Often, the exit of a business will be a once in a lifetime event for its founders, with the potential to influence many generations to come. To obtain a premium valuation that also achieves a founder’s legacy and succession objectives, it is too late to start the exit process at the time in which you decide to put your business on the market for sale. Rather, meticulous and patient planning and execution is required to extract full value in the period of time leading up to this event. I refer to these steps an SME needs to take as “getting the house in order”.
The required time and effort differs from business to business and shareholder to shareholder however typically, it can take three to five years and involve three common factors being people, size and growth. This is predominately due to valuation multiples often being driven by the organisation’s growth and risk whilst human capital is important to the longevity of any organisation.
Human capital is a crucial factor in any transaction. A potential acquirer wants to be comfortable that those integral to the future growth of the business remain involved post transaction whilst founders want to ensure that any deal meets their own personal succession objectives.
To achieve a premium valuation that also meets these specific founder objectives, it is important to first fully understand what they are and then plan for how they may influence a potential deal. Common “house in order” people steps include:
Founder succession: does a founder wish to step away from the operational side of a business when they exit and if so, what is the associated human capital required to bridge this gap? Hiring and training leadership positions (i.e. CEO, CFO etc) into these roles prior to exit takes time. This also allows founders to prove that they have transitioned out of the business at this point
Board members: sourcing experienced and independent board members to help guide the organisation moving forward
Management retention: implementing a management equity plan to reward and retain key staff and show that they are financially committed to the future growth of the business
Additional people investment: further hiring and investment at all levels to facilitate increased growth over the coming period leading up to an ultimate exit and beyond.
As Mark Salsbury (Author of Human Capital Management) said “while extraordinary products and unique services still afford a competitive advantage, the one advantage that stands the test of time…is people”.
Size & Growth
Investors associate size with risk. They tend to deem a small enterprise to be riskier than a larger business in the same industry. Likewise, businesses with growing and diversified revenue streams tend to be viewed upon more favourably. Common “house in order” size and growth steps include:
Mergers and acquisitions (buy): founders have usually already identified companies that would fit well with their business otherwise, a growth partner can assist with this. Acquisitions can bring immediate scale and/or additional complimentary revenue streams. They can also assist with plugging the talent gaps referred to above (i.e. bringing management capability from another organisation)
Building out new product/service offerings organically (build): to help grow and diversify revenue streams, a company may use this period to build out new complimentary service offerings. Even if it is a relatively new vertical, starting this process will help justify to a potential buyer the future growth potential of the organisation
Further investment in existing capability: due to priorities, capacity or capital restraints, the existing business may be underinvested. Often, we see gaps in sales teams, marketing, or product development. With additional investment in these areas there are often quick wins and growth to be unlocked in the existing organisation.
The buy and build strategy is an excellent way to facilitate accelerated size and growth in the lead up to a potential exit. When it comes to inorganic growth, it is important that adequate time is allowed to source, transact and integrate the right opportunities. Likewise, it is crucial that adequate time is allowed to strategise, implement and prove out any new organic growth initiatives.
Pemba works closely with founders to consider an ‘ultimate’ exit. The “two pay day” structure allows founders to partially exit to an experienced growth investor who can help implement some or all of the above steps whilst working towards a shared outcome. Time frames will vary however they are set by the shareholders and linked to their own personal objectives.
If you are interested in hearing more about the above or would like to hear more about how Pemba could assist with “getting the house in order”, please reach out to me for a chat.