Jeff Standridge:
Hey guys, Jeff Standridge here. Welcome to another episode of the Innovation Junkies Podcast.
Jeff Amerine:
Hey, it’s Jeff Amerine here. Jeff, what are we going to talk about today?
Jeff Standridge:
Hey, you know what, we’re gonna talk about passing the torch, helping business owners prepare for successful transitions in ownership. You know, the silver tsunami has been talked about for a number of years, but it’s a term used to describe the wave of baby boomer retirements and that it’s really poised to significantly impact the business landscape over the course of the next decade or so.
Some estimates suggest that over 50 % of US businesses are owned by people 55 years of age and older. And many of them, other research says that up to a third of them right now are looking at transitioning their businesses within the next three to five years and many, many more of them over the course of the next 10 to 15 years. And that could have a significant impact on just general business landscape, economic conditions and what have you.
And so I’d like to talk about that because one of the other critical components of this is that historical data suggests that businesses that are moving from the founder generation to the second generation of ownership, over 70% of those will ultimately fail post-transition. And if they’re moving from to the third generation, inclusive of the second generation, it’s something like 85%. So if you think about tens of millions of businesses, tens of millions of employees attached to those billions, trillions in annual revenues tied to those companies. And as they transition, if they begin to fail at the rate that historical data would suggest, it could be a travesty.
Jeff Amerine:
Yeah, absolutely. I mean, it’s a significant issue, particularly in multi-generational family-owned businesses. Well, let’s talk a little bit more about it. What are some of the key ways we can think about attracting or resolving some of these issues?
Jeff Standridge:
Yeah, generally, the reason for those failures is number one, the leaders haven’t done a good job of planning their exit. They haven’t done a good job of preparing leaders within the organization to carry on the vision, the mission, the capabilities of the organization in the presence of new leadership. And just the evolving competitive landscape, absent the prior preparations are the things that could contribute to the failure rate. And so the first thing is about the people, right? People are the foundation of success in a successful transition. So, identifying those leaders within the organization or those folks to be potential leaders in the organization. If there are people in the organization who have the capability to be replacement owners or second-generation owners or third-generation owners, equipping them to do so and building an environment where a management buyout of sorts occurs is probably the most likely way, but also preparing them to function under new ownership, I think is critical as well. So people is kind of the number one. You agree with that?
Jeff Amerine:
Yeah, it’s so crucial. We’re small business owners, you and I both, of having that next echelon of leadership that you know if you’re gone or you got hit by a truck, the machine would keep right on going. And a good way to kind of test that is if you could be gone from your business for a month, three weeks to a month on a vacation, and things would continue, you’re probably in a pretty good place.
If you don’t feel like you can be gone for any length of time because so much of it is still between your ears and not well documented, not passed down to that next level of leadership, then you’re not ready at all for any kind of succession.
Jeff Standridge:
Yeah. In one instance, you’ve, the former instance, you’ve built a business. The second instance, you’ve built a job. Right. So people, that’s the first one having the right people around you, pushing down leadership. You said this in a prior podcast of, of, of delegating leadership to them and, and, and operating that leadership team in a way that they can continue on in your absence. The second one is around profitability and ensuring the financial health.
Profitability is the hallmark of a well-run business, of an efficient business, of a business with a viable business model, with demand, customer demand, and a proper financial controls in place to ensure the ongoing viability of the business. So stepping back and making sure that the efficiency of the business is such that it is producing sustainable, consistent profit.
Jeff Amerine:
Yeah. And, you know, we’ve seen instances where the founders have viewed it kind of as a personal piggy bank. They’ve spent money on things that are not accretive to the business. They spend money on things that might satisfy some immediate need, but they have a plan for the future in terms of management reserve, funding growth, et cetera. And so I think treating it as a business that could be prepared to be sold at any time. In other words, good financial controls, good financial acumen, lines of credit, management reserve, all that sort of stuff makes a significant difference.
Jeff Standridge:
It does. And, you know, in the vast majority of industries, save a few SaaS companies and others where valuation is determined on a multiple of revenue, in the vast number of businesses and industries, the valuation of the company is determined on a multiple of EBITDA, which is a surrogate for cash flow. It’s a profitability measure, but a surrogate for cash flow. And so understanding that and not, or not understanding that, ends up in business owners experiencing suboptimal selling conditions when they get ready to transition their business.
Jeff Amerine:
Absolutely. You know, I’ve even heard some well-run, 100 % sort of founder-owned businesses will do something to the extent of they’ll get an independent audit on either every year or every other year basis at some point, not because they’re compelled to do it, but just because that gives an indication that if they were to ever sell, they’re ready. They’ve gone through the scrutiny that you typically would get if you were in a business that someone might want to buy or you might want to exit.
Jeff Standridge:
Well, and there’s an entire industry right now of management consultants around prepping your business for transition or improving the efficiencies in your business to make it more attractive to potential suitors down the road as well. The next one’s around your product or the value proposition, products and services. So the core of any business is the products and services. You have to have a compelling value proposition, a clear competitive advantage because you have to maintain interest and demand in the business. And so having a really, really good understanding on what is it your clients are buying from you and why are they buying it from you in terms of products and services and being crystal clear about that.
Jeff Amerine:
Yeah, it’s crucially important. And the thing that a lot of people don’t, they don’t think about it in this way is their clients are often buying something different than what you think you’re selling. I mean, it’s, their buying motives are different. It’s, and there’s some buying motives we talk about occasionally around fear or which can be a compliance based by greed, which sounds bad, but it’s, are you increasing revenues or decreasing costs or ego? Is it some kind of consumer product that’s driven by someone’s personal view of their own brand image, brand association, but understanding what your customers are actually buying versus what you think you’re selling is crucially important and how you can differentiate within that.
Jeff Standridge:
That’s right, and properly positioning yourself with that differentiation. Proprietary knowledge or, proprietary assets or proprietary wisdom, all of those being used to describe what’s the secret sauce. That could be formal intellectual property in the form of, you know, protected patents, copyrights, trademarks, or trade secrets. It could be it could be formal kinds of things there, or it could be, you know, more on the trade secret side, that it’s just the inherent wisdom in how you run your business. Do you have that codified and do you have that, you know, first of all, if it’s patent, trademark or copyright, do you have it legally protected? If it’s a trade secret, do you have it codified and do you have it documented and do you have a way to pass it on from one generation to the next to ensure, and do you have a way to innovate on it to make it better?
Jeff Amerine:
Yeah. So what we talk about is unfair advantage, unfair competitive advantage where you build the economic mode, particularly for smaller emerging businesses. You can almost never win on price. You can win on agility. You can win on best or better customer service. You can win on better subject matter expertise, but understanding what that is, where is it in your business that you can build that competitive economic mode is really important.
Jeff Standridge:
So we’ve talked about people, profitability, product, we’ve talked about proprietary knowledge. The next one’s around predictability or creating a scalable system, having repeatable, reliable processes, systems that perform in somewhat of a predictable way.
Jeff Amerine:
Crucially important, you know, a lot of times in having been guilty of this myself, you tend as a founder to have everything bespoke. Everything is one off. Everything is custom. Everything is driven by personal heroics. You’ve got to get to repeatable processes that can be passed on from one to the other so that everyone knows this is our way. This is how this works.
It also makes transitioning and onboarding new talent or transitioning positions within the organization a whole heck of a lot easier if there’s documented processes.
Jeff Standridge:
And those documented processes can and should occur throughout every function of the business. So there are processes in the sales and marketing function or the sales functions and the marketing functions, different processes. There are processes within the operations function. There are processes within the technology function, the HR function, the finance and administration function. So whatever the big boxes of functional activity are within your business.
There should be clear, concise, documented, repeatable, and somewhat predictable processes and systems in place to ensure the quality of those functions.
Jeff Amerine:
And one thing I would say about that is oftentimes people will immediately jump to, we have to go buy this platform or this technology. That’s not the first step. The first step is document what the process is, understand how that process flow works, then figure out where you insert the right technology tool. So often people will, well, we’re going to use this tool. We’re going to use that tool. It ends up becoming a layered mess of stuff. You’re not getting a lot of utility out of because you haven’t understood the core processes themselves.
Jeff Standridge:
I was running an internal web shop, web app shop for my former employer years ago. And I would have people coming and saying, Hey, we need to automate. I need you to build some software to automate this process. And the process wasn’t really developed yet. I said, I’ll tell you what, there’s this really cool piece of technology out there called Excel. Go, go run your product, go flesh out your process and run it multiple cycles on Excel. Once you’ve run it.
you know, 20, 25 cycles of the process on Excel, you will have made significant improvements, then bring me back that Excel spreadsheet with the descriptions of the changes that you’ve made. And those are the rudiments of a business requirements document that we’ll use to start specing out the software.
Jeff Amerine:
Exactly. That’s exactly the right way to think about it.
Jeff Standridge:
And so then we have patrons or customers, partners, what have you, the people who choose to do business with our company. The loyalty of customers and partners plays a vital role in not only building enterprise value of a company, but also on affecting a smooth transition as well. And so understanding what is it that makes your customer, number one, understanding are they loyal or not?
Number two, understanding the mix of customers that you have. Do you have customer concentration risks? Do you have segment concentration risks? Are there, do you have repeatable processes? So you start to begin also to see the overlap of some of these P’s, so to speak. Do you have predictability in your customer base? Is the revenue relatively consistent? Do you have too much revenue coming from one segment or one client or one subset of clients or what have you. And then what’s the nature of the relationships with your partners? What would happen if you lost this partner or that partner, et cetera.
Jeff Amerine:
Right. Well, yeah. I mean, that one you mentioned about account concentration can really have an amazingly negative impact on businesses. You have, yep, they make arbitrary and capricious changes. It’s a big, significant percentage of your business. It can put you in real financial harm. So, understanding who your customers are, what the concentration is, maybe even how well those customers align with your future direction in growth, sometimes you have to fire customers. It’s not a good cultural fit or it doesn’t align with future strategy. It’s very, very important. And using tools like Net Promoter Score to understand how you’re doing on a regular basis, are they going to recommend you to other people? I think those are all good measures of understanding who your customers are and how loyal are they to you.
Jeff Standridge:
At the end of the day, what we’re trying to do in helping these business owners plan for their succession and transition is number one, as a business owner, you want to get the highest potential exit value as possible. And number two, you want the longevity of your business to exist into perpetuity. You want that business to continue to be successful. So for instance, if you…If you drive and, a lot of small businesses and mid-size businesses, if you drive some kind of management buyout versus a third-party buyout and you may be involved in some form of owner financing and may continue to have skin in the game for a while, it’s to your best interest as a business owner to ensure the long-term viability of your business post-transaction. Not only do you get a higher exit valuation, but for you to realize that exit valuation over the course of the next five, seven, 10 or 15 years, you need to ensure the viability of it. So that’s really what we’re talking about in terms of focusing on these various elements.
Jeff Amerine:
And it’s never too early to start. Even if you have no intention, if you set your business up to where it would be ready to sell at any time, you’ll be ready for any possibility, whether it’s a succession plan or it’s an exit or whatever else may come up.
Jeff Standridge:
That’s right. So we’re talking about passing the torch, how to prepare your business for a successful transition of ownership. If you and your company wants to explore what that might look like for you, Jeff and I would love for you to reach out to us at jeffs@innovationjunkie.com or jeffa@innovationjunkie.com. Give us a shout. We’d love to talk with you about it as you’re thinking about the potential of passing the torch, even if it’s not on the immediate horizon, but could be five, 17 years down the road. As Jeff Amerine said, it’s never too early to start that process.
Jeff Amerine:
Good stuff, Jeff.
Jeff Standridge:
All right. This has been another episode of the Innovation Junkies Podcast. Thank you for joining.
Read the Talk Business article aligned with this episode here.