- What does it mean to grow your business with an exit in mind?
- What drives the value of your business?
- What is a value creation mindset?
Why is exit planning a good business strategy?
Recently, I coined Velorum’s tagline as “Grow Your Business With and Exit In Mind”, so I wanted to take some time to explain what this really means. For many business owners, the thought of exit planning is analogous to a trip to the dentist. It’s very easy to find a reason to defer doing it until one day, the owner wakes up and realizes it’s time to sell. For some, the business may be sellable but will neither fetch an optimal multiple nor will it sell fast. For others, the business has no tangible separation between the owner and the intangible assets of the business, and thus transferring the business may be a difficult task. Either of these situations is a shame since so much of the owner’s wealth is tied up in the business, so not adequately planning how to harvest this wealth can result in significant shortfalls when it comes to the owner’s retirement pool of funds. Velorum’s tagline refers to the notion that the preferred business strategy for an owner to undertake when running their business embraces a holistic approach incorporating both growth and exit planning components.
Good business strategy incorporates both growth (using value-creation principles) and a plan to exit. In many ways, a business owner is like a farmer who has to buy the seed and till the soil in the spring (planning), nurturing the crops throughout the summer (growth), then harvesting the crops when they are mature in the fall (business succession). A failure to adequately manage any of these three stages will significantly limit the amount of crop harvested in the fall. Similarly, a prudent business owner needs to incorporate each of planning, growth, and business succession into a comprehensive business strategy.
Every business has specific characteristics which help to drive its valuation. These characteristics are called value drivers. Some value-drivers such as recurring and predictable revenue are universally applicable in nature while others are specific to an individual business. Growing the value of your business requires an owner to understand the value-drivers of the business, then executing a strategy to continuously monitor and improve them.
Value-drivers fall into two types of categories: those that promote growth and those that de-risk a business. Both are important to consider although the execution of them is quite different. To many owners, the initial thought of growth is more exciting than de-risking a business, but the latter can play a role in making the business more efficient while avoiding catastrophic losses.
Value Creation Mindset
A value creation mindset focuses on the right type of growth: sustainable, repeatable, and transferrable. Sustainable growth implies that new revenues are cash flow positive (and exceeding a certain hurdle rate of return) rather than being margin destroying in nature. Repeatable signifies that revenue is not comprised of “one-off” projects where revenue will disappear but rather driven through contracts where revenues are locked-in through annual or month-to-month subscriptions. Lastly, transferrable revenues are those that are separated from the existence of the owner. In other words, even if the owner takes a step back from the business, the engine of the business itself continues to run.
The advantages of a value creation mindset are numerous:
- The owner can take more time to think strategically about the business…or go fishing;
- It’s more fun to manage a growing business than a stagnant one;
The multiplier effect of increased EBITDA along with an improved multiple can substantially increase valuation.
Why Exit Planning Is Good Business Strategy
Running a business requires you to strategize and plan. You need to plan out sales, customer demand, cash flow, procurement, along with many other aspects of the business. An exit strategy is also an important goal since a substantial amount of your wealth is tied up within the business and due to the complexities of selling one, it is a process that can take years not days or weeks. Making business improvements takes time both from a perspective of ensuring these improvements are creating lasting value along with taking time to tackle each of the numerous elements on the to-do list. It is much better to address a few things each quarter rather than trying to tackle every element on the to-do list all at once, which is likely going to only end in failure and frustration.
Is it ever too early to put together an exit strategy? Even if you are ten years away from a possible exit, putting together an exit strategy now can help improve a business over time while keeping your business “exit-ready” in cases where an unsolicited offer is made on your business, or when life circumstances force an acceleration of your exit through personal or family matters. Yes, the business may be your “baby” but in the end , it is actually a valuable financial asset that needs proper cultivation. At the end of the day, every business owner will have to exit their business; however, the relevant question is will it happen smoothly or under adverse conditions?