Is There Anything CEOish for Me to Do?

Posted on September 20, 2015 by John F. Dini

The line is from one of my favorite New Yorker cartoons. It’s being asked by an executive of his secretary. It is also a common question of business owners who have built successful organizations.

The need for a CEO is present in every company, regardless of size. For most owners, the idea of acting as a CEO gets subordinated to the urgency of their day to day responsibilities as President and some other C-level title; Chief Operating Officer, Chief Sales Officer, Chief Financial Officer, or sometimes all of the above.

If they do their job well, if they learn to train, mentor and delegate operating duties to managers, owners may reach a point where they aren’t buried in the minute-to-minute operations of the business. They have time to think about the future. They can analyze the company’s direction for how it supports their vision.

Thinking ideaA CEO is supposed to think strategically. He or she is the only person in the organization charged with looking for what isn’t there. What missing key capabilities will prevent the business from making the next leap? What competitors or new products threaten the existing flow of products or services? What disrupters challenge the customers themselves?

In reality, most small business owners who can actually carve out quiet time from their workday don’t know what to do with it. They dive deeper into reports, or call additional meetings with their managers to assure themselves that things are still on track. Setting aside time for strategic thought is tough. It feels too much like goofing off.

New ideas don’t come on demand. They are responses to stimuli. The best way to generate those is to be in a situation where they occur. That’s not accomplished by meeting with the people or attending the events that have always been part of your business. You need to expose yourself to different stimuli to get different ideas.

Join a peer group that isn’t focused on your industry. Attend some professional events that your customers frequent for education, not the ones where you sell to them. Attend trade gatherings of your vendors to see what your business really looks like to them. Go to local presentations about business topics that you may have little natural interest in, like technology or finance.

Most importantly, get out. Just carving out time to “be strategic” has little value if you are sitting in the same office surrounded by reminders of your day-to-day challenges.

Posted in Entrepreneurship, Leadership, Thoughts and Opinions | Tagged , , , , , , , , , | 2 Comments

2 Responses to Is There Anything CEOish for Me to Do?

  1. craig eastman says:
    September 21, 2015 at 9:07 am

    That is right on for a successful company. I continue to stimulate with outside influences and appropriate the time for projections on business needs and direction along with diversification. Good and simple read, but most overlooked in small business. Good job John!

    Reply
  2. Steve Davies says:
    September 24, 2015 at 11:14 am

    Well put, as always! When I was running my computer service company we moved to a new building, and I was a little embarrassed at the size of the CEO office that the new office layout had. The thing was huge with a cathedral ceiling, and I always felt that you could play basketball in it! I was talking to a consultant one day who was helping me with strategy, and I mentioned my thoughts to him. His reply has always stuck with me and is germane to your point: “Your job is to sit in your big office and think the big thought.”

    Reply

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Germany Makes a Business Decision

Posted on September 13, 2015 by John F. Dini

Germany just announced that it could accept an additional 500,000 refugees when other countries are jockeying to accommodate as few as possible. As much as the announcement was portrayed as a humanitarian effort, it is just as likely a simple business decision.

Few members of the European Union, or those outside of the EU for that matter, would accuse Germany of fuzzy-headed liberalism. Their insistence on economic reforms focused on austerity, curtailed government benefits and a balanced budget (or at least closer than most nations manage now), has earned them the enmity of most Greeks and  economic liberals throughout the continent.

While I can’t criticize the undeniable human benefits of Germany’s decision, it also reflects two key factors that are important for any business or economy; the size and talent of its workforce.

Like northern hemisphere nations from Canada to Japan, and including the United States, China and the entire European Union, Germany’s working population is ageing. Multiple studies by both their government and private think tanks predict a shortage of up to 1.5 million skilled workers in the next five years.

Any shrink in new and skilled workers (who are also consumers) will slow economic expansion. The EU countries with the lowest birth rate over the last 30 years are Greece, Spain, Portugal and Italy. Japan is already feeling the impact. China will be hit worse, but a bit down the road ( from 2030 to 2050). In the US, the massive exiting of the Boomers from the workplace has begun, and will accelerate over the next ten years.

liberty and NY skylineThe key term is “skilled” workers. As technology whittles away at the middle class, few societies are say “Give me your tired, your poor, your huddled masses” anymore. That’s where Germany’s offer is brilliant.

The Atlantic published a great look at the Islamic State in its March issue. Trained by ex-KGB agents, IS infiltrators enter a city in advance of their military force. They attend town meetings and other public events, noting the names of community activists, elected officials and business executives. When they attack in force, assassination squads equipped with the names and home addresses of these leaders go from house to house eliminating them. Their objective is to decapitate any local nucleus for organization.

The result has been to create a refugee population that is generally better educated and wealthier than their countrymen. Anecdotally, a friend who visited Greece a few weeks ago tells the story of a Syrian refugee’s frustration at the inability of Greek shopkeepers to make change for 500 Euro notes, the smallest denomination he carried. Many of these refugees are anything but destitute. Germany is seizing an opportunity to add much-needed skills (and possibly capital) to their worker population.

In the meantime, the run up to the U.S. Presidential nomination continues to generate waves of anti-immigration rhetoric, ranging from the racist to the silly. Mass deportations, amending the Constitution to limit citizenship and building a giant wall are populist sops that, unfortunately, play well with a frustrated population.

The problem isn’t immigration, it’s the right immigration. I understand that the egalitarian ideal expressed in “All men are created equal” is part of our national psyche, but does it mean that we have to run our economy into the ground in its observance? I’m certainly not racist, but no rational businessperson would argue that a Latin American subsidence farmer has the same economic potential as a Chinese PhD.

Germany has seized a business opportunity by reaching out to talent that can positively impact its economy. The United States can do the same by introducing a sensible immigration policy that includes some consideration of economic merit.

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7 Responses to Germany Makes a Business Decision

  1. Dan Bowser says:
    September 13, 2015 at 10:23 am

    Thanks for putting a face on the other side of the immigration issue. Our country benefited greatly economically from immigration in the past. We can benefit now while helping many people at the same time.

    I wonder if we as a nation can get past the frustration of extreme political self-interest and see through the pandering on the part of some candidates.

    I’m hopeful but concerned.

    Reply
  2. David Cunningham says:
    September 14, 2015 at 12:16 am

    This observation is spot on. Japan will suffer worst because their racial intolerance is so bad that they cannot contemplate the an immigration program at any scale that would save them. On a visit to Yokohama I had repeated experiences in being denied access to jazz clubs, because they were “Japanese Only”. It was a trivial discrimination but it made me aware how bad it can make you feel.
    The least intelligent of the current US immigrant phobias are the proposals to repeal the 14th Amendment to the Constitution – “All persons born or naturalized in the United States, and subject to the jurisdiction thereof, are citizens of the United States and of the state wherein they reside.” and to repeal the Dream Act that removes the threat of deportation for children of illegal immigrants. In most cases, we have already educated these young people and they are an economic benefit to their communities.
    I wish “Cost / Benefit” analysis could be applied to many of the challenges that face the USA.

    Reply
  3. Katrin Anger says:
    September 14, 2015 at 12:33 pm

    Good point!
    While there are many perspectives that can be taken on this topic, this is certainly one with a positive side effect. – Whilst I don’t think that this is the main motivation for the German government, it could indeed prove true and benefit Germany in a few years … if they succeed on integration.

    Reply
  4. Francine DiFiippo says:
    September 14, 2015 at 3:09 pm

    Several years ago I was traveling in Norway and was struck by the large population of Somali immigrants there. Norway also has a negative population problem and had been attracting immigrants from many countries including the US becuase they seem to be color blind according to several former American black people I met. they would rather raise their children there there away from gangs and low expectations. Norway only wants you to commit to raising your children there and will subsidize you to do so with parental leave, education and job training for the parents. I was surprised to see so many olive and dark skinned people in the land of the blond, blue eyed Norsemen even outside of the urban areas..

    Reply
  5. Mike Wright says:
    September 14, 2015 at 5:40 pm

    On Point. One other factor in Germany’s favor is the effectiveness with which they assimilated a less skilled East Germany population back in so efficiently and effectively. We must make education and training of the new immigrants a priority so they can help our economy grow, and not just to perform low skilled low paying jobs.

    Reply
  6. Martin Lindeskog says:
    September 15, 2015 at 12:59 am

    We all should be champions for open immigration and free movements cross the borders, as long it is based on the trader principle. If you have the right to your life, you should be able to live and work wherever you want, in a free world.

    Immigration as become a hot topic in Scandinavia. I hope people will learn from the melting pot and the land of opportunity: the United States of America.

    Reply
  7. electricscootershq.org says:
    September 21, 2015 at 9:49 am

    As with most European countries, meetings etiquette in Germany relies on professionalism, good business sense and formality. Bearing the above in mind, together with a positive attitude will ensure good results.

    Reply

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Companies Sell for a Multiple of…What?

Posted on September 6, 2015 by John F. Dini

Last week we discussed the difference between Main Street and Mid-market companies regarding their prospects for finding a buyer. You can read it here, but the short analysis is that the market is tightening for Main Street businesses, while the number of buyers and valuations for Mid-markets are at or near an all-time high.

The confusion between the two regarding valuation methodologies is even worse than that surrounding potential buyers. Owners and their professionals talk about earnings, add-backs and recasting financials as if they were universally accepted terms. They are not, and their usage differs dramatically between the two types of companies.

Despite this, I frequently (and I mean with something close to half the cases I work with) see professionals (who should know better) toss out valuation multiples like they were written in stone somewhere. CPAs seem to be the biggest offenders, but attorneys run a close second. They casually tell a business owner things like “All small businesses sell for about 5 times earnings,” or “You can expect your company to bring between 3 and 4 times its adjusted cash flow.”

They seem oblivious to the fact that an owner takes their uninformed and uneducated off-the-cuff statement very, very seriously.

level with coinsNo two companies are alike. Besides profitability, growth rate, customer concentration, management depth and geography, valuations can vary by as much as 40% with the swings in the financial markets. There is no “typical small business value,” but how companies are valued is pretty consistent in the two segments.

Let’s start with a high-level view. The buyers for Main Street (under $3 million valuation) businesses are typically purchasing a personal income stream. Those acquiring a Mid-market company are seeking return on investment, whether from profits or potential growth. Therefore, the two look at expenses and cash flow differently.

Main Street: When preparing a smaller business for sale, a broker will “recast” some expenses on the income statement. Recasting starts with profits before taxes, and adds interest expense, depreciation and amortization. The first add-back, interest, is assumed to be a cost of growing the business, and one which an owner could avoid if he or she chose to. (If you are borrowing to cover losses, you company probably isn’t saleable anyway.) Depreciation and amortization are non-cash methods of accounting for tax purposes, and are considered available cash flow.

The rest of the recasting involves those items that are “Sellers Discretionary Expenses” (SDE). Put politely, they are the type of expenses that the seller would probably not be able to take in someone else’s business. They can range from a personal vehicle to transporting the family “Board of Directors” to Orlando for an annual meeting.

These expenses are added to the owner’s salary and benefits to give buyers a better picture of all the financial benefits of ownership. Valuations are different for every company, but when a business is being sold to an individual owner-operator who will use third-party financing for the majority of the purchase, the ability to draw a salary and support the debt keeps valuations for such companies at an average of 2.2 to 2.8 times the SDE. (I repeat- your results may vary, but these are the averages.)

Mid-Market: These buyers don’t really want to see a bunch of hidden benefits. It’s too hard to explain to their investors or corporate executives. They assume that the owner’s compensation package is in line with what they will have to pay a new president to run the company. Except for some GAAP adjustments, their add-backs to cash flow will include Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA).

Falling back on averages again, multiples of EBITDA paid by private equity groups from about 2003 to 2013 ranged year-to-year from 4.7 to 5.2 times “earnings.” Not a very big range, and not surprising considering that they have investment return targets for every deal.

Which one is better? Neither. Both. It doesn’t matter. I’ve seen plenty of companies where 2.8 times SDE was more than 4.7 times EBITDA. It’s just the way the two markets measure.

It is important, however, if you are preparing your company for a third party sale. Many advisors tell their clients to strip all personal benefits out of the company years before selling in order to raise historical EBITDA. That is far more important if you are selling a business worth over $3 million, but usually in such businesses the personal benefits aren’t really material. In a smaller business, most of those expenses will be recast anyway.

Just understand which methods apply to your business. If you are working on an assumption that  your buyer will “typically” pay 5 times SDE, you have mixed apples and oranges, and are likely heading for disappointment.

Posted in Entrepreneurship, Exit Planning | Tagged , , , , , , , , , , , , , , | 5 Comments

5 Responses to Companies Sell for a Multiple of…What?

  1. Jon Konchar says:
    September 6, 2015 at 10:10 am

    Right on target. Thanks for the article. Thought: The experts who have never bought oe sold a business,,, are they experts?

    Reply
    • John F. Dini says:
      September 6, 2015 at 11:04 am

      Good point, Jon. Some believe that their technical expertise in analyzing financial statements or drafting contracts is sufficient to handle a transaction. Too bad so many owners find out too late that isn’t the case.

      Reply
  2. David Cunningham says:
    September 8, 2015 at 10:33 pm

    Hi John.
    If I am representing a buyer, we would look at the discounted cash flow of four year projected earnings, plus a terminal value, particularly if the buyer is using some debt to make the acquisition.
    David.

    Reply
    • John F. Dini says:
      September 9, 2015 at 8:20 am

      David,
      NPV of future cash flows is a reasonable way of calculating ROI for a buyer, but it would still translate into a number that needs to be compared against the industry data calculated in the more standard way.

      Reply
  3. Oswald Viva says:
    September 17, 2015 at 10:20 am

    Good article. The truth is that a business, any business, is not worth what the owner think is worth, and is not worth what the buyer think is worth; it is somewhere in between, but how do you convince both parties of that?

    Reply

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Owners Live in Two Different Worlds

Posted on August 30, 2015 by John F. Dini

Business owners live in two different worlds. If you are a Baby Boomer, the title of this column might bring memories of any one of the many covers of the song by the same name. (Everyone from Nat King Cole to Roger Williams, and from Jerry Vale to Englebert Humperdinck recorded it.)

My application of it in business refers to the chasm between those owners who plan to sell a business valued at less than $3 million, and those who have companies valued at more than that. In M&A parlance; “main street” and “mid-market” businesses.

business presentationSome background is in order. I spent the week at two conferences. At the Business Enterprise Institute’s Exit Planners’ Conference we talk mostly about the complexities and structures of mid-market transfers. From there, I attended The Alternative Board’s International Conference for advisors who run peer advisory groups and provide coaching, principally for the owners of main street companies.

At the latter, I had the privilege of being on a panel with Bo Burlingham of Inc. Magazine, the author of Small Giants and Finish Big, and John Warrillow, the Founder ofBurlingham Warrilow Dini the Value Builder System and author of  Built to Sell. It would be challenging to find three people in the country who have spent more combined time studying how small businesses sell, and what determines their value to a buyer.

Even with two audiences of savvy professionals who are focused on the flood of business owners transitioning from their businesses, in many sessions the presenters had to explain the difference between the two markets. As an owner, it’s critical that you understand what the market is for your company. Using data from the other side of the fence is only destined to frustrate you.

Mid-Market

These are companies with a value (not revenue!) of greater than $3,000,000. To garner the interests of financial buyers (private equity groups), they have to generate pre-tax earnings of at least a million dollars a year. To attract strategic buyers, they must have some real differentiation in their industry or market. Those who are truly scalable and have already grown to over 100 employees are the hottest commodity; but according to Doug Tatum, the author of No Man’s Land, they presently account for about 30,000 of the 6.5 million private employers (2-500 employees) in the marketplace.

The acquisition outlook for these companies is wonderful. The financial market is blazing hot, with 7,000 private equity players and publicly traded acquirers chasing those 30,000 businesses, or at least any among them who will still take a phone call. Valuations  are growing quickly, with multiples in the upper end of the market up over 20% in the last two years, and well over a trillion dollars of “dry powder” waiting to be spent on buying them.

Main Street

Clearly, the odds are pretty high that you are one of the 6,470,000 owners whose company does not fit the description above. Welcome to Main Street, where differentiation is difficult or impossible to quantify. (Sorry, but in all but the rarest cases,  “service” is not a competitive differentiation.) The business exists primarily for the purpose of providing financial security for the owner and the employees.  Likely acquirers include individuals seeking to purchase an income, small competitors, or if you are close to the million dollar pre-tax mark, perhaps a private equity group looking for a “tuck-in” or “bolt-on” to an existing similar acquisition.

The news for these owners could not be more starkly different than for the chosen few in the mid-market. According to Burlingham, somewhere between 1.3 and 2 million of these businesses will come up for sale in the coming decade. According to both IBBA (the business broker’s association) and the US Chamber of Commerce, only about 20% of them will successfully sell to a third party. With the much lower population of Generation X, who have little in the way of liquid savings and eschew 50 hour work weeks, the pre-tax multiples in Main Street values are contracting, and the shrinkage grows worse the farther down the food chain you are.

The message is clear. As John Warrillow said, if you are anywhere close to the magic numbers that attract mid-market buyers, the most important thing you can do is drive your company over the top. The difference can mean double, or even triple the proceeds you receive. Here’s an exercise. A company making $700,000 a year with a valuation of 3x earnings can sell for $2,100,000. If they grow to $1,100,000 in profits with a value of 5x earnings they’d get $5,500,000 at sale. That’s 57% growth in profits for 161% growth in price.

Any questions?

Even the measurement of earnings between the two types of business is different. We’ll discuss that next week.

 

 

Posted in Building Value, Entrepreneurship, Exit Options, Exit Planning, Exit Strategies, Top Blog Posts | Tagged , , , , , , , , , , , , , , , | 1 Comment

One Response to Owners Live in Two Different Worlds

  1. David Basri says:
    August 31, 2015 at 10:22 am

    There is no question about the difficulty in the Main Street market. Another strategy besides fading into the night is to find someone to pass it on to. That likely means finding someone years in advance, nurturing them and at some point starting to share equity. Having said that, I fully recognize that many small businesses are not in a market where a successor is easy to find. While I own a small software company, it is not so easy to find someone willing to start work at 3 AM so there are fresh bagels ready by 6 AM. Thank goodness there are such folks.

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The Toughest Part of Performance Reviews

Posted on August 23, 2015 by John F. Dini

There’s been some noise in the business press of late regarding large corporations’ decisions to eliminate performance reviews. Like those who have installed unlimited PTO (Paid Time Off) and other “new” management methods, review-less organizations are deemed to be more enlightened. Employees, especially Millennials, who work for enlightened organizations are presumed to be happier, and therefore more voluntarily productive.

To quote David Crosby in the song Deja Vu, “We have all been here before.” In the 70’s we had “Management by Walking Around” (MBWA). The idea was that managers would spend more time observing and interacting with their subordinates. This ongoing communication would eliminate the need for periodic formal reviews.

I was living in New Brunswick, NJ as I finished my undergraduate degree. Johnson and Johnson headquarters is in New Brunswick, and J&J dominates the local news as the biggest fish in a small pond. Their enlightened adoption went so far as letting employees decide their own goals for measuring effectiveness.

(A momentary aside. In the 70’s, as the Baby Boomers flooded into the workplace, there was substantial managerial discussion about how they were different from preceding generations. They were more educated, more concerned about the planet and social issues, and less inclined to follow command-and-control management systems. Sound familiar?)

Johnson and Johnson won multiple national awards as a great place to work. Employee surveys ranked it highly for its culture and atmosphere. Unfortunately, J&J began regularly missing Wall Street’s quarterly expectations.

Eventually there was a change at the top. As I recall the newspaper interview with the new CEO, he described J&J as “A great place to work. Unfortunately, we had a bunch of really happy employees who weren’t actually accomplishing anything.”

Now Amazon is taking a media pounding for its “rank and yank” review systems. Wait a minute; isn’t this roughly the same as Jack Welch’s famous (and very popular) “Topgrading” at GE? The book, by Brad Smart, is now in its third edition. Is striving to hire and promote the best workers good business, or just nasty capitalism run amok? Is Amazon really a sweatshop, or merely constrained by its business model from practicing the type of enlightenment that companies with 90% incremental margins (like Netflix) can afford?

performance review formI teach an annual program for first-level supervisors. In eight years, I’ve never had a participant volunteer that he or she likes doing performance reviews. In most small businesses they are avoided, delayed, and rushed when they finally happen. They are as painful for the reviewer as for the reviewee.

The solution is simple, although its not easy. Like so many other business processes, the work has to come up front to make execution simple. The secret is in setting goals. Real goals, not cotton-candy. What employee can measure their progress against “Sally should focus on becoming more proficient at her job,” or “Bob is almost ready to be a supervisor. He needs to develop his ability to delegate?”

I know it’s old hat, but Specific, Measurable, Attainable, Resourced, and Time-Sensitive (SMART) works, and its use in performance evaluation is a powerful tool. On Bob’s expected progress to supervisor, here are the possible goal parameters.

  • Specific: Bob needs to develop the skills and experience to supervise others effectively (This would be the whole goal setting portion of most performance reviews.)
  • Measureable: This will be rated on Bob’s completion of training as outlined, and his proven ability to understand the quality and productivity metrics in his department by preparing all reports for a complete project.
  • Attainable: Bob agrees that the objectives and timeframes outlined in these goals are achievable, and the company commits to making the necessary adjustments to support these goals.
  • Resourced. Approval is hereby given for Bob to enroll in Supervision I and II as delivered by Online Training International, followed by assignment as assistant supervisor on a project of not less that $5 million.
  • Time sensitive: Bob will be responsible for arranging his schedule to permit his completion of Supervision I by the end of the first quarter, and Supervision II by the end of the second quarter. Assignment to a large (>$5MM) project will take place following the training, but no later than the first month of the fourth quarter.

Now Bob has a road map of what he needs to do, and how to do it if he wants to advance. A ten minute check at the end of each quarter can tell if he’s on track. When the next annual review comes, there is plenty of advance notice as to what the likely result will be.

Not every job is as easily broken down. In fact, most are much more difficult, but the payoff is substantial. After all, if you as a business owner can’t define what you expect from your employees, how can you hold them accountable for delivering it?

Posted in Entrepreneurship, Leadership, Management | Tagged , , , , , , , , , , , , , | 7 Comments

7 Responses to The Toughest Part of Performance Reviews

  1. Alfredo Lozano says:
    August 23, 2015 at 5:59 pm

    Annual reviews are a horrible idea. Can imagine getting feedback 12 months later after a positive or negative event – how does it help? It only slightly recognizes what occurred. We are now moving to quarterly reviews and one day to monthly reviews. In the book The Game of Work, by Charles Coonradt, teaches an excellent method of measuring the success of the employee and how to harness that success to mutual benefit both employer and team members.

    Reply
  2. Jon K. says:
    August 23, 2015 at 7:00 pm

    John,

    Thanks for the walk down memory lane, great reminders… As I recall, the things in life that are worth amything are often difficult and a lot of work, not fun and easy.

    jk

    Reply
  3. Oswald Viva says:
    August 24, 2015 at 7:13 am

    I fully agree with the negative feelings about performance reviews and that’s why I wrote my book “Performance Reviews; The Bad, The Ugly, … The Alternative” (Amazon).

    Reply
  4. John Lind says:
    August 25, 2015 at 10:12 am

    An employee is responsible to offer three areas to his/her employer; 1. Performance, 2. (Mutual Respect to organization, fellow employees and customers) , and the, 3. Ability to “Think” as to how they can assist and help achieve the organizations charge. That is it!

    A performance review, on a quarterly “update” basis, keeps the individual attuned and allows an avenue to resolve any issues that may be getting in the way of the best performance possible.

    It works.

    Reply

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