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Built to Sell: Creating a Business That Can Thrive Without You

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Built to Sell: Creating a Business That Can Thrive Without You

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I’ve learned from them has been the fundamental paradox that lies at the heart of company-building, at least as it is practiced by the smartest entrepreneurs: You should always run a company as if it will last forever, and yet you should also strive constantly to maximize its value, building in the qualities that allow it to be sold at any moment for the highest price buyers are paying for businesses like yours.

When you follow an options strategy, he says, you build systems and a management team around you so that if a buyer comes along, or you decide it’s the right time to get out, you have a sellable business. Or so that you can install a president and move into a chairman’s role, which is a kind of quasi-exit. Or so that you can stay involved day to day and work on building an enduring company that can go on without you.

there are many reasons for wanting to build a sellable business: Your company may be your best shot at a comfortable retirement. You may want to start another business. You may need cash to deal with a personal financial matter. You may want more time for yourself. You may want to sleep better at night knowing that you could sell your business if you wanted to or needed to.

“That’s the problem, Alex. You’re accepting too many different projects, so you need all kinds of different talent on your team. You’re a small shop, so you have to hire generalists who are inevitably not as good as the specialists the big agencies can hire. So you’re asking generalists to perform specialists’ work and the results are weak.”

TED’S TIP # 1 Don’t generalize; specialize. If you focus on doing one thing well and hire specialists in that area, the quality of your work will improve and you will stand out among your competitors.

Nobody wants to buy a business where 40 percent of the revenue comes from one company. It’s too risky. If you want to sell your business, you should have a diverse group of clients where no one company makes up more than 10 to 15 percent of your revenue.”

TED’S TIP # 2 Relying too heavily on one client is risky and will turn off potential buyers. Make sure that no one client makes up more than 15 percent of your revenue.

TED’S TIP # 3 Owning a process makes it easier to pitch and puts you in control. Be clear about what you’re selling, and potential customers will be more likely to buy your product.

service company is simply a collection of people with a specific expertise who offer their services to the marketplace. Good service companies have some unique approaches and talented people. But as long as they customize their approach to solving client problems, there is no scale to the business and its 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.”

“When a service company is sold, the owners typically get some money up front and the rest of their money is contingent on hitting performance goals in the years ahead. It’s called an earn-out, and often the owners need to stay on for three years or more to get their money. During those three years, a lot can happen that makes it difficult for the owners to meet the acquiring company’s performance goals.”

“Why are you so against earn-outs?” “In an earn-out, you put a significant amount of what your company is worth at risk. The acquiring company is now in control. An earn-out is almost always a disappointment for an entrepreneur. You’ve assumed most of the risk and the acquiring company gets most of the reward if you’re successful. Acquiring companies use an earn-out formula to buy a business when they know the founders are the business. Your job is to build the Stapleton Agency up to a point where the business is independent of Alex Stapleton. That’s the only way you can sell without putting a lot of your compensation at risk in an earn-out. Alex, you need to train people to handle each of the five steps of your process so you don’t have to be the guy piecing every project together from scratch.”

TED’S TIP # 4 Don’t become synonymous with your company. If buyers aren’t confident that your business can run without you in charge, they won’t make their best offer.

“That’s another reason to think of your Five-Step Logo Design Process as a product. When you have a product, people expect to pay for it in advance. When you go to Costco to buy toilet paper, don’t you have to pay for it before you use it? We’re used to paying for products up front and services after they have been rendered. Think about the last time you had your windows cleaned. The service was performed first and then you paid the bill. Products are paid for before you use them. Now that your service has been productized, you need to start charging up front for it.”

“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—and it sounds like it is right now—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. Alex, give me a rundown on how you bill for your service today.”

“Alex, I need you to listen very carefully to what I’m about to say. You have a negative cash flow cycle. On a typical logo design project, it takes four to five months before you get paid because it takes two to three months to do the work and another two months before your invoice is paid. The more projects you sell, the more cash you sop up. No wonder your bank is on your case. Now compare your existing cash flow cycle with a model that allows you to charge in advance. You win the project and you ask to be paid before they experience the product. You then get to use their money for two to three months while you’re doing the work. Now imagine that you convince five or ten clients to go through the Five-Step Logo Design Process. Now you have 100,000 of your clients’ money to finance your business.”

TED’S TIP # 5 Avoid the cash suck. Once you’ve standardized your service, charge up front or use progress billing to create a positive cash flow cycle.

“Look, Alex, if you’re going to commit to creating a business that can be sold, you need to commit to offering one process. That means you need to stop accepting other projects.”

“Clients will test your resolve every day. They’re used to bossing their service providers around and, if given the choice, would always prefer you customize your solution just for them. If you want to sell your business, you can’t give in. You’ll be swimming upstream. Clients will never know you’re serious about specialization until you say no to other work. You can’t be ‘kind of’ a specialist. If you’re going to be the world’s best logo design shop, you can’t also sneak in a few ad campaigns. It’s why heart surgeons don’t set broken ankles.”

TED’S TIP # 6 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 you say no to, the more referrals you’ll get to people who need your product or service.

“Exactly. Imagine your Five-Step Logo Design Process is an assembly line with five machines and you need to teach someone to operate each machine. Start with how to turn it on, how to make it go, and how to read all of the buttons and gauges as it runs.”

“My advice continues to be about creating a business that can exist without you. That’s the only way to sell your company and be able to walk away without being obliged to stick around for five years.”

“To sell your business, you need to demonstrate to a buyer that you have a sales engine that will produce predictable, recurring revenue. We need to figure out how many sales reps you need to drive your sales engine and how many companies are in your target market. For now, let’s focus on businesses within the city limits. How many companies are there in town?”

TED’S TIP # 7 Take some time to figure out how many pipeline prospects will likely lead to sales. This number will become essential when you go to sell because it allows the buyer to estimate the size of the market opportunity.

“An acquiring company will want to see the model for your sales engine, including how many opportunities you have and your historical close rate, to estimate the market potential. You need to demonstrate you know your sales engine and that you can predict, with a fair degree of accuracy, how your sales engine will perform under their roof. Most importantly, you need to demonstrate that you’re not the only one who can sell logos.” “But I don’t have any sales reps,” Alex reminded Ted. “I know. You need to hire at least two.” “Why two? Shouldn’t I start with one?” “Salespeople are competitive and they will compete with each other, which will allow you to prove that your sales engine is not just dependent on one good sales rep. Besides, you have payroll and rent that amounts to roughly 1 million of logos this year to cover your costs and show some profit.”

TED’S TIP # 8 Two sales reps are always better than one. Often competitive types, sales reps will try to outdo each other. And having two on staff will prove to a buyer that you have a scalable sales model, not just one good sales rep.

“In my experience, people like Blake, who are used to working in a service business, are good at consultative selling. They ask a lot of open-ended questions and probe for a client’s needs. The clients reveal their innermost fears and then expect people like Blake to custom-tailor a solution. Blake will try to convince you to tailor the Five-Step Logo Design Process to meet the unique needs of each client.”

“From what you’ve told me about Angie, she will be fantastic. You have one process and you have packaged it to look like a product with five steps that don’t change from one client to the next. Product salespeople are used to doing the mental gymnastics required to position their product to meet the needs of their prospect. A product salesperson doesn’t have the luxury of changing their company’s product every time they hear a need from a customer. They need to position the product they’re stuck with to meet the customer’s needs. That’s exactly the kind of person you want selling the Five-Step Logo Design Process.”

TED’S TIP # 9 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.

“That sounds counterintuitive to being a service provider.” Ted, not deterred by the wind speed and the increasing angle of the Laser, yelled back, “It is! Again, most service companies are not sellable other than for a long, risky, and painful earn-out. They depend on their owners to be the rainmakers. When the owner goes, there is no more business, and acquiring companies understand that. You need to stop doing the selling yourself and hand the reins to a team of people like Angie.”

“While you’re in the midst of making this change, you will show a loss on paper, and that’s okay as long as your cash flow remains strong and you keep selling logos. In three months, you’ll start entering months with revenue on the books from logos you sold this month. You will be starting each month with a base of revenue and adding to it with each logo sold. You need to sacrifice for the next three months until your paper statements catch up with the progress you’re making.”

TED’S TIP # 10 Ignore your profit-and-loss statement in the year you make the switch to a standardized offering even if it means you and your employees will have to forgo a bonus that year. As long as your cash flow remains consistent and strong, you’ll be back in the black in no time.

TED’S TIP # 11 You need at least two 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.”

TED’S TIP # 12 Build a management team and offer them a long-term incentive plan that rewards their personal performance and loyalty.

“When we first started our work together, the Stapleton Agency was a miserable business to own. Your team was being asked to do work they were not qualified to do; you were doing all of the sales and account management; your cash flow was tight; and you hadn’t had a vacation in a while.”

TED’S TIP # 13 Find an adviser for whom you will be neither their largest nor their smallest client. Make sure they know your industry.

TED’S TIP # 14 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.

“When a company looks for an acquisition, it’s usually because they want to grow. Often, they are not able to grow as fast as they want organically, so they acquire companies to bolster their top-line revenue. For you to get the highest valuation for the Stapleton Agency, you need to show how you can be an engine of growth for an acquirer.”

“But isn’t that like lying?” “Not at all. Your plan has to be possible but not necessarily achievable on your own. Peggy is going to approach companies that are a lot larger than you. They will have more money, more physical offices, more employees, more of everything. If you can plug the Stapleton Agency into a big company’s resources, you will be able to grow much more quickly than you could on your own.” “How do I write the plan without knowing who the acquirer will be and exactly what resources they have?” “The best way to do it at this point is to imagine you have a blank check and unlimited resources. There will be plenty of time for an acquiring company to scrutinize your plan and discount your projections based on what they think is reasonable. I want you to take off your conservative business owner hat and imagine what is possible. Could you start a satellite office in every major city in the country? Could you double your sales force? Could you make better use of the Internet to sell logos? Think like Starbucks.” Ted wished Alex luck and left. Alex ordered a refill and started scribbling notes.

TED’S TIP # 15 Think big. Write a three-year business plan that paints a picture of what is possible for your business. Remember, the company that acquires you will have more resources for you to accelerate your growth.

Alex: I like the new plan. Lots of Starbucks—I think it will serve you well. I’d recommend you make one small change: Stop referring to this year’s financials as a “Forecast.” You need to communicate that you’re confident in this year’s projections. Instead, refer to your projections for this year as “Current Year.” By the time we get to the offer stage, you will be three-quarters of the way through this year and you want an acquiring company basing their offer on 1 million in profit, not last year’s numbers. It’s a subtle shift but it’s important. Great job!

“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.”

“Service firms refer to their customers as clients and product businesses refer to them as customers. You’ve worked hard to transform the Stapleton Agency from a service business into a product business with a standard scalable and repeatable process. Using words like ‘client’ subtly communicates to a potential buyer that you still think of yourself as a service business.”

TED’S TIP # 16 If you want to be a sellable, product-oriented business, you need to use the language of one. Change words like “clients” to “customers” and “firm” to “business.” Rid your Web site and customerfacing communications of any references that reveal you used to be a generic service business.

You want to do whatever you can to communicate to a buyer that you’re a real business, not just a flighty collection of temperamental professional service providers.”

TED’S TIP # 17 Don’t issue stock options to retain key employees after an acquisition. Instead, use a simple stay bonus that offers the members of your management team a cash reward if you sell your company. Pay the reward in two or more installments only to those who stay so that you ensure your key staff stays on through the transition.

buyer wants to hear that you see a future for your business and you want their help to get you to the next level. They want to hear that you personally are going to stay on after the sale.”

“Tell them you’re proud of the growth you’ve achieved and that you’re at a point in your life where you’d like to create some liquidity for the value you’ve created so far and have an opportunity to participate in some of the future upside of the business.”

Peggy added, “Alex, buyers understand that entrepreneurs want to put some cash in their jeans, but nobody wants to buy a sinking ship where the captain is about to jump. They need to feel like you see a future for the business and that you’re excited about exploiting the assets they have. They need to feel like you’re willing to stay on for a period of time to help them tap into some of the synergies of the two businesses.”

“Not necessarily a fit, but every negotiation reaches a point where you need to communicate to the other side that they’ve pushed you as far as they can. David’s job is to ask questions, so Marcus needs to hear directly from you that he’s in jeopardy of losing this deal.”

The first step in building a company that can thrive without you is to find a service or product that has the potential to scale. Scalable things meet three criteria: (1) They are “teachable” to employees (like the Stapleton Agency’s Five-Step Logo Design Process) or can be delivered through technology; (2) they are “valuable” to your customers, which allows you to avoid commoditization; (3) they are “repeatable,” meaning customers need to return again and again to buy (e.g., think razor blades, not razors).

If you sell a consumable, start tracking your repurchase rate from existing customers. This will be a number that acquirers will use to calculate your projected sales into the future—and to calculate how much they’re willing to pay to buy your company today.

Expect to garner a premium for your business if you can demonstrate a loyal group of customers who have made an investment in your platform.

Iron Mountain tracks its cancellation rate down to the decimal point and it can predict its revenue well into the future, which is why it is such a valuable company.

The only thing more valuable than an automatic renewal subscription is a hard contract for a defined term.

As you ascend the recurring-revenue hierarchy, expect the value of your business to go up in lockstep. Once you’ve isolated what is teachable, what your customers value, and what they need most often, document your process for delivering this type of product or service.

Next, name your scalable product or service. Naming your offering gives you ownership of it and helps you differentiate it from those of potential competitors. Once you own something unique, you move from providing a commoditized service or product to providing one whose terms of use you decide. If your product or service isn’t generic, customers won’t be able to compare your price to others’. Instead, name your offering, along with each of the steps you take to deliver it, to differentiate your offer so that you can set its price and payment terms. After you come up with a great name, write a short description of the features and corresponding benefits of each step in the production of your offering. Revamp all of your customer communications (e.g., Web site, brochure) to describe your process in a uniform way.

If you want your business to be profitable, enjoy fat margins, and thrive without you, you need to stop responding to RFPs and start carving out your own oneof-a-kind product or service. RFPs commoditize a category down to the point where the only way for a business to win a contract is to be the lowest-cost provider.

By creating a positive cash flow cycle, you’ll have the financial cushion—and confidence—to make some of the difficult changes required in steps 3 and 4. To create a positive cash flow cycle, charge your customer in full or in part for your product or service before you pay the costs of whatever it is you provide.

Charging up front for your product or service will be possible if you have documented and differentiated your unique offering properly (step 1). Depending on your service or product, you may not be able to charge the entire amount in advance, but try to get at least some portion of your money before delivery.

A positive cash flow cycle will also increase the value of your company. When an acquirer buys your company, he or she needs to write two checks. One, obviously, is to you, the owner(s); the second check is to your company to fund its working capital—the money required for your business to pay its day-to-day bills. If your business needs lots of cash, the acquirer will have to set aside money for working capital, lessening his or her appetite to write you a fat check. The inverse is also true: If your company generates excess cash, an acquirer will usually pay more for your business because he or she doesn’t have to commit funds to working capital.

If you get an offer to buy your company, the second most important number on the page may be the working capital calculation. If your offer does not include details on the working capital calculation, be sure to lock that number down before you agree to anything.

Once you have created and packaged your offering and started to charge up front, you need to remove yourself from selling it. If you have others delivering the product or service but you’re still the rainmaker, you will not be able to sell your business without a long and risky earn-out.

“Your job as an entrepreneur is to hire salespeople to sell your products and services so you can spend your time selling your company. You make a few hundred or thousand dollars when you sell your product, but if you turned those same skills to selling your company, you can make exponentially more. You have the right skills, but you’re selling the wrong product.”

As you build your sales team, look for people like Angie Thacker who, first, enjoy selling and, second, like the product. Avoid hiring salespeople who come from professional services companies; they will likely want to reinvent your product or service for every customer. If at all possible, hire at least two people to do sales, not just one. For one thing, sales careers typically attract competitive people, and a little healthy competition between these employees will work in your favor; for another, an acquirer will want to see that you have a product or service that can be sold by salespeople in general and not just one superstar salesperson.

Again, it wasn’t that they all of a sudden became knowledgeable researchers; they simply got a chance to repeatedly practice a single pitch.

Once you’ve assembled a great sales team, stop taking on projects that fall outside of the standard offering you identified in step 1. It’s tempting to accept these sales because they bolster your revenue and cash flow. If you’re charging up front for your service or product and your salespeople are selling it, then you shouldn’t have to worry about cash flow. That leaves added revenue as the reason to accept projects that fall outside of your process. The revenue may feel good at first, but it comes at an unacceptable cost: Your team will lose focus; customers, realizing that you’re not serious about your standard process, will see a chink in your armor and start asking for customization of their projects; and to meet this demand, you will need to hire other people to deliver. I’ve had the opportunity to speak with hundreds of business owners who have made this transition, and most have told me that customers who used to ask for custom services respected the change they’d made to their business model. Many clients actually buy more once the service or product is standardized. Customers are smart; they often know you’re overreaching your capabilities in accepting assignments that fall outside of your sweet spot.

Stopping yourself from accepting projects outside of your scalable product or service is the toughest part of creating a business that can thrive without you. You will have employees testing your resolve and customers asking for exceptions, and you will secondguess yourself on more than one occasion. This is normal; you have to be strong on this and resist the temptation. There is a point where the wind will start blowing the other way and your customers, employees, and stakeholders will finally realize that you’re serious about focusing on one thing. It takes time. It will happen, and when it does and you feel as if the boat has actually shifted, you will have sailed a long way toward creating a sellable company.

Business owners often believe that to be “customercentric,” they have to give customers whatever they want. But giving customers too much choice can be a detriment, especially if you’re trying to build a company you can scale and ultimately sell.

As I got more desperate for A clients to make the switch, I made a second mistake, which would ultimately be fatal: I started offering to customize each report for my A customers if they agreed to move to the new subscription model. Once our staff got wind that one subscriber was getting a special report, all of our account managers wanted their customers to have the very best reports for them. I fell down the slippery slope of customizations quickly. Soon we were customizing each report for every client—thereby compromising the leverage I’d hoped to achieve through a subscription model.

Over the following five years, I concluded that my two biggest mistakes were: (1) giving my A clients the choice to continue to do business with us under the old model, and (2) customizing the reports of those who did agree to make the switch. I decided to relaunch a version of the program but forced our customers to make a choice: Either subscribe to our standard subscription or end our business relationship. Giving customers an ultimatum actually worked in most cases, and we quickly made up for lost consulting revenue with new A subscribers. We got more focused on the offer and the As and Bs started talking it up, so we received more inbound leads from Cs. The business really started to take off, and, better yet, it was scalable. All because we led and didn’t follow our customers.

Once you have weaned yourself off other projects, you need to operate your newly focused business for at least two years in order to prove…

Over the course of these two years, drive the model as far and fast as you can. Avoid the temptation to get personally involved in selling or delivering your standard offering. Instead, when you get asked for help, diagnose the…

Many business owners realize a tremendous uptick in their quality of life in these two years. Business improves, cash flows, and customer headaches decrease. In fact, many owners like this stage so much, they shelve their plans to sell their company and decide to run it in perpetuity. If this happens to you,…

If you’d like to have a business you could sell, you need to prove to a buyer that you have a management team who can run the business after you’re gone. What’s more, you need to show that the management team is locked into staying with your company after acquisition. Avoid using equity to retain key management through an acquisition, as it will unnecessarily complicate the sale process and dilute your holdings. Instead, create a long-term incentive plan for your key managers. Each year, take an amount equivalent to their annual bonus and put it aside in a long-term incentive account earmarked for each manager you want to retain. Allow the manager to withdraw one-third of the account’s balance each year after a three-year period. That way, a good manager must always walk away from a significant amount of money should he or she decide to leave your company. You may also choose to “top up” the balance in a long-term incentive plan with…

The next step in the process is to find representation. If your company has less than 2 million in sales, a boutique mergers and acquisitions firm is probably your best bet. Look for a firm with experience in your industry, as it will already know many of the potential buyers for your business. To find an M&A firm or business broker, ask for recommendations from other entrepreneurs you know who have sold their companies.

“Describe your sales cycle.” • “How many salespeople do you have?” • “Describe your cash flow cycle.” • “Who are your customers?” • “How do you know if they are satisfied?” • “How often do they repurchase?”

In fact, my banker earned the majority of his fees from buying companies on behalf of his dinner guest, not by selling them.

An earn-out is used by an acquirer to minimize his or her risk in buying your company.

If you feel as though you have to stay to get full value for the business, then expect life to be uncomfortable for the duration of the earn-out.

They’ll want answers to detailed questions like the following: When does your lease expire and what are the terms?   Do you have consistent, signed, up-to-date contracts with your customers and employees?   Are your ideas, products, and processes protected by patent or trademark?   What kind of technology do you use, and are your software licenses up-to-date?   What are the loan covenants on your credit agreements?   How are your receivables? Do you have any late payers or deadbeat customers?   Does your business require a license to operate, and if so, is your paperwork in order?   Do you have any litigation pending?

Rid your Web site and customerfacing communications of any references that reveal you used to be a generic service business.

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