Creating Value: Are you getting the most out of your business?
Every year, I used to get together with a client who was a business owner, and every year I would ask him, “Bruce, have you told your guys that you want them to buy the business?” He had a plan that he would eventually sell his contracting business to his senior executives, but he had yet to inform them of this fact.
“I’m not ready to yet,” he would say.
Then we would go another year, and the same thing would happen: “I’m not ready yet.” And another year. Finally, he called me one day and said, “I want to be out of here in six months.”
“Bruce,” I asked, “have you talked to your guys yet?”
“Well, you might want to talk to them before we try to do this, because you’re an interior contractor, which means you’re only as good as your latest bid.” These types of businesses can be very hard to sell to outside buyers.
So we approached the two managers he wanted to sell the business to, and we said, “Here’s how we would like to see this work.” And their immediate reaction was this: they thought Bruce was trying to take advantage of them. As it happens, I think it was a fair deal for them, but they just didn’t believe it.
The managers went out and hired an attorney and an accountant, and once that happens you are generally getting into an adversarial relationship. Because Bruce had never taken the opportunity to lay the groundwork, there was little trust between him and his managers. When he was ready, he simply walked in and demanded that the deal happen in a particular way.
Instead, the managers came back with an offer for the business that was less than book value. And in the end, Bruce chose to liquidate the business, which allowed him to walk away with more money than the managers were offering. It also meant that he did not have to take the risk that the managers would not be able to run the business well enough to pay him off over time.
Still, at the end of the day, he probably forfeited $700,000 or $800,000 off what he might have gotten if he had brought along his managers gradually. Happily, he had bought some real estate outside of the business. While the sale of his business did not go as well as it might have, he was doing fine. But the business he built, his legacy, has disappeared.
Now, here’s how this is supposed to work. I had another client, an electrical contractor, and he had started working on transferring his business about six or seven years before I met him – about 10 years before he wanted to sell his business.
He chose two people he wanted to sell to who were already working in the company. They were young, they were paid well, and they were happy with what they were doing. “Look,” he told them, “I’m going to be out of here in 10 years. You’re going to own the company if you want it. Here’s what you need to do.”
And he laid out what they had to do. Over that 10-year period, he got a chance to test their management capabilities. Were they able to run the business? This is especially important because when you sell a business internally, one thing is always true: your buyers are not going to have any money. In effect, you are going to have to be their bank.
And that’s a big risk. If they can’t run the business, they will never be able to pay you what you’re owed. Testing and developing their management skills before you pull the trigger is the best way to ensure that you will in fact get your money. But here’s the positive side: if you have to be the bank, it’s better to be the bank for somebody you know, which is one of the reasons I favor internal transfers for small companies.
In this case, my client got a chance to see the managers in action, see them run the company; he worked less and less and took more time off. Eventually, he became a passive owner. For close to four years, he came into the office only a couple of days a week. For that four-year period, he got to enjoy the cash flow the business created with very little work on his part.
When it came time to sell, he pulled the trigger and it was done. He walked away, and the business is still very successful. In fact, it’s even more successful now than when he owned it.
By Josh Patrick
Josh Patrick is a founder and principal at Stage 2 Planning Partners, where he works with private business owners on creating personal and business value.