July 25, 2007

The end of the rainbow:

Three steps to creating your own pot of gold

By Joe John Duran

(SPECIAL)

After years of hard work, tenacity and perseverance, all successful business owners will eventually need to think about transitioning out of their business.

But unlike a full-time employee for a major corporation, the typical business owner doesn’t have a pension plan to rely on in the future.

For many entrepreneurs their business is their most valuable asset. Yet for all of the hard work that business owners put into the growing and nurturing of their business, many typically spend very little time preparing to sell their company, even though the sale of their business is what will determine how they will live the rest of their lives.

What many entrepreneurs fail to recognize is that a great business to own is not always a great business to sell. In order to create a sellable asset, entrepreneurs need to change the way the business operates to make the business sellable. Otherwise, they’ll end up simply handing their company over to a successor for a very modest price, and they might be leaving a small fortune on the table.

Joe John Duran

It doesn’t have to be that way. Some simple planning can help to make that treasure at the end of the rainbow considerably larger.

After interviewing dozens of entrepreneurs in a range of industries for Start It, Sell It and Make a Mint (John Wiley & Sons), we found that there were three must-have keys to creating a valuable, and most importantly, a sellable business, no matter what the size.

The three wealth creating steps are:

1. Build large and predictable revenues.

The single biggest factor in determining the sale price of a business is the size and predictability of the revenue stream.

Obviously the larger the revenues, the higher the price, but it’s also true that the more predictable the revenue streams, the higher the price.

Typically companies that generate recurring revenues (such as those with service contracts or with many loyal repeat clients) command twice as much as commission-based businesses that have one-time customers.

It is also important to note that the higher the revenue stream, the more qualified potential buyers you will find, resulting in a higher sale price. So concentrate on increasing revenues in size and substance before you sell.

How to improve: Identify which of your revenue streams are predictable, and identify how to convert more of your revenue into recurring income.

For example, Lisa, who owned several yoga studios, went from charging a per visit fee of $15, to charging clients for a series of classes at a discount, and, for her most loyal clients offered an annual membership fee of $1,200 ($300 per quarter). The clients who came in more than seven times per month were better off, and the revenue stream became more predictable, and therefore, safer and more valuable for a future buyer.

2. Have no dependence on any one person.

Many businesses rely on one or two key employees (typically the owners). This means that, for any potential buyer, the business has very little value without the current owner, and so they can not afford to pay a premium for it.

If, however, the owners have had the foresight to prepare the business to operate in their temporary absence, then it will probably continue with their permanent absence, and any potential buyer will view that as a major risk removed.

How to improve: Remember, there is an inverse relationship between your importance to the business and the value of the business. When you begin thinking about selling your company, start paring back your day-to-day responsibilities by delegating some of your work to others. That might involve hiring some additional staff or promoting some of your team.

Steve owned a car parts manufacturing business. He had personal relationships with all of the dealerships that ordered their parts. He knew that if he wasn’t at work, sales would taper off. He developed a sales team and over the course of 18 months transitioned himself out of the client relationships. Sales continued growing, but now he could sell the business and any potential buyer would have a lot less concern about the business being reliant on the owner.

3. Ensure you have transferable clients.

If the clients are not willing to continue doing business with a new owner, then clearly, the company has very little value to a new owner.

Focus on building a client base that is loyal to the business rather than to any individual within the company (including you). The more certain a buyer is that clients will not object to new ownership, the more valuable the enterprise becomes.

A buyer who is uncertain if the clients will transfer their loyalties to the new owner will often make the sale price contingent upon a certain amount of clients staying with the firm.

How to improve: The key to having clients remain loyal to the company is to build a strong brand. One easy way to do this is for the business owner to constantly emphasize the company and the team that supports every client rather than focusing on any one individual in the company. After all, the new buyer will want to know that the clients belong to the business rather than to individuals. This is one of the reasons that successful franchises can be sold at an established rate — there is a well established brand with loyal and transferable customers.

Ron had a well established legal practice. As he began thinking about selling the business, he slowly passed all of his clients on to other lawyers in the practice. Once he had very few clients, he sold the firm relatively quickly. The buyers knew that the clients would stay on board with the firm since very few of them worked directly with Ron, the owner.

Preparation is as important as luck and talent in any business endeavor. It’s also the only thing that entrepreneurs really have any control over. Those business owners who treat the selling of their business like a major event requiring serious preparation are invariably richly rewarded for their efforts. Applying these lessons to your business can significantly increase the size of the pot of gold at the end of your rainbow.

Joe John Duran is a chartered financial analyst, a successful entrepreneur and the author of Start it, Sell it & Make a Mint (John Wiley & Sons).

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