Most owners we talk to would do anything for their business, but it rarely occurs to them that their willingness to do so is drastically killing their company’s valuation.
Hundreds of middle-market companies have completed CoPilot, our online market readiness assessment, and learned quite a bit about common business valuation and marketability risks.
In addition, during COVID-19, we developed a buyer survey (for private equity investors and strategic buyers) to assess which business risks were of most concern.
Here’s what we uncovered:
The No. 1 company risk (reflected in over 95% of CoPilot assessments) is that the business is too dependent on the owner.
This risk manifests itself in the owner being too involved in sales or operations, having too heavy a hand in customer or vendor relationships, or simply not having a deep enough bench of management talent.
From buyers, we found that dependence on an owner is also one of the most common risks identified as one that would limit their interest in acquiring a company or significantly impact their view on valuation.
Is Your Business at Risk? How Dependent is Your Business on You?
Answer “yes” or “no” to these questions to find out…
- Do you spend more than 40 hours per week in the business?
- If you left the business and did not check in for six months, would the business be worse off?
- Would your management team be challenged to operate the daily operations of the business without your involvement?
- If you left the business, would your top five customers, pause to find out who they would be dealing with or terminate their relationship with the company?
If you answered “yes” to one or more of these questions, your business may be too dependent on you as an owner.
Why is Owner Dependence So Prevalent?
First, within small companies, the owner is going to be deeply involved in almost every aspect of the business.
This is driven by necessity in some cases (can’t afford additional management personnel) and/or by owner preference (the owner believes that no one could do a particular task as well as he or she does). Second, until a business matures to a certain level, it is probably not realistic to expect the owner to extract themselves from the business in a meaningful way.
Why is Owner Dependence a Risk Factor?
We have asked many past clients why owner dependence is a risk factor. The No. 1 regret they have after going through the selling process is that they didn’t hire their key management team sooner.
These business owners have learned how valuable good management talent can be for a growing business, and they learned how much better their lives could be if they could simply delegate tasks that they did not necessarily enjoy, were not very good at, or were distracting them from adding value to the business in more meaningful ways.
Most investors feel understandable trepidation about writing a big check to acquire a company if the departing owner is intimately involved with the current operations of the business. After all, they are investing in the future earnings of the company—if one of the most important drivers behind the earnings, company culture, and business growth departs the business, an investor is likely to view the business as significantly less valuable.
Furthermore, owner dependence places a ceiling on scalability and growth. These businesses will struggle to create advancement opportunities for talented employees, and the single point of failure will place a governor on the rate at which the business can expand and create incremental value.
How to Fix It
Given that this risk is so prevalent and is of such a concern to acquirers, how can you proactively address it?
Identify Current Dependency
We have an exercise we use with clients called the 80/20 Rule where we ask owners to track where they spend their time on a daily basis, and then identify activities that are most impactful for the business and where they have a comparative advantage. We have found this exercise to be incredibly illuminating to help a business owner better understand where they actually spend their time and identify tasks that are easily delegable to others who are likely able to do them better than the owner.
Develop a Hiring Plan
Next, we develop a recruiting and hiring plan for key members of the management team. Even though the owner might not execute on this plan immediately, giving thought to what skills, experiences, cultural attributes, and other elements will be critical to these hires will help owners start to identify potential candidates when the hire becomes financially feasible.
Finally, we work with the owner to understand what these new hires will mean financially for the business. Yes, they will require some initial investment but, if done right, they will also enable faster growth and give the owner more time to spend on the things he or she enjoys (whether that’s more time on innovation, strategic initiatives, or simply more time with friends and family).
If you currently have a management team and answered “yes” to one or more of the questions above, then one good way to begin making your business less dependent on you is to spend fewer hours at the office (COVID-19 may have provided a head start here!).
Begin slowly by not working evenings or weekends, and, unless there is an urgent matter, do not reply immediately during off-hours if employees call or email. Have the conversation with each manager and discuss your plan. Empower them to promote themselves to the leaders you need them to be (and be understanding when mistakes are made as people learn). Once they get the plan, your top managers will start making more decisions independently.
The risk of a business being too dependent on the owner is very common, but an intentional plan can help you mitigate problems early to enable fast growth, more value creation, and a better life for you as an owner.
As an NSCA Advisory Council member, Class VI Partners works with NSCA integration companies on managing mergers and acquisitions. Executive VP Zack Gibson focuses on the sale or financing of mid-market clients across a broad range of industries. He has worked with over 50 clients on transactions at Class VI and has experience managing and supporting a variety of client engagements, including pre-transaction preparedness services, majority and minority recapitalizations, leveraged and management buyouts, strategic acquisitions, and capital formation transactions. Zack can be contacted at firstname.lastname@example.org or 303.243.5623. Learn more about NSCA and how to become an NSCA member at NSCA.org.