Business Value and Lottery Tickets

In my previous post, a fictional owner, Carl, had just met with an exit-planning advisor, Jane, not because he thought he needed to, but rather out of an abundance of caution. After meeting with Jane, he learned that he needed $6 million of assets to maintain financial security post-exit, but his current assets (including his wholesale bakery business) were worth only $3 million. As so many owners do, Carl discovered—only when he was ready to exit—that the assumptions he’d made about the value of his company, its likely sale price and the rate at which he could safely withdraw funds from his nest egg were incorrect. To retire as he desired, Carl faced years of building value in his business.

We pick up our story as Carl briefly ponders the option of buying hundreds of lottery tickets before his natural cautiousness returns.

Carl Faces The Facts

Of course, no true exit plan would ever rely on the lottery to deliver success. But what can Carl do, knowing that he needs more money to exit his business on his terms and that that will require him to stay in the business for longer than he wants? The ever-studious Carl sat down with Jane and faced four facts regarding his business exit:

  1. Carl knew he needed to figure out how to create $3 million of additional capital as quickly as possible.

  2. He knew that the likeliest source of that capital was his business: He must increase its value and cash flow before he began to seriously consider the lottery as his only out.

  3. Carl begrudgingly understood that he needed to delay his desired exit date. He decided that he was willing to stay in his business for six years—no longer. (This assumes that Carl invests the increasing cash distributions, after-tax, for six years.)

  4. To grow his business’ value and cash flow by 60% in six years, Carl needed to increase business value and cash flow by 8–10% annually.

Have You Faced Facts?

Jane kicked off Carl’s fact-finding mission by having him articulate and quantify his goals and resources. With that information, they ran a Gap Analysis. You, too, must ask:

  1. How much cash must I have when I leave my business to live the post-exit life I desire?

  2. What is my business’ likely sale price, after taxes, debt repayment and transaction fees?

  3. What is the current value of my non-business investment assets?

  4. At what rate do I think I can safely withdraw funds from my nest egg?

If you find that you must cultivate growth in your business’ value and cash flow at an annual rate of 8–10%, you too might be tempted to buy lottery tickets, especially because few businesses over the last decade have maintained annual earnings and revenue growth rates of 10%. According to James Allen and Chris Zook of Bain & Company,

As a benchmark, consider an annual growth rate in revenue and earnings of 5.5%. Most companies expect to attain that level or better—at least that’s what their strategic plans call for. But a [2012] Bain & Company study of more than 2,000 companies indicates that only about one in 10 actually achieves that relatively modest goal over a 10-year period while earning its cost of capital. In other words, nearly 90% of companies fail to achieve that modest growth objective.

Most owners, including me, are convinced that our businesses will grow faster than 8% each year. Sadly, facts and our own histories indicate otherwise.

Get Real About Your Business

The first step in increasing the rate of growth in your business is to know your history : What is your company’s average growth in revenue and earnings over the past five years? If, like most owners, you need to increase that rate to exit on your terms, ask yourself, “What must I do to grow my business at a rate that allows me to achieve my financial security goals within my exit time frame?” As you think about this, realize that only you have the authority, responsibility and skills to effect this change.

Get Real About Yourself

I don’t know the exact answer for growing your company, but I do know that you can’t do business as usual. Change, to be effective, must begin at the top, with you and your management team. Let’s look first at the most common owner-based problems.

  1. Relying on assumptions: Don’t rely on assumptions. Your exit is too important. Recruit an experienced exit-planning advisor to help you accurately determine whether there’s a gap between the resources you have and the resources you need to exit.

  2. Trying to do it all: Successful exits require you to delegate. Peter Drucker, the world’s foremost authority on management theory and practice, says it best:

Long before the time has come at which management by one person no longer works and becomes mismanagement, that one person also has to start learning how to work with colleagues, has to learn to trust people, yet also how to hold them accountable. The founder has to learn to become the leader of a team rather than a “star” with “helpers.” (The Essential Drucker, 2001, 155–156)

  1. Remaining stagnant: Successful exits often require owners to assume a new role. You must take on a different role in the business, such as overseeing and directing strategic planning decisions, and offering advice. Most importantly, your business must be able to thrive without you to give it the most important characteristic for buyers: transferable value (a company’s ability to maintain and grow cash flow without its current owner’s involvement).

Get Real About Your Management Team

The other chokepoint for growth is your management team, regardless of whether you can afford one or not. Again, Drucker explains: “[Entrepreneurial management] requires . . . building a top management team long before the new venture actually needs one and long before it can actually afford one” (145). To Drucker, “new” means companies whose “products are first-rate, the prospects are excellent, and yet the business simply cannot grow” (152).

Your management team, not you, must lead the charge into faster growth. If members of your team do not have the skills, support them via additional training. If they are not willing or able to change, replace them or add new employees who have necessary skills and drive. Outside consultants can help you assess your team and hire to fill its weaknesses.

Once you and your best-in-class management team are in their proper roles, you are poised to consider specific strategies to drive business value, and that is the topic of my next post.

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