Preparing for the unexpected
Who would have thought it was possible that Auburn would upset No. 1 Alabama by returning a missed field goal 109 yards for a game winning touchdown with no time left on the clock? I’m sure it came as a surprise to most, if not all, that watched the game. There were several other possible outcomes that were all more probable.
This can be a valuable lesson for business owners. Plan all you want, but sometimes unlikely events occur that come as a complete surprise to upend your business. Many business owners have operational strategies to help manage uncertainty but too many don’t have similar strategies in place when it comes to an eventual exit plan.
One of the mistakes I see business owners make is not having an accurate idea of what their company is worth. It can be a very difficult proposition to accurately value your own business. When a business owner thinks about all of the work and sacrifice put into building the business, they are naturally inclined to overestimate value.
Outside buyers typically value companies based on market multiples and leave emotion out of the equation. Business owners that have not done the same type of analysis on their company’s value may get an unfortunate surprise when they decide to talk to potential buyers. Market multiples are largely out of the control of the business owner but keeping current with multiples for companies in the same industry and same general size will allow the owner to minimize the chance of a last minute, and very upsetting, shock.
Capital structure is another area that can cause problems when hit with a surprise (positive or negative). Many companies that had overleveraged during the recent economic downturn were forced to liquidate assets, raise more expensive capital, or even go out of business when they could no longer cover the debt service with a decrease in revenues and earnings.
There is also the risk of having to turn down that large new contract because there is no financing available to cover the new costs. Changes to the economy and specific industries happen regularly and without notice. It is difficult, if not impossible, to have a capital structure in place that can deal with all manner of surprises good and bad.
But it is possible to manage capital structure to limit this risk. Build a relationship with your lender so that, when surprises happen you are in a position to deal with them proactively. Also, have an idea of what other financing options might be available and find out where to go to get new financing if it becomes necessary.
Completely unexpected events do occur (just ask Alabama). You may understand your company’s value and it may finally be enough for you to consider selling only to have the economy/industry take a turn for the worse and have your company’s value take a dive. You may have planned well and have a capital structure that will allow you to survive, but it may take many years for the value to return to match your exit value requirement.
What are your options? You can sell and take less than you needed and hope it is enough to cover your retirement needs. You can continue to work for several year longer than you planned and hope to recover the lost value. A third option is to plan ahead and take on a financial partner through a recap to limit your risk.
The recap allows the owner to cash out a portion of the company’s value when the company and valuations are strong and sell the remaining portion along with the financial partner sometime in the future. Taking some cash out before the company reaches its peak valuation might mean getting slightly less for the company but it reduces the risk that an economic surprise will completely sidetrack your retirement plans.