Cashing in the Chips - Transitioning Ownership
There is a popular saying that the two happiest days in the life of a boat owner are the day they buy their boat and the day they sell their boat. In between are countless unanticipated frustrations. The same could be said for business owners. Yet rarely do entrepreneurs, like boat owners, think about their exit strategy when they start the company.
Instead, they often wait until they are bored, frustrated or too old to enjoy it any more before they plan an ownership transition. These are generally not optimal times to pass the baton, particularly when your life savings and professional legacy are involved. And even business owners who put the requisite forethought into transition planning often make avoidable mistakes.
This is understandable, since few have ever made this transition successfully. Determining when and how to exit a company is the single most important decision a business owner will make. It deserves more attention than it usually receives.
Business owners often assume that their children or their senior management team will step up to the plate at just the right time and send them riding off into the sunset with trumpets blaring and saddle bags full of cash. Yet less than one-third of privately held businesses survive the owner’s retirement intact.
Over the years I have witnessed entrepreneurs facing the transition of their businesses make
several common mistakes. The first is that many owners delude themselves into thinking that they will sell “at the top.” However, it is virtually impossible to know when “the top” has arrived. When the company is performing at its best, the market may not be favorable and vice versa.
Markets rise and fall. And business owners are no more adept than stockbrokers at predicting market cycles. Most of the time, professional market timers — investment managers whose careers depend on knowledge of how to buy low and sell high — under-perform the market as a group. The day I learned that none of us really knows what is going to happen to the market was in October of 1989, while sitting in the office of the Secretary of the Treasury debating what to tell the country after the stock market had “crashed” for the second time in two years.
My view was that leveraged buyouts had buoyed the market for years, and when the United Airlines LBO failed to get financed that day, investors saw this as a sign that there was a limit to lenders’ willingness to provide leverage. Yet the Treasury’s chief economist blamed it all on macroeconomic variables. Regardless of who was right, neither of us had the foresight to predict the plunge that day. Scores of private and public company sales were aborted that week, forcing business owners and shareholders to wait years in some cases to execute a transition strategy that had been carefully planned and executed.
Lesson number one, therefore, is for business owners to plan to exit their business when it is right for them personally; don’t try to second-guess markets you have no control over. An owner should modify his or her desired timetable only in the event of extreme market conditions, such the immediate aftermath of the Internet bubble burst a couple years ago, which caused the precipitous drop in the NASDAQ, or immediately after 9/11. If your desire is to check out when the youngest child heads off to college, when you turn 65, or when the company’s value reaches a certain milestone, focus on that objective. Chances are, market conditions will allow a graceful exit within a year or two of your desired transition.
The second lesson is that owners almost always underestimate the time required to execute a successful transition. You need to begin the process at least three years before you expect to be sipping mint juleps on Sea Island. A span of nine to 12 months usually passes from the time you decide to sell the company to the moment you reach the closing table. And if you don’t want to leave a lot of chips on the table, the buyer will generally require a one- to three-year transition period during which the owner must continue to manage the business, or at least be available as a consultant. In virtually every private company the owner possesses invaluable relationships with customers, unique technical knowledge or some other attribute that allows the business to produce the results it does. In most cases, assuming that you can sell your company based on the profits your business has generated with you at the helm, and that you will check out the day of the closing, is folly.
Third, prepare yourself emotionally. Most private company owners’ identities are inextricably linked to that of their company. No matter how intellectually committed you are to passing the baton, doing so can be traumatic. An aborted sale is a colossal waste of time and money and extremely disruptive to the business. Last year, one of my clients hired me with the assurance that if I could get him $10 million for his company (his magic number to retire comfortably) I would have to chain him down as he ran for the exits. After nearly a year of marketing the business, I secured him an offer of $14.5 million. Facing the reality of letting go of a company that he and his father had founded 20years earlier, my client, who had not taken a week off in more than a decade, confronted the reality of no longer being the big cheese in a small town. He recoiled and decided not to sell. By that time his employees, customers and competitors had all caught wind of rumors that his business was for sale.
Another common impediment to a successful transition is owners’ failure to keep their egos in check. Clearly, if you have built a company into a successful enterprise you have personal pride in what you have accomplished. But when someone else gazes upon your masterpiece, they invariably see blemishes. It is akin to having children: no one else sees them quite the same way you do. I recently represented a regional homebuilder who thought every major homebuilder in the nation would love to acquire his company. I personally spoke with every major homebuilder in the nation, and only one of them wanted to own his company. My client’s holy grail was $15 million. Yet when I presented him an offer for$16.5million, he got cocky. He demanded$20 million. Today he has no offer and he has missed what most would say is an unprecedented window to sell a company in the homebuilding sector.
Finally, too many owners simply wait until someone calls out of the blue with an offer to buy their company. You are guaranteed to leave money on the table if you don’t actively market your company. Moreover, if a buyer knows you are not represented they will never offer their best price.
The decision of when and how to transition the ownership of a business is much too important to make the sort of mistakes most entrepreneurs make. It deserves the same degree of planning and commitment that was invested when the company was started or acquired.
Reprinted with permission from Catalyst magazine, July 2003 issue.
Michael Jacobs, Author
Michael Jacobs is the CEO of Jacobs Capital and Professor of the Practice of Finance at The University of North Carolina at Chapel Hill. He's the author of several books and a certified speaker.
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