michaellileyblog

My primary experience has been in senior corporate businesses in financial services, IT and Telcos, as well as marketing, PR and advertising, in Europe, Asia and Australasia. Over the last five years or so I have applied what I learnt in corporate life to increasing the value of a variety of small to medium sized SMEs. With these sorts of businesses, there is a distinct pattern to their growth, often to the detriment to long term value creation in the businesses.

From our experience, it is always possible to influence the value of SME businesses by taking several relative simple steps. This article is designed to outline what these simple steps are and how to use them to optimize your business value. It is vital however, that action is taken well before you plan to sell the business, and your business is usually worth more than you think. In any case, it is ALWAYS sensible to run your business for optimum value as you don’t know what is just around the corner, and in any case it is good business practice.

First, why does one business buy another business? The reasons are many and varied, and it is not only about P&L, although that usually is very important. Other reasons may be:

to buy your expertise;
to buy your management;
to take out a competitor;
to acquire competitive advantage;
to acquire additional clients;
to acquire IP;
to acquire your cash flow;
your business complements and adds to their own;
your distribution; and
your technology.

All businesses have a pattern of development which allows them to stay in business in the long term, but they are not necessarily positioned in a way which optimizes their value. In fact, in my experience they usually are not. From our experience, to optimize business value in the medium term, businesses need to have the following characteristics:

be sustainable;
have quality management;
be internationally competitive;
have a professionally put together strategic plan from which they can demonstrate consistent growth and profitability;
have end-to-end process design; and
have a professional management team.

Critical to this is this whole concept of “sustainability”. By this we me sustainability not in the environmental sense, but in the continuity of your business model and it ability to be self-sustaining. We talk about the “Bahamas Beach Test” by which we mean that you as the entrepreneur who invented the business and nurtured it, have to be able to spend three months sitting on the Bahamas Beach and the business will still grow and prosper, clients will still be happy, and it will still make money.

The critical transition for a business is when it decides to transition from essentially its entrepreneurial stage to it professionally managed corporate stage. This is a critical transitional process if the business is to be worth more than one or two times earnings, but it is one of the most difficult transitions for any business to undertake, and often requires specialised help to bring it off successfully. The “Entrepreneurial Stage” is usually characterised by chaotic, unplanned growth, few processes and systems, reactive to the market, and the business is essentially non strategically managed, BUT, and it is a big “but”, the business has something which makes customers keep on coming through the door and usually makes money. It could be however, so much more profitable and efficient, and will be after it goes through the transition.

Once through the transition, it enters the Corporate stage, which is characterised by strategic management, planned growth around a strategic plan, well developed processes and systems, heavy external market focus, international in outlook and ambition. In this process of transition though, there are several critical mindset changes required of the entrepreneur and well as the staff. In the entrepreneurial stage, most of the operating is done by him/her, and often there is a reluctance to “let go” of the reigns of operation. Often it is because “no-one can do it as well as me” which in turn is related to the fact that the entrepreneur often enjoys the operations/client side of the business.

However, the facts are is that if the business is to be systematised, and therefore scalable, the leader i.e. the entrepreneur, needs to change from being the operator to being the leader, strategist and coach. This is often the single biggest challenge in transitioning the business. An alternative to this, is the entrepreneur beings in a General Manager/CEO to look after the running of the business and the transition of the business to the corporate state, freeing the entrepreneur up to do possibly what he/she does best i.e. harnessing the networks which have allowed the business to operate successfully in the first place. I have seen this operate successfully where the entrepreneur takes up an Executive Chairman position, but the day to day operations are in the hands of the designated CEO, usually with much greater corporate general management skills than the original entrepreneur.

So how in practical terms is this transition brought about? It usually starts with a professionally written strategic plan based on extensive research with all stakeholder of the business: clients, staff, suppliers, associates. After the plan is debated by senior management, and possibly by the Board (if applicable) and it is agreed, then a financial model often based on pessimistic, realistic and optimistic growth assumptions, and centred on the core strategies in the Strategic Plan.

Once the Strategic Plan and the financial target embedded in the financial model is accepted, then it is time to implement the plan. Unfortunately too often at this point the entrepreneurs cease the transition, sometimes for good reasons. Some of these are:

the perceived risks, financial and operational, are too great;
the entrepreneur fundamentally does not want to let go of the reigns of the business, and outsource is day to day operations to someone else;
the business does not know how to manage growth and the additional resources that this brings

This fundamentally amounts to in a sense a fear of the unknown, particularly how the business can be professionally managed without “breaking the bank”. Several organisations, including our own, are now offering a shared management service which allows SME’s going through this phase to hire a professional management team to implement their strategic plan but at a fraction of the cost it would take for the business to hire them itself, This is because the team operates in several businesses at once, thereby very considerably reducing the cost of the management compared to what it would be on a full time basis.

Usually this phase of the process takes 6-12 months in which time the business as it grows. The next step is to consider how the business might be sold if that is what the owner’s ultimate goal is. The first thing to say about this is that the earlier the action to optimise value, the better the end the result is, but the process is also important. Let’s say the entrepreneur wants to sell the business in 3-5 years. To optimize its value the process needs to be started now. So what is the process?

First, possible acquirers need to be identified and an understanding reached as to why they would be interest in the business. Secondly, find out what makes them attracted to the business, and what additional things would they like to see in the business to make it even more valuable for them. There then follows a process where these features are then embodied in the business model provided they do not compromise the overall business value.

Then when the owner decides to sell, your approach the potential buyers, declare the business on the market, and try to set up a bidding match much like selling a house. It creates considerable value to the owner.

If these processes are followed, our experience is that rather than selling a business for one or two times earnings, it can be as much as five or ten times earnings, depending on the type of business it is.

This is not a zero sum game. Amazing value can be created if the business owner acts early and strategically.

michael.liley@transparadigm.net