Maximizing Enterprise Value with David Prowse | E066
Making sure you get the most when you exit but planning in advance.
In this episode host, Jason Pereira talks with David Prowse of Velorum Business Advisory. Today Jason and David are going to talk about “How to make the most of your business valuation.”
Episode Highlights:
1.15: David says that his business is centered around an exit planning business that does a little bit of valuation and corporate financing.
1.34: David is a Canadian CPA, most of his early career days revolved around general CA works. Later in 2015, he got involved with corporate finance and valuation works.
04.00: David shares examples of Personal, Business, and Financial Readiness.
5.15: In-order to plan an exit for a business, it is important to figure out the valuation, says David. Most people overestimate the value of their business so figuring out the potential valuation is extremely important.
06.18: David talks about the tools and diagnostic techniques they use to determine the value of a business.
07.05: Jason talks about personal readiness and the importance of planning about it.
08.00: Jason is curious to know from David that “How does he convince or prepare his clients for personal readiness?”
08.54: David talks about the approach that he takes for exit planning and implementation.
12.09: Business valuation and readiness is all tied-in, says David
13.07: David stresses the importance of holistic exit planning. He says it is crucial to have a proper plan for Personal Readiness, Business Readiness, and Financial Readiness.
15.59: David shares how a value driven assessment can help business owners know the actual value of their businesses. The evaluation also allows business owners to understand what they can do to improve their business performance.
17.17: Once the business assessment is done, it is essential to prioritize and figure out ways to improve the business performance.
17.36: As per David, prioritization of business improvement depends on the owner’s preferences.
19.52: When it comes to business readiness, one key factor that one should evaluate is - “Is the owner actively involved in the business?”; the second aspect to that is – “Is there documentation of those processes?”
20.32: From an organization perspective, it is essential to figure out “To what degree does the top-down communication and bottom-up communication works?”
22.58: “If you really want to grow your business, getting a strong understanding of the metrics is very important”, says David
3 Key Points:
David talks about the importance of introducing holistic business plans for business owners.
David and Jason talk about the importance of Financial Readiness and what is its significance?
Jason and David talk about the qualitative and quantitative aspects of what people need to do in order to sell a business.
Tweetable Quotes:
“Most people overestimate the value of their business so figuring out the potential valuation is extremely important.” - David Prowse
“If you don’t have a financial planner, go find one; if you do have a planner, then discuss and have a retirement plan in place.” - David Prowse
“Prioritization of business improvement depends on the owner’s preferences.” - David Prowse
“If you are not measuring your business matrices, then you are really not accomplishing too much of anything.” - David Prowse
Resources Mentioned
Facebook – Jason Pereira’s Facebook
LinkedIn – Jason Pereira’s LinkedIn
Woodgate.com – Sponsor
LinkedIn – Jason Pereira’s LinkedIn
Transcript:
Producer: Welcome to the Financial Planning for Canadian Business Owners Podcast. You will hear about industry insights with award-winning financial planner and entrepreneur, Jason Pereira. Through the interviews with different experts, with their stories and advice, you will learn how you can navigate the challenges of being an entrepreneur, plan for success, and make the most of your business and life. And now your host, Jason Pereira.
Jason Pereira: Hello and welcome. Today on the show I have David Prowse of Velorum Business Advisory. We brought David on the show specifically to talk about business valuation, what the issues are surrounding getting your business to maximum value, and how to make the most of your business valuation. And with that, here's my interview with David Prowse.
Jason Pereira: David, thanks for taking the time today.
David Prowse: Thank you very much for inviting me.
Jason Pereira: Oh, my pleasure. So let's just clarify one thing off the bat. You are not the actor who played Darth Vader.
David Prowse: No. No, I'm not, he's no longer alive, so I'm thankful I am still alive, but no, I do get those questions from time to time from people who are obviously a big Star Wars fans.
Jason Pereira: I just watched it on the weekend with my son, so it's top of mind. Okay. So David Prowse of Velorum, tell us about what it is you do for a living.
David Prowse: Okay. So essentially, my business is centered around what I would call an exit planning business that does a little bit of valuation, a little bit of value acceleration, exit planning, and a little bit of corporate finance. And by that, I mean fractional CFO work.
David Prowse: And I'll tell you a little bit about my background. So I'm a Canadian CP by background. I got my CPA, or formerly chartered accountant, back in the day, in 1996, and did most of my career, early part was very much centered around your typical CA stuff. And then later on around 2015, I got involved with some corporate finance and valuation work. And it was around there that my mind really started tweaking into just the whole concept of value creation, especially for business owners who are looking to grow and exit their business.
David Prowse: So I got involved a little bit later on with the Exit Planning Institute in the US and got my certification down there, which is the CEPA after my name is Certified Exit Planning Advisor, and ran into other people who were in the field. And so, I decided what I wanted to do is really run a practice that's just solely focused in on middle market businesses, to help them grow and successfully exit their business over whatever timeframe they're looking at, which is usually going to be, let's say, three to 10 years.
David Prowse: And the reason I got into is there's some sobering factors out there that I think are really important, and so I really felt that there was a big need in the marketplace for these services. So I'll just run down some of the more sobering statistics. So in the US Census, for example, they say that by 2030, all the baby boomers will be 65 and older. So if you're running a business, you're going to be past retirement. 8% of the wealth has been tied up in their business, or more. And this is in 2016, it was an estimated about $10 trillion in the US was going to transfer by the time that the baby boomers had finally transitioned all their businesses.
David Prowse: So for use your typical 10 to one ratio, comparing US to Canada, then you could probably estimate that maybe there's about a trillion here in Canada. So that's a big number. And historically, we know that a lot of businesses actually put on the market do not sell. So 70% or plus do not sell. There's also other statistics about, from the personal side, 12 months after exiting, three out of four business owners regretted selling. And then in terms of family transitions, only 30% survive into the second generation, 12% survive into the third generation, and 3% survive beyond that.
David Prowse: So those are really sobering statistics. So really, what we really need is a holistic exit plan for the middle market business owner. And by holistic business plan, I mean taking a look at, number one, financial readiness, personal readiness, and business readiness. So financial readiness, that's somebody who's coming to you and saying, "Jason, tell me what I need to retire. What do I need to retire, and how do I get there?" Business readiness is really about... That's where we get into a lot more details about the valuation of the business.
David Prowse: So I analogize exit planning or business readiness, it's like you're going on a trip. So if you were planning a trip, or you wanted to go from one destination to the other, you're probably going to pull your smartphone up. You're going to try to figure out where am I right now, and then you're going to try to figure out where am I going, and then you're going to figure out how am I going to get there.
David Prowse: So, in the case of, let's just say you're on a vacation, you might start off wherever, but you're going to figure out, based on your phone, what your starting position is. You're going to figure out where am I going? The phone will tell you the most direct route, but also give you some other alternatives. And so, for example, you may want to plan out a side trip to a winery or do this or that. And that's what exit planning is.
David Prowse: And so analogize it, when you're trying to figure out where you are now, what you really want to find out is what's the value of a business right now. And we call that a baseline valuation. And it's very important, if you're going to do any exit planning, that you need to understand what the value of your business is now because for a lot of owners, they probably don't know the value of their business. They probably overestimate the value of their business.
David Prowse: So the next step after that is to figure out, okay, well, what's the potential valuation of your business. So when we take a look at the... There's multiple databases out there and [DealStats 00:05:35] is a really good one. There's a few others. We try to get an idea of, okay, so what's... In the universe of businesses that are transacting, we have some information on their multiples, we have some information on... DealStats has some really good information on some of the operating margins, the gross margins. We have some other benchmarking tools that we can take a look at, for businesses in the industry. So by doing that, then we can figure out, okay, that's what we know what the full range of what goes on within the industry. And the multiples are going to change industry by industry, but we want to have an idea of what's the top level for your industry.
David Prowse: And then, what we do is we do a diagnostic, where we go into a very detailed questionnaire with the owner or owners, and we try to figure out, based on the responses. And what we're really focusing in on is value drivers. We're focusing on the personal readiness. We're trying to figure out where does that business lie in terms of its potentiality. And [crosstalk 00:06:32] because it's really important, for example, in some cases, a business may not even be transferable. If there are certain characteristics to it, may not even be transferable. And then transferability is not a binary thing. So, it's a matter of degree.
David Prowse: And that's where the multiple comes in, is that, yes, I may transfer, but you may not have an optimal multiple. [crosstalk 00:06:52].
Jason Pereira: So let's take a step back [crosstalk 00:06:53] for a bit because you covered a lot here. Okay. So, let's unpack each of these one at a time, in a little bit more detail, as opposed to where we're going. So the first piece, let's actually start with personal readiness. This is something I've actually talked about quite frequently on the podcast, which is I always joke that there's two financial plans. One is the financial aspect, which we'll get to in a second, about being able to pay for retirement. The other one is the what the heck am I going to do with all that time? And your stat on... How many people was it? Two-thirds of people regret it within what period of time? Some
David Prowse: Three out of four regret.
Jason Pereira: Three out of four. Wow. Three out of for. So 75% of people regret it. And it's probably most likely due to the loss of an aspect of their identity. It's what they did for a very long time. So what and who are they now? And they haven't really planned it out. And I always tell people that you need a plan for that, because frankly, there's only so much golf you can play, and at least I can and with terrible scores. And frankly, if you think you're going to go from working the life of an entrepreneur to stopping, that's like driving a car at 100 miles an hour and then hitting a brick wall. That's not going to go well for you.
Jason Pereira: So what do you, when having these conversations around their personal readiness, how do you develop this and get them ready for this altering life change?
David Prowse: Yeah, it's very, very difficult. I think getting the conversation started is important. And for a lot of them, most of them have a very vague notion about what they want to do post exit. And actually for a lot of them, they have nothing concrete really even thought out. So, my role is really [inaudible 00:08:18] in that planning stage is to start that conversation, try to figure out to what degree they've put some thought into it, and then start getting into a conversation about what some of their options are.
David Prowse: Because when I do work, there's the planning stage, and there's an implementation stage. So the planning stage, we're trying to figure out to what degree they've done any work on that post exit planning, and in many cases, it's nothing. So, the first implementation step may be, okay, let's in the next 90 days, why don't you come up and start coming up with a list of three things that you want to do when you retire? And there's a wide variety of things. And for a lot of people, because they haven't put thought into it, it gives them food for thought to think about.
David Prowse: For example, maybe they do want to get into consulting, or they want to stick around as a consultant for the business, and something like that's going to actually play into the exit as well, because maybe there's an exit strategy there that fits in with that particular mindset.
David Prowse: The other thing is, maybe for some of them, they want to start another business. For some of them, it's going to be just pure retirement and just thinking about it's going to be... Yeah, I want to build that deck on the cottage that I've been putting off, or I want to develop new hobbies off after I exit because I can't sit around and be still all the time.
David Prowse: So for every owner, it's going to be different, but so it's starting that conversation and then started to move it into a specific area. And if necessary, there are some specialists in that area that maybe can help them out as well. So if they're really stuck, and that's a sticking point for them, then we can bring someone in as well to help them out. Because one of the things, the reason why it's important is that if you don't address it, what winds up happening is that a lot of the regret's coming from just that lack of planning.
David Prowse: And the other thing that can happen is that you have the owner almost subconsciously maybe sabotage the exit. And we've heard stories from brokers and intermediaries where the owners... everything seems to be moving along, and all of a sudden they just going to get cold feet and blank out or ghost out. And the deal just doesn't end up happening. It's because they're just too afraid to move past that point of time.
David Prowse: So ideally, if you've given yourself runway, and like I said, my runway tends to be two plus years or more, that's a good period of time to start really thinking about and putting together an action plan to deal with your post exit life.
Jason Pereira: So, yeah, it's one thing that frankly, you know all of this, because people are just... This has come up several times, when Peter [Merrick 00:10:51] and a couple of other guests of the podcast around finding purpose and meaning beyond work, because it is a major thing people just do not consider. You spend all this time trying to amass the wealth that's going to let you be free. And then at the end of the day, it's just now you're tied to the job so perfectly, so tightly that it's hard to separate yourself from that.
Jason Pereira: So that's the personal readiness. The financial readiness, that's my job. So let's talk about the financial readiness aspects of that. Someone like me come in first and basically show them that they can do so, with even say no value or even a modest valuation for the business or a realistic one. I think that would make your life a lot easier. But what happens when that conversation hasn't happened yet? Someone tells you about wanting to get out of their business and hires you, but they haven't engaged a financial planner. What does that look like?
David Prowse: It's something where we would identify during the early stages of our discussions. And I would say that probably the number one action, I would say during the implementation stage, is if you don't have a financial planner, go find one. And if you do have one, have a conversation. In 90 days, let's talk about, try to get that discussion going and maybe have a retirement plan in place because it's important because all of this is interrelated. So if you don't have that discussion about the financial readiness and what's going on with your business, because the business valuation and everything is all tied in.
David Prowse: So if you haven't had that discussion, if you're just focusing on the business side, which is fine, but you still don't know what number you're trying to shoot for. So they need to have that conversation with you, to have an idea of, okay, this is the retirement that I'm looking for, and these are the numbers that I'm looking for. And then, when they do the business valuation and we look at the potential value of the business, sometimes the reality is a lot of times, the current valuation isn't going to be matching that number that they need right now for their retirement.
David Prowse: So hopefully if they have time, then they have time to do some value creation program to correct that value gap. But if they haven't had the discussion with you or a financial planner or wealth manager, then the business improvement side is obviously always important, but they still don't know what the retirement looks like, or whether that's going to be enough for them. So really, what my practice is about is a holistic exit planning. It's about putting the three legs of the stool, that personal readiness, business readiness, and financial readiness together, and making sure that you've got all those three components in place. And obviously, during the implementation stages, if there's some gaps there and things that need to be filled in, then that's ideally when you have a two or three or four or five year time horizon, then you can start to fill in those gaps and start to deal with those improvements.
David Prowse: But otherwise, if you've only addressed one of those things, it's like having a stool with a wobbly leg or
Jason Pereira: Going to fall over.
David Prowse: It's just going to fall over.
Jason Pereira: So you mentioned something earlier about the value matches what they think it is. And I'd like to say with this, everyone likes to think their baby's pretty. And unfortunately, especially when they're in a negotiation. If they're in a negotiation, then they've got every best interest in getting the maximum dollar possible. But unfortunately, the reality is not everybody's baby is pretty. How do you deal with that? If you have to meet with a business owner who says, "Well, yeah, I think my business is worth X," and you say to them, "Sorry, but it's 50% of that." How do you handle that situation?
David Prowse: The initial valuation is always a difficult conversation because it's probably the first, maybe the first time they've ever had a valuation of the business. And for a lot of people, they don't necessarily, haven't been educated on how valuation works. And a lot of times, they've been exposed to talking with their peers, and there's something that we call the country club valuation or the golf club valuation, which is what they talked to one of their peers at the golf club. And they said, "Oh, I sold my business for seven times cashflow."
David Prowse: And the problem obviously with that is that, number one, we don't really know to what degree, how accurate that is. Number two, people who brag, they're probably talking about their enterprise value. They're not necessarily talking about what the actual net proceeds were at the end of the day. And the reality is every business is going to be different. And maybe there was a very good reason why a business sold for a good multiple. That has nothing to do with the existing business that we're talking about.
David Prowse: So I tend to use that valuation as an educational point, but I also do the value driver assessment at the same time. So it's a good news, bad news thing. The bad news is your business isn't worth is as much as you think it is right now, but the good news is that you can do something about it. And that's something that a lot of people don't always understand, is that they just assume that the business is whatever the value is. They have no control over. It's just the market that impacts. And while there are some things that are obviously outside of your control, things like COVID-19 or whatever, there are some other things that you, as a business owner, can control, in terms of improving the value of your business.
David Prowse: So what I try to do is I try to incorporate both those things together so that they can... Once they've got over the initial shock of what their valuation is, I want them to really understand, okay, this is what drives it. This is what's going on in the marketplace in terms of the other comparable transactions. And then by looking at the value driver assessment, we can show them, but you can still improve your business. And here's some of the things that you can do. And there's different ways of prioritizing that. And what we tried to do is we try to incorporate that into the action plan specifically, what are they going to do to improve the value of the business?
David Prowse: So there is a huge educational component. A lot of sense is sometimes doing valuations, it's like going to a dentist and finding out you need some procedures. It's not always pleasant, but the reality is that you have to do it, and you deal with it. And owners need to understand is that they don't take a passive approach towards their business. They're usually very involved with their business, and they know that they can actively involve with the strategy and the pricing and the business development. And the same thing is true for the valuation of the business. It's not a passive exercise. It's something that they can actually get involved with.
David Prowse: So once you've helped them to educate them on that process, and they obviously understand what the importance of it is, which is it's obviously a great amount of importance, and they start to understand, okay, now there are some things that we can do. And then you start getting into the next discussion, which is here's the list of things that we think you should do, based on our assessment, and let's start talking about prioritization.
David Prowse: And there's different ways of prioritizing. For example, you could pick the one big rock, the one big problem that that's really the main problem in the business, and then we'll deal with some of the other stuff later. Or you could start off with some easy wins, so low hanging fruit, get some victories under your belt, and then start dealing with some of the tougher stuff. Bang for your buck. There's different ways of assessing the things that are important in terms of improving enterprise value, so you could organize it that way. It's going to really depend on the owner's preferences. And once they get educated on the process, they really do get actively involved in it.
Jason Pereira: Let's get into the business readiness case. So business readiness is probably twofold in my imagination. I'm sure you could correct me if I'm wrong here, but I would say one is from an enterprise maximization by making sure that certain numbers are being hit and whatever to make sure you get the maximum value for it.
Jason Pereira: The second piece probably has to be a very operational administrative issue. I'm sure that you walk in these situations, and everything flows through the business owner. So there's no processes in place. Talk to me about what you most commonly see as both the, let's call it the quantitative and the qualitative aspects of what people need to do, to get ready for the sale of their business.
David Prowse: That's a great question. I think to me, the two biggest value killers in a business are going to be really a lack of separation of the owner from the business and a high degree of customer concentration. So for example, customer concentration could be, let's just say, three customers represent 50% of the revenues. That's a very risky situation. So prospective buyer, for example, comes along, and they're going to view that as a very risky situation because in any given situation, and lots of random things can happen, and maybe one of those customers disappears, and all of a sudden 15 to 20% of your revenues are gone in either overnight or a short period of time.
David Prowse: Those would be probably the most critical things. So what I try to do is try to focus in on, okay, do we have a customer concentration problem? And that's something we'll identify right during the evaluation. There's a separate assessment that we can do in terms of the owner separation. But that's an example where, number one, the owner has to be basically involved with everything. And I ask them, "Can you take a vacation and put the phone away?" And if they can't do that, then there's probably some degree of owner dependence. Because ideally, where you want to be in a perfect situation would be, you're managing that process. You're developing the strategy for the business, but your management team and everybody underneath them is running the business on a day-to-day basis. And if you disappear for a couple of days, that machine still runs.
David Prowse: For a lot of lower middle market businesses, and that's probably five million to 50 million dollars in revenue, that's a difficult situation. So if we do identify... That's probably the biggest rock that would have to be dealt with. So number one is, is the owner actively involved with the processes?
David Prowse: The second aspect of that is, is there a documentation of those processes? And that's important because if a prospective buyer comes along, and they want to buy the business, if everything's sitting up in the owner's head, it's going to be very difficult for them to try to... Unless it's a very intuitive business, it's going to be difficult for them to understand that business. And so it's either going to reflect poorly on what they're going to offer in terms of the multiple, or they just won't put a bid on it. The business just won't transfer.
David Prowse: So those are the two most critical things. And then it also really gets in from an organizational perspective, to what degree does the top-down communication and bottom-up communication work? So top-down is the owner's the one who's supposed to be driving the strategy. So how do they communicate that to management, and how does management communicate that to the employees?
David Prowse: On the other side of the equation, understanding what's going on with the customers and customer satisfaction, customer feedback is important as the frontline employees who are the people who are getting that feedback. So what's the process for them to communicate upwards, up to management? So we'll have conversations about that.
David Prowse: On the quantitative side, obviously I come from a financial background, so I'll ask a lot of questions about what's going on with their financials. And for a lot of those businesses, those owners are only going to look at their financials once a year. And frankly, that's not enough. Now, they may think they have a grip on what's going on. But the reality is that if you're going to go through some value creation program, you need to understand where's your business going to go over the next couple of years? Certainly need to have an understanding of what's going on in the next 12 months. And if you're growing your business, your working capital is probably growing too. So do you have a grip on that? Most of business owners don't understand... They implicitly understand working capital and why they need to manage it, but they don't do it. So the working capital's probably not the most efficiently operated, and again, that's where the benchmarking comes in, is that we can help them out with that.
David Prowse: On the CapEx side, have they deferred CapEx, capital expenditures? Because that's a situation that's going to impact their valuation. A prospective buyers, assuming it's a capital intensive business, they're not going to be fooled by that. They're going to ask those questions during the due diligence. So, those types of things, where you've permanently deferred your capital expenditures, that's something that needs to be addressed as well.
David Prowse: Things that I helped them out with would be, for example, developing KPIs, key performance indicators. And you can do that both on the financial side and the operation side. If you haven't developed those types of metrics on the financial side, chances are you probably haven't done it on the operation side either. And that's going to be important because, assuming you're a manufacturer or maybe a wholesaler, you probably want to understand what's going on in terms of your efficiency and in terms of how you're handling orders, et cetera. So, you need to start getting a grip on that.
David Prowse: So, those are the types of things that are really important, because if you're going to grow your business, first of all... And it boils down to, when we talked about the valuation side of knowing where you are and where you're going, it's the same thing with those metrics. You need to understand, what's the state of my operations, and based on various metrics. And then, are those good metrics? Are those bad? Is there room for improvement? And then the question is, okay, let's try to figure out what the targets are. And then you need to have to start having a process to measure them, to get to where you're going, because if you don't measure them,, you're not really accomplishing too much of anything.
Jason Pereira: So we covered a fair amount there, specifically around the key areas. So, to recap those key areas in layman's terms, not as eloquently as you put it down, one is knowing what you're going to do with your time when you do retire. Two, being able to actually retire financially. Then the last one is basically having your business in the most ready method or most ready state for maximization of enterprise value when you retire. And this is something that you guide people through a process in order to make sure they address those drivers. Fantastic.
Jason Pereira: So, David, thank you very much for this. It's been informative, and I'm sure I get some people reaching out to you. Where can people find you?
David Prowse: They can reach out to me at value@velorum.ca. So that's V-E-L-O-R-U-M.ca. So send me an email. I'm happy to talk with anybody.
Jason Pereira: David, thank you so much for your time.
David Prowse: Thank you.
Jason Pereira: So that was this week's episode of Financial Planning for Canadian Business Owners. I hope you enjoyed that. And as always, if you enjoyed this podcast, please leave a review on iTunes, Stitcher, or wherever it is you get your podcasts. And until next time, take care.
Producer: This podcast was brought to you by Woodgate Financial, an award-winning financial planning firm, catering to high net worth individuals, business owners, and their families. To learn more, go to woodgate.com. You can subscribe to this podcast on Apple Podcast, Stitcher, Google Play, and Spotify, or find more episodes at jasonpereira.ca. You can even ask Siri, Alexa or Google Home to subscribe for you.