Martin: Welcome to the business owners podcast where we throw aside taboos and share strategies for growing, protecting and exiting your business. My name is Martin Checketts and I am here with my colleague Ed Skilton. Together we represent Mills Oakley’s Private Advisory Team. Welcome Ed!
Ed: Thanks Martin, absolutely delighted to be back for episode four of season two.
Martin: Yeah, that is right, the grand finale, if you will, of our season on preparing for exit.
Ed: Indeed, and we are exiting season 2 on a high note today.
Martin: Yes we are. We are very excited to introduce our guest today, Greg Johnson. Greg is an exit planner and we have certainly worked very closely and productively with Greg over the last few years. He really has a unique skill set I think, in that Greg has a trinity of skills that I certainly haven’t seen in any other professional that we have worked with. Firstly he is a qualified accountant, CPA, secondly he is a licensed business broker – so he can not only do the numbers, but then take the business to market. But thirdly, and for me most interestingly, Greg is also a certified exit planner, and we spoke in previous episodes about the rise of exit planning as what I would call a new professional discipline, a bit like how financial planners kind of rose up in the eighties and that is now a new branch of professional advice. We are now, and particularly with the demographics of the baby boomers moving into their sixties, seeing exit planning come to the fore, but hey Ed, I nearly got ahead of myself!
Ed: I was so nervous.
Martin: I nearly made the fatal mistake of interviewing our guest, and perhaps even giving some advice, without properly disclaiming.
Ed: Go for it!
Martin: I will. This podcast contains general commentary only and is not a substitute for independent professional advice. Always seek specific advice related to your circumstances before looking to implement any of the strategies referred to in this podcast.
Ed: Thank you so much Martin, and welcome Greg!
Greg: Thanks very much Ed and Martin, great to be with you today. I have been enjoying your series of podcasts so far so it is a great honour to be here, thank you.
Ed: We are honoured that you are here and I think Martin did put it well, for once, that he is probably if you like, the old, and you’re in some ways the new.
Greg: I’m liking it, (Martin and Ed laughing)
Ed: But it is also new to Australia and the Australian market place. Are the American’s older? Why is it that succession planning and exit planning in particular is so much more advanced in the United States?
Greg: Yeah, look, probably America often leads the way and Australia follows suit. The people in the United States formed an organisation called the Exit Planning Institute, it was founded by a very astute businessman called Peter Chrisman, who identified a very strong need in the market place for all baby boomer generation business owners thinking about what retirement was going to look like and how they going to make a successful exit, and creating a niche opportunity for people to become properly skilled in that discipline. So it started over there in Chicago and has slowly made its way into Australia and venturing into other countries as well.
Martin: And so, you are one of twenty three.
Greg: Yeah twenty three.
Martin: In Australia, certified.
Greg: Certified Exit Planners in Australia, and I guess what that does, it just means that we have a specialist set of skills and knowledge that allows us to be able to apply great outcomes for business owners to help them stop and look at their business as a valuable asset and to maximise the value that they can get from that asset and create an exit that is designed to meet both their personal needs, their business needs and actually thirdly, their financial needs.
Martin: Wow, and it really does kind of cross a number of functional disciplines, doesn’t it? In the old school, or the old world that Ed seems to think that I am attached to, you know, you have got professionals with their siloes of expertise, you have got the lawyer, the financial planner, the accountant, the banker, the business coach, but it seems to me that with this new profession of exit planner you are really drawing on all of these things but overlaying a different skill set in terms of guiding the client through the process.
Greg: Yeah, I think that is a really important point you raised Martin, having the skills to be able to design a successful exit doesn’t mean that you can do everything and I always recommend to business owners to bring in the right experts, to give the right advice about the right aspects of an exit. And that definitely includes accountants, financial planners, lawyers.
Martin: Lawyers (all laughing).
Ed: A few lawyers in different disciplines.
Martin: Yeah the right lawyer is very, very important!
Greg: Lawyers are very, very important (Martin laughing), I was trying to be subtle (all laughing).
Ed: We jumped right on it.
Greg: Yeah, so it is about creating a team of advisors and doing it in a coordinated way. Because often it’s the case, if you are trying to create a certain outcome, a business owner won’t know how to coordinate all those different people in the right way and in the right sequence to get the right outcome, and that is a large part of my role.
Ed: You are right, because when I first met you, Greg, I thought in some ways was that your business model was fairly disruptive to professional services because…
Greg: I hope so!
Ed: Well, yeah like I think it is disruptive in a sense, but it is not disruptive in a sense of taking away from the accountant – who is there in the business advising the business owners – and it is not taking away from the lawyers in any way in terms of legal advice and documentation and the like. But what you do really well is you collaborate. And you collaborate with the business owners, management, and the other professional advisors, and if anything, you drive the conversation forward so that the other professional advisors can do what they do well. From our perspective, it is great to get involved when you know these things are going in the right direction. We find it very frustrating sometimes when we can’t get in early enough and so for us it is great, that you are in there, you are doing the right things, you are having the difficult conversations and we are able to get on board with that, we know the client is being well advised.
Greg: Yeah, look it is great. Creating elaborate relationships with other professional advisors is great for all of the advisors involved as well as the business owner and the way that I paint that model is that if I was to draw them in a diagram I would have a circle in the middle and that is the owner. He is right in the middle, and he should be the focus for all of the professional advisors that are coming in to help out. And there is very clearly a role for all those different people to bring their expertise and skills to the table in a way that is actually logical. And I can also help brief in those professional advisors in a way that is actually mindful of their time and gets the best outcome for the owners, knowing the owner has got really clear goals about where they are headed and what they are trying to achieve.
Martin: That is great Greg and look I have said this before and I will say it again, the longer I am in this game, collaborative advice and multi-disciplinary advice is absolutely what our business owner clients need and that is how they get the best result. So hey, in terms of today, we wanted to pick up on a theme that we have just discussed in some previous podcasts in this season, which is really around locking in senior management as a pre-cursor to exit, and I know that that is something that you have done very, very well with your clients Greg over the years. Could you talk to us about why locking in the management, be it through bonuses, equity, whatever, might be a good idea and then some of the tips and traps for young players around that?
Greg: Yeah sure, look I would start off by contextualising that by saying that what is really important for every business owner and I think you have done a really good job in articulating this point through your podcast, is that they need to have a look at all of their options. There is a number of different ways that an owner can leave their business, it could be a sale but it may not be. It could be that they just want to create an ongoing passive income and they want to stay as part of the business but not work in it. It could be some form of a partial external sale or it could be an internal sale. So having a look at all of their options and working out what is right for them and what is right for the business is a really important starting point. But if we are talking about internal transfers as a way of the owner extracting wealth, then a really good starting point is to give managers or key employees access to equity. Now there’s a number of really good things about those type of options and they come in different forms, we can probably talk about that as we go through. But what is really important about it is doing something like having access to equity by key employees creates clarity for the long term future for the owner, for the employees that participate and for the business. You know I find it amazing that I can go into many, many businesses that have been highly successful, making really good money and often in these cases they have had employees that have been working there for ten, fifteen, twenty years or more, and those employees have been an integral part of the success of that business but haven’t necessarily had access to any upside and the value of the business as it has increased or access to building wealth through equity. So giving an equity option can be really important and really valuable for again, for the key employee as well as the owner.
Martin: If I could be devil’s advocate for a minute, that sounds very nice and altruistic to the hard working, long serving employee but I can imagine some of our listeners might be thinking, well my employees have never put money in the business, they have never taken business risk, they have never had the years of blood, sweat and tears that I have had and living on a shoestring before this thing became successful. What is in it for the business owner?
Greg: A few different things actually, so I would start off by saying, look you could take the altruistic perspective and you could say that maybe they just want to give back. I often see that – the business owner made lots and lots of money and they look at their employees and go, well look, you know what, you have been a great contributor and I really want to find a way to thank you. So, they could take an altruistic perspective and they could just do a good thing. There has been some really high profile examples, Grenda Bus Lines was one of them where he took millions of dollars and distributed it amongst many of the employees just because he wanted to do the right thing. So that is one aspect. The other aspect is, locking in key employees in the long term is actually a deliberate and specific strategy for increasing the value of your business. So you think about it. If your choice is that one day you will actually sell, what is the biggest concern a buyer is going to have in looking at your business? It is going to be about the risk of key people leaving. So what if those key people were actually locked in in the form of an equity? Well what that means then, is that there is upside, the business risk goes down, the value goes up and the owner actually increases the value of the business through that one strategy alone. So it is actually a wealth creation strategy to put it in place.
Ed: I love this, now is there a rule of thumb on how much equity is required to lock people in, how do you go about these conversations?
Greg: Well, it is all about starting with the end in mind. So what is it that you are actually trying to achieve and that is really the best answer to that question. If you are looking for ultimate transfer of control then set that up as a plan. But you know what, you can do that over time, and if you have given yourself enough time; that can be over years, over many years, if that is what you want. But the point is to give yourself enough time to put it in place, don’t wait until the last minute before you try and put a strategy like that into place.
Martin: And what about funding. Because I guess there is a couple of schools of thoughts. Do you give them the equity? Do they buy it? If they are going to buy it, do they buy it at a discount? And frankly, do they have the money? They may very well be people in their thirties and forties with mortgages, school fees and the like. How do you address those kinds of issues?
Greg: Look, in my experience, you are exactly right Martin. Most times key employees don’t necessarily have the capital or the access to the capital to be able to make a specific buy-in. Now depending on the size of the business and the type of capital injection required, that can vary. But as a rule, it is very difficult. So what I recommend is, (a) they should always buy in. In some way, shape or form, even if it is a token amount, it is a principle that I call “Skin in the Game” because the skin in the game means that they have got some ownership and some of the blood, sweat and tears can be shared. In fact, this is when the owner gets to share some of the insomnia that comes with owning and running a business! But the other aspect too, of course, is that if we are talking about a set up that can be done over a period of time, we can actually set up a structure that allows for the shares to be acquired through excess profits, so if the owner says “I want a minimum level of profits but I am prepared to share a percentage of profits over and above that specific target, and I am going to put that towards helping my key employees buy shares” – well doesn’t that mean that everybody wins?
Ed: I think this is very interesting for listeners, now, give us some examples around how that might work, so the turnover is currently X and I have got some staff and I am planning a full exit at some point. Where would this example happen, how does it work?
Greg: Yeah OK, so the fundamental basis behind getting it to work is actually using a trust structure. I refer to that as called an employee incentive trust and essentially the example that I would give you is one of my clients who is well through the process at the moment and is in the domestic construction industry. He decided that he had a long term plan for exiting, he essentially wants to become a chairman, where he has stepped back, that he has got people who actually own a good portion of the business and he is not required to be there within the next five years. So he made sure that he had the right management team in place. He didn’t necessarily have it at the beginning, but we made sure that that took place, and those managers were invited to take up equity in the business. Now, this business was a turnover of twenty eight million dollars, and had reasonable levels of profits but as you would appreciate in the construction industry, it could be a little bit volatile. Nevertheless, we structured an arrangement where we set up the trust and we said to the employees we want you to make a payment into the trust which gets you guaranteed percentage of the business – and look, it was only a couple of per cent, so it wasn’t you know, we weren’t talking sheep stations – it was enough though to say they were deemed as owners. And I will actually just say, one of the most important things about employees taking up some form ownership in the business, is that they change the way they think. So we get employees to think and act like owners because they are one. And you know there is a really fundamental principle there that says you know employees have different thought patterns about the approach to their work or their job than a business owner has to their business.
Martin: Such a great point, Greg and it is the common complaint that business owners have, isn’t it? You know the employees kind of mentally clock in and clock out at five o’clock, do a good job but absolutely don’t go above and beyond and work in the way that the business owner works, and I guess that it is obvious to see why, isn’t it, really?
Greg: Yeah, absolutely, and you know a big part of it is not just giving them the access to equity – it’s the education that goes with it as well. So educate them on what it takes to run a business, and all of a sudden you need to be, if you have got employees that are taking up ownership, sharing the financials. It becomes a necessary part of that. But that forms part of the education, so they can make better decisions in the business that is actually in the interest of the business in the long term because they know everybody benefits as a result of those decisions.
Martin: One thing I do like about these kind of strategies, and clearly they are not for everybody, it depends on the profile of the business and the key people and your own exit plan as you said Greg, but one thing that I really like about it is this optionality in that, by selling down some equity to key staff, that might be a stepping stone to a third party transaction, it might be a stepping stone to a trade sale, it might be a stepping stone to an IPO, and with those people helping you to build value along that journey, and then locking them in meaningfully in the sale documents. Or it could be a stepping stone to a management buyout.
Greg: Yeah, absolutely,
Martin: It could be just the first step, the first twenty per cent that they buy, then forty, sixty, eighty, and you mightn’t in fact affect the entire exit by selling down to your management team in more bite-sized chunks.
Greg: Yeah, and you know I think it is really important that the owner has a bit of an idea about which way they actually want to head and what outcomes they are actually looking for. So the example about my construction industry client was, so he wanted ongoing passive income he didn’t want exit entirely, so that is ok, so we then put the structures in place to facilitate that, but the outcome of keeping access to equity, it is a win/win for everybody. Because no matter which of those paths that you actually choose, the owner gets upside because they are building value and the employee’s get upside because they have got a wealth creation strategy through the business that they are committed to.
Ed: Now what if there is conflict there Greg, you know anyone listening to this might think it’s great but what if it doesn’t go well with those people to whom I have invited into an equity stake? Now I decide I want to sell to a third party and they don’t want to sell to a third party, or let’s say I just want them out of the business, and I want to get my equity back.
Greg: Yeah, very important that you set it up right to start with. So again, get the right advice from the right expert about how that can be structured. So in the one instance, where we have set up an employee incentive trust, all the rules about getting in, about shares vesting and about getting out are well documented and clear, so there is no room for I guess misinterpretation or misuse of those terms. But then I guess you guys would also know the importance of having other clear documents in place, such as shareholder agreements or partners agreements, which is one of my very first recommendations when you have got multiple shareholders is get great legal advice to get those documents in place because the mess that can be created without them can be devastating.
Ed: It really can!
Martin: And I do thank you again Greg for that wonderful positioning of the role of the lawyer in these processes, which is crucial actually. You have got to protect that downside.
Ed: I don’t want to bang on about this but
Martin: I do!
Greg: Can we bang on about it a little bit?!
Ed: Just a tiny bit, look, these strategies are, I think, very appealing to a lot of business owners and as the lawyers, we might be accused of being pessimistic about some of these ventures but it is not that hard to negotiate an agreement when you start talking about these employee options. It is very, very hard to resolve a dispute later on when the dispute comes out. And just to very bluntly put this in dollar sort of problems, even legal fees, you spend X negotiating an agreement for a smooth transition of shares one way or the other as something happens, certain triggers, you know: I am the majority owner and I just don’t want this person in the business anymore, I want my equity back, I want them out and I will get somebody else in, what are my rights? It is easy to have that conversation at the beginning, but in a dispute, you are talking tens of thousands of dollars, if not hundreds of thousands of dollars to resolve these disputes. It would have been quite easy to deal with that upfront.
Greg: And yet there is a great reluctance for people to want to do that upfront, they say, “no, no, it is going to be fine, we are great mates, you know we have known each other for a long time, everything is going to be fine” and I kind of go, that is just potentially the beginning of the end. You know, I would actually add to that by simply saying, in business we are all about wanting to generate growth and build profits and create a great environment to work right? But it is a really crucial part for every business owner to want to be able to manage risk and it is a reality, the better you manage your risk, the better you protect the asset that you have got in this business. And when you think that the value of your business is directly proportionate to the level of risk that sits within your business, then you can create substantially increased value in your business just by reducing the risk.
Martin: Greg, I think I am going to engage you not only as an exit planner but as a marketer for the legal profession (all start laughing). I was just watching and learning there the way that you are able to kind of position and quantify the value of the legal or the risk mitigation strategy and of course, we agree! (all start laughing)
Ed: And from the buyer’s perspective, a business owner who has dealt with that risk, they have locked in management but they have enabled the buyer – who in some ways inherits these agreements – to say, well I don’t want this person in the business any more how can I buy their equity as well? What happens with this key person in the business if they are not performing? What happens if they are unwell or they need to leave the business? Do I have the right to buy them out? And these sorts of things. As a buyer I would want to know that this has been dealt with. That is going to impact on the sale price.
Martin: As the corporate lawyer Ed, if I am acting for a buyer that was looking to buy a co-owned business, as question number one, because you are talking to the majority owner, is “can you drag the others along”, “can you bring along your minority shareholders to this deal” because if they can’t buy us they are pretty much going to walk away, it is going to be very, very hard.
Greg: I think that is right. But then, you know, if it is set up right from the outset, then what we are saying is that everybody can win, and that is so important.
Ed: How often would you see this morphing into a complete sale to management? I almost picture for a lot of people that this is a good stepping stone because if you choose to go down the road of a trade sale, you have locked in management, however you don’t go down that road, or even private equity, you have set things up so that you can continue in this journey of transitioning the shares to management. Do you see this happen? People don’t know really which way to go so they do this, they start this journey anyway of locking in management, giving them some equity or selling some equity and then just keep selling more and more and more, you are seeing a trend in that direction or a trend away from that towards trade sales?
Greg: No, absolutely, towards employee share plans and management buyouts – not only in Australia, but around the world. This is really important, it is once again just looking at the big picture, we have got a third of all business owners that are in their sixties, who are they going to sell to?
Ed: Not other sixty year olds! Presumably?!
Greg: No, well absolutely not, and then you know, you have got Gen Y’s coming through who aren’t necessarily looking to pay lots of money for a business, and you have got your Gen X’s with financial commitments they may or not be able to take up those opportunities. So I am already seeing the beginning of a wave of businesses coming to the market without sufficient good buyers for those businesses. So thinking about the potential wave of businesses coming to the market both now and in the future, means that taking steps now to create internal equity arrangements with your staff is really smart because the upside is even if you did go through a sale, everybody is going to win out of that. Remember, having an employee with an equity stake has taken out some of the risk associated with that business. So preparing for a really good sale in the context of a broad economy where business sales, whether they are strategic or trade sales, is a good move.
Martin: That is so interesting Greg, really kind of tying into some of the macro factors that we are seeing at the moment all over the world. I could talk about this subject all day, but I am conscious that we have got some limited time. I would like to change the subject if that is ok, and ask you in your experience and in your career helping business owners to prepare for exit, what would you say are the three most common mistakes that business owners make?
Greg: I think the key one is not giving themselves enough time, enough time to execute the strategy that is right for them, and thinking that it is going to be ok, and thinking that they will deal with that later, that is the first issue. The second mistake they make is actually not dealing with it at all! And you know, I have got to be really frank here, every one of us is going to leave our business one day, whether we choose to do so or whether it happens to us. So why not actually create an exit that is actually successful for everybody involved? You know, you guys have probably seen as many stories as I have where business owners haven’t planned an exit and they have unfortunately passed on and the mess that they have left for their family, their friends and their employees is not only costly, it not only erodes their wealth, not only massively reduces the value of that business, but the heart ache that it causes for the people that they have left that to is astronomical, and why would you do that? But unfortunately people kind of go, it will be alright, it will be alright, but you know what, it is not.
Martin: It is a bit like people who procrastinate to make a will right, that kind of thing.
Greg: Yeah and you know this is not scare tactics, it is just a simple common sense that says you know it is going to happen so plan for it.
Ed: Well, Greg Johnson thank you so much for sharing these insights today it has been great to hear your views and the things that you advise on and in particular these insights around the management buy-in. I think there are going to be a lot of people interested in this and listeners if you are interested in these concepts please do check out the show notes at the website.
Martin: Yes, that is right and we will have all of Greg’s contact details in there, his website, his email, etcetera, so Greg Johnson from Ascend Business Partners, thank you very much for joining us.
Greg: Thanks Martin, thanks Ed and thanks listeners, it has been a joy.
Ed: Thank you.