Every business is different, but those that survive have a beginning, middle, and end. Dennis Mattiske takes us through the lifecycle of a business and examines the crucial planning stages for successful outcomes.
The Beginning
Following an idea to set up a new business, it is wise to challenge the idea and ask some simple questions. Is there a need for the products or services? Can I attract business better than my competitors? Do I have access to sufficient funds to finance the business?
If the answers are positive there is probably a basis for a successful business. However, many have failed soon after start-up, not because the business idea itself was flawed but because of inadequate planning. So, to maximise the chance of success it is imperative to properly plan the business from the outset and to seek timely advice where necessary.
The business plan needs to address the following:
• the products and services to be offered;
• the competitive edge that is going to differentiate your business from your competitors;
• the customer profile to whom these products and services are going to be offered;
• a marketing plan to reach those customers;
• an efficient operational structure;
• the people and skills required;
• your financial resources;
• documented goals, and an action plan to meet them.
Many entrepreneurs are more concerned with actions than plans, and so it is a good idea to seek assistance with this planning stage. The ideal person is someone who can help prepare the plan by using the ideas and knowledge of the entrepreneur and ensuring that all aspects are covered.
While the plan can include a great deal of detail from the outset, it is more likely to have less detail initially, with more added later. Once the structure of the plan is in place it is relatively easy to add to it when required.
The goals set must be clear and measurable. The most obvious are goals relating to sales and income, and operational aspects such as the number of people, levels of stock, and debtors. These are essential but they are goals that are measured at the end of the business cycle, and as such they are ‘lag’ indicators of performance. Other goals or indicators for early measurement of performance should be set. These include the number of customer inquiries, level of customer service, size of the average order, and so on.
The plan must include both profit budgets and cash budgets. The time needed to get to a sustained level of profitable sales must be carefully considered. Too often this blows out due to any one of the many factors that can influence the start-up phase. Delays in supplier deliveries, teething problems with design, and reactive price reductions by competitors can have a significant influence on profitability. The prudent business plan will have allowed for all of these to some degree. In fact, financial reserves to cover such contingencies are essential to ensure success.
It is important for the cash budget to be prepared from, and tied into, the profit budget. They are inextricably linked and this should be recognised from the outset. Sales generate cash after receipts from customers (try to commit to no more than 45-day sales in debtors) and purchases of product and overheads must be paid using supplier credit terms. A supplier who has received regular and on-time payments is more likely to look favourably on a request for temporary extended credit should the need arise.
A successful business has an alliance with both customers and suppliers. Working capital is required to cover stock and debtors, and longer-term finance is required to cover fixed assets such as plant and equipment.
Longer-term finance is better for the hardcore working capital and plant and equipment, and if structured correctly will be cheaper than overdraft finance to cover fluctuating monthly and/or seasonal sales. Leasing of equipment is a popular option, although the effective interest rate will normally be slightly higher than bank finance. Unfortunately, the family home is often needed for security, but a plan should address how this can be extricated and when the business finance will be self-supporting.
Often, in the first phase of the business, the owner will be involved in many aspects of its operation due to financial constraints restricting the employment of many people. This will include significant involvement in sales and sales development; administration, accounting and control of finances/cash; hiring and firing of employees, and dealing with employee problems; and innovation and product or service development.
It is important to keep a watch on this and, as the business grows, employ others to do those things that are important but less value-adding. The most obvious areas are those of administration, accounting and finance. These are functions that are important but can often be attended to by part-time employees or by outsourcing until they command the need for full-time, in-house resources. This will give the owner more time to devote to sales and customers, and the procurement and development of products and services.
The Middle
A few businesses enjoy immediate success and find they quickly reach their profitability goals and proceed straight to significant growth. In such instances they need to move quickly from a start-up plan to a growth plan. Unless this is undertaken quickly the pressures that stem from uncontrolled growth can lead to unnecessary financial difficulties and sometimes unnecessary closure of what was once a successful business.
More likely, a business will take time to mature and reach a sustained level of sales and profitability. This can then continue for many years until some level of dissatisfaction occurs and gives rise to actions to change the business.
During this ‘mature’ stage, profitability should lead to either a build-up of funds in the business or provide funds for an increase in the owner’s lifestyle expenditure. There can be an opportunity for a reduction in the hours spent by the owner in the business, but quite often the habit of working long hours remains and this can ultimately be the source of dissatisfaction.
The smart owner should use this period of stable profits to properly arrange the funding of the business including the removal of the family home from security for finance. Care should be taken not to leave unneeded funds in the business where there are alternatives for investment and earnings. In a small business, the owner should earn 15 to 25 percent return on the funds invested, reflecting the business risks that are inherent in a business. Currently bank finance will cost in the order of seven to eight percent.
Where possible, there should be an appropriate ratio of owner funds to external finance (gearing) so that owners achieve their 15 to 25 percent on funds while still keeping the external financiers secure with their lending. This makes maximum use of the owner’s overall assets, and separates an investment in the business from other personal and investment assets.
It might be possible to buy business premises instead of renting. An owner’s superannuation fund can sometimes be involved in the property ownership, with good income tax effect.
With a history of profits, a business can approach external financiers to provide finance at reduced rates. Banks have indices of risk. The longer the period of profits and the greater the level of retained profits, the lower the risk and the lower the interest rate and fees should be. But often, if you don’t ask, fees and charges won’t be lowered or personal assets won’t be removed from security.
If business profits have been overdrawn to fund an extravagant lifestyle, the start-up financial pressures (such as shortages of cash) will continue through maturity with regular cash crises and too much time and resources spent dealing with their effects.
More often, with a successful business and a conservative owner, the business will lapse into generating sufficient profits to support adequate lifestyle expenditure without realising full potential for the effort (hours) worke
d or funds employed. This can go on for years until, again, a level of dissatisfaction occurs for one reason or another.
Business planning, or working ‘on the business’ is essential during the mature phase. The planning should involve identifying the multitude of issues that arise in the operation of a business and then prioritising those that are most important in improving the business. Such ‘business improvement’ will assist the company in eliminating bad habits that grow with a business and detract from performance. The earlier the bad habits are identified, the easier it is to eliminate them. Old habits really do die hard!
The trick to dealing with all the issues is to document them. Once issues are documented they can then be prioritised and the most important dealt with first. The list then is a constant source of referral without the need to re-invent it. Once an issue has been overcome, the business can proceed with the next in order of priority and, over time, all the significant issues will be dealt with.
Dissatisfaction with a mature business can arise for many reasons including:
• declining profitability to the extent that the business isn’t supporting the owner’s lifestyle expenditure;
• desire to work less hours;
• introduction of new management;
• new benchmarking indicates an unsatisfactory level of performance against comparable businesses.
Declining profitability can be overcome by simple things such as increased prices or an increase in sales, or more often a combination of both. A business that has a good product and a very good level of customer service can often make a significant price increase without prejudicing sales. There needs to be careful monitoring of not only competitors’ prices but the level of competitors’ customer satisfaction compared with yours. This gives an indication of how willingly customers will absorb a price increase.
Sales growth in a mature business needs a detailed analysis of products sold and a detailed analysis of customer sales. Often, products have reached the end of their lifecycle and need either replacement or rejuvenation. Customers may have declined and/or markets shifted. Customers that have been lost over the years may be targeted and re-gained. New geographical areas may need opening up. The business may need relocating to be closer
to customers or suppliers, or to make use of new infrastructure or sales channels.
All expenditure, both on goods for resale and overheads, must be reviewed. Centralised buying of stock in a business with multiple locations can often lead to quantity discount savings or savings from central warehousing. Additionally, almost every item of overhead has some room for cost-saving. A systematised approach can lead to savings of 20 percent of total expenditure in a mature business.
People should not be ignored in this business phase. Again, there is the opportunity to consolidate with good personnel and eliminate under performers by careful measurement of performance and compliance with the various statutes and laws.
The End
There can be pressure to offer ownership to long-term employees but care should be taken to ensure this doesn’t conflict with either existing or possible future succession plans. Sometimes a title and greater financial reward may be sufficient. An employee may aspire to directorship
until the responsibilities and often financial implications of directorship are pointed
out to them.
When reduced satisfaction with a business comes from the desire for reduced working hours or the introduction of new management, it often coincides with a consideration of business succession.
Too often the desire to deal with succession is left later than it should be. Ideally, consideration and planning for ‘the end’ should be undertaken while in ‘the middle’ phase of a business.
A common term is to run a business so it is ‘investor ready’. The characteristics of a business that is investor-ready include:
• earning an acceptable rate of return (as determined by the market) on the owner’s funds invested;
• commercial ratio of shareholders’ funds to external borrowings;
• paying the owner a commercial rate of salary
• not being dependent on the owner’s input;
• having a properly documented business plan;
• having timely and accurate financial reporting;
• having well-defined processes and culture of improvement and working on the business;
• formality in management including regular meetings with either an outside director or some part-time outside accountability.
A business can be run as investor-ready without any thought that it will actually get an investor during the middle or mature phase of the business. By achieving this, it will then be ready when the time for succession does come, with the introduction of another or substitute investor.
When an owner wants to either quit the business entirely, or step back from it to some degree, the owner has choices including outright sale of the business using a broker; obtaining a percentage buy-out by professional investors, often as a step to listing on the stock exchange; sale to a family member/s; using paid management to run the business, either related or non-related, while retaining ownership; and closing down.
If the business has been successful, the owner may have drawn sufficient remuneration from the business to build up wealth outside it, and so there is no dependence on the business for retirement.
More likely, though, the business will play a significant part in the owner’s retirement. Often the funds from the sale of the business will form a large part of the funding for investments for retirement. Often the owner will place a value on the business that is largely influenced by the amount needed to fund retirement. This may bear no resemblance to the actual commercial value. Too often the owner will leave a succession plan/sale too late and the business will have already started to decline due to at least partial neglect, with a consequent decline in value.
Luckily, the drivers of the value of a business and the concept of a business being investor-ready are strongly aligned, so a focus on one will support the other. The value of a business is driven by its level of earnings (rate of return) and the perceived risk to consistently earn those returns. Obviously, the greater the profit (after a commercial owner’s salary) of a business, the higher the price it would command. Just as importantly, a business run under management with low reliance on input from the owner will have more certainty of earning its profits in the future under a new owner, and will consequently command a higher price. Such a business has a lower level of risk in earning the profit, and an investor may pay, say, five times the before-tax profit (giving a 20 percent return). Different businesses in different industries will pay different profit ratios on sale.
The earlier a business owner works on his business to maximise its worth, the more profits will be enjoyed during the period of ownership, and a maximum price at time of succession will be
more likely.
This holds true whether or not the business is to be passed to the next generation. A business with maximum value will earn maximum profits for the next generation and, if necessary, will still provide a dividend stream to the existing owner if an outright sale to the next generation isn’t possible.
*Dennis Mattiske is senior business services partner with accounting and business and financial advisers HLB Mann Judd Sydney.
Smooth Exit
Here are six tips to help with the smooth hand over of your business.
• When selling a business, value is governed by the return (profit) on funds invested (the price paid for everything, inclu
ding inventory). Goodwill is broadly the difference between the price achieved, and the assets and inventory of the business. In some instances, it can even be negative
• Even a business that isn’t earning a profit can have some value. An established customer base, intellectual property (IP) and business infrastructure can be valuable, governed by the perceived time and cost to establish things from scratch. As one of your most valuable tools, ownership of IP gives you the right to fully exploit your IP to own, sell, license or bequeath your IP in much the same way as you can with real estate. Seek advice on the value of your customer base, IP and business infrastructure so you know its worth.
• Plan your exit years ahead. Have your business investor-ready at all times so you are ready to move when circumstances are right
• Have an exit strategy that suits your circumstances as well as your family situation. If family members are taking over, have they the funds to buy you out? Are they capable of running the business without you? What needs to be done to help?
• With family succession, give proper consideration to the value that participating family members bring to the business—and keep non-participating members informed.
• Plan ahead to maximise the sales price of the business and be aware of the steps you can take to increase its value.
