Driving Value with the Switzerland Structure

Increasing the value of your business requires an understanding of the 8 key value drivers.  The first two value drivers, Financial Performance and Growth, were discussed last month.  This month we address the third value driver, Switzerland Structure. 

Switzerland Structure refers to how dependent your company is on any one customer, supplier or employee.  The greater the dependence, the greater the risk and the lower the value. 

 
Customers 

What would happen to your company's profitability if you lost a customer who accounted for over 50% of your total revenues?  Potential purchasers perceive companies that are overly dependent on any one customer to be much riskier to acquire and may be dissuaded from acquiring the business.  At best, they may offer to acquire your business for a deeply discounted valuation multiple. 

 
To maximize the value of your business, strive to have your top 5 customers account for less than 20% of total revenues.

Suppliers

What would happen to your input costs if a major supplier that you are dependent on decided to increase costs or restrict volumes?  Companies that are dependent on any one supplier for a significant portion of purchases are perceived to be much riskier companies to acquire.  Potential investors may stay away from your business altogether or offer to acquire the business based on a much lower valuation multiple.

To maximize the value of your business, strive to acquire your inputs from at least three or more different suppliers.

Employees

What would happen to your business if your sole sales rep, who is responsible for over 50% of the company's revenues and has personal relationships with your customers, resigned?  Companies that are dependent on a key employee are riskier companies to acquire and will likely sell for a reduced valuation multiple.

To be as valuable as possible, your company needs a sales team - not just a single salesperson.  Hiring a single sales rep will only keep your business reliant on one person - you need to build a sales team.  Here are three tips for building a sales team:

1. Charge customers up front - sales reps are expensive to find and train.  Consider charging some or all of your customer bills up front so you will have more cash to build your sales team and more time for them to train up.

2. Carve territory into small chunks - carve up your market into sales territories or service lines that provide enough opportunity for multiple sales reps to make money.

3. Hire a second rep as quickly as possible - start by hiring two sales people, not just one.  Sales people thrive on competition, and in order to be a sellable company, you need to be able to demonstrate to a buyer that your sales are driven by a sales team and not just one high performing salesperson.

Businesses that are not dependent on any one customer or supplier and can easily replace their top salesperson are more than twice as likely to get an offer to buy their business as those companies who are overly reliant on a single customer, supplier or salesperson. 

Would you like to know where your company ranks under the Switzerland Structure value driver?  Take 13 minutes to complete the Value Builder Score and receive your score out of 100.

Empirical evidence shows that companies with a Value Builder Score of 80+ receive offers that are 71% higher than the average business!  Simply put, reducing your company's dependence on any key customer, supplier or employee will increase the value of your business.

Driving Value with Growth

To increase the value of your business an understanding of the 8 key value drivers is essential.  The first key value driver, Financial Performance, was discussed previously.  Now we address the second key value driver, Growth. 

Increasing the likelihood for growth and the anticipated growth rate will increase the value of your business.  It will also attract a greater number of potential purchasers for your business.

It is one thing to say that your business has growth opportunities.  It is another thing to actually demonstrate that your business is scalable.  Showing that you had a growth plan in place and that you successfully implemented that growth plan gives your current growth plans more credibility.  This adds tremendous value in the eyes of a potential purchaser.

The Takeaway 

If you want to increase the value of your business and have never prepared a written growth plan, do one today!  Prepare a written growth plan for the coming 1, 3 year and 5 year periods.  If you want your future growth plans to be credible, you must document your current growth plan, the implementation strategy and the results.  You should also obtain an independent business valuation today so you can benchmark the future value enhancement results. 

Growth = Size and Scalability

Larger businesses are perceived to be more substantial and stable organizations than smaller companies.  These businesses have found a way to grow beyond the efforts of the owner(s) and become less reliant on the owner(s). 

Investors consider smaller companies to be riskier than larger organizations and this additional risk manifests itself as a lower valuation multiple being applied to the company's annual cash flows/earnings. 

A company with a scalable business model is much more valuable.  But, does your business have the infrastructure necessary to scale its operations?  What are your company's options?  Consider the following:

1. Geographic Scalability - applying your business model in another city

2. Cultural Scalability - applyling your business concept in another culture

3. Horizontal Scalability - selling new products/services to existing customers

4. Vertical Scalability - providing existing products/services to new customers

Or, you can turn to The Ansoff Matrix which considers the following four growth strategies:

1. Market Penetration - selling existing products to existing customers

2. Product Development - selling new products to existing customers

3. Market Development - selling existing products to new markets

4. Diversification - selling new products to new markets

The first two items are lower risk options given that existing customers are generally the ones who know and like the business the most and are often pleased to find out that the business offers something else they need.  Let's take a closer look at these two options:

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 beside 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.

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.  

Would you like to know where your company ranks under the Growth value driver?  That's where the Value Builder Score comes in where business owners complete a 13-minute questionnaire to receive their Value Builder Score out of 100. http://score.valuebuildersystem.com/en#started  

Empirical evidence shows that companies with a Value Builder Score of 80 or more receive offers that are 71% higher than the average business!   Simply put, improving your company's Growth Potential will increase the value of your business.

Driving Value with Financial Performance

Do you want to increase the value of your business?  Are you focused specifically on increasing the value of your business or are you simply hoping that its value will increase as a by-product of focusing on increasing sales or providing 5 star customer service?

A recent client was focused on just that - increasing sales and providing 5 star customer service. Sales did increase but at the expense of margin reductions.  Our client was accepting lower prices to attract new customers and increase sales volumes to existing customers.  Over a three year period, there were no significant changes to the bottom line.  As a result, the company's value did not increase. 

Value is ultimately driven by a company's future income or cash flow expectations.  Increasing your operating cash flows and minimizing the risk associated with achieving and/or exceeding the anticipated cash flows will increase the price an acquirer is willing to pay for your business. 

I recently introduced you to the Value Builder SystemTM, a statistically proven coaching program to help you increase the value of your business that starts with obtaining your Value Builder Score. 

 
The first value driver addressed in determining your company's Value Builder Score is Financial Performance.  Your company's financial performance includes its history of producing revenue and operating cash flows combined with the professionalism of your record keeping. 

 
Increasing your company's annual operating cash flows can be achieved by increasing revenues and/or decreasing costs. 

 
To increase revenues you can increase your prices or increase volumes. Some strategies to consider to increase sales volumes include:

1. Selling more existing products to existing customers (market penetration);
2. Selling new products to existing customers (product development);
3. Selling existing products to new markets (market development); and
4. Selling new products to new markets (diversification).

To decrease costs you can look at ways to reduce direct material and direct labour costs which will help increase your gross margins.  You could also focus on reducing other operating expenses and overheads to improve your net profit margins.  Various outside consultants can assist in this area. Companies like Salvis Group can help improve operating systems/processes to improve efficiency and reduce costs.  Companies like Expense Reduction Analysts can identify general and administrative cost savings to improve your bottom line.  There are also companies that specialize in providing research and development tax credit recoveries to increase your company's operating cash flows.

Improving the quality and integrity of your financial reporting (e.g. monthly, quarterly or year-end financial statements) can also help increase your company's value.  This can be accomplished by improving your accounting information system or upgrading to a review engagement or audit.  Potential purchasers may be willing to pay more for a company with a quality financial reporting system that produces accurate and reliable financial statements and other financial reports.

Wouldn't you like to know where your company ranks under the Financial Performance value driver?   That's where the Value Builder Score comes in where business owners complete a 13-minute questionnaire to receive their Value Builder Score out of 100.

Empirical evidence shows that companies with a Value Builder Score of 80 or more receive offers that are 71% higher than the average business!  Simply put, improving your company's Financial Performance will increase the value of your business.

Over the coming months I will continue to expand upon how the other key value drivers can increase the value of your business.  I will provide examples for each and discuss what you can do to improve your company's ranking in each of the 8 key value drivers.

Summarizing the 8 Key Value Drivers

You may not be looking to sell your business any time soon.  You may not have started planning for the departure from your business despite the fact that all business owners will one day exit their business (voluntarily or involuntarily due to death, disability, disaster, divorce or dispute).

Are you, however, looking to increase the value of your business and continue to build your wealth?

Value is ultimately driven by a company's future income or cash flow expectations, and the future is inherently uncertain.  Increasing your operating cash flows and minimizing the risk associated with achieving and/or exceeding the projected operating cash flows will increase the price an acquirer is willing to pay for your business. 

I recently introduced you to the Value Builder System(TM), a statistically proven methodology for increasing the value of your business.   Business owners can complete a 13-minute questionnaire and receive their Value Builder Score out of 100. 

In order to truly understand your Value Builder Score you need to appreciate where your company stands in each of the following 8 key value drivers:

1. Financial Performance - your history of producing revenue and profits combined with the professionalism of your record keeping.  Greater revenues and profit margins lead to higher value.

2. Growth Potential - your likelihood to grow your business in the future and at what rate.  A proven track record of meeting and/or exceeding prior growth targets (revenue and profits) and a solid business plan with future growth projections will increase value.

3. Switzerland Structure - how dependent your business is on any one employee, customer or supplier.  Minimize your company's dependence on a key employee, customer or supplier to lower your risk profile and maximize value.

4. Valuation Teeter Totter - your ability to manage working capital and continue to generate positive cash flow.  A strong balance sheet with excess working capital and positive cash flow from operations on a monthly basis will increase value.

5. Recurring Revenue - the proportion and quality of automatic, annuity-based revenue you collect each month.  The more revenues you have locked up under long-term contracts or under an automatic subscription basis, the higher the value.

6. Monopoly Control - how well differentiated your business is from competitors in your industry.  A strong niche and/or competitive advantage in your marketplace will increase value.

7. Customer Satisfaction - the likelihood that your customers will re-purchase and also refer you.  Increase your number of satisfied and loyal customers that refer you to others and you will increase your company's value. 

8. Hub & Spoke - how your business would perform if you were unexpectedly unable to work for a period of three months.  Minimize or eliminate your company's dependence on you, the owner, and you lower your risk profile and increase your company's value.

Wouldn't you like to know where your company ranks in each of these key value driver areas?  Armed with this information you can zero in on the value drivers that need improvement and identify where to focus your efforts and attention to increase the value of your business.  That's where the Value Builder Score comes in. www.valuebuildersystem.com  

Empirical evidence shows that companies with a Value Builder Score of 80 or more receive offers that are 71% higher than the average business!  Simply put, improving your company's performance on these 8 key value drivers will increase the value of your business.

Join me over the coming months as I expand upon how each of these key value drivers will serve to increase the value of your business.  I will provide examples for each and discuss what you can do to improve your company's ranking in each of the 8 key value drivers.

The Value Builder System - A Systematic Approach to Increasing Business Value

To further enhance my 17+ year career in business valuation as a Chartered Professional Accountant, Chartered Business Valuator, Accredited Senior Appraiser and Certified Exit Planning Advisor, I recently attended the Value Builder System training program in Toronto  (www.valuebuildersystem.com).

The Value Builder System is a statistically proven methodology for increasing the value of a business.   Business owners complete a 13-minute questionnaire and receive their Value Builder Score out of 100.   Companies with a score of 80+ typically receive offers that are 71% higher than average scoring businesses.  This questionnaire focuses on 8 key attributes that drive the value of a business.   The resulting assessment addresses the specific factors that will increase the value of your business.

The Value Builder Score and resulting Value Builder Assessment are fantastic tools for business owners to identify opportunities to enhance the value of their business.   What I like about the Value Builder System is that it was created by someone with actual experience building and selling four separate businesses, the most recent of which was a market research firm, and vetted by various M&A and valuation professionals.   John Warrilow's background and experience in market research has allowed him to analyze the results of more than 20,000+ Value Builder Score questionnaires and show that there is adirect, quantifiable relationship between your Value Builder Score and the value of your business. 

 
As an experienced business valuation professional I can attest to the fact that the Value Builder Score is truly based on 8 of the key factors that drive business value - factors that we at VSP consider in each business valuation we perform.   It is these 8 key value drivers and how they affect a company's Value Builder Score that we will be sharing with you over the coming months.  I hope that you will stay tuned...

August 1, 2015 Book Release - The Undiscovered Planning Tool for Business Owners

Many business owners will admit that they do not know the current value of their business.  Worse yet, those who claim to know the value will grossly overestimate or underestimate the value of their business, with serious repercussions.

Understanding the value of one’s business is critical. 

I have worked with business owners and their professional advisors (e.g. accountants, lawyers, etc.) for many years on matters involving business valuation.  I am often called when there is an immediate need to determine the value of a business or security – which could be in the context of an actual transaction, a legal dispute, a corporate reorganization or a matrimonial separation.

It became apparent to me that a business valuation can be a very powerful planning tool for business owners.  Despite the tremendous benefits, I find that obtaining an independent business valuation is still a largely undiscovered planning tool among business owners.

I started this blog a few years ago with the intention of disseminating valuable information to the business and legal communities regarding various topics related to business valuation, including the use of a business valuation as a planning tool.

Getting an independent business valuation done now provides the shareholders with a valuation template for future updates.  It also provides the basis for shareholders to discuss major assumptions underlying the value conclusions and key drivers effecting value.

An independent business valuation is something that should be done before it needs to be done and is extremely useful for a number of reasons.

• It helps manage value expectations.

• It helps enhance business value.

• It helps avoid legal disputes.

• It is integral for exit planning.

• It is required for tax and estate planning.

• It is vital for contingency planning.

I elaborate on each of these throughout The Undiscovered Planning Tool for Business Owners.  I will also share some experiences involving business owners who have successfully incorporated an independent business valuation into their planning as well as actual situations illustrating the consequences of not including an independent business valuation into the planning process.  Finally, I address some of the common reasons why business owners avoid exit planning and how these barriers can be broken down. 

If any of this resonates with you, my hope is that you are motivated to be more proactive, positive and successful when it comes to setting and achieving your goals.

For more information or to pre-order your copy today www.undiscoveredplanningtool.ca 

Want to Maximize Your Net Proceeds? Don’t Neglect Your Working Capital!

Cash flow measures the cash coming in and going out of your business whereas income is an accounting interpretation of your company’s net earnings or loss over a period of time.  For example, if you charge $10,000 upfront for a service that takes three months to deliver, you would recognize $3,333 of revenue per month on your profit and loss statement for each of the three months it takes you to perform the work.  But since you charged upfront, you receive all $10,000 in cash on the day your customer decides to buy. 

This positive cash flow cycle improves the value of your company because when it comes time to sell your business, the buyer will have to write two cheques: one to you, the owner, and a second to your company to fund its working capital (i.e. the cash your company needs to fund its immediate obligations like payroll, rent, etc.).  Both cheques, however, are drawn from the same bank account.  Therefore, the less the acquirer has to inject into your business to fund its working capital, the more money it has to pay you, the seller.   

The inverse is also true.  If your company is a cash drain, an acquirer will have to inject working capital into your business on closing day, which will reduce the purchase price for the business (i.e. reduce the amount paid to you as the seller).

If you want to maximize your net proceeds on sale it is important to manage your cash flow and ensure a positive working capital position on closing.  There is value associated with excess working capital by virtue of being able to either: i) liquidate current assets and extract cash from the business without affecting ongoing operations; or ii) borrow this amount from a lender (e.g. bank) using current assets as collateral and then extract the cash from the business without affecting ongoing operations.  

In an actual transaction the buyer and seller will negotiate a "normalized" working capital amount required for ongoing operations (e.g. based on actual historical balances, AR and AP collection policies, inventory turns, industry averages, anticipated growth, etc.).  Any amount over (under) this "normalized" working capital will be reflected as an increase (decrease) to the purchase price on closing.

One Thought For Improving Your Cash Flow

There are many ways to improve your company’s cash flow and, as a result, its value.  One often overlooked tactic is to spend less on the capital assets your company needs to operate. 

In the restaurant business, for example, it may take three bankruptcies at a single location before any restaurant can make money.  The first owner of a restaurant walks in and pays cash for a brand new commercial kitchen thus depleting his cash reserves before opening night.  Within a year, the restaurant owner runs out of cash and declares bankruptcy.

Along comes a second entrepreneur who decides to set up her restaurant at the same location and buys all of the new equipment from the first owner’s creditors for 70 cents on the dollar, figuring she has made a wonderful deal.  But the outlay of cash is still too great and she too is out of business within a year.

It’s not until the third owner comes along that the location actually survives.  He saves his cash by buying all of the equipment off the second owner for 10 cents on the dollar.  

The moral of the story - find a way to reduce the cash you spend on your capital assets.  Can you buy your equipment used at an auction or online?  Can you share a very expensive piece of machinery with another non-competitive business?  Can you rent instead of buying?

Profits are a very important factor in determining your company’s value but so is the cash your company generates.  Don’t neglect your company’s cash flow and working capital if you want to maximize business value and ultimately the net proceeds you receive on the sale of your business.

Want to be More Valuable Than Your Industry Peers?

The value of your company is dependent upon many things, including your industry.  When we look at businesses within the same industry, there are major variations in valuation.  Here are 10 things that will make your company more valuable than its industry peer group. 

1. Recurring Revenue

The more revenue you have from automatically recurring contracts or subscriptions, the more valuable your business will be to a buyer.  Even if subscriptions are not the norm in your industry, if you can find some form of recurring revenue it will make your company much more valuable than those of your competitors.

2. Satisfied Customers

Being able to objectively demonstrate that your customers are happy and intend to re-purchase in the future will make your business more valuable than an industry peer that does not have a means of tracking customer satisfaction.

3. Diversification

Acquirers will pay a premium for companies that naturally hedge the loss of a single customer.  Ensure no customer amounts for more than 10 percent of your revenue and your company will be more valuable than an industry peer with just a few big customers.

4. Growth

Acquirers looking to fuel their top line revenue growth through acquisition will pay a premium for your business if it is growing much faster than your overall industry. 

5. Predictability

If you have mastered a way to win customers and documented your sales funnel with a predictable set of conversion rates, your secret customer-acquiring formula will make your business more valuable to an acquirer than an industry peer who does not have a clue where their next customer will come from.

6. A Management Team

Companies with a management team or second-in-command who has agreed to stay on post sale are more valuable than businesses where all the power and knowledge are in the hands of the owner.

7. Something Unique

Buyers buy what they cannot easily replicate on their own, which means companies with a unique product or service that is difficult for a competitor to knock off are more valuable than a company that sells the same commodity as everyone else in their industry.

8. Location

If you have a great location with natural physical characteristics that are difficult to replicate (imagine an oceanfront restaurant on a strip of beach where the city has stopped granting new licenses to operate), you will have buyers willing to pay a premium for you business in its location.

9. Media Hype

Tired old companies often try to buy sex appeal through the acquisition of a trendy young company in their industry.  If you are the darling of your industry trade media, expect to get a premium acquisition offer.   

10. Clean Books

Companies that invest in audited statements have financials that are generally viewed by acquirers as more trustworthy and therefore worth more.  You may want to get your books reviewed professionally each year even if audited statements are not the norm in your industry.

Like a rising tide that lifts all boats, your industry typically defines a range of multiples within which your business is likely to sell for; but whether you fall at the bottom or the top of the range comes down to factors that have nothing to do with what you do, but instead, how you do it.

5 Ways to Increase Your Odds of Receiving an Unsolicited Offer

In any negotiation, being the person who makes the first move usually puts you at a slight disadvantage.  The first-mover tips their hand and reveals just how much he/she wants the asset being negotiated.

Likewise, when considering the sale of your business, it is always nice to be courted, rather than being the one doing the courting.  The good news is, the chances of getting an unsolicited offer from someone wanting to buy your business are actually increasing. 

According to the Q2, 2014 Sellability Tracker analysis released in July 2014, 16% of business owners have received an offer in the last year, which is up 37% over Q1.  Said another way, you’re 37% more likely to get an offer to buy your business today than you were at the beginning of the year.

Big companies are buying little ones for a lot of reasons and the current market conditions are accelerating their appetite: interest rates are low and stock markets are high, which provide the ideal platform for acquirers to realize a return on their investment from buying a business like yours. 

So how do you ensure you are on their shopping list?  Here are five ways to get noticed by an acquirer:

1. Win an award

Getting recognized as the “Widget Maker of the Year” by the Widget Makers Association is a great way to get the attention of acquirers in your industry.

2. Hire a PR person

Engaging a public relations professional to tell your story to the media can get you on the radar of buyers in your industry.  A lot of media relations professionals focus on the big mainstream publications, and while these are important, ensure that your PR firm also targets trade publication and industry-specific websites that are read by acquirers in your industry.

3. Host an event

Consider hosting an event (e.g., conference, tradeshow, summit) for your industry and invite representatives from potential acquirers to attend.  Being invited to an industry event can be flattering for acquirers and it is a good way to get them to notice you as an industry leader.

4. Join a board

If an executive from a company you think would make a natural buyer for your business is serving on a board of directors, consider joining the board.  Serving on a board together can be a great way for an acquirer to notice you and your company without you having to say you’re for sale.

5. Grab lunch

Consider inviting a senior executive from a potential acquirer to share a meal under the guise of discussing trends in your industry.  At the very least, you may glean some useful information about how big companies are seeing your industry evolve.  At best, your lunch mate may realize that your company could play a key role in helping them grow.

The sale of your business is a delicate dance where it is usually better to be the courted, rather than the courter.  Acquirers are on the hunt for new businesses, and having them notice you will put you in a position of strength when you get to sit down at the negotiation table.

Breaking Down Barriers

Are you passing your business on to the next generation?  Will you be selling to management or an employee group over time?  Would you like to maximize your net proceeds on a sale to an independent third party buyer?

Whether you plan on selling your business to an internal party over time or to an external third party for maximum proceeds, your success depends on how much effort you put into your planning and preparation.

Getting started is often the hardest part.  We learned from Newton that, “An object at rest stays at rest and an object in motion stays in motion….”  Excuses are your biggest roadblock to getting started.  It’s too early for me…  I’m too busy...  It’s too complicated…  It’s too expensive... and so on.

What’s really behind these excuses?  Understanding this may be just what you need to set in motion something that will “stay in motion” until your goals are achieved.  

Here are some tips for overcoming the most common excuses that are preventing you from getting started:

1. Your mind - Your mind can be your main ally when it comes to achieving your goals.  If, however, your mind is not programmed for success, it will do more to derail your efforts than to help you.  Visualize where you want to be after you exit your business and how it will feel when you get there.  This will give you the motivation to act.
2. Your fear - Change makes most of us nervous – even if it is a change in the right direction.  You may not be consciously aware of the fear you have over leaving your business.  Until you conquer this fear, your exit planning efforts will be blocked by self sabotage and procrastination.  Tackle your fears by believing that something must change, that you must change it and that you can change it.
3. Your commitment - We live in a commitment-phobic world, so it's no wonder that people routinely abandon their goals.  If you truly want to achieve your goals when you exit your business then your commitment to the process is critical.  The margin between success and failure is bridged by your commitment.  Don't give up until your goals have been achieved.  If you don't give up, then you'll never fail.  There are two options in life, excuses or results.  Which do you want?  
4. Your patience – Exit planning takes time and there are a number of issues to address.  It took time to build your business and it will take time to exit the business – that is if you want to exit on your terms.  When you find your patience wavering, review your goals - are they specific, measurable, realistic and attainable?  Remember, slow and steady wins the race.  You will be surprised with how much can be accomplished within a three year period after 12 quarterly meetings!
5. Your support network – Taking on this task alone will leave you less challenged, less accountable and more likely to fail.  There are many helpful resources out there.  Reach out to experts to assist you through the process.  Do some research and speak with colleagues and/or other business owners that have been through the process successfully.  Surround yourself with positive and supportive people.  Look for a professional advisor with exit planning credentials and experience to guide you through the process and involve the specialists where and when needed.

Contact us at jason@vspltd.ca or www.vspltd.ca to help you kick-start the exit planning process.  We can help you set your exit plan in motion and assist you with the implementation to ensure you exit on your terms at a time of your choosing.

1.  Inspired by Daryl Devonish, Co-Owner, Body Pump Inc. (www.bodypumpinc.com). 

Will Your Goals Be Thwarted by These Excuses?

All business owners exit their business eventually.  Planning is critical if you want to ensure a successful transfer of your business - whether that transfer be internal (i.e. to another shareholder, a management group or the next generation) or external (i.e. to an independent third party).

According to a recent CFIB study, less than 10% of business owners have a formal written plan, 40% have an informal plan and over 50% have no plan whatsoever. [1]  Why have so many business owners avoided planning their exit?  

Does this include you and, if so, what is holding you back?  Here are the top 5 excuses that prevent business owners from beginning their exit planning:

Excuse #1: It’s too early for me to plan for succession

Fact: It is never too early.  Planning should begin at least 3 to 5 years prior to exit because there are many issues that require time to adequately address.  Identifying your exit option early (e.g. internal or external) is extremely important.  Identifying how much you will need financially when you exit is critical.  Allowing sufficient time to enhance the value of your business and ensure proper tax plans and structures are in place to minimize tax on the transfer before exit is also vital.  Beginning your planning early could mean the difference between success and failure.  

Excuse #2: I’m too busy 

Fact: You are never too busy to do that which is important - it’s a matter of prioritization.  If ensuring a successful transition to the next generation or maximizing your net proceeds on the sale to a third party is important to you then you will make time for the planning that is necessary to ensure these goals are achieved.  If you are truly serious about meeting your transition goals and understand the importance of planning then you will make it a priority.   

Excuse #3: It’s too complicated and I don’t know where to begin 

Fact: It can be complicated but that has not stopped others from starting their exit planning.  There are many helpful resources out there.  Reach out to experts to assist you through the process.  Do some research and speak with colleagues and/or other business owners that have been through the process successfully.  Surround yourself with positive and supportive people.  Look for a professional advisor with exit planning credentials and experience to guide you through the process and involve the specialists where and when needed. 

Excuse #4:  It’s too expensive

Fact: Exit planning is an investment that should form part of your “wealth management” budget.  You pay professionals to “manage” your portfolio of publicly traded securities.  According to The One Percent Solution, privately held business owners should invest 1% to 2% of the value of their business each year on exit planning initiatives (e.g. business valuation, value enhancement initiatives, life insurance, tax and estate planning, etc.) [2]  This investment will pay off in the form of a higher business value (or price received) and less taxes paid, resulting in more money in your pocket - not to mention the decrease in stress knowing that your affairs are in order.  

Excuse #5 – I don’t want to think about leaving my business

Fact: You may not want to think about leaving your business but you will leave your business one day.  The departure from your business will be voluntary at at time of your choosing or it will be involuntary as a result of your death, disability, disaster, divorce or disagreement.  Would you rather exit your business on your terms or have your family deal with your unexpected forced exit?  Who will run the business?  Will it be salable?  Will it be dissolved?  Will there be taxes to pay?  Start planning now so you can choose while you still have the control to make a choice.     

If you would like to sell your business within the next 5 years, you have a tremendous opportunity to sell for a significant premium - provided you conduct the proper planning!  Those business owners that ignore planning could end up selling for a significant discount or face liquidation altogether.

Are you part of the 50% of business owners that have no plan whatsoever?  If so, what is holding you back?  Join me next time when we address how to overcome what is holding you back.

1. Source: CFIB Research Report November 2012 “Passing on the Business to the Next Generation”

2. Source: The One Percent Solution, Z. Christopher Mercer, 2007.

6 Ways to Profit From Your Vacation

Summer may be the perfect time to increase the value of your company.  The most valuable businesses are the ones that can survive without their owner.  A buyer will pay a premium for a company that can operate effectively without the owner’s presence and likely require a steep discount for a business that is dependent on its owner. 

This summer, consider taking an extended break from your business to see how things will run when you are not around.  It is likely that some things will go wrong, but use those errors as feedback for making your business operate more independently of you, and therefore more valuable.  

Here is a six-step plan for profiting from your vacation time this summer:

Step 1: Schedule your vacation plus one day

Whatever day you plan to start working again after your holiday, tell your staff you’ll be back one day later.  That way, you’ll have a full day of uninterrupted time to dedicate to understanding what went wrong in your absence.

Step 2: Log the mistakes

When you return, make a summary of the things that went wrong and categorize them into one of three buckets:

• Mistakes: errors where there is a right and wrong answer;
• Bottlenecks: projects that had difficulties because you weren’t there to provide your feedback;
• Stalled projects: initiatives that went nowhere while you were gone because you’re the person leading them.

Step 3: Correct the mistakes

The first and easiest place to start is to simply correct the mistakes that were made.  Usually mistakes are due to a lack of training rather than outright negligence.  The right answer may be crystal clear in your head but not immediately obvious to your staff.  Write up some instructions for next time the employees face the same situation.  Make sure your instructions are clear, and share them with your team so everyone has them.

Step 4: Unblock your bottlenecks

If you are being asked for your personal input on projects, there’s probably going to be a bottleneck if you are not around.  Make sure your staff is clear on the projects where you need to have a say and the projects where you don’t.  Some employees may wrongly think that you need to approve all decisions.  Make it clear when you want them to act alone and when you still need to be involved.

Step 5:  Re-assign stalled projects

The hardest part of making your business less dependent on you is dealing with projects that get stalled when you are away.  Start by asking yourself if you are the right person to lead the project in the first place.  As the owner of your business, projects often fall in your lap by default, rather than because you are the best person to lead them.  Categorize your stalled projects into two groups: a) strategic projects that you need to lead; and b) non-strategic projects you are leading by default.  Hang on to the strategic projects, but delegate the non-strategic projects to someone on your team who is better suited to drive them forward. 

Step 6: Give your employees authorization

At Ritz Carlton Hotels, every employee has discretion to spend up to $2,000 on a guest, without approval from their general manager.  The $2,000 figure is a large enough number to make the message clear: front line employees should act first, make the customer happy, and ask questions later.  Many employees know how to make a customer happy but lack the confidence to act.  Giving employees some spending authority will speed up the resolution of customer issues and empower your team to do the right thing when you’re not there. 

The sunshine is beckoning, so go ahead and take a vacation – if you follow the six steps here, you may end up with a tan and a more valuable company. 

Estate Executors – How to Increase Your Protection and Minimize Your Risk

The executor of an estate with business interests should obtain an independent professional business valuation as support for the values used in the estate administration tax (“EAT”) filing, particularly in light of recent changes to EAT legislation and the potential for personal executor liability.

At the time of probating the will, EAT (previously known as “probate fees”) of 0.5% must be paid on the first $50,000 of estate assets and 1.5% on the value of the remaining assets. [1]  The estate representative (i.e. executor or trustee) has many responsibilities, including:

1. Filing an affidavit as to the estimated value of the estate; 
2. Remitting the EAT on the estimated value; and 
3. Providing an undertaking to file, within six months, a sworn statement of the total value of the estate, and to pay the balance of any additional tax owing (if any).

In 2011, the Ontario government amended the legislation to enhance the EAT compliance regime.  Beginning January 1, 2013, the Ontario Minister of Revenue will be afforded significant audit and verification functions including the right to conduct a review of the estate inventory and valuation provided by the executor.  If a greater estate value is determined, additional taxes can be assessed.  As a result, there will be much more pressure to verify the value of the assets disclosed in the EAT filing.

Penalties have been added to encourage compliance.  It will be an offence for an estate trustee to fail to make the required filing with the Minister of Revenue.  It will also be an offence for any person who makes, or assists in making, a false or misleading statement in connection with the estate trustee’s filing.  Offences are punishable by fine, by imprisonment or both.  The minimum fine will be $1,000.  The maximum fine will be twice the EAT payable.

An estate representative may be exposed to personal liability if the estate assets have been distributed before the Minister of Revenue issues a notice of assessment.  There is no ability to obtain a “clearance certificate” to protect the estate representative from personal liability.

In light of the responsibilities of the estate representative, the new audit measures, and the potential for personal liability, it will be critical for executors to be diligent in obtaining and documenting proper and accurate valuations of the deceased’s property for purposes of calculating the EAT.  Where the estate holds shares in privately held businesses, the benefits of obtaining an independent business valuation will far outweigh the costs to the estate and the risk to the executor of not having one prepared.

Contact us at jason@vspltd.ca or www.vspltd.ca for an independent business valuation if you want to minimize your risk and increase your protection as an estate executor.

[1]  source: www.attorneygeneral.jus.gov.on.ca

Business Valuations to Support Life Insurance Coverage

We were recently contacted by the Inspection Department of an independent service provider to the Canadian life and health insurance industry with respect to one of our clients.  They were gathering information to assist in the underwriting process and wanted independent evidence supporting the client’s claim as to the value of the business as part of their inspection process.  Our client asked us to provide a copy of the independent business valuation we had prepared for purposes of their estate planning and life insurance.  

We have been providing independent business valuations to help business owners determine an appropriate amount of coverage for many years.  This was the first time, however, that we were contacted by a representative of the insurance company.  It may be that independent business valuations are becoming a more formal part of the underwriting process.

Life insurance is often used for income replacement or to alleviate the burden of estate and probate taxes upon death.  However, when business owners use life insurance to fund a buyout or redemption of the shares of a deceased shareholder it is important to ensure that the death benefit will be adequate to:

1. Fund the buyout or redemption of the deceased shareholder’s shares (Buy/Sell Insurance); and
2. Ensure the continued survival of the business upon the loss of what may be a key person in the business (Key Person Insurance).

As a result, the life insurance coverage should at least cover the current value of the business and many business owners grossly overestimate or underestimate the value of their business.  An independent business valuation provides business owners with third party evidence for ensuring adequate life insurance coverage.  This in turn provides the shareholders with peace of mind that their families and their businesses are sufficiently protected.  

An independent business valuation is also helpful to the insurance advisor as it will help:

1. Manage and control the process in creating the application file - insurance companies and their risk advisors are increasingly requiring support for the amount of coverage requested; and
2. Solidify trust and cultivate the relationship with the client - providing the insured with third party evidence regarding the value of their business eliminates any pre-conceived notions the client may have with respect to being over sold or under estimated as far as coverage.  

The business valuation should also be updated periodically as the adequacy of the life insurance coverage should be reviewed in light of any growth or other changes to the business over the prior years.  Ideally, this process should be agreed to and formalized in the company’s shareholders agreement, which for many business owners, may not exist or may not have been updated for many years.

Life insurance is an integral part of estate and contingency planning for business owners.  If you are in the process of obtaining life insurance or reviewing your current coverage, contact us at jason@vspltd.ca or www.vspltd.ca to assist with your business valuation needs.

Supporting Valuations in Tax and Estate Planning

30% to 40% of business owners are planning to transfer their business internally to another shareholder, management, employees or family member. [1]  One option for those planning to transfer the business to the next generation over time is through an estate freeze.

In an estate freeze the business owner’s common shares are exchanged for preferred shares of equal value to the common shares.  New common shares are then issued by the company to the next generation family members.  This allows the business owner to “freeze” his/her unrealized gain in the corporation on a tax-deferred basis, with any future growth in value of the company accruing to the children.  As a result, the business owner can estimate and plan for the future tax liability, perhaps with life insurance.

Under an estate freeze the fair market value of the common shares must be established.  According to the CRA, the fair market value must be determined “by a fair and reasonable method”. [2]  If not, CRA will likely challenge the validity of the transaction alleging that a benefit had been received by a shareholder who acquired property from a corporation at less than fair market value.

In the event of a potential dispute with the CRA, price adjustment clauses (PACs) are sometimes used to retroactively adjust the fair market value to avoid the “conferral of benefit” problem.  Unfortunately, a PAC may not help if a fair and reasonable valuation attempt was not initially conducted.  

In Guilder News Co. (1963) Ltd. et. al. v. M.N.R., 73 DTC 5048 (FCA), the Court rejected the PAC as a basis for adjusting the price and eliminating the benefit on the grounds that the parties had not reasonably attempted in good faith to transact at fair market value.  Other recent case law involving PACs include St. Michael Trust Corp. v. Canada (2010 FCA 309, affirming Garron, 2009 TCC 450) and Krauss v. Canada (2010 FCA 284, affirming 2009 TCC 597).  Potential implications of not having a fair and reasonable valuation to the business owner include additional taxes, interest and penalties.

An independent valuation prepared by a qualified business valuator can provide a fair and reasonable basis for the fair market value used in an estate freeze, essentially acting as insurance for potential disputes with the CRA.  Inadequate fair market value assessments can give rise to unfortunate tax consequences as well as costly and time-consuming litigation, not only with the CRA but also with the advisors. 

Other tax and estate planning mechanisms involving the transfer of assets or shares to a related party could include business incorporations, corporate restructuring, share reorganizations or family trusts.  In order to take advantage of tax deferrals, these transfers typically must occur at fair market value.  You will be well served and protected by involving and retaining an independent business valuator to assist you with the fair market value determinations.

If you are considering an internal transfer, contact us at jason@vspltd.ca or www.vspltd.ca to assist with your business valuation needs.

1.  Sources: 2007 RBC Study - Quantitative Study of the Business Succession Market in Canada and CICA/RBC Business Monitor (Q1 2010).

2.  Source: CRA’s Interpretation Bulletin IT-169.

Business Valuation Helps Facilitate an Internal Transfer of a Business

According to recent studies on the business succession market in Canada, between approximately 30% and 40% of business owners surveyed are expecting to transfer their business internally to other shareholders, management, employees or a family member.

If you are planning to one day sell your business to an internal party, an independent business valuation can be very beneficial for managing value expectations and ultimately facilitating the transfer of the business at a fair and reasonable price.

It is extremely important for all parties involved in an internal transfer to agree on the current fair market value of the business, to ensure a smooth ownership transfer.  The current fair market value can be used to set the price for the transaction in situations where the purchaser acquires the departing shareholder’s shares or situations involving share redemptions by the company.

In his best-selling book on protecting family wealth, “Every Family’s Business”, Tom Deans suggests that all business owners should arrange for an updated annual valuation of the business.  One of the 12 steps in Tom’s annual checklist for family businesses (referred to as the Wealth Protection Blueprint) states that business owners should:

“… arrange for an updated valuation of the business and calculate whether there is appropriate insurance in place to ensure that estate taxes will not impair the ability of the company to function in the event of the owner’s death.”

Tom then discusses the implications of not obtaining a valuation prior to an internal transfer.  There can be serious repercussions to the business and to family members if the company is transferred to the next generation for an amount that is less than or greater than the actual fair market value of the business, particularly when the transaction was financed with debt.

An independent business valuation will help set a reasonable price, one that is fair to all parties, to facilitate the transfer of all or a portion of the equity to other shareholders, management, employees or a family member.  Having an independent expert business valuator explain the valuation process, approach and assumptions will help ensure that all parties are satisfied that a fair and reasonable deal was struck.

The business valuation can also be used for contingency planning to help protect the business and the business owner’s family in the event of an unplanned involuntary transfer due to death, disability, divorce, distress or disagreement.

If you are considering an internal transfer, contact us at jason@vspltd.ca or www.vspltd.ca to assist with your business valuation needs.

1.  Sources: 2007 RBC Study - Quantitative Study of the Business Succession Market in Canada and CICA/RBC Business Monitor (Q1 2010).