Succession Planning Creates Value

As a Business owner, you put a large amount of time, energy, and money into building a successful business. Your aim should not only be to provide yourself with an income, but to grow the business into an asset that will have future value.

The value of a business very much depends on its ability to function independently. It cannot rely on the skill or knowledge of any one particular person.  This can create a problem for many business owners, who often build their businesses around their own skills and/or personality.

The fact remains, that businesses that are dependent on the skills or personality of one or two people, have a very limited value to others in the marketplace.  While it might be very flattering for you to know that you are irreplaceable the consequences are that as the owner you are unable to take holidays, days off, or have any extended absence from the business.

Let us examine how you can maximise your business’s value and outline how you can put in place a succession plan for selling or transferring your business.

How to Maximise the Value of Your Business

1. Make a profit!

To ensure that your business has value, it must be a profitable business. The business should be able to generate a profit after paying a commercial salary for the working owners/employees that compensates for their skills and effort.

2. Generate a return on the investment

A business should also generate a return on the owner’s investment.  This is to compensate for the risk involved with the capital provided.

Any potential buyer is looking to make a suitable return on their investment.  If you value your business at $500,000 and it is returning you just $25,000 per annum (i.e. 5%), this is not an attractive investment  An investor could get this level of return or better on a commercial property (around 8%-12%).

Most professional business advisors would recommend that you should not invest in any business that will give you less than 20% to 25% return per annum.  

Return on investment can also be referred to as multiple of earnings, a reference to the number of years it will take to get back the amount you originally paid for the business.  For example, if you paid $1,000,000 and earned a rate of return of $250,000 per year, your multiple of earnings would be 4 (number of years to recover your initial investment).  

Well-performing small businesses have a multiple of earnings of between three and four years.  Anything higher than this the business is probably overpriced. 

3. The business shouldn’t be reliant on a few large customers

Although being in business involves a certain amount of risk, a good business should not rely too heavily on a small number of large customers.  

A valuable business has a large number of customers who each contribute to the total sales.

If the business is dependent on its relationships/sales of one or two big customers, it is susceptible to dramatic decreases in sales should it lose one (or both) of them.

4. The business shouldn’t be dependent on the owner’s relationships with customers

Customer relationships should be with the business, not with the owner/individual person. If a customer will only deal with you, or would use your competitor if you left, your business is in a very vulnerable position.

5. The business shouldn’t be dependent on one major supplier

As with customer relationships, businesses that have one major supplier (and no alternatives) will also be in jeopardy if that relationship is damaged. This risk will considerably lower the value of the business in the marketplace.

6. The business shouldn’t have only ‘fad’ products or services

You need to ensure that your business has the ability to introduce new products or services in response to the changing market.

7. The business should have good systems in place

Businesses with good process/procedures in place are seen to be valuable in the market place.  To develop your business to this point, continue to test the systems you have in place and ensure they are followed.

Your business should have a policies and procedures manual which outlines your:

  • Operations policies and procedures;

  • Marketing systems;

  • Sales systems;

  • Accounting and Financial management systems;

  • Terms of Trade policies and how to administer them;

  • Human resources policies and procedures;

  • Technology systems; and

  • Customer and supplier engagement procedures.

Each member of your team should be familiar with all of these systems or, at the very least, the ones that specifically apply to their roles.  These systems should be regularly tested and improved on an ongoing basis.  To ensure this happens specific individuals should be given responsibility for specific systems.

8. The business should achieve consistent results

When trying to establish the value of your business, your adviser will ask for the last three years financial statements (at least).

Businesses with a high value achieve consistent results. If your business is achieving good results one year and poor the next year, look at why this is happening. Then put in place a well-structured plan and systems to achieve consistency.  A history of steady and stable growth will be far more attractive to any potential purchaser.

Due Diligence

When a prospective purchaser is interested in buying your business, they will have their adviser do a “Due Diligence” report on your business.

Due diligence checks the records, financial and others, to establish that what you have represented about the business is the truth.  A good business adviser will look at all areas of the business and give their client an independent evaluation about the performance and risks associated with ownership of it.

If you think deficiencies in any areas of your business can be ignored, you are mistaken. Ensuring that you have addressed them all will maximise the value and attractiveness of your business in the marketplace.

Succession Planning

As a business owner, one of the toughest things to do is to step out of your business.  However, it is important to remember that, in order to create ‘a business’ rather than a job, you have to be able to do just that. 

In that regard, as well as having a plan to maximise the value of the business, all business owners should have a succession plan in place to enable them to take that step when the time comes.

A succession plan involves having a plan for the ‘disposal’ of your business.  Will you sell it or hand it to family?  If you decide to sell, when will you do this?  What do you want it to be worth?  How will you ensure that it has that value on the date?

If you are going to pass it down to family, to whom will you pass it?  What will you expect in return?  Is that a fair representation of the value of the business?  What if they do not want it?  How will they pay for it?  What are your options then?

When developing your succession plan consider the following:

  1. Your business should not rely on your skills alone. Continue to develop/train your staff.  Encourage them to have input into the management of the business to take ‘ownership’ of it.  They are the natural future purchasers of your business and the more they take ownership the easier it will be to sell it to them when the time comes.
    Most successful businesses promote their senior management from within. This can ensure the continuity of the business values and vision. Offer innovative salary packages like profit sharing and/or other financial incentives to retain these key people.
    Consider carefully the option to bring in a General Manager from outside the business.  It is generally a high-cost, high-risk strategy which, in the absence of well-documented systems often fails. Equally if the business is set up for management transition, external recruitment of professional management can be productive.

  2. Build the profile of the business, not of yourself.  Businesses that are built on the skills of one person are very difficult, sometimes impossible, to sell.

  3. Work out what you want your business to be worth.  Have an independent valuation done now to establish what the value is and then talk to an experienced external advisor about how to achieve the desired value by your ‘sale’ date.

  4. Have a plan for retirement.  Focus on the outcome you want to achieve.  Think about when you want to sell and retire, and work out how the business will need to run at that point to enable you to step out of it.  Then using a structured Business Action Plan, document the specific tasks, due dates and people responsibilities.  Start now to make your plan a reality.

Remember that one of the key points in owning a business is to build something of value for your future.  If you think that your business is unique in the marketplace and is totally dependent on your skills, then, as Michael Gerber says in The E-Myth, “you don’t have a business, you’ve bought yourself a job”.  

Reflect on how you can build the value of your business and create a succession plan to create wealth for yourself in the future.

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