Having a real exit strategy

“One of the things they teach you about entrepreneurship in business school is that you should have your exit strategy in mind as you start and grow your company.”

One of the things they teach you about entrepreneurship in business school is that you should have your exit strategy in mind as you start and grow your company. While I realize most of our readers probably didn’t start the companies they work in, many are owners and top managers, and that means you better be thinking about an exit strategy as you run your business. And with a new year underway, business plans are being created and implemented. If you haven’t talked about it with your partners and fellow managers, now is the time.

Some people have the misconception that “exit strategy” somehow equates to “failure” or “going out of business.” Nothing could be farther from the truth. “Exit” in this context merely means getting the value out of your years of sacrifice growing the business when you do eventually cash out. Entrepreneurial ventures should provide TWO sources of income for their owners – what they extract every year in terms of salary, benefits, and profit distributions, and what they earn in equity appreciation upon exit. So, getting the most for the business when you exit is an important part of your financial rewards.

Generally speaking, an external sale will yield the highest value for your ownership stake. Internal sales usually have some sort of discount associated with them for “lack of control” (controlling interest in an internal sale may be another matter but we won’t get into that now). That said, what makes your firm more valuable in an external sale will also make it more valuable in an internal sale, should you decide to go that route when the time comes.

So, here are my thoughts about how to increase your value – whether you exit through an internal or external sale. And these are important strategic matters either way:

1. Revenue growth rate. Many so-called experts tout multiples of EBITDA as the most important value drivers but the fact is high revenue growth rate affects value probably more than anything. If you don’t believe me, look at the public markets where some companies never make a profit yet have multi-billion dollar valuations. And consistent growth is valued more so than sporadic, up and down growth.
2. Profitability. One would be naïve to say profitability doesn’t matter to any buyer of any business. Of course, a buyer needs profitability to pay back their investment. But what really matters is what the buyer’s projections are for post-sale profitability. There are many addbacks and deductions to consider. Many highly profitable companies in this business are that way because the owners underpay themselves salary-wise. That jacks up profits. Another reason for better than normal profits may be a lack of investment in marketing, technology, facilities, or people. These would be deductions, then, from a buyer’s standpoint. Addbacks include things such as excess salaries and benefits for owners, reduced overhead from insurance savings and duplicate outside professional service providers, and/or overhead staff. We have worked with some companies where the buyer’s view of post-transaction profitability was one that more than tripled what the company was currently doing. It is important to understand “profitability” in a privately-held company is rarely reflected accurately on an income statement.
3. Brand name. A good brand is worth a lot of money in this business. CH2M-Hill was a great brand at one time. HOK Sport was an amazing brand. EDSA is a real brand. I could go on. These companies are worth more because clients chase them down to do their work, rather than the other way around. They also have higher fees. It is like “McDonald’s” versus “Joe’s Burgers.” If you open a McDonald’s, cars will line up the first day. Customers know what to expect and will pay a premium for it. But you have to be careful. You don’t want that brand name to be tied only to your star or stars, or it won’t be perceived by potential buyers as something that they can actually buy.
4. Management and staff. You need good people there and depth in the ranks for all positions. If the only “good” people are the owners, your value will go down. Buyers want to know there are others who are trained and capable at every level to not only do the work that comes in but also carry on running the place as the post-transaction demotivated owners (they got theirs) move on or prepare to move on. This takes a real succession plan, training, and mentoring (yes, I despise the word but it is meaningful in this context!).
5. Systems. Having a great file system where everything can be found increases your value. So does a widely shared and up-to-date client and potential client database. No one wants to buy a business where all of the history or marketing information or business development contacts are stored in the brains of those no longer with the company or on portable rolodexes that can be picked up and carried off à la Mad Men.

So, hopefully by now you can see how all of this stuff is important and intimately tied to your firm’s strategy. And it all makes you worth more, whether the sale is internal or external.

Mark Zweig is Zweig Group’s chairman and founder. Contact him at mzweig@zweiggroup.com.