Your questions answered: Selling in or selling out: deciding which ownership transition path to take
What’s the succession plan for your engineering firm? Nick Belitz of Morrissey Goodale responds to unanswered questions from the July 31 webcast event.
Nick Belitz of Morrissey Goodale responded to the many questions that were left unanswered from the July 31 webcast "Selling in or selling out: deciding which ownership transition path to take."
Question: What is the best way to complete a buy-out option?
Nick Belitz: It depends on the terms of the option itself and the restrictions and provisions assigned to both the buyer or organization and the seller. Ideally, the option will be written to protect the liquidity and solvency of the firm while still providing the selling (and presumably departing) owner the appropriate value for the shares.
Question: How is a company's net worth established?
Belitz: It depends on what is meant by "net worth." If you mean net asset value or book value (both accounting terms), then it is a measure of the value of firm assets or the value of the owner's equity after all accounts have been collected and paid. Neither method is the best indication of the true value of an engineering firm. The best valuation tool we have is the discounted cash flow method to assess the value of future benefit (profit) streams.
Question: We have an internal plan involving 10 years. Other than who the next generation is, there has been little structure developed with the assistance of the owner. Any thoughts on how to motivate this activity?
Belitz: Manage it like you would a project for a client. Set project milestones with a timeline in place and name specific individuals responsible for key tasks, like meeting with the bank or making sure the buy-sell agreement is in place. Then hold those individuals accountable. If you have regular meetings to check in on the status of projects, add "ownership transition" to the agenda and ask hard questions of those responsible if the initiative fails to advance.
Question: Two questions: 1. What is the best way to value firm for internal sale? 2. Describe the best way to value firm for external sale.
Belitz: The best way to value in either case is a detailed discounted cash flow model, which often requires the input of an impartial third party or valuation expert to produce, plus a substantial bit of time and thought to model in the correct assumptions about the forecast period. The key to remember as an owner is that in most cases, internal transitions take longer to complete and yield a lower dollar amount for the sellers while external sales result in a greater cultural shift, for better or worse. It's critical to assess your specific firm's culture and next generation leadership before committing to one or another.
Question: How do you put a selling price on one's firm?
Belitz: Make a good profit and do it consistently! Buyers, whether internal or external, will be more comfortable with acquiring shares of an engineering firm when there is a good track record of profitability. The mechanics of doing so are more detailed and are best handled by a discounted cash flow exercise. See the answer to the above question.
Question: How to approximate the value of the company, especially given several recent years of being unprofitable during the economic downturn after more than 40 years of being profitable.
Belitz: In general, we see most buyers comfortable with relying on the more recent years as a guide for the future and letting the bad recessionary years carry less weight in the analysis. The problem is "less weight" is different than "ignoring them completely." We've seen plenty of firms that grew through the recession and, fair or not, you're in competition with those firms' warts and all. Forty years of profitability is a great thing to point to and sets the stage for a good story, but remember business, like politics, is a "what have you done for me lately" kind of world. We're living in a different world than we were in 2000, 1990, and 1980—don't rest on the laurels of decades past!
Question: Buy-sell agreements for internal plans.
Belitz: There is no set rule for how these agreements are written, but they should cover not only how and when shares are transacted, but what happens in the event of a forced sale or the three D's—death, disaster, or divorce—befall of one of the partners. Some agreements include formulas on how share price is determined, but this is an area where an impartial third party—an advisor or attorney—should definitely be involved.