READY, AIM, FIRE – Advising the Board of One

When will the company and the owner be “READY”?
Lots of transactions going on:  age of bureau owners, cost of next gen software, multiple service offerings requiring different expertise in addition to current structure , cyber security of data and flows of funds transfers, regulation, and industry consolidation.

Owners get at least 5 calls a year from the big guys, and from guys who talk big.  It’s flattering, but…

Is the owner ready to take the call:  it’s an emotional experience; it isn’t the “number” that makes it right.  It’s about being ready when the right call comes.  Being ready is about knowing they have created a strong company, and knowing that they are ready to take the next step into their own future.

Owners need to ask themselves if they have built a strong company which can produce repeatable revenue growth and predictable cash flows.  Do they have a team they can count on; are their files, processes, documentation, risk management systems right?

If their company is not ready, it’s too late for the owner to take that call, but it’s never too late for them to get ready to take the right call, in the future.

How do owners know when they are ready?  It often takes two steps to know.

How do they know, as a manager, that they can run the gauntlet of due diligence?  And, how do they know, as the owner, that it’s time to convert their assets to something more liquid, or just do something else.

Selling an asset they have built from scratch is emotionally hard.  Having outsiders review details of how they built it, and how they managed it, is emotional.  The process of selling is something that owners most have not experienced.  It can be puzzling, time consuming, stressful, and fascinating.  Getting and being ready, helps.

The next big step is to find a qualified buyer

Getting ready, as a manager, is easier than “getting ready” as an owner.

There is a process.  The owner/manager should hire an inside team that knows the process of running a strong service bureau, and how to make it profitable.  Internally they need good people to manage operations; financial and cash management processes; IT operations and data management processes and regulations; customer interfaces; and, cybersecurity programs.  When the company runs well, its sales team can run well, and they can meet manager/owner revenue growth expectations.

The owner should also build an outside team to help grow the company and keep it strong.  A board of directors or advisors can be very helpful if they already have experience doing what the owner hopes to do.  The company’s outside accountants and corporate lawyers should also be part of the team and give advice in their areas of expertise.

  • The owner/manager is ready when the company’s operational out comes are predictive and not reactive.
  • They are ready when customer and employee attrition is low; operations and finance have the data to know what volumes they generate and what prices they are effectively charging; fiduciary accounts are balanced daily to the customer account level; customer files are complete and accurate; and, they use outside auditors to attest to the accuracy of the above.

Ready when the timing is right.
Many times, by the time owners have built and maintained a great operation, they, as an owner, put off any idea of selling the company, and why not?  Their business is really a necessary service for customers.  Customers long ago knew that there are advantages to them to outsource what a service bureau provides because the bureau can bring economies of scale and deeper subject knowledge of the administrative functions than they can.  These customers pay the bureau a long term repetitive stream of cash payments, at the time the bureau delivers their services.  The bureau enjoys strong positive cash flows and the owner doesn’t need to tie their Balance Sheet up financing receivables.  It’s hard to find other investments that can reward the owner as well as a well-run financial service bureau.

The owner’s decision to sell is not an easy one. It is a mistake to begin the selling process if the owner is not ready.  An out sider is foolish to try to convince them that it’s time, if the owner is “not ready”.  The owner can tell if they are not ready if they start and stop the selling process.  This activity can injure the company, its employees, and the owner.  Competitors relish the opportunity to attack customer bases and spread uncertainty.

Once the owner understands that they are “ready” to start the process, they can take aim at the future.

Ready when the timing is right.

How does an owner take AIM at the future?

The next big step is to find a qualified buyer.
A good way to find a quailed buyer is to think like one does, then seek them out.

That used to be easy.  If the owner owned a payroll business, they sold to a payroll company, hopefully running the same platform they did.  If they were an HR admin and benefits administrator, they sold to a like company because they understood the complexity of the owner’s business and had a better chance of understanding the opportunity the owner’s company represented.  Same goes for insurance brokerage, and sellers of time clocks.

Today it’s different.  Service bureaus may not be selling just one line of business. They may be selling a combination of human resource management products using one or more data bases.

So how do owners find a like company?  Do they sell to a financial buyer (valuation based on EBITDA and revenue growth)?   Do they sell to a buyer on a different platform and see a discount for customers lost through the system conversion?   Or do they have to sell the company in pieces?  Each piece is different, with some pieces on different platforms.  Each market piece maybe valued using a different multiple for the different cash stream which each piece produces.

The first thing a seller should consider in finding a qualified buyer is to define what the owner is selling: the whole company or pieces of the company. When they define what they are selling, it’s easier to find a buyer who understands the industry, the company, the opportunity, and the value the opportunity presents.

The second thing is to decide their preference in the type of payment they should consider.  The owner should start by requiring all or most of the payment be made in cash. Most sellers are not bankers, particularly for buyers with less than stellar credit histories or strong reputations for best business practices.  The best qualified buyers understand the industry(s), the company and the opportunity, and have the cash to make the purchase.

If an owner aims to close a transaction with a qualified buyer, Due Diligence should have begun two to three years before a deal is proposed.  There are risks which can be eliminated in time.  Beginning that process at the time a transaction is proposed can lengthen the closing process, at best.

In due diligence a qualified buyer will ask questions about the history of the company which the seller needs to have been preparing for long before the questions are asked:

  • what is the capability of the management team, what is the status of the key operations from sales to onboarding to servicing to billing, can the company safely manage the flow of fiduciary funds like taxes and other payments and distributions made on behalf of the customer and its employees?
  • Does the company have a defined organization (chart) with clear channels for command and control?
  • Does the company management use a budget and have a history of achieving financial goals they forecast?
  • What is the company’s current level of service capacity utilization?
  • Is their target market well defined? Does it match the buyer’s target’s customer base?
  • Does the seller know the status of each customer? Can the company retrieve customer data on products/services units used, and current pricing table applications? Is each customer record file complete with authorizations and agreements in place for the customer and their employees?
  • Is their IT environment running platforms which can provide the customer what they need? What is the level of capability of the IT team?  What is the capacity of the cloud/hardware?
  • How secure is the operating environment (and how do they know?)?

If the buyer sees that the seller owner has done a good job on the above for both their current customer base, and their operating systems and environment, they are in a position to look at the size and complexity of a proposed portfolio and judge its impact on their existing operations, on their current and expected capacity utilization, and on their capability to seamlessly assimilate the new customer base.

Buying assets is less stressful than selling them.  Some buyers are not as rigorous as I have indicated. They may tend to take care of many of the issues by saying that they will change everything any way, or just discount the price and increase holdbacks until they put the owner’s house in order.

Being an organized seller, and having information to show a history of best practice management, increases the probability of a good outcome for both selling and buying owner, their employees, and for their new customers.

Buying portfolios of simple clients from professionals who want to retire, but also want their customers and employers well taken care of, is a natural buy.

The Agreement
Most sales are asset sales, where sellers are liable for liabilities they created in the past, and may not be known by the buyer until sometime in the future.  The representations and warranties in the Agreement required of the seller are the most important part of the Agreement.  The seller will not realize the full value of the transaction until the representations have shown to be factual over time, and the warrantees paid up in the case of a misrepresentation.  All the activities in the years of getting ready come down to the moment of determining the degree of risk perceived by the buyer in the representations made by the seller in this document.  All the time and energy spent in getting ready comes to a point when the seller can be confident that they can make the required representations about their company because they can prove to themselves that what they represent is true.

The price for not being ready comes to light in this negotiation.  The cost to the seller for not being as ready as they could have been will be hold backs, escrow accounts, discounts, earn outs, uncertainty, and even the end of a deal with a qualified buyer.  The reward for being ready is a closed transaction with a qualified buyer, and peace of mind in a job well done.

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