Creating Transferable Value: Value Driver Number 1

Submitted by John Brown on Mon, 07/27/2015 - 10:30am
Transferable Value Image with Ladder Stack Coins and Graphs

Do most advisors know how to help their business-owning clients clear the biggest hurdle that stands between them and the business exit they desire: increasing business value? Overwhelmingly, the answer is no. Even among BEI-trained Exit Planning Advisors, few advisors can roll up their sleeves and dive into a client's business to help them grow value and establish transferable value. Fortunately, Exit Planners don't need to know how to help grow business value. What they do know is:

To exit their companies successfully, most owners need to increase business value. The amount by which they must increase value depends on the individual owner's Gap Analysis.  

Peter Drucker, the world's foremost management consultant, held that a fundamental requirement for creating a successful enterprise is "building a top management team long before the new venture actually needs one and long before it can actually afford one."[1]

Professional buyers judge the value of the companies they evaluate as possible acquisitions by looking at the strength of a company's Value Drivers, the most important of which is management. They recognize the value of great management teams and "...don't always bring in star outside managers to run the companies they buy. In fact, they much prefer to buy a company with strong management in place. . . .'The strong preference is to use the talent in the company,' says General Atlantic chairman Steven Denning. 'You want to back a superb management team and liberate them.'"[2]

We agree with both Drucker and the professional buyers. In fact, creating, motivating, and retaining great managers is central to all efforts to grow business value.  

Having best-in-class, seasoned management is indispensable to any company's long-term growth. The reason is simple: Management is responsible for the creation, direction, and rate of growth of all other Value Drivers. Best-in-class management creates transferable value more effectively than any other Value Driver.

A business owner cannot be the only person responsible for driving growth if the company is to grow beyond the abilities of the owner. Companies must grow beyond the limitations of the owner if they are to have transferable value.

Transferable value, as we've discussed in previous articles, is a company's ability to continue operating successfully, with minimal disruption to its cash flow, after the owner leaves. In the absence of transferable value, businesses can't be sold for enough money to bridge the gap between what owners have today and the amount they need to live financially independent lives. For owners and advisors, understanding what can be done to increase the strength of the management team is vital to assuring that business owners exit on their terms.

How Can Advisors Help Business Owners Develop a Best-in-Class Management Team?

Most professional advisors don't directly focus on helping owners find, develop, motivate, and retain management teams. It is likely, however, that they could (and, I'd argue, should) be involved in some aspects of this task.

Exit Planning Advisors are constantly involved in helping owners create (if necessary), develop, motivate/incentivize, and retain excellent management teams. Rarely are they experts in this area, and generally, they don't have the knowledge necessary to counsel owners on how to properly develop this most important of all Value Drivers. What they do have is a solid understanding of what needs to be done and by whom.

Exit Planning Advisors:

  • Educate owners about why they need best-in-class managers to exit successfully.
  • Introduce owners to best-in-class advisors who have the skills and experience needed to develop superior management teams.
  • Coordinate the efforts of owners and specialized advisors to ensure that all recommended actions are completed on time.

Educating Business Owners

An advisor's initial role in helping owners develop best-in-class management is to explain and document the need for great management "long before the company can actually afford it." The two primary reasons to do this are (1) management (not the owner) will be responsible for developing the other Value Drivers and (2) best-in-class management is necessary to move beyond the limitations of the owner and perhaps the limitations of the current management team.

Management team development is indispensable to business growth and transferable value. Private equity firms know it: That's why they insist on best-in-class management and so should business owners. The advisor's role is to help the owner evaluate current management based on its current performance and its ability to grow the company.

Additionally, for an owner's eventual exit to be successful, great management must remain after the owner's exit. Third-party buyers will insist on it, and if insiders (key employees or children) assume the reins, they must be capable of managing the company if the owner is to be paid after exiting. Thus, part of every Exit Plan is the creation of incentives not only for managers to perform (meet performance standards necessary for the development of the company) but also stay after the owner exits.

Introducing Business Owners to Best-in-Class Advisors

Most advisors possess neither the training, skills, nor experience necessary to create or develop management teams. The typical Exit Planning Advisor facilitating the creation of an Exit Plan also lacks these skills. However, Exit Planning Advisors know what needs to be done and which advisors in the community have the know-how to do it. For example, what a particular business owner may need could include:

  1. An evaluation of current management's ability to grow business value to the level needed to achieve the owner's financial independence goals.
  2. Assisting owners in finding, hiring, and compensating new management.
  3. Designing incentive programs to motivate top management to achieve an owner's goals as described in the Exit Plan.

Exit Planning Advisors then involve specialist advisors who know how to accomplish these tasks.

Coordinate Efforts

It's likely that advisors often educate business owners about, and recruit advisors from, areas outside of their current core practice. The advice and products of those outside experts are often integrated into those advisors' work. Exit Planning is no different. What is different is the broad and diverse range of information and advisors involved in the planning process.

Assessing and developing a management team, for example, is beyond the scope of most advisors. Advisors need a process that covers what needs to be done, not how to do it. That process tells advisors who must perform each task and when the task should be performed. BEI has a network of advisors that includes all of the professional specialists that may be required  It is the advisor's job to initiate a process that:

  • Describes what owners need to do to exit their companies on their terms.
  • Helps them close the sizable gap between current business value and the value they need to exit successfully.

To close the gap, advisors start with the pre-eminent Value Driver, a great management team, and recruit and coordinate the efforts of a best-in-class Advisor Team. In future articles, we'll discuss the other Value Drivers.


References

  1. Drucker, Peter F., The Essential Drucker, Harper Collins, 2001, page 145.
  2. http://archive.fortune.com/magazines/fortune/fortune_archive/2006/11/27/8394344/index.htm


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