95% going to the owner, you have to watch out for that person. 

Will it build goodwill and better friendships?

Politicians – Yes, if you’re a donor, a donor’s business, or a donor’s cause. Otherwise, you’ve got to be kidding.

Business – Small business is relationship business. You can’t succeed if there’s not goodwill between employer and employees, the business and its customers, vendors, and service providers. Face it, customers usually have options. In today’s labor market employees have a lot of options (on my list of the top four things an owner can do to prepare the business for sale is, “Show you can attract and retain great talent.”

Will it be beneficial to all concerned?

Politicians – You know my thoughts on this. See the above three sections. If it’s beneficial to the politician they’ll do it (often meaning they’ll do what the Party tells them to do).

Business – If you’re in business, large or small, you must be able to solve problems, meaning beneficial to your customer, your vendors, and you. Try making a promise like a politician and not delivering on it (we’ll have your order out by the end of the month but when it’s two months late you’ll lose the customer). Things must be beneficial to employees also, or they’ll leave. Most want career advancement and want to be able to take pride in their work.

Conclusion

It’s the holiday season and this is a fun essay. I’m sure you picked up on the general theme, we businesspeople have a higher ethical standard than those we elect. As you give thanks on Thanksgiving, wish friends and family Merry Christmas, Happy Hanukah, and Happy New Year, realize it’s best to carry all those feelings throughout the year, not just in December.

Three Important Buy-Sell Lessons

This is something I sent to our clients recently and realized it has good lessons for all.

I’ve been involved in a real estate buy-sell transaction as over the last 18 months we’ve been trying to sell our family cabin in the Midwest. In this part of the country it is not a red-hot real estate market, with only one exception and the exception is places on a chain of lakes, which our place is not. 

Bottom line, it’s been slow. About one year ago we had a verbal “offer” about 25% below the asking price. Our agent told them not to even bother writing it up, which was the right decision. 

All of a sudden, this fall, after no serious interest all summer, we got two offers. One was another lowball offer, which definitely hurts one’s feelings. The other was in the negotiable range, so we negotiated, and reached agreement.

Lesson one: lowball offers destroy all faith and trust. You don’t even want to deal with the person.

After hundreds if not thousands of online views, scores of people looking at the place in-person, two lowball offers, and one negotiable offer, we came to realize the following, which business sellers often don’t want to accept:

Lesson two: the market was speaking to us about what the value really is.

At the same time, we realized, and this applies to business buyers:

Lesson three: no buyer (maybe a very naïve one) makes an offer they expect to be accepted. 

In fact, if a seller accepts the first offer a buyer makes the buyer should wonder what’s wrong. Because rarely is the asking price what a seller really wants and rarely is the first offer the limit of what a buyer is willing to pay.

Summary, in business deals it’s very much about relationship. In business and real estate, emotion and feelings play a big part.

“Promises only bind those who believe them.” Jacques Chirac

Fantasyland

I was recently talking to a business buyer about what he was looking for in a business. What he said all made sense; a B2B business, logical size range, wide geographic area, etc. 

Then he said he needed a business on which he could pay off the debt (SBA, 10-year term loan) in half the time. That’s 25% annual growth, from day one. And yes, 25% can be achieved. A recent client grew 25% the first year. But over five years? If it takes one year to figure things out, all of a sudden, it’s about a 33% growth rate. But then came the kicker:

“And I don’t want to have to make any investment in the business (to achieve the growth).”

No new (additional) equipment, vehicles, marketing, or people. All the earnings go to debt reduction. This is fantasy land. And it makes me wonder what other fantasies are out there. Some that come to mind are:

  • A business seller believing his or her business is so special traditional valuation methodologies don’t apply to their business.
  • Owners thinking it’s easy to find good salespeople.
  • Advisors (and salespeople) figuring because they know what they’re doing the phone will ring.
  • Business buyers thinking an owner with no family in the business has no good options, other than selling to them with a low down payment (actually this owner has all the options).
  • Company founders believing a bank will lend them money based on their great idea.

I’m sure you’ve seen many more fantasies. 

“We are living in a world today where lemonade is made from artificial flavors and furniture polish is made from real lemons.” Alfred E. Neuman

What is Your Real Income

I’m working with a private equity firm to find add-on HVAC, plumbing, electrical, or refrigeration companies for their plumbing construction firm in the Seattle area (so if you know of any doing at least $5 million in sales who want an investor let me know). The founder of the PE firm has a distinct term for the earnings/income of a company.

He calls it “real income.” What this means is, it’s the income after allowing for all the expenses required to run a business. This means expenses for:

  • A CEO at fair market salary.
  • A CFO type, not just a part-time bookkeeper who doesn’t know what a KPI (key performance indicator) is.
  • Anticipated capital expenditures.
  • Operating interest (a working capital line of credit).

About 15 years ago I started using the term “free cash flow,” which is pretty much the same as what’s above. I would add together profit, owner salary, depreciation, and interest and subtract fair market owner compensation, anticipated capital expenditures, and operating interest.

What I didn’t include was the CFO/controller role and compensation, even though I’ve seen hundreds of businesses with crappy financial systems and crazy financial statements. Not to mention no management reports, no metrics, KPIs, etc. It took a while, but I now understand that’s a role we need to account for when adjusting earnings.

I like the term “real income.” It conveys trust, non-fantasy, and sincerity. It’s now my go-to term.

“The trouble with having an open mind, of course, is that people will insist on trying to put things in it.” (Author) Terry Pratchett

Scams in buy-sell deals

On September 8, 2019 the Buzz column in the Seattle Times was titled, “Seattle Cider sues founder, former CEO” and dealt with a lawsuit against the founder of Seattle Cider and Two Beers Brewing initiated by Agrial, a French company that acquired them. In simple terms, the plaintiff alleged the books were cooked to increase the price.

More about the above later and it fits with a quote I saw this summer from Richard Parker, “Numbers don’t lie, sellers do.” I wrote him and told him how I had seen a case where the owners/sellers (creatively) made the numbers lie, at least temporarily. Richard’s response was something like, it’s amazing how creative people can get with this stuff.

The Seattle Cider case involves the seller supposedly doing “channel stuffing.” He allegedly had his top distributor accelerate orders, so sales looked stronger than they really were and then, post-sale, orders declined because the distributor had months and months of product. Oops, the buyer is now getting no orders and had the privilege of paying the seller an inflated amount (again, alleged).

It seems so easy, but this stuff always comes out (at some point). For example, a seller ripped a letter off a bulletin board as she gave the buyer a tour of the business. Turns out the letter was from their top (30%) customer informing them a change in strategy meant they were ending the relationship. The buyer later found out from an employee.

Or many years ago when a buyer sabotaged himself by letting the seller convince him he couldn’t talk to the customers because the industry was so tight word of the sale would somehow get out. Even though his attorney and I told him to “kill the deal,” he agreed (to not do customer research, even as a reference check). Turns out the top, 25%, customer was doing a “test kitchen” of new systems without inviting their current provider (the seller’s firm) to participate. No wonder the seller didn’t want any customer related due diligence. (By not talking to the customers a buyer risks not knowing about damaged relationships. If the customer has already stopped doing business and is still disclosed in the purchase and sale agreement as being an active customer there should be protections in the representations and warranties in the agreement, although it’s still deception and a major hassle.)

And this is not confined to the small business and lower middle market. Just look at what’s in the headlines about We (WeWork). 

When it comes to integrity and ethics, 99% of business owners have a high level (unless you count blending the personal and business checkbooks). But the other 1%…

“Don’t look back. Something might be gaining on you.” Satchel Paige

Non-compete Agreements Become Almost Worthless (in Washington State)

This is a little different than our regular memos, but I feel it’s an important subject for Washington business owners.

I recently sent past and present clients a fantastic summary of Washington State’s new non-compete law, taking effect January 1, 2020, which I received from Jeanette Adams Gorman with Socius Law Group in Seattle.

I received a lot of “thank you” and “interesting” comments but the best was, “Wow! this is distressing.” I was a bit surprised so many business owners hadn’t heard much about this.

I won’t get into the details (and I’m glad to send you Jeanette’s report) but will give you my top takeaways.

  • Non-competes will only be applicable to people earning $100,000 or more with the threshold for independent contractors is at $250,000.
  • Non-solicitation agreements and non-disclosure agreements, including sharing of trade secrets, are not affected.
  • Non-competes when the business is sold are still valid (the seller is bound by it).
  • There may have to be compensation to a terminated employee if the company wants to enforce a non-compete.

I encourage business owners to get professional advice on this, so you’re prepared for 2020. Advisors, make sure your clients are aware of this.

“An ounce of prevention is worth a pound of cure.” Benjamin Franklin

Is it Crazy for a Business Owner to Pay A Buyer to Take Over the Business?

Many business owners claim their business would take off if only someone did a few simple things. The usual suspect in “simple things” is to do more marketing. Really? If it’s so easy why isn’t the current owner doing these supposedly simple things? And why would a buyer take the chance on these “simple things” working?

An example

A friend pointed out a retail business for sale whose owner claims it’s in a great location. And it is, for walking around and (having fun) but not for what this business does, given the congestion and limited parking.

The seller states with a little marketing and the addition of multiple additional services they could substantially increase the revenue. This includes extending their hours and hiring more employees. In today’s tight labor market good employees are hard to find and it’s made to sound like it’s easy to find good people. 

Also, the business’s sales are declining, it’s breaking even, and the owner is not taking a salary. 

The seller has a five-year lease, probably with a personal guarantee, and other obligations. It may be cheaper to give someone the business or pay a “buyer” to get out of that lease, other obligations, and the associated worries and headaches.  

Even in this case the “seller” needs be able to back up “why” the business has the potential to get out of its rut. All buyers want to see a clear path to growth and know where they can add value. 

Let’s be realistic, the above is a bit extreme (also rare is hiring a buyer on a consulting contract to fix a business and then buy it via an earnout, but I’ve seen it). But in rare cases, paying to discard a business, like we pay to take junk to the dump, may be better than five more years of hard work for no pay. 

“What’s surreal to you is just somebody’s Wednesday somewhere.” (Novelist) Karen Russell

This was written by Jessica with John’s input

The Grass is Always Greener (When You Only Care About Headlines)

One thing President Trump and other politicians have in common is the bashing of large tech companies. It used to be bashing Walmart. Yes, Walmart took over a lot of small to mid-sized towns. Yes, some small businesses (perhaps many) didn’t survive. But the politicians made it seem like these small retailers were thriving businesses with very high paid employees. 

After talking to owners of and/or looking at information on thousands of businesses I can say, 

“Overall, there aren’t that many good businesses.”

There are a lot of companies providing the owner a well-paying job and nice lifestyle, but these don’t have much value. Value comes from profit over and above owner salary. There are even more businesses with overworked owners whose salary is just adequate. 

When I’m asked how businesses are valued my initial response is, “I don’t know anything about your company and in general, it’s a function of profit. The more profit, the higher the value.” So where is all of this going? To these three points:

  • If you own a thriving business (solid profits after your fair market salary) realize you have one of the ~20-25% (the top quartile). Keep it there, grow it, get yourself out of the day-to-day, and if you have a dominant customer, diversify ASAP.
  • If you’re a business buyer, realize it’s like the old “needle in a haystack,” so keep searching because it can take a long time. Not only do you have to find a business in the top quartile, the owner needs to be motivated to sell (for a fair price), and it has to match your skills.
  • If your business is barely getting by, it’s a struggle to pay bills, you can’t save any money, etc. realize it will be tough to sell. And, by all means, remove from your head thoughts like, “We’ve been in business for 15 years so there’s value to the name.” As per above, the value comes from profits.

We all think what we have is great – better than cold beer (or lemonade) on a hot summer day. But that’s not what matters. What matters is what others think including banks, buyers, appraisers, etc.

“Strive not to be a success but to be of value.” Albert Einstein