GREAT IDEAS FOR ENTREPRENEURS FROM THE THOUGHT LEADERS AT CASEY NEILON
5 STRATEGIES FOR SMB CONTRACTORS TO BUILD INHERENTLY VALUABLE BUSINESSES READY FOR EQUITY TRANSFER
HOW TO RESPOND AFTER A POOR VALUATION
Over the last few years, I’ve had the privilege of working with SMB (small-to-medium business) contractors. Many of these companies are family businesses where a founder established and grew the business. Most of these companies have been around for at least a decade and have provided a good income and even a sense of identity to the family.
But sometimes, an independent valuation of the business shocks the owners with a sense of disbelief. More than once I’ve heard of situations where the founder-owner felt like the valuation was less than half of what it should have been. This is particularly problematic if their near-term retirement was based on a strong valuation. If you or someone you care about has faced this situation, here are five strategies that can really help you.
Who Needs This Counsel?
I want to be clear about who this counsel is for because the situations and approach I’m about to describe are specific to a certain kind of business. While my ideas will help nearly any kind of SMB enterprise, SMB contractors face some unique challenges.
The SMB contractors that run into a shocking valuation often seem to share these characteristics:
- One person founded the company more than a decade ago and continues to be the primary driver behind the business today.
- This person has grown the business through hard work, being honest and capable and by not letting important details go unmanaged. They get the work done and done right.
- They typically have long-standing business relationships with people they trust to do specific things. This often includes a set of sub-contractors they rely on to complete projects.
- They are a family business, in the sense that the business exists to support the owner’s family, produce income and provide a good quality of life. But their heirs may or may not be interested in taking over the business.
- The founder is now of an age where they have to seriously start thinking about their future, once they are no longer working in the business. In some instances, health concerns are forcing them out of the business. This becomes especially problematic if their children will not take over. In that instance, they know they have to sell the business.
- The owner is very close to the business and feels a deep personal connection to everything about it, from employees to the business name (sometimes the same as the family name) to the history – the many years they’ve run the business and built it up.
- Someone, somewhere, at some time, has told them that their expectations about how valuable the business is are nowhere close to its actual value. This makes them angry, frustrated and concerned about the future.
If this sounds like you, someone you care about or someone who you know will one day face this situation, here are five key ideas that I think can really help.
In SMB contractor businesses, the owner is usually doing far more than one person should be doing and this makes the business far less transferable.
Five Key Strategies
If you want build a business that is easily marketable and can be valued at the number you think it’s worth, I recommend these five strategies::
- Think of your business as a set of systems.
- Take a five-year approach (or longer) to transfer every system to someone you trust.
- Analyze and document every system by task, tool and process.
- Transfer each system – one by one.
- Establish success criteria for each system transfer so you and your team members know it’s working.
Think Of Your Business As A Set Of Systems
One of the biggest challenges in working inside a small business is that it seems there are never enough people or enough hours in the day to get all of the work done. This means that the business owner, whether they’ll admit it or not, is probably doing way more than they should be doing. This creates a bottleneck. But that might not be the biggest problem.
The real challenge with the owner doing too much is that it makes the equity of the business and the actual operations far less transferable. Let me ask you two questions.
- If you didn’t show up for work for the next 5 days, what would happen to your business?
- How would the business thrive if you took a 2-week vacation and when is the last time you actually did that?
If those questions scare you, you are probably a bottleneck within your business – even if you don’t realize it.
The solution to this problem is rather simple. You need to transfer responsibilities to people you trust who can manage things independently of you. But, most SMB contractors have trouble letting go of certain tasks for a variety of reasons – often because they’ve tried before and it didn’t work out. If this sounds like you, I have an approach that I’ve seen work well for others.
Think of your business as a set of systems. Let me give you an example. Think of yourself, for just a moment, as a home builder. Every home, really, is just a set of systems that are designed for a specific purpose. You have the electrical system, the plumbing system, the appliances and the walls, floors and ceiling. These systems operate together to produce a great experience for the family who lives in that home.
It’s unlikely that one person would be responsible for, or qualified to design and install, all of those systems. An architect probably designed it and drafted the plans. A carpenter framed the floor, walls, ceilings and roof. A roofer installed roofing. An electrician installed the electrical system. A plumber installed the plumbing. A finish carpenter likely installed the cabinets and flooring. A drywaller installed the drywall and a painter finished it off with a great paint job.
If one person tried to do every task themselves, it would take longer and the project could suffer in quality. Why? Because their focus and time would be spread across many tasks instead of spending all their time concentrating on what they do best. After all, each of these trades is its own specialty developed over time through proper training and experience.
In the same way, your business is a set of systems. For each system to work well, you need to manage tools, tasks and processes. Here are the major systems (although not an exhaustive list) that most SMB contractors manage on a regular basis:
- New business development
- Human resources and hiring
- Project management
- Bookkeeping, payroll and accounting
- Capital equipment purchases
- Financial forecasting and tax planning
Take A Five-Year Approach To Transferring Systems To Someone You Trust
The approach I’m about to describe below takes time – quite a bit of time. It works, but it requires focused effort on your part. This is why I recommend that you plan to take five years (or possibly longer) to complete the transfer of all systems. This all depends on how fast you want to move and how much of an analyst and trainer you are willing to become.
Many SMB contractors are great at making decisions and getting work done. But patiently training other people to take over tasks (possibly even tasks they enjoy) may not be their strong suit. If this sounds like you, it’s probably a good idea to hire a coach or a consultant to help you.
It’s also important for you to carefully consider to whom you will transfer each task. I find that the more you trust someone, the higher your tolerance will be for initial mistakes (which they’ll inevitably make). Training someone else in tasks you manage today requires real patience and a willingness to communicate things more than once.
If you’ve been in business for a decade or more, you probably know your people pretty well. But I encourage you to keep an open mind and even an open door. If you complete the steps below (analyzing and documenting systems) and then start telling people that you are looking for someone to take over that part of the business, you just might be surprised about who steps forward. This also prevents you from having to volunteer someone – which may not work out so well.
Analyze And Document Every System By Task, Tool And Process
Just above I outlined the 6 most common systems that SMB contractors manage. For you to transfer responsibility to someone else at your company, you’ll need to analyze and document each system by task, tool and process. Let me explain the difference.
A task is typically a set of steps, like little projects, that need to be completed. A tool is what you use to complete the task. The process is the order in which you complete the tasks and the set of dependencies that require one task to be completed before another. For example, you wouldn’t install expensive flooring unless you had a roof over it to protect it from rain.
What I’ve noticed, over the years, is that different contractors prefer different tasks, tools and processes. This is why you have to analyze how you do things and how you want others to do them. Then you’ll need to document your approach so you can, at some point, explain to others how they should manage the systems. Let me give you some examples, based on the 6 common systems.
New business development:
- Do you handle advertising and promotions internally or through an agency? If internally, what tools do you use to produce your promotions?
- Who takes the initial phone call from a new client and what tools do they use to document what the client wants?
- Who estimates the work and what tools do they use to do this?
- Who communicates with the prospective client about the estimate, modifies it if necessary and closes the deal?
- What tools do they use to produce a contract, where are the contracts stored and who has access to them?
Human resources and hiring:
- How do you go about finding both sub-contractors and new employees?
- How do you complete the interviewing process and what questions do you use?
- What documents do you require from new employees and where do you store them once they are completed?
- How do you train new employees in your preferred procedures?
- What tools, (such as hammers and screwdrivers), do you require employees to provide versus what you provide?
- What tools do you use to manage the overall phases of each project to track progress?
- Who decides which employees and sub-contractors get assigned to which projects? How do they make these decisions and establish priorities?
- How do they communicate with employees and subs to keep things humming – by phone, email, text or some other way?
- Who schedules and communicates with building inspectors and government agencies involved in the permitting process and what tools do they use to do this?
Bookkeeping, payroll and accounting:
- What tools do you use today for bookkeeping? Who handles bookkeeping internally? Who is responsible for routine data entry?
- How do you handle payroll today? How often do you run payroll? How do you calculate withholdings and who is responsible to do this? How do employees report hours and how do you ensure the accuracy of those hours?
- Do you use a payroll service? If so, who communicates with the service provider and what tools do they use – email, phone, fax, cloud-based apps? Who communicates with employees if there is a discrepancy and takes responsibility to resolve it?
- Who handles your accounting needs today? Who is responsible on your side to communicate with your accountant and what tools do they use to do so? How do you securely transfer data to your accountant?
Capital equipment purchases:
- Who decides what capital equipment expenditures your business needs? How do they make these decisions? What tools do they use to calculate the expenses and the projected return on investment?
- How are capital equipment expenditures financed today? If the business owner is leveraging their personal credit, what steps can be taken to build credit for the business?
Financial forecasting and tax planning:
- Who is forecasting the expenses of the business today and what tools and processes are they using?
- Who is forecasting the cash-flows and profits of the business today and what tools and processes are they using?
- Who is managing financial records and how accurate are those records? (If your day-to-day record-keeping is not consistent or precise, your financial projections are probably also inaccurate.)
- Who is working with your CPA to anticipate tax burdens and large capital equipment expenditures? What tools are they using?
As you can see, there is a lot to think about here.
Transfer Each System – One By One
Each of the 6 systems has a set of tasks, some of which will need to be completed just a few times a year and others which will need to be completed daily. It’s a tough call deciding the order in which to analyze, document and then transfer systems to someone you trust. When I do this with my clients, we often make this choice based on what’s comfortable for them or what is most broken and in need of repair.
No matter which system you choose to transfer or the order in which you do so, my advice is that you transfer no more than one system at a time. In my experience, family-run construction businesses that have been successful for more than a decade appear, from the outside, to be deceptively simple to run. But once you pull back the covers, they are rather complex. The reason most of these businesses are successful is because of how they are run. The owners have a secret sauce and they don’t share it with many people.
You want your business to be stable, profitable and growing while you are doing this work. If you try to do too much at once, you might become overwhelmed, frustrated or simply give up. Slow and steady wins the race.
Establish Success Criteria For Each System Transfer So You Know It’s Working
Once you begin to transfer systems, you’ll want some criteria that indicates the transfer is working. These criteria should be clear, concrete and fully communicated to the person taking over the system. One of the biggest mistakes I see contractors make is starting the transfer, encountering some bumps, halting the process and slowly, step-by-step, taking it back over themselves.
Usually this has to do with the comfort level of the owner. This is why I think your criteria should be objective, not subjective. Let me give you an example. Let’s assume you’ve been handling weekly payroll for several years and you want to hand it off. Objective criteria for success could be:
- If payroll is completed by Friday at 1:00 PM…
- If every employee gets paid on time…
- If there are no reasonable employee complaints…
- If all payroll taxes are properly withheld…
- If workman’s comp is properly estimated and paid…
- If the payroll account balances out…
- If all of this happens 6 Fridays in a row – then the payroll process is considered successfully transferred.
Remember that you want people to bring their ideas to the table too about how to improve processes and make your business run more efficiently. So just because someone doesn’t do things that way you do them, this doesn’t necessarily mean they’re doing it wrong. If you have objective criteria, they can apply themselves creatively to achieving the tasks.
How To Use This Counsel
If you’ve received a business valuation that you find shocking, it could very well be that you’re doing too much – that the business is too dependent on you. If that is the case, your best course of action is to identify which systems your business uses. Then develop a plan to transfer those systems to people you trust.
While I’ve provided some good guidance in this article, you may not be sure about where to start. If you’d like an objective analysis from me about how you can best prepare your business for maximum value and equity transfer, please reach out for a conversation.
Lucas Gonzalez – CPA, Manager
I am a Senior Accountant at Casey Neilon. In this role, I provide business and tax consulting for small to medium sized businesses and individuals. I have been serving clients in this capacity since 2013. My experiences have taught me about the challenges that a small business owner faces on a day-to-day basis and just how valuable it can be to that business owner to have trusted advisors they can regularly call on for advice and guidance.