Perhaps succession planning therefore begins with a much simpler question than we normally ask. It is not necessarily, “Who will buy my business?” and it is certainly not, “What multiple will I get?” The better opening question may be, “When I am no longer here, where do I expect the value created by all these years of work to be?”
There is an episode of The Big Bang Theory that, rather unexpectedly, provides a useful starting point for a discussion about business succession. Sheldon Cooper calculates that his expected lifespan may leave him a few years short of the technological singularity he believes will eventually allow human consciousness to be transferred into a machine, thereby allowing the mind to continue after the body has reached its use-by date. His first attempts to solve the problem involve diet and exercise, but when those prove rather less attractive than anticipated, Sheldon does what Sheldon does and builds a Mobile Virtual Presence Device, quickly christened “Shelbot” by Penny, so that his physical presence can move around while the important part, Sheldon himself, remains somewhere safer.
Science fiction has played with versions of the same idea for decades. Change the body, change the machine, download the consciousness, transfer the memory or somehow move the essential “id” of the person from one container to another, and we are invited to accept that the individual continues because the important part has survived the transfer. It is wonderfully convenient for storytellers, although considerably more difficult when we attempt something remarkably similar with a privately owned business.
The desks can be transferred. The computers, vehicles, plant, stock, telephone numbers, trading name and perhaps even the employees can be transferred, while leases can be assigned and contracts dealt with according to their terms. The problem arrives when we discover that the most important piece of intellectual equipment in the whole operation has spent thirty years residing between the ears of the person now intending to retire.
Perhaps we need a Shelbot for business owners.
I say that with some humour, but there is a serious question sitting underneath it. I have seen many profitable businesses where the owner is not simply the person who owns the shares or signs the cheques but effectively constitutes the operating system of the entire enterprise. They know which customer needs soothing before anybody else realises there is a problem, which employee can handle a particular job, which supplier will come through when everyone else says no and which number on the financial statements does not look quite right even though nobody can immediately explain why.
None of those abilities necessarily appears on the balance sheet. Collectively, however, they may explain a considerable proportion of why the balance sheet exists in the first place. Remove that one mind and the business that appeared so substantial from the outside can suddenly begin looking like a collection of assets searching for instructions.
That takes me to a distinction I think needs to be made much earlier in the life of a business than it normally is. Some owners are deliberately building a business they hope somebody else will eventually buy, some are deliberately using a profitable business to generate cash that can be converted into wealth elsewhere, and some have effectively created employment for themselves without ever deciding which of the first two they thought they were doing. All three can produce good income during the working life of the owner, but they can produce extraordinarily different outcomes when that working life eventually ends.
The danger is therefore not that every business needs to be saleable. I do not believe that for a moment, despite an entire industry of advisers, coaches and entrepreneurs who sometimes make an “exit” sound like the final examination every business owner is expected to pass. The danger is believing for thirty years that the business itself is becoming the retirement asset when, in reality, most of its value depends upon the continued presence of a human being who intends to leave at exactly the same time the purchaser arrives.
That is personal goodwill in its most practical form, without needing to become lost in valuation terminology. If customers deal with the business because they trust Jeff, Mary, Bill or whoever happens to own it, then the important question is whether that trust belongs to the enterprise or to the individual. If the owner disappears for six months and customers immediately begin asking when they are coming back, we may have learnt something rather significant about what a purchaser is actually being asked to buy.
The business can still be enormously profitable. Indeed, this is where the issue can become deceptive, because strong profitability may reinforce the owner’s belief that they are building something valuable when those profits might principally demonstrate how valuable the owner is while they remain inside it. There is a subtle but important difference between a business earning $400,000 because its systems, people, reputation and recurring relationships produce that result and a business earning $400,000 because one extraordinarily capable person continues holding everything together.
If Sheldon could transfer his consciousness into another machine, our succession problem would be considerably easier. We could sell the trading name, hand over the keys, download thirty years of intuition into the new owner and perhaps include six months of technical support in the sale contract. Unfortunately, knowledge can be taught, systems can be documented and relationships can be introduced, but judgement accumulated across thousands of experiences does not transfer simply because settlement occurred on Friday afternoon.
That does not make the business a failure. It may simply mean we have been measuring its success using the wrong destination.
I sometimes use a deliberately inelegant expression and talk about “raping the business for cash”. By that I do not mean stripping working capital, ignoring tax liabilities, refusing to replace equipment or weakening the very enterprise expected to continue producing income, because that is merely eating the seed corn and pretending we have harvested well. I mean deliberately recognising that if a substantial part of the business value resides in the owner and may never be completely transferable, one legitimate strategy is to progressively extract sustainable surplus profits and turn them into assets that do not disappear when the owner stops working.
Superannuation is an obvious example. Property, shares, managed investments, cash reserves and investments in other enterprises may all perform a similar function according to the circumstances and objectives of the particular owner. Over twenty or thirty years, a business can quietly become the engine that creates a portfolio of assets elsewhere, so that by the time retirement arrives the amount somebody is prepared to pay for the trading operation becomes far less important.
Seen that way, a business that eventually closes its doors for very little consideration may still have been an extraordinarily successful business. It may have educated children, paid off a home, created employment, funded holidays, accumulated superannuation, purchased investment assets and given its owner decades of independence. To stand at the end and declare the whole exercise unsuccessful because there was no seven-figure cheque from a purchaser would be to ignore where the economic value actually went.
In some respects, the business has been sold progressively to its existing owner. Instead of waiting thirty years for an outsider to arrive with one large cheque, portions of the wealth produced have been transferred elsewhere year after year. The trading business may eventually have little independent value remaining, but the owner does not particularly care because the value needed for the next stage of life no longer resides there.
That is very different from merely spending everything the business produces. An owner can take substantial amounts from a profitable enterprise for decades and still arrive at retirement with very little if most of those withdrawals disappeared into an ever-expanding lifestyle. Harvesting a business for wealth creation and consuming a business for lifestyle can look almost identical in the bank statements while producing completely different financial positions at the end.
This is where the numbers deserve to become involved and where What the Accountant Saw sits naturally beneath the discussion. Profit tells us something important, but it does not tell us what happened after the profit appeared. Did the surplus strengthen the business, repay debt, fund retirement assets, create investments elsewhere or simply disappear into expenditure that became progressively easier to justify as income increased?
The answer does not need to be the same for everybody. An owner deliberately building a transferable enterprise may quite properly leave substantial amounts within the business to employ management, create systems, strengthen working capital, reduce dependence upon themselves and increase the probability that the profits will survive their departure. Another owner may consciously decide that creating that infrastructure would add complexity they do not want and instead choose to remain central to the operation while steadily transferring surplus wealth outside it.
Both can be rational strategies. The contradiction occurs when someone operates according to the second model while expecting the eventual outcome of the first.
That is why I would be reluctant to begin this conversation with business valuation. Before discussing multiples, maintainable earnings or what similar businesses might have sold for, I would want to understand what the owner has actually been trying to create. Are we building something another person can operate, are we building an income-producing machine from which wealth will progressively be harvested, or are we simply working very hard and hoping that forty years of effort somehow becomes an asset because forty years have passed?
The last possibility is the one that worries me. Hard work has value, but time served does not automatically create goodwill that another person will purchase. A forty-year-old business whose customers, decisions and knowledge remain completely dependent upon its seventy-year-old founder may be older than a ten-year-old competitor without necessarily being more transferable.
This is where the Discipline of Boring earns its place again. If sale is the intended destination, documentation, staff development, customer diversification, management systems, reliable records and the gradual transfer of relationships are not administrative annoyances sitting beside the real work; they are part of the process through which personal capability becomes business capability. The owner is effectively attempting something Sheldon imagined technology might eventually achieve, transferring enough of what resides inside one mind into a structure capable of continuing after that mind is no longer controlling every movement.
There will always be limits to that transfer. Procedures can explain what normally happens, but they cannot document every judgement call produced by thirty years of experience, while a customer can be introduced to a successor without being instructed to trust them. CANEI – Constant and Never-Ending Improvement, may nevertheless allow the dependence to be reduced progressively rather than pretending it can somehow be eliminated six months before retirement.
The alternative strategy requires its own version of the Discipline of Boring. If the intention is to harvest the business rather than sell it, the owner still needs to know what can safely be extracted after allowing for working capital, taxation, equipment, staff, contingencies and the investment required to keep the income-producing engine healthy. Removing every available dollar is not a strategy if the following year begins with the business unable to fund itself.
That is where I would expect the accountant to behave like the “silent” partner envisaged in the original Banks Consultancy pillars. The job is not to announce that the owner ought to sell, ought to expand or ought to maximise superannuation simply because each can be sensible in particular circumstances. It is to understand the destination well enough to ask whether the financial decisions being made today are actually taking the owner towards it.
There is also a 20 Days Too Late aspect to all of this that cannot be ignored. A business owner cannot spend thirty years making every relationship personally dependent upon them and then expect an adviser to manufacture transferable goodwill during the final year before retirement. Nor can someone who has extracted and consumed virtually every dollar for decades suddenly decide that the missing external investment portfolio should have existed all along.
Time matters because both strategies depend upon accumulation. Saleability can accumulate through systems, people, relationships and reduced owner dependence, while outside wealth can accumulate through years of disciplined investment of the cash the business produces. Waiting until retirement is visible through the windscreen before asking which one we intended to build rather reduces the available road.
Perhaps succession planning therefore begins with a much simpler question than we normally ask. It is not necessarily, “Who will buy my business?” and it is certainly not, “What multiple will I get?” The better opening question may be, “When I am no longer here, where do I expect the value created by all these years of work to be?”
If the answer is “inside a business somebody else can operate”, then perhaps we should start transferring as much of the owner’s knowledge, relationships and decision-making capacity as reasonably possible while there is still time. If the answer is “inside superannuation, property and investments that have been funded by the business over my working life”, then perhaps the focus should be on building those assets without damaging the machine producing the cash. If the owner wants a combination of both, there is nothing inherently inconsistent about that either, provided the numbers and behaviour support the intention.
Sheldon’s problem was that the technology he needed to transfer himself did not arrive according to his preferred timetable. Many business owners eventually confront a less spectacular version of precisely the same problem when they discover that the one asset upon which the business depends cannot simply be downloaded into its purchaser. The machinery can change hands, the name can remain above the door and the telephone can continue ringing, but there is still no settlement document capable of transferring a lifetime of judgement from one human brain into another.
Perhaps that is why the business that cannot be sold should not automatically frighten us. It should simply cause us to decide earlier what job we expect the business to perform during our lifetime and where we want its accumulated value to reside when our involvement ends. The failure is not choosing to build something that eventually closes its doors; the failure is discovering too late that the business and the owner have been the same asset all along, while the owner’s retirement plan depended upon somebody being able to buy them separately.
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