Most business owners assign themselves final decision-making authority for their companies. But what happens if you’re away for a couple of days and there’s a crisis requiring a decision? If you were to represent your role in your company visually, where would you put yourself? Are you at the helm, steering your business and solely responsible for its direction? Or do you have a competent team behind you who can step into your shoes if need be?
Just like forcing water through a hose, you, as the company owner, have only so much capacity. No matter how efficient or detail-oriented you are, every business that depends too much on its owner eventually reaches maximum capacity.
Most business owners do not realize the extent of their involvement in their businesses. If not in denial, they are stuck in the hub-and-spoke model, working at the center of their business and responsible for every business decision.
A few clear signs indicate if your business depends too much on you:
- You are the only signing authority. You have not given a co-signing authority (within an acceptable limit) to anyone, or there is no process in place to handle vendor payments in your absence.
- Your vacations do not feel like holidays. You spend your vacations ensuring that things run smoothly, and there is no system to handle your absence, even for a few days.
- You are copied on all emails. Being copied in all the emails either indicates that everyone around you wants to ensure that they have your tacit approval or that you require you to be involved in all official decisions or communication. This is also a sign that you have trouble delegating work and have trust issues.
- You do not have critical people to fall back on. You are often at a loss when it comes to delegating tasks. This indicates that you have not built a competent, mid-level team that can take over critical tasks if needed.
Are You the Face of Your Company?
While there is no harm in being accountable for your company’s success, there are definite drawbacks when there is no one else to handle day-to-day business operations should there be a need.
Consider this scenario: If more than half of your company’s income relies on a single client, then you expose it to the significant risk of financial collapse if that client chooses to leave. You would realize that it is essential to diversify its client base to reduce the risk of any one client’s departure.
Similarly, no buyer wants to acquire a company that cannot exist without that one key person, i.e., its present owner.
Business exit planning is an amalgamation of understanding and identifying the needs of a business owner professionally and personally. These personal and professional goals help determine how prepared the company is for the owner’s exit.
You may wish to sell your business to an outside buyer. However, suppose your business operations are not streamlined. In that case, if you do not have a competent and empowered management team, and if you are involved in every aspect of running your business, there is a problem. The company may not survive the transition to new ownership.
Under such circumstances, you limit the exit option of an external transfer. You might not profit as much from an internal transfer simply because you don’t have a management team to fall back on or a team unsure of running the business in your absence.
All this has an impact on your personal and business exit goals.
What Happens When You Leave the Company?
M&A industry research indicates that owner dependence is a critical factor impacting the valuation and marketability of a company. Although many business owners dream of an easy transition into retirement, handing over the business to a buyer means the new owner will deal with all the risks.
Companies for which the owners have failed to codify processes and systems to transfer essential knowledge to new management get classified as “knowledge-intensive firms” (KIFs). This mostly happens in small businesses where an enormous amount of unwritten knowledge exists only in the minds of the owners and key managers. This essential knowledge concerns business processes and extends to other areas such as sales processes, customer and vendor relationships, employee management and relationships, company culture, business autonomy, employee training, etc.
In a nutshell, human capital determines the value of a KIF. Without a codified method to transfer this intellectual capital, the buyer’s perception of increased risk affects the price, marketability, and deal structure during a sale. Without the owner and key managers, the business just isn’t worth as much.
Effect on the Price
Caveat emptor means buyer beware. An educated buyer evaluates the effect of the owner’s absence on business operations, profitability, and market reputation before buying the company. They will analyze whether future sales and client relationships will transfer. The buyer considers the risk of losing sales or customers with a transition to new ownership. Applying this risk to the income approach valuation model affects the company’s future earnings. This will negatively impact the price of the business.
Buyer’s Perception of Company Marketability
When buyers doubt a company’s future viability due to the owner’s over-involvement, they will scrutinize the business transition plan terms and valuation. Such a buyer will view that business as a risk when acquiring it. What may seem like a small risk to one buyer can be an excessive risk to another. All these factors slow the business sale process and do not allow the sale to align to maximize the business’ value. As a result, many buyers decide not to get involved in a business that poses so many transferability questions.
Sharing the Risk
Suppose a prospective buyer is worried about transferability and other business synergies. In that case, they are more likely to offer a lower price and contract terms requiring the seller to assume a higher significant risk.
For example, the buyer and seller agree on a company valuation of $200,000. But instead of a one-time payout, the buyer may offer $100,000 cash at the closing of the sale, $50,000 as a seller note with marginal interest, and an earn-out of $50,000 based on future revenue.
Buyers are more likely to do this to reduce their own risk in buying a business where the outcome is far from assured.
Manage Your Business’ Dependency
To measure your business’s dependence on you, slip backstage, let other employees take charge for a few days, and see what happens. Record how often, when, and why your management team requires you to make decisions. This experiment will inform you as to what needs to be done next. You may need to:
- Focus on the management team. Your goal should be to build a competent, skilled, and empowered management team.
- Build employees’ skills and capabilities. Schedule frequent training to keep your people updated with the industry trends and processes.
- Document all processes and critical information. Build a system for knowledge retention and transfer.