When it comes to planning for a business transition, many business owners fail to implement value enhancement strategies that are often needed to achieve a desirable exit from the business, whether that is a third party sale or a transfer to a new generation of family or management.
According to the 2013 State of Owners Readiness Survey co-sponsored by the Exit Planning Institute, 86 percent of business owners have not taken on a strategic review or targeted value enhancement project. Yet transition planning is one of the most important issues facing any business – and one of the most commonly avoided.
Why? One reason is that many business owners do not associate transition planning with "working on" the business to increase its value. Preparing the business for succession and successfully completing a transfer is often more difficult than building the business itself.
A transition plan (also known as an exit or succession plan) is an integrated plan that asks and answers all of the personal, business, legal, financial, tax, and estate questions that are involved in exiting from a privately owned business. In practical terms, exit planning is a way of running a business that maximizes its value and provides a means to achieving the owners' personal and financial goals. A key element that connects an exit plan with a company's larger business plan is value enhancement.
Value enhancement results from actions that "de-risk" the business from legal, financial, and other variables. De-risking can add value to core business functions and can increase the salability of the business. This has benefits regardless of the owners' time frame for exiting the business.
Before you know how much value enhancement is needed, it is important to determine the value of your company. There is often a large gap between what business owners think their business is worth and what it is actually worth. According to a study conducted by the Alliance of Mergers & Acquisitions Advisors, 95 percent of mergers and acquisitions professionals believe that business owners' unrealistic expectations of company value is the biggest obstacle to sale or transfer. To help owners move swiftly and cohesively in considering strategic opportunities, it is important that all owners reach consensus about whether the enterprise value is acceptable.
If the value of a business is below what the owners feel they need to support a comfortable lifestyle after an exit, or if the value is insufficient to drive desired strategic growth, owners are usually best served by taking time to enhance the value of the business before transitioning.
What are de-risking strategies and which ones drive the most business value?
As advisors to privately held businesses, we focus on numerous value factors related to personal motivation, business operations, industry and market conditions, legal and regulatory conditions, and financial/economic conditions. Here are some examples of de-risking strategies:
Adopt a written "contingency plan" to document how core business functions will be performed if key personnel with institutional knowledge about those functions are absent.
Ensure that written agreements memorializing the terms of the company's key relationships are in place, and that the agreements will not trigger a termination right if ownership of the company changes.
Ensure that key employees are incentivized to help the company grow and ultimately achieve a desired transition.
Appoint an advisory board of "outsiders" to advise the company regarding major decisions.
Audit the company's tax filings and registrations to ensure that the company is paying taxes in all required jurisdictions.
Obtain an environmental assessment of the company's facilities to identify and address possible environmental concerns.
Confirm that the company has sufficient insurance in place to cover potential liabilities, including product liability claims if applicable.
Identify and register or otherwise protect the company's intangible assets such as patents, trademarks, copyrights, and trade secrets.
There are, of course, many more value factors and de-risking strategies. Owners should focus on strategies that present the most opportunity for improvement and the potential to yield the greatest benefit. For example, if a significant portion of the company's value is related to its intellectual property assets, but the company has not secured intellectual property protections, focusing on this strategy is likely to create a high return. Your exit planning advisor can help you identify and rank the value factors applicable to your business.
To most effectively implement value enhancement strategies, focus on five actionable steps that can be completed in a ninety-day time period. Track the status of each action item. Assign responsibility for completing the tasks within the organization. Lay out a road map of all action steps needed to complete each task.
Once actions have been implemented, move on to the next items. Throughout the process, it is critical to take stock of how de-risking is affecting the value and salability of the company. Map the company's progress by making at least a cursory valuation or "recast" of the financials each year.
The more a company de-risks during its life cycle, the more attractive it will be to a buyer if and when the owners decide to sell. If the owners want to keep the business in the family, de-risking can help preserve the business legacy, ensuring the next generation takes over a business that has a solid structure in place to support growth and to ensure stewardship over the business.
First published in Daily Journal of Commerce, August 7, 2014.