The Facts of Business Life

by Bill McBean

  The first thing you have to bear in mind in this situation is that those you are turning responsibility over to are not you. In some cases this may be good news for your employees, but, as a rule, successful owners don’t have many employee problems at this level. Most of their employees respect them, like them, and trust them. But that’s a hard combination to replace, and having to start putting their trust in someone else may make some employees feel they’ve been abandoned. This in turn will make it hard for those you have designated to take charge to maximize your employees’ performance. Keeping this problem from arising—or eliminating it if it does—is your responsibility, and there are several ways you can do this. For example, being visible and communicative is extremely important. So, too, is recognizing employees for doing something particularly well and letting them know you are still on top of what is going on. Saying a kind word, asking about their families, or asking for their input on something doesn’t hurt, either.

  It’s also important that you be very careful in selecting those you put into positions of responsibility, and oversee them to make sure they are upholding the company’s values as well as maintaining the business’s DNA. When the people you pick are a good fit—that is, have the talent and personality to handle the job—the transition can go very easily. Unfortunately, that’s not always the case, and it can make things very difficult for everyone. In situations like this, the most prevalent school of thought among owners is to let the new manager or supervisor get a feel for the job and settle in, but I don’t agree. There is too much at stake—for you, your customers, and your employees—to allow a poor choice on your part to disrupt what you and your employees have built. I believe if there is any doubt whatsoever about anyone who is taking over even part of your job, it’s your responsibility to take immediate steps to fix it before it causes any more damage.

  What you want, ultimately, is a replacement who is essentially an extension of yourself, only better, and to make sure this happens you may have to rein the new manager in and control and teach him or her how you expect things to be done and why. I don’t believe in the sink-or-swim theory when it comes to others filling any of your responsibilities. You have to guide them, coach them, hold their hand, do whatever, but you can’t let the business slide backward. Your job, and your replacement’s, is to move it forward, do whatever is necessary to make the transition seamless, and keep the customer–employee–owner relationship in perfect harmony. Finally, you must remember that until you’re gone. it’s still your business, your employees, and your customers, and it’s up to you to protect those assets from any negative fallout from your bad decisions.

  Level 5: Moving on When It’s Time to Go

  The company’s focus on maintaining success—and protecting assets—at Level 4 carries over to Level 5, and continues through to the owner’s eventual exit from the business. This is because the business’s goals don’t change, even if the owner’s personal goals do. In other words, it’s the owner—when he or she is ready to make a change—who dictates the move from Level 4 to Level 5. This change essentially takes place when owners become more serious about leaving the business and begin thinking about its monetary value and whether selling it will provide them with enough to live on. It’s essentially at this point, when the owners’ goals and interests begin to separate from those of the company, that the business begins to move to Level 5.

  As an owner, it is essential that you be aware of this paradigm shift in your thinking and take appropriate action to make sure the business’s assets are protected and the company continues to be successful until your exit. Exactly what constitutes appropriate action, of course, depends on the condition of the company. It can be as extensive as restructuring the business or as minimal as having a few key personnel take over some oversight responsibility so you can devote more time to planning your exit. This is true whether you are selling the business, turning it over to a successor, or closing it down.

  If you have taken asset management seriously throughout your career as an owner, there will be a huge dividend waiting for you when you exit. This dividend can take several different forms, but the most important may well be goodwill. This is a misunderstood term, and some buyers are unwilling to pay it because they don’t understand what it is. Goodwill, in this sense, is the amount sellers ask buyers to pay above and beyond the value of the company’s assets to compensate them for the future profits they will be giving up by selling the company now. The amount is usually calculated based on a number of years. For example, if the business averages $400,000 a year in profits, the owner may feel he or she can ask for three years’ worth of goodwill, or $1,200,000. Knowledgeable buyers would probably consider this reasonable because they are buying a proven business, particularly if they believe they can improve on the profits.

  Another dividend of protecting assets lies in the advantage it provides a seller in his or her selling presentation to a buyer. It’s one thing to show a buyer past profits, but it’s quite another to show that those profits will remain at the same level and why. By explaining how you protected your assets and their value, you will be able to demonstrate that your success was not a fluke but the result of instilling skills throughout the business that won’t disappear when you’re gone. For you, this is a great way to capitalize financially on the company’s value through goodwill. For your buyer, a story like this—one that’s backed up by facts—is hard to ignore or argue against, and not only builds confidence but also enables him or her to develop a better of understanding of what you are actually offering for sale. This is true in succession as well because your successor will want an accurate picture of what he or she is taking over or buying, and other family members will want to know the value or what they are giving up—an important point where family harmony is concerned.

  The bottom line, then, is that since both your business’s tangible and intangible assets have value, they can not only help you tell the business’s story, they can help you sell it. And if you have taken asset protection seriously, and your company has profited by it year after year, these added dividends will be your well-deserved reward.

  The Benefits of Protecting Your Assets at Level 5

  Understanding the need to protect your assets enables you to realize that you have a new customer at Level 5—a buyer or a successor.

  Understanding the need to protect your assets helps you accurately explain your business, including its tangible and intangible assets, and choose a buyer or successor who understands the value of the business.

  Understanding the need to protect your assets means you will have seen to it that they are working and producing income, and can accordingly be used by the buyer or successor as soon as he or she takes over the business.

  Understanding the need to protect yours assets means when you exit the business there will be limited write-offs for obsolete inventory and nonexistent or nonfunctioning equipment.

  Understanding the need to protect your assets enables you to demonstrate to buyers or successors how you maximized assets and in doing so produced or created opportunities that will benefit them in the future.

  Understanding the need to protect your assets gives you a clear understanding of how all the assets tie together and helps you give the potential buyer or successor a clear picture of what he or she is buying or taking over.

  Understanding the need to protect your assets, and demonstrating that you have done so, gives both buyers and successors confidence in the internal structure of your business, as well as a “playbook” of its inner workings.

  Protecting Tangible and Intangible Assets at Level 5

  Protecting both tangible and intangible assets at Level 5 is as important—and works the same way—as at Level 4. In fact, some argue that it’s even more important that you pay attention to it at this point because, as you prepare to leave, it is easier to become distracted and forget about it. And Level 5 is definitely not the time for you to back off asset protection. It’s th
e time to make sure it continues so you can show a buyer the added value it provides him or her in the way the business is operated, or pass on to your successor a great business with no surprises.

  Ultimately, every business has three types of assets—real estate, goodwill or blue sky, and tangible and intangible assets. Regardless of how you choose to exit the business, at Level 5 it is your responsibility to determine the value of those assets. The most important thing to remember in doing so is that the value must be justifiable and connected to reason. This is an important part of the exit for several reasons. First, the value placed on assets will determine the qualifications of potential buyers as well as potential successors. Second, asset values have to be justified not only to a buyer but also to a buyer’s lender. Third, in a succession, if a member of the family is picked to operate and own the business, a reasonable value has to be established on behalf of the family. That is, if the owner wants his or her successor to buy the business, the value established for it must be fair and justifiable to the other members of the family who will want their fair share of the pie. And, finally, the determined value of the assets will give you your “cash-out” financial position, which will indicate if you will have enough money to live well after your exit or you need more time to build up the business to a specific profit level before you can leave.

  Determining the value of your assets can be something of a balancing act because your goal is to maximize your assets’ value while your buyer or successor wants to know that the value you’ve placed on those assets is supported by the business. For example, if there is real estate involved, the usual way its value is determined is by the owner, buyer, or successor having the land and/or the building appraised. However, even though such an appraisal might seem to be very straightforward, as with most things in business, it isn’t always so. If, for example, the value of the property has increased over the years and is now greater than the ability of the business to cover its cost, it creates a problem for the buyer or successor. This is a problem the owner has to solve, possibly by leasing the property to the new owner, selling the operating company and having the buyer/successor find other property, or finding a way to make up the difference in goodwill or operating asset values. That’s where the balancing act comes in.

  But the balancing act doesn’t apply only to real estate. Since goodwill and other tangible and intangible assets have to be taken into consideration in establishing the total value of a business, exactly how an owner and buyer or successor get to that number is invariably a result of negotiations. But if you’ve made asset protection a part of your business, you will have an advantage over those who haven’t because you will know the value of your assets—all your assets—and will know the best way to structure your payout to minimize the tax effect. For example, capital gains may be taxed differently than goodwill, and if this is the case more money can be allocated to whichever category is taxed the least, thus maximizing your payout. Similarly, the buyer’s lending source may be reluctant to lend too much money on goodwill but comfortable doing so on tangible assets. In this situation, the buyer can pay more than you’ve agreed to for tangible assets and an equally smaller amount for goodwill. The overall goal is to maximize the monetary value of your tangible and intangible assets, and knowing what they are enables you to structure the deal so you can take home as much of the sales price for your business as possible.

  Protecting Products or Services at Level 5

  At Level 5 you have a new product—the business itself. And like any product, its value has to be explained and justified. Price, quality, the business’s longevity, the employees, the customer base, and past profits are all factors in the business’s valuation. How well you can explain all these aspects of the business to a potential buyer directly affects the overall price. However, when you are selling this particular product, you have to do more than simply explain what it is. As I mentioned earlier, your explanation should also include a value-added presentation that enables the potential buyer to picture him- or herself at the helm of your business and points out all the great things the new owner will be able to accomplish with the business in the future. And no one knows the future possibilities of a business better than an owner who has been able to forecast market changes and successfully adapt the company to those changes.

  So if you can help your potential buyer see not just what the business is now but also what it can be after you’ve gone and he or she has taken over, you will be able to paint a picture of the future showing where the opportunities lie and how those opportunities can be used to grow and expand the business, which in turn gets the buyer excited and gives him or her confidence in the business’s moving forward. This is always a good strategy, but when talking about the future and its opportunities you should always follow it up with a statement like, “I only wish I were young enough to keep growing the company,” or something similar. This is because, after you’ve painted such a positive picture of the future, not only may the buyer wonder why you’re selling, someone along the line is bound to ask him or her, so you might as well provide an answer to the question before it’s asked and reinforce it if it’s already been discussed.

  Protecting People at Level 5

  Level 5 is a particularly difficult one in terms of the customer–employee–owner dynamic. By the time a business has successfully gone through Levels 1 through 4, the owner, his or her managers, and the employees will have developed a relationship based on mutual respect and trust. In fact, if that trust hadn’t been developed, it’s unlikely the company would have ever attained—much less maintained—its success. One of the reasons this trust develops is that over the course of the business’s history the owner has discussed most of the important decisions with his or her trusted employees. At Level 5, though, the situation is different because, in thinking about leaving, he or she is essentially breaking that bond of trust with the company’s employees, and it puts an understandable strain on the relationship. What’s worse, the more drawn out the decision or the negotiation process is, the more difficult the situation becomes.

  As noted earlier, it’s essentially the owner’s decision to make a change that moves the business from Level 4 to Level 5, and few owners discuss it with their employees. Of course, if a current employee will be succeeding the owner, or one or more of the employees are buying the company, they will be involved. But if the decision is to sell the business, turn it over to a family member, or close it down, employees are usually left in the dark about the owner’s intentions. There are basically two reasons for this. The first is that the owner doesn’t want the business operation to be jeopardized or disrupted in any way. The second is that, even if the owner wants to sell or close the company, it may not be happening for years, and he or she doesn’t want to erode the shared trust, or lose the momentum, focus on results, or excitement of moving the business forward.

  Both of these reasons are entirely legitimate and justifiable, but it’s always hard to keep a secret, and you can be sure that rumors will begin circulating almost as soon as you start working toward leaving. Obviously, rumors like these won’t help the business, but what’s even more important is that it rattles the confidence of those who trust you. Eventually, someone will ask you about the rumors, and you’ll need an acceptable answer, because dodging the question or giving a vague answer will only generate more anxiety and add fuel to the fire. Perhaps the best way to deal with this situation is to acknowledge the rumors, say that you will be exiting at some time in the future, but not today, and then ask the questioner about his or her department or area. You must be careful, though, because the last months are important for both the buyer and the seller, and you don’t want unnecessary gossip or chatter getting in the way of focusing on objectives and results.

  Of course, you also have to keep in mind that not every negotiation works out, and you don’t want to get excited—or get your employees excited—about selling the business only to see the deal evaporate at the
bargaining table for any one of a hundred different reasons. If negotiations break down, it will be hard enough for you to refocus on business, but it will be even harder for your employees because the trust you will have accumulated over the years may have been damaged or broken in the process. And once that trust is broken, it’s hard to earn back. Unfortunately, there is no way to entirely keep something like this from happening, but there are things you can do to minimize the damage and rebuild the trust.

  One way to do this is to put some fun back in the business by challenging your staff’s competitive nature with short-term objectives that have substantial financial rewards attached to them. This in turn will refocus your employees on the business at hand. The problem is also likely to be less severe if you have a meeting with your managers and key employees and tell them that the rumors were true but you were bound by a confidentiality clause, but that in the end it wasn’t what you wanted. At that point you can pick up the pieces by refocusing the staff on what needs to be done going forward.

  On a positive note, if the sale becomes a reality, one benefit of maintaining a positive relationship with your employees at Level 5 is that it provides your buyer or successor with a big advantage as he or she takes over as owner. If the customer–employee–owner dynamic is in balance, the buyer or successor will have a clear understanding of what his or her ownership role is and know what the employee and the customer expect. This can help make the transition as seamless as possible while the new owner or successor and employees get used to each other. It can also give the person replacing you not only added confidence but also a direction in which to move the business forward right from the beginning.