No one puts their home on the market overnight and expects to get top dollar. That’s because the personality and comforts you’ve infused into your home may not appeal to potential buyers. The same logic applies to your business. The systems and processes in place in your business may work perfectly well for you – or perhaps only because of you – but that’s not what’s going to drive value when you’re looking to exit.
Over time, it’s easy to overlook small inefficiencies in your operation or tactical upgrades that could boost the business value. After all, if it’s not broke, why invest? Of course, that logic starts to break down once an exit is in view and that the importance of seizing on opportunities to add incremental value to the business become clear. Without enough runway, options narrow. Buyer interest weakens. Valuations can fall short of expectations, which can force difficult trade-offs in retirement or estate plans.
If you’re looking to maximize value, trying to cover up any blemishes at the last year or two before your exit just won’t cut it. “Put yourself in the buyer’s shoes,” says John Paniccia, Vice-President and National Director of Business Advisory & Succession Planning at BMO Private Wealth. “If the business is completely reliant on you as the owner to generate future cash flows based on your relationships, and I’m stepping in as the buyer, what exactly am I buying?”
The question is becoming more urgent for Canadian small business owners. An estimated 76% are expected to exit or retire over the next decade, with more than $2 trillion in assets set to change hands. Yet, just one in 10 has a formal succession plan in place.
That can leave little time to strengthen the business in ways that buyers value most, says Paniccia. Building towards a successful transition takes strategy and sustained attention over time. “It’s a process, not an event,” he explains. “You don’t want some unforeseen circumstance like death or illness to drive the transaction, because then your options are limited if you haven’t prepared the business.”
What buyers are really paying for
A common misunderstanding Paniccia hears in succession-planning meetings with clients is around what they think their business is worth. The instinct is to take last year’s earnings and apply a multiple they believe is standard for their industry. That can work as a rough benchmark, but it isn’t how buyers approach a sale.
“Value is based on future cash flows, and specifically the risk of achieving future cash flows,” he explains. Buyers are paying for what a business will generate after the deal closes and how confident they are that those earnings will continue to roll in.
Viewed through that lens, reducing a business’s dependence on its owner is a critical part of succession planning. It means taking time to embed the relationships, knowledge and skills the founder carries into the business itself. As Paniccia puts it, there comes a time in your career to work on the business, not just in it. This will de-risk the business, increase commercially transferable goodwill yielding higher multiples, and also keep your exit options open no matter what type of transition you are contemplating, even family transitions.
Building value that survives a sale
The factors that drive business value before a sale are consistent, says Paniccia. Buyers are drawn to stable, predictable cash flow and strong performance against industry peers on growth and margins.
But they also reward the kinds of value that carry forward – brand strength, long-standing customer relationships, documented systems and proprietary technology. Equally important is having a management team able to deliver results without the founder at the centre of every decision. Putting all that in place takes time and, sometimes, the discipline to delay an exit if conditions aren’t right.
Paniccia recalls a chemical company that came to him after early offers had fallen well below expectations. “We took a detailed look at the business and had advised them that it would be a better idea if you take the company off the market, work on it over the next number of years and then sell it again.”
The owner agreed, spending the next few years diversifying management, documenting processes and bringing structure to operations that had previously lived only in the founder’s head. It eventually sold for more than double the offers from years earlier. The company took personal goodwill that lied with the owner making future cash flows risky for potential buyers and converted that to commercially transferrable goodwill the market was willing to pay for, says Paniccia.
De-risking the business for optimal outcomes
Digging in, stepping back and working “on” the business five to seven years before a sale provides a healthy runway to identify risks in the business and build value, though many owners, absorbed in day-to-day operations, find it difficult to create the time. “The problem is that many entrepreneurs aren’t wired that way. Many of them are the business and the business would falter in their absence.” says Paniccia. “Whether preparing for a third-party sale or an intergenerational transfer, the key is to build a business that can operate successfully in your absence – it’s important to look at key roles and the current team then decide where gaps need to be filled. This will ensure continuity of the business, transition of goodwill, and flexibility in exit options.”
BMO’s Chartered Business Valuators, part of the Business Advisory & Succession Planning team led by Paniccia, work closely with owners to pinpoint the true drivers of value. They help business owners identify how buyers would perceive the business, provide a transparent view of current risks in the business and future cash flows, and strategies to eliminate those risks that not only strengthen the business today but also pay a larger dividend in the future.
The best bid isn’t always the highest
The reward for putting in years of work isn’t only a higher number on the offer sheet. In Paniccia's experience, the highest bid fails to win the deal about a third of the time. Owners often consider other priorities, including protecting employees or preserving their legacy. Some are after a strategic partner who can keep building on what they started.
Early planning can also help to reduce costly misunderstandings and even personal conflict, especially in family-run businesses. Paniccia recalls an automotive group where two adult children each worked in different parts of the business. Their parent had assumed each child would take over the operation one day. But it became clear that one child had no intention of staying in the business at all.
“By having the right conversations, it really helped everyone clear the air in terms of what their expectations were,” he says.
Owners who start early are usually in a much stronger position when it comes time to sell or transition.
“We often ask clients, if you were to spend time away from the business what would happen to the business,” says Paniccia. “When we speak of working “on” the business versus solely “in” the business, according to individuals who have transitioned their businesses, this accounts for 80% of planning but is often initially overlooked. The key is to start early, years in advance of any sale or transition.”
