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Ep #052: Proven Approaches to Business Transition Planning with Laurie Barkman (Certified M&A Advisor) Thumbnail

Ep #052: Proven Approaches to Business Transition Planning with Laurie Barkman (Certified M&A Advisor)

In this episode of Business Exit Success, Laurie Barkman and I discuss the strategies, tips, and proven approaches for successful business transition planning.

We discuss valuable insights to help business owners maximize their business's value during times of change. Whether you're navigating changes in leadership, ownership, or structure, we discuss key considerations to ensure a smooth transition that preserves and enhances your business's value.

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Episode Transcription


Tom: All right Lori Barkman welcome to the Business Exit Success podcast and I just want to start right away I did read your book The Business Transition Handbook. So I am looking forward to our conversation today because you're going to have some great insight and knowledge for our listeners so excited to kick this off.

Lori: Thanks so much for having me and thank you for reading my book.

Tom: Yes absolutely. So let's just tell us a little bit about yourself and the work that you're doing with business owners.

Lori: I've spent a career working with companies from small to big and found a passion for working with entrepreneurs to help them on that growth journey. This phase of my career and the phase where I'm working with entrepreneurs is in this next act. We have an opportunity as a business owner to build a business that someone else may want to own one day and that is where I'm spending my time.

So how do we as owners think about that? For some it's very daunting, they've never done it before. It's very intimidating they want to have someone helping them on that journey so as the business transitions sherpa, that's what I'm doing. I'm working with them on this next phase of their entrepreneurial journey from building value, to letting go. From transition to transaction. I'm a certified M&A advisor and I work with companies on that path to get the business ready for an ultimate transition of ownership, succession of leadership and then it could be a sale to a third party. It could be a sale to a family or could be an ESOP. It doesn't matter what the mechanism is. But what is that ultimate letting go for them professionally, personally, and financially?

What drives an owner to exit their business?

Tom: Yes, and you mentioned that challenge of letting go. It can certainly be a challenge and I think I want to start there. I guess with this topic of life after business, and you mentioned in your book most owners feel they get pushed out of their business. When they leave the happiest and most fulfilling exits occur when they are pulled into the next chapter of their life rather than pushed and this is important because I feel talking about that next chapter is often neglected. Because it's the most difficult I think to talk about. Can you just touch on the push and pull factors that an owner will have to go through and maybe should start thinking about much sooner in advance?

Lori: Yeah, let's just think about your home. Something that everybody could probably relate to. If you own your home and you're looking to move one day and you've lived in this house for 40 years, you've raised your children. How easy is it going to be to pack up your stuff and move out? Well, it depends right? Are you going to move to a super exciting place that you're just so thrilled about and there's something about the house, there's something about the area, there's something about your family that's a pull factor? You're being pulled into this next exciting thing so as a business owner what's an equivalent feeling of that? Maybe it's because you are going to start another company. Maybe it's because you are going to serve on boards or you're going to be in the grandparent business. It's something that really gets you excited. You've started to work on that identity transition, the relationships, and how you spend your time. Those are all factors that can pull you towards something exciting and when you feel that energy and you feel that you're want and you're ready to start to spend more of your time there, what's going to happen is your body will follow right. If your heart and mind are there, your body will follow. On the opposite side of that, if you dig your heels in on something you just don't want to do. What's going to happen is you're not going to do it. No, you won't fall through there your mind's not there it's going to fall through and those are the push factors that can have that impact. Push factors can be also very negative things that you don't control. They can be a death. A death of your partner, your demise you know.

Unfortunately, we don't want that to happen, but we don't control it. Could be a divorce. It could be a disaster like COVID that affected all of us. But we had no control over it. We call them the D's right the five D's. Nobody likes to talk about the D's. They're bad, we hate them, but we must plan for them. These are the contingencies, the things that we also might not control somewhat is how we feel about the business. Are we not wanting to go in every day? We're just sick of it. You know we're bored and maybe that's sort of pushing us kind of in the middle. It's not really a pull factor it's not really a push, it's sort of this danger zone of wow if you are just coasting along with your business and taking your foot off the gas, eventually you might find yourself on that negative side of the spectrum. Which is why I really don't want to be here. This business is going in the wrong direction. What's going to happen to the transferability, and scalability of the business if you start to have more of those negative factors in your life? Negative factors in the business accumulate so that's the distinction I try to give is things that we control, things that we don't control. Are there more positive factors in one of these pull factors that we want to participate in or the more things we're trying to avoid and almost like sweep them under the rug and therefore don't participate in and affect our mindset and then those ultimately can harm the value of our business.

Tom: Yeah, and it's this dance right because it's obviously a very emotional event of thinking about leaving and going into that next chapter of their life. But many don't understand, like the reason why you're exiting, what you're going towards or away from can affect the value. Like no one's going to want to buy a business when you're like I'm exhausted, this is stressing me out. I got to get out. No one's going to want to buy that so having that thought out well in advance sounds like it not only adds value but makes sure for yourself that you're going to have fulfillment in that next chapter of your life. Is that pretty accurate?

Lori: Yeah absolutely.

What are the top three risks not being addressed before a business exit?

Tom: So continuing with that concept of planning with the end in mind. I kind of want to talk about the planning for the end but also the risk. You know everyone you mentioned is going to leave their business whether it's on their terms or not. Hopefully, it's not forced but the longer someone waits to plan, the less time they must address the weaknesses in their business. This can drag down the value so what are the top three risks that you see or have seen that maybe owners are not addressing or maybe they just haven't even thought about it when they come to sell their business? Does anything come to mind?

Lori: Absolutely the first and foremost is going to be just this understanding that you can't plan your exit when you're exiting. So, let's just acknowledge that for a second right? That does happen quite a bit. I want to leave but oh I haven't done this work to prepare the number one thing. The financials are a mess. The financials are inconsistent year over year. They're not accurate. There are just issues and issues if we are trying to sell the first thing that a buyer is going to want to see are your financials. So again, just think back to the house analogy, if you're trying to sell your house and they walk in and it's trash in your kitchen on the floor, oh my goodness right. They're just going to turn around and walk out. See you later. They may not be willing to wait around for you to sort of get accurate financials to share them. Time kills deals. As we say so I think that number one is the financials. The second thing is your people. If you as the owner are the most important person in the business, how transferable is that business going to be? How valuable is that business going to be? If you're not there the new owner, look at your business from the outside in, look at it as if you're the buyer. That's so eye-opening and I know you're a Value Builder advisor as am I and that's what I love about that system is it really helps us look at the business with this lens of what are these value drivers and what buyers might be looking for. So again, number one financials, number two is really related to you as the owner. What role do you have and if you can separate from the business? Also, your processes. Are your processes well documented? Are they documented and shareable so that people can learn and do what your business needs to be done and not just you?

Are projections important to have for a successful business exit?

Tom: Absolutely yeah it resonates very well with me because that's most of the conversations is having the people, the financials because the financials tell a story right and the one thing that I think when buyers come in, yes, they want to know what you've done in the past, but then a big part that they'll often miss is projections. What are you going to do after I buy your business for the next three or four years? What does that story look like because they want that story to look pretty darn good. If they're going to invest or buy your business, can you talk about maybe the projections and just that perspective of yes you need a strong history yes you've been in business for 25 years but a buyer is going to want to see what the future looks like as well. Can you talk about that?

Lori: They do, but there's a little bit of a rub and we should talk about this. Most business owners that I've encountered who are in the lower Middle Market don't do projections well or at all. The most common thing that I hear from the sellers is that oh I don't know right and what do I know and I said okay I understand that but let's put together projections one to two years. Not more than that because you're right beyond that. What do we really know? So, one to two years out maybe your business enables you to have ones that we can build from to predict year-over-year growth or flat or decline. So we want to use your history. We want to base it on some conservative assumptions and not go wild. I've seen assumptions go wrong. I was not working with my client at the time but she was working with a financial planner who I'll call them an accountant excuse me who she was working with an accountant who did some three to four year projections and the growth rates I think that he had were maybe 15-20. Very noticeable growth rates. When her historical year-over-year growth rates were more like eight percent, ten percent. You know at its peak maybe 15. And it was just dramatic. It was too dramatic so we can’t the buyers were poking all kinds of holes in the plan as they should have because it wasn't believable. I was working with her to put one-to-two-year projections and how we think we're going to get there and if anything it's only too conservative. That's another question you know that's another conversation, so for the buyers, I think they want to see that there is a plan but that they can capitalize beyond it because that's their goodness right? If they're going to acquire this business that's their role to take the baseline and then do better than that.

What’s the difference between exit planning and succession planning?

Tom: Absolutely yeah that all ties into and I kind of want to shift into a couple of terms that I see and hear get intertwined and mixed up quite often. There's the exit planning side and then the succession planning side which are two very different types of planning. But very important in each of their own right. They kind of get mixed up together. Can you just talk about the differences between those and the importance of addressing both of those areas when it comes to planning an exit?

Loti: Yeah, let's start with succession. So the first question is a succession of what? And the two categories that I usually talk about are succession of ownership and the succession of leadership. You can have a succession of leadership and still maintain ownership and control of your company. You can have a succession of ownership where you maintain control also but where you're thinking about your ownership as a continuum of time. So for example I have a client who is the founder and he has a partner so my client is 64% owner right now. He's got a daughter in the business and he wants her to have an ownership stake over time and so he's planning for her to get a 20 % stake over time and that enables him to maintain control. But if and when he's ready to completely roll out of CEO and completely roll off the board, you know with his estate plan that we're putting together then it'll also enable a succession of ownership with his family that he's going to be very purposeful about. So we're working on that with him. The other side of that is the transition of leadership and we've put together this overall plan of okay 10 years what's going to happen with these key Executives including his daughter and does it line up nicely. When we talk about an exit is just literally, I'm going through that door right I'm opening that door and I'm stepping through it and then I'm closing it boom it's like a moment in time which is why I use choose to use the word transition because it's a transition over a period of time. At some point you might have an exit where you're literally closing that door, opening and closing a door. And what are those flavors of an exit? Well an exit can be a sale to a third party, it could be a sale to management, it could be a sale to an ESOP, it could be a sale to another type of buyer, which would be a financial buyer or it could be a strategic buyer, but there's a buyer.

There's always going to be a buyer because we're human and we are going to leave this earth. Let's just put that out there right, yes so there's going to be a succession of ownership how and when and to whom are all the variables and that's part of this wonderful practice that you and I have of trying to help business owners figure out some of those variables and what's the right option for them. An exit can also mean a shifting of roles so if you're the day-to-day CEO, you're the owner operator, you know is there a shifting where you are more of an owner of a business right, you're not in the day-to-day, you're a little more arm’s length and maybe you're taking on some real estate properties and maybe you're again serving on boards or the other things we talked about earlier in this conversation.

Tips for a successful family business transition.

Tom: Yeah I love that the one key takeaway I want listeners to get is there's not one way to do this. Like it's not I have to leave and shut my door and I'm done. There are options but you only can take advantage of those options when you plan well in advance. As you mentioned especially in a family business transitioning it over time and some assume and maybe you've run into this too Lori, the family-owned business owner, they're saying hey my kids will take it over. Well did you talk to your kids yet? Some of them haven't and maybe they don't want to take it over so then what do you do? Usually, there isn't and I'm sure you run into this as well, a leadership team in place that is reliable that also wants to take it over and that can even afford to take over the business, there are a lot of those variables so what are some of the, especially for a family business for succession, top three mistakes or you could even consider, hey three things to consider if you're a family business and looking at succession. What sticks out with that and maybe you mentioned a couple already but I feel that's worth repeating. If that is the case anything come to mind?

Lori: Absolutely I think when it comes to let's say leadership succession having the conversation to understand the timing of that is important too you can have that conversation when they're in high school, but that's really just you know a very high-level conversation because they're not even through college yet. Or they're not you know starting the workforce yet what do they really know? But I'm close to a second-generation family business in construction and they're in this situation right now where they have one of their family members would be the third generation who is interested and he's pursuing an engineering degree in college and wants to enter the family business one day. They've had that conversation and he's pursuing his degree because he's got this interest in mind. That's a great example where they were proactive on that and the other nieces are not interested. They've expressed no we're not interested so they had that conversation with him when he was in high school.

Tom: I'm sorry to cut you off but they're making them get their education still and then come back and see if we're still fit. I love that.

Lori: Absolutely and then there's the management team who is so loyal but maybe there's an issue with that. So for example one of my clients has a very loyal management team but they are apprehensive about being owners. Heavy is the head that wears the crown, right? So it's not only the financials I need to be able to afford to buy this business, but then it's oh my gosh I will have the responsibility whereas today I get a paycheck. It's very different to be an owner. That liability as well as the equity you know it's both sides of that coin and so when you're thinking about succession of leadership and succession of ownership there's a lot of watchouts. And one is interest as we've been talking about the other is skill set. Yes do people want it, but inherently don't have the acumen for it. That has happened where I've heard stories people have fired their son or daughter. It's complicated but it can happen and it can rift a family. It can be really tricky to navigate that, but I think if you put your hat on as a family and say what is the best thing for the company, it will lead you to the right answer.

Tom: Yeah and that's coming to separating family and business right which again not as easy to do but taking those perspectives and breaking them apart because I would imagine when they're stressed like that the conversation around the Thanksgiving dinner table is going to be kind of weird.

Lori: Yeah no absolutely.

What are the top misconceptions about business value?

Tom: Awesome so how about transitioning now to a common question, especially us as Value Builders you know how much is my business worth? You know I talked to my buddy he sold it for “X” amount so you know mine's kind of similar to his. Mine's probably the same. So like in my world as the financial planner, I need to know the evaluation to figure out, all right if you sold this, here's your net proceeds after taxes and fees to figure out what they need to live on. I would love to hear your perspective as the M&A advisor who's going again through the transaction of selling because you're in the trenches doing this, what comes to mind as far as any mistakes or misconceptions around business value?

Lori: There can be a lot just the number one thing you said Tom which is oh I talked to a buddy on my golf course and they sold their company for this. But if we're hearing that story and we think oh generally speaking that means my company could get the same. That's a pretty big leap to make that assumption. The other part of that is you need to know the math. Most often it's a multiple of your net profit or your EBITDA or if it's a company where we're estimating a net income and we're doing adjustments for owner expenses we'll get to a number that we generally call seller discretionary earnings which is an acronym of SDE. So if you're talking to someone they say, oh I got a four multiple a 4X multiple, I want you all as a listener to go multiple of what? Because immediately you're putting them on notice that you know what you're talking about. Multiple of what means there are two sides to a factor of multiplication right so it's this times this and is it a multiple EBITDA? Is it a multiple of SDE? Is it a multiple of Revenue? In most cases, it's going to be a multiple of EBITDA. Okay but also SDE is out there and those numbers look differently so just acknowledging there's math and there's a formula so there's an art and a science to this. The other part of it is well why would your multiple be higher or lower? If you are, using our house analogy, if you own a home on a street and all the houses are the same size and all the lots are the same size and they basically look the same from the outside, but then you go in and somebody has this Mack Daddy you know jacuzzi and basement bar and decked out, well they're going to get a higher price in the market. Same thing for your business. The same thing when someone walks into your manufacturing facility and you are clean, you could eat a picnic off the floor, versus the manufacturing facility that just looks awful. There are a number of differences between a business that a buyer is going to look for.  As you and I have probably talked about in our podcasts and in depth there are eight core drivers of value in any business and then there are the nuances by industry that can give reason for your business to punch above its weight or be below with a discount.

For buyers to perceive risk, it's all about risk. The multiple essentially reflects value but it's also a reflection of risk. The buyers are taking on risk because they have probably been they're borrowing right so they have a cost of capital and they need to get a commensurate return. So in any deal, there's risk and so for your business to punch above its weight versus your competition, what do you think about valuation? It's going to be first and foremost, the financials as we said right, there's going to be a discussion of the financials. They're going to come up with an industry normative number of what that multiplier should be and they're going to move it up or down based on the nuances of your company. That's the art and the science of evaluation. When I do valuations, we're looking at comps in your industry. The NAIC code is let's say movie production okay, we're going to try to find comparables in the in the last five years that are around the size of your business. We've got to find comparables that make sense. We're also going to try to look for public company comp so we have to discount those because we're not a public company. We're a small company and we put that all together in a report for clients to get a range of value and I think the work product is really important because it helps us baseline the value of the business today. Then as you said earlier, we can set some goals around your financial future. I love partnering with financial planners on this by the way because you know you and I are singing from the same song sheet of what goals are we setting for the lifestyle you want to live. Let's work backward. If we discover that we need to double the enterprise value of your business and we have 10 years to do it okay let’s go. How are we going to get there? So I like working with this holistic picture of the personal, the business, and the financial. Let's set some goals around those things and make it happen.

How do you increase the multiple to achieve a higher business valuation?

Tom: Yeah 100 percent and you brought up the multiple, I get this often so kind of take a step back the very baseline formula for evaluation is EBITDA or cash flow for folks times your multiple equals your value to keep it very simple. I get questions on the multiple like what drives the multiple? How can we increase the multiple? Because there's that balance between the tangible and intangible factors right? You have your financials which are pretty concrete if they're accurate and reviewed, but then there are those factors of what are your processes, you mentioned Standard Operating Procedures, what is your culture, do your employees like showing up to work every day, and if I brought them in a separate conference room and asked hey do you like your job? What do they say? So like can you talk about the intangibles versus the tangibles I know we're coming up towards the end here but I really want to drive this home. You need good cash flow but there's that other side of the coin that drives value and that's the multiple. Can you touch on that a little bit more with the intangibles and tangibles?

Lori: Yeah I think it's important for business owners to know what are their real assets and how transferable are those assets. They may be tangible, or they may be intangible. So for digital businesses like e-commerce businesses or e-learning, what are their assets? They are inherently the customer database, or it could be subscription contracts or contracts that are in place that are multi-year. If you’re a Staffing firm and you get multi-year contracts recurring those things have a lot of value because they are enabling more predictable revenue. So a business that has more predictable revenue, a recurring Revenue model is typically going to see a higher multiple. There could be hybrids or pieces of your business that are recurring revenue and we try to maybe get a hybrid multiple on that. If you're a SAAS business and you're 100 recurring revenue or if you're Netflix that's why you'll start to see more multiples of Revenue and that's ideal. Most owners would love to have multiple Revenue but it's very difficult to achieve if you don't have a recurring Revenue business. That said I think there are other things for intangibles like brand identity also intellectual property. Intellectual property can be your patents, it can be trademarks, it could also be things that you as your business the know-how of how you deliver your product or service. That can be of value.

Tom: Yeah that's fantastic Lori such great insight. I really appreciate you coming on today. Where can listeners connect with you, where can they find your book, The BusinessTransitionhandbook.com is the place to go. They can get access to some free goodies and I encourage them to do that. It's also available on Amazon if they want to pick it up there.

Tom: Awesome the businesstransitionthandbook.com. Very cool so everyone listening I will include all the links in the show notes for you go check out the book. I read it. It's a great read and again thank you Lori for coming on. Really appreciate it.

Lori: Oh thanks Tom, it's great to be with you.

Tom: Take care.