How to create a valuable and sellable business

Built to Sell's sub-title is what caught my attention - Creating a business that can thrive without you.  How cool is that? :)

The author, John Warrillow, wrote the book based on the premise that most business owners start their companies because they want more freedom like working on their own schedules, but later on, they become too involved that the company can't function without them. Warrilow points outs out, if this is the case, the company, no matter how big or profitable, is worthless to a buyer if everything depends on the owner.  

So in Built to Sell, Warrilow gives some tips on how to create a valuable and sellable business.  The book is an easy read as it is written in the form of a simple story - there's an advertising agency owner (Alex) who's having some business challenges - typical problems like non-performing employees, demanding clients and slow collection of accounts receivables.  He reached a point of giving up and he just wanted to sell his agency.

He sought the advice of a family friend (Ted) whom he considers his mentor.  Ted has a successful track record in building and selling businesses over the years.

But during their first meeting, Ted's assessment of Alex's agency is worthless because everything depended on Alex so Ted guided Alex on how to make his agency a valuable and sellable business.

Here are excerpts of Ted's tips to Alex which could be applied to any kind of business:

- Create a standard service offering, a consistent process for delivering our product or service.    (In the case of Alex's agency, they have identified it as its unique methodology for designing a logo which they have broken down into a specific and repeatable 5-step process.)

- Make sure the product or service is something clients would need on a regular basis so you could count on recurring revenue.  

-  Stop thinking as a service company and start thinking like a product company.  Your product is your unique methodology.  Because if you think as a service company and customize your approach to solving client problems, there is no scale to the business and your operations are contingent on people.  When people are the main assets of the business -  and they can come and go every night - the business will not be worth very much.     

- Acquiring companies use an earn-out formula to buy a business when they know the founders are the business.   What does earn-out mean?  In an earn-out, the owners typically get some money up front and the rest of their money is contingent on hitting performance goals in the years ahead.   Usually, owners need to stay on for 3 to 5 years and a lot can happen which can make it difficult for the owners to meet the acquiring company’s performance goals. This is the reason why you have to build a product company so it's not dependent on the founders.

- When you offer a product, people expect to pay for it in advance versus when you offer a service which they expect to pay after services have rendered.  

-  Avoid the cash suck.  Once you’ve standardized your service, charge up front or use progressive billing to create a positive cash flow cycle.  

- When someone buys a company, they look at the amount of capital they need to tie up to buy the business.  If your business is a cash suck, then they will be willing to pay less for the business.  If your business generates cash, they will be willing to pay more to buy your business.

- Promote your specialized process so you'll be more memorable and referable.  Again, in Alex's case, it's their specialized logo design process.  Ted points out that if Alex were to offer a generic service like advertising or marketing, people will have trouble describing to their friends why his agency is special because they are just like everyone else.  If, however, Alex's agency is positioned as the best logo creator, people could easily describe their service and refer them.

- Don’t be afraid to say no to projects.  Prove that you’re serious about specialization by turning down work that falls outside your area of expertise.  The more people say no to, the more referrals you’ll get to people who need your product or service.

- To sell your business, you need to demonstrate to a buyer that you have a sales engine that will produce predictable, recurring revenue.  Figure out how many sales reps you need to drive your sales engine.

- Hire people who are good at selling products, not services.  These people will be better able to figure out how your product can meet a client’s needs rather than agreeing to customize your offering to fit what the client wants.  

- You need at least 2 years of financial statements reflecting your use of the standardized offering model before you sell your company.

- If you’re going to sell your business, you need to demonstrate that it can run without you.  You need to show a potential acquirer that you have a management team that can keep the business running when you’re gone.  

-  Build a management team and offer them a long-term incentive plan that rewards their personal performance and loyalty.  In Ted's case, he doesn't like giving equity as equity could get messy and time-consuming.  He also points out that equity is only worth anything if there is a market for the shares.  Assuming that the company will never go public, it's easier for an employee to understand a cash bonus plan.   

Ted uses a long-term incentive plan designed to reward his managers' performance and their loyalty to the company.  He gives his managers targets and corresponding bonus for achieving their personal targets.  He pays them their bonus at the end of each year and puts aside the exact same amount into a social pool of funds earmarked for them.  Three years after launching the plan, and each year thereafter, they were allowed to withdraw 1/3 of the pool.  That way, their pool grew in value each year corresponding with their personal achievements, but they could not access the extra money until 3 years after earning it.  If they ever decided to leave, they would be walking away from 3 years’ worth of bonuses sitting in the pool.   

Another reason why Ted doesn't like stock options it is could also complicate the process of selling your business as minority shareholders have rights.  You will be required to to keep them in the loop as you review offers.   So Ted advises to keep it simple by giving your management team a simple, one-time cash bonus if you successfully sell your business as a thank you for helping you with the management meetings and their dedication to the business.  Pay the reward in 2 or more installments to those who stay so that you ensure your key staff stays on through the transition.

- Avoid an adviser who offers to broker a discussion with a single client.  You want to ensure there is competition for your business and avoid being used as a pawn for your adviser to curry favor with his or her best client.  

-  Strategic buyers will typically pay more because you’re worth more to them than you would be to a financial buyer.  A strategic buyer  will model how you would perform as a business if they owned you and applied all of their resources to your business.  A financial buyer is simply looking for a return on their investment and wouldn’t bring much more than their checkbook to a deal.   With few synergies to exploit, financial buyers will typically offer you a lower price to ensure they get a good return on their money.  

Built to Sell is a great read whether you're just thinking of starting a business or you already own one.  It was first published in 2010 and was tagged as one of the best business books of 2011 by both Fortune and Inc Magazine.