In our prior post on transferable value, we described the business characteristics that buyers demand if they are to purchase a business. As you know, Value Drivers are critical because they can create business transferable value—the Holy Grail of Exit Planning.
Transferable value is what a business is worth to someone else without its original owner.
Business owners aren’t always aware that transferable value is more than a formula involving multiples of earnings or some projection of discounted future cash flows. To point them in the direction of transferable value, Exit Planning Advisors ask, “If you permanently leave your business today, would it continue with minimal disruption to its cash flow?” An obvious follow-up question is, “Who will be responsible for running the business without you—and with minimal disruption to cash flow?” The answer advisors are looking for is, “My company’s management. They’ve already proven their ability to grow the company.”
While a company’s management team is also instrumental in growing cash flow or business value, the discussion advisors have with owners relates to growing cash flow beyond the capabilities of the owner. We call those managers “next-level.” Peter Drucker calls them “entrepreneurial management.” Either way, they are indeed the mother of all Value Drivers.
Drucker, says this about entrepreneurial management: “It requires . . . building a top management team long before the new venture actually needs one and long before it can actually afford one."1
Spotting Next-Level Managers
Next-level managers are often those who have worked in companies that are larger, often much larger, than the business-owning client's. They know how to grow companies at least to the level of the larger companies they’ve worked for. Finding next-level managers involves attracting people with the experience and skill sets necessary for the company the business owner wants and needs it to be.
That, we believe, is part of Drucker’s message to entrepreneurs: Growing a business significantly requires management that knows how and what to do, management that has done it before for a larger company. This level of management will demand more money, and perhaps ownership, as a condition of employment.
Breaking It Down for Business Owners
Skilled Exit Planners assign three tasks to owners who appreciate the value of developing and retaining next-level management.
Task 1. Attracting and retaining next-level management can involve training and coaching existing management to the level needed, adding next-level management, and replacing or transferring underperforming management.
Making the decision to replace existing management is not easy for owners. Still, most usually have a gut feeling when doing so is the right decision. When that intuition butts up against loyalty, friendship, and the obligation they feel toward long-time managers, advisors can help them stay the course.
When owners consider whether to replace part or all of their management teams, advisors can help them understand that doing so is normal for rapidly growing companies. Next-level management, in large part, causes that growth. Eventually, the first set of next-level managers may also be replaced.
Advisors can reassure owners that hiring next-level management does not mean casting out management employees with six weeks of severance pay. Members of current management may still be very valuable, just in different roles. Often, they can remain employed and perform well and responsibly, but in a sphere more appropriate to their experience level.
Task 2. If appropriate, advisors engage management consultants and outside resources to spur growth. Exit Planning Advisors maintain robust networks of other professionals so they can recommend the appropriate consultants to assess, train, and coach existing management.
BEI member Ken A. Stiefler, CExP™, did exactly that in working with one of his Exit Planning clients. “This owner brought me in when he recognized two things about himself: (1) Too much of the business revolved around him, and (2) he wasn’t capable of taking the business to the next level. In an effort to change his role, the owner began planning to replace himself by (1) bringing in a new general manager (instead of simply delegating to existing management), (2) creating a plan to delegate his responsibilities, over time, to others in the company, and (3) looking at outsourcing some tasks.”
Task 3. Only owners can provide leadership and motivate top management to achieve the goals owners have set in their exit or growth plans. Advisors work with owners to design plans that provide strong incentives to management to remain with the company beyond the owner’s departure.
Motivate for Today and Tomorrow
Motivating employees to perform at a higher level benefits owners today and tomorrow.
Current Benefit: When owners provide top managers financial incentives designed to grow cash flow or business value, the company is more likely to achieve the value or cash flow necessary to support the owner’s exit goals.
Future Benefit: Well-designed incentive plans also motivate management to remain after the owner exits. To thrive, management usually must stay in the business when owners leave. If they do not, transferable value suffers and the owner is not likely going to achieve their financial or values-based goals.
Exit Planners commonly use a “non-qualified deferred compensation plan,” or NQDC plan, that involves both a benefit formula and vesting schedule to motivate and retain key employees.
The benefit formula typically relies on a performance benchmark that motivates participating key employees to increase the profitability or cash flow goals of a company. Employees usually receive cash awards—typically about half of it paid in cash each year if cash flow or profitability reaches or exceeds the pre-determined benchmark. The remaining half of the award is deferred and subject to vesting. Unless the business or key employee reaches the benchmark, employees receive no benefit.
Vesting schedules in NQDCs are similar to those used in many qualified retirement plans such as 401(k) or defined benefit plans. Like many qualified plans, a key employee is vested in the benefit over several years. If that employee leaves before becoming fully vested, they forfeit part or all of the accrued benefit.
The appeal of incentive plans for key employees (i.e., management) is understandable: To create transferable value, someone other than the owner must be similarly motivated to grow value and produce the cash flow necessary to achieve the owner’s exit goals and continue the company beyond the owner’s exit. That “someone” must be, can only be, the management team.
If all fails, invoke the Father of Modern Management, Peter Drucker: Unless owners “build a top level management team before [their company] reaches the point where it must have one,"2 a company will not be the great, durable enterprise it must be to enable owners to leave it when they want, for the money they need, and in the hands of the successor they choose.
- Drucker, Peter F., The Essential Drucker, HarperCollins, 2001, 145.
- Drucker, Peter, F., The Essential Drucker, HarperCollins, 2001, 156.