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

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

Lessons From Events

On November 6 we* hosted our 10thanniversary “Getting the Deal Done Breakfast Conference” at the Bellevue Club. About 150 people heard about our featured topic of management buyouts & buy-ins from our panel and our presenters, Tom Varga, founder of CFO Selections, and Kevin Briscoe, CEO.

Tom and Kevin shared their experiences and feelings as part of Tom selling off ownership and giving up control and Kevin investing in the company and taking over its leadership. They were incredibly open. One might say it was “open kimono” time as they shared detailed financial information, their fears, and the results. FYI, Kevin shared with me prior to the start they wondered if they could fill 30-35 minutes. They did such a good job we had to stop questions after 60 minutes.

Our panel then discussed our thoughts and experiences with management acquisitions. And, of course, Marc had his annual prop, a statue of Zeus with the lightning bolt of tax, which he brought out to signify the exciting tax law changes from the recent tax bill.

Some of the insights offered by our panel included:

  • Make sure management wants to take on the responsibility of ownership, and, most importantly, they are willing to sign personal guarantees (and if there’s a bank use their home equity as collateral).
  • How to handle it when the business is too large for management to buy (using other investors).
  • Financing options, the bank and more.
  • What entity should the buyer’s firm be, especially if there’s roll-over equity for the seller?
  • What the bank is looking for in both the buying team and the company moving forward.
  • What’s the bank’s relationship with the buyers and will the buyers agree to guarantees.
  • The industries most conducive to a management buy-out (construction and professional services top the list.
  • How advisable is it for the founder to stay on in some capacity?

We had to hustle to end at 9:30 so all-in-all, a very successful event.

* Greg Russell – PRK Law, Marc Hutchinson – Hutchinson Walter CPAs, John O’Dore – Chinook Capital Partners, and Kit Gerwels – Columbia Bank

 

On November 13 I was part of a panel presenting at Seattle U as part of their Family Business program. Others on the panel were Julie Eisenhauer with Clark Nuber CPA, Jesse Ficks with Skis Painting, and Casey Schindler and Jake Licht with Baden Sports.

The focus of the meeting was “Value Creation” and it was a combination of Q&A, small group discussions, and audience participation. Besides giving overviews of our respective business we discussed:

  • Strategies and tactics the operating company representatives have used to grow their business.
  • Examples of how the two advisors have worked with clients.
  • Measuring of value, i.e. it’s not just the dollar amount. This includes culture, life balance, passing the business on to the next generation, the quality of work, and keeping valued employees
  • The challenge of change when you have longtime employees.
  • Having a strategy and matching it to value drivers.
  • The use of metrics, management reports, etc. to make decisions.
  • The softer things like safety training and getting rid of bad customers.
  • Knowing what’s important and what excites you.

In addition, one of the audience members shared how his company has made four acquisitions and how they were willing to pay more for companies with “their house in order.” In fact, he said one company received twice as much (multiple of earnings) as another because they had their house in order.

The bottom line, if you run a company as a business and not as a lifestyle, cash cow, or toy business you make out in the long run, both financially and emotionally.

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.

Sometimes You Just Can’t Win

In the Seattle Times October 7, 2018 business section’s, “Speaking of Business” feature (a weekly roundup of quotes from the week’s most popular stories) were a couple examples of the above headline.

“We listened to our critics, thought hard about we wanted to do, and decided we want to lead.” Jeff Bezos on Amazon’s raising it’s starting wage to $15 an hour. Amazon got a lot of praise and then the Seattle City Councils admitted Socialist declared Mr. Bezos evil because he’s still rich. Others jumped on board because the wage increase came at the expense of stock grants, which were eliminated.

“It’s been a little like watching the air going out of a balloon.” Richard Lattanzi, steelworker and mayor of Clairton, PA on the unmet expectations of higher wages and better benefits due to tariffs on steel imports. The workers initially cheered because they felt the tariffs would raise all boats but now feel it’s only raising company profits not wages (correct based on other reports).

Everybody has an agenda. From the shop workers to middle-management to executives and especially the politicians. I don’t think this is different from past eras. One of my first jobs, in high school, was cleaning a warehouse a few evenings a week. I lost the job when the manager had a friend become unemployed and he got to take over the minimum wage, part-time job.

Every decision we make has repercussions, some good and some not so good. Being in business is often like raising kids. You better make sure you think through how others will perceive “what’s in it for me.”

“There are no easy answers, but there are simple answers.” Ronald Reagan

The Scan That Saved My Business’ Value

The title paraphrases a Wall Street Journal article from August 27, 2018 titled, “The Scan That Saved My Life.” The sub-title includes, “After years of exercise and healthy eating, a reporter’s blocked artery came as a shock.”

A health industry reporter, who exercised, ate healthy (a lot of salmon, oatmeal, and similar but with a passion for cheese), and paid attention to his health found out he had a almost completely blocked carotid artery. He had an ultrasound scan after a few “minor” symptoms of something being off. This resonated with me because a good friend had a stroke this past summer and found he had a 99% blocked artery.

Business Scan

Scans, tests, exams, and similar are common and necessary when health related. But when it comes to businesses, most owners don’t want anything close to a diagnostic exam of their company. Probably why the WSJ wrote only 10% of businesses are likely to sell for maximum value and Kiplinger’s wrote, “Most businesses will sell at a discount.”

Why won’t owners want an assessment of their business? Three reasons come to mind, for small, mid-sized, and lower middle market firms:

  1. Ego– the attitude of nobody knows my business better than me, it’s special, it’s unique, the standard rules, i.e. proven good business practices, don’t apply to my firm. I remember a client who, every time a strategy or tactic was discussed started out his reply with, “Yes, but….” and went on about how his firm was different.
  2. Time– yes, it takes time. Whomever is doing the assessment will interview the owner, management, key employees, customers, walk around observing, etc. It will take time away from the day-to-day, but it does give a fresh perspective. Here’s an example. A client had a very thorough assessment done and one of the observations was the shop employees have a quasi-union going on, meaning they set their own rules. Interesting.
  3. Money– money always plays a part in this, especially when the owner doesn’t think others will “get” his or her business.

Benefits

You can assess the financial systems, operations, management, marketing, and other areas. Here’s what you should get from it.

  • Confidence your numbers are true and correct or an understanding of what will make them better. Accurate financial statements will help with operations, the bank, and any eventual buyers.
  • Uncovering cultural issues or advantages. The quasi-union mentioned above is one example and on the other end of the spectrum is a client who says they have no problem finding employees because of their reputation. In fact, their vendors refer people to them because it’s a better place to work than others in their industry.
  • Better operations are often the result of this. It could be work flow, sales, supply chain, marketing, sales, or something else.
  • Growth will occur when bottlenecks and inefficiencies are corrected.

Overall, this means an owner will know more about their competitive advantage and how to exploit it.

Conclusion

The previous sentence is no doubt the most important item in this article. When you have a competitive advantage and use it your company has a much better chance of thriving. To be an owner, and especially a founder, means you are super confident. It shouldn’t mean you know it all or should refuse advice from experts. The owners who value outside advice, are in peer groups, and always strive for continuing education have a much greater chance of success whether it’s a few employees or hundreds.

 

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