Source: John Brown from Forbes
Exit planning is the creation and execution of a strategy that enables owners to exit their businesses on their terms.
In 2016, BEI conducted the BEI 2016 Business Owner Survey, which asked hundreds of owners when they planned to exit their businesses. 79% of owners said that they planned on exiting their businesses within the next 10 years.
The survey also asked, “If a buyer offers you enough cash for your business to provide you with complete financial security, would you sell today?” Seventy-five percent of the respondents answered “Yes.”
Taken together, it’s evident that most owners would exit today if they could achieve financial security, but they know they can’t. Are you in the same situation? Would you like to exit your business now (or soon), but can’t do so with financial security?
If so, ask yourself two questions:
- Can you grow business value and cash flow sufficiently to exit the business on your terms?
- If not, what needs to change? Must your business grow faster, or must you lower your post-exit income goal?
Many owners are tempted to scale back their post-exit lifestyles in return for leaving their businesses on their original timetables. I suspect they choose this option because they don’t believe they can grow their businesses any faster than they already are.
I suggest that you resist this temptation to compromise your financial security goal just to exit when you want. Instead, I have some ideas (based on a lifetime of experience dealing with thousands of owners in this position) to help you figure out what you need to do to grow your business faster. Let’s first look a bit deeper at the challenge that underlies growth before we discuss possible solutions.
Income Today vs. Income Post-Exit
It’s normal for owners to need to grow business value and cash flow faster than both have grown in the past in order to exit when they choose with financial security. The reason is simple: A business with a value of, let’s say, $2 million produces far more available income to an owner than investment assets of the same value.
Financial planners generally suggest a prudent withdrawal rate for retirees (that’s what you’ll be after you sell!) of 4% from their investment portfolios. That means $80,000 per year from an investment portfolio worth $2 million.
However, an owner of a business worth $2 million likely has annual compensation and perks of $250,000 to $400,000 PLUS cash flow (e.g. S distributions) of another $400,000 to $500,000 per year. (Note: Four or five times a company’s cash flow or EBITDA is a typical multiple for valuing a business of this size.) Compare the $80,000/year of post-sale income to the $250,000 to $900,000/year you earn while you own your business.
As you contemplate that difference, think seriously about what financial security means to you and your family. Is it maintaining your current compensation alone or does it include additional cash flow from the business? Whatever you decide, you need to be certain that your non-business investment assets are up to the task of assuring financial security.
In my example of a $2 million company, the owner’s post-exit financial security goal is likely closer to her current annual compensation of $250,000 to $400,000 than it is to $900,000 of total income.
10% Of Owners Have It Figured Out
The obvious way to close that gap is to increase business value and cash flow today in order to (1) accumulate a larger pre-exit investment portfolio and (2) increase your net proceeds when you do sell.
All you have to do is grow business value and cash flow to a point that allows you to exit on your terms. “Well, that’s easy,” some owners say. While it’s easy to say for most businesses, it’s difficult to achieve.
Why is it so difficult? Let’s first look at closely held businesses in general and ask, “How difficult is it to achieve and maintain a sustainable rate of growth?”
According to a study by Allen and Zook (2012) of Bain & Company,
"As a benchmark, consider an annual growth rate in revenue and earnings of 5.5%. Most companies expect to attain that level or better — at least that’s what their strategic plans call for. But a Bain & Company study of more than 2,000 companies indicates that only about one in 10 actually achieves that relatively modest goal over a 10-year period while earning its cost of capital. In other words, nearly 90% of companies fail to achieve that modest growth objective."
In short, it’s darn hard (as the Bain study documented) to grow at the pace most owners need to exit successfully on their schedules. Only 10% of middle-market companies enjoy substantial revenue and earnings growth at the level most owners will need to exit in on their terms. Will you be part of that 10%? If you need to significantly grow the value of your business to attain financial security upon its sale, doing business as usual won’t cut it.
But here’s the rub: While you may be satisfied with the lifestyle your business is providing you now, realize that at current growth rates, your business will not grow sufficiently for you to be able to exit on your terms. (“Terms” include, at a minimum, leaving your business when you want, for the money you desire and in the hands of the person you choose.) Further, you may not have the knowledge or experience necessary to increase business revenue and profitability as rapidly as is needed. The Bain survey suggests that this is the case for most businesses and owners.
Get Out Of Growth’s Way
So, what should you do? You may be unwilling to work harder and longer to grow value. After all, you’re comfortable now. Owners who grow value quickly change their roles. However, the change necessary to ignite business growth does not equate to you working either harder or longer.
The smartest thing that owners of modest growth companies can do is get out of the way or change their role from critical to non-essential. “Critical” owners generally impede rapid growth because they don’t know what to do or no longer have the fire in their bellies to do what it takes. If you recognize yourself in either description ask, “How can my company grow more rapidly — especially without me doing everything?”
Again, my answer is simple in concept, but difficult to achieve in practice: Acquire, incentivize and retain a top-flight management team that can take your company to the next level. In doing so, your company will grow to the value it must if you are to achieve all of your exit goals.