Alternatives for Creating Owner Wealth
There are four alternatives that we recommend and implement with our clients other than or in addition to the sale of the business for developing owner wealth. These alternatives are not mutually exclusive. Often we build plans that utilize more than one of these and integrate them with ultimate sales of the businesses. They are: 1) shrinking the business, 2) managing for cash flow rather than growth, 3) accumulating owner wealth as you go, and 4) succession.
Shrinking the Business – This path is totally counter-intuitive for the vast majority of owners. But for many smaller businesses that will have a limited value when the business is sold, a reduction in Sales can lead to a disproportionately greater increase in Expense reduction. When this is true, the consequence is an increase in cash flow beyond the requirements of the business. This cash can be distributed directly to the owners, building their personal owner value.
Managing for Cash Flow Rather than Growth – Growth is not a viable strategy for every business and industry. Numerous industries have ‘sweet spots’ where, for market or resource reasons, a business has an ideal size to be competitively viable. When this is the situation, owners have the opportunity to make the generation of free cash flow a priority for owner return purposes as opposed to growth.
Accumulating Owner Wealth as You Go – Bluntly, many owners spend too much personally. Developing the habit (early if possible) of taking some of the remuneration from the business and putting it into reasonable, secure investments outside of the business will create the accrual of owner wealth; taking pressure off of the need for the highest price when the business is sold. If an owner is using one of the two previous methodologies, it is essential that they integrate this technique as well.
Succession – Succession is a difficult option to implement for many businesses. But it may provide a much higher return to owners in many situations if it can be put into practice. This is particularly true for businesses and industries where valuations represent lower multiples of earnings and cash flow. Service industries and professional firms are two examples. A successful succession can allow owners the ability to maintain a distribution of cash from the business even after they retire followed by a sale at a fuller valuation to the successors.
A Manufacturer Pursues Alternatives
This client was a manufacturer with a successful proprietary product line. The company was fully committed to a growth strategy revolving around the development of new products. We illuminated for the owners their desire to exit in five years and a sizable gap between their requirements and the combined value of their business and current owner wealth accumulation. Factoring in the cost of growth and the investment/payback cycle for developing new products, the projected growth over five years was not going to cover the gap. We studied two other options; restricting growth with a focus on free cash flow generation, and instituting a real succession plan.
This change in focus immediately allowed the owners to start adding to their accumulated wealth via cash distributions. Partial succession allowed the owners to work much less and maintain their salary and cash distributions. This made working easier for the owners resulting in their stretching their exit window beyond five years. Seven years after they adopted the new strategy, they were approached by a Strategic Buyer. The succession planning had made the company more attractive to the buyer because management no longer depended upon the owners. The accumulation of owner wealth over the seven years plus the sales price provided more than was required to meet the owners’ retirement needs.
No one is going take care of an owner’s future needs if the owner does not. Accumulation of wealth in a pragmatic and unemotional process is critical to a business serving the personal needs of its owners.