IMPLEMENTATION GUIDE
How to Create a Business That Can Thrive Without You
Like Alex Stapleton, many business owners find themselves trapped in an unsellable business. Customers ask to deal with the owner, the owner becomes personally involved in serving the customer, reinforcing the customer’s reliance on the owner, and the cycle continues. A business reliant on its owner is unsellable, so the owner becomes trapped in the business.
The following eight steps provide a road map for creating a company that can thrive without you. I’ve also included my own personal observations and experiences gleaned from applying the process in my businesses.
Before you start this process, engage a good accountant experienced in helping business owners with succession planning. Depending on your tax jurisdiction, there will be tax-planning strategies your accountant can put into place now that will minimize your tax bill when you sell your business. Do not wait until you have an offer to see an accountant. Timing is critical.
STEP 1: ISOLATE A PRODUCT OR SERVICE WITH THE POTENTIAL TO SCALE.
The first step in building a company that can thrive without you is to find a service or product that has the potential to scale. Scalable things meet three criteria: (1) They are “teachable” to employees (like the Stapleton Agency’s Five-Step Logo Design Process) or can be delivered through technology; (2) they are “valuable” to your customers, which allows you to avoid commoditization; (3) they are “repeatable,” meaning customers need to return again and again to buy (e.g., think razor blades, not razors).
Brainstorm all of the products and services that you provide today and plot them on a simple diagram with “Teachable” on one axis and “Valuable” on the other:
Once you have plotted everything you offer on the chart, eliminate services or products that a customer needs to buy only once.
Often, you’ll find that the most teachable services or products are the ones that customers value the least. Alternatively, you’ll find that the products and services your customers value most are the least teachable. That’s normal. Try combining one or more services or products to create the ideal offering.
By way of a hypothetical example, let’s take a look at how Alex Stapleton might have plotted his services before deciding to focus exclusively on creating logos. You’ll recall he had Elijah working on the branch posters for MNY Bank. Since creating a branch poster is a simple task that lots of marketing agencies can do, Alex would have plotted the branch posters at the top left of the chart: high on teachable, since he could get his juniormost designer to do them, but also low on value to customers because branch posters can be done by lots of other marketing agencies.
You may also recall how Chris Sawchuk was struggling to get the local bicycle shop to be ranked number one on Google’s natural search listings. Chris was a generalist designer without any specific knowledge of search engine optimization (SEO). In fact, SEO is a highly sought-after skill in the market that requires a deep subject matter knowledge and years of experience to do well. Successful SEO is very valuable but also very difficult to teach, which is why Alex would have plotted the SEO project for the bike shop on the bottom right corner of the chart.
On another level, creating logos was something Alex could teach his staff to execute, and since they had come up with a unique, proprietary approach to developing them that clients liked, Alex would have plotted Ziggy’s Natural Treats logo at the top right of the chart.
LESSONS FROM EXPERIENCE
Of the three criteria for a scalable product or service—teachable, valuable, and repeatable—I found the single most important factor in driving up the value of my companies was ensuring my revenue was repeatable, meaning customers had to repurchase somewhat regularly.
Although all recurring revenue will have a positive impact on your company’s value, some forms are more desirable than others. Based on what I’ve learned from talking to buyers, here are six forms of recurring revenue presented from least to most valuable:
NO. 6:
CONSUMABLES—TOOTHPASTE
Consumables are disposable items customers purchase regularly but that they have no solid motivation to be brand-loyal toward.
Each morning I wake up and brush my teeth with Crest Whitening Gel. I’m fairly sure the “whitening gel” is a placebo, but it appeals to me given the amount of black coffee and red wine I consume. Every once in a while, I’ll go off the beaten path and try a Colgate product that promises “extra whitening,” but I always work my way back to Crest.
If you sell a consumable, start tracking your repurchase rate from existing customers. This will be a number that acquirers will use to calculate your projected sales into the future—and to calculate how much they’re willing to pay to buy your company today.
NO. 5:
SUNK MONEY CONSUMABLES—RAZOR BLADES
More valuable than basic consumables such as toothpaste are “sunk money consumables.” In the case of these items, the customer has made an investment in a platform.
When I started using Gillette Sensor razor blades, I first had to buy a handle. Now I buy a new five-pack of blades every month, and I can’t bring myself to try Schick because then I’d have to purchase its handle mechanism. I’ve been a Sensor guy since I grew my first patch of peach fuzz. I’ve made an investment in the platform, and that makes me reluctant to switch providers.
The same is true at the office. When I was in the market for a printer, I bought a Xerox. And even though I probably won’t need to buy another printer for a while, I still have to buy Xerox’s expensive toner cartridges.
Expect to garner a premium for your business if you can demonstrate a loyal group of customers who have made an investment in your platform.
NO. 4:
RENEWABLE SUBSCRIPTIONS—MAGAZINES
Even better than having loyal customers who repurchase is having revenue that is guaranteed into the future. For example, I am a loyal subscriber to Outside magazine. Each year I get a re-up letter, and I send a check to cover my next twelve issues. Outside recognizes one-twelfth of my subscription fee the month it receives the check and each of the next eleven months.
Magazines are cheap compared with the subscriptions that analyst firms such as Frost & Sullivan or IDC sell their customers, which can run into the hundreds of thousands of dollars, making these companies more valuable than their competitors that offer project-based consulting on a one-off basis.
NO. 3:
SUNK MONEY RENEWABLE SUBSCRIPTIONS—THE BLOOMBERG TERMINAL
When customers make an investment to do business with you, they become very sticky. If they buy on a subscription model, you will have one of the most valuable businesses in your industry.
Traders and money managers swear by their Bloomberg Terminal. Bloomberg customers have to first buy or lease the terminal and then subscribe to Bloomberg’s financial information. Having sticky customers loyal to a proprietary platform allowed Michael Bloomberg to build a valuable company.
NO. 2:
AUTO-RENEWAL SUBSCRIPTIONS—DOCUMENT STORAGE
When you store documents with Iron Mountain, you are charged a fee each month until you ask for your documents to be shredded or you agree to pick them up. Unlike a magazine subscription, for which you have to make the conscious decision to re-up, Iron Mountain just bills you until you tell it to stop.
Iron Mountain tracks its cancellation rate down to the decimal point and it can predict its revenue well into the future, which is why it is such a valuable company.
NO. 1:
CONTRACTS—WIRELESS PHONES
The only thing more valuable than an automatic renewal subscription is a hard contract for a defined term.
As much as we may despise being tied to them, wireless companies have mastered the art of recurring revenue. Many give their customers free phones as long as the customer locks into a two- or three-year full-service contract.
As you ascend the recurring-revenue hierarchy, expect the value of your business to go up in lockstep.
Once you’ve isolated what is teachable, what your customers value, and what they need most often, document your process for delivering this type of product or service. You’ll recall Ted helping Alex to define and document the Five-Step Logo Design Process. As Ted explained, describe each of the steps so that you can repeat the model in the same way each time. This will form the basis of your instruction manual for delivering that product or service. Use examples and fill-in-theblank templates where possible to help ensure that your instructions are specific enough for someone to follow independently. Test your instructions by asking a team or team member to deliver the service or product without your involvement. Getting the instruction manual right will require time and patience. Expect to develop many drafts.
Next, name your scalable product or service. Naming your offering gives you ownership of it and helps you differentiate it from those of potential competitors. Once you own something unique, you move from providing a commoditized service or product to providing one whose terms of use you decide. If your product or service isn’t generic, customers won’t be able to compare your price to others’. Instead, name your offering, along with each of the steps you take to deliver it, to differentiate your offer so that you can set its price and payment terms.
After you come up with a great name, write a short description of the features and corresponding benefits of each step in the production of your offering. Revamp all of your customer communications (e.g., Web site, brochure) to describe your process in a uniform way.
LESSONS FROM EXPERIENCE
I used to own a marketing services business that provided focus groups. You know the drill—the clients are sipping beer on one side of the one-way mirror while eight hapless “respondents” on the other provide their feedback on whatever the client wants to peddle.
Focus groups used to be a great business. It cost about $2,500 per group to rent a facility and pay the respondents. We would charge $6,000 for each group and clear a tidy $3,500, or roughly 58 percent gross margin. I say “used to be a great business” because as other companies caught on to the profitability of focus groups, the competition increased, driving down prices. Worse, clients started to issue requests for proposals (RFPs) for their focus groups.
The first time I saw an RFP, I was excited. The client was a big phone company, and it had asked our little company for a proposal to conduct six focus groups. A $36,000 potential order was a big deal for us, so I painstakingly responded to all of the RFP’s questions. I sent off my proposal and waited. Eventually I got a call from the phone company saying it had chosen another bidder. I couldn’t believe it. I’d thought my proposal was perfect.
I followed up with the buyer, and after several failed attempts finally reached him and demanded an explanation. He told me the winning bid was $3,500 per group. I would have had to drop my gross margin to $1,000 per group, or 29 percent! I would have had only twenty-nine measly points to pay for all of my operating expenses such as payroll, rent, and so on.
If you want your business to be profitable, enjoy fat margins, and thrive without you, you need to stop responding to RFPs and start carving out your own oneof-a-kind product or service. RFPs commoditize a category down to the point where the only way for a business to win a contract is to be the lowest-cost provider.
In my business, I decided to develop an alternative to focus groups that I could control the pricing for. We called them “customer advisory boards.” A company that wanted consistent and candid feedback from its customers could hire us to set up and run an annual advisory board on its behalf. We documented the process, developed an uneditable PDF deck for our salespeople to use to pitch the service, and, since customer advisory boards were unique in the market, set the price at a point where the gross margin returned to our historical averages.
STEP 2 : CREATE A POSITIVE CASH FLOW CYCLE
You’ll recall that Alex Stapleton found it hard to make the big strategic changes Ted was recommending, in part because he was simultaneously fretting about having enough money in the bank to pay his employees.
By creating a positive cash flow cycle, you’ll have the financial cushion—and confidence—to make some of the difficult changes required in steps 3 and 4. To create a positive cash flow cycle, charge your customer in full or in part for your product or service before you pay the costs of whatever it is you provide. For example, when you subscribe to a magazine, you send the magazine company your check and then, a few weeks later, you receive the first of a year’s worth of magazines. The magazine company gets to use your money (along with that of its other subscribers) all year to hire writers, editors, and photographers to produce the magazine.
Charging up front for your product or service will be possible if you have documented and differentiated your unique offering properly (step 1). Depending on your service or product, you may not be able to charge the entire amount in advance, but try to get at least some portion of your money before delivery.
A positive cash flow cycle will also increase the value of your company. When an acquirer buys your company, he or she needs to write two checks. One, obviously, is to you, the owner(s); the second check is to your company to fund its working capital—the money required for your business to pay its day-to-day bills. If your business needs lots of cash, the acquirer will have to set aside money for working capital, lessening his or her appetite to write you a fat check. The inverse is also true: If your company generates excess cash, an acquirer will usually pay more for your business because he or she doesn’t have to commit funds to working capital.
LESSONS FROM EXPERIENCE
I was driving home when I got the call I had been expecting from the mergers and acquisitions firm I was using to sell my company. I pulled over—this conversation was going to require some focus.
“We have two offers we’d like to meet to discuss,” said my banker.
My pulse leaped as I tried to contain myself. “Meet?!” I said anxiously. I didn’t want to wait any longer to find out what my business was worth in the eyes of an acquirer. “Are you kidding me? What are they offering?”
My advisers went on to describe the only number I cared about at the time: the purchase price the acquirers were offering to buy my business.
I didn’t realize how naive I was until I sat down with my accountant, who dissected both offers. At first blush, Offer A looked like the better of the two because the purchase price was higher. My accountant, however, encouraged me to look more carefully at Offer B. Offer B included a detailed description of how the buyer would calculate the working capital I was required to leave in the company at closing.
When I first read the paragraph about working capital, I glossed over it, assuming it was irrelevant MBAspeak. Truth be told, I didn’t really know what working capital meant. I had a vague notion that it had something to do with the money we needed to keep in the bank to pay for things, but I certainly didn’t think it made much difference to the relative merits of each offer. My accountant explained that, given the way the potential purchaser was offering to calculate working capital, Offer B was allowing me to withdraw most of the money we had accumulated in our bank account before the deal closed—and since we charged our customers up front, we had built up a significant amount of cash. The working capital calculation in Offer B had the effect of raising the value by more than 15 percent, making it at least as good as Offer A.
If you get an offer to buy your company, the second most important number on the page may be the working capital calculation. If your offer does not include details on the working capital calculation, be sure to lock that number down before you agree to anything.
STEP 3 : HIRE A SALES TEAM
Once you have created and packaged your offering and started to charge up front, you need to remove yourself from selling it. If you have others delivering the product or service but you’re still the rainmaker, you will not be able to sell your business without a long and risky earn-out.
LESSONS FROM EXPERIENCE
In 2002, on the executive education campus of MIT, I learned that I had been selling the wrong product.
I, along with sixty-one other entrepreneurs, had been going to MIT for three years to learn how to be better company builders. The program was called “The Birthing of Giants,” and we had been selected from a pool of applicants who all met the same criteria: own a company with at least $1 million in annual sales and be under the age of forty.
In the final year of the program, Stephen Watkins, an entrepreneur who had recently sold his business, came to the campus to speak.
Watkins began by canvassing the room to see how many of us were involved in selling our product or service to our customers. I, along with virtually every other entrepreneur in the room, raised my hand.
With that, he proceeded to scold us all for spending too much time selling our products and virtually no time selling our company. He went further, and I’ll try to paraphrase his message for you: “Your job as an entrepreneur is to hire salespeople to sell your products and services so you can spend your time selling your company. You make a few hundred or thousand dollars when you sell your product, but if you turned those same skills to selling your company, you can make exponentially more. You have the right skills, but you’re selling the wrong product.”
His message landed on me with blunt force. I felt like an amateur who had gotten a glimpse at a professional game and realized the pros were playing with an entirely different set of rules. Here I was spinning my wheels selling our services when I should have been marketing my company.
From that day forward, the way I thought about my role changed. I started hiring salespeople to call on customers. At first I missed the adrenaline rush of personally making a big sale, but in time I came to enjoy seeing other people make sales even more.
I still went out on sales calls, but they were to people I thought might one day buy my company, not my product.
As you build your sales team, look for people like Angie Thacker who, first, enjoy selling and, second, like the product. Avoid hiring salespeople who come from professional services companies; they will likely want to reinvent your product or service for every customer. If at all possible, hire at least two people to do sales, not just one. For one thing, sales careers typically attract competitive people, and a little healthy competition between these employees will work in your favor; for another, an acquirer will want to see that you have a product or service that can be sold by salespeople in general and not just one superstar salesperson.
LESSONS FROM EXPERIENCE
In the early days of my market research company, I churned through salespeople. Despite my spending hours coaching them and offering plenty of incentives for success, most struggled to hit whatever measly quota I gave them. By contrast, I was consistently able to sell our services. I met with customers, tried to listen to their needs, and went back to them with ideas to fix whatever ailed them. More often than not, they bought what I was selling. It seemed easy, making it all the more frustrating that I couldn’t hire salespeople to replace me.
In retrospect, it wasn’t that I was a superstar salesperson and my team was made up of underperformers. I had simply invested more time learning the market research profession than they had. Like most business owners, in the early days I did both the selling and the doing, so I had executed all kinds of research projects and had made many mistakes, and consequently I’d built a base of understanding around what worked and what didn’t. When I did the selling, I was subconsciously relying on seven years of experience in market research.
My salespeople were being asked to talk intelligently about a wide variety of research services that they couldn’t possibly know everything about. Meanwhile, I was thrashing around grasping for revenue anywhere I could find it and tailoring our services for every customer who asked. All of my zigzagging and customization undermined my salespeople; they were like police officers trying to trail a drunk driver.
It wasn’t until we stopped selling 90 percent of what we were offering in favor of a single subscription of reports and events (step 1) that I was actually able to get salespeople to start making sales. With less to sell, my salespeople were able to master one kind of market research. Again, it wasn’t that they all of a sudden became knowledgeable researchers; they simply got a chance to repeatedly practice a single pitch.
STEP 4: STOP SELLING EVERYTHING ELSE
Once you’ve assembled a great sales team, stop taking on projects that fall outside of the standard offering you identified in step 1. It’s tempting to accept these sales because they bolster your revenue and cash flow. If you’re charging up front for your service or product and your salespeople are selling it, then you shouldn’t have to worry about cash flow. That leaves added revenue as the reason to accept projects that fall outside of your process. The revenue may feel good at first, but it comes at an unacceptable cost: Your team will lose focus; customers, realizing that you’re not serious about your standard process, will see a chink in your armor and start asking for customization of their projects; and to meet this demand, you will need to hire other people to deliver.
I’ve had the opportunity to speak with hundreds of business owners who have made this transition, and most have told me that customers who used to ask for custom services respected the change they’d made to their business model. Many clients actually buy more once the service or product is standardized. Customers are smart; they often know you’re overreaching your capabilities in accepting assignments that fall outside of your sweet spot.
Stopping yourself from accepting projects outside of your scalable product or service is the toughest part of creating a business that can thrive without you. You will have employees testing your resolve and customers asking for exceptions, and you will secondguess yourself on more than one occasion. This is normal; you have to be strong on this and resist the temptation. There is a point where the wind will start blowing the other way and your customers, employees, and stakeholders will finally realize that you’re serious about focusing on one thing. It takes time. It will happen, and when it does and you feel as if the boat has actually shifted, you will have sailed a long way toward creating a sellable company.
LESSONS FROM EXPERIENCE
Business owners often believe that to be “customercentric,” they have to give customers whatever they want. But giving customers too much choice can be a detriment, especially if you’re trying to build a company you can scale and ultimately sell. I learned this the hard way.
It all started after I read a glowing article about Jupiter Research (now part of Forrester), a consulting firm that provided research studies to customers through a subscription offering. Jupiter would do one piece of research and present it to all of its customers. Finally, I thought, a model that could bring some scale and leverage to my consulting business.
I spent the next weekend plotting how to shift my consulting firm to a similar model. I decided that my company would publish six major research reports each year with an annual subscription price of $50,000. It would cost a single company more than that to commission one report, but now the company would be getting a total of six reports—a good deal for the customer, I reasoned. And at $50,000 per subscription, all we needed was one hundred subscribers to have a $5 million business. A good deal for us too.
I divided our prospects into A, B, and C leads. The As were our long-terms clients, Bs were sporadic customers, and Cs were people we’d never met. Interestingly, the plan sold best with B customers. They knew us better than the Cs but were not so entrenched with us that they viewed a cookie-cutter offering as a step back in our relationship.
The problem was, I burned through our B customers quickly. I managed to get seventeen subscribers, which amounted to $850,000 on an annual basis. A nice chunk of revenue to be sure, but not enough to make it worth walking away from our other clients. If I was going to make the subscription model fly, I would need to convince my A customers to join the seventeen Bs who had already committed.
However, my As simply weren’t interested in the subscription. Some thought they were giving us so much consulting work that we should throw in the subscription free as a thank-you for their business. Others didn’t like the model’s cookie-cutter nature. Each time I met with my A customers, I would listen carefully to their feedback and invariably assure them that they could continue to do business with us using the old model. And that was my mistake. Giving our A clients the choice ensured that they would never make the move to the subscription offering. Our A customers had become As because we were providing value to their business, and they didn’t want to mess with a formula that worked for them.
So I ran the subscription program while at the same time continuing our consulting business. Things went downhill quickly. Client deadlines and demands eventually overshadowed the subscription business, and the quality of the reports suffered. Employees preferred to work on custom consulting projects instead of writing formulaic reports. I felt as though I were trying to take off with an overloaded plane—I could get the front wheels off the ground but didn’t have enough torque to get the heavy plane airborne.
As I got more desperate for A clients to make the switch, I made a second mistake, which would ultimately be fatal: I started offering to customize each report for my A customers if they agreed to move to the new subscription model. Once our staff got wind that one subscriber was getting a special report, all of our account managers wanted their customers to have the very best reports for them. I fell down the slippery slope of customizations quickly. Soon we were customizing each report for every client—thereby compromising the leverage I’d hoped to achieve through a subscription model.
It wasn’t long before things started spiraling out of control. With six major studies per year and seventeen clients demanding special reports, we faced the prospect of creating 102 unique reports—untenable for our twenty employees. Finally, mired in requests for customization and tired of the difficulties of running two different types of business in parallel, I shut down the subscription business.
Over the following five years, I concluded that my two biggest mistakes were: (1) giving my A clients the choice to continue to do business with us under the old model, and (2) customizing the reports of those who did agree to make the switch. I decided to relaunch a version of the program but forced our customers to make a choice: Either subscribe to our standard subscription or end our business relationship. Giving customers an ultimatum actually worked in most cases, and we quickly made up for lost consulting revenue with new A subscribers. We got more focused on the offer and the As and Bs started talking it up, so we received more inbound leads from Cs. The business really started to take off, and, better yet, it was scalable. All because we led and didn’t follow our customers.
Once you have weaned yourself off other projects, you need to operate your newly focused business for at least two years in order to prove to a buyer that your new model works.
Over the course of these two years, drive the model as far and fast as you can. Avoid the temptation to get personally involved in selling or delivering your standard offering. Instead, when you get asked for help, diagnose the problem and fix your system so the problem doesn’t recur.
Many business owners realize a tremendous uptick in their quality of life in these two years. Business improves, cash flows, and customer headaches decrease. In fact, many owners like this stage so much, they shelve their plans to sell their company and decide to run it in perpetuity. If this happens to you, congratulations. If you still want to sell your business, continue on to the next step.
STEP 5 : LAUNCH A LONG-TERM INCENTIVE PLAN FOR MANAGERS
If you’d like to have a business you could sell, you need to prove to a buyer that you have a management team who can run the business after you’re gone. What’s more, you need to show that the management team is locked into staying with your company after acquisition.
Avoid using equity to retain key management through an acquisition, as it will unnecessarily complicate the sale process and dilute your holdings. Instead, create a long-term incentive plan for your key managers. Each year, take an amount equivalent to their annual bonus and put it aside in a long-term incentive account earmarked for each manager you want to retain. Allow the manager to withdraw one-third of the account’s balance each year after a three-year period. That way, a good manager must always walk away from a significant amount of money should he or she decide to leave your company.
You may also choose to “top up” the balance in a long-term incentive plan with a one-time special bonus in the event of the sale of your business. That way, your key managers will have an increased incentive to help you sell your business and stay with your company after the sale to get their share of the proceeds.
LESSONS FROM EXPERIENCE
When I owned my marketing services company, I brought in a general manager—let’s call him Jim—to run the day-to-day business operations. Over time, Jim proved himself to be a reliable manager. He was good with clients and could deal with the administrative side of running our business.
I had not yet discovered the long-term incentive plan technique for retaining key staff, so instead I gave him a good salary and a share of our profits each year. Jim was doubly motivated to increase our pretax profit because I gave him 12 percent of whatever profit we generated below $200,000 and 20 percent of every dollar we generated above $200,000.
As the primary shareholder, I was thrilled when Jim delivered larger profits year after year. He was earning 20 percent of every dollar we made, but I was making 80 percent. What’s more, Jim was so good that I was able to step away from some of the daily operations and take vacations for the first time in years. Profits and cash kept rolling in, and my stress level diminished.
Then one day I decided to sell the company. I didn’t tell Jim.
As I prepared the company for sale, I started to learn about what would make an acquirer willing to pay more for my business, and I was told that buyers want standardized, long-term contracts with customers. I explained to Jim that I wanted to get all of our clients to sign a long-term contract and that I thought we should be willing to offer them a discount in return for their commitment. The discount would cut into our profitability for the year—and therefore Jim’s bonus. Understandably, Jim wasn’t keen on the idea, and we both dug in our heels.
Increasingly, we found ourselves on opposite sides of just about every decision, from building a new Web site to compensating our salespeople: Jim wanted what would increase our annual profit, and I wanted to focus on what would increase our value in the market—which was related to profits but not always exactly aligned. Things went from bad to worse as Jim started to shut me out of client relationships. He turned employees against me, and we became a fractured company with some staff loyal to me, others to Jim. He was a superb performer when our goals were aligned, but as my goals changed and we became misaligned, the same things that had made Jim an outstanding performer—tenacity, drive, and passion—made him a formidable thorn in my side.
Eventually, Jim and I agreed to part ways and I had to postpone my plans to sell the business by a year while I rebuilt the relationships with my clients and employees. I felt as though I had squandered an opportunity.
After my experience with Jim, I started to use a long-term incentive plan for key managers. This plan had my most valued employees taking a longer-term view of the financial rewards associated with their job, and ultimately they worked with me, not against me, as I set my business up for sale.
STEP 6 : FIND A BROKER
The next step in the process is to find representation. If your company has less than $2 million in sales, a business broker will best serve you. If it has more than $2 million in sales, a boutique mergers and acquisitions firm is probably your best bet. Look for a firm with experience in your industry, as it will already know many of the potential buyers for your business. To find an M&A firm or business broker, ask for recommendations from other entrepreneurs you know who have sold their companies.
Your broker should appreciate what you have done to transform your business. If he or she considers you to be the same as the commoditized service providers in your industry, move on. Your broker needs to recognize that you have created something special and deserve to be compensated at a higher rate.
Once you have an M&A firm or broker engaged, he or she will work with you to create “the Book” or to populate an “online data room.” This information describes your business and its performance to date along with spelling out a business plan for the future.
Brokers typically charge a percentage of the proceeds of the deal in the form of a success fee.
LESSONS FROM EXPERIENCE
When I finally got serious about wanting to sell my events business, I asked around about how the process worked. I soon discovered that there are people who make a living selling and buying businesses. As I dug deeper, I found out most brokers specialize in a specific industry. I narrowed my list down to four companies, all located in New York, that specialized in selling conference businesses.
I had a warm introduction to three of the firms, so I was able to get face-to-face meetings. The fourth did not respond to my e-mail, which I found curious but would later learn was not uncommon.
I spent the day in Manhattan interviewing intermediaries, or perhaps I should say they interviewed me. Investment bankers only make any real money if the business actually gets sold, so they grilled me to ensure I had a sellable business:
• “Describe your sales cycle.”
• “How many salespeople do you have?”
• “Describe your cash flow cycle.”
• “Who are your customers?”
• “How do you know if they are satisfied?”
• “How often do they repurchase?”
My last meeting of the day was the most memorable. The banker on the other side of the table looked uninterested as he began asking his stock set of questions. His mood began to warm with each of my answers, to the point where his face actually broke into a broad smile as he finally interrupted me: “I know just the company to buy your business.”
My reaction to his proclamation was a mixture of excitement and skepticism. After all, we had only just met. I asked him to elaborate, and he described a large company he knew well that wanted to get further into the events business in North America—he thought it was a perfect marriage. He explained that he would charge me 5 percent of the transaction value and that I would have to promise to work exclusively with his firm as my broker. I agreed to his terms, and my newfound banker friend arranged a dinner in one of Manhattan’s most exclusive restaurants for us to meet the division president of the company he thought should buy my business.
As I walked into the restaurant a few minutes early for our 7 p.m. reservation, I found my banker and the division head sitting at the bar. The lads looked as if they were old friends. My guess was that they were already onto their second scotch and soda, which I found strange given that my broker was supposed to be representing me. He seemed awfully chummy with the person he would soon be negotiating against. As the evening progressed, it became clear to me that my banker and the division president were actually long-term colleagues who had done many deals together. In fact, my banker earned the majority of his fees from buying companies on behalf of his dinner guest, not by selling them.
My adviser was simply trying to deliver me as a gift to his friend. If successful, he would earn a quick fee from me and ingratiate himself further with his main client, who would have been given a first look at my business without any competition at the table to drive up the price. I left dinner far more knowledgeable about the whole process but minus a broker. The next day, I set out to find myself another—one who would be working for me.
STEP 7 : TELL YOUR MANAGEMENT TEAM
Once your broker has found a prospective buyer, he or she will set up management presentations for you and your team. At this point you will need to confide to your key managers that you are considering selling your business.
Telling your management team can be a daunting task. Think about it from their perspective and make sure there is something in it for them if the deal goes through. An acquisition can often mean significant career opportunities for your managers, and that may be enough. Nevertheless, an acquisition can be disruptive and unsettling for them, so I recommend you offer key employees a simple success bonus deposited into their long-term incentive plan (see step 5) if a deal goes through. As an added bonus, a potential acquirer will value your putting a deal-related incentive in place for your key employees to stay.
LESSONS FROM EXPERIENCE
Whenever you sell people’s time, you become beholden to your employees as their expertise increases and their client relationships deepen. Like installing wheels under your most precious pallet of inventory, the better they become at their job, the more likely your best people are to roll out the door. It’s one of the reasons service firm owners typically dilute themselves into nothing more than a collective of highly paid employees and rarely get acquired for much more than a long and grueling earn-out for the principals.
Warren Buffett talks about the depth and breadth of the “moat” around the businesses he invests in. A big moat gives you pricing power against your competition, but it also makes it harder for employees to leave you and set up shop as a competitor.
If all you’re selling is time, the moment an employee is fully trained and meeting independently with clients, he or she becomes a flight risk and a potential liability. If you have a deep and wide moat, employees will need to invest significant time or money to build what you have created and they will realize there is more to your business than marking up their time.
In my research company, we set out to own the de facto conference in our industry. By owning the most important trade show in our space—one that both companies and vendors wanted to attend—we created a moat that was hard for a single employee to replicate. In fact, I did have one employee leave to set up a competitive shop despite having signed a noncompete agreement. She claimed to offer the same service we did, but we had a five-year head start on creating the “go-to” conference for the industry. More than just hawking hours, we had a moat that proved more than difficult for a single former employee to re-create.
Wondering what your moat could be to protect you against employee defection? Here are a few ideas to get you thinking:
• Own the annual ranking study for your category: Interbrand does the ranking of brand equity among marketers, making it tough for a one-person brand consultancy shop to compete.
• Own the annual awards program for your category: Ernst & Young created the Entrepreneur of the Year awards program, and it has solidified its position with fast-growth entrepreneurs, which gives the company a real advantage over a disgruntled former employee who hangs out his or her shingle at tax time.
• Own the event for your industry. New York–based investment banking company Allen & Co. organizes the annual gathering of media and technology executives at Sun Valley, Idaho.
• Own the benchmark: Fred Reichheld is the founder of Bain’s loyalty practice and the creator of the Net Promoter Score methodology as a way to predict repurchase and referrals for businesses. His firm owns the database of benchmarks. Companies using the Net Promoter Score want to know where they stand with other companies, so they go to Bain for the benchmarks and strategy for implementing a loyalty program. Bain has a barrier to entry that would take years and many millions of dollars for a single aggrieved employee to replicate.
STEP 8 : CONVERT OFFER(S) TO A BINDING DEAL
Once you have completed your management presentations, you will, you hope, get some offers in the form of a nonbinding letter of intent (LOI). A letter of intent is not a firm offer. Unless it includes a breakup fee (rare for smaller companies), the buyer has every right to walk. In fact, deals often fall through in the due diligence period (discussed below), so don’t be surprised if it happens to you.
As you review the LOI, keep in mind that your adviser will be trying to sell the benefits of the offer to you because he or she (1) will get paid if the deal goes through and (2) wants to justify the steep advisory fee by reminding you of the hard work he or she has done. Do not be swayed by your adviser. Study the offer. It will likely contain an amount of money (or some other currency, like stock) up front, with another chunk tied to one or more performance targets for your business after the sale, often referred to as an earn-out. Treat the earn-out portion as gravy. An earn-out is used by an acquirer to minimize his or her risk in buying your company. This means that you take most of the risk, and the buyer gets most of the reward. Some earn-outs have proven lucrative for the owners who accepted them; most business owners who have sold a business, however, have a nightmare story to share about an overbearing parent company not delivering on what was promised in an earn-out contract. As long as you get what you want for the business up front and treat the earn-out as gravy, you can walk when things get nasty. If you feel as though you have to stay to get full value for the business, then expect life to be uncomfortable for the duration of the earn-out.
The due diligence period, spelled out in the LOI, usually lasts from sixty to ninety days. A veteran entrepreneur I know likes to refer to it as the entrepreneur’s “proctology exam.” It isn’t fun, and the best strategy is often just to survive it. Due diligence can make you feel vulnerable and exposed. A professional buyer will dispatch a team of MBA-types to your office who will quickly identify the weak spots in your model. That’s their job. Try to keep your cool during this period, and try to present things in the best possible light, but do not lie or hide the facts.
LESSONS FROM EXPERIENCE
Most professional acquirers will have a checklist of questions they need answered before buying your company. They’ll want answers to detailed questions like the following:
When does your lease expire and what are the terms?
Do you have consistent, signed, up-to-date contracts with your customers and employees?
Are your ideas, products, and processes protected by patent or trademark?
What kind of technology do you use, and are your software licenses up-to-date?
What are the loan covenants on your credit agreements?
How are your receivables? Do you have any late payers or deadbeat customers?
Does your business require a license to operate, and if so, is your paperwork in order?
Do you have any litigation pending?
In addition to these objective questions, they’ll try to get a subjective sense of your business. In particular, they will try to determine just how integral you are personally to the success of your business and if it is possible for your business to grow without you. Subjectively assessing how dependent the business is on you requires the buyer to do some investigative work. It’s more art than science and often requires a potential buyer to use a number of tricks of the trade:
Trick #1: Juggling calendars. By asking to make a lastminute change to your meeting time, an acquirer gets clues as to how involved you are personally in serving customers. If you can’t accommodate the change request, the acquirer may probe to find out why and try to determine what part of your business is so dependent on you that you have to be there.
Trick #2: Checking to see if your business is vision impaired. An acquirer may ask you to explain your vision for the business, which is a question you should be well prepared to answer. However, he or she may ask the same question of your employees and key managers. If your staff members offer inconsistent answers, the acquirer may take it as a sign that the future of the business lives only in your head.
Trick #3: Asking your customers why they do business with you. A potential acquirer may ask to talk to some of your customers. He or she will expect you to select your most passionate and loyal customers and therefore will expect to hear good things. However, the customers may be asked a question like, “Why do you do business with these guys?” The acquirer is trying to figure out where your customers’ loyalties lie. If your customers answer by describing the benefits of your product, service, or company in general, that’s good. If they respond by explaining how much they like you personally, that’s bad.
Trick #4: Mystery shopping. Acquirers often conduct their first bit of research behind your back, before you even know they are interested in buying your business. They may pose as a customer, visit your Web site, or come into your company to understand what it feels like to be one of your customers. Make sure the experience your company offers a stranger is tight and consistent, and try to avoid personally being involved in finding or serving brand-new customers. If any potential acquirers see you personally as the key to wooing new customers, they’ll be concerned that business will dry up when you leave.
Once the due diligence period is over, there is a good chance that the offer in the letter of intent will be discounted. Again, don’t be surprised if this happens to you. Expect it, and you’ll be pleasantly surprised if it doesn’t happen. You’ll need to go back to the math you did when reviewing the letter of intent in the first place. If the discounted offer meets your target cash up front, then go ahead and sign your business over. If the discounted offer falls below the threshold, walk away—no matter what the acquirer promises to help you hit your earn-out.
If you accept the revised offer or the due diligence period ends, you’ll have a closing meeting. Typically held at the acquirer’s law firm, this is where the formalities are handled. You sign a lot of documents, and once the documents are signed, the law firm will move the cash portion of the sale from their account to yours. The deal is done.
