Category: Op-Eds Triangle Business Journal

Why it’s not easy to sell a business during a pandemic.

View the original article in the Triangle Business Journal by clicking here.

Since pandemics are new for most of us, there aren’t a lot of data points or roadmaps that provide insights for business owners who want to, or have to, sell their business in the next couple of years. Those considering, or forced to consider, an exit generally fall into three categories:

Companies that will not survive Covid-induced economic dislocations, which are far from over, that are losing value on a daily basis. Companies that have a business model that is resilient to the current economic difficulties, or even thrive in the disrupted world we now live in, that are highly marketable today. Businesses whose owners wanted to seek a liquidity event in the next few years, can survive but not prosper in an extended downturn, but are unwilling to accept a price that reflects the “new normal.”

The unprecedented government actions being taken by the Federal Reserve and Congress to flood the market with cash, including the Paycheck Protection Program, have given business owners a false sense of security. Having been head of corporate finance and M&A policy for the U.S. Treasury during the 1991 downturn, and run my M&A advisory firm during the 2001 tech implosion and the 2008 market meltdown, there is one consistent pattern I have witnessed in the past that will inevitably be common among business owners who will not make it through this crisis – denial.

Entrepreneurs are an eternally optimistic bunch, which is why we were willing to take the risks that led to our success. But the flip side is that we often ignore the handwriting on the wall. Every business owner needs to objectively paint a picture of how the world is changing and how the pandemic has been a catalyst to expedite that change. Don’t just consider the obvious forces produced by the pandemic such as changes to shopping, dining, travel and event activities. Consider the new state of global politics, especially the friction with China; the high probability for radical tax and regulatory changes under a new president; the potential for massive cuts to government budgets at all levels; and unprecedented disruptions to the workforce caused by students abandoning online classes and dropping out of universities and millions of workers who now prefer to work from home.

Many business models can adapt or even thrive in this new world order. And companies that have staying power through an extended downturn are highly desirable. Large corporations need to diversify revenue streams quickly, which creates a bias for acquisitions over organic growth. Additionally, private equity firms survive by putting money to work, not sitting on the sidelines. They hold trillions in “dry powder” looking for a home. And since the landscape of acceptable industries and business models has contracted considerably, now is actually a good time for companies that can benefit from the current disruption to seek liquidity.

This club is not just biopharma businesses working on a Covid-19 vaccine and Zoom. There are countless business models that are more needed today than ever, such as a provider of benchmarking cost data to universities, sanitation products and services, real estate in more rural locations and smaller markets, home security, warehousing and delivery services, etc.

Business owners whose cash would have run out except for their PPP loan may well be the walking dead. Each day that they put off an inevitable sale increases the likelihood they will not be sell-worthy. And business owners who are not going to thrive in a new world order who are waiting for the world to get back to “normal” when they can get the price they could have sold for a year ago are going to find that 2019 price may never reappear. And by waiting they will face capital gains tax rates twice what they are today and will have a lot less to live on after a sale.

So for many business owners, now is a good time to sell. For many others, the longer you wait the worse your prospects look. In either case, being a deer in the headlights is not a good strategy, even though that is the natural instinct when our inclination is to simply hunker down and get through difficult times.

Why business owners need boards.

View the original article in the Triangle Business Journal by clicking here.

The old adage ”it’s lonely at the top” applies nowhere better than to running a private company, where CEOs make daily decisions about disciplines in which they have no background.

Having worked with over 200 private-company owners over the past 25 years, it is my observation that the most underutilized resource for private companies is a “real” board of directors.  If you want to maximize the potential of a company and fully enjoy the experience of running a business, owners need to surround themselves with a seasoned, diverse compliment of business minds that meet on a regular basis.

Most business owners have complete autonomy.  In fact, the primary reason many started their own company is that they don’t want anyone looking over their shoulder.  However, not only is running a business too complex for any single individual, it is no fun to make decisions in a vacuum over an extended time period.

Business owners succeed because they are really good at something.  It might be science, medicine, manufacturing or sales.  But that something is rarely business.  The Achilles heel of most business owners is that they don’t know what they don’t know.

It is not an admission of failure to acknowledge that you need help making key business decisions.  In the 1980s the board of Coca-Cola, one of America’s most successful companies, was comprised mostly of marketing experts, with some lawyers and doctors who were buddies of the CEO thrown in.  Coke’s stock had been dormant for years.  Roberto Goizueta emerged from an unlikely background–head of the R&D department–to take the helm at Coke.  The chemist questioned everything about the business despite its great success, and he reconstituted Coke’s board with experts who knew what he didn’t know.  Over the next decade Coke stock grew ten-fold, dwarfing the S&P 500, largely the result of implementing new financial strategies his prior board had never considered.  Today Emory University’s business school is named after Mr. Goizueta, because he knew what he didn’t know and built a board to supplement his skill set.

What Should Your Board Look Like?

The key to constructing a successful board is to assemble a diverse set of business skills that are complimentary, not redundant.  You need at least one person who has significant knowledge of corporate governance.  Unless there are people in the room who know what a board is supposed to do and how boards function most effectively, you will have the blind leading the blind.

You also need someone with specific industry knowledge, who knows what is going on in your competitive landscape.

You need an expert in finance.  Most private-company CFOs are really controllers.  You should have a board member that knows all aspects of the capital markets and has worked on transactions.  Even if you have no immediate need to raise equity, borrow money, make an acquisition or sell your business, some day you will.

The backgrounds of the other board members depend on your business and your personal skill set.  Recruit directors whose competencies are in areas in which you are the weakest.

Except in rare instances, employees should not serve on the board.  They can attend board meetings to make presentations and contribute to dialogue, but there should be times when the directors are free to discuss management issues without management (except the owner) present.

Likewise, every company should have a competent lawyer and accountant, but they should not be on the board.  Public companies are prohibited from selecting their accountant and lawyer to serve on the board for a reason.  They have a different role as paid advisors.

Your board should meet at least four times a year.  Any less, and it is impossible for directors to get to know the company and its management team, limiting their ability to offer insightful advice.

While it may be counter-intuitive, the best boards have an even number of members.  You never want a board decision determined by a single vote.  If a solid majority of the board is not convinced a path is the right one, you shouldn’t go down it.

Your directors should receive some compensation.  The amount and form depends on the size of your business, its financial resources and its stage of development.  If you have the right directors, their sage advice is probably worth many multiples of whatever you pay them.

Consult your board between board meetings.  Directors are a resource 365 days a year.

Surveys show that private companies with true boards outperform those without.  What is not commonly known, though, is that business owners who have a true board of directors enjoy their jobs more—it is not so lonely at the top.

Hello! I want to buy your business.

View the original article in the Triangle Business Journal by clicking here.

If you own or run a mid-sized business and don’t receive at least one call a week from someone professing to want to buy your business, you should wonder why. If this is an all-too-common occurrence, I will offer some ideas to help you sort through which, if any, of these calls to return.

First, if your attitude is: “I don’t plan to sell my business anytime soon, so it’s a waste of my time talking to these people,” let me push back. Perhaps, if you have nothing to learn, then maybe that’s true. But interacting with professionals who buy companies could be a valuable learning experience.

As an example, after a rigorous sales process that produced a dozen offers, I invited five potential buyers in to meet with the owners and senior management team of a client.

Unfortunately, the company’s performance tanked before we received final offers, so we took the deal off the market. But the client implemented several of the ideas that had surfaced during these visits, and within two years doubled its profits. We just received 24 offers at much higher prices.

That said, most unsolicited calls come from people who are a waste of time. You should ask a couple key questions before divulging any information.

The first is: “Are you a buyer or an agent?” There are many “bird dogs” who are simply trying to find business owners willing to engage in a discussion of selling their business. They then pass your name to private equity firms with the hope of receiving a referral fee in the event something materializes.

There is also no shortage of underemployed business brokers on fishing expeditions trying to find prospective clients. Before returning a call or responding to a letter, visit the web site of the caller and see where they went to school, who their previous employers were, and what deals they have done. If there are no deals listed on their web site, there is a reason.

If the caller says they are a principal, not an agent, the next question should be: “Are you a funded sponsor?” If you ask this question, you will achieve instant credibility by simply knowing the jargon of the private equity world. A “funded sponsor” is simply a term for a real private equity firm, one with a “fund” available to consummate an acquisition.

There are many individuals masquerading as private equity firms which are not. “Search funds” are individuals looking for a job with equity. Often these individuals are recent MBAs who have parents with rich friends who “commit” to put up the equity for a deal if the young lad or lass sniffs out a decent deal. In most cases they have never done a deal before; you don’t want to be their guinea pig.

A “fund-less sponsor” is similar; they may have done some deals, but they are making offers to buy businesses with no capital in place to consummate an acquisition without raising money.
The parties most worthwhile in getting to know are the private equity firms that have funds and a track record of successfully buying businesses.

Of course, with about 5,000 such funds out there, the chances that the one who is calling you is the best cultural fit willing to pay the highest price are slim to none. So while you don’t want to sell without running a professionally-managed sale process, it never hurts to talk to potential buyers in the meantime. You might actually learn something.

Really, how much is your business worth?

​​One thing that executives of both public and private companies have in common is that neither has a very good understanding of what determines the value of their stock.

When I headed corporate finance policy at the U.S. Treasury Department, I met with groups of Fortune 500 CEOs on numerous occasions, and they invariably complained about how Wall Street priced their stock.

“How can we announce a 20 percent growth in earnings and have our stock price fall?” Easy. If the market expected 30 percent growth, and had priced that into the stock, the earnings announcement told traders they had overestimated the company’s expected cash flows, and the price declined accordingly.

It is imperative for any executive, whether of a public or private company, to understand what determines the value of their business. The value of any business, simply put, is the sum of all expected future cash flows that will accrue to the owners, discounted to the present by a discount rate that reflects the time value of money and the risk of those cash flows materializing.
Just because a company performs exactly as expected does not mean the stock value remains static.

Every time assumptions change about the economy, interest rates, global peace, etc., that evolving world view has implications for a company’s ability to generate cash for its owners in the future. CEOs who complain that Wall Street only cares about short-term earnings are misguided. Please explain Tesla’s stock valuation as a function of its quarterly earnings! Ditto for any growth company. For companies that are not growing rapidly, quarterly earnings are a reliable proxy for future cash flows, so they do matter more.

One advantage public company executives have is that, on any given day, they can look up their stock price. Private company owners cannot; so they tend to focus on the wrong metric, one which is easily monitored: sales. This is very dangerous, as revenues are often a poor proxy for cash flow, which is what dictates value.

Private company owners frequently make false assumptions about how the pricing of a few deals in their industry translate into the value of their business. Not every company in a given sector sells for the same multiple of cash flow, which is commonly estimated by EBITDA. And when companies sell for a multiple of revenues, it is only because they have no cash flow, and revenues are the best signal for future cash flows.

I had the owner of a logistics company try to convince me the value of his company was equal to one times its annual revenue because one of his competitors sold for that amount. His competitor owned sophisticated proprietary software used to schedule shipments for clients; it generated impressive margins. The owner I was speaking with had no proprietary software and produced much lower margins. Each dollar of revenue equated to much less cash for the owners, so the multiple should be materially different.

In selling over 100 companies, I have witnessed countless business owners exhibit extreme confidence in their assessment of their company’s worth, despite never having been through the process. Business valuation is far more nuanced than most people believe. But in some respects, it is also more straightforward. For example, when I explain how cash flow drives valuation, I invariably hear: “What about my people, my reputation, my market position?” If you have good people, a great reputation and a defensible market position, all those will show up in the consistency and growth of your cash flows. If they do not, then you have misjudged their value.

Can we trust big companies anymore?

Thank goodness for Congress. If not for its dismal approval rating, corporate America would rank dead last among all institutions in our country. Only one in five Americans respect big business. And that was before the Facebook fiasco.

As a conservative UNC business school professor who graduated from the West Point of Capitalism, Harvard Business School, I am supposed to be a cheerleader for corporations. But even the staunchest defenders of free enterprise have to be disappointed in the moral decay of corporate leadership.

Twenty years ago, Triad-based Wachovia Bank was one of the three most highly respected financial institutions in the country. Today, after Wachovia’s near-death experience in 2009, its successor Wells Fargo has become the least respected brand in the nation. Wells Fargo rewarded staff who opened accounts without customers’ knowledge or consent, among several other breaches of fiduciary responsibility.

Charlotte-based Bank of America reached a $415 million settlement in 2016 with the Securities and Exchange Commission for misusing customers’ cash and securities to generate incremental profits. It was deemed the second largest settlement ever with a “Wall Street” bank. BofA is actually a Tryon-street (Charlotte) bank.

It seems that every segment of business has its own version of scandal. Between 2012 and 2016, over 1500 “small farmers,” including many based in North Carolina, secured SBA-backed loans to finance chicken farms. As it turns out, these farms are effectively controlled by billion-dollar poultry companies who profit from government-subsidized SBA borrowing rates.
This is a national epidemic.

We should have seen the Facebook crisis coming a mile away. I haven’t posted on Facebook in five years, assuming a major data breach was inevitable. Even if they protected your data, Facebook’s business model has been to exploit your personal information and sell access to your mind in order to enrich itself, without your consent. Systematically facilitating the manipulation of users’ world views by Google, Facebook and other tech giants is a scandal of Orwellian proportions.

As with personal relationships, trust is the foundation of any commercial relationship. When a corporation loses the trust of its customers, it will pay an economic toll. Ironically, it is the unbridled pursuit of profits that is almost always what motivates behavior that destroys trust and, ultimately, profits.

Perhaps no company in American history stood for trust more than Sears did in its heyday. I teach a case to my MBAs on Sears shifting its auto mechanics to a pay system based on how many repairs they performed, to juice profits. Predictably, the mechanics began performing unnecessary “repairs.” Eventually, consumers figured this out, and the distrust that ensued not only harmed the auto centers, it permeated the entire Sears brand.

So how do we stem this tide of moral decay in corporate America? The solution is not to teach more ethics classes.

People typically do what they are paid to do. It is human nature to maximize one’s outcomes. So we need to monitor and reward behaviors that increase trust and financially punish actions that destroy it. Every company should establish metrics that measure customer and employee trust, and build those metrics into reward systems.

In my small merger and acquisition advisory firm, a business sector infamous for nefarious characters, I make sure my employees know their core mission is to produce clients who will provide glowing recommendations about our integrity and commitment, which leads to more clients. This is the first consideration in determining annual bonuses. Every business, regardless of size or industry, should make trust metrics part of their compensation system. And shareholders should demand it.

Are liberal arts colleges becoming irrelevant?

Should young people focus on STEM classes, in order to develop the technical skills required to secure gainful employment in today’s workplace; or do all “enlightened” people need to be well versed in the liberal arts?

The answer is “yes”.

We need both. But while STEM courses have evolved with the global economy and effectively prepare young people for emerging careers in robotics, artificial intelligence and data analytics, the liberal arts course lineup has become increasingly irrelevant. Take a moment to peruse the course catalogue of your favorite liberal arts school, and prepare to be shocked.

Stories of unfilled corporate positions are ubiquitous, as our universities churn out anthropology, gender studies, and psychology majors buried in debt who are waiting tables and seeking remedial training in disciplines where they might be employable. The largest consumers of college graduates, such as Facebook and Google, are beginning to disrupt higher learning by vertically integrating into education to assure a more reliable supply of trained workers than our universities produce.

States have cut billions from university funding, in large part because so many Americans feel colleges fail to prepare our youth for life. One in three people, up from one in ten a few years ago, believe that universities have a negative impact on our country.

It is dangerous, though, to assume STEM courses alone will suffice. Experts have found that the critical skills required to be successful in today’s economy evolve over one’s career. Increasingly, technical skills differentiate young people seeking jobs, as well as separate them from the pack in the early years. But unless a worker wants to remain at the lower levels of an organization in perpetuity, they need to develop an entirely different skill set to move up the corporate ladder.

Progressing in a career requires an ability to communicate without staring at a hand-held device or computer screen. One has to be able to articulate a vision, understand diverse viewpoints, build teams and motivate others. These capabilities are not taught in computer science, statistics, or data analytics classes. Unfortunately, they aren’t taught in most liberal arts courses either.

Instead of teaching conflict resolution and how to assimilate divergent viewpoints, colleges offer a four-year escape from people and ideas that make us uncomfortable, an illusory ecosystem that exists nowhere outside a college campus.

At UNC-Chapel Hill, where I will be adding a new course on the intersection of business, politics and public policy, we offer over 100 courses with “gender” in the title or course description. Universities are catering to more and more identity groups, and less and less to the masses who want to succeed in life and a career.

So how do we get public liberal arts universities to reinvent the curriculum to be more relevant, given the structural impediments that resist change? We all know the dysfunction that accompanies tenure. It makes it very hard to reallocate resources. And as long as every department selects its own members and course offerings, we will continue to have group-think, rather than thought diversity, in the modern university.

One would hope the growing movement to disrupt higher education would light a fire under academics to self-police and develop more courses that teach skills needed to be successful in life, but university governance and culture make that unlikely.

We need disruptors–more university leaders who have succeeded in the real world. And governing boards with more members who understand the university structure and culture, so the parties could collaborate to make liberal arts more relevant.

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