ESOP Authority Resource, Exits, Uncategorized, Valuation
Business valuations are calculated a number of ways, as outlined in our business valuation blog post here. What’s important to note, though, is that typically an owner who is selling his or her business will want to maximize value.  Our goal with this post is to break down the factors that make the largest impact to company valuation.

Recurring revenue / subscription revenue.  Recurring revenue gives confidence to the longevity of the business.   If there is any way to have recurring / subscription oriented revenue, this will command a higher valuation multiple, which will then result in a higher overall valuation.

Profitability.  I have to kind of laugh as I write this, given all the publicity that silicon valley gets.  Most people have read about the unicorn tech startups that sold for double- or triple-digit millions pre-revenue, or while running at a loss.  Sadly for the remaining 99.5% of business that want to be acquired, running a profit is pretty important. A great way to kind of see this in action is to actually watch the TV show “Shark Tank”.  Shark Tank is portrayed as a group of loud investors yelling at businesses that are often very odd and obscure, however, if you watch a few episodes of it, a theme emerges very quickly. The “sharks” are typically financial investors — they are buying or investing in a company to see a return, and ideally sooner than later.   It is our experience that most acquirers are doing the same. If you still aren’t sold on this concept, then consider it this way. If company A and company B sell the same thing and have the exact same business, are the same size, and truly all factors are the same, except company A generates a 30% profit margin where company B generates 6%, company A will certainly be valued quite higher.

Growth.  Growing companies are healthy and have a bright future, particularly if profitable while growing AND if the company is both aware of and in control of what is driving growth.  If you can show your company is growing and explain what specifically you are doing to drive that growth, your company will receive a stronger valuation. The converse is true for flat / stalled growth, as well as companies that are shrinking.

Scalability.  An acquirer is purchasing your company to receive a return on his / her investment, and a way to expedite this return is to grow the company faster.  If your company has a specific plan, management team, culture, and processes in place to scale the company, then your company will be valued higher. If you do not have these, the acquirer will know that he/she will have to create these, and thus that will incur a discount on your valuation.   Factors to really develop for scalability are hiring processes, repeatable workflow a company value chain that is documented, repeatable sales processes for new revenue generation, established culture that sustains with the company’s growth and protects the integrity of the company’s current success, as well as other factors (links to future blog posts).   Scaling Up by Verne Harnish outlines several of the predictable revenue milestones of $1m, $2M, $10M, $50M, and $100M+, and the differences in how companies must transform and be prepared to operate differently to grow to these levels, abandoning some of the things that “worked” or were “OK” at smaller company revenues.

Culture.  As mentioned above, your company should have a unique identity and position within the marketplace that justifies your existence.  Ideally, you have a defined set of core values that you are using to unite your company around a mission statement, which explains why you exist and what your company is about.   Hiring, talent management and retention, internal work and efforts, and everything else that the company does should align with these values in a quest to further the mission of the company.  Creating these is not an overnight matter, and so if your company doesn’t have these, or you have a set of values that don’t function in the manner described above, we would encourage you to take the time to do this.   This post explains the value of why this is so important for scaling the business and thus breaking through growth plateaus.  (note: We don’t believe in doing this just to do it, or for the sake of “Kum ba yah”. We believe and have experienced that this is crucial to have in place for effective and frictionless growth.

Unique IP.  This can be truly unique technology, a unique solution, a product or process that is patented, or just an approach that is core to your company that both produces a better result when your company is engaged and is absent from competitors.

Brand.  Brand strength, particularly for larger companies, commands higher valuation.  A strong brand has loyal customers and is not easily disruptive, which has the same value principle as recurring revenue: stability.
Other valuation factors are considered, and in most circumstances, there are factors that are both unique and specific to certain industry segments.   

The goal of a company owner, whether there is a plan to sell the company now, later, or not at all, should be to maximize the above.  The irony is that the best kind of company to own is one that does the above, and in the event you are approached for a potential sale of your company, if the above are in optimal shape, you can expect top dollar for your company (and really, you shouldn’t accept any less).

If you’re interested in learning about how to calculate your business’s value, we’ve prepared How to Calculate ESOP Valuation.  

Finally, a very good reason to consider selling to an ESOP is that the valuation you can command for your firm is often more fair and frankly higher than you would receive via a third party exit.  If an acquirer were to approach you and ask to purchase your company, ideally you would already know what it would sell for if sold to employees (including proper and documented justification), and would then use that as a starting point for negotiation.  
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ESOP Authority Resource, Uncategorized
Simply stated, an ESOP, or employee stock ownership plan, is a qualified defined-contribution benefit plan comprised of company stock, held by shareholders at a company (which is usually all vested employees).  For the purposes of this website, however, an ESOP is a way to sell your company to your employees, enabling all employees to become shareholders in the company, and selling shareholders to obtain liquidity.

ESOPs are a great way to align the financial incentives and rewards of employees with those of ownership, as all employees will hold shares in the company.  

Technically, ESOPs are a standalone entity (a trust), and the ESOP buys some or all of your company, and then issues shares to employees.   

ESOPs work like this:

 

1. A company decides to sell some or all of its stock to an ESOP.  

 

2. A valuation and formal sale process are undergone, where the business is valued, and a negotiation is held between the selling shareholders and the employees.  Employees are represented by a trustee (a lawyer), who advocates on behalf of the employees for the purposes of the transaction, valuation, deal terms, etc. 


3. Once terms are agreed to between selling shareholders and the third party trustee, a transaction is completed. 


4. Sell shareholders receive liquidity for their shares, and employees become shareholders.


5. The business moves forward in this new operating state, with employees now having equity / stock in the company, and ownership having obtained liquidity (and in some cases, exited all together).


There are many nuances to an ESOP.  For example, a company may choose to sell some or all of its stock to an ESOP.   Some owners may choose to exit, where others may choose to stay on.

 

The point of this is that ESOPs are a highly customizable solution, and through exploration, an ESOP can be designed to meet any number of circumstances.

 

Criteria for an ESOP to work well:

 

1. Ownership is seeking liquidity.

 

2. Company has a well established culture, with employees that “buy in” to the company mission and core values.

 

3. Established management team that plays an active role in running the business (this doesn’t have to be formally established, or it could be partly established, however, the people who would comprise this management team need to be currently a part of the team)

 

4. Company is profitable

 

Situations when an ESOP doesn’t work well:

 

1. Company culture is not defined 

 

2. Core values are “stock” and not modeled nor stitched into the fabric of the business

 

3. There is no management team — the company revolves around one owner


Read a bit more via our library of ESOP topics, as there is quite a bit more to explore, such as:

 

How to Calculate ESOP Valuation?

 

Factors that Affect ESOP Valuation?

 

See Videos on the Experience of an ESOP Exit

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ESOP Authority Resource, Exits

An ESOP exit, in the simplest sense, is a sale of a company to that company’s employees.   The mechanics of how this all works, as well as how it all operates after the fact, are outlined below, and for the sake of simplicity an ESOP exit is a true sale of one business to another, with the typical outcomes expected (liquidity, new ownership, etc).


Now, a more detailed explanation of this is as follows:  A sale of the company to its employees is a classic business acquisition transaction where there are the predictable roles of both buyer and seller.  The buyer is a company’s employees, and the seller (or sellers) is any existing equity holder in the company. Each side is independently represented via legal counsel, and there is a standard negotiation of price and terms.   Once all parties agree, the transaction is executed and the company is sold.


There is more information regarding the specifics of an ESOP transaction here, and for the purposes of this article, we are going to focus on the exit itself rather than the transaction.


Exit is defined as “going out of or leaving a place”, and a common misconception with an ESOP is that you can actually exit.  It should also be explained that goals of selling shareholders often differ. Some may want to exit, some may want to stay on, and an ESOP supports all of these options well.


For shareholders who want to exit, the ESOP offers to ability to create a position to backfill yourself.  The process looks like this:


1. Plan to take a full exit, and be sure to include the value of your salary add back, which is usually 4-6X your annual salary.


2. Be sure to also add back anything else that is in your overall comp package, which includes any benefits and owner discretionary perks you are receiving.  These can also be added back at a 4-6X multiple, depending on your valuation multiple.


3. Create an enticing equity position in the company as a member of the management team, and include participation in the management incentive plan.  If it makes sense to do this, break your role up and offer two established team members roles on the management team, as well as participation in the management stock option plan (called a management incentive plan).


4. Present your teamers with the offer, and explain they have now become partners in the company.  Their stock percentage is likely now between 6% and 9%, and their compensation has some very compelling layers.  See here for more information about creating partner roles and cementing key management team members in the management plan.


5. Lastly, expect there to be a transition period.  You will likely want to stay on board for a period of time to transition your role(s).

 

At Techwood, I was able to transition my role of CEO and lead sales person to two people.  I offered a promotion to our COO to my role of CEO, which included a compensation improvement and a strong position in the management incentive plan, and then I recruited a colleague away from a tenured position as a lead sales director of an existing solutions firm, which is much easier to do when able to offer a four-level compensation package (salary, bonus, equity, and management stock options).


Once I had supported an effective transition to these members, I was able to reduce my role to one of board member (in my case, chairman of the board).

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