Planning for your smooth transition
Subscriber Benefit
As a subscriber you can listen to articles at work, in the car, or while you work out. Subscribe Now
Deciding how and when to exit one’s company is a challenge that faces all owners. The stakes are generally high, as most owners have a substantial portion of their family wealth invested in their business. This necessitates proper preparation and advanced planning to ensure that they can eventual transition out of their business, on their own terms and timeframe.
Maximizing value while maintaining operations through the transition process is a daunting task. Here are some key factors owners should consider as they prepare for their potential exit.
What drives the value of your business?
Determining a reasonable value is one of the first steps in transition planning. To get the best price takes preparation and focus. Potential buyers prefer to consider companies that are well organized and transparent.
When the time comes to sell a business, deals often collapse during a buyer’s due diligence when problems are discovered. Being proactive in identifying problems and developing solutions to mitigate or reduce them helps to de-risk your company for the future owners. Potential suitors prefer no unwelcome surprises during the sale process.
Picture yourself from the buyer’s perspective. Given what you know about your business, would you buy your company in its current condition? What will drive future value for a buyer? Can the business continue to operate effectively and grow if you are no longer at the helm?
Reducing risk is a key element in a proactive transition strategy. The goal is to make your company more attractive to create a competitive buyer environment, increase value, improve negotiation and deal terms, and minimize the time to close the sale.
Understanding business value: Why EBITDA matters
There are several methods for valuing a company. One of the simplest and most common methods is based on a cash flow measure known as EBITDA (earnings before interest, taxes, depreciation and amortization). The EBITDA metric gives a snapshot of the raw earnings potential of your business.
To get an estimated value for your business, multiply EBITDA by a multiple. The multiple is a “rule of thumb” multiplier. It typically falls within a range and is based on company size and recent deal activity in your industry. The multiple can vary based on both internal and external economics. For example, a company with $5 million of EBITDA and a multiple of 5 could be worth $25 million. Estimating your company’s value using EBITDA is a great starting point. However, to get the best measure of current market value, you should seek the counsel of an investment banker or a valuation specialist.
Preparing for the future sale of your business
As discussed, advanced preparation is the key for maximizing your company’s value. Here are some recommendations to consider as you prepare your company for potential new ownership.
- Get your business documentation in order. Make sure all your business operation and process documentation is up to date. Formalize and extend key customer and vendor contracts and confirm that well-documented procedures are in place.
- Organize your financial statements. Make sure your financial recordkeeping and reporting are transparent and easy to evaluate. Carefully evaluate non-business-related expenses that may appear on your business’s income statement. Look for clear lines of separation between personal and business expenses.
- Consideration a “quality of earnings” analysis. Typically conducted by an independent Certified Public Accountant (CPA), a quality of earnings or “QE” analysis will determine if earnings are reliable and sustainable. Paying for a quality of earnings analysis before going to market may help identify areas of weakness.
- Develop formal strategic plans. Look to reduce risks that may decrease the value of your business. Evaluate your business’s core competencies. Develop a strategic plan for each key business segment, such as sales, marketing, operations, technology, finance and legal. Know how your business compares to other in your industry and look to boost the key metrics.
- Create business succession and contingency plans. Prepare formal succession plans and communicate them to your leadership team. Such plans are critical when it comes to running a professional business and building confidence with prospective buyers.
- See that legal records are in good order. Review and shore up your employee procedures and agreements. Assess and address any open environmental, compliance or regulatory issues. Review lease agreements and take a closer look at real estate holdings. Make sure your intellectual property is adequately protected.
- Secure your leadership team. Potential buyers want to know that you have a strong management team in place and that they will provide continuity through the transition. Having arrangements like deferred compensation, retainage or transition bonuses and non-compete agreements could give added confidence to a buyer.
- Consider a formal board of advisors with outside members. A board of advisors can provide perspective and experience, especially when going through a transition of ownership. Consider including outside members who own or have owned successful private companies. Outsiders bring fresh perspective, provide guidance and can help you see the big picture differently.
- Minimize your business’s reliance on you. A common concern for most small business is whether or not the business can survive and thrive without the current owner. Establishing a seasoned management team and building solid succession and contingency plans helps lessen the company’s reliance on any on person and thus makes it more attractive to an outside buyer.
Each business is different and preparing for a transition is a complex process. If you lack a comprehensive plan to pass on your business, now is the time to give serious thought to a formal business transition plan. A well-crafted transition plan identifies a long-term strategy that can inform short-term decisions. Start thinking about how you can maximize the value of your business today.
Steven Young is a Senior Vice President of Wealth Management for UBS Financial Services. He is the team lead for the Business Transition Consultants based in Indianapolis, IN.