Growth - What To Do When It Flat Lines

Growth is a key value driver for most businesses.  A good growth story with plans for future growth is very appealing to potential purchasers.  Many successful businesses, however, reach a point where their growth starts to slow as the company matures.

Demonstrating how a business is likely to grow in the future is one of the keys to driving a premium price for the company when it comes time to sell.  Showing a potential purchaser that the business has achieved past growth plans will increase the credibility of a current growth plan.

The Ansoff Matrix is one tool business owners can use to develop a growth plan.  The following four growth strategies are considered:

1. Sell existing products to existing customers (market penetration) 
2. Sell new products to existing customers (product development) 
3. Sell existing products to new markets (market development) 
4. Sell new products to new markets (diversification) 

Figuring out how to sell existing and new products/services to existing customers (i.e. the first two options) often provides the lowest risk options for growth.  The best customers are the ones who know and like the business the most and are often pleased to find out that the business is offering something they need.

Existing Products to Existing Customers (Market Penetration)

Consider a hardware store with a key cutter hidden off in the corner.  Despite the huge mark-up on cutting keys, sales are very low because nobody can see the key cutter.  By moving the key cutter up front behind the cash register customers begin to see the cutter and realize that the hardware store cuts keys.  Not surprisingly, many more keys are sold to existing customers, which increases the overall revenue per customer.

To figure out how to sell existing products to existing customers, a list with the existing customers’ names down one side of the paper and the products and/or services across the top should be prepared.  Cross-referencing the customer list with the product/service list will help identify opportunities to sell existing customers more of the existing products.

New Products to Existing Customers (Product Development)

Consider a BMW dealership whose typical client is an affluent family man in his forties.  After saturating the market for wealthy forty-something men, the dealership decided to think of the customer as the financially successful family rather than only the patriarch.

Instead of trying to sell more BMWs into a market of diminishing returns, the owner bought a Chrysler dealership so he could sell minivans to the spouses of his BMW buyers – a new product to the existing customer.

Existing and loyal customers trust and respect the business and its representatives. Identifying and meeting a separate or supplemental need for those customers will result in sales growth and value enhancement, provided the products/services can be delivered profitably.  If they cannot be provided profitably it may be more beneficial to consider investing in market development (existing products to new markets) rather than product development.

If you are building a business to sell one day and are curious to see how your growth stacks up, take the 13 minute Sellability Score questionnaire:

http://www.sellabilityscore.com/vsp/jason-kwiatkowski

Exit Planning Step 6 - Action Plan

"A goal without an action plan is a daydream."

               Nathaniel Branden, practicing psychotherapist, corporate consultant, and author

The final step in the exit planning process involves creating the action plan for the business owner and the business.  The action plan moves the business owner from the planning phase to the implementation phase and deals with the following basic questions:

1. What tasks need to be done and when?
2. Who will do it?
3. Who will ensure it is done?

Developing the action plan is a process that will take time but it is a critical step because this will determine what initiatives (short-term and long-term) will be implemented to ensure that the exit planning goals are met.  This process begins with assembling the key individuals (e.g. business owner, family, management team, professional advisors) for a strategic planning session.

Strategic planning sessions should be limited to 2 or 3 hours to avoid information overload, frustration and inefficiency.  The meeting chair will also distribute an agenda to participants beforehand.  Agenda items for the initial strategic planning session will include:

• Goals - restating the goals and objectives (from Step 1)
• Challenges - brainstorm obstacles that will prevent the business owner from achieving these goals
• Strategies - brainstorm strategies that will help overcome the challenges and help meet the goals
 

As many challenges and potential strategies as possible should be identified in this brainstorming session - aim for at least 20 challenges and 10 strategies at this stage.  Each strategy will be linked to one or more challenges.

Each strategy can then be rated in terms of timing (immediate, short-term, long-term) and priority (low, medium, high).  The top 3 to 6 strategies should be selected to form the basis for the action plan.  Ideally a consensus will be reached after much discussion regarding the pros, cons and other issues surrounding each strategy.  2 or 3 strategic planning sessions may be required to accomplish this.

Exit planning strategies could include: prepare a business plan, prepare a contingency plan (update the will and obtain adequate insurance coverage), prepare tax and estate plans, implement value enhancement initiatives, identify a successor, etc.

Specific tasks will then be identified for each of the selected strategies and an individual will be assigned responsibility for ensuring that action items are implemented.  This process can be overwhelming and should be simplified ("KISS") by breaking each strategy down into manageable pieces that will be easier to accomplish.  This will build momentum for the implementation of the entire action plan.

Some of the strategies can be implemented by the business owner and/or management directly.  Others may require the involvement of professional advisors with specialized expertise. 

  

Regular meetings (e.g. quarterly) should be scheduled with the entire team to hold individuals accountable for their responsibilities by reporting back on progress made and next steps.  Having an outside consultant chair the meetings will keep the team focused and accountable for getting tasks done efficiently and on time, ultimately ensuring results are consistent with goals and expectations.

Don’t let your goals remain a daydream - turn them into reality with an effective action plan!

In the coming weeks, we will discuss some of the specific exit planning strategies and value enhancement initiatives in more detail as well as how to ensure an effective strategic planning session.

Exit Planning Step 5 - Net Proceeds Analysis

The exit plan is progressing.  We have identified the goals under Step 1, determined the financial needs upon exit under Step 2, assessed the current value of the business under Step 3 and selected the relevant exit option(s) under Step 4.

The net proceeds analysis involves determining how much the business owner will "pocket" from the sale of the business after settling all liabilities, income taxes and other obligations such as sales commissions and professional fees.  Some business owners may not appreciate that the actual net cash received upon sale can be significantly lower than the agreed upon sale price.  This analysis should be conducted for the relevant exit option(s) and under various assumptions regarding the value of the business.

A good starting point is to estimate the net proceeds assuming a sale price equal to the current value of the business determined under Step 3.  Certain assumptions with respect to sales commissions and professional fees will be required.  

Does the resulting net proceeds meet the financial needs determined under Step 2?  If yes, then great, we are on track!  If no, then further analysis and action is needed.  Specifically, the sale price that provides net proceeds equal to the financial needs must be determined and the value enhancement initiatives that will increase the value of the business to that level must be identified and implemented.

It is vital to conduct this analysis 3 to 5 years before the intended exit in order to allow sufficient time to implement the value enhancement initiatives that will enable the business owner to meet the financial needs and achieve the goals.

Whereas the seller is interested in net proceeds, buyers are generally interested in a company’s enterprise value (i.e. value of the operations attributable to both debt and equity holders).  In order to reconcile the two, enterprise value is increased by the company’s redundant (i.e. non-operating) assets and decreased by the interest-bearing debt outstanding, closing costs and taxes to be paid on the transaction.  Redundant assets are not required to generate operating cash flows and generally not sold as part of the business operations.  Examples include excess cash, marketable securities, real estate and related party loans. 

With respect to transaction structure, the business owner may prefer a share sale to realize the benefit of the capital gains exemption.  A purchaser, however, may prefer to purchase assets to avoid undisclosed liabilities or to take advantage of the tax benefits from "stepping-up" the cost base of certain depreciable assets.  Transaction structure is often a key agenda item in negotiations between the buyer and seller.  As such, the seller should understand the implications of both an asset sale and a share sale.

A Chartered Accountant, Certified Financial Planner or tax lawyer can assist with calculating the net proceeds under various scenarios, including: different exit options, different sale prices, and different transaction structures.

Next week we discuss the final step in the exit planning process: developing and implementing the action plan.

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	Advantages	Disadvantages
1.	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
2.	Shareholders	-  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
3.	Management	-  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
4.	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	Advantages	Disadvantages
1.	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
2.	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
3.	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
4.	Liquidate	-  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.

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
1.	Customer Base	Not dependent on any one customer or customer group Strong relationships leading to repeat business Existence of customer contracts
2.	Growth	Scalable operations going forward Viable growth plan Growing industry
3.	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.

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:

	Step	Brief Description
1.	Benchmark business valuation	Independent baseline valuation From perspective of potential purchaser Presentation to management
2.	Detailed value driver analysis	Complete Sellability Score questionnaire Detailed management interview Value factor assessment
3.	Prioritize the key value drivers	Each value factor rated on Relevance and Impact Identify top 5 to 10 key value drivers Presentation to management
4.	Develop action plan	Strategic planning session with management Identify goals and brainstorm obstacles Brainstorm and prioritize strategies to overcome obstacles
5.	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.

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1.    http://www.sellabilityscore.com/vsp/jason-kwiatkowski

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.

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1.   Source: "Divorces Mess up Firms as Much as Families", The Globe and Mail, Monday, June 4, 2012, by Wallace Immen.    http://www.theglobeandmail.com/report-on-business/small-business/sb-money/valuation/divorces-mess-up-firms-as-much-as-families/article4228307/