Succession and exit remains one of the leading issues we are asked to advise on at Beaton Capital. What is my firm worth, my staff can’t afford to buy me out, how do I prepare for a third party sale are just some of the questions that follow this common theme. Here’s where to start…
I recently spoke at a conference for specialist and boutique executive search firms. Many of the business owners were facing similar ownership issues:
- how to transition leadership and client relationships to the next generation so as to preserve the sustainability of the business; and
- how to sell down shares in the business at a price that is fair to both seller and buyer – and be affordable?
The valuation of a professional services business rests on two key variables; sustainable profit (or revenue, as in the case of the search industry) and a capitalisation multiple. Whilst ‘profit’ (or ‘revenue’) can (often be) be a fairly clear cut number (we can audit historic numbers and investigate forecasts), what makes profit sustainable and believable is much less clear cut – and it is this that impacts the size of the multiple.
Operational succession – yes or no?
A key question is: Can the level of revenue and profit remain at current levels and ideally grow if you, the owner, sell out or step back? If yes, then you have managed operational succession well and so you can be entitled to financial succession (i.e. a financial exit). Put simply, this involves transitioning leadership and client relations away from you to those following in your footsteps. One of the tests is that your clients readily accept your replacement and stop calling you direct.
Invest time and money in succession
Too often founders of firms struggle to transition their leadership and relationships to those coming through because they have not invested time and money into succession, for example they have not recruited well enough, or their ego remains a barrier (a symptom of this is that they can’t retain good recruits), or both. If you can’t prove you have achieved operational succession you can’t expect a top end multiple and hence price for your business.
Price does not equal value
The other pressing issue is price. Ordinarily third party buyers will be acquiring for strategic reasons and will see value in many ways, for example the target firm may be a specialist in a sector or geography that the acquirer is seeking to enter. This rationale will usually increase the multiple paid. But how do you price for a sell down to the staff? All too often we see founders using independent valuations as the price to sell down to staff, but these valuations are often based on a third party sale. The result is that they are ‘fully priced’ since they are based on a market multiple – the upshot is that there is no upside to the employee buyer other than incremental profit growth. We would argue that an owner selling down to staff should leave a meaningful portion of multiple growth on the table, so the employee shareholder can see growth there too.
Meaningful dividend yield too
Staff employees should also be able to earn an attractive dividend yield relative to other forms of return – this too impacts the share price (i.e. downwards). This may be a tough call for many business owners who want to maximise their valuation on exit – and as they say the market price is that determined by a willing buyer and willing seller.
Maximising exit value
The bottom line for a founder is that if you want to maximise your exit value you must achieve operational succession, to do this you may have to sell down some of your equity at a price less than a third party exit price (call this an investment), you will have to put in time away from revenue generation to transition leadership and make your firm fit for sale, and then you need to find the right third party buyer that puts a premium on your expertise and market standing. There are plenty of examples of where this win-win-win scenario has been achieved.
Other related blogs and thought leadership from Beaton Capital can be found here:
- Valuation and price are not equal
- Selling the firm – does size matter?
- 20 questions to test your resolve: do you really want to sell your firm?
- Takeaways from a recent sell mandate – points to consider when it comes to selling your firm
This post was written by Warren Riddell of beaton. Warren’s details can be found at LinkedIn.
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