Usually, business owners start their companies on their own or in a partnership. The foundation of the business lies in the ingenuity and creativity of the owners. The value that the owner brings to his/her business eventually fades, but it’s not always for the reasons you might think.
A few years ago, while working with a client, I was surprised to hear that the owner was facing liquidation after being unable to sell the business over a 2-year period. There had been a significant number of available buyers, but certain internal issues were forcing liquidation. After investigating the various issues in which a company’s value is decreased, I have found one prevalent problem that often discourages potential buyers: the company’s overdependence on the owner.
For example, one midsize company (about $40 million and approximately 40 employees) was facing stress and getting close to burnout. The owner said he wanted to scale up his business and increase the capability for decision-making to happen lower in the company. His perception was that he didn’t have talent that was capable of greater autonomy. What he needed was a way to hire and develop people to scale the company’s functions and increase its value. This dependence on an owner and his/her inability to transfer leadership abilities within the company can lead to a number of significant problems. One such issue is a discount in sale price, or the ability to finance the sale with a buyer, which could require that the owner stay on for a period of time after the sale and a promissory note, with the remaining price contingent on the future success of the business.
In another example, a small company (about $3 million and seven employees) was dependent on the owner for almost every major decision. Because buyers often require company-dependent owners to stay on to transfer his/her skills to the new ownership, a promissory note was required to close the deal. The promissory note required that the owner stay with the new company for a period of 4 years after the sale date. Additionally, 65 percent of the sale price would be paid in a lump sum in year four, but was contingent on how many customers continued doing business with the new company and on revenue targets achieved over the following 4 years. As is often the case, because the new owner was less experienced than the previous owner, this arrangement set up a number of struggles between the new owner and previous owner.
Almost 1 year after the sale of the company, the new owner became impatient with the status quo and started making changes that he felt would make the deal fit his own purchase agenda. However, the previous owner was reluctant to change his old methods because he didn’t want to risk his balloon payment on a new idea from a less experienced owner, especially with 3 years still remaining in the deal. This caused a verbal tug-of-war between loyal employees to the previous owner and the new ownership, who now paid their checks.
Throughout this chaos, three valuable employees were lured away by competitors, all within a 6-month time frame. By then, a number of customers heard about the issues and decided they also did not want to be involved with the new company, and signed on with competitors.
While an owner is an asset in the early to later years, buyers require that when the owner sells the company, the value of him/her has to remain with the company in some way. Buyers do not want to buy an asset that disappears, whether it’s an owner on which the company is too dependent, or it’s a situation in which the employees cannot identify who the boss is during the transition to the new owner.
If a current owner wishes to maximize the value of his/her company, he/she should decide to continue working for the new owner, according to an agreement, or the current owner should spend time prior to his/her exit from the company to transition his knowledge to a key employee or employees. If the owner decides on the latter, then the owner must work himself/herself out of his/her role, so that the business is valuable without him/her. If the owner avoids being required to stay on as an employee of the new company after the sale, then many of problems mentioned above can also be avoided.
When the owner can hand off a well-run company and step back from day-to-day operations, he/she will enjoy more of a work/life balance and present a potential buyer with a more confident picture of a high-value company.
For more insight on this issue, read books like “Exit Signs” by Dr. Pamela Dennis or “Finish Big” by Bo Burlingham. Both books are great resources to help you plan for the endgame. Most resources and experts in the construction industry suggest that current owners should start preparing 5 to 7 years before they are ready to move out of their current role.