Building with the end game in mind

Editors’ note: This is the third of a three-part series from Lawn & Landscape on exit strategies for business owners.

©iStockphoto.com/Saul HerreraDid you know that only one of three businesses is able to successfully transition from the first generation to the second? And only thirteen percent transition to the third generation? In my experience, the reasons fall into several categories: children are less and less likely to stay in the family business; businesses are becoming larger and more complex to pass on; the founder wants liquidity that potential heirs are unable to provide; and there is a lack of professional succession planning.

The odds are that your children or grandchildren will not step up to take over your business. However, your commitment to planning for your exit will increase the probability of a successful succession, whether to your children or an outside buyer.

Building with the end game in mind means building a business that will be attractive to potential owners above and beyond its intrinsic or book value. Here, we’ll outline concrete steps for increasing the value and marketability of your company so that you can exit at the right time for maximum value.

It’s important to remember that the goal of any potential buyer of your company will be the same as yours – to grow your company’s revenues and profits. The ideal time to sell your company is while its prospects for continued growth and profitability are still on the rise. While you continue your goals of increased revenue and profits, positioning your company for sale requires an additional focus on shoring up your company’s infrastructure, putting an effective organizational chart to work, recruiting a best-in-class team of employees and advisers, and keeping accurate, organized and professional records. Here are some tips for transforming your business into one that could generate a bidding war among buyers.

Revenue, Growth, Profits 
To get maximum value for your company, you should ideally sell when the business can demonstrate both historical and projected growth. If your profits are flat to declining and you’re able to attract buyers, they will likely be the variety who want to buy your business cheap. And as we’ve previously discussed, your revenue is irrelevant if you are not making any profit. Growth and profitability drive value. Further, in the green industry, value is especially driven by ongoing and repetitive maintenance and enhancement revenues.

While one-time, project-oriented construction jobs might instantly boost sales and profits, their cyclical nature as well as issues of retention and bonding make this segment of the business less valuable from the buyer’s perspective. While a heavier mix of construction is less of a negative in an ESOP transaction than in a sale or a recapitalization, it’s always better to have strong maintenance profits to get the highest valuation.

Bench Strength
Potential buyers may scrutinize your team as much as they examine you, the owner. Remember, the buyer might technically be buying the assets of the businesses but they will find the company’s real value and growth potential in the people – you, your employees and your client base. To push the value of your company, you must build “bench strength” by incorporating key responsible players on your team that will outlast your career with the company.

Simply put, sales grow from relationships. If all your company’s sales are built on the founder’s relationships, potential buyers will question their ability to generate comparable sales when the founder exits. You can boost the marketability of your company by institutionalizing your business development efforts and assigning sales responsibilities to other leaders within the company.

Buyers love to see a team that can shoulder significant growth. However, we often see flat organizational charts where everyone reports to the owner. This is often clear from our very first meeting with a client – the number of times the meeting is interrupted by employees seeking guidance on issues that can and should be solved by someone else is a great barometer of how efficiently the company might run when the owner has moved on. Strive to create a scalable organizational structure so that your company can run without your constant input.

Infrastructure
While a bookkeeper and QuickBooks can get you going and last for a while, they likely won’t support your company through the growth you and your buyer are expecting. Make it your goal to make your information and data work for you. Find and implement resources that your team can access with ease to create and effectuate your growth plans. To grow you must employ systems, procedures and technology. A buyer will be attracted by smooth-running and easy-to-use systems. Many owners think they can skimp on this since the buyer will just plug them into their systems in the end. While that may eventually happen, buyers will discount your value if you have not built an organization of real quality.

Advisors 
While you certainly do not need to go hire the most expensive accountants, attorneys and insurance advisers in your city, it’s essential that you back your success with professional advice. Too many owners stick with their original advisers and end up outgrowing their ability to get all the advice they need. While the practice of being loyal is admirable, you should not sell your company short with advisers who can’t continue to bring you value and expertise. There is tremendous benefit to building a team of advisers that is skilled and experienced enough to see your company through a major sale transaction.

Further, advisers can add value to your company pre-sale by readying your corporate structure and financial records for a smooth closing. For example, an excellent attorney can help advise you on the benefits of registering as an S corporation or a limited liability company rather than a C corporation, prior to marketing your company for sale. While there are a multitude of considerations regarding corporate form, in general C corporations introduce inefficiencies to a sale process, whereas structuring a deal for an S corporation or an LLC is far simpler.

A capable accountant will help you get your financials in shape – drastically reducing the time required to prepare your company for market. Quality corporate information and financials are key to surviving the due-diligence process with your valuation intact. While you don’t necessarily need audited statements to get a deal done, maximizing value is certainly easier when a reputable third-party provider has at least reviewed your numbers and blessed them as materially correct and in compliance with generally accepted accounting principles.

Investment bankers or merger and acquisition advisers can help you understand the specific components of valuation, marketability, timing of the deal (yours and the market’s) and how to position your company to achieve its highest and best value. They can also work with you to help organize your results and slice and dice them at a buyer’s request. A buyer might ask you to list your top 25 clients by revenue for the last three years, demonstrate profitability by service line, illustrate not only gross profits but net income and EBITDA as well, demonstrate client retention over historical periods and separate profits between construction and maintenance work. Are you prepared to do so? Well-suited advisers can remove obstacles to the sale of your company.

Addbacks
You own a business. Expectedly, you enjoy the perks of being in charge – namely, choosing how and when to compensate yourself for all your hard work. While it’s not our job to opine on exactly how you choose to do this, you need to know that your compensation and the perks you provide to other shareholders or family members from the company’s coffers will be scrutinized.

While many of these amounts will be added back in the valuation process, hence the term “addback,” they should not represent too large a percentage of the company’s EBITDA. While you can convince a buyer to make adjustments to the value of your company for these addbacks, and thus normalize the company’s true earnings, there are limits. If the addbacks are egregious, you will raise concerns and doubt in the eyes of a buyer. Significant personal expenses make a buyer wonder whether there are more being hidden and how they will affect the value of the company post-sale.

While you should enjoy the benefits of owning a business and not pay more taxes than you need, pushing the envelope too far hurts your company’s marketability.

It’s never too early to begin looking forward to your exit and planning to make it as easy and as profitable as possible. Keeping an eye on marketability, as well as value, is essential. With these goals in mind and a working understanding of EBITDA and the options that exist in the market, you will be well-equipped to transition your company when the right time arrives.

The author is the managing partner of CCG Advisors. Send him an e-mail at bcorbett@gie.net.