Begin with the end in mind! For many business owners, planning for the future often becomes a priority only as retirement looms. However, there is significant merit in shifting this mindset from merely maximising profits in the present to strategically building a business that increases in value over time.
Starting to think about succession or exit strategies earlier on in the life of your business not only prepares you for retirement; it also opens up opportunities for increasing your business’s worth over its lifecycle. This proactive approach enables you to implement strategies to improve your current business performance but also enhance its appeal to future buyers or successors, potentially even before you’re considering stepping down.
Why have a Succession Plan?
The best way to capture your strategy for exit or succession is to put together a Succession Plan. This document will help you distill the key aspects of what your endgame is, key milestones, valuation methodology, and who the key stakeholders are. Importantly a good Succession Plan will also outline the strategy to drive up the value of the business and provide a powerful way of focussing your ongoing effort – a good device to help you keep your eye on the prize!
In addition to helping capture a plan for the exit of your choice, a succession plan will also cater to the worst-case scenario – where are a result of unforeseen events you are unable to continue to run the business. A Good Succession plan can help avoid confusion and additional emotional stress by outlining instructions regarding how the business will continue to trade if it enters a crisis.
Common Exit Options
There are a range of ways that owners can either sell down their stake in the business or completely exit. following is a list of various options to consider based on the stakeholders involved and the goals of the existing owner.
- Wind Up / Liquidation: This is where the owner winds up the business and sells assets on the market. Often used when there is no obvious value in the business outside the owner’s individual effort.
- Water down and Step Back From Operations: Once the business has a strong team and robust systems and processes there is an option to sell a stake in the business to key staff or family members, maintain access to company profits but not be as involved in daily operations.
- Sell to Family: Selling or transferring the business to the next generation is still fairly common in trade businesses. Because of the relationship dynamics involved this can either be a smooth transition that works extremely well in terms of transferring wealth from one generation to the next. Without a clear plan that is well communicated this process is at risk of derailing not only the company activity but also family relationships.
- Sell to Existing Partner/Shareholder: It’s common to have multiple partners in a business, and eventually have one of these partners sell to the other/s. This may happen over time as part of an agreed watering down of equity with either staff or family members.
- Sell to Staff: Another common exit plan is where one of your team has shown interest and real promise in taking on the business. As with family succession, selling to staff can quickly go off course if there are no clear expectations regarding the value of the business, the timeframe for the exit, and the role the employee may have played in creating value in the business.
- Sell to an External Party: Either through a connection or via a broker, selling to an external party is also an option. In some cases this option presents the opportunity for a higher value, however, this will depend on your ability to clearly demonstrate the value of the business without you involved – i.e. What are they really buying?
Valuation Models
A key aspect of your succession and exit strategy is arriving at what you think is a fair market price for the business. The primary models in use when it comes to trade businesses are:
- Earnings Multiple: where your annual profit is multiplied by an agreed figure to arrive at the value of the business. This method can be used where the ongoing profit of the business is not directly tied to the current owner’s activity and where there is clear evidence of ongoing demand – like long term customer contracts. Read further in this article to learn about areas of the business that can act as value drivers to dial up the earning multiple.
- Asset-Based Value: where there is no real certainty around the ongoing profit potential of the business and/or where the majority of the activity and profit is clearly the result of the existing owner the value of the business can really only be determined based on the assets of the business.
Value Drivers
When it comes to increasing the earnings multiple of your business value the core theme is all about the businesses ability to generate profit without the owner being involved. A good way to answer this is by asking yourself how long you could go on holiday without everything falling apart… an hour…. day… week… months???? Following are areas you can focus on in your succession planning to drive up the earnings multiple:
- Location: Your business may be in a geographical area where there is high demand and few competitors or high barriers to entry.
- Business Model: Operators who are reliant on winning new projects and contracts, and who don’t have a team carrying out this activity will struggle to demonstrate ongoing value. Alternatively, if you have long-term formal contracts in place for maintenance work this can underpin the confidence around future profits.
- Specialisation/Niche: Values can be increased through demonstrating unique expertise within a specific niche, as long as there is clear demand and a lack of competitors.
- Customers: aspects that impact value here when it comes to customers include the diversity of customers – are you relying on one customer for a large amount of revenue). Do you have formal contracts in place with customers who will continue to work with the business?
- Market Presence and Marketing Assets: How strong are your brand and marketing systems and processes? Have you set up a good machine for lead generation that will outlive you as the owner?
- Team: One of the key drivers of value is the strength of your team to run the business without your input. Importantly you will need to make it clear what arrangements are in place with key staff both in terms of contracts and also what would motivate them to continue to work in a business when you’re not there.
- Systems and Process: This is a critical value driver. You might have a great team, but without you, they don’t know what to do, or the system is your own custom design that is impossible for anyone else to drive. To drive up the value of the business you need to be able to show your business is underpinned by well-designed systems that are documented, understood by the team, and based on industry-standard platforms and techniques.
- Financial Visibility: Finally, you may have nailed all of the value drivers mentioned above, but not be able to show the impact in your financials. This is often the case because the financial reporting in small to medium businesses is often prepared only for tax purposes – not for a commercial accounting audience. Key figures like your ratio of GP to Overheads and what your EBIT figures look like over time are critical. Apart from the headline numbers other key metrics like GP per employee, utilisation rates, and profit per customer/project need to be accurate and obvious.
Tax and Structure
The last thing you want is to have a large chunk of the proceeds of your business disappear through tax because you didn’t have the right structure and weren’t leveraging the tax arrangements on offer.
This is a complex space so it’s important that you get specialist advice on how to structure your business and tax affairs. At the core though, the most important principle to acknowledge is that you have to make plans for your exit well before the proceeds of the sale hit your bank account! It will be too late to get an optimal outcome by then.
The importance of having a good plan!
Planning for the future is not just about preparing for the end of your career; it’s about making informed decisions today that will enhance your business’s value tomorrow. A good plan will not only drive up future value, it will increase your earnings potential in the short to medium term. The ingredients to improve the exit value of your business are exactly the same as those you need to maximise your current earnings.
Need help with your plan?
Our team are specialists in helping business owners not only drive up their current earnings but putting together effective plans for the future. We work alongside our clients to implement the changes required to increase the value of their business and the quality of earnings. And when it’s time, we help clients negotiate and navigate the sale of their business, working at every stage to make sure our clients get the best possible outcome.
If you’d like help with building and executing a plan to maximise the value of your business, get in touch today for a free consult to find out more.
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