One of the biggest small business risks can often start with the owner! In our many years of working with business owners, it’s not uncommon to hear the following:

“My customers will be with me until the day I die”.

“My business is my identity”.

“My business is my superannuation”.

If you agree with these sentiments, it is likely that your business is overly reliant on you.

You might ask, so what?

A business that relies heavily on its owner is not as valuable as a business that is not reliant on its owner. When we talk about small business risks, many business owners don’t understand the risks of key person reliance and how it can significantly impact the value of their business.

Compare the following valuation scenario of the same business when key person reliance is reduced or minimised:

Business Key Person Reliant Same Business not Key Person Reliant
Business Profit $200,000 $200,000
Business Valuation Multiple 3.05 3.5
Business Value $610,000 $700,000
Value Improvement $90,000
Improvement % 14.75%

 

Buyers will pay a higher price for a business that can be easily integrated into their current business or smoothly transitioned to a new principal. They will want some comfort that the business’ key customers and staff will stay with the business once the current owner departs.


What can you do to reduce the small business risks of key person reliance?

There are many different business and risk management strategies business owners can implement to reduce or minimise key person reliance.

The table below provides some suggested examples:

 

STRATEGIES ACTION
Business  

 

1. Business Systems: introduce systems into your business. For example, a good quality stock management system will reduce reliance on the owner’s product and services knowledge.
2. Client Relationship Management: establish customer relationship management protocols so staff can manage key customer relationships.
3. Management Succession: invest in the professional development of your key staff so they can eventually share in part ownership (succession planning) of the business.
Risk Management   The very nature of some businesses means it is difficult if not impossible to reduce or remove key person reliance. A specialist surgeon is an example of an occupation that will always be key person reliant. In this case where key person reliance cannot be removed or reduced the purchase of business insurance is considered an effective risk management strategy.

 

Start assessing the impact of key person dependency on your business by requesting a business valuation from your accountant. Your accountant is best positioned to provide advice on key person reliance, business valuation and business and risk management strategies to reduce, remove or minimise the risk from key person reliance.

The team at MGI South Queensland can help you with all aspects of improving your business valuation as well as business succession and exit planning strategies and business benchmarking for business growth. Give us a call on 07 3002 4800 or book a consultation online today.

Disclaimer: this information is of a general nature and should not be viewed as representing financial advice. Readers of this information are encouraged to seek further advice if they are unclear as to the meaning of anything contained in this article. MGI accepts no responsibility for any loss suffered as a result of any party using or relying on this article.

Learn the secrets of entrepreneurs who have made a fortune building and selling businesses!

People don’t build and sell multi-million dollar businesses by accident! Just like you wouldn’t build a house without a plan, you can’t build a high value business on the fly or simply by chasing sale after sale.

Watch this webinar to learn how to exponentially build the value of your business and ensure that you reap your dream financial reward when you decide to call it a day.

Watch webinar

A successful exit strategy is dependent on numerous elements, from what industry you work in to the nature of your business and of course, the scale. The way you choose to exit your business is a very important and personal decision and one that shouldn’t be taken lightly. The type of exit will depend on your personal goals, financial needs and industry conditions.

Below we have detailed five different types of exit strategies to identify which best fits your organisation.


1 – Sale to Market (third party)

Let’s start with the most common exit strategy – selling to market. The sky is the limit on your perceived value but you still need to find a willing buyer on the open market. Typically you will require services from a team of consultants, including business brokers, lawyers and accountants; this can be costly depending on the complexity of the transaction.

The up sides of selling to market are that you can set a higher price than you would for say, a family member or friend. You could also potentially have multiple buyers which would result in a bidding war and increased sale value. Furthermore, by not passing on the business to family means your loved ones benefit from the money without the pressure of the business operation.

There are downsides of selling to market however. Depending on your business it may not be able to cope with the handover. The acquisition has the possibility to get messy and difficult and if the buyer doesn’t hold your values which could seriously alter the culture of your business. There’s also a chance that you could find it hard to let go.


2 – Internal Sale

When it comes to an internal sale, the owner is usually very emotionally attached to the business and wants to see it go into good hands so will choose someone they know. This person tends to be an employee or business partner, or a family member to ensure the legacy that has built up over the years continues to grow as the owner wanted.

The pros of this type of sale include that the owner has confidence that the business will be ran by someone who has an existing knowledge of the business, improving chances of future growth and longevity. The buyer already has the commitment to making it work as they have an emotional attachment to it. Selling internally also means that the owner could stage their exit over a longer period of time.

However, as the buyer has more power because of the knowledge of the business, the price tends to be sacrificed. In most instances, the buyer has to finance the sale to allow the buyer to pay the purchase amount off. If there are several family members interested in the business, this can cause conflict over who gets what share. In addition, if there are any liabilities in the business such as unpaid taxes that are then handed over to the new buyer, it may damage that relationship post-sale.


3 – Merger / Acquisition

It could be necessary to exercise the option to merge with another company should cash flow or liquidity become an issue. By ensuring your company stays afloat will provide a level of security to investors .

The difficulties that can occur with a merger include: it’s often complicated to set up and execute seamlessly, it can be difficult to sustain long-term, there could be a damage of culture as you’re mixing two separate businesses, and depending on the nature of the company, it just may not be suited to merging.

If the merger goes ahead then it could provide a lot more access to new markets and expand your product options as well as opening the business up to new technologies, people, supply and capacity.


4 – IPO

Summary: An initial public offering (IPO) is the first time that the stock of a private company is offered to the public. IPOs are often issued by smaller, younger companies seeking capital to expand, but they can also be done by large privately owned companies looking to become publicly traded. Of the two million plus companies registered in Australia, around 2,000 are listed on the ASX.

IPOs are very rare and take a lot of time and money to carry out. In fact, the financial and accounting requirements need to be in place from day one and they will be well above the normal required by SMEs. The other downside of an IPO is you will lose the ability to operate confidentially.

The upside to an IPO is the instant recognition and fame within your industry; if your company is listed it brings a certain amount of prestige and public awareness. Once it’s listed, the business will have high stock worth potential and it improves the financial position.


5 – Liquidation

Going into liquidation is a normal exit plan for companies that will not go on and survive without the owner. Assets are disposed to pay off creditors and any minor profits are divided among shareholders . This is usually a considered option if the business owner is stressed and just wants to exit; an attitude of enough is enough.

Liquidation is not normally a planned exit strategy but unfortunately, it happens regularly. This method of exit strategy is more common in the situation of microbusinesses and when the owner is so closely associated with the brand, image and running of the business, making.

Although going into liquidation is seen as a final resort there are some pros such as the simplicity of it and how quick it can happen as well as you don’t have to worry about the selling price or the time it could take to sell and there’s no stress about transferring control to a third party – be it a relative, close friend or stranger.

Of course, having to go into liquidation can be a terrible feeling – the reputation that you have built up, your clients, contacts, time and effort effectively disappears. This option will also not impress your shareholders and you’re not likely to get your highest sale value.

1 HuffPost article Startup Exit Strategies for Investors http://www.huffingtonpost.com/david-drake/six-startup-exit-strategies_b_8254780.html
2 Small Business United, Pros & Cons of 5 Different Exit Strategies http://www.sbua.org/articlesJune/june_article04.html

I’ve often been asked by clients to assist in a trade sale of their business or a sale or hand over to the next generation. These all take different forms depending on the motivation of the parties concerned.

While there seems to be an increasing awareness of the need to prepare for transitioning the business, figures from the latest MGI Family Business Survey indicate that more than 75% of family businesses have no formal, written management or ownership succession plan.

I was recently asked what I thought were the secrets to good business succession for a family-owned business. A common scenario is where the mum and dad business founders want to retire and hand the business over to one or more siblings.

As in life generally, communication is the key. Differences can arise when the parties have a mistaken perception about the motives and actions of each other. Talking things through is therefore critical to avoid the potential for the parties to make assumptions and jump to sometimes erroneous conclusions.


I have listed below my Top 5 issues to include in your business succession discussions:

  1. Develop a Family Business Constitution
    One of the best ways to ensure that the necessary issues are discussed is for the family to work through the process of documenting a family business constitution. As in all cases, its horses for courses. If your business is relatively small, the starting point may be to initially just cover the basics. You can build on it as time goes by. For larger businesses, it’s worth the effort to get it right and documents what the family has agreed and enables family members to clarify expectations, minimize conflict and maintain family relationships.
    By identifying processes for communication, decision-making and handling disagreements and creating a clear set of guidelines for resolving issues before they escalate, a family business constitution helps to formalize procedures and relationships, reducing the potential for issues to become personal and emotional.
  2. Get buy-in from the whole family
    Involving all family members in the process, regardless of their current level of involvement in the business, is critical in ensuring that the plan is workable. Without everyone’s input, there may be underlying issues which can ultimately lead to resentment within the family.
    If the business is not going to be passed on to all children equally, make sure your estate planning reflects this. Having an up to date Will that reflects your intentions is often overlooked.
    Finally, it might sound obvious but it’s crucial to plan the involvement of the successor sibling to ensure that all knowledge and intellectual property is captured and passed on in a timely and effective manner.
  3. Agree a business valuation framework
    A business valuation framework should be Included in the Family Business Constitution so that all family members are clear on how the business will be valued. The key here is to make sure that it is workable and that the terminology is well defined so that there can be no room for misinterpretation. It is important for both the vendor parents and the purchasing sibling to feel that the transaction price is fair. However, it is just as important that siblings not involved in the business perceive equity in the process.
  4. Review your business structures
    There are two issues with this step. The first is to ensure that your current structure is right for you. Family (discretionary) trusts are very commonly used in family businesses. Whilst these may work well for a typical mum and dad family business they are unlikely to be appropriate where siblings are involved. With a family trust, you don’t own anything and therefore do not have an asset to bequeath in the event of your death. What happens if a sibling dies or there is a matrimonial split?
    The second issue is to ensure that you take full advantage of some of the capital gains tax concessions currently available on the sale of a business. If structured correctly, it is possible to have a capital gain of up to $4m and pay no tax but there are many “hoops” to jump through in order to qualify, so get advice well before you’re ready to sell.
  5. Consider implementing a put and call option arrangement
    Whether a business will ultimately be transferred from mum and dad to one or more of the children, or whether a number of siblings are already owners of the business, one thing that is generally not well addressed is what happens if one of the owners dies or is seriously incapacitated. Often, the siblings of the deceased are left in business with the spouse or family of the deceased, sometimes with disastrous consequences. One way to deal with this is to put in place a Put and Call Option arrangement.
    In the event of death or disablement of an owner, it provides the spouse or estate of the owner the right, but not the obligation, to force the remaining owners to buy out the ownership interest. It also provides the remaining owners with the right, but not the obligation, to force the spouse or estate of the deceased, to sell. This provides certainty for both parties. The buy out is often funded (either fully or partially) by having the parties take out life insurance.

Of course, having a framework to work through the process is vital but one thing you cannot predict is how people will react – their thoughts, feelings and concerns. Taking account of the human side of the planning process and having a process to deal with it is critical to the effectiveness of the final plans.

Creating an effective plan may seem quite a daunting task, especially when it involves getting the buy-in of all family stakeholders but if you break it down into bite sized chunks and set realistic deadlines for yourself, it can prove to be one of the most valuable exercises you will undertake for your business.

In over thirty years advising family businesses, the most successful succession plans I’ve seen have been the ones where there was solid stakeholder engagement – in other words – good communication within the family. Even if you think everyone is aware of what is going on and generally on the same page, don’t leave things to chance for people to fill in the blank spaces. Fill them in for them.

Often there will be an “heir apparent” to the family business – someone that has worked in the business already. But do you really know the personal (and business) vision of all family members? Have you taken the time to talk to ALL family members to ensure they’re on the same page? The risk of not doing so is a potentially unhappy sibling which could lead to a lifetime of bitterness and resentment.

A good place to start is to actually ask all family members about their personal vision.

  • Do they actually want to work in the family business?
  • Do they want to own part of the business or are they happy just working in the business?
  • Do they want to be the business leader?
  • Are they happy for their siblings to be part of the business?
  • Do they want to own all of the business, not just part of it with their siblings?
  • What are their future plans for the business? Do they plan to grow it? The implications of this can be significant.
  • Do they want it to stay within the family?
  • What do they think the purpose of the business is? Is it to accumulate wealth for the family or is it to fund lifestyle? Alternatively, is it to provide careers for multiple generations of family members and to pass onto the next generation?

When talking with business owners I like to obtain the above information by way of a succession planning questionnaire and have each family member complete this. If you intend to have multiple family members owning the business, make sure there is cohesion around investment decisions and dividend policy. In my experience, this is where things can go awry. Let me give you an example.

Sibling one sees the future potential of the business. They want to grow it and invest all of the profits back into the business for the strategic growth of the business. Sibling two is also happy to grow the business, but wants (or needs) the monthly dividend cheque in order to fund their lifestyle. You can see that the disconnect between the personal (and business) visions of each sibling will end up as a recipe for disaster.

Another of the potential areas for disagreement and resentment can be if one sibling feels another sibling has got something unfairly. In other words, if one sibling feels another sibling has been “given” the business or at a significant discount.

So, make sure there is total transparency in relation to price. Get the business valued by an independent party so that everyone knows that a market price has been paid, even if most or all of this is vendor financed by the parents transferring the business.

As in any relationship – communication is always the key.

Barriers to succession I’m often intrigued when I read in the press about rather large family-owned businesses which are impacted by family and succession issues. Someone commented to me recently about the issues surrounding Bob Jane’s family and his business and how these have been in the media in recent years. I was asked: “Why do these types of issues arise in quite large businesses? Are they common and do they occur in all family businesses?” Firstly, family disputes are nothing new. They have been going on for thousands of years. However, when you overlay family relationships with business you have a unique dynamic.

As with any relationship breakdown, the breakdown of a family business relationship usually occurs due to a lack of communication between the parties. I’ve previously published my top 5 tips for successful family business succession. The first two of those tips related to communication.

By way of background, we know from the recent MGI Family & Private Business Survey that the average age of a family business owner is 58 and this has increased on surveys over the past decade. Over a third (37%) are aged between 60 and 70, with 25% aged over 65. Interestingly, the survey also found that nearly 60% of family business owners felt that the younger generation family members are not as interested in actively managing the family business.

In a sector that employs over 60% of employees and is estimated to be worth some $4.1 trillion nationally, family business succession is a crucial issue facing the Australian economy.


What do we mean by succession?

Firstly, I think it is important to identify what we mean by succession. In relation to a business, there are a number of areas of succession, but the two most common are management succession and ownership succession.

Whilst some issues spread across both means of succession, I believe that greater clarity can be achieved by looking at these issues separately. For example, there is no reason why parents cannot retain ownership of the family business but handover operational management to the next generation. In this scenario, difficulties arise if, for example, the parents won’t “let go” of operational matters. In family and private business, business owners often wear three “hats”:

  • an employee hat – what they do in their employee role
  • a directorial hat – what they do because they are a director of the business and
  • an ownership hat – the role they play as an owner of the business.

Sometimes these roles get blurred and when they do it is not always apparent which “hat” the person is wearing. So a useful first step is to understand and agree whether a business is dealing with management succession, with ownership succession or with both.


What are the key challenges?

According to the MGI Family & Private Business Survey, around 60% of family businesses are first generation businesses.

It makes sense to assume then, that most family-owned businesses won’t have dealt with this area before and in my experience, the biggest reason these issues are not addressed is that most business owners just don’t know where to start. Many also say that they don’t want the business side of things to impact on a close family relationship. This is perfectly understandable but also quite manageable.

However, sometimes these issues are swept under the carpet in the interests of family harmony. In my view, this is just putting off a problem to another day – a day when the problem may be much bigger, and harder, to deal with.

Suffice to say, in my experience, the likelihood of successful succession planning can be enhanced by both using an external party to facilitate the discussions and following a process. If this is done effectively, the likelihood of conflict between family members can be significantly reduced and managed.

In any family business, the motivations and aspirations of the various family members will be different. I find that one useful exercise is to have the family members complete a simple survey designed to identify what it is each of them are looking for out of the business.


Consider this scenario:

  • One sibling may simply be interested in just having a job.
  • Another sibling may be interested in taking over management of the business, growing and reinvesting all the profits into the business to fund that growth. Receiving a dividend cheque is not the motivator for them.
  • Conversely, another sibling may say they want no active part in the business but they actually do. Not only that, they want their dividend cheque to fund their lifestyle and build prestige. They are not interested in reinvesting profits to grow the business.
    I often find that by working through a process with the key family stakeholders that the “end game” becomes much clearer. It helps identify issues that the various family members never realised or articulated and invariably leads to an “a-ha!” moment.

There are numerous options that can result including:

  • Ownership and management being assumed by one child. In this case, great care needs to be taken to ensure that other family members perceive this to be an equitable arrangement. Often this will involve a sale of the business (usually at market value) to the child by the parents. This may also involve some form of vendor finance.
  • Ownership and management being assumed by a number of children. Clearly, the more family members involved in ownership and management, the greater the potential for conflict and therefore the greater the need for clearly defined rules and objectives for the business and the family members (e.g. a family business constitution). Understanding and discussing the motivations and aspirations of the various stakeholders up front is a key issue.
  • Management being assumed by (usually) one child, with ownership remaining with the parents. Once again, care needs to be taken to ensure that roles and responsibilities of all parties are clearly defined and agreed.
    Handing over leadership and control of the family business is arguably one of the most difficult decisions facing the owners of these businesses. It has potential to impact not only the performance of the business, but also the life-long relationships within the family. It is therefore critical that it is openly addressed and tactfully handled and a family business advisor can be an invaluable asset to facilitate this process.

In business management guru, Stephen Covey’s, best-selling book, The Seven Habits of Highly Effective People, beginning with the end in mind was a top habit of his. This got me thinking. Why is it that so many business owners don’t have a clear picture of what they want their business to look like when it’s ‘done’? And what would be the best way to achieve an exit plan for small business owners?

Covey’s habit is based on the ability to envision what you can’t presently see with your eyes. He believes in the principle that all things are created twice – once in the mind (the first creation) and once physically (the second creation).

So with this theory in mind, if you can’t visualise how your business will look at the end then you can’t make it happen.

I often ask my client’s one question: When do you intend to exit your business and how much cash do you want to walk away with?

A typical answer might be: “I want to sell my business for $10m in ten years.”


Below I have outlined what steps you can take to help power you though and build an exit plan for small business.

  1. Conduct a simple analysis and look at what the business is currently worth and how much work needs to be done to achieve the $10m payout in ten years’ time.
  2. If the business is currently worth only $1m then there is significant work to be done. However, at least we have identified the end point.  Mathematically, there are only two variables in working out your business value – your profit figure and the valuation multiple. The valuation multiple is simply a measure of risk; the less risky you make your business, the higher the multiple
  3. Map out ten columns on a page. In the first column set out the profit and loss statement for the current year, the current valuation multiple and the current business value. In the last column is the goal e.g. $10m in ten years.
  4. Back fill a potentially achievable valuation multiple and work out what the profit needs to be in year ten. Ideally, the valuation multiple should be greater than the one used in year one because you should be trying to reduce the risk for a potential buyer over the ten years. For example, if the valuation multiple is four then the profit needs to be $2.5m to get the $10m business value.
  5. Then fill in some ballpark numbers into the profit and loss statement –what sales will be needed to arrive at a $2.5m profit? What gross profit margin am I likely to be achieving and what are my expenses likely to look like?
  6. Do the same in columns three, five, and eight. These create “sign posts” on the ten year journey and there’s now an indicative profit and loss statement that you know you must achieve in order to reach the ten year goal (walking away with $10m).
  7. Once you’ve got your “sign posts” flagged on your journey, you can then drill this down to strategy i.e. what needs to be done in order to bring about the required change?
  8. Use an appropriate revenue model to focus on building the top line sales for example, Revenue = Number of Customers x Transaction Frequency x Average Dollar Sale. In order to grow the top line you’ll need to work on each of these three variables.
  • What are your strategies to increase the number of customers?
  • What are your strategies to increase transaction frequency?
  • What are your strategies to increase the average dollar sale?
  1. Even small, incremental changes in each of these can have a compounding impact on revenue growth. Set lead indicators to measure and manage the activities that you’ve implemented to achieve the required increases in the above three variables. Unless you’re measuring and managing these activities on a regular basis (e.g. monthly) you’re unlikely to achieve them.
Reds5005 Mgi Exit Strategy V1

The challenge for many business owners is that they are too busy doing it, doing it, doing it – working in the business, not on it.

In my experience, the businesses that have had the most success at reaching their “end in mind” are those that have engaged someone outside of the business to meet with them on a regular basis to ensure they remain on track – to turn up the heat when things aren’t happening.

The choice is yours. More of the same or begin with your end in mind and achieve your dream.

Logo

Subscribe Now

Enter your details to access the guide

This field is for validation purposes and should be left unchanged.
Our Details

Share This

Select your desired option below to share a direct link to this page.
Your friends or family will thank you later.

Share on facebook
Share on twitter
Share on linkedin
Share on pinterest
Share on email