Planning Ahead for a Business Transition
Marion Van Keken-Rietkerk
Owning your own business is a dream for many people: to be your own boss, set your own hours, and reap the benefits of your hard work and dedication to your craft. Flexibility, financial rewards, and the opportunity to innovate and impact your community are just a few of the rewards business ownership provides.
Still, all good things must come to an end. The runway of life will require you to have an exit strategy and eventually transition the business to a new owner. Planning for a transition will help ensure you get paid for your hard work and help you get the most value for your business.
Exit strategies come in different shapes and sizes and should be planned and measured as carefully as any woodworking project. Will you be able to pass the business on to your children, employees, or will the successor be external? Each option will require different professionals to guide the process, like a family advisor, management buyout advisor, employee stock option specialist, or business broker.
Whichever way you decide to go, you’ll want to ensure you have optimized the business by ensuring the following value drivers:
- Financial performance: The business should have a history of producing revenue and profit and have good records.
- Growth potential: Is there room to grow, and what will it take to achieve that?
- Dependence: Is the business dependent on you or any particular employee, customer, or supplier? If so, diversify, cross-train, and generally ensure that business success can continue if any one of these falls away.
- Stable margins and cash flow: Ensure you manage your receivables and payables well.
- Recurring revenues: Can you pinpoint where future payments will come from?
- Dominate the market: Differentiate your business from the competition.
- Business contacts: Evaluate your relationships with other businesses and how you work together.
I’ll focus the rest of this article on the last of the three options as I’ve been helping business owners sell their businesses for the last twelve years.
Once you’ve maximized the value of your business, it’s time to get an independent valuation. A business broker can offer an opinion of value (BOV) and develop marketing materials to get your business on the market confidentially and target buyers. The BOV should reflect what the company earns, what the company owns, the present value of future earnings, and what the discretionary cash flow can support.
As a seller, you must be prepared with supporting materials for the broker to provide an objective opinion of value while ensuring they have everything necessary to manage due diligence that an intelligent buyer will undoubtedly dive into. Such due diligence isn’t just limited to the company’s financials but also includes operations, client lists, supplier info, HR, and marketing, to name just a few. The broker will know how to protect you from snooping competitors and ensure that confidential information is blacked out and that there’s a timely response to buyer’s requests.
Buyers should be prepared to sign a non-disclosure and sometimes a non-interference agreement before requesting information. They’ll also need to provide some background about their financial capacity, the reason for acquiring the business, and demonstrate a good fit. Remember it’s a two-way street. Don’t expect the seller to provide everything about their operation without knowing who they’re dealing with.
Business valuations and transactions are all based on three approaches: the income approach, the cost approach, and the market approach. There’s an income stream that’s assessed. The cost to recreate a similar business is considered, and we look at what similar businesses have sold for. Under these approaches, there are different valuation methodologies that sellers, buyers, and brokers use, and rules of thumb should be applied with caution.
The custom architectural woodwork and millwork industry (NAICS 337212) comprises establishments primarily engaged in manufacturing custom-designed interiors consisting of architectural woodwork and fixtures using wood, wood products, and plastics laminates. Industry output is made to individual order on a job shop basis and requires skilled craftsmen as a labour input. A job might include custom manufacturing of display fixtures, gondolas, wall shelving units, entrance, and window architectural detail, sales and reception counters, wall paneling, and matching furniture.
Businesses that fit into this category are loosely expected to be valued at a multiple of the seller’s discretionary earnings (inclusive of inventory). Still, growth opportunities and customer lists can affect this multiple dramatically. No less important is what’s included in the multiple, like inventory, and how the discretionary earnings are calculated. Is the owner paying themself a fair market salary for the work they do? Are there any non-operational expenses that should be removed? The above-mentioned value drivers will also affect the multiple.
Although considered in the cost approach, the equipment is only worth what it can generate in income when valuing the business as a going concern.
Finally, it’s essential to have an understanding of where the market is going. IBISWorld Industry Outlook states that,“Over the five years to 2024, the millwork industry is expected to resume moderate growth. Home improvement spending and housing starts, the key drivers of the industry’s two largest markets, are expected to continue increasing. Private spending on home improvements is projected to increase an annualized 1.6%, while housing starts are forecast to rise an annualized 2.5%.
Although both growth rates will lag those exhibited during the previous five-year period, both import and substitute competition are anticipated to ease, helping to reduce volatility in the industry, bringing its performance more in line with downstream demand. Over the five years to 2024, industry revenue is projected to increase at an annualized rate of 1.1% to $29.1 billion.”
Marion Van Keken-Rietkerk is a Certified Business Intermediary at NAI Commercial in Vancouver, BC.