Successful Succession

The following is based on one of The Covenant Group’s clients. All of the names and telling details have been changed.

Rene Kropp had his retirement plan all figured out: sell his business and move to the country. Unfortunately, he got a rude shock when he tried to put his plan into action.
After 25 years in the business, Rene had established himself as one of the leading advisors in his suburban community. He wrote articles for the business section of the city’s newspaper and was a frequent guest on local radio stations. His client base of over 600, including over 200 of his community’s top small business owners, was coveted by the other advisors who worked in his area. He valued his business at half a million, but after spending a year shopping it around, the highest offer he received was 150K.

When I asked Rene how he came up with the figure of 500K for his business, Rene said, “I’ve been averaging 250K in revenue for the past few years. A simple two-times multiple would put the business at 500K.”

“Where did you get that formula?” I asked.

“I’ve had clients who sold their businesses using a multiple of revenue.”

“Were any of those clients in the financial services business?”

“No,” Rene said, “one owned a chain of Laundromats. Another had a printing business. Actually, I think the two-times multiple for my business is conservative, considering the growth potential in my client base.”

“Rene,” I said, “a valuation formula that works for one business isn’t likely to apply to another. The two businesses you just mentioned both have hard assets, machines and equipment, etc. which tend to make the value of a business easily transferable from one owner to another.”

“Are you saying my business isn’t worth as much as a chain of Laundromats making the same revenue?”

“Using revenue as an indicator of value is dubious for an advisory business,” I said. “Revenue doesn’t really give you an indication of whether the business is making money. A better indicator would be earnings.” I asked Rene what his earnings were.

“50K.”

“Is that the business’s real earnings?” I asked.

“What do you mean?”

“Did you account for a fair salary for yourself? And what about your expenses? A lot of advisors include ‘discretionary’ expenses, such as club or association memberships, which they say are for marketing purposes, but which a new owner might not incur.”

The further I probed into Rene’s accounting practices, the looser his numbers looked.

“Rene,” I said, “like most sole owners of a business, you’ve done your accounting so that it benefits you personally, which is fine so long as you’re running the business, but it makes putting a value on your business very difficult.”

I suggested that Rene go to a professional experienced in valuing a financial services business for a proper analysis of his financials. “But,” I said, “while getting clear on the numbers will help, you still have the challenge of making the value in your business transferable. In the Laundromat business, there’s generally little or no interaction between the owner and most of its customers, making it easy for someone to walk in and take over the business with little disruption. But in an advisory business, the value is largely in the relationship between owner and client. A buyer would be taking on a huge risk buying your business — how do they know they’ll be able to keep any of your clients?”

“I’m not going to sell my business to just anybody,” Rene said. “I still care about my clients. I’m going to make sure that whoever buys my business is someone my clients will want to stay with.”

“But every advisor has their own unique way of managing their client relationships. My guess is, your relationship management system is all in your head.”

“What do you mean?”

“How and when you see which clients is probably not something you’ve systematized. You know who your top clients are, but do you have that written down or stored anywhere? Have you segmented your entire client base? Which clients do you see in person once a year? And how long do you usually meet with them? What do you like to accomplish with them during your meetings? What are their expectations? Which clients are going through significant life changes now? Are the answers to these questions something a new owner would easily be able to find?”
Rene shook his head.

“Unless a new owner knows exactly what your sales and service practices are, the transition isn’t going to be easy. Clients are going to notice a difference in service, and the change is going to be unsettling. And what about your marketing practices? Will the new owner be able to take over all your marketing and promotional activities? Will the newspaper want them to write articles? Will the radio stations want them as a guest?

“Rene,” I continued, “selling your business and recognizing that value in it takes more planning and effort than you’ve put into it. You need to transfer your business practices from your head onto paper and into processes and systems so that a new owner would know how to run your business without you. But no matter how good your systems are how detailed your plan is, transferring the business isn’t going to happen overnight. To reduce the risk to the new owner that the value in the business will erode once you leave, you’ll need to stay on during a transition period, whether that’s as a partner or advisor or consultant. Would you be willing to do that?”

“It’s not what I planned, but I guess I don’t have much choice.”

“Succession planning is a complex endeavour,” I said. “Advisors need to give it more thought and planning than they usually do. In fact, the time to start succession planning is when you enter the business. We have a client who entered the business fifteen years ago with a clear plan to build a business she could sell in ten years. She wrote a detailed business plan and constantly revised it every year. That plan included highly detailed marketing, sales, service and resource plans. Anyone looking at her plans would clearly see what the business was all about, where it was headed, and how to get it there. Plus, she used technological tools, such as a client relationship management program, to create systems for all aspects of her business. When ten years came up, she sold her business — and did so for nearly twice what she’d originally planned on selling it for.”

“I’d love to get two times 500K,” Rene said.

“You might, Rene, but you have to realize as well that you’re not likely to find someone willing to pay you cash in one lump sum for your business. That’s not realistic. You’ll have to negotiate a payment plan and one that might include contingencies to protect the buyer. You might end up with what you want out of the business, but it will likely be over a period of time, years maybe.”
After our meeting, Rene spent the next two months taking the business out of his head. He developed a detailed business plan and hired a consultant to install a client relationship management system. When he went to market again, this time with a plan to stay on during a transition period, he found a buyer willing to pay him an initial lump sum of 100K and finance the rest in yearly instalments, the amounts of which would be determined in part by the business’s performance.

Rene stayed on full time in the first year and then began to taper off his involvement, working three days a week during the second year and then, in the third year, staying on as a part-time consultant. Now, four years later, he lives in the country fully retired drawing on the more than 800K he ended up receiving from the sale of his business.

Lessons Learned
Rene learned four important lessons about succession planning:

• It’s never too early to start planning for your succession.
• A business where the business’s practices are in the owner’s head is of little value to a prospective buyer.
• You will maximize the price of your business by making its value as transferable as possible through maintaining a thorough business plan and creating processes and systems that someone can easily take over.
•  An effective succession plan shares the risk between the vendor and the purchaser, by including a transition period in which the vendor remains active in the business and by including a payment plan contingent on the business’s performance.

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The Covenant Group is referred to by many as the place entrepreneurs go to become Business Builders. They are considered to be thought leaders and have authored the best-selling books, The 8 Best Practices of High-Performing Salespeople, The Entrepreneurial Journey, and The Business Builder.