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Transferable Value: The Hard Truth

Submitted by John Brown on Fri, 06/12/2020 - 8:00am
money

When Ida and Gary Nella began to think about leaving their business, they didn’t know who to turn to for advice. Neither their CPA nor financial planner had ever raised the topic of Exit Planning. Unlike so many owners, the couple took action. They set up a meeting with a mergers and acquisitions advisor to discuss what their company would likely sell for—in about five years.  With that piece of information, they could make a decision on if and when they wanted to sell, for how much, and to whom.

During their meeting, the M&A advisor (Ramon) looked over their financials and asked questions about the business. All was going well until he told the Nellas that their company had little value to a third-party buyer.

“How can you say that?” Gary asked. “We make over a half million dollars per year!”

Before Ramon could respond, Ida added, “There’s got to be plenty of buyers who would jump at the opportunity to run a company with our profit margins!"

"Your company only has that level of profit,” Ramon began, “first, because you two work 60 hours a week and rarely take vacations. Second, third and fourth, you don't pay a management team, have updated systems, or do any significant marketing. Without the two of you present, there would be no profit, so what would a new owner be buying without you two in the business?”

“But an owner would make $500,000 per year!” Gary reminded Ramon.

“That’s true,” Ramon agreed, “if that owner had your knowledge, had the business relationships you have, and was willing to work as hard as you do.”

Ramon continued, "Private equity firms are the likeliest buyers for companies of your size. The problem here is that they focus on three primary value drivers. First, they look for capable management team members that will stick around after the business is sold. These firms also require that the companies they acquire have up-to-date operating systems and broad customer bases. There are plenty of other value drivers that buyers analyze, but those are typically the top three value-driving characteristics these buyers demand.”

“Plenty of other value drivers?” Ida managed to ask.

“Yes,” said Ramon. “But let’s focus on the first value driver: a reliable management team. Today, you are the management team. Aside from that, the company’s marketing systems are not current and eight customers account for 75 percent of revenue. Unless you build a management team that can address these issues and install other value drivers, you won’t be able to sell the company for much,” Ramon concluded.

After the shock wore off, Ida and Gary decide to hire capable managers. They approached two candidates who were working for competitors and offered to match their current salaries and award bonuses equal to 20% of any increase in annual cash flow. The two agreed to come on board if Ida and Gary documented salary, bonus arrangements and responsibilities in employment agreements. The Nellas happily agreed and had their attorney draw up the agreements. Once the agreements were signed, Ida and Gary were elated. The exit they imagined before they met with Ramon was finally becoming a reality.

In our next post, we see what the Nellas’ attorney recommended they include in those employment agreements and what the Nellas decided to do.

Takeaways

  • The top three value-driving characteristics that professional buyers require are:
        •  
    • Strong management teams
    • Current operating systems
    • Customer diversity
  • Businesses that are run primarily by owners tend to lack transferable value.
  • Owners of these businesses seldom have proactive advisors so the advisors who do reach out to them have a great opportunity to help them.


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