Kyle was in a much different mood than when he had first come to see me two years earlier. He had been referred in by an investment advisor who I knew from Illinois. He hadn’t been sure back then that he needed to come in, but his investment advisor had insisted. He didn’t engage us then on what turned out to be his first retirement.
Over the course of 26 years, Kyle had founded and built a very successful consumer product distribution business. He had built a very effective distribution network which was producing a $2 million per year EBITDA and growing at a 5-year average annual rate of about 10% in top line revenue and about 12% in bottom line EBITDA. When he came in 2 years ago, he had been ready to finally sell the business to his key employee, Ralph. Ralph had been with Kyle for 15 years. Kyle was sure that Ralph was the guy to succeed him. He had visited with Ralph off and on for a couple of years and felt that Ralph was both interested and very capable and would be able to take the business to the next level. He had already talked to Ralph about the key terms and how he would seller-finance 30% of the transaction with a bank of Ralph’s choosing to finance 70% of the purchase price.
I explained to Kyle back then that we had a unique, proprietary process for accomplishing a successful sale to an inside key employee. This involves specific steps which, if followed, would produce a high likelihood of completing a successful transition and exit.
Kyle thought otherwise. He had already determined what the terms would be and that his regular corporate attorney was prepared to draw up the documents so that Kyle could promptly get on with his well-earned retirement.*
That was 2 years ago. Kyle was here now to report to me that indeed the sale to Ralph had proceeded. As it turned out, the bank wasn’t willing to finance any part of the transaction, so Kyle needed to seller-finance 100% of it. At the time, he decided that was no problem. He had full confidence that this was going to work out just fine.
Unfortunately, rather than spending his retirement years at his Wisconsin cabin with his wife, he was now back owning and running the business. Within 6 months, Ralph had defaulted on the seller-financing and, after a 4 month attempt to restructure and work things out, Kyle finally realized that Ralph just wasn’t cut out to be an entrepreneur, a leader, a CEO or a business owner. While Ralph had been a strong operational manager, he just wasn’t ready, and never would have been ready, to own, lead and execute what was needed to take the business forward successfully.
Ralph had moved on. Kyle was now stuck with a business which was now producing an EBITDA that had fallen to $1.5 million per year, had lost certain other key personnel, and was showing a negative trend to top line revenue. Kyle decided it was time to actually start his succession planning over and take a closer look at The Next Move ProgramTM .
Research shows there are 12 principal reasons business owner transitions, successions and exits fail. Each of these reasons impacts the company’s longevity and ongoing annual profitability as well as an owner’s transition and future exit results. This article addresses the 11th of these 12 reasons:
Reason #11. No Capable Inside Buyer Exists. You haven’t groomed a capable inside buyer (such as a partner, key employee or family member) to be ready to buy when you’re ready to sell, and you haven’t designed an economically and financially feasible, mutually beneficial, tax efficient sale structure to an inside buyer.
As it turns out, Kyle learned that the leadership skills, entrepreneurial insights, and intestinal fortitude which he possessed and took for granted, simply don’t exist in most key employees and cannot necessarily be taught. And, as Kyle learned, the business which he thought he had so carefully constructed, simply wasn’t something that could be put on automatic pilot with any hope of future success.
A successful transition to a key employee or other successor requires a number of carefully thought out and reviewed actions, including the following:
Business Model Assessment. If you haven’t assessed the strength and viability of the 9 components to your business model (and that of your competitors), how can you realistically hope that you, let alone your successor, can realistically expect to succeed in a world of rapidly changing business models throughout every business sector. This is the reason I have been leading business model workshops around the country the past few years (based on the internationally acclaimed Business Model Generation program for which I am a co-creator).
Business Execution Structure. You may think your business is humming along, but how much of that is because of your presence as the traffic cop and the glue which holds everything together. Professional buyers are very tuned into what is necessary for a business to be effectively built and operated. After all, they are in the business of investing millions of dollars and therefore they need to understand what is necessary in a target company. Using our “Simply Built to Win” program, which I have designed based on these professional buyer insights, we can quickly evaluate the 54 key factors which will help you to determine whether your business is in fact ready to be transferred.
Key Employee Assessment. Research shows that business owners/CEOs are only correct about 60% of the time in choosing their successor. However, when this process is coupled with an evaluation by the right industrial psychologist, that percentage on average increases to about 90%. Quite clearly, not everyone is cut out to lead a company. The right assessments will reveal whether your chosen successor is wired for this type of job and, if so, will also reveal those areas of coachable improvement necessary to be successful.
Transaction Structure. The purchase price for virtually any transaction needs to be paid for out of the future net “free cash flow” from the business operations. This cash flow needs to be sufficient to cover the net which the seller wants to receive and the net which the buyer (and therefore the company) is capable of providing. Unrealistic expectations, implacable terms, poorly conceived tax planning, inappropriate financing terms, etc., all end up resulting in transaction meltdown.
Kyle and his corporate attorney were experts at handling the day-to-day, year-to-year company operations. However, neither understood what was necessary to accomplish this type of transition successfully. We call it the “Fourth Quarter Game PlanTM ”. Kyle had attempted to do a “2 Minute Drill” on his own. His net worth and expected time at the cabin had suffered. He was now ready to reset his plan and do it right this time.
*This Newsletter contains no information that can be used to identify a specific client. This illustration was not the business in which our specific client was engaged.