Thursday, June 28, 2012

Exit Planning Step 4 - The Exit Options

There are various exit options available to business owners.  The key to Step 4 of the exit planning process is to identify which exit option will best accomplish the goals defined under Step 1.  The exit options generally fall under two categories: internal transfers and external transfers.

The internal exit options include a transfer to the next generation, the existing shareholders, management or the employees.  Some of the advantages and disadvantages of each option to consider include:

Internal Transfer


Family member
-  Business stays in the family
-  Can be a timely and seamless process
-  Avoid information leak and confidentiality issues
-  Likely will not maximize price
-  May cause family discord 
-  May not receive cash at closing
-  Existing shareholders know the business
-  Can be facilitated through SH agreement
-  Funded with proceeds from life insurance
        -  May not maximize price          
        -  Potential dispute if poorly prepared SH agreement
        -  May not receive cash at closing
        -  Management team knows the business
        -  Avoid information leak and confidentiality issues
            -  May not maximize price
            -  May not receive cash at closing
            -  May require additional debt or equity financing
            Employees (ESOP)
            -  Allows gradual exit over time
            -  Increase employee productivity and company profitability
            -  May be a lengthy process
            -  Business buys back shares if employees leave

            The external exit options include a third party sale (business owner stays under contract for a period of time to ensure a smooth transition or leaves the business immediately), a public offering, a recapitalization or liquidation.  Some of the advantages and disadvantages of the external exit options include:

            External Transfer

            Third party sale – stay or leave
            -  Potential to maximize price
            -  Strategic buyers may pay a premium
            -  More likley to receive cash at closing

            -  Information leak and confidentiality issues
            -  Could be a longer process
            -  Buyer may require VTB or earn-out
            -  Issues with transferability of customers and relationships if owner leaves
              Public offering (IPO)
              -  Provides additional capital to fund growth
              -  Gives company a higher profile
              -  Valuation multiples are higher
              -  Need high revenues, earnings and growth
              -  Business owner could lose control
              -  Time consuming and very costly
              -  Securities regulations
                Refinance / recapitalize
                -  Owner can take some money off the table and diversify risk
                -  Owner can remain actively involved
                -  If debt used, increases leverage and risk and may require personal guarantees
                -  If equity used, owner now accountable to equity partners
                -  Generally simpler and faster

                -  Lower net proceeds due to liquidation costs
                -  Loss of jobs and severance costs

                Serious consideration should be given to each of these exit options.  The options that will best achieve the business owner’s goals warrant further analysis and investigation.  Next week, we discuss the further analysis under Step 5 – The Net Proceeds Analysis.

                Wednesday, June 20, 2012

                The Value Enhancement Process - Step 2 of 2

                In order to increase the value of a business the key value drivers must be identified.  Determining the key value drivers requires an assessment of each value driver’s relevance and impact in affecting value.

                Relevance - refers to how important the value driver is to increasing the quantum and/or quality of the cash flows in light of the owner’s goals and time frame.  Each value driver can be classified as: (a) Not Relevant; (b) Somewhat Relevant; or (c) Very Relevant.

                For example, having a sound business and growth plan will help a business sell more quickly and attract better buyers.  Therefore, possessing such plans would rank as very relevant.

                Contrast this with implementing a more efficient manufacturing process to reduce costs.  This would be expensive, disruptive to existing operations and take significant time to implement.  If the owner’s goals include spending less time at the company and exiting the business at the end of one year, then this initiative would score lower on the relevance scale.

                Impact - refers to the potential increase in value that addressing a value driver may have given the investment required and the company’s existing strengths and weaknesses.  Each value driver can be classified as having a: (a) Low Impact; (b) Medium Impact; or (c) High Impact. 
                For example, the business may have customer relationships but no contracts.  In addition the relationships may be entirely with the business owner.  The lack of contracts and significant reliance on the owner’s relationships with the customers for repeat business are two value drivers that will score high on the impact scale.

                Contrast this with a business that has name recognition in the marketplace, customer contracts in place and does not rely solely on the owner for continued business.  For this business, focusing effort and attention on these areas would not have a significant impact on value and, therefore, would score low on the impact scale.

                After identifying each value driver’s relevance and impact, the key value drivers can be determined.  To assist in this process, each value driver should be classified as "neutral", "positive" or an "opportunity for growth".  A positive value driver implies that it is either not relevant or it will have a low impact on value.  An opportunity for growth represents the value drivers classified as very relevant with a high impact.  These are the key value drivers that, with effort and attention and through a solid action plan, will serve to enhance the value of the business.

                Although there are many different value drivers, certain key value drivers are common to many businesses.  The top three categories of value drivers that tend to provide the best opportunity for value enhancement are as follows:

                Value Driver Category

                Specific Characteristic That Will Increase Value

                Customer Base
                • Not dependent on any one customer or customer group
                • Strong relationships leading to repeat business
                • Existence of customer contracts

                • Scalable operations going forward
                • Viable growth plan
                • Growing industry

                Management Team

                • Transferable management team 
                • Significant experience and knowledge base
                • Formalized roles and responsibilities

                Next week we return to the 6 step exit planning process with Step 4 – Exit Options Analysis.

                Wednesday, June 13, 2012

                The Value Enhancement Process – Part 1 of 2

                Enhancing the value of a business is a process that takes time, which is why it is vital for business owners to begin this exercise at least 3 to 5 years prior to an exit or sale of the business.

                The value enhancement process consists of the following five steps:


                Brief Description

                Benchmark business valuation

                • Independent baseline valuation
                • From perspective of potential purchaser
                • Presentation to management
                Detailed value driver analysis

                • Complete Sellability Score questionnaire
                • Detailed management interview
                • Value factor assessment
                Prioritize the key value drivers

                • Each value factor rated on Relevance and Impact
                • Identify top 5 to 10 key value drivers
                • Presentation to management
                Develop action plan

                • Strategic planning session with management
                • Identify goals and brainstorm obstacles
                • Brainstorm and prioritize strategies to overcome obstacles
                Implement, monitor and follow-up

                • Assign tasks and responsibilities to key individuals
                • Develop short-term targets/objectives
                • Quarterly meetings to monitor progress
                • Updated business valuation to measure progress

                The value enhancement process begins with a benchmark business valuation.  A detailed value driver analysis is then conducted that starts with the business owner taking the Sellability Score [1] questionnaire followed by a detailed management interview.  We will discuss the Sellability Score in more detail at a later date.

                Understanding how value is created and what the key value drivers are for the business is vital to enhancing the value of the business.  Chartered business valuators are trained in this regard.

                Value for most operating businesses is a function of two primary components:
                1. The quantum of the expected future cash flows – referring to the revenues minus the costs and required investments associated with generating those revenues; and

                2. The quality of the expected future cash flows - referring to the sustainability and variability of the cash flows, measuring how sensitive the cash flows are to the various risk factors facing the business.
                Prospective purchasers will place more value on a predictable stream of higher cash flows that are expected to increase than a volatile stream of lower cash flows that could potentially decline in the future.

                There are many value drivers that affect either the quantum or quality (or both) of a business’ expected future cash flows and, therefore, its value.  The key to enhancing the value of a business in the most effective and economical way is to assess each value driver on the basis of its "relevance" and "impact" and then to focus attention on the high priority key value drivers.

                Next week, in Part 2 of 2, we will discuss how to identify and prioritize the key value drivers and what the top 3 value driver categories are for most businesses.


                Thursday, June 07, 2012

                Exit Planning Step 3 - Business Valuation

                The exit plan is now beginning to take shape.  The goals have been identified, including the anticipated timing of exit and the preference for either an internal transfer or an external sale to a third party.  The financial needs have been quantified, including how much is required from the sale of the business to achieve the financial goals.

                Now that we have determined where the business owner needs to be upon exit (i.e. the financial needs), the next step involves assessing the business owner’s current net worth, which includes the value of the business.  For many business owners, this can represent a significant proportion of their total wealth.

                An independent business valuation is an important benchmarking tool that can be used as a basis for enhancing the value of the business over time.  It can also be used for insurance coverage purposes and for tax & estate planning purposes (two other important considerations dealt with under the comprehensive financial plan in Step 2).

                A current business valuation is also useful in the event of a potential shareholder or matrimonial dispute.  A recent article in The Globe & Mail stressed the importance of obtaining and updating a business valuation every two to three years as companies grow and take on other shareholders.  Otherwise there could be a battle over the valuation of the company in a shareholder dispute or divorce.  Having this type of dispute drag on for years could also drag the company down with it. [1]

                To illustrate the importance of Step 2 (Financial Needs) and Step 3 (Business Valuation) in the exit planning process, assume a business owner requires $8 million from the sale of the business (net of taxes and other liabilities) and the business is currently worth only $4 million (net of taxes and other liabilities).  This is the shortfall referred to under Step 2 last week. Once this shortfall is quantified, an action plan for enhancing the value of the business prior to exit can be developed and implemented.  The value enhancement process takes time, which is one of the reasons why business owners should begin the exit planning process at least 3 to 5 years prior to an exit.

                A professional business valuator can assist with developing a value enhancement action plan.  An experienced valuator will be able to identify the key value drivers that the business owner should focus on to increase the company’s value up to the level identified in Step 2 (Financial Needs).

                Next week, before discussing Step 4 (Exit Options), we will discuss the topic of value enhancement in more detail.  Specifically, we will discuss how a business valuator can assist with identifying and prioritizing the key value drivers and what the top 3 value drivers are to most operating businesses.

                1.   Source: "Divorces Mess up Firms as Much as Families", The Globe and Mail, Monday, June 4, 2012, by Wallace Immen.