Join us as we talk with John Mill about why a lot of business owners should consider this strategy as they think about leaving their business.
In this podcast you’ll learn:
- Why selling to your managers is often your best option when it comes time to leave your business.
- What you need to do to get your manager ready to buy your business.
- Why your buyer needs to put “skin” in the game.
- What you as an owner need to do to get ready to transfer your business to a manager in your business.
The internal transition is one we believe is a very satisfying way of transferring your business. It you’re thinking about selling your business and holding paper, you need to listen to another way of selling your business.
Holding paper is always a risky and sometimes dangerous way to transfer your business. Instead think about transferring your business to someone you’ve known and trained for years.
Narrator: Welcome to the Sustainable Business Radio Show on podcast where you’ll learn not only how to create a sustainable business but you’ll also learn the secrets of creating extraordinary value within your business and your life. The Sustainable Business is all about creating great outcomes.
Here’s your host, certified financial planner, student, entrepreneur and private business expert, Josh Patrick.
Josh: Today’s podcast features John Mill. John is an attorney who specializes in working with private business owners and he’s discovered that many owners get to the end of their career and they just don’t have great options for what succession means for them. He’s developed a process that he calls “hiring the next owner.” It’s one of my very favorite ways of passing a business to a younger generation and one that is often safer than trying to sell your business to an outsider. So let’s get right to it and learn about some new ways you might not have considered when it comes to leaving your business?
Hello John, how are you today?
John: Good, Josh. How are you?
Josh: Good. I’m glad that you could join us. I really appreciate it.
John: Thank you for inviting me.
Josh: You’ve just written a really interesting new book called Hire Your Buyer: A Philosophy of Value Creation. What do you mean by “hire your buyer”?
John: I work primarily in the small business market, the microbusiness market. I’m not at the level of the M&A advisor where they would be working at $5-million plus enterprise value transactions. I’m under that and many times substantially. But in the small business market, we find that there’s no reliable statistics. It may be that as many as 90% of those businesses will not be able to sell for an amount that will satisfy the owner’s income requirements in retirement and create a legacy for them so they have to look at some other options. And so, that’s why I talk about value creation.
And the other option which seems to be, in my mind, really overlooked and I think it’s because the business brokers cannot figure out how to generate a commission off of it. But the other option, I think that works well in many cases if you have a good solid business, is to look at your workforce or even look externally and bring somebody in and create a position of a buyer, somebody who’s specifically going to take over the business, that’s their reason, their mission and their mandate. They may have been an employee yesterday but now they’re training to be the person that’s going to take over the business and through tax and legal planning, we can structure a very nice transaction where over a number of years the owner can get paid out by that person.
Josh: What kind of training do you think that a business owner needs to provide for their next buyer, if it’s going to be somebody who works for them?
John: That’s a very insightful question. Obviously, it’s as situational as there are numbers of businesses. It depends on what the person/the employee already knows. But the idea is that the person who is currently an employee and fulfilling a job function is now going to have to step up and become a leader. So, they’re going to have to learn to be a leader.
I guess, ironically, some of the training is the same sort of training that we’re working with the owner in order to get the owner to delegate in order to get the owner to be able to remove himself from the business, a lot of that kind of training and developing process in the business and making sure that there’s documentation and making sure that there’s job descriptions – that building a business within the business. That’s the type of training that the buyer needs to know essentially. What are the key drivers of value in the business? How does the business function and work? How can they make it work?
Josh: What if the owner themselves really isn’t very clear on how to do systematizing as it is. And actually, does he really understand what the key drivers of value are? How would you handle that?
John: Well, that’s fairly common. In many cases, because the owner is in a lifestyle business, they’ve just done everything instinctively and intuitively. But when you go to sit down and develop the business processes and develop the job descriptions and those things, some of that work is really cut and paste, fill in the numbers, fill in the blanks type of–it’s not very brilliant work, if you will. It’s more clerical in terms of getting everything done. There’s a number of types of consultants that don’t charge tremendous amount of money that can help you put the documentation together.
The key drivers of value though is a little bit different. That’s a little more sophisticated and you have to understand. But, in my business, when I’m working, generally, there’s only one lines of business. I’m not working with very complicated, multi-line businesses that interact and interplay. So in a lot of the smaller businesses, it’s a plumbing outfit or it’s a construction company and so it’s fairly easy to determine that if we send plumbers out on the road, they bill certain dollars per hour and it’s a fairly easy analysis from that perspective.
Josh: What do you think the central problem is in business succession planning?
John: Well, currently, the way that I view it—even though succession planning has been with us since the dawn of business, I see it now as an emerging profession and I analogize it to where maybe business valuation was 40 years ago, at least in Canada. I’m not sure in the United States. Usually, in the United States, they have these types of business issues. But 40 years ago in Canada, there was no institute of business valuators. There was no standards of how an evaluator would qualify in court. There was no clarity or agreement as to what evaluation exercise should look at or how it was done. So, I see the central problem as that succession planning is very much in the same state. I refer to succession planning as an emerging industry.
Nobody’s really sure exactly what it is. Around the periphery – I call it the periphery, around periphery in a circle or around the halo of the sun, if you can imagine, is a number of the transactions. We have the tax transaction. We have the shareholder’s agreement. We have the insurance policy. We have the valuation. And all of those transactions, those are all necessary but none of those in and of themselves is actually succession planning.
So, in the core of what ties all of those transactions together, that’s what succession planning is and there isn’t a broad consensus as to what that means but we know for sure that succession planning is clearly more than simply a marketing buzzword used by banks to sell financial products. And we know that there’s more options than simply selling your business externally.
And so, a friend of mine expressed it very well. He’s been actually doing this with farmers for 30 years. He said, what he looks for in an assignment are two things, one is harmony and the other is profitability. I’ve never heard it expressed more simply or elegantly than that. Harmony refers to the emotional intelligence piece of the group of people that are involved. Profitability of course goes to the key drivers. And if you have harmony and you have profitability, now we really have something to work with. And all of those expenses on the transactions, the tax planning, the legal and all of those things are investments that are solidifying our value creation machine rather than expenses that are eroding a diminishing asset base.
Josh: A lot of businesses I look at, especially smaller businesses, profitability is a challenge. In fact, it’s such a challenge that it becomes difficult for a manager to come in and buy the business from a departing owner. How do you help a business owner come to terms with that?
John: Well, that’s a really good question. I have a couple of answers on that. One of them is if you have a business like a metal bending shop or something like that that’s essentially in a profitless industry or where [inaudible 00:07:49] where they’re coming in and the large auto companies are actually literally auditing their suppliers’ books in order to determine their profit margins specifically for the purpose of grinding down their costs. I mean, that’s a pretty pernicious situation to find yourself in.
But the interesting thing about those businesses, even though they’re flatline in terms of profitability, is that they’re not going to be taken away by the internet. You’re still going to need to bend metal. There’s going to be a supplier and the supplier is not going to bankrupt you because they need a source of supply. They’re just trying to grind you down. So what you can do there is this employee engagement piece and if you can do the employee engagement piece and what’s quite interesting—
A great example of the employee engagement piece, that means where everybody is gung ho, working on the team. There is a great company in Quebec call TEMBEC. It was a pulp and paper company in a small town in Quebec, 300 jobs. It was going to close down which meant the whole town was going to close down. They got together and they said, “No, we’re going to do this.” Everybody took voluntary wage cuts and they worked together. And within about 15 years, they were doing – going from 300 to about 12,000 employees. The CEO who was their at TEMBEC said that based on the employee engagement, he knew that he could go into any bidding competition and he had a 17% cost advantage. A 17% margin that did not exist in any of the other companies. And so, even though industry as a whole was profitable, by virtue of employees working together in an engaged way, in an intelligent way, they were able to generate a profit margin with an extra 17% of savings.
Josh: Interesting. What kind of things did they do to help with employee engagement?
John: Well, employee engagement generally comes from—there’s three critical driving factors and we know for sure that simply incentives can be a bad thing. So, simply walking into a company and doubling their wages – everybody’s wages tomorrow does nothing for profitability. All it does is generate some sense of entitlement and when you try to take it back, or you don’t pay the incentive this year—in many companies, there’s been reported stories where they were not able to pay the bonus. And because the employees did not understand the financial picture, they assumed that somebody was essentially stealing their money and they felt very upset.
So, by themselves, in isolation, none of these things work. They have to work together. The first step is financial education. Financial education is also referred to as open-book management. I don’t really particularly like open-book management because it’s not as descriptive as what you actually need to do. I think what you need to do is financial education about the drivers of the business and why the person is there. And so, that person has a good understanding of their impact on the company. That’s step number one.
Step number two, I think they do have to be incentivized but the incentive has to be rational and the incentive has to be tied to the key drivers of profit and the person’s productivity at production. That could be a team or a department or an individual, depending on the situation.
And then the last thing is the employee equity piece. I know, in the United States, you have a very large—what’s called ESOPs (Employee Share Ownership Program). We don’t have the same types of legal structure in Canada. You have a ERISA and some interesting rules that we don’t have. But in Canada, we can get to the same end result just using different tools. But if you look at the ESOP structure—Bo Burlington just wrote a book in the last couple of weeks called Finish Big and it’s a great book but littered throughout that book is the term open-book, ESOP and engagement.
So to wrap this up, the three things – when you financially educate and you have to treat people well. I mean, that’s very important. Trust is a very important factor. You have to be trustworthy and you have to understand. And really, that just comes down to simple common decency. There’s not rocket science there. We just don’t yell and scream at people. I mean, that’s a pretty simply formula. Treat them decently, the way that you would want to be treated, and educate them financially so they understand what’s going on in the business and cut them in for a share of the profit. And if you do that, over time, that has shown that that can produce very good results.
Josh: When you go into an engagement with somebody, what is it that you actually do? How do you approach a succession engagement?
John: Well, the first thing we have to do is we have to get a valuation of the company. That establishes a benchmark of where we’re at and where we want to go because we need a yardstick so that we can show some demonstrable results. Then I’ll try to determine, with the business owner, what’s the value gap. And so, what the value gap is a term I picked up from John Leonetti. The value gap is looking at the owner’s net worth outside of the business plus the transferable value of their business and measuring that against the cost of retirement. There’s all kinds of retirement calculators out there in the internet so it’s fairly easy to forecast what 30 years of retirement is going to cost based on if you’re spending 40,000 a year or a 100,000 a year. And then you look at what you actually have – what you can get from your business. If there’s no value gap and they can sell and satisfy what they want then what I tell them is, “Listen, you need a broker not a book or not an assignment. If you can sell and get what you want then by all means do that. But if you can’t, then here’s another avenue in working with your employees.”
So now, once we have our valuation, once we know our value gap, then we have to start looking at what are the key drivers and reviewing that and who’s the team and how do we supplement the team and start building a forecast of where we think we can get to. Can we expand? Is there another line of business that we can do? If we’re doing air conditioning, can we start to do something else? Could we use our skills and build up the business?
Here’s that key and critical difference, unlike a lot of books you would read where you want to go and make a bazillion dollars like Facebook or something like that, in my business, my only goal is to increase the value of the business enough to satisfy the value gap and the interest of the participants. Once we’ve done that, my job is done. I’m not saying to stop, you can keep going if you want. But I’m only satisfying the lifestyle requirements, always increasing the value enough to keep everybody happy and meet that value gap.
Josh: What kind of players should be on this team?
John: Usually, what I do is, I act as a—I don’t know what’s the term, as facilitator or quarterback or what you want to say but I work with the client’s existing advisors. If they already have an accountant and a lawyer then as much of the work that can be done and the assignment, I have and as much as the work of the accountant wants to do. If they feel that they understand the tax, they can do the tax planning. If they don’t feel they understand tax, they can do the accounting and we’ll arrange it so it kind of is fluid. Obviously, you need the accountant and the lawyer involved. You need somebody to do the valuation and you need somebody that understands the process of succession.
As I said earlier, succession is an emerging profession. So that is, I refer to myself as a succession professional but in the context of that emerging profession, that’s what my role is, it’s to make sure that all of the players are there.
Josh: What do you think keeps people from doing this?
John: To me, it seems very, very obvious. What keeps people from doing this is the fact that nobody is sitting down and explaining to them a solution that they can go “I get that. That makes sense.” Most of the people that claim to understand succession planning again are using for marketing purposes. And really when you unbundle it, well what do you mean by succession planning? Well, succession planning really is this really large insurance policy you should be buying or it’s this tax plan you should be buying. And when they get those kinds of answers it just doesn’t resonate. They don’t know why it’s not right because they don’t have enough background but they know it’s just not going to solve the problem they have. There is no other option so they procrastinate.
Josh: Cool. So John, if somebody wants to work with you how would they find you?
John: Well, I’m in Southwestern Ontario. I’m a Canadian. They can go and find my book which is at www.hireyourbuyer.com or they can phone me at 519-973-1223.
Josh: Super. I really appreciate you spending some time with us today. Your information is really good.
If you’re thinking about selling your business when you’re having a hard time doing so, you really should think about hiring your buyer. It’s an awfully satisfying way of going.
Thanks, John. I appreciate your time today.
John: Okay. Thank you.
Josh: You’ve been listening to Sustainable Radio Podcast where we talk about what you need to do with your business if it was to be here 100 years from now. If you like what you heard and want more information, please contact me at 802‑846‑1264 ext 2 or visit us on our website at www.stage2planning.com or you can send me an e-mail at firstname.lastname@example.org.
This is Josh Patrick. Thanks for listening. I hope to see you soon for another edition of The Sustainable Business.
Securities and investment advisory services are offered through NFP Advisory Services, LLC – member of FINRA/SIPC. NFP Advisory Services, LLC is not affiliated with Stage2Planning Partners.