Why standardizing operations is crucial for scaling up--and cashing out.
When you started your business, someone probably handed you a copy of Michael Gerber’s book The E-Myth and urged you to read it. Ever since that day, you have known the importance of building systems in your business so it can run without you. But there is also a hidden benefit to standardizing your business and documenting your processes: It will help you get paid when you’re ready to cash out.
Case in point: Computerized Facility Integration (CFI), a company founded by Robert Verdun. Verdun and his team have built a $20-million-dollar–a-year business that helps big companies manage their investments in real estate. When companies like Dow Chemical or Pfizer want to better manage facilities anywhere in the world, they call CFI to make the process as efficient as possible.
Verdun is not looking to sell, but he allowed me and my colleague John Duguid, an M&A Professional and the Managing Director of Gallium Corporate Finance, to take a look at his company and give him advice regarding how he could prepare CFI to be sold if and when the time ever comes.
When we got to know Verdun’s business, we realized just how deeply he had standardized the squishy business of moving offices. "You don’t just move a person," Verdun explains. "There are many people involved. We have to take into consideration movers, construction, permits, artwork, IT, security, capital planning, etc." Because of those processes, he says, CFI routinely takes out $300 to $500 in cost per move. "Most big companies move 40 percent-plus of their people every year, so it adds up quickly," he adds.
Verdun has also cross-trained his staff so that most of his people can do more than one job in the company. That way, in the event of an employee departure, a cross-trained staffer can slip into the open spot, follow the instructions the company provides, and execute the work.
Not only has this helped Verdun scale up CFI--which was number 3,052 on the 2011 Inc. 5000 list--it will also help him get out cleanly when he’s ready to sell. Most service businesses are overly reliant on a couple of key personnel, which is risky for a buyer. Instead of paying a decent multiple upfront for a service business, most acquirers offer to pay the principal the bulk of their proceeds from the sale in an "earn out"--a scheme where the risk is shifted from buyer to seller, with the seller having to hit set targets in the future in order to get their money out.
I know one multinational advertising agency that has a standard formula for acquiring marketing businesses. It offers 10-times earnings, 30 percent of which is paid on closing, with the other 70 percent paid if the owner hits a series of targets in the future. Imagine you’ve worked your entire adult life to build an advertising agency up to a million dollars of EBITDA and a buyer comes along and offers you $10 million for your life’s work, only to take most of it away--in the fine print--by putting $7 million "at risk" in what amounts to a potential bonus for three years of your life spent as a middle manager in a multinational conglomerate.
Most CEOs would rather get paid on closing, which is what Verdun is poised to do when he’s ready to sell. "Assuming CFI’s business systems, processes and key employees stand up to buyer due diligence," says Gallium’s Duguid, "the necessity of having Robert stay on is significantly reduced, and his M&A advisor would be resisting an earn-out."
Yes, your systems will help you scale up, but the hidden reason to focus on systems has nothing to do with running your business and everything to do with being able to make a clean break when you’re ready to hit the eject button.