Why deferring exit planning can impact your business valuation
Looking at Exit options should never be left to the last minute. To achieve a full valuation on your business many elements need to be thought about and prepared long in advance. Failure to do so will have a negative effect on your business valuation.
While it may come as a surprise to many M&A advisors, the reality is that business owners seldom consider the timing of their own exit option. Entrepreneurs are by nature a curious bunch, who (rightly) put customer and staff satisfaction, as well as future business development before any consideration of what many advisors will tell you is the “most important decision of your life”. Leaving aside the condescending nature of such a statement, (since I know most entrepreneurs understand the importance of their life decisions in a way which is unimaginable to the ordinary advisor), the fact remains that timing your exit is a subject that should be given due consideration sooner rather than later.
The timing of your retirement plans can affect the valuation of your business.
The successful sale of your business at a premium value, ultimately involves both the buyer and seller being satisfied that they have both concluded a good deal. While it may be perfectly understandable for business owners to consider their future retirement plans in isolation, this fails to consider the attitude of the buyer to such a retirement plan, which is a key component to securing a successful outcome.
It is not surprising that business owners dream (even when awake!) of a time when they can safely hand over the reins of their business when it is has become a true testament of their historic achievement. After all, Business Owners first fight to establish their business, then navigate through all the minefields that the economic roller-coaster can throw at them, while all the time driving it forward until finally the business reaches its peak and it is time to exit.
But also missing from this equation, is an appreciation of how an owner’s retirement plans will affect a buyer’s interest and thus the valuation. This is where timing becomes so important,
A buyer’s assessment of a business will always rely heavily on the continued involvement of the business owner. No matter how modestly the business owner might represent the impact of his involvement, and his value to the business, it is rare that a buyer can separate the success of a business from the steady stewardship of its owner. Since a buyer regardless of their future plans aims to preserve value, they will often seek to lock in the seller for a transition period of between 1- 3 years, so that the special recipe continues unchanged post-sale.
Many large TIC buyers need to rely on the management of the company they have acquired.
This logical position is often overlooked by sellers due to a common misconception that large TIC buyers have a crack team of ready-made business leaders ready to be deployed at a moment’s notice. The reality is that these TIC players compete in similar markets where price is king and will often operate with a surprisingly lean base. This means they will be heavily reliant on the continuity of current management to steady the ship in the initial years after an acquisition to ensure the business achieves its investment business plan. If the seller seeks retirement immediately or within 1 year there will be an additional risk factor to the acquisition. Any such additional risk will impact the valuations offered, since the normal short-term risk of acquiring and integrating a new business has just been compounded by the need to recruit and transition a replacement leader.
How to reduce the risk to the buyer and increase your businesses’ valuation
There are two obvious approaches which a seller can take to mitigate this risk to the buyer.
One approach is to put in place a succession management plan for the business. While ultimately this is the best solution to accelerate an owners exit, the timing of it is key. It is important that such internal development or external recruitment is “substance over form”, since only the most credible succession will pass detailed diligence of a buyer, who will naturally approach with a highly skeptical eye and will need to be satisfied that appropriate experience is being retained. To that end such succession should be transitioned at least 1-2 years before you seek a sale, and this may involve the seller himself transitioning into a part-time role, so that the recent successes can be a reflection of the new management, as well as offsetting the additional salary cost incurred.
The other approach is to anticipate a buyer’s reaction, by considering the sale of your business some 2-3 years before you want to retire or exit. Such approach would ultimately see the owner continue leading the business under the new owner for 2-3 years, and the issue of succession management would not need to be considered until the business is completely stabilized under their new ownership structure. The benefit of such an arrangement is that a buyer will often seek to reward the seller for continued service through a range of benefits including performance or retention bonuses, group share-options, an earn-out arrangement for upside trading or even retention as a minority shareholder which can often be highly lucrative. Of course, from a buyer’s perspective such seductive arrangements simply represent a means of “locking-in” management to offset the alternative risk of losing the seller’s experience. Such arrangements can often drive a premium package for the seller.
Planning and Timing are key.
What is critical to note however, is that both approaches rely on careful planning and timing well in advance of any potential exit. Otherwise, the end result will not optimize the personal ambitions of the seller.
At Red-Swan Partners our team have extensive experience from growing and selling their own businesses, being TIC corporate’s M&A executives, as well as working with a wide range of TIC business owners to support them in the development of their own exit strategy. This wealth of relevant market experience allows us to work with business owners to develop the most appropriate plan well in advance of an exit, to ensure that the seller intentions do not conflict with obtaining a premium value for your business. Benjamin Franklin, the US’s founding father once is quoted as saying:
“by failing to prepare, you are preparing to fail”
Red-Swan are ready to assist in ensuring appropriate advanced planning to ensure a future successful exit and we are also ready to help you identify the ideal timing to avoid any negative impact on your business valuation.