Sell Your Job Shop for More Money

How to Sell Your Job Shop for More Money using the Theory of Constraints (TOC)

In this article, we’re going to explain how to sell your job shop for more money and what you need to do to maximize the value of your business so that when you do decide to leave, you leave on your own terms, getting paid what you deserve with the ability to step away from the business and leave it and all its obligations far behind. We do this by combining the power of the TOC Thinking Processes and savvy exit tactics into a complete, holistic strategy which is unlike any other that is out there and solely focused on maximizing the dollars you will receive from your business.

If you asked folks about how to sell your job shop for more money, most folks think they’ll simply list their business with a broker, find someone who wants to buy it, get the local attorney to draft a sales agreement and then go meet a few times with the CPA to count all the money – and hopefully avoid a lot of the taxes involved.

And many business owners have deluded themselves into believing that this process is how you successfully exit. It’s not.

The unfortunate reality is that many businesses (more than 60%) never sell, they liquidate and of the ones that do get “sold”, many owners end up settling, not truly selling. Only a very small minority of business owners actually sell their business AND get what they want out of it.

Preparing yourself to exit your business is an important topic, and one best considered before it becomes urgent. It’s the answer to how to sell your job shop for more money.

Unlike real estate investors, who enter a real estate deal with a sense of how and when they’d like to exit the deal, a business owner typically goes into a business without a sense of how they will successfully exit the business. That, combined with the fact that so many business owners’ identities are directly linked to their businesses, and it is easy to see why exit planning is an oft-neglected element for many business owners.

Having a solid exit plan in place is essential, whether you plan to keep working for another 30 years, or you’re not yet ready to sell, or even if the economy is in the depths of a recession and you can’t sell for what you’d like or need.

The best thing you can do for yourself, your family, and the business itself is to have a well-formed, fully thought-through exit plan, prepared, and assembled BEFORE you need it.

With that being said, both Brad Stillahn and Beau Ganas are Certified Exit Planners and we will devote the remainder of this article to describing what it is that YOU, the owner of a job shop, need to consider in order to exit your business in style (and with a lot of money), same as we would with our clients.

How the Theory of Constraints (TOC) Affects How to Sell Your Job Shop for More Money

The Theory of Constraints is actually much more than most folks realize. Many folks know about Drum-Buffer-Rope, or Throughput Accounting, or perhaps heard about the Mafia Offer Boot Camp.

Few however know about the Theory of Constraints Critical Thinking Processes. With the Thinking Processes, TOC is applied logically and systematically to answer these three questions which are essential to any process of ongoing improvement:

• What to change?
• What to change to?
• How to cause the change?

It’s with these three simple, yet powerful questions that we can begin to apply the Theory of Constraints to Exit Planning.

What to change?

In the context of selling your business, the question, ‘What to change?’ is commonly associated with the owner’s desire to sell their business and get rid of the hassles of day-to-day management of a company.

However, that’s a fit for SOME, not all owners. Other owners may want to get out of the day-to-day management of the business, but still own the business and have earnings from the business’s net profits.

No matter the case, this question forces you, the business owner, to think through what is it that you are really trying to change? Another way of approaching this question is: ‘What problem are you trying to solve?’.

The answer to ‘What to Change?’ can dramatically affect the course of your exit planning process, so it’s important to have confidence and clarity about the answer to this question. The first step in the exit process is designed to help you answer this question.

What to change to?

Now, after answering the first question, it’s likely that you, the business owner have a sense of the problem(s) you’re trying to solve; however, knowing the problem is a far cry from having a fully developed solution.

Too many times business owners never stop to properly answer this question, but rather, they brashly disregard the question entirely and simply go down the well-trodden, conventional path of selling a business: get a broker, hope for the best!

That’s far from sufficient, especially if you realize you only exit once and getting your exit right could mean all the difference between enjoying your post-exit life and lifestyle or clutching onto your last few pennies as long as you can hold out.

This is where we generally work with our clients by using the Theory of Constraints Buy-in Process to consider the wide range of alternatives. Yes, there is the conventional path of get a business broker, sell for 3x earnings (less than you want/need), and owner finance 50-80% of the deal.

It IS an option, but it’s just that: one of MANY options.

And, until you have taken the time to fully think about what exactly it is that you’re trying to change to, you’re not going to feel the confidence, clarity, and drive/motivation/enjoyment of knowing that you’re exiting your business as well as possible.

Instead, you’ll likely have the experience of feeling like you’re settling for less: less money than you need, less money than you’re worth, and less of a deal than you deserve after all these years of hard work. It’s possible to increase sales in job shops and machine shops and become highly profitable so you can sell your job shop for more money.

How to cause the change?

Finally, the third of the three questions: ‘How to cause the change?’. This is where the rubber hits the road, but it’s only having clarity about the answers to the first two questions are you adequately prepared to any this question.

All too often business owners get out in front of their skis, whether they commit for a year to a less than adequate business broker or sign and letter of intent which takes their business off the market for a number of months, these things that may be done with the best of intentions and in the spirit of moving the process forward can often become major missteps.

Another axiom Dr. Goldratt gave us in the TOC body of knowledge is: “Any improvement is a change, but not all changes are improvements.”

To cause effective change, you need a well thought through implementation plan. It’s not a to-do list on a sticky note or on your phone, but rather a comprehensive, detailed assessment of the objectives you need to achieve, logically arranged from start to finish which enables you to go from your current position to your desired state.

We utilize the Intermediate Objective Map (IO Map) which is a TOC Thinking Process tool in order to guide business owners in designing their customized, shop-specific exit plans.

Let’s now look at the exit process, using the three questions as a framework to approach the issues.

The Seven Steps of Exit Planning for Job Shops and Custom Manufacturers

Step 1: Identify Your Exit Goals and Objectives

The first step in the process is to consider your exit goals and objectives. The following questions can help you clarify your exit goals and objectives for yourself:

• What do you want to achieve by exiting your business?
• Do you want to maximize your financial return and how high of a priority is this for you?
• Would you prefer to have a smaller total financial return, but with more cash in hand at the time the deal closes?
• Do you want to transfer the business to your family, employees, or to a strategic buyer?
• What do you want for yourself, after the exit? To stay on, to transition, to walk away?
• Do you have a vision of what happens to existing employees, the building, customer service into the future?

Once you know your exit goals, you can develop a strategy to achieve them. And, while this step seems self-obvious, take the time to write down your responses to these questions and share them with your spouse and/or other “thinking partners” you have in your business/personal life.

Once you’ve done that, ask yourself the following questions:

• Did you think of everything?
• Do you have some things to think through and decide for yourself?
• Did you identify anything that has become less of a priority, or not important at all?

It’s likely these questions will be applicable now, and throughout the remainder of your exit, so take the time necessary to gain comfort around your exit goals and objectives. It will require some time and thought, but this is an essential step along the way so you can sell your job shop for more money.

Step 2: Analyze and Assess Business and Personal Finances

The next step in the exit model is to analyze and assess business and personal finances.

On the personal side, you may have a CPA and/or investment advisor that you work with. They should be able to plot out your needs for retirement given your desired lifestyle and provide the funding gap (if any) you’ll need to fill in order to meet those needs.

They will take a look at things like the cash you have on hand at your bank, stock/brokerage accounts, 401(k) and retirement accounts, land, real estate, and other investments you might have in order to assess your financial position. A good professional will be thoroughgoing, turning over every rock along the way and painting a clear picture of your financial position both now and in the future.

At the end of the process with your personal financial advisor, it might be a great time to visit your estate planning attorney and update your will(s) and estate plans (you’ll have a complete listing of most everything financially to think about having done the personal financial assessment already).

In thinking about your business, do realize that the local CPA who’s always done your taxes or the attorney that lives in your neighborhood, may NOT (and probably ARE NOT) the right professionals to help you through your exit.

Reason being? They do not specialize in exits.

There are folks out there who specialize in exit planning, have been a part of numerous deals, and are seasoned experts when it comes to the exit planning process (like us). So, know that going into your exit planning process – you may need to seek better help, and they might live in a different area code.

On the business side of things, one of the first things we generally recommend is to get an outside valuation of your business done by a reputable third party business valuation specialist. The cost can range from $10-15,000 on the low end to tens of thousands of dollars on the high end, depending upon the size of your business.

While it does represent a cost, yes, the information contained in the valuation can be of immense importance.

Suppose you know you need $3MM net from the sale of your business in order to retire comfortably. If your business valuation exceeds that amount, you might be primed to continue the process and move forward with exiting your business.

However, if you find that your business is worth only $2.5MM before taxes, well, then you know that you’ve got some work to do in order to bridge the financial gap between what you want and what your business may be worth.

And, while an independent valuation of your business is far from the last say (only you get that), it may help ground your expectations about the real value of your business (however, Brad and I would tell you that it only takes one buyer at the price you’re looking for to have a successful exit).

We see too many times business owners who are naïve and tremendously overvalue the business they have built. They see the years of toil, effort, and can often look back over decades of hard work to improve the business to where it is today. A business owner in that situation typically thinks anyone stepping into their business will have a much easier path than they had, especially if the business owner started their business themselves.

However, what the business owner will not see are the outdated machines (which work just fine), the old offices (which are miles better than what we started with), and the workforce who have grown accustomed to the way things are (we finally got a decent crew working with us).

A prospective buyer will not have the emotional attachment a business owner may have to their business and will be very shrewd in assessing all aspects of the business, through the well-honed eyes of having seen many businesses, from good to bad to downright awful, you can count on buyers to be more seasoned than most sellers of businesses in the market.

This, unfortunately, all translates into why so many business owners need to go through interacting with a potential buyer (or two) in order to bring their expectations about their exit down to reality. Oftentimes when confronted with the shrewd buyer who is attempting to beat the price of the business down at every turn, a naïve business owner will simply fold like a lawn chair, relent, and sell the business for much, much less than it is worth.

Don’t let that be you – get a valuation done early in the process, know what gaps you need to fill, and do what it takes so you can exit on terms acceptable to you – not merely the terms offered by a disaffected buyer.

How Much is My Business Worth?

This is the million dollar question. The answer is, of course, it depends.

In a conventional sales arrangement that’s financed by a bank, you are likely talking about 3-5x Owner (Seller) Discretionary earnings.

In a competitive bid situation, the same business could sell for 4-8x earnings, or more.

It depends on your business, your customers, risks specific to your business/industry, who the buyer of the business is (first time entrepreneur, strategic buyer, private equity group, etc.) and a whole host of other factors.

However, what we provide below is a general, conventional-minded guide to valuing your business. It’s not perfect, but it could give you a general sense of what your business could be worth – but remember, beauty is in the eye of the beholder and any one buyer may see more value than another and be willing to pay more.

However, a significant key to this puzzle lies in the amount of cash flow your business generates.

What is Seller Discretionary Earnings?

In most shops which are closely held by private owners, the net profit of the business does not necessarily reflect the cash flow of the company. The reason being owners commonly integrate their personal tax objectives into the business for tax purposes.

For instance, the owner’s personal vehicles may be a “company” car, certain supplies of the business may be utilized by the owner personally, and/or the owner may have certain other items expensed through the business. All that’s common practice – but it needs to be considered     when calculating the REAL cash flow of the business.

That’s what Seller Discretionary Earnings represents: the REAL cash flow of a business that a buyer would actually be acquiring.

What is Owner Discretionary Earnings?

Now, before we too far along on this topic, you may have noticed our use of the word Owner and that we put Seller in parentheses. What is Owner Discretionary Earnings vs Seller Discretionary Earnings?

Owner Discretionary Earnings are exactly the same as Seller Discretionary Earnings.

So…what gives? Why have a separate title for the same thing?

The reason we use Owner Discretionary Earnings instead of Seller Discretionary Earnings is that when we work with our clients, if we use the term Owner Discretionary Earnings, it doesn’t set off any alarm bells that the business could be for sell.

Imagine your company’s bookkeeper who prepare the monthly financial statements sees a new line called “SELLER Discretionary Earnings” on those reports. You might as well have an all-hands meeting to tell folks you’re selling your business – the word will get out.

And we, being as savvy as we are around this subject, know that letting the word out too soon or at an inappropriate time can have disastrous consequences, thus we use the term Owner Discretionary Earnings and NOT Seller Discretionary Earnings.

It’s the same number, but it’s perceived in a totally different way by those that see the figures on reports.

How Do You Calculate Owner (Seller) Discretionary Earnings?

Recall from earlier in the article that we made mention of the fact that the net profit of the business may not necessarily reflect its cash flow. Now we’re going to explain how to go from Net Profit to Owner (Seller) Discretionary Earnings.

So to calculate Owner (Seller) Discretionary Earnings, take your net profit and add back any interest, taxes, depreciation, amortization and seller-specific items (e.g., wife’s car payment, “corporate retreat center” aka beach house, etc.) to the net profit of the company and you will have calculated Seller Discretionary Earnings.

Let’s look at an example. There are the annual financials of our sample company we’ll review:

Revenue	$10,000,000
Total Variable Costs	3,000,000
Throughput-margin	7,000,000
Operating Expense	5,000,000
Net Profit	$2,000,000
Net Profit % (Return on Sales)	20%

 

This company has a 20% Return on Sales, which means that prior to any adjustments a potential buyer would be evaluating the value of the business based on the $2,000,000 Net Profit.

Having a 20% Return on Sales is world-class and would likely earn this company a substantial premium (i.e., a higher multiple) if it were to be sold…but wait, there’s more!

Let’s also suppose the following items have been included in the financial statements of the company:

Depreciation Expense	$150,000
Interest Expense	$45,000
Results-based Consulting Fees	$245,000
Owner Car Payment	$35,000
Owner Beach House Corporate Retreat	$55,000
Total of Items to Recast	$530,000

 

Thus, this means that the valuation of the company should look something like this:

	3x Multiple	4x Multiple	5x Multiple	6x Multiple
Revenue	$10,000,000	$10,000,000	$10,000,000	$10,000,000
Total Variable Costs	3,000,000	3,000,000	3,000,000	3,000,000
Throughput-margin	7,000,000	7,000,000	7,000,000	7,000,000
Operating Expense	5,000,000	5,000,000	5,000,000	5,000,000
Net Profit	$2,000,000	$2,000,000	$2,000,000	$2,000,000
Net Profit % (Return on Sales)	20%	20%	20%	20%
Total of Items to Recast	$530,000	$530,000	$530,000	$530,000
Owners Discretionary Earnings	$2,530,000	$2,530,000	$2,530,000	$2,530,000
Multiple	3	4	5	6
Potential Business Value	$7,590,000	$10,120,000	$12,650,000	$15,180,000

From the table above you’ll notice that the net profit of the company was increased by the amount of the addbacks, which amounted to $530,000. The difference in business valuation ranges from $1.5MM to an additional $3MM of business value due to the addbacks. Thus, it’s in every owner’s interest to identify and recast as many owner discretionary items as possible.

The fine line to walk here is to add back owner discretionary items which are supported by the facts as truly owner discretionary.

A couple of examples: Adding back above and beyond repairs might be accepted by a potential buyer; trying to add back maintenance staff wages likely would not be accepted.

The first case has an element of discretion; you could’ve made less costly repairs and kept working, but instead chose to do more extensive repairs and presumably the equipment is in better condition than it would have otherwise been. In the second case, maintenance wages are a normal, ongoing expense of the business and generally these types of expenses would NOT be recast into Owner’s Discretionary Earnings.

Additionally, while you as the owner of a business certainly want (and should) recast as many items as REASONABLY possible into Owner Discretionary Earnings, you shouldn’t go so far as to undermine your credibility.

Numbers are more than just numbers on a report. Numbers tell a story – and you don’t want the buyer perceiving your story to be one of fraud and/or deceit. You want that story to be one of trust and integrity.

Step 3: Create and Sustain Profitable Organic Growth

Step 3 in the Exit Process is normally thrown about as though it were merely another simple step along the way, no different than the few phone calls required to hire someone to do a valuation of your business. Step 3 in the Exit Process is creating and sustaining profitable, organic growth.

Unfortunately, while everyone would agree you need to create and sustain profitable, organic growth in your business…very few actually know how to do that.

When pressed, many exit advisers will simply tell you to “buy another business”…but that’s a far cry from a solution and a likely distraction. Not only that, if you’re trying to exit, you may not necessarily be in the mood or position to take on the work, stress, and risk of a business acquisition. It’s a half-baked idea, at best.

Another direction could be to look internally at improvement projects. However, that avenue is fraught with peril as well.

Many of the consultants and programs that exist today focus on cost-cutting measures, which at the end of the day will ultimately fail to provide the necessary, sustainable, profitable organic growth that you, the business owner, MUST have in order to maximize the value of your business at the end of your exit. You will not “save your way to profitability” and cutting costs is NOT the same thing as organic growth.

It’s like this in every direction you turn. Everyone talks a great game…buy this ERP and make more money, invest in this new machine and make more money, read this book and make more money…but as a business owner you know better. You’ve been there, done that and have the T-shirt to prove that the conventional ideas just never pan out in the real world, at your shop.

The reality is that almost no one knows how to systematically create and sustain organic growth in a business, let alone a job shop or machine shop.

No one understands the demands of high mix, low volume work. They don’t get the fact that you typically may only make the same part once or twice a year, if ever again. They don’t understand the difficulties finding qualified employees to run your types of machines (great welders, EDM operators, and folks who know how to read prints are NOT a dime a dozen…they are REALLY hard to find gems).

So…what’s the business owner of a job shop or customer manufacturer to do? Well, we would tell you that we think we have unlocked many of the secrets to success, and we’ll share two of them right here, right now with you:

Secret #1: You MUST be reliable.

You must be reliable, which means you do what you say you are going to do. When you commit to a certain due date, your customers MUST KNOW that they will get their parts, barring some significant, unforeseen event.

Customers NEED TO KNOW that you’re going to deliver their parts on time, all the time.

To that end, our very own Dr. Lisa’s Velocity Scheduling System is the single best way to get more jobs done with the same people and resources.

Think about that last statement. It’s important. “Get more jobs done with the same people and resources.” If that was true, you’d ship more jobs, invoice for more work, all the while you have the same amount of operating expenses.

What’s the net effect? Organic growth that can be generated now and in the future.

That’s why it is so critical to be reliable. Now, the primary mechanism that controls reliability in a job shop or customer manufacturer is the scheduling system (note, “system” here does NOT mean the ERP, it means the set of policies and procedures you follow which bring the desired results, namely high on time due date performance).

We use Velocity Scheduling System (VSS) to make our clients amongst the most reliable in their industries.

Secret #2: You MUST have a profitable pricing strategy.

The second secret lies in establishing a PROFITABLE pricing strategy.

Many shop owners just assume that if they mark up their costs and do their best to keep costs down throughout the month, that everything will be ok. Right? Right?…WRONG!

You see, being profitable isn’t a matter of simply covering costs and trying to be as efficient as possible. It goes much, much deeper that.

You see, at the foundation of cost-based pricing systems lie many false assumptions. One such false assumption is that your workers actually can AND DO work close to 100% of the time.

You see, in setting cost rates, you must make judgments about how many hours your workers will be working in order to develop the cost rates. And the question inevitably comes up, “Well, of the total time that we’re paying employees, what percent of the time do we want them working?”.

The answer is usually something like, “What kind of question is that?! If I’m paying, I want them working. Period, full stop, the end! 100%!”. Heard that before?

Now, maybe you are generous and allow for the occasional bathroom break, so you lower your expectation to 95%. Or perhaps you know all too well how football season, deer season, or how any other season can cause you to lose much of your capacity due to folks being out, for whatever reason. In that case, you might say something much more reasonable, like 90%.

No matter what the answer, the result is the same. In the cost world, you must work AT OR ABOVE this efficiency percentage that you’ve selected, simply to BREAKEVEN. That means your workers MUST work AT LEAST 90-95% percent of the time just for you to breakeven and get by without going on credit hold at all of your vendors at one time.

Sound ridiculous? You bet. Sound profitable? Anything but.

That’s why we have a totally different view of capacity – one you won’t find anywhere else. It’s one of the paradigm-breaking strategies we employ to help you build a PROFITABLE pricing strategy, which is unlike you’ve ever seen before and certainly doesn’t involve the drudgery of cost rates, allocations, and worrying every little assumption of every single quote.

To learn more about how you can build a PROFITABLE pricing strategy for your shop, check out our site which is 100% dedicated to pricing for job shops and customer manufacturers at www.VelocityPricingSystem.com.

Now, these are just two of our secrets, but check out the charts below to see the results of some of our past clients:

We’re not saying that these programs will work at your shop; they may not be a good fit. These shops had uncooperative workers who were very skeptical, managers that were scarred by previous improvement project failures, and customers who never seemed to be happy – at any price.

However, our processes are straightforward, easy to implement, and we guide you and your team along the way. And we’ve had success navigating some of the most challenging environments, places that folks said could NEVER improve. Some of those places are represented on the charts above.

Now, to be sure, every step of the way through your exit is important. However, never lose sight of what a buyer actually is buying from you. It’s not reputation, machines, your sweat equity, or anything else of the like.

They buyer is buying one and only one thing: a stream of future cash flows. And only Step 3 in the Exit Process deals with actually increasing this stream of future cash flows. All the other steps are the side dishes and garnishments to Step 3, which is the main course.

This one step has the power to change your exit more dramatically than any other Step in the Exit Process. Make sure that you are paying attention to your organic growth and taking it where it needs to be so your exit will meet your goals.

So, check out www.VelocitySchedulingSystem.com and www.VelocityPricingSystem.com when you’re ready to make improvements that go to your bottom line.

Step 4: Ownership Transfer to Third Parties

Now that we’ve “checked the box” on sustainable, profitable growth, it’s time to look out and consider one potential route for your exit to take: An ownership transfer to third parties.

Now, most people just assume that they’ll get a business broker who will list their business for sale, much like selling a home. In fact, we’ve had certain folks (before working with us) whose business WERE in fact listed by a realtor friend of theirs…obviously that wasn’t the preferred route to go.

However, the standard business broker listing route is a conventional way of doing things – and you should know by now that we’re anything but conventional.

An ownership transfer to a third party might also mean going out and searching for a strategic buyer, one that would disproportionately benefit from buying your business. A strategic buyer often can and is willing to pay a much higher multiple to buy your business (and all that organic growth you created in Step 3).

Not only is there the option of finding a strategic buyer, there’s also the option of running a controlled auction. Imagine eBay, except instead of spendthrifts trying to find deals on used junk, it’s packed with eager (and competitive) business folks who are all vying for the opportunity to purchase your gem of a business. This type of third party transfer of your business can create SIGNIFICANT additional sums of money, much more than you would earn if you followed the conventional wisdom of just getting a business broker and “throwing it on the ‘net”.

Now, there are a few items that need special attention if you sell to a third party.

Tax Implications of Selling Your Business to a Third-party

The largest item you must consider will be the tax planning ramifications of selling your business. The treatment of the sale of your business will be impacted by several factors:

• Type of Sale
• Legal Entity Tax Classification
• Recapture of Depreciation

We only want to paint a cursory picture of these items as they are interactive with the ownership structure of your business and there are also state-level tax issues which vary based on where you live and also where the business is located.

Suffice it to say, it gets complicated with taxes. But, at a high level, here are some things you should be considering.

Type of Sale

The first thing to consider is the type of sale. Generally speaking, there are two primary means of selling a job shop: An entity sale and a sale of assets.

With an entity sale, you’re selling the actual legal entity (and all its assets, IP, trademarks, goodwill, etc.). While the buyer is buying the legal entity, they’re also buying all that comes with it – good and bad. Typically, many buyers will not want to buy the legal entity of the business as they also assume any liabilities associated with the entity.

For example, suppose there was a disgruntled employee who was planning to sue the company. Let’s also suppose the buyer has now acquired the legal entity before the employee brings their lawsuit. Once the suit is brought against the legal entity, the buyer (and now new owner) is on the hook for any liability resulting from the lawsuit. This is why many organizations simply choose to buy the assets of a company.

With an asset sale, it’s just that. The buyer is buying the assets of a company, which could also include intangible assets such as customer lists, trade secrets, certificates, etc. This is the path that most buyers want to pursue.

Now, the tax issues of an entity sale vs an asset sale are dramatically different. Depending on the entity, the sale of an entity could potentially receive preferential treatment and be taxed at capital gains rates. Alternatively, the sale of assets is likely to trigger depreciation recapture and have a substantial portion of the proceeds be taxed at ordinary rates.

Knowing the type of sale you are entering and the tax ramifications of that sale type are CRTICAL. Our advice is to have early and ongoing discussions with professionals that specialize in exit-related tax issues.

Legal Entity Tax Classification

The second tax issue we are putting before you is the legal entity tax classification. If you are taxed as a C-Corp, it’s likely you could end up paying taxes twice, once at the entity level, another at the personal level as a result of exiting your business. Generally speaking, being taxed as a C-corporation is a disadvantage for a small business.

Now, there is a route to convert your C-corporation to an S-corporation, but it must be done carefully, and a full understanding of both your business and personal finances must be had prior to making any changes.

If you are an S-corporation, you generally receive preferential tax treatment relative to a C-corporation. The entity itself generally has no tax liability as the income of the entity flows through to the shareholders.

LLCs can take many forms, but generally are taxed as S-corporations; however, they can also be taxed as a C-corporation or a Partnership, depending upon how the entity was established and how certain tax elections were (or were not) made.

Depreciation Recapture

A third key tax topic we’ll cover here is depreciation recapture. Say what?

Remember those machines you bought 3 years ago and took the Section 179 depreciation on? Well, once you exit your business – and keeping it very basic and at a high-level here – let’s assume your exit is by way of an asset sale (as opposed to selling the actual legal entity).

You’re likely going to end up having ordinary income to the extent that you previously took depreciation on those machines which you previously depreciation. That’s depreciation recapture.

Now, this is a huge topic all by itself, and actually connects into how the negotiated price of your exit is allocated across the assets in your business and intangible assets like goodwill.

And that brings us back to the value of an exit planner.

Having someone on your side that understands these complexities and can interact with other professionals on your exit team to help bring about the best outcome for you is critically important.

How your deal is structured, how the negotiation process plays out, and the key criteria you have for yourself will all determine the success or lack thereof for your exit. That’s where exit planners like us come into play: We help you build the process you need to ensure you get the results you want, all the while avoiding the pitfalls other business owners learn the hard way – by making a painful (i.e., expensive) mistake in their exit journey.

Step 5: Ownership Transfer to Insiders

The next Step in the Exit Process deals with an ownership transfer to insiders. In many ways it’s very similar to Step 4: Ownership Transfer Third Parties; however, this type of exit commonly involves family members and/or key, long-time employees.

In these circumstances, the primary focus is not one of entity value maximization at the time the exit consummates, but rather focuses more on long-term, or total entity value.

This means that the tax planning shifts from a negotiated, transactional approach to one that maximizes total combined benefit.

For instance, in the case of a transfer of a business to the next generation of a family, the generation selling the business may take less advantageous positions from a tax perspective as the family unit as a whole might benefit from structuring the exit in such a way. That would not be done typically in an Ownership Transfer to Third Parties.

There may also be additional operational details in this form of an exit to work through. Perhaps Dad hangs onto certain responsibilities he enjoys that the children are not yet ready to take on and/or have an interest in doing at this time.

However, in either a Step 4 Ownership Transfer to Third Parties or Step 5 Ownership Transfer to Insiders, the main driver of value is the future steam of cash flows – which serve to confirm and further demonstrate why Step 3 Create and Sustain Profitable Growth is so important.

Step 6: Risk Management

The sixth step in the Exit Process is focused on evaluating the risks facing the company and its ownership and taking steps to remove, mitigate, insure, or otherwise manage those risks identified.

The Importance of Keeping Your Exit Plan Private

Oddly enough, the fact that the owners are seeking to exit the business is in itself a risk. If word gets out too soon or in an uncontrolled fashion that the owners are exiting (or even considering a future exit) the business could be damaged in any number of ways.

Employees may become disgruntled, some may decide to jump ship to a competitor, or worse yet, they may attempt to hold up the sale and essentially extort the business owner out of some of the exit proceeds. However, we’re going to directly address this risk and tell you how to manage it in just a few paragraphs.

If word of an exit reaches your customers, they may go shopping for new vendors. The damage of losing an important customer during an exit cannot be understated; it could potentially be a devastating event causing the business to lose revenues, impair the value of the business and/or potentially remove exiting as a viable alternative.

How to Manage Key Employees in an Exit

Let’s come back to the risk we identified earlier, that of an employee holding up an exit and attempting to derail the exit or potentially extort the business owner. The approach you take to your  employees before, during, and after your exit is by itself an issue that needs to be thought through thoroughly. Too many business owners naively assume everything will simply be ok and that employees will accept an exit without hesitation so long as their jobs are preserved. This is NOT the case.

First, in every business there are employees and then there are the KEY employees. The ones who make it happen, the ones you couldn’t run the business without. If one of those employees were to leave in the process of an owner exiting a business, there would clearly be negative effects stemming from the Key Employee’s departure.

Second, as you get into the details of your particular exit, it is a real possibility that the payout you receive could be contingent upon the performance of the business into the future (or at least it’s ability to service debt you may provide). And, as a business owner, you know how highly reliant the success of your business is on your key employees.

Thus, it is apparent that in order to provide you with the widest range of options for your exit, maximize the value of your exit and to mitigate risks for the future owner, keeping key employees happy, motivated, and on the payroll is a top priority.

This is where the concept of a Stay Bonus enters the picture.

How to Use Stay Bonuses in Your Job Shop Exit Plan

A stay bonus is a useful tool to keep key employees around to ensure the business has continuity in operations for a prospective buyer and also can help protect the exiting owner from having an employee potentially derail an exit.

A stay bonus, at a high level, works as follows: An employee is granted a substantial bonus (e.g., ½ year’s pay, a full year’s pay, etc.) if they stay for a predetermined time (1-3 years typically) after an exit.

Now, there can be any number of additional provisions added to this very basic version of a stay bonus we just illustrated. You could link it to vesting, performance goals, and/or potentially tier the amount that is paid based on the time the employee remains in place at the business.

Now, practically, how do you go about putting a stay bonus in place? Well ideally, you’d think through who are your key employees, what station of life they are at, their motivations and attitudes about their career and your business.

Then, at the right time (NOT while you’re signing the sales agreement with a potential buyer) and with much forethought, the business owner discusses the need to protect the business and fellow coworkers as part of a broader risk management plan the company is putting in place. A key provision of the plan is to ensure that in the off chance of something happening to the business owner that the business would be able to continue as a going concern. This would lead to the need to ensure that employees stay on after a change in ownership, thus providing the opportunity to introduce the concept of a stay bonus to the employee.

The concept of a stay bonus is a very powerful tool for any business owner looking to lock down key employees and mitigate the risk of them leaving or derailing an exit; however, there’s much more to it than just paying a big bonus for staying on at the company. And getting right means navigating the employment laws of your state, federal and state tax consequences for your exit and for the employee as well, and also treading carefully so that you get the stay bonus in place without tipping off employees that you’re working on your exit. That, while an easy process to describe, is much more difficult to think through and execute a full-on solution.

How to Use Non-Compete Agreements to Boost Business Value

In addition to using stay bonuses, there is likely a role for non-compete agreements in your business to protect both your revenue base and the intellectual property of your business.

While it is true that some non-compete agreements do not hold up in court, it’s also true that many non-compete agreements work effectively and can prevent the loss of major customers and sources of revenue and also prevent a key employee from establishing a competing business as a consequence of you exiting your business. Perhaps you don’t get your entire list of desires met with a non-compete so that it is actually enforceable; however putting a non-compete into place is good for you as the seller and the prospective buyer as well.

Putting a non-compete in place is sound advice; how to do that is a legal matter. Our recommendation is to seek counsel that specializes in exit planning related matters, and/or an attorney that specializes in non-compete arrangements. The type of attorney that best suits your needs will depend on your business, the nature of the non-compete agreements you’re seeking to put in place, as well as the employees and nature of risks involve.

Put Customer Agreements in Place to Reduce Risk

Most job shops simply take orders from customers on a PO by PO basis. At best they may have a blanket order that provides releases over the next 6 to 12 months, and while blanket orders offer the promise of future work, they fall short in terms of truly protecting the company from a risk management perspective.

Additionally, putting a customer agreement in place is so far out of most owners’ paradigms that they never consider it in the first place or do not consider it feasible to put into place with their customers. Both are bad assumptions about how to manage a job shop.

A customer agreement would ideally be put in place and specify a wide range of terms and conditions by which the two parties will conduct business and provide the job shop with a sense of security about what level of work it might expect in the future. Even if the customer is unwilling to commit to a certain level of work or standards of conduct related to issuing work to its vendors (e.g., we’ll have a conversation about price before we simply just pull the work), there are still a number of other terms and conditions that should be thought through and documented in writing. Items such as:

• Pricing Arrangements:
  • What is the expected pricing given the various service levels the job shop may offer (expedited delivery, stocking programs, etc.)?
  • What happens when material prices change?
  • How to manage annual price adjustments for inflation?
  • How fast will quotes be provided to the customer?
• Operational Concerns:
  • Dealing with unreliable material vendors (whether they are specified by the job shop’s customer or not).
  • Due date performance expectations for delivery of orders.
  • What are the procedures for resolving quality/rework issues?
  • How does customer supplied (or customer required) material affect these items (e.g., are they responsible for lost time on your shop floor due to bad materials?)?
• Expectations regarding payment performance.
• How will both parties protect intellectual property?
• Standards of communication
  • Is sufficient notice given via email? Or do you need hard copies?
  • How do you handle print/revision changes?
  • How do changes to parts affect the existing inventory you have on the shelf?
  • What happens when a small change results in a large price difference?
  • Do you require a 3d model of certain type to be provided?

Step 7: Personal Tax, Investment and Estate Planning

The final step in the Exit Process is to develop a solid personal tax, investment, and estate plan. All too often folks manage these items by themselves and as a result you get a one-off plan for each, none of which integrates together.

While we certainly have experiences and backgrounds in all these areas, we’re not going to delve too deeply into these topics as they’re not what we do day-to-day.

Our advice to you here is to ensure that regardless of how or who is managing these various aspects of your financial life, that these three be tightly integrated fashion and that the various professionals who help you manage these items are aware of one another and have established open lines of communication and understand your intent, goals, desires, and expectations related to these items.

Job Shop Specific Exit Concerns

Now that you are aware of the 7 Steps in the Exit Process let’s dig into some areas which are unique, different, and special to Exits for job shops.

Evaluating High-mix Low Volume Revenue Streams

One item you are intimately aware of if you own a job shop is the fact that job shops have revenues which come from high mix and low volume work (jobs). This can cause buyers who have expectations of recurring, ongoing work and revenue to “run aground” in their evaluation of your business. The fact is, that’s what a job shop is by definition.  The fact alone shouldn’t surprise a potential buyer who is actually serious about owning a job shop. If this is an issue, you likely have brought the wrong buyers to the table.

What is Customer Concentration?

Now, an extension of how job shops work on high mix low volume work is the issue of customer concentration. Technically defined, a customer concentration is receiving more than 10% of total revenue from any one customer.

How does a Customer Concentration form?

Customer concentration can form due to a number of factors. Commonly, we see customer concentration develop in our clients’ business after they first begin working with a customer who need specialized, hard to make parts. Once the customer gets a taste of a reliable vendor that can handle specialized, complex, hard to make parts the flood gates seem to open and the customer rewards the job shop with additional work. All of this is a great thing and ideally how many customer relationships begin and grow in your business.

How Do Buyers View Customer Concentration?

Unfortunately, a prospective buyer lacks the historical context and perspective around customer concentration in your business. Where you see a shining example of how you served a customer well and they rewarded your shop with more sales, a prospective buyer could see a risk to the business’ ability to have consistent revenues into the future – especially if there was a reasonable possibility the customer could leave or replace your shop with another vendor.

How Do You Position Customer Concentration in Your Exit?

The issue here isn’t so much that you have customer concentration, those should be expected; the issue lies around positioning the customer concentration in your Exit Process, making the buyer aware of mitigating factors around any customer concentration, and also being savvy enough to know when a buyer is simply trying to use the existence of a customer concentration to lower the price they pay to you.

For example, if you’re the only shop which has a unique capability like precision cylindrical grinding, 5-axis machines or mill-turn capabilities in your region, then the odds of this customer finding a competitor to match capability, reliability, and price is unlikely.

Thus, the issue of customer concentration comes back to have you done your homework?

• Do you know the capabilities of your competitors in your region?
• Do you even know who you’re up against? Who else is in your area?
• Who else do your customers work with?
• Whose trucks do you see delivering parts to their plant?
• What logos are on boxes/pallets which are in their staging area/warehouse?
• How machines do they have?
• What kinds/capabilities of machines do they have?
• How many employees do they have?

With this understanding and context, you should be able to properly position any customer concentrations not as risks in your Exit, but rather as opportunities for a potential buyer to acquire a “sticky” set of customers which are dependent on your shop for their critical, important parts.

This why we have built a competitive analysis into the Velocity Pricing System.

How Do You Mitigate Customer Concentration in the Sale of a Business?

In addition to correctly positioning a customer concentration, there are ways to mitigate its impact on your sales of a business.

Perhaps the best way to mitigate the impact of customer concentration on the sale of your business is by having well-qualified potential buyers. In the case of a customer concentration, if a potential buyer was simply looking to add an additional site to their footprint or acquire your business to combine into their existing business, what may be a concentration for your business may not be as significant to the buyer.

For example, if you have a presence and certifications in an industry that is hard to break into, for example, firearms, the fact that a buyer could gain entry into that market, acquire your FFL (assuming you have one), and have a ready-made list of customers they can keep selling to (and/or potentially sell more to), may be where the value in the sale of the business lies for the buyer. They may look at a customer concentration as less important than gaining access to this difficult to enter market and having a solid customer list from which to expand.

How High Mix/Low Volume Affects Pricing Models

There’s also another key area that the high mix low volume nature of job shops has significant impact on and that is on your shop’s pricing.

Many shops utilize a conventional pricing model, one that leaves much to be desired.

First, they take the drawings and develop engineering time estimates. The estimator (or owner) has to take the time to develop a routing for the part, documenting each step in detail. The department, the work center(s) involved, which employee will likely run the job, the cost rate of each machine/employee, the setup time, the run time, the scrap or defect rate likely to be experienced, and many, many other details from material handling to shipment of the job. There are many, complicated spreadsheets, industry/trade manuals, charts, vendor price lists, etc. involved and what emerges from the process is often less than confidence inspiring.

After reviewing all the information in detail (and after several hours, or days waiting on information), finally what emerges is a “cost estimate”, which then gets marked up.

Thus, every part, every quote, every opportunity gets treated like a one-off, requiring a detailed, custom developed estimate and pricing. This is conventional practice; this also leaves much to be desired.

First, it takes a long time to do a quote. Second, it takes a high level of technical experience to develop the time estimates. Third, because people are involved – the process is highly variable.

As an aside, we claim that you can give the same part to the same estimator at different times on the same day and you’re likely to get two different prices. We commonly see things when studying our clients’ pricing practices.

How Pricing Models Affect the Sale of a Business

Given conventional practices related to pricing, imagine you’re a prospective buyer and you step into this environment.

• Would you feel comfortable with this pricing process?
• How would you know what to do?
• How do you know if folks are estimating correctly?
• How do you even know what correct IS?

Now, just as in the case of managing a customer concentration by selecting well-qualified buyers to evaluate your business, you could employ that same tactic here. You could simply have buyers that were already well versed in your industry and could get up to speed for estimating and quoting in a relatively short period of time.

However, while that is a option, it’s not the option that maximizes the value you can receive in the sale of a business. To do that you must put in systems and processes that reliably enact your pricing model in a way that’s not dependent on any one person (or their mood that day) to generate pricing for your business.

In the Velocity Pricing System, we achieve this in Step 11 Pre-Pricing. We work with you to show you how to not only develop pricing for almost any type of job you might encounter, but we also help you systematize and implement the process so that pricing becomes more reliable, consistent, and accurate, job after job.

This creates an immense amount of confidence in your pricing SYSTEM, and it also will enable you to increase the pool of potential buyers who would feel comfortable buying your business. That’s how you maximize the value of your business, it’s by developing the systems and processes that a buyer can rely on to work into the future and continue to generate cash flow, which after all is what they’re really buying.