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33 SECRETS: AN OWNER’S GUIDE TO BUILDING A SELLABLE BUSINESS John Warrillow
Fall, 2012
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Introduction Whether you're growing your business or actively planning to sell it, these 33 “secrets” will help you to:
• Build a successful business that continues to grow; • Increase the sellability of your business so it’s attractive to future buyers; and • Negotiate the best possible deal when it’s time to sell.
The “secrets” combine the most important lessons I’ve learned over the last 18 years as I’ve started and exited four businesses and interviewed hundreds of business owners and acquirers for the articles and books that I’ve written. I’m now running a fifth start-‐up dedicated to helping entrepreneurs understand how to maximize the value of their business. Even if you have no intention of selling your business anytime soon, the best businesses are sellable; smart businesspeople build a company that will be ready to go on the market when it’s time for them to exit. This e-‐book is designed to be read like an à la carte menu; you can skim to find the sections that are appropriate for whatever you or your business need at a particular time. Or, if you like, you can read “a tip a day,” or read it from start to finish as an overview of what you need to do to work toward having a business that will attract buyers.
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Table of Contents Part I: Build a Successful Business
1. Defending Your Turf 2. Are You a Schmoozer or a Closer? 3. Sell Your Company, Not Your Product 4. Avoid the C-‐Word 5. The Ansoff Matrix, Part I: Where to Start When Your Growth Stops 6. The Ansoff Matrix, Part II: Make More Sales to Your Existing Customers 7. Have You Considered Recurring Billing? 8. The Hierarchy of Recurring Revenue 9. The Hidden Benefit of Systematizing Your Business 10. Four Ways to Foster Innovation in Your Company 11. Can You “Productize” Your Service Business? 12. Four Steps to Turn a Service Business into a Product Business
Part II: Increase the Sellability of Your Business
13. Write Down Your Number 14. Get a Divorce 15. Three Steps to Letting Go 16. More Steps to Letting Go 17. The Eight Factors that Drive Up Sellability 18. The Switzerland Structure: Minimize Your Dependence 19. Do You Have a Transferable Culture? 20. Create a Positive Cash Flow Cycle 21. Measure Customer Satisfaction 22. Your Growth Potential 23. Employee Loyalty: Carrots and Sticks 24. Re-‐energize Your Business
Part III: Negotiate the Best Possible Deal
25. The False Finish Line 26. Managing the Long Goodbye 27. Three Things I Wish I’d Known about Selling a Business
28. Questions You’ll Be Asked When Selling Your Business 29. The Math Behind Your Multiple 30. The Relationship Between Return and Risk
31. Four Reasons Big Companies Buy Little Ones 32. Avoid Deal-‐Killing Mistakes, Part 1: The Objective Questions 33. Avoid Deal-‐Killing Mistakes, Part 2: The Subjective Questions
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Part I: Build a Successful Business Contents:
1. Defending Your Turf 2. Are You a Schmoozer or a Closer? 3. Sell Your Company, Not Your Product 4. Avoid the C-‐Word 5. The Ansoff Matrix, Part I: Where to Start When Your Growth Stops 6. The Ansoff Matrix, Part II: Make More Sales to Your Existing Customers 7. Have You Considered Recurring Billing? 8. The Hierarchy of Recurring Revenue 9. The Hidden Benefit of Systematizing Your Business 10. Four Ways to Foster Innovation in Your Company 11. Can You “Productize” Your Service Business? 12. Four Steps to Turn a Service Business into a Product Business
Building a successful business requires keeping in touch not only with the ever-‐changing marketplace but also with the requirements of business acquirers, because either sooner or later you will want to sell
your business. This section has tips that will help you to: 1) get your business running smoothly and compete more successfully in the marketplace; 2) examine your role as business owner /CEO and keep your long-‐term goals.
1. Defending Your Turf How can you widen the protective moat around your business?
Warren Buffett famously invests in businesses that have what he calls a protective “moat” around them – one that keeps the competition away and allows them to control their pricing.
Big companies lock out their competitors by out-‐slugging them in capital infrastructure investments, but smaller businesses have to be to be more creative. Here are four suggestions:
Create an army of defenders Ecstatic customers act as defenders against other competitors entering your market. An example is Trader Joe’s successfully defending their market share in the bourgeois bohemian (bobo) market despite
heavy competition. Get certified
Is there a certification program that you could take to differentiate your business from the competition? A Canadian company that disposes of radioactive waste decided to get licensed by the Canadian Nuclear
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Safety Commission. It was a lot of paperwork and training, but the certification acts as a barrier against other companies jumping into the market and competing.
Get your customers to integrate The basic switching costs of Customer Relationship Management (CRM) software are virtually nil. Everyone from 37signals to Salesforce.com will give you a free trial. Is there a way you can get your
customers to integrate your product or service into their operations? Can you offer your customers training in how to use what you sell to make your company stickier?
Become a verb When you look for a recipe, you probably “google” it. Part of Google’s competitive shield is that the company name has become a verb. Is there a way you could control the vocabulary people use to refer
to your category or specialty? Widening your protective moat triggers a virtuous cycle: differentiation leads to having control over
your pricing, which allows for healthier margins, which leads to greater profitability and the cash to further differentiate your offering.
2. Are You a Schmoozer or a Closer? Have you ever stopped to think about your selling style?
To bring in big business, you need two distinct types of personalities: the schmoozer and the closer. Have you ever stopped to think about your selling style?
The schmoozer A schmoozer is a front person for a company—good at glad-‐handing customers and making people feel
loved. They remember customers by name and ask them about their lives. They are both door openers and door warmers.
The closer To be effective, a schmoozer needs to hand opportunities to a closer. The closer, understanding a customer's needs in detail, exposes a problem—often to the point of discomfort for the prospect—and
proposes a solution. Closers may be friendly but rarely become friends with customers, keeping their distance to retain their bargaining position in a negotiation.
Which one are you? I don't think a founder can be—or should be—both a schmoozer and a closer. You have to decide your role and hire for the other.
A good schmoozer needs to remain everybody's friend—keeping things light and informal, smoothing over the rough edges of a commercial relationship. A good closer, on the other hand, needs to know
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how to ratchet up the pressure in a negotiation, applying just the right amount of leverage to get a customer to decide without turning them off. If a schmoozer is the grease, the closer is the crowbar. For example, Don Tapscott, co-‐author of Paradigm Shift, Wikinomics and the 2010 bestseller
Macrowikinomics, built his former company, New Paradigm, with the help of Joan Bigham, his second-‐in-‐command, who is a great example of a closer.
“[A salesperson] is an amazing kind of person,” says Tapscott. “They view ‘no' as information, and they never take it personally. A consummate salesperson thinks dispassionately and strategically about the selling process.”
3. Sell Your Company, Not Your Product
As an entrepreneur, it’s not your job to sell products and services In 2002, I and 61 other entrepreneurs had been going to MIT for three years to learn how to be better
company builders. In the final year, Stephen Watkins, an entrepreneur who had recently sold his business, spoke to us, and he forever changed the way I think about entrepreneurship.
He began by canvassing the room to see how many of us were involved in selling our product or service to our customers. Almost everyone put up their hand, and Stephen proceeded to scold us. Basically, what he said was: “You’re selling the wrong product; your job as an entrepreneur is to hire salespeople
to sell your products and services so you can spend your time selling your company.” He explained that entrepreneurs add the most value when they design and start their business. After
that, the return on their time starts to go down rapidly as the business gets going. The entrepreneurs who earn the best return on their investment of money, time and energy are the ones who get in and out quickly.
His message was like a whack on the head. I felt like an amateur who had gotten a glimpse of a professional game and realized that the pros were playing with an entirely different set of rules. Here I
was spinning my wheels selling our services when I should have been marketing my company. From that day forward, I changed my role. I hired salespeople to call on customers. I still went on sales
calls, but they were to people I thought might one day buy my company.
4. Avoid the C-‐Word …and stop using consultant lingo
A lot of businesses start off providing a service and then fall into the trap of using the buzzwords of the consulting world. The problem is: consultancies are typically not valuable businesses because acquirers
generally view them as a collection of people who peddle their time on a hamster wheel.
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If you want to build a valuable company–one someone will buy down the road–consider re-‐positioning your company out of the "consultancy" box. You can start by eliminating consulting company
terminology and replacing it with the terminology of a valuable business. Consultancy
"Consultancies" rarely get acquired, and when they do, it is usually with an earn-‐out. Replace "consultancy" with "business" or "company."
Engagement An engagement is something that happens before two people get married; therefore, using the word in a business context reinforces the people-‐dependent nature of your company. Use “contract” instead.
Deck A deck is something you drink beer on. It's not a word to describe a PowerPoint presentation unless you
want to look like a "consultancy."
Consultant
Instead of describing yourself as a "consultant," describe what you consult on. If you are a search engine optimization expert who has developed a methodology for improving a website's natural search performance, say you "run an SEO company."
Deliverables Consultants promise "deliverables." The rest of the world guarantees the features and benefits of their
product or service.
Associate, engagement manager, partner
If you refer to your employees with these telltale labels of a consultancy, consider changing to titles like "manager," "director" and "vice-‐president."
Clients Companies with "clients" are usually prepared to do just about anything to serve their needs, which sounds great to clients but telegraphs to outsiders that you customize your work to a point where you
have no leverage or scalability in your business model. Use "customers" instead.
5. The Ansoff Matrix, Part I Where to start when your growth stops
Why would two companies in the same industry, with the same financial performance, command vastly different valuations? The answer often comes down to how much each business is likely to grow in the
future.
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The problem is that a lot of successful businesses reach a point where their growth starts to slow as the company matures. In fact, the price of doing a great job carving out a unique niche is that the specialty
that made you successful can start to hold you back. If you make the world’s greatest $5,000 wine fridge, you may have a successful, profitable business until
you run out of people willing to spend $5,000 to keep their wine cool. Demonstrating how your business is likely to grow in the future is one of the keys to securing a premium
price for your company when it comes time to sell. To brainstorm how to grow beyond the niche that got you started, consider the Ansoff Matrix, first published in the Harvard Business Review in 1957 but still a helpful framework for business owners today.
Sometimes called the Product/Market Expansion Grid, the Ansoff Matrix shows four ways that businesses can grow, and it can help you think through the risks associated with each option.
Imagine a square divided into four quadrants representing your four growth choices. The choices are:
1. Selling existing products to existing customers;
2. Selling new products to existing customers; 3. Selling existing products to new markets; and 4. Selling new products to new markets.
The choices above are presented from least to most risky. In a smaller business, with few dollars to gamble, focusing your attention on the first two options will give you the lowest risk options for growth.
6. The Ansoff Matrix, Part II
Grow your business by making more sales to your existing customers
You may think that you’ve got all your bases covered when it comes to your existing customers, but
think again. With a little creativity, you may be able to come up with some new ideas. Sell more of your existing products
It’s natural to feel like you’re being greedy when you go back to the same customers for more of their dollars, but the opposite can often be true. Your best customers will likely be pleased to find out that you – someone they trust – are offering something they need.
Greg was a hardware store owner who earned a 150% mark-‐up on cutting keys, but his cutter was hidden in a corner of the store. When he moved the key cutter directly behind the cash register, Greg
started selling a lot more keys to his loyal customers, increasing his overall revenue per customer.
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Consider drawing up a simple chart of your products and services. List your best customers’ names down one side of the paper and your products across the top. Then cross-‐reference to identify opportunities to sell your best customers more of your existing products.
Sell new products Another approach is to sell new products to existing customers. For example, there is a BMW dealership
owner in the Midwest whose typical customer is a family patriarch in his forties. When he felt he had saturated the market for well-‐heeled forty-‐something men, he considered what other products he could sell, but instead of defining his customer as the forty-‐something man, he decided to think of his
customer as the financially successful family. He bought a Chrysler dealership so he could sell minivans to the spouses of his BMW buyers and then
bought a Kia dealership to sell the family a third, inexpensive car for their driving-‐age teens. To increase the value of your business, you need to be able to grow, and the least risky strategy will be to determine what else you could sell to your existing customers.
7. Have You Considered Recurring Billing?
A win-‐win for you and your customer
Instead of trying to fight for retail space, GreenTeaDaily decided go directly to customers and ask them
to pay for their tea like a cable bill: on a monthly subscription. For $49.99 a month, GreenTeaDaily will auto-‐ship you a box of their green tea every month. That way,
you don’t need to remember to stock up and they don’t need to pour money into advertising. If you’re thinking of evolving your business model into a recurring billing arrangement, consider these
four ways to get your customers to switch: Set it and forget it
Some basic services (alarm, spring water) are no fun to shop for and customers may be happy to be billed monthly.
Be pre-‐emptive Promise to proactively manage the relationship. Instead of waiting for customers to call, home maintenance firm Hassle Free Homes provides an annual home management contract. In the fall,
Hassle Free Homes shows up to clear the leaves from their customer’s gutters, and in the winter they swap the furnace filters.
Offer 911 service
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Salesforce.com sells its customers service packages like the “Premier Success Plan.” Instead of having to report an issue or ask a question online, subscribers get a special phone number to call, promising a response within two hours.
Bribe them You can simply offer customers a discount. GreenTeaDaily customers save $10 per box of tea.
Recurring billing companies are often the most valuable and profitable businesses in their category. What you have to do is figure out what’s in it for your customer so you can get a.
8. The Hierarchy of Recurring Revenue What is more valuable in the eyes of the acquirer?
One of the biggest factors in determining the value of your company is the extent to which an acquirer can see where your sales will come from in the future. If you’re in a business that starts from scratch
each month, the value of your company will be lower than if you can pinpoint the source of your future revenue. A recurring revenue stream acts like a powerful pair of binoculars for you to see months or years into the future, so creating an annuity stream is the best way to increase the value of your
business. The surer your future revenue is, the higher the value the market will place on your business. Here are
six forms of recurring revenue presented from least to most valuable in the eyes of an acquirer.
No. 6: Consumables (e.g., shampoo, toothpaste)
These are disposable items that customers purchase regularly, but they have no solid motivation to repurchase from you or to be brand loyal.
No. 5: Sunk-‐money consumables (e.g., razor blades) This is where the customer first makes an investment in a platform. For example, once you buy a razor you have a vested interest in buying compatible blades.
No. 4: Renewable subscriptions (e.g., magazines) Typically subscriptions are paid for in advance, creating a positive cash-‐flow cycle.
No. 3: Sunk-‐money renewable subscriptions (e.g., the Bloomberg Terminal) Traders and money managers swear by their Bloomberg Terminal; they have to first buy or lease the
terminal on order subscribe to Bloomberg’s financial information.
No. 2: Automatic-‐renewal subscriptions (e.g., document storage) When you store documents with Iron Mountain, you are automatically charged a fee each month unless you tell them to stop.
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No. 1: Contracts (e.g., wireless phones) As much as we may despise being tied to them, wireless companies have mastered the art of recurring revenue. Many give customers free phones as long as they lock into a two or three-‐year full
service contract.
9. The Hidden Benefit of Systematizing Your Business Beyond growing your clientele, you’re preparing for the future
If you’ve read The E-‐Myth, you know the importance of building systems in your business so it can run without you. But there is another benefit to standardizing your business and documenting your processes: it will help you get paid more money when you’re ready to cash out, as opposed to settling
for a large “earn out” – where the seller(s) having to hit set targets in the future in order to get their money out.
Take, for example, Computerized Facility Integration, LLC (CFI), founded by Robert Verdun. Verdun and his team have built an $18-‐million-‐dollar–a-‐year business that helps big companies manage their investments in real estate. When companies like Dow Chemical or Pfizer want to plan new facilities
anywhere in the world, they call CFI. Verdun has deeply standardized the squishy business of moving offices. “There are many people
involved,” says Verdun. “We have to take into consideration movers, construction, permits, art work, IT, security, capital planning, etc.”
Not only does Verdun have systems in place for his employees to follow; he has also cross-‐trained his staff so that most of them can do more than one job. In the event of an employee departure, a cross-‐trained staffer can slip into the open spot.
Not only has this helped Verdun scale up his CFI – to number 3,052 on the 2011 Inc. 5000 list – it will also help him get out cleanly when he’s ready to sell. Most service businesses are overly reliant on a
couple of key personnel, which is risky for a buyer. “Assuming CFI’s business systems, processes and key employees stand up to buyer due diligence,” says
M&A Professional John Duguid, “the necessity of having Robert stay on is significantly reduced, and his M&A advisor would resist an earn-‐out.”
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10. Four Ways to Foster Innovation in Your Company Yes, you have to be predictable, but make room for new ideas
You want your business to grow, as do investors and acquirers, and growth comes from new products,
new services and/or new customers. Can you be predictable and innovative at the same time? I put the question to Jeremy Gutsche, author of Exploiting Chaos and founder of TrendHunter.com, a business that tracks emerging trends for customers like Google, Pepsi and Cadbury. Here are some of his
suggestions. Set up a gambling fund
Put aside some money to gamble on new ideas. When the BBC, the U.K.’s national broadcaster, was stuck in a programming rut, it set up a gambling fund for ideas that failed the usual new-‐program screening process. Producers could apply for gambling funds if their idea was cut, which is how The
Office, one of the BBC’s most successful programs of all times, was funded.
Think like a portfolio manager Like a manager, envision your business as a portfolio of investments. Gutsche recommends having some areas of your business that are reliable and predictable while reserving part of your portfolio for trying
new things. Reward sound decisions
Most companies pay their employees based on results and outcomes; which means the best employees want to work where they are most likely to generate good results in a predictable way. It also means your best employees stop taking risks. Gutsche recommends you reward good decisions rather than
outcomes so you can incent your employees to try things that may be risky. Give your employees playtime
Set aside some company time each week or month for employees to use to work on pet projects. 3M, of Post-‐It note fame, popularized this technique, which has since been adopted by companies like Google and Amazon, who give their engineers time for to tinker.
11. Can You “Productize” Your Service Business?
Switching from a service model to a product model Jason Fried and David Heinemeier Hansson co-‐founded 37signals in Chicago as a three-‐person web
design shop. As their products grew larger and more complex, they found themselves looking for software that could help them better manage jobs among a growing network of staff and contract help operating from different locations. In the end, they built a piece of project management software
themselves for their own internal use.
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Then a funny thing happened: 37signals’ clients saw the simplicity of the software and started asking where they could buy it. It wasn’t long before Fried and his partner realized they had built a product that might have mass appeal. They polished it up, gave it the name Basecamp and, through their blog,
announced its availability. A year later, Basecamp was more profitable than the web design business, and 37signals stopped being a service business and started being a product business.
Today, tens of thousands of small businesses use 37signals software; and the company hasn’t built a website—other than its own—since 2006.
In my former research company, Warrillow & Co., we spent seven years as a project-‐based service business before we redesigned our model into a subscription-‐based product company. Changing to a product business made it more predictable, enjoyable, and ultimately sellable.
12. Four Steps for Turning a Service Business into a Product Business Make your service business more valuable
Step 1: Develop a subscription offering In the case of 37signals, customers buy software on a subscription model. They pay a small amount
each month, so Fried and Hansson can predict their revenue well into the future. Predictable future revenue diversified among many customers gave 37signals the courage and resources to eventually turn off its service business. At Warrillow & Co., we went from project-‐based consulting to offering a single
annual subscription to our research. Step 2: Build an audience
37signals had authored a popular blog for seven years before it announced Basecamp to its readers. With a direct line to thousands of daily readers, 37signals was able to use the blog as its primary marketing vehicle to sell subscriptions. At Warrillow & Co., we had been running a conference since
1999, so when we switched to the subscription model in 2005, past attendees were a natural audience. Step 3: Don’t give yourself an out
In a service business, clients always take priority, so it’s hard to fine the time to work on your product offering. In the case of 37signals, it needed project management software to better serve its clients, so it
had a natural motivator to develop the precut quickly. At Warrillow & Co., we quit accepting consulting projects cold turkey, which was made possible because
we charged tens of thousands of dollars upfront for an annual research subscription. Step 4: Start saying no
It took a year for 37signals to build up enough subscribers to start turning away projects. For me, it was tempting to accept consulting projects, but saying no triggered the opportunity for us to talk about our subscription offering and how it could help solve the client’s problem.
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Part II: Ensure the Sellability of Your Business
Contents:
13. Write Down Your Number 14. Get a Divorce 15. Three Steps to Letting Go 16. More Steps to Letting Go 17. The Eight Factors that Drive Up Sellability 18. The Switzerland Structure: Minimize Your Dependence 19. Do You Have a Transferable Culture? 20. Create a Positive Cash Flow Cycle 21. Measure Customer Satisfaction 22. Your Growth Potential 23. Employee Loyalty: Carrots and Sticks 24. Re-‐energize Your Business
This section looks at the elements that make your business more sellable; so when it’s time for you to sell, your company will be shipshape and ready to be shown off to serious buyers. It discusses eight
factors that drive up sellability and how to begin implementing some of the changes you need to make. It also asks you to examine more closely your long-‐term goals for selling your business and how to evolve your position and your company in terms of those goals. Ultimately, your business has to thrive
without you.
13. Write Down Your Number
Picking a number will remind you that your goal is to build your business and sell it Most business owners have a number, even if they don’t talk about it. My advice is to write your
number down. Most of us start companies because we want to achieve something remarkable or because we have a
deeply rooted need for independence. In the absence of an objective measurement for “remarkable” or “independence,” your number can act as the marker to let you know when you’ve crossed your finish
line. I used to meet with a group of entrepreneurs once a quarter and we would do a formal review of our
goals. I would look at my number and ask myself three questions:
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1. Where do you stand right now? Is your business more valuable than it was last quarter or last year? To value your business, you can estimate your earnings before interest, taxes, depreciation and amortization (EBITDA), and
use the multiple that businesses like you are selling for. The multiple can be a guesstimate; what’s more important is the process of thinking through what your business is worth and being clear about the progress you’re making.
2. What do you have to do in the next 90 days, and over the next year, to make your business more
valuable?
This question is not about selling more or making more profit, but about making your business more sellable.
3. What experiences do you want to enjoy after you sell? I found it motivating to write down experiences I’d like to have (rather than things I’d like to buy). My list included living in another country, taking my kids to every continent, qualifying for the
Hawaii Ironman, and starting a foundation to lend money to entrepreneurs in the developing world.
Each quarter I would imagine these experiences. It helped me to remember why I was in the business in the first place, and that yes, I did want to sell it.
14. Get a Divorce Your business isn’t you; it’s an inanimate economic engine that you will at some point sell
When I started Warrillow & Co., my name was literally on the door, and I poured all my waking hours into the business. My hobbies and relationships started to wither from lack of attention and I
rationalized that I could get back to “my life” once I got the business going. After a while the business did get off the ground, but I didn’t change my work schedule; it was an adrenaline rush to be building a successful company.
It all started to come undone when a key employee on our team got hired away by a big multinational firm. I was left with a skeleton staff and a bruised ego, but the experience made me realize just how
much my business had become part of me; in fact, I had let it define me. After that, I started to look at my business more realistically; it wasn’t a part of me; it was an inanimate
economic engine. In short, I got divorced from my business, and I vowed to get in touch with the people and things that were important to me.
When I look back, I’m glad I had a near-‐death experience in my business as it forced me to nurture outside interests and investments in my life before I actually attempted to sell.
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15. Three Steps to Letting Go Ultimately, your business has to thrive without you
Can your business thrive without you? To be valuable to an acquirer, your business must be able to succeed and grow without you. The more your customers need you, or ask for you personally, the harder it is to grow your business and the less valuable your company will be. To start letting go,
consider these four steps:
1. Get out of the “break/fix” business It’s a lot easier to train people how to prevent a problem than it is to show them how to fix something once it’s broken. For example, a swimming pool company can teach a summer employee to scoop debris out of a pool each week, but it needs an expert – often the company
owner – to replace a pump that has overheated due to a clogged drain.
2. Go on vacation Start slowly by taking evenings and weekends off completely and leaving your cell phone at the office. Then take a day off midweek and do the same. Build up to where you can take a week off
without checking in. Once your employees realize they’re on their own, the best ones will start to make more decisions independently.
3. Ask employees what they would do in your shoes To get employees to start thinking like an owner, encourage them to solve their own problems. When an employee comes to you with a problem, ask, “If it were your business, what would you
do?” This simple question gives your employees the opportunity to start developing a decision-‐making perspective.
16. More Steps to Letting Go Give your employees the opportunity to step up to the plate
As you go through the process of making your business less dependent on your skills and management, and more dependent on your employees, consider the following steps with your advisor:
• How do you currently spend your business day? Create a pie chart representing the time you
spend at work and assign a slice for each of the activities you do. What observations can you
make about how you spend your time? What can you start to let go of? • Is there a current employee who could be promoted to head up either your sales and marketing
or your product/service quality and innovation? • Are you under-‐utilizing your employees’ skills and abilities?
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• What sort of long-‐term incentive plan do you have in place to keep key managers from leaving?
• How does your long-‐term incentive plan need to evolve to be an asset when you are ready to sell your company?
• What recurring problems in your company could be fixed by having a formal process or instruction manual? The documentation of processes is also an important step in ensuring the company can run smoothly without you.
• Why do customers request that you serve them? If you’re not sure of the answer, ask your best
customers.
17. The Eight Factors that Drive Up Sellability
How sellable is your company right now? From many years of researching businesses, I have determined there are eight factors that drive up the
sellability of a business. Using these factors, I developed The Sellability Score, a tool business owners can use to assess the sellablility of their business according to a score out of 100. The eight key factors are:
1. Financial Performance
To be sellable, a business needs to show consistent revenue and earnings growth.
2. Growth Potential In addition to strong historical financial performance, the business needs to have growth potential in the future.
3. Neutrality A business must not be overly reliant on any one customer, employee or supplier.
4. Positive Cash Flow
Not only does the business need to be profitable on paper; it needs to generate cash flow in real life.
5. Recurring Revenue
The biggest fear of a potential buyer is that sales will dry up after the founder exits. In order to mitigate this concern, a business must have a recurring revenue stream that gives the buyer confidence customers will continue to re-‐purchase in the future.
6. Protected Competitive Position Warren Buffett is famous for investing in companies with a protective “moat” around them – in
other words, an enduring competitive advantage. The deeper and wider the moat, the harder it is for competitors to compete. This also gives an owner more control over pricing, which increases both profitability and cash flow.
7. Satisfied Customers
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Acquirers look for companies that have satisfied customers and often require that a customer satisfaction survey be completed before buying a business.
8. Independence from the Owner
Sellable businesses must be able to succeed and grow without their owner.
18. The Switzerland Structure
Minimize your dependence on any one company or individual
The Swiss obsession with neutrality inspired the name of one of my core ideas for creating a valuable
company. "The Switzerland Structure" is a way of evaluating your business to ensure that neutrality allows you to minimize your dependence on any one company or individual. I'd recommend you consider the Switzerland Structure in all areas of your business:
Employees If you're too reliant on any one employee, you are at a significant risk if that employee chooses to leave
and at a disadvantage when it comes to negotiating his or her salary. To avoid this situation, nurture a pool of people you want to hire. Toronto-‐based executive search firm IQ Partners offers a bench-‐building service: it proactively recruits a short list of candidates who could fill your key roles so that you
have a bench of people to go to in the event of an employee defection. Suppliers
If your business is dependent on one or two key suppliers (companies or independent consultants), you are at their mercy. Cultivating a bench of suppliers, on the other hand, means you will never feel beholden to anyone. Spread your business around – even if you lose some special pricing discounts.
Neutrality is worth more than a few dollars in savings. Customers
If you're too dependent on any one customer, your business will be highly unstable. It will be stressful to run in the short term and virtually worthless if you ever want to sell it. Try to work your customer concentration down to a point where your largest customer represents no more than 15 percent of your
revenue. You'll sleep better at night and have a more valuable company when it comes time to sell.
19. Do You Have a Transferable Culture? Ensure your culture is durable and can survive your departure
Pat Lencioni’s latest book, Getting Naked, is a fable about a business owner who has to abruptly sell his company. The acquirer discovers that the company is successful not because of its superstar sales team or proprietary methodology but because of its unique culture.
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I asked Lencioni how business owners can develop their culture and ensure it will survive after they’re gone. Based on our conversation, here are three steps for creating a durable company culture:
1. Figure out who you are, not who you want to be. Stay away from aspirational clichés like “integrity, teamwork, respect,” advises Lencioni, and pick one or two company values that truly represent who you are. For example, for Southwest Airlines,
humor is a core value and an essential part of everything the company does. 2. Be picky when hiring and promoting.
Once you know who you are as a company, the second step is to ensure your entire company embodies these values. Jim Collins, the author of Good to Great and Built to Last, talks about “getting the right people on the bus and in the right seats.” Says Lencioni: “At Southwest Airlines,
they will not hire anyone—even for the most technical jobs—without a sense of humor.” 3. Stay involved in hiring.
“The very last thing the owner should delegate is hiring,” states Lencioni. He believes it is the company founder’s most important tool to ensure new hires embody the company’s culture. He advises business owners to use their values as hiring, promoting and firing criteria.
These three steps will enable you to turn your company culture into one that is self-‐adjusting, that will pass muster with a potential acquirer, and that will endure long after you’re gone.
20. Create a Positive Cash Flow Cycle
Accumulate cash as you grow In order to be a sellable company, one of your goals is to create a business that accumulates cash as it
grows. The more cash an acquirer must inject into your company when taking it over, the less he will pay for your company. The inverse is also true: the less cash your acquirer must deposit into your business, the higher the price her or she will pay.
One way to create a positive cash-‐flow cycle is by getting customers to pay you sooner while you lengthen the time it takes you to pay your expenses. In addition to maximizing your overall profitability,
having money in the bank makes running your business that much more enjoyable before you sell. Consider the following questions:
• If you bill your customers in installments, could you charge them a greater percentage of the overall price up front?
• Could you evolve your business into a membership or subscription model in which you bill
customers before they receive the benefits of their membership or subscription? • If you sell a service, could you do more to “productize” your offer and thereby make it easier to
charge up front?
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• Could you reduce the amount of inventory you pay for in advance of needing it? • Could you lengthen the time it takes to pay some vendors?
21. Measure Customer Satisfaction How to measure the one number investors/buyers want you to track
Fred Reichheld, author of The Ultimate Question, found that most traditional customer satisfaction surveys do a poor job of predicting the likelihood of a customer repurchasing from you or referring your
company to a friend. So he and his colleagues developed the Net Promoter Score methodology, based on asking customers a single question: "On a scale of 0 to 10, how likely are you to refer <company name to a friend or colleague?"
Reichheld discovered that when customers answered this question with a 9 or 10, they were statistically more likely to repurchase from the company, refer it to others, or do both – and companies that scored
well on this measure were more likely to grow than lower-‐scoring companies. The news that there was a way to predict growth triggered Fortune 500 companies to latch on to the
methodology. But it’s also well suited for use in smaller companies: you can deploy the questionnaire in five minutes using a survey tool like Survey Monkey and enjoy a high response rate because answering is easy.
To see how your company measures up, survey a group of your customers by asking Reichheld's question. Those who give you 9 or 10 are your "Promoters," in Reichheld's lingo. "Passives" are those
who give you 7 or 8 – satisfied but not likely to repurchase or to refer your company. "Detractors" are customers who score you between 0 and 6.
To calculate your Net Promoter Score, take the percentage of Promoters and subtract the percentage of Detractors. Reichheld found the average score was 10 to 15 percent. If your score is north of 15 percent, you're above average and can expect your company to grow at a rate faster than the economy.
An investor or acquirer checking out your company will be more interested if you have an above average Net Promoter Score.
22. Your Growth Potential Four ways to scale up your business
Acquirers typically pay the most for businesses with the potential to grow. As you contemplate what it
would take to scale up your business, consider these four basic ways to grow: Geographic Scalability
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Will your business concept work in another city? Mia and Jason Bauer started selling their $4 cupcakes on Manhattan’s Upper West Side in 2003. Realizing there were other well-‐to-‐do communities of people who would like to splurge on a Pink Lemonade or Chocolate Sundae cupcake, they expanded
geographically and now have 30 stores. Horizontal Scalability
Do you have a brand that resonates with a specific audience? If so, you may have the raw material to scale up your business by selling more things to your existing customers. For example, Richard Branson’s Virgin brand resonates with a certain psychographic. He began with an airline and then scaled up his
concept to offer his target market everything from train travel to mobile phones to credit cards. He now owns over 400 companies.
Vertical Scalability If your existing infrastructure (office space, machinery, staff) could handle more customers without adding much to your variable costs, you have the ability to scale vertically. For example, a 200-‐room
hotel that averages 75 guests per night has the potential to be scaled up more than two times before its owners would have to make any significant infrastructure investments.
Cultural Scalability If your success works in one culture, could it achieve the same success in other cultures? Paul Bakery, founded in Croix, Franc in 1889, is now ubiquitous in France and has spread to 19 other countries.
23. Employee Loyalty: Carrots and Sticks
You need both employee rewards and employee agreements In order to achieve employee loyalty, business owners typically use both “carrots” and “sticks.” As an
example, let’s look at e2b teknologies, a five-‐million-‐dollar-‐per-‐year technology reseller based in Chardon Ohio that my colleague Emmet Apolinario and I analyzed for this article. e2b’s founder, Lynne Henslee, has done a number of things to create a work environment that makes her team feel loved. “I
believe our relaxed culture is what keeps everyone loyal,” says Henslee, “We make breakfast for everyone in the office every Friday morning. We have company fun days at least annually. Everyone's birthday is celebrated with a cake of his or her choice.”
Along with the softer side of loyalty, Henslee has also got the hard stuff right by having her employees sign both non-‐compete and non-‐solicitation agreements that are “assignable” in the event of a change
of ownership at e2b. Apolinario elaborates: “If an acquirer were to buy e2b, they would, at least in part, be buying the company for the extensive and varied technical expertise of its staff. The buyer is
therefore going to want to ensure that this asset – the people – will stick around under the new owner.” If you want to make your business sellable, you need to include some “sticks” in your employment
agreements that make it hard for employees to wiggle out of their commitments to your business when
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it changes hands. Lawyers call this glue “assignability,” and it’s a clause in an employment agreement saying that in the event you sell your company, your employees have to honor the terms (e.g., confidentiality, non-‐compete, etc.) of their employment contract with the new owner.
“Henslee has positioned her company well,” says Apolinario, who is a certified Exit Planning Advisor and the president of Columbus-‐based Confidential Sale. “If she ever wants to sell, she will have plenty of
options.”
24. Re-‐energize Your Business Do you need some pre-‐sale adrenaline?
Recently a reader of one of my columns wrote the following comment: 'If you are running your business with one eye looking at selling it, how much passion and dedication are you putting into it?'
In fact, I have never been more passionate about a business than in the weeks and months prior to selling it; and I have never woken up with a greater sense of purpose and determination than just before selling it. Putting your business up for sale can give you the energy and discipline to tackle tasks like:
Offloading pet relationships Every business owner has them: customers who are loyal to them personally and insist on dealing with
them directly. When I went to sell my last business, I had to gently pass my pet customers over to other people to manage.
Standardizing contracts My customer and employee agreements were developed iteratively over time. When I started to prepare my business for sale, we needed to get disciplined about having one standard employee
agreement and one standard customer agreement. Fixing up your website
Updating our website was always a bit of an afterthought for me. That is, until I decided to sell my business. Then I got serious about making changes to the site so potential buyers' first impression was of a professional, relevant company.
Dealing with problem employees I tend to procrastinate when it comes to dealing with problem employees. When I know I'm getting
ready to sell a business, my desire to close the deal gives me the courage and determination to stomach the most difficult business conversations.
If you find yourself losing passion for your business, the fastest way I know to get re-‐energized is to prepare your company for the market. Whether you decide to sell it or not, your business will benefit
from the shot of adrenalin.
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Part III: Negotiate the Best Possible Deal
Contents:
25. The False Finish Line 26. Managing the Long Goodbye 27. Three Things I Wish I’d Known about Selling a Business
28. Questions You’ll Be Asked When Selling Your Business 29. The Math Behind Your Multiple 30. The Relationship Between Return and Risk
31. Four Reasons Big Companies Buy Little Ones 32. Avoid Deal-‐Killing Mistakes, Part 1: The Objective Questions 33. Avoid Deal-‐Killing Mistakes, Part 2: The Subjective Questions
Do you have a realistic view of what “selling” a business looks like? The reality is that it can be a long, grueling process where you’re still involved in the business years after it’s been sold. If you want to
avoid “the long goodbye,” you need to understand the complications of selling a business and the importance of knowing what buyers are looking for when they check out your company. There were a lot of things I didn’t know when I sold my first business, but having exited three more businesses since
that time, I’m more aware of what buyers are willing to pay actual money for and how best to prepare for putting a company on the market.
25. The False Finish Line The seller sees the finish line; the buyer hears the starting gun
If you’re like most of the business owners I know, you imagine selling your business, having a going-‐away party, and riding off into the sunset. But increasingly it’s not working that way. In a down economy, with banks shy to lend, the proportion of cash that business owners get when they sell is
decreasing, while the proportion of the sale price put “at risk” in some sort of “earn-‐out” is going up. I recently invited a Mergers & Acquisitions (M&A) professional to a workshop I was hosting. She spoke
about the typical deals she is doing and shared the story of one buyer who is acquiring marketing services businesses for as much as ten times earnings before tax. The fine print? They only pay three times earnings upfront and leave the possibility of the other seven in a five-‐year earn-‐out.
Buyers and sellers come at the M&A process from totally different points of view. The seller sees the finish line; the buyer hears the starting gun.
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For the buyer, the acquisition represents what they hope will be an amazing opportunity, and they expect you, the founder, to be their driver. Sellers need to understand that the days of driving off into
the sunset on closing day (unless maybe you own a technology business that runs itself) are over. If you are the seller, I suggest that you plan to sell way earlier than you think you want to, so you still have the energy, passion and ideas for the business to get you through the earn-‐out.
If you think you want out in five years, my advice is to plan to sell in two years, so you have some juice left to get you over the finish line, which is moving ever further away.
26. Managing the Long Goodbye
Three possibilities for the slow exit Given the current reality that buyers are becoming increasingly risk-‐averse, it’s good to be aware of the
different possibilities for a slow exit. According to the Mergers and Acquisitions (M&A) professionals I speak with, all three are on the rise.
1. The 70/30 earn-‐out The proportion of cash a buyer pays upfront for a business, compared to what is available to the owner for meeting future targets (the earn-‐out) is decreasing. One M&A professional told me her
typical deal is three times earnings upfront, with the potential for the owner(s) to get up to ten times earnings if the business meets the three to five-‐year targets set in the share purchase agreement.
2. The vendor take-‐back
Since 2008, there is a growing trend among buyers to ask the sellers to lend them the money to
buy their business. This bizarre financing arrangement is called a “vendor take-‐back” because if the new business owner defaults on the loan, the seller of the business gets their business back – albeit in much worse shape than when they left it. In one recent example, the seller of a
construction business was asked to finance 3 million of an 8 million dollar offer to buy his business.
3. The management buy-‐out In a survey I conducted with the readers of my book Built to Sell: Creating a Business That Can Thrive Without You, of the 632 business owners surveyed, only 37 had received a written offer to
buy their business in the last two years. Of those, the average bid was for two to three times earnings. Given these paltry multiples, more and more business owners are considering
transitioning their business to a set of managers. The next generation of owners uses the free cash flow from the business to buy out the owner over many years, and the seller avoids the fees and hassles of selling to an external buyer.
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27. Three Things I Wish I’d Known about Selling a Business Sometimes the basic elements of the sale can trip you up
Here is a list of three things I wish someone had told me about selling a business before I went through the process for the first time:
1. Find a “sell-‐side” intermediary Like selling a house, you probably want someone to represent you in the sale of your business—
either a business broker or a Mergers and Acquisitions (M&A) professional. But beware: both buyers and sellers can hire intermediaries. When your broker has a “buy side” mandate, it means they have been hired by a buyer to find them a company to purchase. As a seller, you want to make
sure you choose a broker that does the bulk of their work on the “sell side” (being hired to sell a company).
2. Seven drips till you quit Once you have an intermediary engaged, they’ll work with you to develop a list of prospective buyers. Your broker will then contact prospective buyers to try and interest them in a conversation
about buying your company. However, make sure you watch out for the “three-‐call scenario.” Your broker may try calling a prospect once or twice, give up after the third time if his calls are not returned, then tell you “they’re not interested.” There can be many reasons a call goes unreturned,
so the old sales adage “seven drips till you quit” is apropos – make sure your broker tries a prospect seven different times before delisting them.
3. Answering THE question At some point in the process of selling your business, a prospective buyer will ask you – oftentimes casually – “Why do you want to sell your business?” These eight seemingly innocuous words have
derailed more deals than any other question. Answers like “I want to slow down a bit” or “I want to travel” communicate to the buyer you plan on winding down when they take over; but what they want to hear is your intention to help them realize the potential locked inside your business.
28. Questions You’ll Be Asked When Selling Your Business
Make sure you’re prepared to be in the hot seat One of the most intimidating parts of selling my last business was facing the barrage of questions during the various management presentations I did for companies interested in buying it. As mentioned above, you’ll definitely be asked why you want to sell your business, but there are other questions you should be thinking about. Based on my experience in the hot seat, here are some likely questions: What is your cost per new customer acquired? The potential acquirer wants to find out if you have a predictable, economical and scalable formula for finding new customers.
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What is your market penetration rate? The acquirer is trying to understand how big the potential market is for your product or service and what part of the field remains to be harvested. Who are the critical members of your team? The acquirer wants to understand the depth of your team and determine specifically which members need to be motivated and retained post-‐purchase. Who buys what you sell? Strategic buyers will be searching for any possible synergies between what you sell and what they sell. The more you know about your customer demographics, the better the buyer will be able to assess the strategic fit. If your customers are other businesses, a buyer will want to know what functional role (e.g., training manager, VP of sales and marketing) buys your product or service. How do you make what you sell? This question is asked in an effort to size up the uniqueness of your formula for creating your product or service. Potential buyers want to know if you have any proprietary systems that would be hard for a competitor to replicate. What makes your product truly unique? A buyer is trying to understand how big the moat is around your business and what kind of protection it offers from competitors who may decide to compete with you in the future.
29. The Math Behind Your Multiple How buyers figure out their future profits
A financial acquirer sees buying a business as paying today for a stream of profits in the future, which is why companies are usually bought and sold using a multiple of earnings. Buyers acquiring a company will do some math to figure out what they are willing to pay today for the rights to that business’s future
profits. We’ve all made a similar calculation. For example, you may have decided in the past to invest $100 in a bond that offers 5% interest a year; that is, you decided to spend $100 on something that would be worth $105 a year later.
To see how this math affects the value of your business, imagine you have a company that you expect to generate $100,000 in pre-‐tax profit next year. Buyers looking for a 15 percent return on their money in
one year would pay $86,957 ($100,000 divided by 1.15) today for $100,000 a year from now. When valuing a business, financial buyers will typically value not only the next year’s profit, but all
expected profits in the foreseeable future. For every year into the future that buyers must wait to get their profits, they will discount the future profit you are projecting from the rate of return they expect.
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30. The Relationship Between Return and Risk How can you de-‐risk your business in order to get a higher offer?
The price buyers are willing to pay for your business depends on a lot of factors, but one of the most important is the return they expect to get and the risk associated with achieving it.
Let’s assume your revenue is flat or growing modestly. The higher the return on investment the buyers are looking to achieve, the lower the multiple they will be willing to pay for your business.
At the risk of oversimplifying a complex equation, if buyers are looking for a 22 percent return on their investment in your company, they will derive the multiple they are willing to pay as follows: 100 divided by 22 = 4.5 times EBITDA
Provided you’re not the next Google equivalent, the buyers would be willing to pay around 4.5 times EBITDA. If their expectations are higher, however—let’s say 30 percent—they will be willing to less for
your business. 100 divided by 30 = 3.3 times EBITDA So what drives up buyers’ expectations for return on investment while at the same time driving down
the price they’re willing to pay for your business? In a word, “risk.” Likewise with your own investments: you are willing to settle for a lower return when you buy relatively safe assets like a government bond.
So how do you de-‐risk your business in the eyes of an acquirer? Ted Davidson, a valuation consultant with SPARDATA, an independent business valuation firm, suggests considering factors like the following:
1. Client risk: Do you rely on just one or two key clients for most of your business? 2. Supplier risk: Will you be in trouble if one of your suppliers goes under?
3. Depth of management: What happens if a key employee disappears? 4. Contracts: Do you have legal agreements or handshakes?
“Show investors safety in your pattern of earnings, and you can expect a higher offer,” says Davidson.
31. Four Reasons Big Companies Buy Little Ones Your most attractive exit option is a strategic sale of your business to a larger company
Over the past year, Google has bought a company every two weeks, doubling its stated goal of 12 acquisitions a year. In each case, the acquisitions have been “strategic” rather than “financial.”
Many companies are looking to acquisitions to supplement their weak organic growth. Typically, strategic buyers are willing to pay more for your business than financial buyers (e.g., private equity firms) because they have strategic assets that can increase the value of both your company and theirs.
Here are four reasons big companies buy little ones:
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1. To sell your product to their customers First Research creates cheat sheets for salespeople who want to sound smart when they call on a
new customer in an industry they are unfamiliar with. Dun & Bradstreet has hundreds of thousands of customers buying sales leads from its Hoovers division. Seeing an opportunity to cross-‐sell, D&B was willing to pay $22.5 million to Bobby Martin and his partners so it could sell First Research
industry profiles to Hoovers’ customers 2. To leverage your technology to make one of their products better
Google paid $25 million for DocVerse because it had built a better way for users to share documents. By swallowing DocVerse, Google is accelerating the adoption of its GoogleDocs platform.
3. To get hold of your smartest employees In the hit TV series Mad Men, Sterling Cooper got acquired because of the creative genius of Donald Draper. While in this case the players are fictional, big ad agencies and other businesses often buy
smaller ones for the people. 4. To acquire a new place to sell their stuff
Bell Canada bought The Source last year to add 756 new stores in which to sell retail consumers phones, TVs and Internet access.
Understand what makes you attractive.
32. Avoid Deal-‐Killing Mistakes, Part 1: The Objective Questions Make sure you know the answers before a prospective buyer comes calling
A business owner I know refers to due diligence as “the entrepreneur’s proctology exam.” It’s a crude analogy but a good representation of what it feels like when a stranger pokes, prods, and looks inside every inch of your business.
Most professional acquirers will have a checklist of questions, both objective and subjective, that they will want to get answered before making an offer on your company. Examples of objective questions
include:
• When does your lease expire and what are the terms?
• Do you have consistent, signed, up-‐to-‐date contracts with your customers and employees? • Are your ideas, products and processes protected by patent or trademark?
• What kind of technology do you use, and are your software licenses up to date? • What are the loan covenants on your credit agreements? • How are your receivables? Do you have any late payers or deadbeat customers?
• Does your business require a license to operate, and if so, is your paperwork in order?
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• Do you have any litigation pending?
As part of your pre-‐meeting homework, and depending on what type of business you have, figure out
other questions the buyer may ask you.
33. Avoid Deal-‐Killing Mistakes, Part 2: The Subjective Questions A seasoned potential acquirer is likely to have various tricks up his sleeve
In addition to asking objective questions, acquirers will try to get a subjective sense of your business. It’s more art than science and often requires a potential buyer to use a number of tricks of the trade, such as:
Trap 1: Juggling calendars By asking you to make a last-‐minute change to the meeting time, they will try to determine just how
integral you are to the success of your business. If you can’t accommodate the change request, the acquirer may probe to find out why and try to determine what part of the business is so dependent on you that you have to be there.
Trap 2: Checking to see if your business is vision impaired An acquirer may ask you to explain your vision for the business, and he or she may also ask the same
question of your employees and key managers. If they offer inconsistent answers, the acquirer may take it as a sign that the future of the business is in your head.
Trap 3: Asking your customers why they do business with you A potential acquirer may ask to talk to some of your customers, and he will expect to hear good things. The customers may be asked a question like “Why do you do business with these guys?” If your
customers answer by describing the benefits of your product, service or company, that’s good. If they respond by explaining how much they like you personally, that’s bad.
Trap 4: Mystery shopping Acquirers often conduct their first bit of research behind your back before you even know they are interested in buying your business. They may pose as a customer, visit your company, or check out your
website. Make sure the experience your company offers a stranger is tight and consistent, and try to avoid being
personally involved in finding or serving brand new customers. If potential acquirers see you as the key to wooing new customers, they’ll be concerned that business will dry up when you leave.
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Acknowledgments I would like to thank:
- The community of 1,200 Sellability Score Advisors around the world who are helping business owners to build companies that are more valuable and more sellable;
- The Built to Sell reader community whose comments and case studies have helped to inform the book;
- All those who have participated in the various surveys that we do; your participation helps us to produce up-to-the-minute data that helps businesses create sellable companies;
- My editor Cathy Reed; - My editor at Inc. magazine, Kimberly Weisul.