Eight Introspective Boundaries for Principals

Introduction

The notion to write about this comes from the fact that there’s been more merger/acquisition (M/A) activity in this field recently than I’ve ever seen in any six-month period. What’s especially notable is that it’s occurring in a difficult economic climate.

For background, over the last 15+ years I’ve been the lead advisor on nearly 150 transactions, crafting 700+ valuations in the process. (If you’d like to use the valuation formula in your buy/sell agreement, you are welcome to do so for free.)

The When/Why of M/A Activity

I’ve collected the more frequent triggers for M/A activity, listed below in no particular order. Some are obvious and others are not.

Lease Boundaries. About 7-9 months before your lease is up, it’s not uncommon to get a little introspective. When you think about it, a facility lease is the only long-term commitment you make to the business. “Do I want to do this another 5 years?” I think this is good, because you slow up for a minute and are honest with yourself about what’s working great and what isn’t.

Burnout/Disenchantment. Not much explanation is needed, here, except to note that it may come from clients who don’t treat you with respect or employees who require more managing than you’re willing to give. Usually it’s worth trying to fix the underlying causes, since this is your wave, so to speak, and you might not want to stand waist-deep in the ocean indefinitely looking for another one. Frequently this is the point where a partner comes aboard, rounding out the capabilities the sole owner struggled with, like business development or managing people.

Entrepreneurial Loneliness. As good as your employees are and as much as you depend on them, only a principal can embrace the challenges and pressures that stem from being responsible for others. That includes making tough choices when the data doesn’t favor a clear course of action, making decisions about the whole group that might not favor particular individuals, etc.

Sudden Death. This is very rare, but it’s happened to a half dozen firms I know of. Your own transition plan is not an issue, so to speak, but some good thinking ahead of time will enable a smoother transition for employees and clients.

Career Change. This is often a very positive move in that you take the next step on a path you’ve dreamed about for some time. It’s possible that the wealth you’ve earned from your marketing firm allows it, and sometimes it’s something you do regardless.

Playing on a Bigger Stage. You may have the employees, service offering, and experience to do effective and profitable work. All that’s missing is clients that are big enough and sophisticated enough to turn you loose. In this case it may just make sense for you to be acquired by a larger firm. Yes, you’ll have a smaller piece, but it’ll be of a bigger pie.

Keeping Key People Around. In a smaller firm, especially, the career ladder is more like a stepping stool. So the logical next step to keeping key people around may turn out to be partnership.

Unsolicited Offer. Whether this comes from a major corporation for which you’re the in-house department already, or a larger entity wanting to expand for any number of reasons, often you’re forced to consider an M/A opportunity even if it’s not something you’ve actively sought.

So those are the eight common triggers for a change in ownership structure. To give you a little more guidance, let’s pick three of these and expand a bit.

Lease Boundaries

If you’re at the place where you need to begin making facility plans for the next few years, and if you’re hesitating at all about making that longer term commitment, tread very carefully. I’ve written a very long article on just that subject. Send an email requesting it specifically and I’ll send it for free. It also compares the options of leasing versus purchasing a facility.

Keeping Key People Around

The first two steps I apply to determine whether this person might be a candidate and whether you might be ready are these: would you be comfortable if they had access to the financials, including what you make; and would you be comfortable singling them out publicly with a special arrangement. If it’s worth moving forward, I would make sure the potential partner is a risk taker. Most of them are not, which is why they are working for you, but many principals did work for someone else at one time. For this, I use a tool that has been verified 1,340 times, without a single false positive. Third, make sure they understand the downsides of ownership. There are eight that I walk through, including the additional financial risk, the additional legal requirements, etc. Fourth, at this point some of the partner candidates will eagerly ask if there’s some way to reward them without actual equity, in which case I introduce a non-qualified profit-sharing plan and the option of an ownership warrant. This provides nearly all the benefits of ownership without many of the complications, and it can be a great solution. Fifth, and assuming that these two tools don’t scratch where it itches, we move to real ownership, in which they are required (for several reasons) to bring some money to the table. The plan is constructed in a very logical manner, with safeties and ramp-up provisions along the way. By the way, ideally you’ll start this process of making someone a partner early enough so that you’ll still be actively involved for at least two years, but not more than five years.

Being Acquired

Defining Success. Determining how you will measure success, at the end of acquisition process, is absolutely critical.

First, success needs to be defined as what is best and fair for all parties. The whole “win win” mantra may be trite, but in this case it applies. The only appropriate use of leverage by either party is in deciding whether to walk away or consummate the deal. Forcing the other party’s hand is counterproductive in that the relationship begins with resentment. Instead, it’s best to drop the used car sales techniques and be vulnerably honest from the outset of the process.

In fact, the very notion of “success” needs rethinking. Some M/A consultants, for instance, refer to their remuneration as a “success fee,” as if somehow advising a client against moving forward isn’t just as “successful” on their behalf. Success means doing the right thing, whether that’s a yes or a no.

Second, fully exploring cultural compatibility is job one. If you’re the firm being acquired, you’re getting a new boss (yes, you are). Find a project to work on first, spend plenty of social time together, get to know the people that work for him or her already, etc. You can’t explore this too completely.

Third, make sure your new role is clearly defined. What are the specific expectations by which you will be judged? How quickly will you need to meet specific goals?

Fourth, identify an exit path at each major boundary. That exit plan might very well be painful, but it needs to be there. What if the acquiring firm doesn’t meet a key obligation? What are your options? Can you tear up the non-compete?

Fifth, make sure that both parties have real skin in the game. If the acquisition doesn’t succeed, it needs to be painful for you and for the firm that acquired you. Without something on the line for both parties, there will be an uneven commitment to making it work. It’s all about aligning interests and crafting appropriate penalties.

Price vs. Terms. Even though there’s not much to say about this point, it may be the most important one to make: the terms of the sale are always more important than the actual price of the transaction. The devil is in the details, as they say, and those details are the terms for not only calculating the final price but in the type of compensation and the terms of payment. Always settle for a lower price with better terms.

Looking Forward Responsibly. Let me suggest three specific action steps, regardless of where you are in the process.

First, count on getting nothing for your firm. Statistically, that’s the safest assumption you can make. So when your financial planner wants to know what number to put in the blank, just put zero there.

It’s imperative to realize that the value of your firm comes from the money it throws your way on a regular basis, year after year. If you live within your means and make smart investment decisions, that is the value derived from your firm, and not some unlikely sale down the road. Part of that realization comes when you quit lying to yourself by saying, “it’s okay if I lose a little money on X, because if I do X, it’ll set me up to make a lot of money.” If you’ve said that more than a few times, you’re just covering for lack of profitability in the here and now.

Second, manage your firm as if you’ll get a lot of money for it. This is one of those rare times in life when you can have your cake…and maybe eat it too. Managing it as if you’ll sell it—even if you don’t—will result in greater profit along the way, more control over your client base, and a more sustainable role for yourself.

How do you do this? Pay attention to the things that any sophisticated acquirer will look at. Do they have a truly unique niche carved out in the marketplace? Has the firm taken a mature approach to the role of the principal so that the firm’s work is somewhat institutionalized without his/her daily shaping? Has the financial performance been notable?

Third, enjoy life regardless of the outcome. Life is short. Do what you can and don’t wrap your entire life up in the business, especially in the hope of selling it.