Shownotes
We often hear the saying, “Begin with the end in mind.” However, no one would think of applying this when it comes to business. Thinking about the end is often overlooked that it becomes a problem. Statistically, 80% of business owners either do not transact at all or did not transact with the value they think they should have gotten. Holly Flores, president of the Rocky Mountain chapter of the Exit Planning Institute, talks about exit planning, succession, and why it’s important for businesses to take this in mind. She covers the EBITDA which stands for earnings before interest, taxes, and depreciation, as well as the valuation, the processes, transactions, sales options, and more.
Why Businesses Should Think About Exit Planning with Holly Flores
We have Holly Flores. She’s the President of the Rocky Mountain Chapter of the Exit Planning Institute. She is also a Certified Exit Planning Advisor. We’re very fortunate. Thanks for taking the time to come in.
It’s my pleasure. I’m excited to be here.
Holly, tell us a little bit about what you do with the Exit Planning Institute as well as what you do as a Certified Exit Planning Advisor?
I got to the Exit Planning Institute via my day job as a Value Advisor with Quantive where we do business valuation. Those business valuations are often a triggering point for Exit Planning. What Exit Planning is, some people think of it as a negative because exit, they think I’m coming near the end of my life, but it means succession planning in business. Exit Planning does not mean planning for an exit for tomorrow. It means planning for transitioning out of your business sometime down the road, whether it’s six months from now or five years from now. We often say you always want to start with the end in mind. We transfer that over into other parts of our life but when we run a business, sometimes we fail to have that conversation.
With the Exit Planning Institute, who has done a great job over the past five or so years, bringing that vocabulary to the forefront of advisors all across the country, I wanted to be part of it and see how I could integrate that into my business. From day-to-day, I may work with the business on determining their current value and maybe looking at that for a handful of reasons. First of all, for transaction, for litigation, for tax planning but often that conversation, when they see the value, all of a sudden, the light goes on. They see what it’s worth and they’re excited or they see what it’s worth then they’re a little disappointed and they start thinking about, “What does the path forward look like?”
We hear triggering event and we hear exit and succession and go, “I died.” That’s usually what you get. In going backwards a little bit, the statistics around Exit Planning, succession planning are pretty grim, aren’t they?
They are. Statistically, 80% of business owners either do not transact at all or do not transact at the value that they think they should have gotten. If you think about that, the opportunity that is out there for us to improve upon this is huge. It’s limitless, especially when you think about how many small businesses there are in every city in America. If you are an advisor working with business owners and you’re not having this conversation, then maybe there’s an opportunity that you’re missing as well as there was a part of me that thinks we’re failing as advisors if we don’t have that difficult conversation and say, “Have you thought about what’s next?”
Most business owners think they’re immortal.
I think about that and for folks as well, I don’t have much sympathy for the business owner, but the next step past that is the number of people that are working for that particular small business. Most business owners think they’re immortal. So far 64,000 generations and nobody survived, so they aren’t that immortal. What happens when the business owner passes? What happens to the employees? What happens to their families? On that side of the table, it’s extremely important to go and have that conversation. What I thought was interesting is because the backstory too is I’m a certified exit planning advisor as well. I picked up the designation way after Holly, so she led the way. I think about the valuation commentary that you made where they think it’s worth X and maybe it’s worth some percentage lower of X than they thought. Can you talk a little bit about how Exit Planning helps that perception?
We call that filling the gap. To be honest, most business owners think their business is going to be worth at least five times what it is worth. That may be from hearing what other people sold it for misperception. A lot of times people will hear about this multiple and you don’t necessarily know, is that multiple revenues, multiple of net profit, it can be of so many different things. It’s best to have somewhat a third party person come in, take a look at it and give you that idea. What goes into the valuation is seeing where the market data is. Where have other businesses that are like that business sold?
You mentioned a term that many may not know EBITDA. What is EBITDA?
EBITDA is earnings before interest, taxes and depreciation. A lot of businesses don’t look at it. The best thing maybe to say for small business owners to look at the net profit and see where the business is at or the seller’s discretionary income. What the business owner takes home plus any other expenses that are not necessarily associated with running the business.
You mean my racehorse in my business is not part of that?
Maybe. If your racehorse is getting you to your clients, then that might be legit. If the next person that takes it over is going to need that horse, but probably not in Colorado Springs.
As I think about the Exit Planning Institute and the chapter here locally, you have events on a monthly basis. What are the types of things that you talk about in the monthly meetings?
We started the Chapter early in 2018. To give you a little bit of a backstory on it. Surprisingly that’s all we’ve been around even though Exit Planning, one of the other competitors, but we are all in it together. Major Exit Planning Institutes in the country are based out of Denver. We’re the first chapter to come there. Our chapter, the focus is, it’s all about collaboration and education. To be a member of the chapter, you do not have to be paying dues or have a membership fee. What we want to do is attract people to collaborate.
If by doing this you decide that you want to go get your Exit Planning certificate, then fantastic. More importantly we’re coming together, advisors all along the spectrum. From the beginning of a transaction where you’ve got a valuation person or you also may have a financial advisor that’s talking to them and wants to take a look at, “What is your business worth it?” If this is what you think is a big part of your asset allocation and you’re going to retire with this one day, maybe that’s the discussion that starts that. Then you go on down the process, you have accountants in there, you’ve got attorneys in there, investment bankers, private equity funds. We also have some neat and specialized people that maybe work on the psychology of a transaction or they’re part of a community foundation. Community foundation is important because a lot of times when people are planning what to do with their wealth as it happens, they may want to be in touch with the foundation and have those.
We all come together, all these different groups and entities and we have different discussions from the big picture, talking exit planning. We talked about buy and sell agreements. We’ll talk about due diligence and we have a special program with business owners who will be on the panel and they’re going to talk about what went right and what went wrong and how they were ready and the things that they wish they did better.
These are the business owners that have already sold their business?
Correct, which is a little bit of a challenge to find business owners that sold that are willing to be on a panel. Typically, they’re far enough away where they’re beyond any agreements and maybe the emotional pieces have passed them a little bit and we’ve got some great panelists lined up. It’s going to be a great discussion.
Exit Planning: Exit Planning does not mean planning for an exit tomorrow. It means planning for transitioning out of your business sometime down the road.
One of the things that struck me after finishing the certification is the differentials between an average company in your industry versus below average, best in class, the multiple differentials and the income gap or the revenue gap. Can you touch on that a little bit?
When we do an evaluation and everyone wants something for free a little bit and you have those free advice, what’s the rule of thumb of where my type of business would sell? What are the multiple times the seller’s discretionary income? The range that will say on average for a midmarket company could be anywhere from four to seven times.
What is a mid-market company?
A mid-market company would be a business with revenue anywhere from $20 million to $100 million. Anywhere from four to seven times, these numbers they are a range that I’m saying even on a midmarket company. A company could be smaller, but they’ve got great earnings so maybe that push them more into the middle market or lower-middle market. Just take that four to seven times their earnings. That swing can be a 70% difference. Whether you are at the bottom of that four times or you’re the best in class and you’re seven times, it’s broad. Without digging in to what is going on in your company through the financials, you don’t know where in there you may be. By starting out with a valuation and seeing that triggering event, this is where I am.
Triggering event is what?
Knowing where you stand and where you are right now triggers further discussion.
Triggering event is one of those things that starts the conversation. In my mind, knowing where you stand, where you are right now, triggers further discussion. From there, you can start to come up with a strategy and strategy could be, “I know where we’re at. I know I’ve got three years or four years to influence this and I want to improve the value,” or it could be, “I know where I’m at. I know I don’t have that much time, so let’s get on the market.” Whatever it may be, it’s starting the conversation. In order to do that, you’ve got to know where you’re standing.
For a lot of folks, they don’t consider that the business sale may not be an elective event for them. It may not be that you pass away, it could be that you’re disabled, it could be that there’s a family event, it could be that there’s a disagreement that’s not possible to get over. The thing that struck me the most about going through the process, I don’t remember who said that basically this type of process is good business. If you step out of the business as the operator and you step into the shoes of a potential acquirer, you look at your business differently. Maybe you could touch on a little bit about the eyes of a potential acquirer and the things that are important to a potential purchaser in a business.
It was Chris Snider who is the President of the Exit Planning Institute who said, “Exit strategy makes good business strategy,” and that is true. As you take a look at it and when we say value, there are three things that are going to drive the value of a business. You’re going to have your earnings, you’re going to take a look at your risk and you’re going to take a look at your growth potential. Earnings, that’s money coming in the door. It’s managing your expenses and that’s going to impact value. From an outside buyer, a third party comes in to look at purchasing your business, the other two pieces of that will hold even more important because you want to take a look at risk. How saturated are they on their clients? They’ve got to clients that make up 80% of their revenue. If I come in there, what is the likelihood that I’ll be able to keep these two clients? That’s significant.
The other piece is growth. If you are in a mature market, a mature industry and someone from the outside is coming in and they’re like, “You guys have done well,” but is there room to take it further? I did an evaluation of the company and the business owner thought, “This could go big,” but they were pretty much at a negative net operating profit. They were running the business as a lifestyle business, which means they were taking money out of it and they live a good life. In terms of presenting a package that made it look great to announce that buyer, it wasn’t there. They thought, “An outside buyer could look at this and if they did these five things, it would be worth so much money.” Maybe that’s true, but that’s up to the sweat equity of a potential buyer. That’s not what you’re doing right now. If you would like to harvest that potential, as the current owner, as the seller if you want to harvest it, that’s something you’ve got to be able to put into it.
I thought one of the things too as a lot of folks think about, “I have to do this to see if I’m going to sell my business.” What if you go through the valuation and the process and you look at that and you go, “You’re doing a great job, your numbers are great and you’re best in class, maybe you should be looking at acquiring other companies.” Maybe there’s some mileage to talk about there.
A lot of times we’re working with small and main street businesses and having an outside person come in, on a small business, main street business, those business owners are so busy running their business on a day-to-day. They need a third party that comes in, helps them lift their head up a little bit and see what’s going well, see what things they can change and adjust, sometimes as you said they think, “There’s a reason why I started this business.” They start to have fun again and maybe get a little bit of energy to keep it going for a future sale. There’s that piece. There are plenty of other reasons why people will transition out of the business. It’s not always a transaction, that’s what you hope for. As you’re planning a strategy, you get to have strategy so that you’re ready if death, divorce, disability and all of those things happen. Taking these steps to grow that value helps minimize risks, so the business is prepared.
What if I’m that business owner who goes, “I’m not worried about that stuff. I’m going to hand my business to my kids?”
There are plenty of other reasons why people will transition out of the business. It’s not always at a transaction.
That’s maybe less frequent these days because there’s a visual. We’re very aware that the next generation is not as interested in mom and dad’s stuff. Even if you thought you were going to hand it off to your number two guy, but you kept it a secret, that secret might catch not that person by surprise, but you by surprise when you find out, “I had no plans of this nor do I have the money to buy you out and for you to get that payday that you were planning on.” One of the mistakes that business owners make, and I say mistake cautiously, is they keep the conversation secret. Back in my college days, we have to write down our goals on a 3×5 card and put it out.
I’d be remiss if we didn’t say what college you went to.
At West Point, we had our cards at the beginning of each semester and our cards were posted right above our desk, which are our goals for the semester. I think it’s 95% of the people that don’t write their goals down. They might end up somewhere. Same thing with your business, if that goal exists that you want to do something but you’re not communicating it with anyone, the likelihood of you going down that path might stay in your head and it may shift directions. To say that you’re going to sell your business one day, it’s not rocket science. You are or you plan to leave it one day. As you start to communicate that, you might be doing yourself a favor not to mention everyone else. The people that are running the business, they may all of a sudden start to think about, “How can I be a part of that?”
If you’re 70 or 75 years old, your employees know you have an exit plan one way or another.
Or they’re worried that you don’t.
For the business owners that are in the audience, how do they find you?
They can find me at our website, www.GoQuantive.com or social media, Holly Flores, PMP, CEPA.
For the business owners past social media, if they reach out to you, what should they expect if you come to see them in when you walk through the door?
To have a conversation. First and foremost, it comes down to having a conversation and answering some difficult questions. One of the key things that our EPI chapter is we try to get beyond focusing on a transaction that’s, “I want to sell. I’m looking for this pay day.” There are so many other pieces that go into it. The most important thing is that initial conversation, understanding what’s important to you, who else would be a part of this conversation, should your family be part of this conversation, should your business partner, should your employees be part of the conversation? It’s a process.
We talked to business owners after we do an evaluation when we say, “You can grow the value of your business because you don’t have a marketing plan in place. We help businesses put processes in place.” This whole thing is a process. If you’re an advisor on one of those pieces and all you do is see your piece, you’re not helping your client see the opportunity or the risks and all the shortfalls that could happen along the way. You’ve got to treat it as a process and be ready for more conversation, more talk up front to make it smoother along the way.
For the business owner...
