Many owners today are becoming aware that a process exists to help them plan for the exit from their privately-held business. Some of these owners are also beginning to see that the greater amount of dependence that their company has on their individual efforts, the harder it will be to transition to a new owner. This newsletter is written to assist owners with understanding how their options for an eventual exit can be impacted by how dependent their business is on them. It also introduces a new tool, the Owner Dependence Index (“ODI), to assist with taking this initial measurement.
A Company’s Dependence on Its Owner’s Efforts will Impact Exit Options
Business exit planning includes identifying what an owner wants most – at both a personal and company level – and combining that with how well-prepared they are to execute a transition. For example, an owner may want to transfer their business to an outside buyer. However, if the business is too dependent on the owner, there is a risk that the business will not survive in the hands of another owner. In this case, the exit option of an external transfer may be limited, which may limit the owner’s overall ability to transition the company to someone else and ultimately reach their exit planning goals.
Different Exit Options
In the world of private business transfers, there are five (5) primary ways that a business can transition to a new owner. ‘External’ buyers include competitors and investment groups that can purchase the business, the first two (2) options. By contrast, ‘insiders’ include co-owners, managers, and family members. ‘Internal transfers’ can consist of a management buyout, an employee stock ownership plan, and/or gifting to others, such as family members. The amount of dependency that a business has on an owner can impact these various exit options in different ways.
Sales to Outsiders / Competitors
Let’s begin with a sale to a competitor. If the company has a high dependency on the owner, then a competitor is unlikely to pay the full value at the closing. Rather, that buyer will often look to structure a transaction with deferred payments, such as notes and earn-outs; at least until a point in time when the buyer is comfortable that the company can survive without the owner. Moreover, with these transactions owners are often asked to stay on board for a neat and orderly transition period of time. If this is the case and there is a high level of owner dependency, then a separate issue could arise because most owners do not make good employees. If the buyer and seller are both unhappy after the transaction, but the company needs the owner to continue to run effectively, this could tie both parties together in a very unhealthy relationship.
Sales to Private Equity Groups
Private equity groups don’t mind high owner dependency too much, provided that the owner is agreeing to work for these investors after the transaction. If the owner dependency level is high, then both parties need to give serious consideration as to how their relationship will be after the transaction. Moreover, they will need to consider that this relationship could exist for a very long time. By reducing owner dependency and by empowering a management team, that owner should be able to attract more investors because they have demonstrated scale in their business.
Sales to Insiders / Management Teams
A sale to a management team can be an attractive option for many owners. However, the highest downside to this form of transaction is that the payments from the management team will most likely be drawn from the future, continued success of the business. Therefore, if a high level of owner dependence exists, then what that owner may discover is that the company that cannot run without them is also not going to be able to make the purchase price payments without that owner’s active involvement. Therefore, many owners may simply conclude that if they are continuing to work hard in the business, then perhaps they should just hold onto it. The logical conclusion is that no transaction or exit happens. Therefore, reducing owner dependence on an internal transfer can help increase the likelihood of success.
Concluding Thoughts –
Measuring and Managing Owner Dependence
The Owner Dependence Index™ is a free online survey tool that allows owners of privately-held businesses to measure the amount of dependence that their business has on their individual efforts. Owners take a forty (40) question, twenty (20) minute assessment and get a score from 1% to 100% that lets that owner know how dependent their business is on their individual efforts. The ODI™ was created to help owners take this measurement and then work, over time, in a focused manner to reduce the amount of dependence that their company has on them. By completing this online survey tool you can take the first step in knowing your Owner Dependence Score and begin the process of better understanding how that score will impact your options for a future exit.
We hope that this newsletter helps you see the importance of knowing how dependent your business is on you.
John P. Foster
Written By: John Foster
John Foster has 30-plus years of distinguished leadership and management experience with multiple companies at various stages of development across several fast-paced industries.
Learn more at pathfindergroupus.com