The retiring type

After 20 years of running your own business, it's easy to lose sight of the real reason for the hard slog. After all, you have lived it, breathed it, and both loved and hated it at times. But, ultimately, what you probably had in mind was spending your retirement on a boat in Antibes. And if you don't plan carefully how to realise some of the capital tied up in the business, it could be a longboat on the Leeds-to-Liverpool canal instead.

Engineering a way through

So how do you go about exiting the business you have spent years building up? Planning ahead is crucial - and to do that, you need to know the options. One common approach is a trade sale to a third party. This avoids many complications because the original owner gets out with few ‘heritage' problems.

A management buy-out can be far more complicated. Here, relationships between the original and new owners often become fraught due to the obvious potential conflicts of interest. It is often better to get a third party to facilitate the delicate negotiations.

At my company, Elementa, which specialises in sustainable energy and mechanical and electrical solutions, we opted for management buy-out so the original owners could stay active for a long, planned period.

We are transferring ownership to the directors over a seven-year period. So far, it has proved challenging yet excellent for the business, and, importantly, good fun. It's goodthat everyone now knows where they stand - including the opportunities that lie ahead.

Start deciding which route you want by asking yourself some important questions. Firstly, consider your personal objectives - are you really a workaholic and intent on remaining involved? Do you want to be kingpin until you leave? How much time do you want to spend on work and on your private life?

You also need to decide how your business supports your personal objectives. Consider, where are you now; where do you want to be; and what is your vision for yourself when you hand over the reins? The answers to these questions will help you shape how you get to where you want to be. If you do not have answers to these questions from the outset, you may end up with unclear messages running through the business, resulting in confusion and lack of drive.

You also need to think about assembling a team of people who will help you realise your objectives. Investing in the right advice is key. Your auditor is unlikely to be the best person to advise you on how to get through the process. Cast around for the right team - and most importantly take up references on your advisers. After all, your clients do it for you. When it comes to getting the right help your team will include accountants, bank managers, solicitors, independent financial advisers… But although they all offer expensive help, most will not get your business into shape for your exit. You have to put in effort yourself, or pay the price.

Potential investors or your management buy-out team's advisers will take something of a ‘lion's den' approach. They will be after financial results and evidence of sustainability. The traditional owner/manager or entrepreneur, may have built up the business to achieve a high income, but won't necessarily have kept an eye on the balance sheet value.

Sections of the business or individuals may have been underperforming for years, compensated by others who have done exceptionally well. It will all come under scrutiny.

Adding values

Valuation can be a complex matter. Most small and medium-sized businesses will be valued on net asset value, plus a goodwill valuation. Goodwill reflects the future profitability. Stock market valuations based on price-to-earning ratios of 20 to one or so just do not apply. For many small businesses, the profit multiple for goodwill valuation might be less than three times the average net profit. Work in the pipeline may not materialise or might be cancelled (think PFI!) - and the customer base may be ageing too. On the other hand the value could be much higher. For consultancies, ratios of seven to 12 (a big range) are sometimes talked about.

Then there is ownership of the company to consider. The sole proprietor might be happy just to have a salary for his last three years as long as the staff are looked after, assuming he has saved up enough. Dividend or drawings policy will have a big impact on relevant profit. A new owner may not want to be a working partner or director. All parties may need to adjust their expectations.

Premiums to the value are likely to be a good quality, well-managed workforce; brand value; and contact networks. Discounts to the value might include inconsistent results; over-reliance on a few key staff; gaps in management; and poor business processes. The variation in profit multiple on valuations arising from premium and discount has a big effect on decisions concerning growth; multiples can range between three and six times the net profit, which can have a significant effect on value. In the construction industry, problems commonly arise from valuing work in progress. Consider what different values you might have applied to a contract to rebuild Wembley, three and 18 months after signing the contract!

Although you might not like to think of yourself as dispensable to the business, also of paramount importance is the ability to transfer the work from one generation of owners to a new one.

Exit this way

Whether you opt for a trade sale, merger, management buy-out or family succession, you need to manage the business for value rather than for income. This can mean quite dramatic change. ‘Grooming' the business for sale is a service offered by companies that specialise in selling businesses. At best, it should mean a fundamental overhaul of the business and processes for a management buy-out. At worst, it is a window-dressing exercise for a quick sale and agent's profit.

Assuming that you can make the transition to a culture where the balance sheet, rather than annual income, is king, important decisions need be made as to whether to stay as a ‘small, manageable business', or to become a ‘medium-sized venture' or ‘large organisation'. Managing change will require flexibility from the company culture. There will need to be clear channels of communication in place to allow decisive leadership. Client/associate views should be clear and marketing plans robust.

At the end of the day, making the business right for the buyers is what matters. That will require thorough clarity on your market position; buyer awareness; optimising growth; optimising profitability; cleaning up the balance sheet; brand management; and securing relationships with suppliers.

A lot of work will be needed to get your organisation ready for sale.

You started the business relying on technical, selling, personal and financial skills. You took risks; you were an entrepreneur. Now you will need to draw on that same passion again. Put the effort in, and you'll be able to pass on a shipshape company - and sail off into the sunset once your work is done.

Martin Clowes is managing director of Elementa Consulting. He can be contacted on 01932 232277 or at martin.clowes@elementaconsulting.com