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

 

Don’t Forget to Have Fun

By Jessica, with a tad bit of help from John

Page one of “Buying a Business That Makes You Rich” lists the top nine reasons audiences have shared on why they want to own a business. The reason we think is the most important is, “to have fun”. But over 98% of the time it’s not mentioned.

According to a recent article in the Wall Street Journal, “An Ignored Skill in Aging: Having Fun,” seniors have experts on almost all age-related issues except on having fun. Yet, they are the ones with the most time to have fun, many say they have forgotten how since they have spent the last forty years plus going to work, raising children, and taking care of aging parents.

Seniors have fun and business buyers looking for something that will be fun have a lot in common.  Fun is in every aspect of our lives work, family, and friends, as it should be.

Dread getting up in the morning and going to work? How productive can you be if it’s not fun? FYI, the Gallup poll on the workplace shows about 70% of workers are not happy or engaged in their jobs, and it’s been that way for at least five years. And, if it’s the grind of a job you hate it will take a toll on other areas in your life.

When this happens, people start thinking about a career change to bring back the fun.  For some it is to own their own business. Sick of the corporate world, they want to call the shots and benefit from their actions and decisions.

If this is you, one question to ask yourself is “What are my reasons for wanting to own a business?” Chapter one goes into a bit more depth on how to answer and assess those questions. (And realize, it’s not for everyone.)

On the other side, there are the business owners that are ready to move to their next great adventure in life. Hopefully they have an exit plan for a smooth transition and to pave the way for the new owner’s success.

A Win-Win! Is when the buyer comes in and has fun and the seller leaves with style, and grace and more money.

When buying or selling a business, the two parties involved need to have a good relationship. One thing we often hear from business owners talking about selling is “take care of my employees, they’re family.” If a seller feels like her employees are not going to be taken care of, it could mean the difference between deal or no deal.

Employees are just one example, but the buyer needs to understand what is important to the seller, it is imperative they get along and have a great working relationship. They both need able to wake up and be excited for the day ahead.

Control Doesn’t Mean Controlling

“I like being in control. I don’t like to listen to anything from anybody.”

The above is from the owner of a struggling business on the TV show Restaurant Impossible. When my wife and I heard it we immediately hit rewind so we could play it again and transcribe it.

I’m sure there are all kinds of fancy names for this as it’s one of the most common traits of business owners, especially founders. Ironically, in my opinion, the strongest statements about being in control come from owners of business not firing on all cylinders. No wonder there are over 1,000 books on Amazon when searching by “delegation” and over 300,000 when searching by “management.”

The top “blemish” I see in the hundreds of companies I come in contact with every year is a controlling owner who:

  • Has his or her hands in everything
  • Thinks they’re the only person who can do it right
  • Believes delegating is a sign of weakness

I recently visited my friend and past client Keith Jackson, owner of Industrial Revolution. He told me his four-person management team pretty much runs the day-to-day. On a personal note, Jessica has been with me since January 1. I turned over some client-based office work and she’s doing things I don’t know how to do, getting it done faster than I could, and this allows us to grow the business.

Being in control doesn’t mean doing it all. It means making sure it gets done and done right, and that makes the business more valuable.

“Only the educated are free.” Epictetus

The Value of Non-Compete Agreements

By Jessica (with a little help from John)

Recently I (Jessica) attended a presentation at Equinox Business Law Group titled “Non-compete, Non-Solicitation and Non-Disclosure, Oh My! Crafting Effective and Enforceable Employee Restrictive Covenants.” Victoria Bartow did a wonderful job presenting and I learned things that I wasn’t aware of, given I’m new in this industry. Here are the most important things I learned.

  • The best time to have an employee sign a non-compete is at the time of hiring. If it’s done with an existing employee there needs to be compensation, as you’re changing their terms of employment.
  • When there’s an asset purchase of the business the employee is newly hired by the buyer and no compensation is required (but can be given).
  • If you are going to have non-compete agreements for everyone in the company, make sure you tailor it to the person’s specific role. Don’t have the same criteria for the office admin as you do for a sales associate.
  • It is good practice to ask a potential employee if they have any restrictive agreements from past employers before you hire them.
  • When considering if you need an employee non-compete, an important criterion is if they have access to proprietary information that is of value to your business. For example, customer lists, sales methods, trade secrets, and business strategy are just a few. If it’s of value to your business and could hurt you if used against you, then you should have a non-compete agreement.
  • A non-solicitation agreement means if an employee leaves your company they are not allowed to solicit your customers or employees for their benefit or the benefit of a competitor. This can eliminate the worry for any owner, especially a new owner post-sale.
  • Employee non-complete agreements are generally not enforceable as you can’t prevent someone from earning a living in their chosen profession, but you can enforce a non-solicitation agreement. Non-competes with a business seller are enforceable, as there’s significant compensation given via the purchase price.

“A wise man once said, nothin’ at all” Drake

 

 

The Best Business Sale Transactions are Facilitated in an Environment of Full Disclosure

Guest post from Gregory Kovsky with IBA in Bellevue, WA

Due diligence is a process that benefits both sides in a business sale transaction.  For the buyer, it is an investigative process used to verify the information employed to make the decision to negotiate a letter of intent to purchase the business.  If the information is not verified, the buyer should either exit from negotiations or attempt to renegotiate the terms of the transaction.  For the seller, the goal for due diligence is to create an environment of full disclosure for the buyer, so the buyer completes the transaction with “open eyes” with a clear understanding of the potential and risk associated with the acquisition.  If an environment of full disclosure & knowledge is created, then post transaction liability for the seller will be mitigated because the future success or difficulty of the company after the change of ownership will be tied to the buyer’s management ability and not a lack of knowledge.

There is enough risk in entrepreneurship without adding the variable of making decisions without a good foundation of knowledge.   An experienced mergers & acquisitions professional will outline a strategy & process for facilitating due diligence between the parties.   Many potential transactions are lost in due diligence.  Facilitating due diligence without an experienced intermediary, accountant, or attorney managing the process can have similar results as asking a sailor to circumnavigate the globe without GPS, a sextant, or star map.

As a 24-year mergers & acquisitions professional, I have successfully facilitated 100’s of due diligence processes on the road to completed transactions.   I have also witnessed alarming discoveries related to business practices during due diligence that have amazed me in terms of their sophistication and dishonesty.  In addition, I have seen situations where a buyer ignored information or warning signs and completed transactions to their future detriment.  The following are four examples of unique due diligence situations that occurred in transactions facilitated by IBA.  In the first two situations, there was no way the business broker facilitating the transaction or the buyer purchasing the business would have discovered the situation without a comprehensive due diligence process.  In the final two situations, the issues were presented to the buyer by IBA in the environment of full disclosure created for the transaction and ultimately ignored by the buyer in completing the transaction.  It is also true in all four situations the seller understood the mechanics of business valuation.  It is my hope in sharing these stories that the information can be used by future business buyers to avoid completing a transaction at an inflated value resulting in enhanced entrepreneurial risk.

The Shell Game Playing Entrepreneur

The seller in this transaction owned two companies and operated each under a unique set of tax identification numbers with the IRS and State of Washington.  One company was a mature company with a good customer base making reoccurring purchases and a track record of increasing revenues & profitability.   The second company was a young business that was struggling to reach profitability. The seller in this transaction wanted to sell his mature business to inject capital into the new enterprise to enhance the tangible asset & employee infrastructure, rate of growth, and potential for success of the new company.  Superficially, this was a reasonable narrative regarding the motivation for sale.  The mature company was valued based on its historical financial performance and presented to potential buyers in the marketplace. Market reaction was positive and agreement was reached with a buyer for the sale of the business.  Due diligence commenced and the buyer, their CPA firm, and lender all found the tax returns & historical financial documents justified the value of the business agreed to in the letter of intent.  Funding secured the transaction was targeted for closing.  As a final stage of due diligence, the buyer reviewed the accounting software employed by the business for paying billswith the primary goal of identifying expenses that could be reduced after acquisition through better management and potential vendor migration.   However, the investigation uncovered unexpected information.  The mature company was not paying all the bills associated with its operations.  A percentage of its bills were being paid by the business that was not being sold. The net result of this action was negligible for the seller when the financial performance of the two companies flowed together in the seller’s 1040 tax return.  However, for the buyer the action had significant implications as it resulted in a significantly overstated purchase price for the mature company because every dollar of additional profit was multiplied five times when the goodwill of the business was valued.  The shell game revealed, the buyer exited from the transactions with encouragement & facilitation by IBA.  Shortly afterward, IBA ended representation of the client.  On a positive note, IBA presented another company to the buyer and the party completed the transaction successfully achieving their acquisition goals.

The Doctor Who Wanted Just a Little More than Market Value

The seller in this transaction was a doctor who wanted to retire and sell his practice.  It was a good practice in a good location with an excellent staff.  The seller was happy to sign a robust non-competition agreement, as retirement would start with the sale of his practice.   The practice was valued based on its historical financial performance and presented to potential buyers in the marketplace.  Market reaction was positive and agreement was reached with a doctor for the sale of the practice.  Due diligence commenced and the buyer, their CPA firm, and lender all found the tax returns & historical financial documents justified the value of the business agreed to in the letter of intent.  Funding secured the transaction was targeted for closing.  As a final component of due diligence, a reconciliation of monthly revenues was conducted between QuickBooks and the bank statements.  It was identified during this process that the company had an abnormally strong revenue day.  Curiosity demanded investigation.  The buyer for obvious reasons wanted to know what had occurred and whether it could be repeated.   Unfortunately, what was discovered could not be repeated.  The seller had deposited an inheritance check in the business account and counted it as business revenue in the most recently completed tax year. This action had increased the value of the practice significantly when a multiple was applied to the additional net profit in the subject year when calculating the value of the practice. The inappropriate action revealed, the buyer exited from the transaction with encouragement & facilitation by IBA. Shortly afterward, IBA ended representation of the client.  Like in the previous example IBA eventually facilitated the sale of another practice to the buyer.

The Business Owner Who Worked Days, Nights, and Weekends

The seller in this transaction was a highly skilled, hard-working, financially motivated entrepreneur.  As is the case with many business owners, she managed the company to maximize the income personally derived from the company on an annual basis.  One of the ways she enhanced her income was by working long hours in the business at a high level of productivity reducing the need for support employees.  This labor contribution to the business and the resulting low labor costs made the business look like a “cash cow” on its tax returns.  As is often the case when business owners sacrifice work/life balance for dollars, the owner of this business started to “burnout” and contacted IBA to sell her company.  The seller was honest with IBA related to her labor contribution to the business and two full-time labor equivalents with the seller’s experience & skill set were incorporated into our evaluation of the business to determine its “fair market value” prior to taking the business to market.  Properly valued, the business was brought to market.  Market reaction was robust as buyers valuing the business using standard multiples believed they had identified a value proposition. The business owner & her IBA professional intermediary consistently conveyed when meeting with potential buyers that the business was not a value proposition when labor was “right-sized”. It was a good company offered at a “fair” price.  A buyer believing he could personally replace the seller’s labor contribution eventually bought the business at its full asking price.  Several years later, he shared with me that his personal hubris regarding his abilities made him believe he could fill the seller’s shoes. This ended up not being the case. He ended up having to add 1.50 employees to the staff, in addition to himself, to replace the business owner. He acknowledged and appreciated the honest presentation of the company by the seller & IBA.  A presentation of historical facts (tax returns) could have been facilitated without comment regarding the seller’s labor contribution, but this is not the way IBA does business.  IBA has a reputation in the marketplace for facilitating transactions in an environment of full disclosure with integrity employing “best practices”. This is one of the reasons that annually entrepreneurs who purchased businesses from IBA in the past return to IBA for representation in the sale of their companies.  This return for sale is the best testimonial a buyer can provide IBA related to the quality of the representation services we provide our clients.  It is also the reason quality buyer brokers like, John Martinka, regularly encourage their clients to evaluate IBA represented businesses as acquisition opportunities.

The Business Owner Who Overpromised & Underdelivered

The seller in this transaction had a business model that generated cash sales.  He elected to not include a portion of the cash sales in the revenues he reported to the IRS and Washington Department of Revenue.  The business owner made a persuasive case to IBA regarding the annual amount of unreported revenue.  IBA elected to represent the business for sale for a value between what could be verified through tax records and what was conveyed by our client as the ‘true” picture of business profitability.  A willing & able buyer with relevant industry experience was identified and agreement reached between the parties on a Letter of Intent.  Due diligence commenced and it became apparent that the information conveyed earlier by the seller during the business valuation process was not accurate and the seller was continuing down a road of dishonest communication.  IBA’s professional intermediary representing the business for sale decided he could not be party to the transaction without jeopardizing his personal integrity and the integrity of the firm.  IBA’s representation agreement was terminated and the seller advised that he was welcome to proceed with the transaction without financial liability to IBA.  The IBA intermediary also conveyed to the buyer that he was ending his representation of the business, would not be receiving a commission, and encouraged the buyer to walk away from the deal.  Unfortunately, the buyer ignored this advice and completed the transaction. Several years later I learned from the buyer the business was closed, that he had lost his investment, and was back working as an employee.  He ended the conversation by saying how much he respected the integrity of his intermediary as a professional with the comment, “I was an idiot not to walk away when a business broker who was two weeks from getting paid walked away from the transaction and his commission, there could not have been a clearer warning side of a bad transaction.”.  As a general rule, IBA does not represent businesses for values that incorporate unreported income.  It is our philosophy that if a party would lie to the IRS and Washington Department of Revenue that they would lie to IBA and a potential buyer for the business.

George Bernard Shaw famously said, “The most tragic thing in the world is a man of genius who is not a man of honor”.   History is full of geniuses who made the world a better place and people who used their intelligence to find shortcuts to fame and fortune.  Over time sunlight will generally reveal the truth about any situation.  IBA is pleased to employ “best practices” in the sale of privately held companies.  It is our goal in every transaction we facilitate to create an environment of full disclosure & transparency between the parties during the due diligence process.  The knowledge & experience of how to facilitate a due diligence process correctly is one of the reasons why IBA has successfully sold more businesses to entrepreneurs in the Pacific Northwest than any other business brokerage firm since 1975.

Gregory Kovsky, the President & CEO of IBA, is available as an information resource to the media, business brokerage, and mergers & acquisitions community on subjects relevant to the purchase & sale of privately held companies and family owned businesses.  Professionally, as an intermediary, he specializes in the sale of manufacturing, distribution, technology, industrial, marine, and winery businesses. Mr. Kovsky can be reached directly at (425) 454-3052 or .  Additional information on IBA, the Pacific Northwest’s oldest business brokerage firm, can be found at www.ibainc.com.