Understanding EBITDA; How To Calculate Earnings Before Interest, Taxes, Depreciation & Amortization

The article below is written by Viking M&A, and it goes over EBITDA. EBITDA is the primary metric for determining a business’ true profitability and cash flow. We see most good businesses in the lower middle market selling between 3-5x EBITDA. This is known as a multiple, and it can be adjusted up and down based on specific factors of each individual business. Some positive multiple increases occur when a business has strong recurring revenue, consistent annual EBITDA, or good opportunities to grow. Some factors that would hurt a multiple would be keyman risk, customer concentration, or a cycle business model.

WHAT IS EBITDA? WHAT IS IT USED FOR?

EBITDA stands for Earnings Before Interest, Taxes, Depreciation and Amortization. EBITDA is one of the indicators our firm uses in determining the value of a business, as well as its future financial performance and earning potential. EBITDA is net income with interest, taxes, depreciation and amortization added back, and is used as a calculation for determining the cash flow of the business. At Viking M&A, our experienced financial analysts use this proxy in calculating the value of a business. An EBITDA analysis is essential when comparing similar companies within a single industry during the valuation process.

Let’s look at the aspects involved in an EBITDA calculation:

INTEREST

Interest expense is found on a company’s income statement or profit and loss statement and is added back in our valuations. Interest is a non-operating expense and will differ between individuals. The interest expense line item can consist of interest from loans, lines of credit, or other forms of debt. In order to perform an accurate valuation, we always ask business owners to provide us with appropriate financial statements which will include interest expense. These include the last two years of federal tax returns, two years of Profit & Loss Statements (P&L) including balance sheet, and interim financials.

TAXES

At Viking, we use the net income on the first page of the tax return and only add back items that have been expensed from that net income. This includes the expenses listed on the first page and expenses on the Other Deductions Statement. The tax portion of EBITDA rarely comes into play in our valuations because of this. However, when looking at a P&L, estimated tax payments to the State or Federal Government will be part of EBITDA.

DEPRECIATION

To understand depreciation, you must first recognize the importance of fixed assets. Fixed assets are tangible assets, meaning that they have a physical form and can be touched. Tangible assets include equipment, machinery, land, etc. Depreciation involves the expensing of fixed assets over its useful life. Useful life is the predicted lifespan of a depreciable fixed asset. Depreciation is a non-cash expense that restores the cost of a fixed asset.

AMORTIZATION

Amortization involves the expensing of intangible assets rather than tangible assets. Intangible assets are non-physical assets that include goodwill, copyrights, patents, trade names, customer lists, franchise agreements, etc. These assets are included on a company’s balance sheet and have a multi-period useful life. Intangible assets are typically difficult to evaluate compared to fixed assets.

CALCULATING EBITDA

Calculating EBITDA involves reviewing a business’s income statement and can be expressed in two different ways:

  • EBITDA = Earnings + Interest + Taxes + Depreciation + Amortization

  • EBITDA = Operating Profit + Depreciation + Amortization

Both calculations result in the arriving of EBITDA.

Please visit Viking M&A for more information on business valuation and other M&A topics.

Pittsburgh Named Best City for Small Businesses

Not Boston, not Chicago, but Pittsburgh was named the best city for startups and small business per an evaluation by Citymart that assessed public procurement experience and innovation in 56 U.S. cities and counties. “Pittsburgh scored highest on the Small Business Accessibility Score (SBAS), providing the best discovery and decision-making experience.” Per the Pittsburgh Business Times article, “The scores range from zero to five. Pittsburgh led the way with a score of 4.30, followed by San Antonio, Texas at 4.15 and San Diego, California at 4.07.”

Having Fun Learning My New Business

Below is the text from an interview of prior GTE Operator-in-Residence after transitioning into his role as President of Pro Max Fence Systems.

SEARCHFUNDER INTERVIEW OF BRENDEN VAN BUREN 

We spoke with Brenden Van Buren who co-founded Generational Transfer Entrepreneurs and acquired Pro Max Fence Systems.

How did you get on the search fund path?

I worked in a large family business which specialized in heavy highway construction and construction materials supply. I am fifth generation with many other family members and wanted to break out and have more senior level management responsibilities. I decided to leave and went to work with my dad on a company that he had acquired doing his own search (not using the search fund methodology). Our goal was to acquire, manage and grow more businesses. At about the same time, I applied to business school to learn more about small acquisitions and entrepreneurship.

I found out about search funds from a classmate of mine at Carnegie Mellon, Rob Southern, who is Jim Southern’s son. I then met with one of my professors at Carnegie Mellon who encouraged me to do more research about search funds. It was enlightening. While in school, I decided that I definitely wanted to search and buy a business. CMU was incredibly helpful in helping me in this path as I quickly joined the EtA Track. My dad and I adapted some of the search fund techniques to form Generational Transfer Entrepreneurs, to allow multiple people to search alongside us. It was a no-brainer with what I wanted to do and learning about this thing called a “search fund.”

Tell me about your search.

The search process starts about a year before you actually start searching. I reached out to all the previous searchers to build a system that would be as successful as possible. I talked to dozens of searchers to figure out what went right or wrong, what they liked about interns and didn’t. Do we want to do a proprietary search, opportunistic or both? I like the proprietary channels. As someone who has always really liked working with people, I like the idea of having a lot of interns working with me.

We then had to figure out what was the best system. We had to figure out where we should get our lists from. A lot of that came from previous searchers on what worked well for them and what didn’t. At GTE, we had 20 interns at any given point in time. 6 of whom were on my team. I was looking at the construction industry based on my background. We sent out several hundred emails each week. The company I acquired was through one of those letters.

It’s amazing how different all your owner conversations go. That was probably one of my biggest lessons learned: Take every call. There is no such thing as a bad meeting or a bad call. For this business, the first call went very well. The owner wanted to meet very quickly. I just happened to be in the area. We got together on a Saturday. What I thought would be a one-hour conversation turned into a 4-hour discussion.

The search process was to grind through as many lists and owner phone calls as possible. I probably took 3 to 6 new calls per week for the year. That leads to a lot of potential companies, somewhere between 150 to 300 companies, just having first calls.

How many LOIs?

Our IOIs looked a lot more like LOIs. In our discussions, before we got to what most people would get to on an IOI, we were talking to owners about price and making verbal offers and then sending IOIs. We did the IOI before spending money on attorneys to do a more binding LOI. I had 6 or 7 IOIs and just the 1 LOI. I probably made verbal offers of some sort – just trying to figure out if their price was ever going to be close to ours – on a couple dozen companies.

Were there any IOIs that you were disappointed did not go through to a deal?

There were a couple of those. One of which was more surprising than disappointing. The owner and I had talked about price several times. I originally thought we would never be close to the owner on price. So, I told the owner so in an email. He responded that he thought we would be close and he was interested. He responded, “No, no, no. I think we’ll be closer.” I then met with him for a third time, informing him that the terms we were offering was as good as we could do. He seemed to accept it and asked that I draw something up, saying “I think that will probably be good.” He was a cabinet maker, which sounds like a boring business. He had a lot of growth opportunity. He was a craftsman. So, he hadn’t been working on the business at all. I was very excited about that one. It was also close to where I was living, which has its benefit. It turned out we weren’t close on price after all. As I said, it was more of a surprise than disappointing.

What do you think happened in hindsight?

In hindsight, I think a broker contacted the owner around the same time that I did. I think the broker put a number in his ear that was unrealistic as far as the business’ value.

How long did it take you to go from IOI to closing your acquisition?

Around 6 months. The first IOI was sent around December 14th. We negotiated that for another month or two. We signed an LOI in late February. We closed June 22nd.

Any hiccups along the way?

A few, but they were standard things. For instance, you thought you’d discussed the point, like the seller note, and then maybe his lawyer got in his ear maybe or wanted to push it a little more. Nothing major. The diligence surprised us a lot. The business was in better shape than we anticipated during the diligence.

That’s always a happy surprise.

Yes. It’s construction which generally has many single job contracts. But, there’s more recurring aspects to this business than we anticipated. The software he was using in this field made it very easy to go through his books, talk to him about his financials and confirm his financials. We did an asset sale. We did a fair amount of diligence on the legal side to ensure there weren’t big liabilities lurking out there. He was getting paid quickly and he paid his vendors well. All those things were better than we were anticipated going into the process.

Did he have a business advisor or broker?

No. He talked to his accountant and his lawyer. In the early stages, his accountant was advising him. Once we got to the LOI stage, he was working with his lawyer.

Any lessons learned during the diligence process?

I would have clarified a couple of points earlier, relating to the seller note, how long the payback period would be and if there were interest only periods and how long those would be. I would have clarified a little more in the IOI or LOI. It added more stress on me having to re-negotiate points that I thought were already done.

Tell me about your first day.

It flew by. I met with everyone the first day. At GTE, we have a CPA on staff. The CPA and I came down together. I worked on more of the operations side. He was talking to the office staff to ensure that we were going to be able to work and pay every one the first week. Getting payroll squared away within 1 week is a lot of work. We must have certified payroll for government projects. There was a lot to go into that that had to be condensed into 7 days.

The first day was meeting all the crews and then shadowing the owner. The way it works with the previous owner is that he’s been doing his day-to-day tasks and I shadow him. Next month, we will switch. I will do the day-to-day and he will shadow to let me know things that he would do differently. That way, I get his processes all down.

The first day we started on working on how to schedule all the crews. And, on the other side, making sure the accounting system was ready to accept payroll come Friday.

Did the employees have an idea beforehand that the sale was taking place?

No. The owner and I discussed making an announcement. He made the announcement to the office staff on Wednesday evening and the crews on Thursday. We closed on Friday. I arrived at the office on the Monday.

The Vice President, who ended up buying a little back into the company with us, knew a little earlier.

So, I’m interviewing you 1 month into operating.

It’s been a very busy, crazy month. My background in construction has helped in the transition, but there’s a lot of knowledge in the owner’s head, trying to get as much of it out as possible is a lot of work.

How long will the owner stay on?

We negotiated a 90-day full time consulting with an option to extend another 3 months if we wanted. After that, there is 9 months of part-time consulting. The goal is from months 3 to 12 to drop down to 10 hours per week.

What do you think so far?

I am having so much fun learning about this business and then working with this staff. The owner did put together a great team. I’ve had a great time working with all of them. How well will you mesh with the team is always a question going in. It harkens back to the first conversation I had with the previous owner, which lasted 4 hours, and a lot of the following conversations. We just had a lot in common. Russ built a team that had other things in common with him. So, just by default, I have a lot in common with the people here. That’s been very helpful.

Any other priorities for this first period (beyond getting to know the people and addressing the accounting/payroll)?

The number one priority relating to operations and business is learning how to schedule all the crews as efficiently as possible so that's probably where I spend the vast majority of my time. Each day is just learning from the previous owner what he does and the processes he follows to do that. There's also making sure billings are out. We're going to do our first month end accrual next week. Then, there's the typical owner tasks. The priority is really making sure the scheduling is done as efficiently and effectively as possible.

You’re just a month in and may not have had a chance to digest things. But, is there anything that you know now that you wish you had done differently?

It's probably a little too early to say. They're small things. Following the example in the ^Greg Ambrosia case study, I have been taking daily notes after everyone leaves and just writing everything that I can remember from that day down. In some of those, there are clearly some little things like: “I wish I would have had the handbook ready on Day 1 to introduce to everyone.” Nothing huge, probably maybe just a little bit better introduction on Day 1. On the other hand, I was trying to keep it short and simple which I think helped. I probably could have a little bit more preparation from an HR side.

What do you mean as far as a better introduction?

I think more about HR policies. The goal (which we told them) was “We're going to try to keep everything close to or similar to what you've been doing as possible.” But, there's going to probably be some minor adjustments and having a couple those suggestions that I probably knew at that point just ready would have been helpful

 In the construction industry, there's always call offs. I think we probably could have introduced ourselves a little bit better to try to prevent the call offs.

What is a call off?

A call off is whenever an employee calls you in the morning of, saying “I won't be there today. I'm sick.” Sometimes health is the issue, many times they just might not feel like coming in to work; unfortunately, it can also be personal issues or something at home. In construction with a blue collared worker, it's not uncommon. We’ve seen it in our family businesses for years. We've come up with solutions that really help with that. The goal is to implement them. I'm waiting for a roll out of a new handbook and some other HR policies with our 401K, which will be ready next month. While all the guys were together in one room, it would have been helpful to have some of that stuff prepped before showing up. There's just so much to do leading into the closing that having an HR policy ready to go would have been tough.

Wouldn’t you worry that you might send too strong of a signal of there being “a new sheriff in town."

It's one of the things I go back and forth in my head. The way we would have worked the policy is to give more incentives versus disincentives -- which is what we will do. More of “Here are rewards you can expect if you do these things” versus “These are your punishments if you don't show up.”

Here's goals that I would have for you as we progress. Just having some of those in place earlier would have been very helpful. I haven't even done it yet. We're in the middle of the summer and construction is very busy this time of year. So, bringing the guys together is a big-time loss. Thus, it would have been helpful while everyone was together that one day at once to roll out couple things earlier.

That’s a very interesting point based on the industry you are in. Anything else about your experience so far that you’d like to share with other searchers?

The busy season is different for every company. If we had closed a few weeks earlier, I think it wouldn’t have been as big of a deal. We just hit right as a lot of jobs were coming in for them. So, timing is everything there.

As far as other lessons learned, it's early on. Building a good relationship with the owner and the staff is just so important. I think we've done that well so far. A lot of that relationship was built during the acquisition process. Stressing how important that is for the transition. You always hear the negative stories of: “I showed up and the owner was gone and barely doing anything within a week.” That hasn't been the case here at all. Does that mean this is the right way to do it? I have no idea. But, building the relationship has been very helpful for me.

So, it was ambitious doing your own search but then doing a search while starting your own search enterprise. Do you have limitless energy?

My wife will tell you that I never stop working even at home. On top of it, we have a 5-month-old. She was born about a week before we signed the LOI. It’s been a very busy six months.

I think it just comes down to building the correct processes. If you're building the one process for yourself, how much of a difference does it make if you build five people at once. A little bit of it was economies of scale. I had good partners along the way. For example, Gabe Chick, who is working at GTE now. He was brought on very early in the school year of our second year. He and I basically had been trying to prep the whole system before we even showed up. There's always tweaks. While you're making the tweak, it's improving everyone else’s search. You probably would have made the tweak anyway. Then, we hired a person to handle our search management which I was doing originally. So, a lot of stuff just slowly went off my plate. I just had to teach other people to do the stuff I was doing early on. Maybe there's a little bit of more energy but for a lot of it, you must build the process anyway and you really want to analyze what you're doing. Having a team around you to do that probably builds enough efficiencies that the loss of efficiency from trying to build both at the same time might not be a break-even but it comes pretty close.

I must ask you about the conversation with your wife when you said: I want to start a search fund plus I want to form an incubator, GT entrepreneurs. What was that like?

She always knew that I just like to go. Going into business school, the goal was that my dad and I wanted to buy more businesses and grow them by finding inefficiencies in them or where they're missing their sales opportunities. She knew the goal and was pretty accepting of my wanting to search and start the enterprise. It was a clearly stressful for her as far as the question of where are going to live.

But, having me work a little bit extra probably wasn't that much different than what we've always had, because I always had some sort of side project that I was working on while at work. This was just the side project. I know a lot of business schools have a lot of work -- but with all the analytical stuff that we end up doing at Carnegie Mellon on top of the regular MBA curriculum, I probably worked less after grad school than I did during grad school. So, she was probably happy as far as that goes. It was more of the uncertainty of where we were going to be. She was in grad school while I was in grad school.

Congratulations on having a baby and buying a company at the same. Those are some huge life changes all at once.  

Whenever you search right out of school, everyone is in a similar boat, maybe you are just married or just about to get married, and then maybe you have a kid or maybe you have one while you're searching. At the age of 28 to 35, there's a lot of life events going on. So, they just all end up getting compounded on top of each other. They're all rewarding experiences you sometimes have to slow down and look at everything that's going on. It's tough to do it all at once. I think I did help convince my wife a little bit when we went on a two-week vacation right before we closed, being pretty certain that everything was going to be finalized. I think it helped alleviate a little bit of her stress.  

Tell me about where Generational Transfer Entrepreneurs is now and where you think it's headed in the future.

Right now, we've closed on two companies. We just hired someone to replace me. We'd already hired someone to replace Tom which was the first acquisition. With anything you have the chicken-and-egg problem. You must show successes before everyone starts coming to you but we have been having success getting interest at least from Carnegie Mellon and the school has been helping us out a lot in terms of both work area and space and then also finding good recruits and advisors. Where I see us is with 3 to 5 searchers every year, continuing to go forward and gaining more investor recognition as well as we close a few of these deals. Most of the money was started with our family money and some close personal family friends as well. We've been getting a lot more traction since we closed on two deals with people being interested in what we're doing. I see us continuing to grow that way. We will need more office help as we get bigger. Right now, for the non-searchers, we've got our search manager, our accountant and then my dad, as the managing director. We currently have 3 searchers after replacing Tom and I.

What do you think differentiates Generational Transfer?

The biggest thing is just the types of companies that we will look at. The search fund model has very specific parameters some of which are followed very strictly by some other groups or by the investors themselves. Our investors backgrounds are in slightly different industries. As a result, we are pretty industry agnostic. That being said, we're looking for searchers that have some experience in the Industry. If I wanted to go buy a tech company, I don't know if I would have gotten support for it. Tom buying a tech company made a lot of sense, even though he ended up with a medical company.

Our ability to look at a different box then some other groups is our main differentiator. We've been flexible in what types of deals we allow the searchers to do as far as what types of deals they can look at and then also how the deal ends up getting structured. We also allow the searchers to add their own money or friends and family money on their deals. I’d classify us almost like an accelerator on the Harvard model or something like that.

A lot of searchers are concerned about the mentorship aspect of it. Can you talk a little bit about that?

This goes back a little bit to the chicken and egg thing. We have built a group of people that have experience in business. Our family’s network is large in terms of Industry. Tom, who I mentioned was our first searcher, bought a medical company that had a practice and a device. We quickly found within my dad's personal network, a person who had built out an orthopedic practice in the past who had run that from two offices to 8 offices. We knew what type of mentor would be good for that business and brought that person along as a paid Advisory Board position. The goal is to have mentors for the searchers

As companies are acquired, we end up being able to help each other out a lot. For example, yesterday I was on the phone with one of our other Searchers about a deal that he was looking at just based on looking at similar deals to them. Then my dad being fully involved on the day-to-day, he ends up talking to each of us all the time about where we are. Our family business was fairly large; we did just shy of a billion in sales. He helps mentor a lot and was the chief operating officer of our business of our family business before we went out and start doing things on our own.

There’s mentorship there and the goal is to use our personal networks to for mentors as we grow.

You discussed searchers with industry experience. Is there anything else that you're looking for in GTE’s searchers?

 I think it’s the ability to be in some industry. Gabe was in the military before getting his MBA. He’s looking at businesses that would have similar work forces to that. The real key that we look for is the ability to manage people because you can get some really smart MBA's who can solve problems really well but we're buying companies with people that already are there. Being able to manage them on Day One is incredibly important. That's the number one thing that we probably look for.

Anything else you'd like to add?

We received some great advice got from some very smart people as we were starting up our search. There are a lot of different options out there now. They should all be explored before deciding. Do you want to do a search fund? Do you want to get into the group? Do you want to self-sponsor? Or, do you want some hybrid of all them? Go and see what the pros and cons are. Each choice is different. Each one is better for different people for different reasons. That's the best advice I got because we were trying to decide do we start up GTE, do I just go do a search fund, or another option? I spent the whole summer researching everything. I skipped an internship offer that I had that was pretty nice to go and make sure that I made the right decision for myself in terms of searching. Talk to everyone and learn the pros and cons from the people that are doing it.

That's all the questions I have. Thank you for your time.

Great talking with you.

Summary of Insights

Here are our a few of the key takeaways from our discussion with Brenden:

  • Take every call. There’s no such thing as a bad meeting or call.

  • Clarify the seller note early on.

  • In preparing your Day 1 introduction, there’s a trade-off between assuring the employee base of continuity and a desire to make changes. The seasonality of your business may impact your timing of changes.

  • Building a good relationship with the owner pre-acquisition is paramount.

  • Fully investigate the different search models to choose the one that best fits you.

For more information about acquiring and the early days of owning a business, you can find the original article below at Searchfunder.com.

https://www.searchfunder.com/p/9GQgud7e+&cd=1&hl=en&ct=clnk&gl=us

5 Simple Rules For Transitioning a Family Business to the Next Generation

The idea of passing along a business to one’s children—and hopefully again to their grandchildren—is one that appeals to many business owners that have started and grown a company. However, making the initial transition from Generation #1 to Generation #2 can be more difficult than it seems.

However, there are a few helpful considerations to make if you have begun to start thinking about a generational shift in your business:

(1) Determine whether or not your children are truly interested in inheriting the business, along with its responsibilities.

(2) If your son or daughter is in fact interested in the business, adequately preparing them for the role is a must. This may include majoring in a related field, or gaining 5-10 years of experience with another business in a similar industry.

(3) In the case that more than one of your children is interested in getting involved with your business, you should establish clear domains for them to navigate and assume responsibility for.

(4) Strategize an “exit” in a way that makes sense. Specific considerations to make include recognizing the fact that you may lose any longtime executives serving under you that may have hoped for the chance to run the company themselves if you choose your child as a successor, as well as ensuring that you are around long enough after bringing on your children to ensure that they understand the ins and outs of the business.

(5) Do not be afraid to consult outside sources (ideally, skilled experts in helping family businesses) as a means of navigating the generational shift in ownership. Avoiding the splitting of family ties over questions about fair distribution should be a top priority at all stages of the process.

For more information on successfully transitioning a family business to the next generation, read the following article from Inc.com:

https://www.inc.com/jim-schleckser/5-simple-rules-for-transitioning-a-family-business-to-next-generation.html

Photo Credit: Getty Images

Search Funds: Big Opportunity and Big Returns

Did you recently earn an MBA? Do you want to own a company? What factors are keeping you away from this goal? For some recent graduates, they may not have the funds, or they don't have CEO experience, or they just can't think of an idea to create a business out of. A good way to start achieving this goal, and to combat the mentioned obstacles, is to buy a small company. 

Such a strategy derives from the idea of search funds, a fast-growing niche in the private equity market. By participating, recent graduates and entrepreneurs find investors to fund the former's search for a promising small company. The investors can also mentor the entrepreneur in building up the company from where it was in the market, potentially earning very high returns for both parties. In the very long term, this experience makes the entrepreneurs look incredibly attractive as CEOs for larger companies. 

For more information and examples of search fund successes, read the following article from Market Business News: 

https://marketbusinessnews.com/promising-small-company-ceo/189125/

Photo by Olu Eletu on Unsplash

Mergers & Acquisitions & Mergers & Acquisitions…

Large M&A transactions are becoming a key to survival for companies. In today’s globalized economy, a company’s own resources can only help them grow so quickly; acquiring and merging with other firms is necessary to keep up with the competition.

M&A has been especially prevalent in the tech and telecommunications industries. In the race to 5G, T Mobile and Sprint announced their merger which will help them pool resources to get the network up and running. AT&T’s acquisition of Time Warner represents the consolidation happening all over the streaming services industry- the Department of Justice finds the consolidation monopolistic and is taking a closer look at the deal.

The most recent news in M&A is with Apple- the company has purchased Dialog, a major supplier of iPhone parts. This is Apple’s biggest deal, but not the first of its kind; the company has a history of acquisitions in an effort to vertically integrate its manufacturing.

Could corporate consolidation pose a danger to the competitive landscape in tech and telecommunications? What will this landscape look like in a decade if consolidation continues and hypervaluations in tech stocks don’t hold? Make sure to keep a close eye as it all unfolds.

GTE Moves Its Office Into the New Swartz Center for Entrepreneurship at the Tepper School of Business

As the public Thursday tours Carnegie Mellon University's futuristic new business school complex, with sweeping views of Oakland and amenities from smart-looking classrooms to an espresso bar, some may be moved to ask:

"What exactly is supporting all this?"

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.

How to Lose Your Best Employees

You want to be a great boss. You want your company to be a great place to work. But right now, at this very moment, one of your key employees might be about to walk out the door.

She has consistently brought her best game to work and has grown into a huge asset. But her learning has peaked, her growth has stalled, and she needs a new challenge to reinvigorate her.

As her boss, you don’t want anything to change. After all, she’s super-productive, her work is flawless, and she always delivers on time. You want to keep her right where she is.

That’s a great way to lose her forever.

This was my situation more than a decade ago. After eight years as an award-winning stock analyst at Merrill Lynch, I needed a new challenge. I’ve always liked mentoring and coaching people, so I approached a senior executive about moving to a management track. Rather than offering his support, he dismissed and discouraged me. His attitude was, We like you right where you are. I left within the year.

This kind of scenario plays out in companies every day. And the cost is enormous in terms of both time and money. But if I had stayed and disengaged, the cost may have been even higher. When people can no longer grow in their jobs, they mail it in — leading to huge gaps in productivity. According to Gallup, a lack of employee engagement “implies a stunning amount of wasted potential, given that business units in the top quartile of Gallup’s global employee engagement database are 17% more productive and 21% more profitable than those in the bottom quartile.”

And yet engagement is only symptomatic. When your employees (and maybe even you, as their manager) aren’t allowed to grow, they begin to feel that they don’t matter. They feel like a cog in a wheel, easily swapped out. If you aren’t invested in them, they won’t be invested in you, and even if they don’t walk out the door, they will mentally check out.

How do you overcome this conundrum? It starts with recognizing that every person in your company, including you, is on a learning curve. That learning curve means that every role has a shelf life. You start a new position at the low end of the learning curve, with challenges to overcome in the early days. Moving up the steep slope of growth, you acquire competence and confidence, continuing into a place of high contribution and eventually mastery at the top of the curve.

But what comes next as the potential for growth peters out? The learning curve flattens, a plateau is reached; a precipice of disengagement and declining performance is on the near horizon. I’d estimate that four years is about the maximum learning curve for most people in most positions; if, after that, you’re still doing the exact same thing, you’re probably starting to feel a little flat.

Take my own career: I moved to New York City with a freshly minted university degree in music. I was a pianist who especially loved jazz. But I was quickly dazzled by Wall Street which, in the late 1980s, was theplace to work. I secured a position as a secretary in a financial firm and started night school to learn about investing.

A few years later, my boss helped me make the leap from support staff to investment banker. It was an unlikely, thrilling new opportunity that required his sponsorship and support. After a few years, I jumped again to become a stock analyst, and I scaled that curve to achieve an Institutional Investor ranking for several successive years.

When I began, I was excited to be a secretary on Wall Street. I was also excited to become an investment banker. And I loved being a stock analyst. Though I started in each of these positions at the low end of their respective learning curves, I was able to progress and achieve mastery in all of them.

Eventually, I became a little bored with each job and started looking around for a new challenge to jump to. Most of us follow similar patterns — our brains want to be learning, and they give us feel-good feedback when we are. When we aren’t, we don’t feel so good. The human brain is designed to learn, not just during our childhood school years but throughout our life spans. When we are learning, we experience higher levels of brain activity and many feel-good brain chemicals are produced. Managers would do well to remember that.

Because every organization is a collection of people on different learning curves. You build an A team by optimizing these individual curves with a mix of people: 15% of them at the low end of the curve, just starting to learn new skills; 70% in the sweet spot of engagement; and 15% at the high end of mastery. As you manage employees all along the learning curve, requiring them to jump to a new curve when they reach the top, you will have a company full of people who are engaged.

You and every person on your team is a learning machine. You want the challenge of not knowing how to do something, learning how to do it, mastering it, and then learning something new. Instead of letting the engines of your employees sit idle, crank them: Learn, leap, and repeat.

Generation X and millennials: Don’t screw up the largest wealth transfer in history

As we build families and age, the discussion of wills and estate plans becomes increasingly prevalent. Our financial planners (and children) want to make sure our assets go where we hope when we pass away — that nothing ends up in probate and that our money and valuables will be transferred seamlessly to those we love.

The only problem: no one talks about what happens after.  Why does it matter? Here’s why: We are at the brink of the largest intergenerational wealth transfer in history.

A $30 Trillion Wealth Transfer

Accenture reports that over the next 30 to 40 years, $30 trillion in assets will pass from boomers to their heirs in the United States alone. What many people don’t realize, however, is that 70 percent of those intergenerational wealth transfers will fail by the time they reach the second generation, according to The Williams Group, a financial advisory firm. Another study found that one third of people who received an inheritance had negative savings within two years of the event.

There must be a better way.

Many of those inheriting money are ill-prepared to manage it. A sudden windfall is often a huge temptation to spend and splurge, rather than an opportunity to make smart financial decisions. Without proper planning, the inheritance you pass on could easily dissolve, rather than providing your children and grandchildren with a solid financial future.

3 Ways to Pass on Values and Money

Luckily, you can turn the tide of failed wealth transfer. Here are three ways:

1. Make wealth a family discussion. Don’t wait until end-of-life to discuss what wealth means to you with your children and grandchildren. Let them know why financial security matters and how you would like them to use your money when you pass away. Yes, you might want them to take a family vacation to create special memories. But you might also want them to finish college, set up a retirement account or establish a foundation for a cause you love. They won’t know until you talk about it.

2. Focus on values — not balances. Many kids and grandchildren discuss how much they’ll get when someone in their family makes their transition. Instead of talking to your kids and grandkids about net worth, try talking to them about values. Forget your legacy — what is your family’s legacy? Do you want to instill the concept of giving to those in need? How about saving animals or serving refugees? When children grow up living certain values, they are far more likely to live them when you’re gone.

3. Establish a clear purpose for your wealth. You’re allowed. After all, you earned it. If you want your kids to use your wealth to launch a foundation, pay for their own child’s college or provide the down payment on a new home, let them know. Stipulate that those funds must be used as intended so they won’t go to waste. If you want a minimum of 50 percent of your wealth to be put toward a retirement nest egg or invested to launch a long-term scholarship fund for those in need, say it! Your children will likely thank you in the long run.

No matter how much or how little you are leaving to your children, it’s imperative that you take steps to keep that wealth safe. Money isn’t just for spending. It’s for building brighter futures, more secure retirements and safe living conditions. It’s for making a difference — and with your help, it can.

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