Preparing a business exit strategy

Friday, 13 October 2006 15:09 Noric Dilanchian

Last month I jumped at the chance to speak at a conference of business consultants.

I knew the audience would be owner/operators of consultancy businesses.

I titled my presentation "Preparing your service business for sale".

From my PowerPoint for the conference I have extracted for Lightbulb law blog readers:

• Eight hints for planning now for an exit;
• Six hints to increase your sale price; and
• Nine options or types of collaborative arrangements.

I began my presentation by emphasising that a more appropriate title is probably "Preparing your service business for exit". I said that while consultants sometimes get to sell their business, it is far more common for them to form collaborative arrangements.

I added that the Business Review Weekly, and most other popular press writing on the subject of business exit paths, fixate on sales. This is despite the reality that various types of collaborative arrangements can quite logically be treated as having many of the hallmarks of a sale exit. In other words you don't have to sell to exit.

Settling into my presentation I said that a focus on business sales is nonetheless useful as a form of exit. A sale transaction is easy to understand. Many hints for a "for sale" transaction also apply to "for exit" type transactions.

Moving towards being a "business builder"

A business sale or other exist path is not possible for most self-employed service providers, advisers or consultants. We will refer to this group as "self-employed professionals".

Self-employed professionals typically die, fail, close or retire from their business; they rarely achieve a "for sale" or other "for exit" transaction. You can read more on this topic in recent posts by a consulting colleague, Jim Belshaw, in his blog titled Managing the Professional Services Firm. Jim has a deep level of learning on the fate of self-employed professionals. I have personal experience in learning and taking counsel from him to make my own transition to being a business owner and builder.

QUESTION: If you are a self-employed professional and want to exit how can you change your fate? The answer is to become a business builder.

Those in the audience at my presentation were almost all self-employed professionals. I took a quick straw poll. Of the about 26 consultants in the room only two said they had employees and only five said they had been involved in or advised clients in connection with a business sale.

I knew immediately my talk was "on message" so I then said that the change management project required to become a business builder generally involves the following list prepared for me by Jim Belshaw:

• Develop revenue streams beyond just selling time.
• Develop, clarify and document your business model, business functions, business process, and business systems. Remember a business is an abstract concept until it is defined, preferably in writing and graphics.
• Move towards also selling assets – with contracts, intellectual property (IP), or a brand.
• Move towards deeper collaborative arrangements with clients, suppliers and colleagues.
• Move towards leverage and yield from developing things to go with a business sale.

Eight hints for planning now for a sale

Developing a business for sale I said involves thinking about the sale contract from the outset. I provided eight hints for planning now for a business sale. They involve reviewing the following:

1.  Frameworks - define the business and thus prepare for sale of business non-competition clauses

• Consider a "crown jewels" IP holding company versus just using an operating company

2.  Work in progress, workflow and project management methodology

3.  Assignability of “assets” – IP, IT, contracts, licences, forms and templates

4.  IP inventory (trade marks, copyright, patents, confidential information etc) and IP compliance

• IP auditing; the role of policy and procedure documents
• “Information law” compliance is a big job – confidentiality law, privacy law, IP law, spam law, moral rights law, IP licence conditions

5.  Contracts/deals for employees, contractors, others – maintaining value

6.  Risk minimisation – warranties, indemnity, terms for payment to you

7.  Capital gains – small business relief provisions under capital gains tax law. In Australia:

• Net asset value must be less than $5m
• Must be active assets (ie used in the business)

8.  Apportionment of the sale price, eg for capital gains tax:

• Review the book value of goodwill
• Value and protect IP and review the book value of IP (eg pre-1985 assets)

Six hints to increase your sale price

Whatever exist path is in the plan, there will be a real or notional sale price. It is usually imperative to increase that figure. During my presentation I provided the six hints below.

The list is based on advice prepared years ago by Jim Belshaw when he assisted me for a business builder client of mine who was preparing to sell his publishing, consulting and software licensing business.

1. Improve revenue

2.  Improve operating margins

• Productivity
• Net profit

3.  Improve IP assets and make the business sustainable

• Methodologies (What's your secret or your “factor X”?)
• Templates (eg stationery, forms, procedure documents)
• Business systems (eg for job scheduling, workflow, billing, bill recovery)

4.  Clean up exposure to risks and liabilities

• Document informal arrangements (normally a huge gap or risk area!)
• Review insurance (professional indemnity, directors and officers insurance etc)
• Bring tax and company compliance up to date

5.  Re-align with "industries" with higher valuation multiples (eg EBIT, EBITDA or rule of thumb).

6.  Collaborate with others.

"Grab your partner, dosado" - exit paths with collaborative arrangements

I concluded my presentation with hints on forming collaborations. As already noted, as an exit path the formation of collaborations is an under-reported yet often followed route. Business collaborations are more common than business sales. Over the years I have prepared or reviewed literally thousands of contracts for various types of collaborations (provided you include IP licensing deals, as I do, in the list of "collaborations").

News reporting distorts perceptions by focusing on M&As, business sales and trade sales. This simple to understand, as well as glamour activity, obscures the mundane but rewarding reality in the marketplace involving many alternative exit paths available with collaborative arrangements.     

Collaborations are less familiar to most people who are used to the simpler concept of a "buy" or a "sell" transaction (ie an M&A, business sale or trade sale). Now here's why I've selected the photo which began this post. Collaborations are a bit like square dancing, polka and reels. Each involves similar but distinctly different routines or dance steps. So too with the various types of collaborations, there are similarities between them, yet the distinctions between them are important if not in some cases critical. Distinctions may be based on law, business or other considerations.

In the commercialisation of a product or a service business, finding a collaborator can provide both growth and an exit path. Here are nine collaboration types, though it's not a comprehensive list I have in fact found it a useful and stable list for a very long time.

1. Co-operative
2. Licensing
3. Distributorship
4. Joint Venture (contractual or incorporated)
5. Franchising
6. Outsourcing (some types)
7. Strategic Alliance (some types)
8. Co-production
9. Partnership

As you move down the above hierarchy, in general terms there is more:

• Knowledge sharing
• Integration in business operations (eg structures, functions, processes, offerings)
• Interdependence
• Commitment of resources for joint interests, rather than separate interests
• Joint asset ownership
• Focus on long term outcomes

A good collaboration contract translates all of this into legally binding terms and conditions. Before doing so a good business lawyer would apply or refer to planning and management know-how to assess the suitability of the proposed terms and conditions. It is therefore a good idea to conduct thorough due diligence and see a lawyer well before you make any firm proposal to anyone about a collaboration. Together you can shape the proposal to maximise the chances for collaboration success as opposed to collaboration failure.

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