Declaring Independence: building business value by breaking owner ties

Eliminating the dependence of a business on its owner is arguably the most important factor in enabling a profitable sale.

If people, systems and processes that enable a business to run independently of its owner in day-to-day operations have not been put in place, potential buyers will find it a risky investment that may not be worth taking up, or only at a highly discounted price.

Putting it bluntly, buyers don’t want a business that is heavily reliant on the owner because it is likely that business will suffer with the departure of that person.

Business value drivers

Potential buyers investigate a range of value drivers and the better the condition they are in the more you can drive up the business’ value and asking price. Two of the top drivers are:

  1. A stable, motivated and competent team of employees (and managers in larger businesses); and
  2. Operating systems that have systemized many of the day-to-day procedures.

These two drivers, human capital and systemized processes, provide a great deal of the comfort factor to a buyer.

Human capital

In early years the owner is usually everything. Without their involvement in the business there is no business. As such, the concentration of knowledge lies mainly with the owner across all the key areas.

As the business gets larger and the scale and scope of its operations widens, owners should have found ways to transfer knowledge in key areas to employees – particularly to any management team – so that at selling time the concentration of knowledge has shifted from the owner to the employees.

Failing to make that shift shackles the owner to the business. As its most valuable asset, the owner will be forced to sell at a discount rate to compensate for the loss of that asset at transfer.

Once owner-managers develop their human capital value driver, they provide themselves with room to more actively manage their business. At the same time they have enhanced the value of the business by reducing a buyer’s investment risk.

With key operating and management personnel capable of running the operation, a new owner can make the acquisition and learn the business while the company's personnel continue to effectively carry out the day-to-day operations. Corporate purchasers generally prefer acquisitions with existing management teams in place.

Working on the HC value driver involves training and development and delegation of responsibility as a basis, but it should go further. The actions you can take can be both positive and defensive.

Positive actions include ways of tying employees to the business so they remain beyond the sale.

Defensive actions protect against the dangers inherent in people leaving.

Examples:

  • put in contracts an equity participation scheme for those in key positions or with key skills.
  • Clarifying responsibilities and authorities with job role descriptions adds another layer of security that employees will continue to work in an organized manner while the new owner adjusts.

Examples:

  • Include appropriate non-compete and confidentiality provisions in contracts.
  • Where the business owns or develops intellectual property, provisions should be included in the contracts of employment to ensure that all ownership rights vest in the business.

Process systemization

Beyond the need to develop human capital, there is a need to assure continuity of operational effectiveness and its associated value driver, profitability.

This means documenting important relationships, special product or services knowledge and procedures for carrying out many of the operations of the business. It’s important to get knowledge about how things work turned into systemized business processes as a basis for sustainable productivity when the owner departs.

The most powerful improvements in productivity come from systemizing processes so that the business performs in the manner of a franchise. Franchises have been an incredibly successful form of business because of their turnkey nature – proven systems and processes within the business – are documented and can be used by anyone. Franchisees don’t have to learn everything from scratch for themselves.

Documenting procedures offers the opportunity to rethink and improve them and an operations manual gives a buyer some security that they, or their managers, will have any answers they need to find after they have taken over and are running the business. If a buyer concludes from their due diligence that they are going to have to spend money sorting out the infrastructure it will probably come off the purchase price.

Simple, documented processes that transfer the owner’s skills and remove them from the process ultimately add to the value of the business.

Out with the old …

Taking the owner out of the business is an essential prerequisite to putting a business up for sale if it is to achieve top value. The better the business can operate without the owner the more attractive it will be to a buyer.

The better this can be achieved the more the business will be worth as a saleable asset.