Setting up your business for successful harvesting
Gerrie van der Merwe, Lecturer, School of Financial Planning
Joe, 67, stares at the computer screen without taking anything in. It is 5:30pm, and he is trying to catch up on some work. The last couple of years have been hard, and he is no longer excited about running his own business. He remembers how the future used to seem full of promise, and how he built a successful enterprise through hard work. The business provided enough income to take care of his family, and he always managed to get all the work done on his own. There seemed to be no need for a partner, and he preferred making decisions on his own. Now, however, he is steadily losing clients because he cannot keep up with the workload. He put the business on the market for a fair price a couple of years ago, but interested buyers just could not obtain the required financing. In the meantime, the value of the business has declined to such an extent that, even if he could find a buyer with capital, it would not be enough to fund his retirement. He wishes that he could go back and do a few things differently, as he would prefer to spend more time with his loved ones at this stage of his life.
This story is typical of many South African SME’s (Small and Medium Enterprises), whose founders make immense sacrifices to build strong, profitable businesses, yet fail to put realistic exit strategies in place. They enjoy running the business and do not like the idea of relinquishing control. Thus, the business relies on input from a dominant personality, but at the cost of excluding potential buyers who do not possess the same attributes as the founder. The result is that, although the businesses are profitable, there is little scope to exit the business as the life stage of the founder changes and, as such, the value created in the business is lost, as it is not packaged in a way facilitates a sale.
In this article, three building blocks of setting a business up for harvesting (selling) are introduced. These building blocks can increase the realisable value of your business while attracting and retaining talented staff.
The first building block is to set up a process system for every action that takes place in the business. You have to document every process and standardise the way each business action is performed. The simpler this system is, the better; and it can be done with any tool – from a basic word document to a digital enterprise management system with dashboards. Whatever route you follow, it is important that the founder keeps control of the processes, and ensures that employees can understand it easily. The systems should focus on achieving uniform service delivery, regardless of which employee the client deals with. Fast food franchises are a good example of businesses with good process systems, where service delivery is generally within the parameters that a client expects. Regardless of which person the client deals with, a client can generally expect to receive products of the same quality, delivered in the same way.
Perhaps you are thinking that the nature of a fast food business is particularly suited to a process system; however, the same principles can be employed successfully in most businesses. These types of systems have been successfully implemented in businesses as diverse as accounting practices, construction companies, small accommodation establishments and retail stores. Whether the founder is aware of it or not, the processes already exist, as every business has a certain way of doing things. It may be embedded in the culture of the company, transferred in training, or it may exist solely in the mind of the founder. The challenge for the owner is then to transfer that knowledge to the employees in the form of a system and to develop it further in order to ensure that the needs of the employees, customers and the owner are met. There are numerous benefits to creating such a process system: it can improve client satisfaction, free up time for the owner, make the business more attractive for prospective purchasers and create certainty and confidence among personnel. In the context of setting a business up for harvesting, it facilitates the operational transfer from the founder to a new purchase.
The second block is to identify potential partners from the current employee pool that can eventually take over the business from the founder. This will not be relevant to every business exit strategy, and in some cases the only available purchaser will be an outsider. Still, it is one of the easiest ways of selling a business, particularly as the phased approach, which is outlined below, overcomes funding issues.
According to the phased approach, the founder should search for competent individuals that share the values of the founder and are interested in running their own business. The founder makes small portions of ownership (shares, member interest or other) available for purchase to the prospective partners. The purchase can be structured with a loan account, and new partners can repay the loan by using profit distributions that they now receive as owners.
A good approach is to search for individuals from different generations. In a typical SME, this could take the form of three partners: the senior partner, a middle-aged partner and a junior partner. As the senior partner gets closer to exiting the business, more ownership is made available for sale to the younger partners, thus allowing a natural phased handover of the business. An added benefit is that the business stays relevant to all generations of clients, as multiple perspectives are represented in its ownership structures. It also aligns the goals of all the partners, and older partners are motivated to transfer their skills to younger ones in order to ensure that the business remains profitable and loan repayments continue.
The third building block is a buy and sell agreement. In financial planning circles, buy and sell agreements are often considered synonymous with the life and disability policies that fund a buy-out in the case of the untimely death or disability of one of the partners. The policies are an important risk-mitigating measure to ensure business continuity, but the agreement itself should also consider aspects such as repayment conditions on loans, the envisaged timeline for sale of ownership and methods of determining the value of the business. A transparent and objective buy and sell agreement strengthens the relationship between partners, and ensures that they all work together for the common good and success of the business. It creates an orderly transition of ownership, which enables partners to realise the value of the effort that has gone into growing the business.
The founder can use these three building blocks to build a more sustainable business, which is attractive to new purchasers and rewards them for the effort that went into creating the business. Some may be reluctant to embrace these concepts for fear that the excitement of running the business on a day-to-day basis may be lost; however, once they start working on their exit strategy, they should find that the new challenge of enterprise building invigorates them and creates excitement for the next phase of their lives. As the saying goes; “A change is a good as a holiday.”
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15 Oct 2020