Battling Assets

Posted on February 1, 2025 by John F. Dini

Occasionally, we run into what I call “Battling Assets.” That is when an owner is drawing a comfortable income from the business, but it is arranged in a way that denigrates the business value, the value of the asset, or both.

Here are three true case studies for examples.

Under-optimized Real Estate

Two partners operated a beautiful campground. The acreage was along a river, and despite rapid suburbanization in the area, the bluff on the opposite bank prevented any visual encroachment. Like many such facilities, it had been a destination for the same families year after year.

The owners were ageing, and sought a buyer who would continue the tradition for their “family” of campers. In our interview they were emphatic about not selling to a developer who would cut up the land into lots for expensive homes.

I assessed the business, and found that their Seller’s Discretionary Earnings (SDE) was roughly $100,000 plus a modest salary for the partner who ran day-to-day operations. I told them that a presumed owner-operator seeking a lifestyle business and possessing substantial cash might pay as much as $1,000,000 in a deed-restricted sale.

They were enraged and accused me vehemently of being some type of grifter. They had already talked with an interested buyer who said he would pay them $4,000,000 for the property.

I asked about the identity of buyer. They said it was a developer who wanted to chop it up into lots for high-end homes. They only wanted a “fair” price for the land from someone who wouldn’t use it in that way.

I’m in Love with My Car

A contractor with an excavating-based business hated to see his workers idle. To make certain they were fully occupied at all times, he maintained duplicate inventory of his heavy equipment.

battling assetsHe would use his flatbed trailers to deliver a backhoe loader, bulldozer, rock saw and dump truck to the next scheduled job a few days in advance. The laborers would be picked up from a completed site (even if it was midday) and delivered to their new workplace promptly. A few days later he sent flatbeds to transfer the equipment from the finished job.

With two sets of equipment, the chances of any one being out of service were pretty high. To be safe, he kept a third set as spares. He was also proud of his substantial knowledge about used equipment values, and usually had a one or two “deals” that he had just purchased and a few others listed for sale.

His business had been good to him. He had a beach house, a ranch, and was essentially debt free. He rewarded his management well, and was perfectly happy with a nominal salary from the business. We estimated that his cash flow would justify a sale price of about $2,000,000.

He was shocked. “I have more than that just in equipment!”

The truth was, he could sell most of the equipment, sell the business to his managers for a note, include just one set of working tools, and still be better off financially.

The Battling Assets

This owner had a large building fronting on a busy highway. He had paid it off years before, and took the substantial rental payments as his principle income.

He occupied the premises with his business, a wholesale distributor of construction supplies. His wife took a salary for her administrative work, and the company paid health insurance for the two of them. Otherwise the business was at break-even.

At first, I found it difficult to understand why he even bothered with the business. In his eyes, it had little purpose other than as a triple-net renter for his building, although he worked more than 40 hours a week running it. It paid the rent plus all the expenses of maintenance and taxes.

When we looked at “normal” rents as a percentage of revenue for his industry, his costs were double the average. When we compared rents for the area, what he paid for his building  was about one-third less than the market rate.

We ran the numbers. I could show him how much more profitable the business would be if it paid thousands of dollars a month less in rent. I also showed that without his business there, the building could be charging thousands of dollars a month more to a tenant who wanted the highway visibility.

The practical results would be almost a doubling of his current income, as well as making the distribution business saleable.

Sometimes business owners become focused on a comfortable lifestyle at the expense of maximizing their investments. Pointing out battling assets can be both eye-opening and (usually) much appreciated.

Posted in Building Value, Exit Planning, Exit Strategies, Management | Tagged , , , , , , , , , , , | 1 Comment

One Response to Battling Assets

  1. Valerie Koenig says:
    February 3, 2025 at 4:37 pm

    Good insights, love the examples.

    Reply

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Purpose – Life After the Sale Part 3

Posted on December 27, 2024 by John F. Dini

The third component of life after the sale is Purpose – “Having as one’s intention or objective.”

Many exit planning advisors discuss the three legs of the exit planning stool – business readiness, financial readiness, and personal readiness. In our previous two articles, we focused on two of the “big three” components of a successful life after the sale, activity and identity. The third is purpose.

So many advisors point to the 75% of former owners who “profoundly regret” their transition, and say it’s because they didn’t make enough money. To quote Mr. Bernstein in the great film Citizen Kane, “Well, it’s no trick to make a lot of money…if all you want is to make a lot of money.”

I’ve interviewed hundreds of business founders. When asked why they started their companies, by far the most common answers are about providing for their families and having control of their future. Only a very small percentage say “I wanted to make a lot of money.”

Decades of Purpose

So what kept them working long hours and pushing the envelope after they had reached primary, secondary, and even tertiary financial goals? Sure, non-owners may chalk it up to greed, but Maslov’s hierarchy of needs drifts away from material rewards after the first two levels. Belonging, Self-Esteem and Self-Actualization may all have a financial component, but money isn’t the driver.

For most owners, the driving motivation is this thing they’ve built. The company has a life of its own, but it’s a life they bestowed. They talk about the business’s growing pains and maturity. Owners are acutely aware of the multiplier effect the success of the company has on employees and their families. In a few cases, that multiplier extends to entire towns.

That’s the purpose. To nurture and expand. In so many cases every process in the business was the founder’s creation. He or she picked out the furniture and designed the first logo. This aggregation of people breathes and succeeds on what the owner built.

That’s why so many owners still put in 50 or more hours a week, long after there is any real need for their presence. This thing they created is their purpose.

Life After the Sale

Unsurprisingly, so many owners find that 36 holes of golf each week, or 54, or 72, still isn’t enough to feel fulfilled. You can get incrementally better, but it doesn’t really affect anyone but you. Building a beautiful table or catching a trophy fish brings pride and some sense of accomplishment. Still, it never matches the feeling of creating something that impacts dozens, scores, or hundreds of other human beings.

life after the saleThat’s why we focus on purpose as the third leg of the personal vision. In the vast majority of cases, it involves impacting other people. Any owner spent a career learning how to teach and lead. Keeping those skills fresh and growing is a substantial part of the road to satisfaction.

Purpose in your life after the sale may involve church or a community service organization. It could be serving on a Board of Directors or consulting for other business owners. It might be writing or speaking. Purpose doesn’t require a 50-hour week, but it does require some level of commitment, and the ability to affect the lives of others.

Posted in Exit Options, Exit Planning, Exit Strategies, Life After | Tagged , , , , , , , , , , , , | 2 Comments

2 Responses to Purpose – Life After the Sale Part 3

  1. Jim Marshall says:
    December 27, 2024 at 2:57 pm

    This column is right on. I found many of those for whom I served as a consultant were the happiest after the sale if they had a hobby / purpose. For one it was building and flying personal aircraft, for others caring for a disabled spouse or other family member, or serving as spokesperson (officially or non officially) for an organization for which they had/have a passion were the happiest with having left their business.. And the route to that success started with plannning for no longer being “boss”. or known ownly by their connection to their business. As parrt of their exit strategy they passed on responsibilities to others and used that freed up time to start / continue their non business passion.
    One of my former clients started his association with me in 2006 with a goal of retiring in three years. He slowly passed clients and responsibilities and eventually sale of his company to his partner. He still (in 1924) performs those activities he likes with the clients he likes, when he likes. But travels, coordinates groups of friends E.g. into book clubs ,spends time with family and maintains his “mini farm,” acrerage” .He has no “need to do this” or “be there” at a specific time” etc. In his mind he is retired…and I think on the basis of my observation duiring our continued friendship .. his “third year” will be marked by his funeral. Not everyone can do what he has, but if desired, can do a variation.

    Reply
  2. Suzann Woodward says:
    December 27, 2024 at 3:48 pm

    Thanks John, this is very meaningful.
    I have sold my business and am in the process of transitioning to new owners now. I will work through 2025 and then just be available for consulting and questions on clients. So far all is going smoothly, hope that continues!

    Reply

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Technology Costs and Quality of Earnings

Posted on December 18, 2024 by John F. Dini

Are you avoiding technology costs? A few months ago, a subscriber to our planning tools called with a tech support question. “Your software doesn’t work,” he said.

After some investigation, we identified the problem. He was using a version of the underlying engine, (a part of Microsoft Office) that was four or five generations past end-of-life.

When asked about his willingness to upgrade he said, “I don’t want to be forced into getting a subscription.” As a side note, no software developers try to develop for compatibility with end-of-life products.

I understand his issue completely. When Microsoft introduced Office 365 in 2011, I was as irritated as most folks were. We maintained generally up-to-date software but usually skipped a release or two. Upgrading applications happened when we began buying the next round of PCs with newer Windows operating systems. I protested the need to pay for software every year.

Clearly, we lost that battle a long time ago. None the less, I can understand our client’s issue. He runs a solo practice, and his software works just fine for his relatively limited needs.

What are “True” Technology Costs?

As I’ve coached for many years, true hardware and software costs should be measured by employee productivity.

technology costsBegin with hardware. Keeping an old computer alive isn’t efficient. (And this is from someone who drives a 17-year-old car!) An IT managed services client of mine described the “break/fix” portion of his business for a customer who didn’t want to “subscribe” to managed IT services.

“We get a call that the printer isn’t working and dispatch a technician. We haven’t looked at that particular PC in eighteen months. Employees have loaded new programs. They’ve done some, but not all of the required updates. The technician performs the updates, reinstalls the printer drivers, and gets it working after about 2 hours.”

“When we invoice the tech’s time, the customer has a fit. ‘I could have bought a whole new computer for that much!’ he says.”

No fooling. That’s why break/fix has become pretty much the domain of a walk-in trade for storefront technicians. Most IT companies can’t afford to do it anymore.

More importantly, what did the malfunction create in indirect costs to the company? What’s the cost of the idle employee, the job that wasn’t printed, and the boss’s time to fight over the invoice?

Let’s say for a simple illustration that an office employee’s fully loaded cost is $52,000 a year, or $1,000 a week. Buying a new PC every three years is about $500. How much time does the employee need to save to pay for the newer computer?

The answer is a bit less than 7 hours… a year. That’s 2 minutes per working day. So, the real question becomes “Will a newer computer save this employee 2 minutes a day?” It may not be immediately obvious, but if the tech support company is charging five times the employee’s salary ($150 an hour,) saving even one incident over the next three years more than covers it.

Technology Costs in Quality of Earnings Audits

Technology costs have become an integral expense item for almost every business. This hasn’t escaped the notice of business buyers, especially professional buyers.

Expect a Quality of Earnings (QoE) audit to encompass software licensing and subscriptions, hardware and equipment, IT support and maintenance, cloud storage, telecommunications (bandwidth and redundancy,) cybersecurity, and data protection insurance.

If a company is still working with the old “If it fails, then we’ll replace it,” you can expect a substantial downgrade of its EBITDA. A dozen new PCs, a server, new software licenses, cloud storage, annual costs for a bigger Internet pipe and a second carrier could easily cost $100,000.

Depending on the multiple being paid, each $100,000 deducted from the EBITDA means 3, 4 or 5 times that amount deducted from the price. That will get the seller’s attention, but by then it will be too late.

Technology coats for current (not cutting edge) equipment and software are money well spent both now and at the time of a sale. Expected and budget for upgrades on a regular cycle. Deferring the expense might be the definition of “Penny wise and pound foolish.”

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What is an Exit Plan?

Posted on November 27, 2024 by John F. Dini

“What is an Exit Plan” is an article I wrote ten years ago. It was just brought to my attention and I realized I never posted it to Awake for some reason. Here, with some updating, we celebrate its 10th anniversary.

Exit planning is the buzzword for those who consult to Baby Boomer business owners. Business brokers, wealth managers and other professionals are adding “exit planning” to their marketing messages. It’s a logical reaction when over 5,000,000 Baby Boomers (about 3,000,000 in 2024) are preparing to leave their businesses.

Not surprisingly, when a business broker creates an “exit plan,” it usually involves listing the business for sale to a third party. An attorney’s planning focuses on the legal documents that allow the transition of the assets of a company to new ownership. An accountant or financial planner will look closely at tax and inheritance issues, and an insurance broker offers products that reduce the risk of interruption or disaster.

All these are important to the successful implementation of a plan, but each professional focuses on his or her specific skill set. If your shoulder hurts, you could go to an orthopedic surgeon, a neurologist, a general internist, a chiropractor, or a physical therapist. Each will have a treatment approach for a painful shoulder. Each will be different, based on his or her specialty. Each will reduce the pain at least somewhat, although some of them may or may not address the underlying cause.

Similarly, there are many professionals who claim competence in exit planning. Each has a different area of expertise, and what they term exit planning tends to focus on those areas. A comprehensive exit strategy encompasses legal, tax, and risk management issues, but it also examines the operational issues of the company whose value is the underlying driver for everything else.

Why do an Exit Plan?

Before drafting the first document or embarking on a plan to spend the money from a sale, the business must first realize the proceeds of a transaction. That means it must find a buyer who will pay for it. That buyer could be a third party, but it might also be an employee, an employee group, or family members.

Any third party considering the purchase of a business will do extensive due diligence. Their willingness to pay a premium for a company will depend on its track record of revenue growth, the stability of its margins, and how well-established its systems and customers are. If the company is larger than about twenty employees, they will look for supervisory and management talent who will stay after the sale.

Regardless of size, a business that is highly dependent on the owner for revenue or making all key decisions will be deeply discounted or even impossible to sell. An exit plan should look at these factors and help to make the adjustments needed to realize full value.

Selling to employees or family is often an attractive option because it allows the owner to choose a retirement date, and price is less of an issue than financing terms. Unless you are willing to accept a promissory note for most of the price and feel secure that your successors can maintain payments over a long period, a plan for this kind of exit should begin at least three, and preferably five to eight years before the planned transfer date.

What is an Exit Planner?

An exit plan needs legal, tax, risk and wealth management expertise to be successful, but it also requires a practical examination of the operational strengths of your business. Selecting one professional to manage the efforts of everyone, and to help keep you on track, is a wise investment.

In America, the average small business owner has nearly 75% of his or her net worth in the company (still true in 2024). The single biggest financial transaction of your life deserves special attention.

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Cash Flow Normalization

Posted on October 8, 2024 by John F. Dini

Cash flow normalization is done with the intention of identifying Earnings Before Interest Taxes Depreciation and Amortization (EBITDA) or Seller’s Discretionary Earnings (SDE). These differing measures are not interchangeable, but are used by different classes of buyers for different categories of acquisition.

Free cash flow is an important measure when calculating the value and price for any business. It is the amount theoretically available for servicing acquisition debt, working capital, return on investment for any cash outlay in the acquisition, and future expansion.

Cash Flow Measures

EBITDA establishes free cash flow as a measurement for most mid-market businesses. It evens out the differences in earnings caused by various tax jurisdictions. In the United States, there is federal income tax at the corporate level, but many states have additional income taxes, and in some cases, even smaller jurisdictions like cities may have their own income tax. These obviously impact the profitability of a company and could distort a buyer’s impression of its profitability.

EBITDA calculations do not include the owner’s earnings, since the companies being examined are more likely to be acquired by investors who would replace the owner with a management executive.

SDE is the measurement used to illustrate the sum total of financial benefits available to the owner-operator of a business. It assumes that the owner is running the company on a day-to-day basis. SDE encompasses not only salary, bonuses, and distributions, but includes insurance and other benefits such as a company-paid vehicle.

A simple way to put it is that EBITDA is the cash flow available for a return on investment. SDE is the cash flow available for a return on the owner’s labor.

Making  Adjustments

cash flow normalizationIn the SDE calculations, there are two places where there is often an adjustment of expenses to market. The first is for a family member employed in the business or partners who intend to leave simultaneously with the principal owner.

In many instances, family members are paid according to their needs or the needs of the business instead of at a market rate for the position. With family members who are “underpaid” adjusting to the market rate will have the effect of reducing the cash flow available in the business. This reflects the fact that the family member or partner will have to be replaced by someone who is unlikely to work for a below-market salary.

The opposite is of course true for family members or partners who are overpaid. Reducing their compensation to a fair market rate will add to the discretionary cash flow of the business.

A second area of adjustment is when the owner of the company also owns the real estate that the company operates in. Again, the rents paid on the real estate often reflect the owner’s objectives more than they do the practical reality of the local real estate market.
A company that is underpaying rent is having its bottom line shored up by the reduced income to the real estate entity.

Overpayment of rent requires the owner to make a decision. If they expect the same rent from a new tenant, the profitability of the business as presented to a prospective buyer will be lower. Considering that most transactions involve a multiple of cash flows, you can usually point out to the owner that trying to maintain a higher rent is not in their interest as the seller of the company. Adjusting the rent to a market rate increases the cash flow of the company and presumably the basis for an evaluation multiple.

Which Cash Flow is “Right?”

The decision of whether to use EBITDA or SDE when calculating cash flow is dependent largely on the size of the client’s business. If the company has cash flow in excess of $1 million annually or is large enough to be a likely target for professional buyers, EBITDA is the appropriate measurement for cash flow.

If the company is going to be purchased by family members, employees, or another entrepreneur and has a cash flow of less than $700,000, SDE is almost always a more appropriate measurement.

Which cash flow is used is a situational decision and may change if different classes of buyers are being engaged.

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