Selling Your Business: Money isn’t Everything

When I was a kid my mother said “Money isn’t everything” in response to every envious glance at another kid’s stuff. As I became successful enough to afford things for my children, I reversed the meaning. “Money isn’t everything” became my reminder that their possessions didn’t make them better or happier than others.

The same holds true for companies. An entrepreneur who is struggling to generate sufficient working capital is an unlikely prospect for a lender, let alone an investor.

I regularly receive approaches from business owners who have a great ideas, but have run out of capital without generating cash flow.  They usually have trouble understanding why I don’t want to represent them in their investment search (for a fee contingent on only my success, of course.)

“But everyone says there is plenty of money looking for deals,” they say. It is true. There is always more money available than good investments. That’s why so many investments lose money.

Once your business approaches $1 million in annual earnings, the whole capital landscape changes dramatically. If you are scalable (meaning you likely have around 100 employees or more) your deal is attractive to financial investors such as private equity groups. There are currently about 7,000 such buyers in the US, pursuing the 17,000 or so companies who meet their criteria.

These buyers range from Search Groups (who have investors lined up if they find a company), to investment funds with a billion dollars or more in “dry powder” (cash in the bank).

If you are smart, and clever, and tenacious, and lucky, you can reach the point where there is plenty of money to buy you out. In fact, money is probably chasing you. Most sellers, however, come to realize that money isn’t everything.

shark with dollarThe M&A world abounds with horror stories of financial buyers who stripped the employee benefits from a company and drove off its key personnel. Others pulled their capital as soon as they had control (to leverage it in another deal) and left the business staggering under the debt replacing it. Still more inserted a Hired Gun executive from another industry whose inexperience quickly ran the business on the rocks.

That might not be your concern if you walk away with a terrific multiple, but if the deal (like many) requires you to leave a substantial amount on the table for a few years, it’s critical.

I work with business owners in their exit planning. Although I haven’t brokered in years (meaning list and market businesses for sale), I regularly advise owners who are dealing with an approach from financial buyers. Here’s my mental checklist for vetting a financial buyer:

  1. Do you trust them? Can you see working side by side with them as your partners?
  2. Do they understand your business and your customers, or are they just looking at your financial statements?
  3. How important to you is the future of your employees and your reputation?

Notice that the questions don’t include “How much money do they have?” If you are attractive to one financial buyer, you are probably attractive to a lot more.

Many of my clients, when they examine the non-financial aspects of selling, choose alternative exits. They arrange for the employees to buy the business, or merge with a friendly competitor. They may not make quite as much, but money isn’t everything.

If you enjoy Awake at 2 o’clock and know a business owner who would benefit from reading it, please share. Thanks!

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Employees Who Make Bad Choices

Employees who make bad choices in their personal lives usually create problems in the workplace. Should you take their issues outside of the business into consideration when hiring or assigning responsibility?

The legal answer of course, is “no.”  Employers are expected to erect a Chinese wall around working hours, and dutifully ignore anything that doesn’t relate directly to job performance. In reality, all owners know that is both untrue and unwise.

We don’t hire a Director of First Impressions who shows up to the interview dressed like a cross-country hitch hiker. If a prospective hire informs us that his wages are being garnished for unpaid child support, we are unlikely to give that as a reason for choosing someone else, but it is.

A classic Dilbert carton features the “Room of Useless Employees.”  In it, men and women are staggering around like zombies reciting their personal distractions. “Buying a house.” “Having a baby.” “Getting married.”

good bad choiceOf course, employees have the right to their lives. We are all distracted by problems involving home, health and family. Some people, however, just seem to make  a lot of bad decisions despite the best support you can render.

A few years ago a city was inundated by a major flood. Most of the citizens evacuated, but some remained, apparently for the free merchandise opportunities. The front page of the newspaper featured a young man wading through chest deep water with a new television set held over his head.

Clearly, he was a practitioner of serial bad choices. He should have left the disaster area when given the opportunity. Since he didn’t, food and safety would be better priorities. That aside, he had no access to electricity, and his abode was likely uninhabitable for a long time to come. Making the television his loot of choice was clearly not very well thought out.

Employees who make bad choices are not necessarily limited to the entry-level, either.

An owner I worked with was seeking a financial manager. A candidate interviewed who had advanced education and experience credentials, but had served time for embezzlement. Since his release several years before, he had supported his family by splitting his time between menial jobs in food service and acting as the controller for a non-profit organization. He presented very well, was clearly knowledgeable, and expressed passionately how he had learned his lesson.

This business owner had a few second chances in his own background, and decided to offer one here. He put the appropriate safeties in place (no access to bank accounts, oversight, split responsibilities for accounts payable and receivable, outside audits), and gave the man a job.

Six months later the financial manager came into the owner’s office “just to let him know” that he was leaving his wife (who had stuck with him through his incarceration) to move in with a subordinate a few decades his junior.  He hoped that the company wouldn’t get sticky about the legal issues of a liaison with someone who reported to him. Of course, he was promptly terminated, apparently to his great surprise.

As the owner told me later, “I should have realized that people who make bad decisions, just make bad decisions.”

Personal issues will arise in any business that employs people. Sometimes unexpected or unavoidable events come in waves sufficient to temporarily derail even the best employee. But if you’ve ever worked with someone whose life was a train wreck as a result of their own bad choices, and was also a great asset to the business, I’d love to see their story in the comments.

Do you know a business owner who would enjoy Awake at 2 o’clock? Please share.

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2 Responses to Employees Who Make Bad Choices

  1. Tracey C says:

    I had a small family business with one employee. She was very loyal to us as a family and came to work nearly every day (which was an important part of the job because we were very small and very dependent on each other). She could manage herself and her work load very well. The customers loved her, she knew the business, understood the risks involved and – probably most importantly – knew when to ask for help and when not to. She always got the job done and did it well. She started on a part-time basis and then moved into full.

    After she became a full-time employee, I began to see the horrific choices she was making in her personal life (because she would come and talk to me about them – often for long periods of time). Her issues began to dominate the office started causing more and more problems for me. One day, our work was interrupted because someone showed up to repossess her car….but how do you fire someone for that? And through it all, she still came to work every day, got her work done and the clients still loved her.

    I tried to create boundaries to manage the drama, but probably didn’t do a great job of it, and it had a fairly negative effect on our relationship. I also had a hard time getting support from the other family members for terminating her because she did such a good job with her work and knew the business so well, and was so loyal to us and the company. In many ways, she would have been very difficult to replace.

    It was a difficult situation that really had no good answers or solutions. In the end, it was resolved because we had to close the business for reasons that were completely beyond our control (and had nothing to do with her).

    Closing the business actually solved a number of problems that had been brewing beneath the surface and threatened to make families dinners rather painful, but I can’t really recommend it as an effective or ongoing problem-solving tool.

    • John F. Dini says:

      Thanks for the story, Tracey. I wish I could say it was the first such I’ve heard. Closing the business is a more radical solution than I’d typically recommend, however! 😉

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Selling to Employees: Is Your Exit Strategy Right in Front of You?

When I interview a prospective client for exit planning assistance, we usually explore selling to employees. The first reaction is always “That won’t work. They don’t have any money.”

If you have a company with reasonable cash flow, a talented management team and sufficient time, selling to employees is not only a realistic option; it may be the best way to get value from your business. I’ll define those parameters for you in a minute.

If you haven’t read my eBook Beating the Boomer Bust, follow the link for the free download. My research shows that the hard numbers will inevitably translate into a hard market. There are 3,000,000 Baby Boomers (over 50) who own businesses with employees. Over the next 20 years, that’s an average of 150,000 owner retirements per year. Intermediaries (brokers, private equity and M&A) account for about 9,000 transactions a year.

That leaves a lot of folks looking for a way to cash out. Selling to employees is a process that lets you keep control until retirement. By structuring the sale correctly, you can leave with the proceeds in the bank, not in a promissory note.

How does that work? It requires a bit of mental gymnastics. First, any owner has to accept that the only source of funding for any transaction is the cash flow of his or her company. If a buyer pays cash, he expects that cash flow to pay him back. If a bank finances the acquisition, they expect the cash flow to service the debt. If you finance it, you are the essentially the bank.

Selling to employees is the same. You use the current cash flow to help employees buy stock. In return, they qualify by working to increase the value of the business until your final return is equal to (or more than) what it was when you started.

Think of it as taking a note for 30% of the purchase price while you are still in control, so that you can get a 70% cash down payment when you leave.

Now, let’s discuss the parameters.

Cash Flow: Your company has to be earning more than just your paycheck. My rule of thumb is that around $500,000 a year after owner’s compensation gives enough to work with. More than that doesn’t change much, since then we are usually looking at a higher purchase price. Less than that is doable in a longer time frame, or if the owner is willing to subordinate some debt to the bank.

Management Team: You need at least one decision maker who does more than just go through the operational motions. Any third-party lender wants to be comfortable with company leadership when you’re gone. A large portion of our planning surrounds transfer and documentation of management capability sufficient to satisfy a lender.

Time Frame: Many business owners tell me “I’ll think about exiting in five years.” That’s fine, if your plan is to retire in fifteen years. Generally speaking, the longer you have, the more lucrative an internal sale can be. I’ve done three year plans, but five is much more comfortable, eight years is even better, and we regularly work on transitions of ten years and longer.

all for one one for allSelling to employees requires legal agreements, specialized compensation plans and a willingness to run the company transparently. The return is a team that is committed to the long term, highly motivated, and all on the same page when it comes to growing the business.

Why should you consider selling to employees?  Because your company lives on with the culture you created. Because you can choose the value, not negotiate it. Because your employees aren’t comparing your company with other investments. Because you control the timing of your exit.

Because it is probably the biggest financial transaction of your life.

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Employee Experience: Is Bigger Better?

Small businesses provide much of the initial employee experience. We take younger folks and teach them decent work habits like showing up every day, being on time, and working to deadlines.

As owners, our personal skills may not be sufficient. We can’t teach everything necessary to run a growing company. We turn to the outside for experienced employees, people who can bring what they learned elsewhere to our team.

In many cases, we are looking for someone who has performed at the next level, handling more people, more responsibility or higher level functions. Instead of helping someone grow into a job, we want someone who can help the company grow into what they can already do.

Often, those people come from much larger organizations. They may have run a department that was bigger than your whole company. We know that big corporations have a very different culture than small businesses. How can you determine whether a prospective key hire is going to be a fit for your business?

First, there is attitude. I’ve found many veterans of big business are condescending towards “little brother” businesses. They believe that their knowledge should be welcomed with unconditional acceptance, and that the way they learned to do it in BigCorp is the only way to do it.

Be careful of attitudes that indicate the prospect believes that having fewer subordinates or a smaller budget means less work. I’ve had candidates tell me that they wanted to move into small business because they wouldn’t have to work so hard. (!)

Resources drive the managerial employee experience in large organizations. You may not be able to throw personnel, marketing dollars or technology at a problem. Check for resource dependence by asking how the prospective hire would tackle a problem, then remove some of the resources and ask for another approach. They aren’t cut out for small business if they get that “deer in the headlights” look.

The biggest issue in qualifying employee experience from a larger organization is personal responsibility. In BigCorp missing budget means you don’t get a bonus, not that everyone doesn’t get a paycheck. Ask about times he or she failed to reach a goal, and the consequences.

zebrasIn large organizations you can hide in a crowd for a long time. Be wary of resumes that concentrate on credit for group activities. Carefully review claims from a member of an “award-winning team,” “record setting department,” or “nationally recognized initiative.” Such people may be superstars, or they might just be very skilled at standing next to superstars. Examine their personal contributions in detail.

A key employee who brings solid experience to your organization can be a huge boost towards the next level; but if he or she can’t walk the talk, it’s just an expensive drag on your whole company. Don’t get caught up in the halo effect of ‘Bigger is Better.”

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What’s in YOUR Nondisclosure Agreement?

A Nondisclosure Agreement (NDA) has become one of the basic standard documents in every company’s wallet. Between the rising swell of Baby Boomer owners entertaining exit planning, and greater caution surrounding the legal issues of strategic partnering, an NDA is now the standard next step following many initial exploratory conversations.

What should you protect in an NDA? (Note: I am not an attorney, and I don’t create Nondisclosure Agreements for clients.)

Secret informationFirst, there is the question of who is covered by the agreement. Most allow for advisors to each party to see the agreement. That can encompass accountants, attorneys, consultants, bankers and employees. I think employees present the greatest risk, since they are the most likely to personally benefit from information about customers, vendors and pricing.

Some attorneys include language requiring every person who shares the information to sign and return a separate copy. That is cumbersome, and opens the question of enforcement. If you talk to someone on the other side of the transaction, and don’t have a signed copy of the agreement first, have you voided that condition yourself?

Try to keep the responsibility for protecting information with the other side. One mechanism is to have each person who sees information add their signature to the agreement, with language that makes it the other party’s responsibility to only share with signatories. At a minimum, the other party should be required to make certain everyone on their side is informed of the confidential nature of the information. Electronically stamping everything “Confidential” and converting it into pdf is also a basic caution.

Then there are decisions about what information to share. Most potential acquirers are concerned about customer concentration in sales. They will ask for customer purchasing history as one of the first items in preliminary examination of your company.

That is a legitimate concern, but it doesn’t mean they need the names of the customers until much later in the process. We provide redacted reports, identifying customers by letters or numbers.

The same type of common sense applies to vendors, employee compensation and margins by product line. You can provide sufficient information for valuing the business without the details. No matter how honest or well intentioned the other party may be, he or she will remember that you are making 10% more on a specific product, or are selling substantial amounts to a customer they thought was all theirs.

Finally, we recommend that the Nondisclosure Agreement go beyond just keeping information confidential. It should always include a non-employment clause regarding your employees. Non-solicitation is okay, but it’s hard to prove if the company claims the employee approached them. Just make it simple; they can’t hire any employee for two years following your discussions. You may be surprised at how many potential partners balk at this condition.

Always have a qualified attorney draft any Nondisclosure Agreement, but there is no need to go wild. One page is typically insufficient, but more than two pages and you are usually loading it up with conditions that are either irrelevant or unenforceable.

No NDA will stop someone from being dishonest. It is intended to make plain what you consider yours, and how you expect it to be handled. As in any other business transaction, what’s written on the paper doesn’t replace trust.


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Posted in Entrepreneurship, Exit Planning, Managing Employees, Selling a business, Strategy and Planning | Tagged , , , , , , , , , , , , , | 4 Comments

4 Responses to What’s in YOUR Nondisclosure Agreement?

  1. Jim marshall says:

    In some areas an NDA requirement preventing hiring any your employees have been found not legal because of is effect on freedom to find new employment for the employee. EG where there are limited opportunities for certain skill sets in the geographic area.

  2. In many areas, employees’ response to an open advertised employment solicitation is normally not covered by the NDA’s restrictive provisions….while direct contact is. From a client perspective, it is important to note the difference and that the risk exists, but is essentially the same as it is in “normal” times.

    • John F. Dini says:

      Good point Richard. Actually most large companies won’t agree to a non-employment clause for just that reason. They don’t want liability (or screening responsibility) for normal recruiting activities. With smaller acquirers, JV and merger discussions, I have seen it included (subject to state unemployment law, as was previously noted.)

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