Podcast: How to Become a Passive Owner in Your Business
If you want to sell your company, you must prove to a buyer that success is not dependent on your day-to-day involvement. But how can you start to remove yourself from the business? Learn how from one of the thought leaders on the topic, Josh Patrick.
In this session you will learn about:
- Steps needed to become operationally irrelevant in your company;
- Importance of financial literacy in building business value;
- Increasing value through implementation of operational efficiencies; and
- Carving out a niche in your industry to grow your business.
About the Guest
Josh Patrick has owned and operated a variety of businesses dealing with food, including food vending, coffee service, catering, wholesaling, and several other channels dealing with food. For the past 15 years he has owned and operated a wealth management business, Stage 2 Planning Partners, that focuses on the strategic issues faced by owners of private businesses.
Mr. Patrick contributes to the New York Times' "You're the Boss" blog and writes about creating value. He has also written for Inc.com, Open Forum and various other trade publications. He has also chaired the education and training committee of the National Vending Association, where he helped develop and deliver bootcamp programs on financial and strategic management to more than 150 companies.
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Read the Full Transcript Here:
Noah Rosenfarb: Hi. It's Noah Rosenfarb. Our guest today is Josh Patrick. Josh works with private business owners to create value in their personal business life. His goal is to help his clients make their life better. He blogs online on his own site, at stage2planning.com, and he's also a contributor to the New York Times' "You're the Boss" blog on small business issues. Josh is a great guest because he's got lots of wonderful stories that he's going to share with us about business owners that are thinking about exit and succession planning. Josh, thanks for joining us.
Josh Patrick: My pleasure. Thanks, Noah, for having me.
Noah Rosenfarb: My pleasure. So let's get started then. Why don't you tell us some great stories that you have about owners? I know one that you and I had talked a little bit about was getting an owner to become operationally irrelevant. Take our listeners through the value of becoming irrelevant and how they might go about it and what this case involved.
Josh Patrick: Cool. I think the most important thing a business owner can do to create value is to make themselves a passive owner. Whether you're going to keep your business or you're going to sell your business, under either case, if you're not involved in the day-to-day operations, you make your business significantly more valuable. If you're going to sell your business to a third party or try to transition it to somebody else, the buyer or the new owner is going to be really interested in your team members. He’s going to be interested in your senior management team. They are not interested in you.
There's usually more buyers than sellers. One of the great lies of the world is: "I'm going to come and buy your business, and I’m going to give you all this money, but I really don't care about your cash flow or your business. I really want your brains." That gets an awful lot of people excited about selling to a particular buyer. The fact is if you go to the person buying your business and say, "Look, I've built this great business, and you don't need me. I can walk out tomorrow, and you're going to be able to run this business without me," you're going to get more money for it. It's just that simple.
On the other hand, let's say I want to keep my business. I’ve created this great business. Again, I've made myself into a passive owner. I'm not involved in day-to-day operations. I'm involved in financial decisions. I'm involved in strategic direction of the business. I've got a really good staff who implements these stuff. I don't have to work really hard. I mean, I've already worked probably for 20 or 25 years really hard, and I've created this great business where I'm not involved in the day-to-day operations, and I get to keep all the cash flow. Now there's a certain amount of risk in that. There may come a time where I don't want to keep that cash flow anymore, and now I've got a choice.
One of the things I always tell folks when I'm working with them is saying, "Hey, let's get our business ready to sell. Have it in a sell-ready position all the time." It doesn't mean you're going to sell the business, but businesses that are sell-ready run much better than the businesses that don’t.
The question is: "Okay, great, I want to be a passive owner. How do I go about doing that?" Well, the first thing you have to do is you have to start to systematize your business. I'm a big fan of "The E Myth" in that a lot of business owners build businesses, they get to 5 employees, 10 employees, 20 employees, maybe 25 employees, and they've got all these systems running around inside their head and they've never written it down, so people really don't know what they're supposed to be doing. When you hire new people, it's sort of urban legends. They get told, and there's not written-down systems. If you want to become a passive owner, the first thing you need to do is to systematize your business. The second thing you need to do is you need to get yourself a really good Chief Operating Officer or General Manager or somebody who's going to be responsible for the day-to-day operations of the business. You let them run the business. The third thing you've got to do is you've got to learn to start trusting your employees. You got to start allowing your employees to make mistakes.
One of the big mistakes I think that a lot of private business owners make is it's okay for them to make mistakes but it's not okay for everybody else to make a mistake. The fact is we're all going to make mistakes, and the question is: are we going to learn from our mistakes by making them public and then going through the learning process, or are we going to hide our mistakes and hopefully they don't get bad enough that they put us out of business? If you do those sort of combination of things, you start moving down the path towards passive ownership.
The important thing to realize about that, at least what I think is important, anyhow, is that you're not going to become a passive owner in a week, two weeks, a month. It's going to take you somewhere between two years and five years to get there, and it's a process. It's not something that happens all at one time. You take one step forward, you take two steps back. You take three steps forward, you take one step back. It's not a linear line between controlling everything in my business and becoming operationally irrelevant. It takes a long time.
I used to own a vending company. It took me about 7 or 8 years to go from being involved in everything to essentially being involved in nothing, except unless it was strategic or financial. When I finally sold my business in 1995, I sold my business. I walked out three hours later. I never walked back. One of the things I'm most proud of is the business I sold was running just as well a year later as it was the day I sold it, and they still had our staff in place and still used our systems but they didn't need me. For me, that was a great result, and I think it was a pretty good result for the guys that bought our business also.
Noah Rosenfarb: That's great. A couple of things you talked about that I wanted to pick up on. One was "The E Myth," which I think is a bible of sorts for business owners. Anyone who's listening to us has probably done their own research in listening to other experts and reading other material, but if you haven't read "The E Myth" or if it's been a while, I highly encourage you to read it again and take those great tips and apply them in your business.
The other thing and where I wanted to probe into you is on the mistakes and letting your team make mistakes. What’s been your experience… What's the worst mistake you've seen an owner make or their management team make and how have they recovered?
Josh Patrick: I may get the award for that. I'll tell you my story because I'm not completely embarrassed by it, but it was a pretty big one. The worst thing that can happen in the food business is to have a salmonella breakout. I had a commissary manager that decided he was going to save me some money. Now the commissary is a full-production facility within the main company. Instead of using ground beef, he decided to use ground turkey, and he didn't handle the ground turkey appropriately. One day we got a phone call that said, "One of our employees got sick on your stuff." I, you know, hung the phone up and said, "It can't be true. That wouldn't happen with us," and then an hour later, another phone call rang, and then another phone call. By the time the fourth phone call came in, I realized we had a problem. That was the worst mistake that we ever had, and what have we learned from that? Well, what we learned is we have systems and those systems need to be followed more carefully, and that it would have become a fireable offense not to follow the recipes and not follow the safety procedures that were established. That was something that was new.
Now the good news about that was that we had done some scenario planning around that particular issue. I'm a big fan of what's called scenario planning, where you try to see, "Okay, let's look at the four or five things that could cause a really bad day for us." In the food business, it was that particular issue. We had 27 people that actually got sick from the food that we had. We didn't lose one account, and everybody was handled extremely well. We got with our insurance company immediately, and our insurance company assured us. We went out and met with everybody and all our clients and we said, "Look, if you have people who are sick, we want to know who they are. We want to make sure they've been treated properly and we want to make sure they've been fairly taken care of." We did have one case that went through the courts and got settled, but the other 26 we just settled privately, and everybody was happy with the outcome.
The reason we didn't lose any accounts was we took responsibility. The whole thing with taking, which was a big deal in our company, is that when you make a mistake, take personal responsibility for it. Don't blame other people. Don't justify the behavior. If you're going to cause personal responsibility, then mistakes become something that are okay. If you have a culture where you're going to justify and blame people, all that happens is when a mistake happens, you get toxic, and you want to stay away from that toxicity if you possibly can. Does that lead it down the road properly?
Noah Rosenfarb: Yes, that's terrific. I guess what I hear from you, and I think what most owners share when they talk about mistakes is, really, the fear of the mistake is, you know, the business is over, but the reality of these mistakes, even terrible mistakes, is that typically they help make a company stronger. They might have a short-term cash-flow impact. They might have, you know, there are problems that are caused, but more often than not, the mistakes help you create a better and stronger company. It sounds like that's the same as what happened with you.
Josh Patrick: Yes. There's a reason that owners are mistake-adverse, and the reason is that when you first start your business, say, you're doing 300,000 dollars in sales and somebody makes a mistake that cost you 100,000 dollars, you're out of business. But if your business is doing 3 million dollars and you have 100,000-dollar mistake, that mistake will be painful, but it's not going to put you out of business.
Owners often have a hard time making that transition from having to be in control of every little detail, because some of those little details might put you out of business, to understanding that we don't need to be nearly as worried about the little details as long as we learn from the mistakes that happen because it's going to take a pretty big thing to put us out of business. It's that understanding, that when people finally get that or owners finally get that, that they'll start letting mistakes happen in their company, which means they're starting to trust their people more, which allows them to grow their business to a larger size.
Again, you can sell businesses and you can transfer businesses of five or six employees, but it's pretty hard. It's a lot easier to sell or transfer a business with 50 or 100 employees, but you're never going to get to 50 or 100 employees unless you learn to trust the people that work for you.
Noah Rosenfarb: Yes. It sounds like if I were to summarize how an owner could become operationally irrelevant: create the systems, let your team make mistakes, have a great management team or at least a management team.
Another thing that you and I had talked about, which you didn't comment on, is having a means to measure and manage the operations of the business. Do you want to talk about that briefly?
Josh Patrick: Yes, well, I think you have to - I mean, metrics are really important. If I could, you know, wave a magic wand over all business owners, I would have them become financially literate. The amount of financial illiteracy in businesses in the United States is unbelievably high. Most business owners can figure out their profit and loss statement. I would dare say less than 50 percent understand a balance sheet, and I will say under 10 percent understand a cash flow statement, and the most important statement that you have in a business is your cash flow statement.
Let's say, public companies are worried about profits. They don't really worry about cash because they all have too much cash or they at least have enough cash. The cash is not the issue. Managing profits for the markets is what they concentrate on. A private business is the other issue. I mean, at the end of the year, what do you do? You try to kill your profits so you don't pay taxes. So it's all about managing cash, and if you don't read a cash flow statement, how are you going to manage cash? Now on top of that, businesses have important numbers that you should all measure. Most of the time, these really important numbers that drive the value or the success of a business, you don't even see in a P&L or a balance sheet or a cash flow statement.
Again, going back to my vending business, the key number for us is what was called dollars per stop. Every time a route driver went to a vending machine, how many dollars of merchandise do they put in that machine? If they're putting 30 dollars in the machine at a stop or 130 dollars in the machine at the stop, you'd rather have him do 130 dollars because your productivity is so much higher. You're not going to see that number on a profit and loss statement.
If you're a sales-based organization like an insurance company or an investment management firm, it's all about creating new business. Well, that's about how many sales you're making. If you look at the traditional sales methodology, you make 10 calls to get 3 appointments to create 1 sale. It's 10-3-1. That exists in almost every industry I've ever looked at, by the way. If you have a good marketing strategy, maybe you can make that 10-6-3, but it's really about the metrics that you’re measuring. It's how many calls are your sales people making? It's really knowing what are the metrics that drive your business, measuring those metrics, and then putting in plans together to improve them. That's a real big driver in making your business more successful.
Intellectual property or intangible assets you have in your sale make your business more valuable. They make your business more valuable while you're running it because your business will become more profitable, and they make your business more valuable when you go to sell it because you're more profitable than the average bear. You can explain to a buyer why you're more profitable, why they should pay you more, a higher multiple than they normally pay, because they're going to get your methodology for what makes your business successful, which they can apply to a larger enterprise. I mean, those are really important things to do. Another thing that ...
Go ahead. I'm sorry.
Noah Rosenfarb: I was going to say let's talk a little bit about maybe a different type of business and how they would prepare for a transition or, you know, get prepared to enhance the value of their business in maybe the operations side.
Josh Patrick: Sure.
Noah Rosenfarb: I’m thinking about how a company does things and how you might look at that. Maybe you could tell a story that you think would be valuable, where someone re-engineered their company.
Josh Patrick: Yes, I'm a huge fan of what's called lean manufacturing or Lean thinking. There’s a book by Eric Ries called "The Lean Startup," which is a pretty good book. Then there is, if you look at lean manufacturing, which is the Toyota production system, how Toyota runs their company, and you take this and you apply it to a privately held business, you can really dramatically increase your value.
Let's start off with the metric. Let's say that I have a system where I measure the - I’m in the specialty manufacturing world, and I have a system where I measure the efficiency of the factory that I'm running, and I think I'm running at 85 percent efficiency. Now anytime somebody tells me that their factory is running at 85 percent efficiency, I know they're lying to themselves. I don't mean to say this in a mean manner, but they're lying to themselves because Toyota, who's the best in the world, runs at about 80 percent. I take a look at their numbers and I say, "Okay, how are you actually measuring?"
I'll give an example. I had a specialty manufacturing company I work with, and they make a beauty product, and they thought they were running at an 89 percent efficiency rate. I said, "That's not possible," so they went back and actually ran the real numbers. It ended up they were running at an 11 percent efficiency rate. By the way, they're making a 10 percent profit at an 11 percent efficiency rate. In other words, the utilization rate in the plant was 11 percent. Now here's the good news about that. If you'll say, "11 percent? Oh, my god, that's terrible." When they told me that, I said, "Wow, that's great news." Now why would you think that's great news? Because it's only 11 percent.
Noah Rosenfarb: It's only 11 percent, right. Imagine what they can make at 50 percent.
Josh Patrick: If I could get to 22 percent, I’d double the productivity. So that's what we're doing. First thing we figured out: they had seven lines that were running. We sold two. We got rid of two out of seven lines, which means we automatically increased our productivity by a significant amount because we got rid of this capacity that we were never going to use. What this getting rid of this capacity allows us to do is to go into a different line of business.
They were going to have to get into another building and open a new building to go into this new line of business. Instead, we can do it in the same space that we did before. We're using the space more effectively, and we're going to dramatically improve the value of the business. The line of business running right now is profitable, but it's marginally profitable. The new line we're going in is three times as profitable as their old line business, so we're really excited about this. Now we can make it a lot easier because we're not going to try to run a business out of two buildings. We're going to run a business out of one building, so it's simple.
It's these sorts of things that allow you to rethink your business, and that's what the whole lean process is about. In my opinion, lean is one of the Midas strategies out there. It's what can make your company worth a lot more money. Now here's the challenge with Lean. When you read the books on lean, you're reading about Toyota, you're reading about Boeing, you're reading about General Electric. You're reading about these gigantic companies that have zillions of resources. They can throw teams of people without a problem.
If you own a company, you've got 50, 100, even 200 employees, you really have very limited resources for doing this sort of stuff, so you can't use the same strategy and methodology that these big companies use. You have to use a small company strategy, which means we pick one discrete part of lean and we do that. We get that running really well, then we move to the next discrete part of doing it. When we do that really well, we’re going to move on. We don't try to solve the whole problem at once. We take little pieces at a time. Taking those little pieces at a time over a period of a couple of years has huge results.
Now there’s a place that we always start with this. Going back, there was something with W. Edwards Deming. Again, I will quote books all day long, but I think reading the book "Out of Crisis" by Deming is probably one of the more important reads you can do in business. In there, he says, "You know, the issue is, is that most businesses are not in control." When Deming said "in control," he meant statistical control.
When you take a look at a particular process, you want that process to be within what's called within three standard deviations, which is 99 percent of the time. Anything that falls within that range is expected behavior. You would think that most times most processes fall in there. Well, my experience is, when we start measuring, that it's rare that we get it then, so we have to do work first to get our processes under statistical control. Once we get our processes under statistical control, then we start taking a look at what we can do to move the bar forward. Again, it all comes down to measurement. You've got to measure what you do. If you don't measure it, you can't improve it.
One of my little stupid sayings I had is, "That which gets measured gets done." As soon as I start measuring a process in a manufacturing facility, it automatically gets better. The reason it automatically gets better is because people start paying attention to it. When you pay attention to things, they get better. It's just the way it works, and it's really pretty simple stuff to do.
You really want to take a look at a business and say, "Where's my largest opportunity, and how can I take advantage of it?" If you have a small business that's trying to be all things to all people, let's not try to be all things to all people. Let's develop a niche. Let's be known in our niche for being the best that there is in the industry, and let's be involved in the industry. When people need it, they come to you automatically. When you're building, if you're a home builder and you’re trying to build houses that are between 200,000 dollars and 3 million dollars, nobody knows what you're good at, and they don't know how they're going to find you.
It's really important to say, "Hey, there's five or six things that we can do to make businesses really good. Which one's going to get me the biggest result? And let me work on that one area first." When I get really good there, then I could say, "What's next?" It's really narrowing down what we're trying to do, not expanding. One of my new sayings, which I really like a lot, is: "Go slow to go fast." In other words, do a few things. Do them really well. Get them done. Move on to the next thing. You'll find you move much more quickly doing 1 or 2 projects at a time than trying to do 10 or 12 projects at a time.
Noah Rosenfarb: Yes. Good advice. Hasten slowly, right? That's a popular saying. So let's move on to maybe another example where you advise clients to look towards a niche. I think you started talking about that in the sense of a builder that builds 300,000-dollar homes and 3-million-dollar homes. Where do their talents lie? Talk about that this and maybe you can…
Josh Patrick: Well, I actually have a great - we had a client. We had a really good experience with that. It was a graphic artist in Vermont. Vermont's not a very big state, so people believe there's not enough business for anything. So I had this graphic artist walk in my office, and we did some work with them. I asked her who is she serving, and basically she said, "What do you mean?" I said, "Well, who's your niche?" "I know a lot about the food business, the specialty food business." Then she showed me her portfolio. She had a home builder and she had an auto shop and she had a repair shop, and I said to her, I said, "Well, why are you doing all these other things that are outside of the food business." She said, "Well, there's not enough business in the food business." I said, "Really?"
So we did a little search, and only in Vermont, by the way, of how many specialty food manufacturers were in Vermont. There's about 100 of them, so I said to her, I said, "Well, this seems to me there's plenty of people for you to work with in Vermont, and you know a lot about food and you can easily prove to these folks that you can improve their business by your design that you do with food. On top of that, you're not reinventing the wheel every time you do a job." Essentially, one specialty food company is pretty much like another specialty food company. Once you've figured out what works, you can just go right across and sort of, you know, take what you do with one company and apply it to another company and apply it in another company.
To make a long story short, she decided to only serve in the food market. She's making, I think, three times the amount of money she was making when she was trying to be all things to all the people, and she's much more efficient and she's having more fun. So it really comes down to… She said, "Okay." She took the plunge, and she decided to learn how to say no.
Most of us in business have really never learned how to say no very well. We're afraid that if we don't say yes to everybody that walks in the door that wants to do business with us, no one else is ever going to walk in the door. I convinced her, and she agreed to give it a shot. She started saying no. By saying no, what she did was she created a capacity in her business to say yes to those high-value high-profit customers who she could really help. That's what happens. When you learn to start saying no and you develop a niche and you really stay within your niche, you're really learning to say no to the person that doesn't fit, which leaves you room to say yes to somebody who does fit. If you're really lucky, you get to have a waiting line for people who want to say yes to you and you want to say yes to them.
Noah Rosenfarb: That's always the best-case scenario. All right.
Josh Patrick: That's a great place to be.
Noah Rosenfarb: Let's talk a little bit about the mechanics of transfers and sales.
Josh Patrick: Okay.
Noah Rosenfarb: Let's focus a little bit on internal sales, and maybe you could give an example of an internal transfer that worked and an internal transfer that failed, and what your advice to our listeners would be if they're contemplating an internal transfer.
Josh Patrick: Yes. Again, we were talking about it before when I was going through my litany of how many businesses there are. There's about 28 million businesses in the United States. Only 6 million have employees. Of that 6 million, maybe a half a million to a million are really saleable to a third party. The rest are really better off transferred internally. Because a lot of businesses don't plan for an internal transfer the way they should, they end up liquidating their business.
I'll give you two stories. I had an electrical contractor we were working with, and he had started working on his transfer about six or seven years before I even met him. He started about 10 years before he wanted to sell his business of lining up people to take over the business when he was ready to get out. What he did is he had chosen two people in the company. They were paid well. They were happy with what they were doing. They were young folks. He said, "Look, I'm going to be out of here in 10 years. You're going to own the company if you want it. Here's what you need to do." He pretty much laid out what they had to do and how they had to do it.
Over that 10-year period, he got a chance to test their management capabilities. Were they able to manage the business? Were they able to run the business? Because when you sell a business internally, one thing is always true: your buyers don't have any money. That's not always true, but it's mostly true, which means that in an internal transfer, you're going to become the bank.
By the way, on a small business transfer, you're also going to be the bank. I would rather be a bank for somebody I know than somebody I don't know, which is one of the reasons I like internal transfers versus a small company external sale. He got a chance to see these folks in action, see them run the company, took less and less time off and became a passive owner. Now for him, it took him, you know, about, probably six years to get there. For the four years between the time that he actually sold his business, he had become a passive owner. He only came in a couple of days a week. For that four-year period, he got to enjoy the cash flow from it.
By the way, while this was going on, he had a very nice retirement plan where he's saving a ton of dough outside the business. He had bought a bunch of investment real estate, so he was pretty much financially independent by the time the business came around to be sold. We got to the day the business was to be sold. They had figured out how they were going to go through the transaction. We had made it a tax-efficient thing, and we pulled the trigger and it was done. He walked away. The business is still very, very, very successful. In fact, it's even more successful now than when he owned it, and he's in retirement and very happy. That was one that worked really well.
Another one that didn't work so well was an interior contractor. Again, I was working with this client probably six years, seven years before he actually wanted to leave the business. Every year we get together, and every year I'd say, you know what I say, "Bruce, have you told your guys that you want them to buy the business?" He said, "I'm not ready to yet." Then we go another year, same thing, "I'm not ready yet," and we go another year, "I'm not ready yet." He finally calls me up and says, "I want to be out of here in six months."
I said, "Bruce, have you talked to your guys yet?" "No." "Well, you think you might want to talk to them before we try to do this because you're an interior contractor. You're as good as your last bid. No one's going to really want to buy you," which was true. Then he went out and looked at the market. We got the two guys he wanted to sell the business to, and we said, "Here's how the transaction ... We’d like to see the transaction work." They thought Bruce was trying to take advantage of them. As it worked out, it was a fair deal for them, but they didn't believe it. So they went out and hired an outside attorney and an outside accountant, and once you do that, you’re into an adversarial relationship and there wasn't a lot of trust.
By the way, in our first case, because we had taken 10 years to get to groom and get ready in place, there was a lot of trust built up between the owner and the guys that were going to take over the business. In our interior contractor's place, there was almost no trust.
He was going to negotiate a deal, but as we're trying to get this thing under a shotgun, it was sort of … He came in and demanded that this is what they were going to have to do. There was really poor communication between the owners and the buyers. I kept recommending to the seller that he really have a conversation without attorneys, with just he and they, and try to build some trust around this thing and make it work. It ended up that we … He ended up liquidating the business because what they came back and offered him was under book value. I mean, he could just liquidate his business and walk away with more money than he could have by selling the business to these guys.
Had he done it right, he probably would have ended up with another 700,000 or 800,000 dollars more than he did, but at the end of the day, in this particular case, even though it was a disaster as far as a business sale goes, he's fine. He had bought some outside real estate, and there was plenty of rent coming in from the real estate to support his lifestyle going forward. It really came down to he didn't get the sale done, the business name disappeared, the business disappeared, his legacy disappeared, but financially he was okay.
A lot of times financially we are okay, but if you're going to transfer your business and you're going to do an internal transfer, it can't be done at the last minute. It's going to take you at least three years, probably five to seven years. It's just not a fast thing to do. If you plan out long enough, it will likely go well. If you don't, then you're going to go through a liquidation or have a fire sale, one or the other. Again, really, the choice is up to you. You really need to be thinking about this far in advance.
The folks in the M&A business are not going to be interested in internal transactions. They don't make any money. But the folks in the succession and transition planning business, they’ll call themselves exit planners … By the way, I really dislike that term, and so do business owners, so I would love to see the industry go back to succession and transition planning, which is what we're really doing because we're transitioning ourselves from one stage in our life to another, and we're putting together a succession strategy for who's taking over our business. I think it's a much better group of words to use.
I find that words really matter, and staying away from jargon-laden stuff is always a good idea. Jargon and business owners do not go together. A lot of folks who grew up in business never had business training. As I mentioned before, they're not great at finance, but they know how to do stuff, and they're not stupid, and using jargon makes people feel stupid. At least that's my opinion. Anyway, internal sales are a really interesting thing, something that I like working on a lot, but they take a fair amount of time to make it work properly.
Noah Rosenfarb: What about for an external sale? What advice would you have for an owner that, you know, their business qualifies to sell externally and they're looking for the highest price in a competitive offer situation? How do they go about finding someone to help them accomplish that goal?
Josh Patrick: I think if you're selling to an external market, whether it's a Main Street business or a middle market business - a middle market business is typically a business between 5 and 100 million dollars in sale. Main Street business is typically under 3 million dollars in sales. There's this no-man's land in the middle. You always should use an outside intermediary to help you sell your business.
People who buy businesses in the middle market know what to do. When you work in a private equity, venture capital, M&A acquisition teams, if you don't have a pro representing you, you're going to get your lunch eaten. If you're in the Main Street business, there are a lot of potholes to run across because you're likely to be holding paper. A good Main Street businessperson would know how to work with the SBA and bring in SBA loans so you're holding less paper and you're taking less risk. As far as I'm concerned, the only thing you should ever count when you sell your business is the cash you get when you sell it. I get into a lot of arguments with M&A people about that, but the fact is on awful lot of times, earn outs or owner financing never gets paid, so there is a trick to this. I mean, these folks who are good at this stuff are very good at it, and those who aren't, aren't. The problem is there's a lot of people running around the M&A world who don't work in the best interest of a seller.
If you can afford it, it's a great idea to have an adviser who’s advising you, has no financial interest in whether your business is sold or not sold, but is only working with you to get you through the process. I mean, that's something that I've done several times. I think, as of today, it adds a lot of value that way because this person can help you find the right M&A person to hire. You might use your CPA if he's good at that. You might use an attorney who does transaction work that's good at it. You'd want to have a methodology for how to hire the M&A person you're working with. I use the exact same system that we use when we hire an employee. We have a thing we call the "will-do can-do" fit factor method of management where we go through those three areas. We put together a list of what we're looking for under each heading, and then we start interviewing. When you find somebody that's a good fit for you who is technically competent and is willing to do the activities that will get us success, that's the person you want to hire.
Be prepared to pay fees for it. If you're in the middle market world, you're going to pay a fee for someone to put together an offering memorandum, but you're going to have a lower success fee, and the success fee is the amount of money that you pay when the business is sold. In the Main Street world, you pay a higher success fee, but there often is no memorandum, which means you don't pay a fee to have one put together. Be prepared that you're going to lose somewhere between 40 and 50 percent of your sales prices to taxes and fees. If you can't afford to sell your business, come up with a better strategy and then go and sell your business and get your business ready to be sold. You want to have your business be sell-ready. You want to look at your business through the eyes of a buyer, not through your eyes and what the value is for you. It's the value to the buyer that counts.
The best place to be is to have your business want to be bought by three or four people so you can do a controlled auction. Hopefully, you get these people bidding against each other, and if you're really lucky, you've got a couple of billion-dollar companies beating each other over the head. If you look at what Microsoft paid for Skype, which was a ridiculous amount of money, it was because Google and a couple of other big players were in there wanting the business. It just got bid up, and with a billion-dollar company, an extra 10 million here or 10 million there doesn't really mean anything, so if you can position your business to be bought by those folks, you're going to get more money.
The other thing is when you’re selling your business to a third party, my advice is take the best offer financially. Don't listen to what they say about how they're going to treat your employees because they all lie. Buyers who have bought a lot of businesses realize there's a certain language pattern that you can use with sellers that are going to get them to want to sell to you. It doesn't mean that these folks are … They're not bad people. They're not mean. It's just that they know if they want to get a transaction done, they want to buy your business, they're going to have to tell you certain things. They want your business. They want your intellectual capitals sometimes. They definitely want your cash flow, but they're not really interested in you. They're going to run the business the way they want to run the business.
Be prepared for what's next. Be prepared for seller's remorse. It's rare that I see a seller sell their business and is happy with what the buyer is doing with the business after they sell it. The folks who've bought my business, I wouldn't run the business the way they are, but they own the business. Frankly, it's their right to do what they want to do, and if my employees want to continue working there, that were working for me, they're going to have to work under the aegis and what the new owner wants them to do. They bought the business. It's one of those things.
The other issue, and again Jack Beauregard talked about this a lot out of Boston from - I can't remember what his name is, but he is such … He works with people. Do you know his name?
Noah Rosenfarb: From the Successful Transition Institute?
Josh Patrick: Yes. Successful Transition Institute, yes. He talks about the what's-next-in-your-lifesort of thing. When you sell your business, the phone will stop ringing. It stops ringing almost immediately, and a lot of folks get very lonely because their business was their life. Private business owners are not good at separating their business from their personal life. In fact, I don't think they should. I think it's unhealthy to do that. I think you need to integrate it, not separate it.
Having said that, once you sell your business, that part of your life is gone, so you need to fill that up with something else. If you don't know what that something else is, you're likely to have a couple of years where you're very lonely and have a really hard time.
Noah Rosenfarb: Before we wrap up, Josh, why don't you offer our listeners, especially the owners on the call, some tips, tricks, bits of advice that you think they should heed?
Josh Patrick: This is how we work with folks that we always offer. We have this process we call "What-Why-How-Who." It essentially goes like this. You say, "Okay, what is it I'm trying to accomplish," which is my postlude. It's something I think I want to accomplish. Then I want to ask why. I'm not going to ask why once, I'm going to ask why five times. I'm going to drill down on the reason until I get a core reason of why I want to do what it is I think I want to do. Then I'm going to go back and I'm going to check on, "Is that what's the right what?" If it's not, I'm going to change my what, "What is it I'm trying to accomplish?"
Once I get clear about what I'm trying to do, then I can figure out who do I need to help me to get there and how am I going to do it? Once I am really clear on what I want to do, when other people start wandering off in their own directions as most advisers do at some point, I can reel them back and say, "No, we don't want to go there. We want to go here." If you do that, no matter if you're going to keep your business, you're going to sell your business, you're going to grow your business, you're going to make yourself a passive owner, whatever you're going to do, you're going to be pretty clear about what you're trying to do, who do you need to get there, and how you're going to do it. If you do that, you're likely to be pretty successful in what you're doing.
Noah Rosenfarb: Great advice. Well, Josh, if anyone listening wants to get in touch with you, they want to have a better life and they want your help in creating value in their personal business life, what's the best way for them to contact you?
Josh Patrick: Well, probably e-mail is the best way, and my phone is the second best way. Either way you can do that is just go to our website, which is www.stage2planning.com, with the number 2, and on the top right-had corner, you'll see a number for Burlington. I'm in the Burlington office. Or you can e-mail me at [email protected]. Either way is fine.
Noah Rosenfarb: Great. I want to thank you so much for joining us today. For our listeners, please, I encourage you if you can to take a moment on iTunes and leave us your feedback. We always appreciate hearing from you. Thanks to Divestopia for hosting us. We look forward to having you join us again for another podcast. This is Noah Rosenfarb, always glad to have you with us.