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27 Aug The Real Problem With Most Companies: They’re Not Built to Sell

There is a real sickness in most lower middle-market businesses: they’re not built to sell. They’re built to operate, make money and provide a living, but they’re rarely prepared to transition as a standalone package deal.

In fact, most small to medium business owners generally go into business in order to make money and otherwise provide for their families. All too often, they don’t consider where the real value can be extracted from their recurring cash flows.  In that spirit, here we will discuss a few of the types of companies we see and how they can be altered and better prepared for the eventual exit.

Owner-dependent companies. We’ve seen too frequently businesses who’re built around the owner. The relationships, tacit knowledge and expertise that have taken the company to where it is are all housed in the founder(s). In company meetings, the founders are what one might call the “smartest guy in the room.” Sometimes they think they’re the smartest in the room and sometimes they really are. In the case of the latter, it is often done by choice as an ego boost to the owner who likes to feel smart and stay in control. Those enterprises that are built to sell, typically have highly-involved and highly-intelligent managers at the helm who’re not only willing to aid in the transition, but who’ll be around for long after the original founder is gone.

Lack of mental preparation. Like the overly-hovering mother with extreme separation anxiety for your young child who heads off to college, many founders find it difficult to prepare mentally to let their baby go. Because this can sometimes take years to prepare mentally, many avoid the inevitable and find themselves not as mentally prepared as they should be for the time when their business needs them to transition it to another generation if nothing more than to maintain its survival. This is especially true of those who may have delayed passed the 70+ mark, which we’ll see in the scenario discussed below.

The “one vs. many” issue. Unlike private equity fund managers and family offices, the SME owner generally only buys or sells a business once, maybe twice. On the other hand, private equity groups make hundreds of acquisitions as both buyers and sellers.  It’s safe to say that buying and selling businesses is part of their core competency. A company not prepared to sell, will get eaten alive by sophisticated buyers who’re used to finding the proverbial chinks in the company armor and using them as excuses to pay less, offer earn-outs or force other concessions on the seller.

Finance issues. This goes without saying, but many smaller companies could be more prepared from a financial reporting and analysis perspective. This is not only necessary when preparing to sell a company immediately but is also helpful  when owners want to look at the business objectively to see how performance metrics are playing out. Financials are good for YOY comparisons vis-a-vis the general market and can help prepare you to sell based on a perfect storm of micro and macro factors which play together to boost business value. Proper 30,000 foot understanding of the business can also help take it to a larger scale.

Here’s a recent story from a current client. 

The business has been holding steady with roughly $3,000,000 in EBITDA for the last several years. The founder is old, much older than most retirees. He’s in good health and with parents who lived to 100+, he’s expecting to still be around a while. However, he recognizes his business has hit a plateau and could grow exponentially more if he would prepare himself mentally, hire other much smarter and more capable tier 1 managers and ultimately let go of the reigns for the next generation to take over the business. He’s too personally involved and–at this point–if something were to happen to him the relationships, operational nuances and general know-how would leave with him. That’s a major liability for a highly-performing business asset. It also means any buyer will have a longer transitional period between the current owner and the next manager/operator.

The saddest part of this story is that after this seller was brought multiple offers that exceeded his initial valuation, he decided to walk away because he felt he’s going to be around for another 30 years. The worst part of this scenario is that the seller has already courted the industries biggest and most important strategic buyers–only to waste their time and ultimately leave them empty handed. He may have unwittingly burned a bridge which may need recrossing in the not too distant future.

The fact is that if most companies were prepared to sell, they’d most likely improve the owners’ overall happiness and livelihood as well. Think of it. Managers managing the business provide more free time to owners. Hiring smart people could provide better chances for growth in cash flows. Finance and operational assistance can help owners better assess how to work ON the business rather than working IN it. That’s the difference between making the transition between a small business and one that operates independent of owners.