by Bill McBean
As far as product is concerned, however, there is an important difference between Levels 3 and 4. At Level 3, your business and its products were offensive in nature, trying to punch a hole in the market big enough to allow your business to succeed. At Level 4, though, your product is both a weapon and an asset that needs protection, especially in the war zone, where you have to protect the market share you have already won. And this isn’t something over which you have a choice—it’s your reality. Every one of your competitors wants what you have, and you have no choice but to defend your position in the market. Actually, the stronger and more aggressive your attack on the market is at Level 4, the easier it will be to defend your product lineup. That’s because if your competitors are busy reacting to what you’re doing in the market, they can’t be thinking about how they are going to attack your customers and market share.
To be honest, though, defending—and increasing—your market share is not easy to do, and it can’t be done without understanding the effect your increased sales will have on your overall business. In fact, making an aggressive effort to maintain success is more of a balancing act than anything else. That is, by Level 4 you will have realized that business decisions have consequences, and little happens in isolation, all of which has to be taken into consideration. For example, being aggressive will mean your war zone strategy will have to be rethought because you’re going for more sales. That means more money will have to be spent on marketing and inventory. It also means you will have to ramp up expectations of your staff, possibly even add people and then train them, to meet the increased demand for your product. That, in turn, means you will have to have more or at least improved controls, and that accounting and finance will have to make sure the proper information is flowing in and out so you and your managers can monitor important variables like gross profit margins on your product lineup, mix of business, cash flow, and others.
People at Level 4
At this level, there are some serious owner–employee issues you have to be concerned with. Until success has been achieved, it is essentially you who are leading the charge and making sure your employees are operating the processes the way you want them to and with the results you expect. But even before you get to Level 4, you can no longer risk the business being entirely dependent on you, and for three very good reasons. First, you can burn out and, despite your best intentions, start leading the business on a downward slide. Second, if you were to suffer a serious injury or worse, the business would lose its only leader. And third, if you choose to micromanage your company, you are likely to retard its growth because if everything has to go through you, everyone else has to wait for your decision before moving ahead. The answer to this problem is to develop and educate key staff members so their collective knowledge and talents can be focused on maintaining success. Basically, this means you have to remove yourself from any day-to-day operations, which is something some owners are reluctant to do. Nevertheless, if you want to maintain the success you’ve worked so hard to achieve, it is necessary.
The first step, of course, is to select appropriate employees to take over your responsibilities. This is usually not particularly difficult because by now you will have developed a very good sense of your key employees’ abilities, as well as their ambitions. The difficult part, in fact, is molding these key employees to work as a team and get them to understand what you have learned—that a successful business depends on a number of business principles operating in unison. Perhaps the best way of doing this is to widen their perspective of the business by concentrating on teaching them about how the various parts of the business operate and interact with each other rather than focusing on their own departments. While it is possible for egos and/or attitudes to get in the way of this process, it is essential that you, as the owner, be prepared to take swift and decisive action if they do. Eventually, your employees will figure out that they need each other’s wisdom to grow their departments, solve problems, and help move the business forward, and the result will be continued success for everyone involved.
Accounting and Finance
As I’ve already noted, the vast majority of owners would not list accounting and finance as one of their business strengths. However, after a couple of “rude” and expensive surprises and lessons learned, they begin to realize the value of financial analyses and the proactive power they give company. They realize, for example, that such analyses can protect them from making bad decisions based on wrong information and assumptions, or alert them to problems that need attention before they become crises. Accounting and finance can also help an owner fine-tune the business by proactively controlling expenses, working on inventory turns, identifying which products are hurting the business’s overall gross profit margins, and generally providing the owner with “what-could-be” scenarios if he or she did this or that. At the same time, though, even having this kind of important information will be of little value to an owner who has limited overall business knowledge, simply because he or she won’t know what to do with it.
All successful owners, depending on their experience and business knowledge, have certain “key” ratios, asset or liability balances they look for, or industry standards they measure themselves against. It’s these warning signs and measurements, used skillfully, that can make the difference between a good business and a continuously great one. Benchmarking, for example, is a great way for owners to measure their business performance as it is usually a summation of their industry’s best practices. In fact, for owners who benchmark and drive their businesses toward these key measurements, owning a great business may only be a matter of time and talent. What is perhaps most important is knowing what needs to be measured and what the measurements mean. And, again, unless you have a good understanding of business in general, you will not be able to do that.
In addition, sharing your knowledge of business with key employees and exposing them to accounting and finance is a great way to teach them how their departments work in conjunction with all the other departments, and how the success of one department helps the overall business achieve its goals. For example, by sharing how your managers’ departments are measured by the company’s balance sheet and profit-and-loss statement, you not only increase their knowledge, you show them how you are judging and grading them as well. Teaching your key staff members how everything in business is related changes their paradigms about the business, and generates efficiencies within departments that move the business closer to the benchmarks, positively affects the bottom line, and helps maintain success.
You at Level 4
One of the things that happens at Level 4 when you start letting your employees take on more responsibility for the company is that you begin to see yourself and your life as separate from the business. For the first time, in fact, you realize that your personal goals and the company’s goals can be separated, and that’s when you begin thinking about how you will exit the business. This is not to suggest, of course, that it isn’t something you won’t have thought about before. Rather, it’s at this point that it starts to take on a reality it never had in the past, and it’s now that your paradigm begins to change. That is, you begin to wonder how much your business would be worth if you sold it, or what you might need to do to make it easier for a successor to take it over. You are also likely to feel a greater urgency to increase both sales and profits, as well as look for other ways to add value to your business to make it more attractive to possible buyers or successors. Eventually, this change of paradigm leads you to define a new destination for the business, that is, new objectives and goals, as well as a new idea of what maintaining success means.
You may decide, when you first start thinking along these lines, that you’re not ready to exit the business yet. Even so, it won’t stop you from wondering what could be, or from focusing more carefully on how your business operates and how it generates its profits. In other words, you will begin to realize what happens from one year to the next has
a new and different meaning than it did before. However, if your understanding of business is limited at this point, your ability to exit the business successfully will also be limited. You will not, for example, be able to identify who your best buyer is, point out the upside potential of the business to a buyer, or increase profits in order to maximize your payout. You also may not be able to choose the most appropriate successor or give that successor the best possible chance of success. In other words, as in virtually everything you do in business, the more you know about business in general, the better off you will be.
Level 5: Moving On When It’s Time to Go
On one level, the decision to exit your business may seem fairly simple—you have to decide if the reasons to stay outweigh the reasons to go. Unfortunately—and perhaps not surprisingly—this is not as simple as it seems. In fact, as I’ve already discussed, there are a great number of issues you have to take into account when you’re thinking about moving on. Some of those issues are of a more personal nature, but from a business point of view there is perhaps nothing more important than the question of valuing your business. And, perhaps also not surprisingly, the greater your understanding of business, the easier that valuation will be.
In determining the value of your company there are essentially two questions you must ask. The first is “how much is the business worth now?” As I’ve already discussed, there are three elements that have to be taken into consideration in valuing a business—assets, real estate, and goodwill. Adding these three figures together will give you, as close as possible, the amount of money your business is worth at the moment, which is the figure you will take into account in devising an asking price when you offer the company for sale. The second question you must ask is “how much will it be worth at some specific point in the future?” Determining this figure is considerably more difficult. The reason for this is that there are many more things that have to be taken into consideration. And this is where your general knowledge of business—or lack of it—comes into play. In order to calculate the future value of your company, you must consider the strength of the market today and in the future, how much your employees and processes are likely to improve over time, and how this will affect profits; and demonstrate through the profit-and-loss statement exactly how these positive changes will affect future profits. Beyond this, however, you should also take into consideration such items as the strength of your competition going forward, that is, their performance in the war zone; the life of your products (marketing); possible changes in the industry (leadership); maximizing the business’s assets (asset protection); and others. The point is that determining a business’s future value is not as easy as it might appear to be, and to do it well it’s important that you have a broad understanding of the various aspects of business.
Being able to accurately value your company is not the only advantage of knowing business at Level 5, and some of the additional advantages are discussed later. What is ironic about all this, however, is that the more you know about business, the more complicated the exit decision becomes, but also the more likely you are to make the right choice. Conversely, the less you know about business, the easier the decision-making process will be, and the more it will be based on erroneous assumptions, unsubstantiated claims, and emotion, which is obviously not the way to attract serious buyers.
The Benefits of Knowing Business at Level 5
Knowing business enables you to more accurately value your business today and in the future.
Knowing business helps you use valuation as a “compass” by which you can determine the best direction to move your company in order to realize its maximum exit value.
Knowing business shows you the importance of facing the inevitable, and gives you the time you need to set the business up for maximum payout, to create the best possible situation for your successor, or to close it down.
Knowing business enables you to develop an appreciation of the many business concepts the exit decision entails.
Knowing business helps you understand your exit decision is about business and not just about what you want and need.
Product at Level 5
If you don’t know all the Facts of Business Life at this level, you will be severely limited in your understanding of the value of your product, that is, your business. And if you are, you will be handicapped in determining, creating, and explaining its optimal value to any potential buyer, whether you decide on an asset or a share sale. In fact, it could mean that your buyer will have a better understanding of the value of your business than you do, and that is not a position you want to be in. But it’s a position a buyer would love to be in because he or she would then be given the opportunity to possibly “steal” your business. In business, knowledge is king, and not least of all when you are exiting it.
When you are selling your business as a product, the more you understand about business, your product, and your buyer, the easier it is to explain and justify the price. For example, if you can tell a prospective buyer about future opportunities and how your employees are trained to take advantage of these opportunities, and tie it into expected future profits, you can make a compelling argument that adds value to your business. Similarly, if you can explain to a competitor who is considering buying your business how the economies of scale will lower the overall costs of both businesses, and the profit windfall this could create, you are much more likely to get the optimal price for your company.
Having a good understanding of business is important if you choose to pass your company to a family member as well. Not only will it help you determine the best candidate to take over, if you pass along not only the company but also your understanding of business, you will be doing all you can to ensure his or her success. Bear in mind, too, that when there is a successor, the “fair value” of the business can become a family issue, especially if the successor becomes the owner. Others in the family will have to be convinced that their payouts are adequate compensation for their loss of the benefits and income from the business. In addition, the more you know about business—including issues like taxation, asset protection, and prospects for the future—the smoother the transition will be for you, your family, and the business.
Finally, if you choose to close your business down, you must remember that your business assets have value and should accordingly be sold for as much as possible. For example, your business’s customers can have value to some of your competitors, so knowing who these competitors are and who would pay the most for this asset is obviously important. Similarly, if your business has been around for a while, your company’s brand name may have value. In addition, knowing accounting and the difference between book value and market or replacement value can mean more money in your pocket. The point is that just because you’re closing down your business doesn’t mean the business assets don’t have value, and the more you know about business the easier it is to determine which of those assets have value, what that value is, and who would pay the most.
People at Level 5
One of the basic facts of business is that successful businesses are invariably built on the relationship between a company and its customers. Most successful owners realize this, and when they can show prospective buyers their employees have good relationships with their customers it increases the good will or blue sky value of their companies. If, for example, when selling your business you can give the buyer confidence that it will continue to run as it has in the past, even without you, the higher your payout is likely to be. However, if you don’t show a buyer that you understand the importance of people and processes in operating the business, it will likely be viewed as a flaw and probably result in a lower price being offered. Similarly, if your employees are poorly trained and exhibit unprofessional attitudes, a prospective buyer is likely to pick it up quickly, and to take it into consideration in making an offer, to your detriment. The point, of course, is that the more you know about business, and the more you make sure your
people act the way they should to foster success, the more likely you are to realize the greatest amount possible from the sale of the company.
Your employees also play a critical role when succession is involved. No successor wants to lose good employees, their knowledge of how the business operates, or the relationships they have with customers. The best way you can avoid this is to do all you can to make sure the employees do not feel threatened by the change and to make your successor understand the importance of upholding the companies DNA. It is also essential that you give your successor the room to develop his or her own relationship with the key employees as well as with the rest of the staff, and not cast too large a shadow.
Finally, if you choose to close down your company, even though your employees will no longer have any business value to you, they will have value to the companies you used to compete against. Helping them find new places to work, and explaining their value to one of your former competitors will not help your business, but it’s the right thing to do, and it’s a gesture your employees will always appreciate, however things work out in the future.
Accounting and Finance at Level 5
Accounting and finance has a unique place at virtually all five levels of a company’s life. From the creation of pro forma financial statements showing the cash needed and potential profits at Level 1, to providing support for your business’s growth at Level 3, to helping you maintain success by alerting you to threats and opportunities at Level 4, to moving onto center stage as you begin developing and implementing your exit plan at Level 5, it is the one department that can tie all the business functions together. In addition, accounting and finance can describe and demonstrate how processes operate the business, how they work, and how they are controlled. What all of this means is that it is in a unique position to not only tell the story of the business’s success but also to back it up with facts. And facts are what’s needed whenever an owner exits because they help justify the value of the business to the buyer, to the owner’s family if succession is chosen, and to whoever may buy the company’s assets if it closes down.
