Bootstrap Capital

Over the years, we have heard every excuse imaginable for why a business owner has not developed a succession plan. Clearly, there are some very real emotional and personal issues that are involved when a business owner steps aside. But even in cases where an entrepreneur has crossed the “emotional chasm” and desperately would like to hand the reins to a successor, not all are able to do so. Why is it so difficult for even the most committed business owners to groom a successor?

Prioritizing the Lifestyle
Our experience is that, in the lower middle market, many businesses are just not big enough or profitable enough to accommodate a key lieutenant who could someday run the company. It’s a common trap for entrepreneurs to become reliant on the cash flow from their businesses to support their basic lifestyle needs, incapable of funding the investment in a potential successor.

There are only a few ways out of this potentially endless cycle. The owner can initiate austerity measures in his personal life. He can borrow money in the hopes that adding a senior executive will grow the business and produce enough cash to service the debt and support his lifestyle. Or he can sell some or all of his business.

Often, the idea of reducing personal expenditures is not even a remote possibility. Since it is the solution most in the entrepreneur’s control, if he or she were going to do it, it usually would already have occurred. Similarly, borrowing money is rarely a legitimate option because, in these situations, the company’s size, profitability or balance sheet typically cannot support it. And selling a portion of the company and dealing with the dynamics of a partnership is so unappetizing that it would not be worth discussing.

Limited Exit Options
These are the reasons an entrepreneur can become trapped. Without the cash to invest, the business stalls (or potentially declines) and the owner has to wait until the proceeds from a sale will support him and his family through a shortened retirement. Moreover, when he sells, he will need either to attract interest from strategic investors (which is not always easy for small companies to do) or find another buyer who can step in and run the business, someone who can essentially offer a pre-packaged succession plan.

In situations where a business owner has not developed a succession plan and there may be limited interest from strategic buyers, Bootstrap Capital is an excellent solution. Our owner-operator model can provide liquidity to retiring business owners and deliver the leadership to keep the business from missing a beat.

It is amazing how many businesses we have seen plateau at $5 million in revenue. Since the late 1990s, this magic number has been stubbornly consistent, even across industries. Countless entrepreneurs seem to be able to build their businesses to $5-10 million in revenue, only to then stall. We have seen it happen with value-added-resellers, branded products companies, professional services companies and in other industries. Why is it that so many business owners, so consistently cannot grow their revenue beyond this point? What is so special about the $5 million mark?

Delegate or Peak
The issues appear to be linked to the command and control structure of these businesses. At some point, in order to grow, an entrepreneur must relinquish substantial control to one or more able lieutenants. This is an uncomfortable transition and, as a result, many refuse to do it or fail to do it properly.

Our point of view is that $5 million in revenue is a proxy for the point that the entrepreneur can no longer find time to visit even one more customer or deal with one more operational snafu. It’s the point where the business must develop into something more than a personal sales support team and turn into a fully functioning (and growing) enterprise.

One of the problems business owners frequently cite is that it is costly and time consuming to train people to take over customer relationships, new account sales and other key functions in the business. It is always easier to just do it yourself than to coach a new guy how to do it. Since most entrepreneurs are already busy, it can be impossible for them to bite the bullet and slow down long enough to train someone.

Another, and potentially more important issue, has to do with expertise. We have seen many extraordinary sales people, for instance, build their companies from scratch quite skillfully. But some of these excellent sales people are not also great business builders and managers. When they try to step away from the first-hand interactions with customers, they stumble and find themselves gravitating back to the front line activities. Reinforcing this tendency is the fact that many of these business owners have developed personal relationships with their clients, and miss the daily interactions with their friends.

Time to Sell?
When businesses hit this command and control plateau, it might be time to sell the business. We see many great businesses that could thrive under new leadership that is willing to delegate control and make the investments in the senior leadership and infrastructure necessary to help the business thrive. Whether the business has plateaued at $5 million, $10 million or more revenue, these are situations where Bootstrap Capital can be a great solution.

In our work with business owners, we have noticed a pattern of decision making which most entrepreneurs go through when selling their companies. We have seen very few who do not wrestle with each of the key decisions at some point before closing. In our approach, we use this simple framework to gauge the likelihood that a deal can get done. When entrepreneurs have difficulty demonstrating that they have gone through the full decision tree, we suspect that it is unlikely that they are really ready to sell their businesses.

Emotional Decision
It is no secret that many owners have great emotional ties to their companies. If an owner thinks of his company as a family heirloom, then it is very difficult for to part with it. On the other hand, if he views it as just another financial asset, then the decision to sell can be straightforward. Early on in our processes try to gauge where on the continuum between heirloom and asset the owners are. Similarly, we look for signs that the seller’s identity is broader than “business owner.” When they view themselves as much more than the owner and have a clear sense of what they want to accomplish after the sale, we know that the odds of a deal increase substantially.

Sufficiency Decision
When business owners sell their companies, their financial profile changes significantly. For instance, many owners retire when they sell their companies and experience a decrease in income. We are careful to make sure that sellers have calculated whether the after-tax proceeds from the sale of their companies will be enough to sustain their lifestyles and potentially fund any aspirational goals they have, such as making a donation to a favorite charity. If they have not done so, and it is not readily apparent that the sale will provide a surplus of liquidity, we recommend the business owner first work with a skilled financial planner.

Risk-Reward Decision
Selling a company and investing the proceeds in a balanced portfolio of stocks and bonds can greatly reduce the riskiness of the owner’s holdings, but it almost always comes with lower expected returns and cash flow. This reduction in both risk and reward will be even more pronounced if the owner’s company had borrowed money and, as a result, “leveraged” the equity returns. Finally, the size of the balanced portfolio will be reduced by the amount of capital gains taxes the sellers owe upon the sale of their businesses, adding to the financial hit the seller will take.

Our experience is that, unless there is a strong personal or strategic rationale for selling, it is rare that a business owner will see enough value in the risk reduction to accept the lower expected returns of a diversified portfolio. For this reason, we do not see a lot of private business owners selling simply because there is hot market. As such, we take great comfort when there is a bona fide non-financial reason for a business owner to be selling.

Summary
When a business owner no longer has emotional ties to the company, has done the analysis to confirm the sale will provide asset sufficiency and has identified a bona fide reason for the selling the company, the stage is set for a transaction.