Depth Not Dependency

At the start of the 2018 baseball season you might not have believed it when you saw a record number of games snowed out across the Midwest. The Seattle Mariners got off to a decent start is and that’s pretty good when you consider four starters (all proven good hitters) were each on the disabled list for 10 days or more.

They’re winning, and hitting well, because they’re lineup has depth. And depth is something too many businesses ignore. Yes, a lot of owners’ love being in control, but it doesn’t add value.

Maybe I’m sensitive to this because recently I’ve run into a lot of businesses that sound great until you find out what the owner does, which often is way too much. One was described by his number two as, “a very active president” but it’s another that deserves mentioning.

When the owner said he could only be reached at 8:00 pm or later it caught my attention. He has what appears to be a very successful business, but my comment upon learning more was, “He has a high-paying, long-hours job” and the business has a dependency, which is him.

During the day he visited job sites, ran a machine, met customers, etc. At night (8-11 pm he said) he did bids, bookkeeping, and other office work. Yes, he made good money but how could someone replace him? No sane buyer would pay for the company based on the current profits knowing they’ll have to hire a full-time employee to replace some of what the seller does.

The point of business is to have people below your pay grade do work you shouldn’t be doing. As they grow and get experience they should delegate the same way to others. This is what’s called depth, not a dependency.

“Isn’t it nice to think that tomorrow is a new day with no mistakes in it yet?” Novelist Lucy Maud

 

It wasn’t even a full moon

It was mid-month, not even close to a full moon, when I had three weird and similar situations occur with business owners.

  1. An owner told me he would be glad to sell his business, but nobody would see his financial statements or tax returns. Only his CPA and the IRS see them he said. It seems he had sold another business to a consolidator that only cared about revenue. All he had to do was prove his revenue and they were happy. He figured this applied to all business sales.
  2. My friend Tom Broetje with CFO Selections talked to me about a possible referral and warned me I’d have to explain to the owner why he’d have to share his tax returns. I guess he questioned why he’d have to show them to anybody (buyer, bank, etc.).
  3. Finally, we got an NDA from an owner and the last paragraph said the buyer needed make a $5,000 completely non-refundable payment just to see the financial information. When I said in my 25 years in the buy-sell industry I’d never seen or heard of this she replied, “Well, we’re pretty savvy businesspeople.” No, you’re not. You’re not motivated and just being annoying.

I know there’s a (small) trend of people buying houses without seeing them in person but they don’t buy sight unseen as they take virtual tours and often have agents onsite to advise them. People wouldn’t take a job without meeting their boss, reviewing the requirements, etc.

And that’s what a buyer’s analysis is, a virtual tour (see the financial information), “interviewing” the seller, and studying the product, processes, etc. This is normal and something the seller should do on a buyer, an employer on a new hire, and a business on prospective customers and vendors.

Flip the Switch

Recently I got an e-newsletter from my friend Allan VanderHamm with Berntson Porter.

Allan is their valuation and exit planning expert and the newsletter was titled, “How Does Exit Planning Protect Business Value?” My response to Allan was:

One of my lines is, “Owners don’t wake up, flip the switch, and say I want to sell in 2, 3 or 5 years. They flip the switch and say, it’s time to get out (now).”

The newsletter told the story of two owners of similar businesses and how one owner worked very hard, “in the business” and the other sought and acted on advice and worked, “on the business.” The latter owner built a team, converted to S Corp status, and did something near and dear to my heart, grew by acquisition (one of my top reasons to consider growth by acquisition – along with 18 others in my book Company Growth By Acquisition Makes Dollars & Sense – covers how the larger the company the more it will sell for, all else being equal (because the multiple of profit gets higher as businesses get larger).

Planning is important, as is timing. I recently had discussions with a client who would like to sell to one of his three competitors (given his industry, these are the only logical buyers). We talked about where the business is, where it will be (this year is shaping up to be a very good year for him), and the time of the year (it’s a seasonal industry and now through September is the busy season).

While he has a feeling of urgency to move on to his next great adventure in life, it makes sense to do a few things within the business, go full speed ahead to maximize revenue and profits, and be able to present a great story in six months.

The above is a mini-version of a planning story. It does take time and effort to shift from, “what we do now” to “what we need to do to make the business more attractive.” And it can be threatening to an owner who wants to be in control of everything, because one thing that makes a business more attractive, and adds value, is a self-sufficient management team. A solid team means there’s a greatly reduced likelihood of a dependency on the owner.

The last point about owner dependencies is one of my top four things an owner can do to increase value, make the business more attractive to buyers, and have a better business along the way. The other three things are:

  • Show you can grow, don’t just say it or say we tried to keep the business where it is.
  • Have solid financial systems and accurate financial statements. (One of the first things I do when I see financial statements is check if the year-to-date income on the P&L is the same as the year-to-date income on the balance sheet. You’d be surprised how often it isn’t the same.)
  • Demonstrate you can attract and retain good employees (especially in our currently tight labor market).

Conclusion

The 80-20 might even be the 90-10 rule when it comes to owners flipping the switch. It is tough to manage a business, be in control, and implement (a new) strategy. So, it all catches up on the owner, they flip the switch, and say now’s the time. Finally, this is completely different than the owners who are coasting by design, as in, I’m making good money so why would I want to work harder to make more? It’s the same end point but via different routes.

The Magic Question – What Does the Owner Do?

Often simple is the best course of action. In fact, Ockam’s Razor, from William of Ockam in the 14th century, states one should solve problems by choosing the solution that makes the fewest assumptions.

In the case of buying and selling a business, there has to be a match between the skills and interest of the buyer and the seller. And it goes a lot deeper.

The following simple little question to the seller uncovers at least five issues or opportunities. That question is, “What does the seller do on a daily, weekly, monthly basis.” Let’s examine this.

Skills match – as per above, it lets the buyer know if there’s a match between the duties he or she wants to perform and what the seller does (or should I say what the seller needs to do). An overly analytical, introvert type person may love the business model but if the owner is a key component of the sales team and process it’s probably not a good fit. Correspondingly, the outgoing, “I want to be in front of customers” buyer isn’t a good fit for a business requiring attention to detail on bids, contracts, job prototypes, etc.

Dependency – In my talks I say to audiences, you have a dependency on the owner if you can fill in the blank with statements like, “If the owner is the only one who can ___________:”

  • Program the machine
  • Make the big sales
  • Approve all bids

Most people think of dependencies in terms of customer concentration but in small business it’s what the owner does or doesn’t do that often makes a difference. Buyers want owners who can take off for three weeks and return to a company in as good of or better shape as when they left.

In versus on – as in, the buyer wants an owner who works “On” the business versus “In” the business. Working on the business means strategy, growth, vision, etc. Working in the business means being on the shop floor, making sales calls, doing bids, etc. While on the surface it may look like opportunity if the buyer can add strategy and vision, in the short-term it means hiring someone to do the day-to-day tasks that are eating up the seller’s day. It’s the difference between having a job as company president and having a job similar to when the buyer was an employee.

Lifestyle business – my favorite story is about the owner (seller) who told the buyer how he and his sales team worked just hard enough to make the income they wanted and didn’t work anymore. He lost a great buyer who figured changing the culture of laziness to one of growth would alienate the employees, and he’d lose them. This was a lifestyle business, and there are a lot of them.

2No number two – just like on Star Trek Next Generation, you have to have a good number two (employee). Actually, when we say, “no number two person is a red flag,” what we’re really saying it’s the tip of the iceberg, meaning there’s no management team. It ties into the above reasons because it means the owner is integral to the day-to-day operations, works in the business, and this is probably not what the buyer wants in a business.

A simple little question that opens up a plethora of information. As a PS, one of my other top questions for buyers is, “Can you see yourself going there every day?” This one is a gut check, to make sure it’s not just emotion driving the buyer’s interest in the business.

Deal Die When Trust Disappears

It was a bolt-on acquisition, a perfect fit, and a small deal. And it died. It died because of the relationship, or lack thereof.

The buyer and seller seemed to get along fine but a few things happened that caused the buyer to not trust the seller to deliver on post-close obligations.

It started when the seller asked to delay the closing by one month, which didn’t fit the buyer’s plans because that month was a high revenue month (while the next month was a low revenue month), the buyer had other initiatives tied to the acquisition, and some comments made (by the seller’s team) brought to light the fact the seller’s wife was a lot more important to the business than previously claimed.

Then a very reasonable purchase and sale agreement was virtually destroyed by the seller’s attorney. All the legal language issues aside, the edits made it very clear the wife wouldn’t be available for much transition support. This after realizing she is the key employee. Plus, there was again language about delaying the closing date.

Trust is a synonym for relationship. Whether you’re a buyer or a seller, when your gut tells you something is wrong, the chances are high something is wrong. In any event, go with your gut feel.

Emotions and Negotiations

There was a story in the sports section about a Toronto Blue Jays pitcher who had just gone through baseball’s salary arbitration process. He is, to put it mildly, irritated with the team. He said it was tough sitting in a room hearing how bad you are for five hours.

Now let’s put that in perspective. As I recall, his salary was going to about double and the arbitration was over if it should be about $5 million a year or $5.5 million. I am guessing the team wasn’t badmouthing or denigrating him but giving statistical backup as to why their offer was justifiable (compared to his asking price).

My question is, why was the player in the room? Isn’t this something his agent should handle? There are reasons for agents, intermediaries, and other client representatives. When it comes to negotiations we can shield our clients. Someone can tell me what they think about my client, the offer, or anything else about the deal that might be taken the wrong way (and I can do the same to them).

We all know the feeling. I remember selling a truck, the prospective buyer showed up, and the first four or five things out of his mouth were all pointing out what was wrong with the truck. He thought he was negotiating. I thought he was insulting and there was no way I was going to sell it to him unless the offer was for the asking price, which of course it wouldn’t have been.

I’ve sat in meetings where business buyers and sellers have yelled at each other, and then closed the deal. If your skin is so thin you can’t take it, use a pro.

“Human beings are the only creatures who are able to behave irrationally in the name of reason.” Anthropologist Ashley Montagu

 

Employee Lesson From Sports

In early January the Seattle Times broke a story saying the Green Bay Packers asked the Seattle Seahawks permission to interview Seahawks general manager John Schneider for the GM job in Green Bay.

The Seahawks refused permission and Schneider supposedly wanted to interview for (and wanted) the job. The Times reported NFL rules say permission can be denied if it’s a lateral move but can’t be denied if it’s a promotion. It became a moot point Sunday when the Packers filled the position.

I doubt this will have any effect on any of the parties moving forward but things like this can be sticky situations. Many years ago a client had an employee leave, they went to enforce a non-solicitation agreement, the customer said, “we don’t want to be in the middle so figure it out (without us).” What do you do? Run up legal bills, lose any chance with the customer, or let it go?

I remember another client who did everything right when hiring someone but the industry’s 800-pound gorilla put their legal department on it and the cost of winning wasn’t worth it.

What’s interesting about sports is it’s in the culture to groom people (primarily assistant coaches) for advancement, knowing the advancement will probably be with another team. There’s pride in seeing protégés move ahead, as it should be.

“Never take anyone’s advice.” John Banville

If You’re in Business You’re Providing Value

Recently we had to take our Kitchen Aid mixer in for repairs. I was amazed at the sight of hundreds and hundreds of small appliances on the shelves of the repair shop. In this age where so much is disposable (think electronics like a DVD player) there were a lot of items being rehabilitated.

It demonstrates there’s a need for all kinds of services. The shoe repair shop near us looks the same, hundreds of items on the shelves. Good shoes or boots cost hundreds of dollars and it makes sense people want to keep them even when the basic parts wear out.

Think about where you add value. The above examples are simple to understand. Your appliance works again or your shoes don’t leak. At “Partner” On-Call we always said our goal is to have our clients better off with us versus without us. Here’s a simple three step process.

  • Determine how you can get in front of more people you can help (it’s using the phone and in-person meetings, not Twitter).
  • How do you figure out the value you can add (ask questions)?
  • Impress them with valuable information before they hire you (no hard sell, have them realize what they’ll be missing without you on their team).

We all can provide value. But if your value stays hidden within you it’s not helping anybody.

“A life spent making mistakes is not only more honorable, but more useful, that a life spent doing nothing.” George Bernard Shaw

Make Yourself Dependent

We recently went out for dinner with some good friends and in our discussions the husband touched on how his customers tell him if he was to leave they don’t know what they’d do (he’s in sales of technical production equipment). In other words, he’s indispensable, at least in the short-term.

I often mention how business owners need to reduce and eliminate dependencies but there’s a flip side to it. Often we need to make ourselves a dependency. This can take many forms.

As described above, an employee with special skills, especially in small to lower middle market businesses, has job security. Not only is it expensive to replace someone, in today’s market it’s darn hard to find great people. Our friend has good job security.

When your company provides crucial services to your customers you’ve become a dependency to them. Without abusing it, it’s revenue security. It’s why repeat business and any “value-add” service is the top choice of business owners (and buyers).

On the other hand, if you are the reason one of your suppliers has customer concentration issues you have some leverage (as long as there are other suppliers). This one is easy to abuse. I remember in grad school learning about how Sears would become the highly-dominant customer of mid-sized businesses and use that to buy the company, and not at what the price would be if they weren’t so dominant.

While I “preach” about the evils of dependencies, if you’re the dependency it can be a good thing.

What Drives Business Sellers

I was recently asked if money was the top issue for business sellers (once they’re motivated to sell). My answer was it’s one of the top three, which are (in alphabetical order):

  • Employees
  • Legacy (including taking care of customers)
  • Money

Every owner/seller has different priorities, like we all do when it comes to business and life. There are reasons we stay at our job, leave our job (usually it’s the boss not the company), start, keep, buy, or sell a company.

It’s a rare business owner who doesn’t mention how important the employees keeping their jobs is to the deal. It’s why in all my books (including the upcoming, Company Growth by Acquisition Makes Dollars & Sense) have a diagram of the three-legged stool demonstrating how the buyer, seller, and the employees all want job retention but fear one of the other parties will kick a stool leg out.

Customers are almost as key. I’ve had owners tell me how they don’t want their competitors serving “my customers.” This is legacy. The business grows, the customers are happy, and the employees are happy.

Money is obviously important and at the same time I’ve worked on numerous deals where the seller sells for less (than they could have or less than other offers) because it’s the right buyer. The flip side also happens, buyers pay a little more because they know what they can do with the business and don’t want to lose the deal over money. As a private equity person told me years ago, “If we pay four times EBITDA and it doesn’t grow it’s a bad deal. If we pay seven times and it grows like we want it to, it’s a great deal.”

If you have any other important priorities for sellers let me know.

“If your dreams do not scare you, they are not big enough.” Ellen Johnson Sirleaf