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Small Business Management Buyouts: The Employee’s and Manager’s Guide

© John Mill, MBO Coach, November 2018

www.mbocoach.ca; write to: john@mbocoach.ca

Introduction

In Canada, there are more than a million small businesses (that is, firms with fewer than

100 employees), according to Statistics Canada. Most have been operating for more than

ten years with owner-managers in the traditional retirement age zone of 55–75. Exit options

are limited because small businesses attract the lowest valuations and are difficult to sell.

This problem is so large that the Canadian Imperial Bank of Commerce (CIBC) has described

the potential loss of millions of jobs and trillions of dollars as a “growing macroeconomic

risk.”

That said, hundreds of thousands of small businesses are profitable and have solid

business foundations. Even though they are difficult to sell there is a viable alternative.

Management buyouts are the most successful form of business transfer, but employees and

managers seldom have sufficient skin in the game to buy out the original owner.

This guide presents a buyout method that is designed for employees and managers who

have skill in the game and who are willing to learn leadership and value creation skills.

These leadership and value creation skills are then applied to develop the solid business

foundation of the company to create enough value to buy

out the owner and reward the managers for their effort.

Management buyout coaching is a train-the-trainer

approach. It is the start of a continuous learning journey.

The value creation skills are culture, operations, sales, and

finance. Acquiring these skills offers two advantages: first,

they can create funding for the buyout, and second, they

offer the highest probability of continued success after the buyout.

Leadership and value creation skills are not unique to a management buyout. The skills that

employees and managers can develop are the same skills any successful business leader

needs to master. Small business leaders need to develop a well-rounded generalist

understanding of the value creation skills and then expand that learning through continuous

team training and development throughout the business.

The secret to success in business is that there is no secret. The truest, most reliable path is

the simplest. Focus on the work and the value the work delivers to the customer. Develop a

routine and train in a mindful, conscious way. Be respectful and improve continuously.

If you are interested in finding out more about how management buyout coaching can help,

please contact me,

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Contents

Introduction .................................................................................................................................................. 1

Small Business Buyouts ................................................................................................................................. 3

Is a Small Business Management Buyout a Good Idea? ........................................................................... 3

The Third Path ........................................................................................................................................... 3

The search fund..................................................................................................................................... 4

The management buyout ...................................................................................................................... 5

What Type of Small Business Should You Look For? ................................................................................ 6

Leadership ..................................................................................................................................................... 8

Leadership Is a Choice ............................................................................................................................... 8

Transitioning to Leadership ...................................................................................................................... 9

Culture ........................................................................................................................................................ 10

What Is Culture? ..................................................................................................................................... 10

A Dramatic Example of Culture Change .................................................................................................. 11

Seven Drivers of Employee Engagement ................................................................................................ 13

Operations .................................................................................................................................................. 14

The Most Successful Small Business in the World .................................................................................. 14

Standard Work ........................................................................................................................................ 15

Sales ............................................................................................................................................................ 16

Commercial Teaching .............................................................................................................................. 16

Voice of the Customer ............................................................................................................................ 19

Standard Work in Sales ........................................................................................................................... 19

Finance ........................................................................................................................................................ 20

Financial Statements Are the Problem ................................................................................................... 20

Debt and Equity Financing ...................................................................................................................... 22

Debt financing ..................................................................................................................................... 22

Equity investments .............................................................................................................................. 22

Small Business Management Buyout Example ....................................................................................... 24

Conclusion ................................................................................................................................................... 25

Resources .................................................................................................................................................... 26

Leadership ............................................................................................................................................... 26

Culture .................................................................................................................................................... 26

Operations .............................................................................................................................................. 26

Sales ........................................................................................................................................................ 27

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Finance .................................................................................................................................................... 27

Small Business Buyouts

Is a Small Business Management Buyout a Good Idea?

This is a guide for employees and managers; however, owners will benefit from reading it.

For simplicity, we will use the term manager and management buyout throughout. Before

embarking on the exciting journey of a management buyout, a manager should ask these

questions:

- Is a small business management buyout a good idea?

- Can I afford it?

- What’s involved?

This white paper answers these questions from the manager’s perspective. Although this

guide is not written directly for the existing owner, the owner is going to be an important

team member for several years. It is important that managers and owners understand each

other’s perspectives—doing so will highlight the win-win nature of a properly framed

management buyout.

This paper does not claim to present any original ideas; leadership and value creation skills

are in no way unique to the management buyout. In fact the intent here is to avoid original

ideas. There is such a torrent of information washing across the internet every day that there

is no need to reach past the basics. The leadership and value creation skills discussed

herein are tried and true and have been proven to work in almost any type of business.

This does not mean that this paper is a general business manual; it is not. It is a collection

of simple, proven, timeless business improvement ideas presented in a workable format at

a small business level and specifically tailored to get managers into the game.

To answer the first question: Is a management buyout a good idea? The answer is a

resounding yes, so much so that it is now recognized as the third path.

The Third Path

Traditionally there were two career paths: find a good job or start a business. Recently the

small business buyout has been recognized as a third path. The reason is that there are

hundreds of thousands of profitable small businesses with solid business foundations. This

is an enormous opportunity but capturing it requires specialized skills. Management is one

of the major hurdles to clear in a small business transition.

Generally, small businesses are owner-managed, if the owner wants to sell and leave the

business, a new manager is required. Investors who have the capital to pay for a business

do not want to manage it. And a small business does not generate enough cash flow to

- buy out the owner,

- provide a good return on investment to the buyer, and

- pay for professional management.

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For this reason, two successful small business buyout methods are starting to emerge. Both

address the three main concerns in a small business buyout:

- how will the owner be paid?

- who is going to manage the business when the owner leaves? and

- how will a return on investment be generated?

These two emerging buyout methods are the search fund and the management buyout.

The search fund

The search fund method was developed at Stanford University 50 years

ago. In 2017 the Harvard Business Review published the HBR Guide to

Buying a Small Business: Think Big, Buy Small, Own Your Own Company, by

Richard S. Ruback and Royce Yudkoff, based on a successful course that

Harvard Business School has offered since 2012.

It is useful to understand the framework of the search fund as clearly

demonstrates the inter-relationship between two core drivers of business

buyouts: money and management.

Graduate students, like managers, usually don’t have enough money to pay

for a business. The HBR Guide explains how to organize a group of investors into a search

fund. The search fund finances the students’ search to find, buy and run a small business.

To managers wondering if they have what it takes to be entrepreneurs, the HBR Guide has

this to say:

“You may be more qualified to run a small business than you think…Contrary

to popular myths about entrepreneurs, all of them are generally careful people

rather than reckless risk takers. We hope you see [buying a business] as we

do—as an attractive third path, an exciting alternative to big corporations and

risky start-ups.”

Business buyouts are good investments. The largest business buyout player is the

$2.5 trillion private equity industry. Private equity investors expect to triple their investment

in five years. Business buyouts offer this kind of return and more; it is this kind of return that

makes the small business management buyout feasible.

Private equity investors triple their investment by identifying solid businesses that can grow

in value. The two skill sets that private equity investors rely on to create and manage growth

are financial engineering and operational engineering. Each skill set creates significant

value in different ways. Financial engineering creates value by analyzing and improving

financial statements, and operational engineering by analyzing and improving the work.

Finding someone with both skills is rare.

Financial engineering is the primary skill of investors, and operational engineering is the

primary skill of managers. Private equity investors have money, so they are in a position to

buy the business. But the critical point for managers is that having a lot of money does not

mean an investor can manage the business.

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Excellent management is so important that private equity investors typically offer 20–30% of

the equity of the deal to the management team. In a $200 million buyout, this is a lot of

money. The purpose is to align the interests of the managers with the interests of the

investors. The goal is that the managers will make decisions that will maximize their interest

in the business and by extension the interest of the investors. As they say, when you are

playing with your own money you are a lot more careful.

Investors still like the idea of skin in the game. However, good managers may have young

families, mortgages, and university tuitions to pay. Therefore a practice has emerged to have

the managers pay an amount that is personally significant but affordable. The result is that

managers are often offered a generous price—in the range of 6–12 months’ salary—at which

they can purchase the 20-30% of the shares.

A search fund is structured like a mini-private equity fund. The investors put up the money to

buy the business, and the former student - the searcher - searches for it. After the business

is purchased, the searcher steps into the manager’s role to run it. Search funds using this

formula have proven to be very successful investments.

The success of search funds is directly relevant to managers. Just Google the term and you

will see there is an entire industry built on small business buyouts—a very well funded,

successful, and profitable industry. Not only is the road to business buyouts tried and true,

but that road has extended to small business buyouts. There are no guarantees but we can

say with confidence that a manager using tried and true techniques to build value on top of

a solid small business foundation has a high probability of success. The buyout is not a Hail

Mary pass.

The management buyout

The small business management buyout does not rely on investors. Instead, managers are

taught to rely on their skill in the game. Managers learn leadership and value creation skills

and then create sufficient value so that both the owner and management team are properly

paid.

An interesting difference between the search fund and the management buyout is the

attitude to growth. The HBR Guide says, “Although high growth would seem like a wonderful

characteristic of a business, it comes with high risk. …there are many ways to get in trouble.

High growth requires great management effort.”

By contrast, the small business management buyout relies on growth and great

management effort together. The difference is skill set. The skill set of a search fund is

financial engineering, whereas the skill set of managers is operational engineering. Growth

is less risky if there is a solid business foundation to build on. It is a relatively

straightforward process to create efficiencies and expand on that solid foundation to create

substantial value.

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There is a cultural bias that managers need to deal with. Many business owners view

management buyouts as a form of charity, a gift to help out loyal managers rather than a

real investment opportunity. Owners have often been advised that it makes more sense to

keep earning the profit from the business as they

have always done. Selling the business to

managers on beneficial terms, they are told, is

tantamount to giving the managers the money to

buy the business—a gift. This “gift” idea leads to the

common question, “Why should I let my managers

buy me out with my own money?” The answer is

that this is how the world’s most successful

investors do it.

The HBR Guide provides an example of a real-life

search fund buyout. The business was valued at

$10.25 million. A former student entrepreneur was

given 20% of the annual profit and growth in value

for free, in addition to a $150,000 annual salary.

The investors received 80% of the annual profit and

growth in value in exchange for their $3 million

investment. The total return on the investors $3

million over the 10-year timeframe is expected to

be $26 million. This return is comparable to industry average returns for search funds.

Owners and their advisors have to move past the “my own money” charity/gift idea. In the

right circumstances, giving equity to managers to provide incentives and align ownership

interests is the best business decision an owner can ever make.

The biggest barrier to a management buyout is not capital, financing, or entrepreneurial

experience. The biggest barrier is the same human barrier that arises in every great

endeavor: believing in yourself, believing that you can do it, and finding the confidence to

start.

What Type of Small Business Should You Look For?

In 1986, Michael E. Gerber wrote The E-Myth: Why Most Businesses Don’t Work and What to

Do About It, which became a perennial bestseller. The e-myth (that is, the entrepreneur myth)

is the misconception that businesses are usually started by people with concrete business

skills. But the majority of companies are created by people who have excellent technical skills

in a trade like plumbing or baking, but actually don’t know anything about running a business.

As a result, 80% of businesses fail in the first five years. But many of the remaining 20% are

highly profitable, have a solid foundation, and stay in business for decades.

The fact that there are a million small businesses in Canada with owners near retirement

means there are hundreds of thousands of owners who have spent decades building and

maintaining a solid business foundation. This is significant.

Creating a solid foundation is the most difficult stage of a business. The site has been

excavated, the forms put in, the concrete poured and set. But then what happens? For most

How much value does

an investor add?

If these small businesses are

such good investments that the

best business schools in the

world recommend them to their

students, why not cut out the

investor and have the owner

and the management team take

it to the championship?

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of these owners, the answer is…nothing. They stop building the business at the foundation

stage. Why? Because the business either satisfies their lifestyle needs or their individual

management capacity is tapped out.

Statistics Canada uses these definitions to categorize business sizes:

A small business has 1–99 paid employees.

A medium-sized business has 100–499 paid employees.

A large business has 500 or more paid employees.

All large businesses started as small businesses. The small businesses that grow into large

ones do so because they keep reinvesting in the business, developing functionality in the

core skills of operations, sales, and finance, and the infrastructure required to support

growth. Starbucks always developed functionality for a company three times its size.

Functionality comes from the many management skills that are available to a company that

can afford them.

Each of these management skills has a chief officer, an

executive who is responsible for leading that area. The

core chief officer positions are: chief executive officer

(CEO), chief operating officer (COO), chief marketing officer

(CMO), and chief financial officer (CFO). These executives

ensure that the company has competence in the core

skills of culture, operations, sales, and finance.

Small businesses do not have chief officers. Instead they

have owner-managers. The business will grow to reflect the

strengths of the founder. An engineer will be strong in engineering and likely weak in

marketing. A marketing person may be weak in operations. Solid small businesses are

strong in one area and often completely lacking other functions.

These businesses will grow until they plateau. This plateau does not reflect the marketplace

or the potential of the business; it simply means that the owner cannot or does not want to

grow any further. It is only when the owner wants to exit that the problem becomes

apparent.

The HBR Guide describes the small business opportunity this way:

“…these businesses are often available at prices that are low relative to the

companies’ annual profits. Opportunities like this exist because most owners

of successful smaller firms eventually need to sell them…But few people have

both the ability to raise the required capital and the interest in managing a

small company that are required to buy the business.”

Similarly, few people have both the ability to create value and the interest in managing a

small company. The fact that there are few such people is what creates the opportunity for

those willing to learn. And completing the development of an already successful business

with a solid foundation has to be the least risky business opportunity you can find.

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The very fact that a business has a solid foundation and is small is a significant indicator

that a value creation plan will work. This is the driver behind the value skills proposition:

develop leadership skills and a well-rounded value creation skill set so that you as the

manager can develop the business to its next stage.

Leadership

Leadership Is a Choice

The power to make choices is our greatest strength. The reason that command-control

management does not effectively create value is that it limits the power of choice. The

leaders make decisions, and everyone else follows orders. Perceiving yourself as an order-

taker without the power to choose ends innovation and engagement.

In your business life, the most important choice you have is the choice of leadership.

Choosing to be a leader is a choice of perception that opens the door to buying out the

business. This choice is not merely for the manager. A wise owner encourages leadership

development because it helps build value and allows the owner to exit the business when

the time comes.

A common question merger & acquisition experts ask is whether the owner could take a

three-month vacation. An owner who cannot take three months off has not successfully

delegated leadership. It is one thing to delegate tasks and assignments. It is an entirely

different thing to delegate the leadership of the business itself.

Paul Pittman of The Human Well describes it this way: “Small business owners in a rush to

grow often hire people who will do as they are told to keep the momentum going. If an owner

is concerned with the future of her workforce, her legacy, and her community; management

capability is an important consideration.”

In the same way that a manager can learn leadership skills, an owner can learn to delegate

leadership. If the owner is not going to delegate management responsibility and control,

then a management buyout will not create value.

Effective leadership is the most valuable skill of all. Leadership is why a CEO is paid 300

times as much as a salaried worker. Leadership is why private equity investors incentivize

management teams with 20–30% of the deal. Leaders create value. Good leaders develop

the business and take it to new heights.

A leader must be comfortable with ambiguity. Following orders means you get to live in your

silo; you don’t have to look around and see the ambiguous. Leading means climbing out of

your silo and going to the front of the wagon train. You have to walk into places you have

never been before and decide which way to go.

Leaders thrive in ambiguity because that is where opportunity resides. Exercising the power

of choice creates ambiguity. The willingness to make mistakes, to fail fast, to learn, and to

change course are the hallmarks of leadership. Leaders look for signals in the noise. They

pay attention to their intuition and try to understand what it is telling them.

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Having a high change tolerance is essential if you are to buy and lead a business. We live in

an increasingly kaleidoscopic landscape. By contrast, in the dark ages virtually nothing

changed for 400 years. With the exponential rate of change described by Moore’s law, every

aspect of business is constantly morphing. The best way to cope with change is to build a

continuous learning, continuous improvement culture.

Courage is important. We live in the world. We must accept reality as it is. Danger is real but

fear is not. As Paul Assaiante the winningest coach in US college history says:

We create, on a subliminal level, scary monsters in our minds. If you address them,

they go away. If we can encourage young people to run to the roar, to deal with the

monsters, they’ll learn how to take care of their own problems.

The courageous person is the one who feels fear like everyone else but pushes through in

spite of it. We are not talking about superpowers; the courage of a first responder arriving on

the scene is sufficient.

As many people in many fields have said, hope is not a strategy. Waiting for someone else to

take the initiative is an abandonment of your leadership responsibilities. It is the job of the

leader to set the direction, to create the purpose, and to develop the culture and habits

needed to accomplish the mission.

Leaders have growth mindsets, not fixed mindsets. If you have a fixed mindset you are

voluntarily shutting down your capacity for choice. A growth mindset means you are open to

possibilities and possibility presents choice.

Transitioning to Leadership

Leadership is a skill, and all skills can be learned. Some managers will rise to be superstars,

but leadership is a skill that ordinary people have been learning for thousands of years.

Most major universities offer online courses and executive education programs to help you

learn leadership. New books about leadership are published every day.

Books are not the only way to learn. People learn through music, language, and movement.

A small business owner I will call Tony graduated college, completed his apprenticeship, and

then started a business manufacturing industrial equipment. Tony did not like to read;

instead, he learned at the bar. Every night he would go out and start conversations. Over the

years he made all kinds of connections and learned all kinds of things, from politics, to law,

to finance, plus an amazing amount of intel about his own industry.

The most important learning is learning from work itself. You must learn to study the

workflow and continuously improve it. The larger goal of leadership is to develop a

continuous learning, continuous improvement culture in the business.

Before Henry Ford introduced mass production to the auto industry, automobile production

was a cottage industry of skilled craftsmen. All parts were made by eye, and each

automobile was handcrafted. In between the creation of the parts and the assembly of the

automobile was an additional level of workers whose job was to re-craft each part so that it

connected properly to the next part. The first automobile owners were wealthy people who

hired drivers also skilled in automobile repair and maintenance.

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Most small businesses function as craft businesses. They pride themselves on selecting

highly skilled workers and worry about their intellectual property walking out the door at

night. The retirement of a skilled artisan is a real loss to the company.

Bringing new hires up to speed takes years in such a business, and skill level is all over the

map. Top performers evolve into the role of chief problem-solver and spend their time

firefighting. No one has time for training, which is seen as a low-value activity, not worthy of

serious consideration. This is a seriously costly error.

Training is the hallmark of excellence. Transitioning to leadership is in many ways based on

training and the learning it takes to train. A leader’s job is not to produce billable hours or to

make products. A leader’s job is to improve the process of producing billable hours or

making products—to create standard work. We will examine the idea of standard work in

depth in the Operations section.

Transitioning to leadership means that you must also develop a clear understanding of

strategy. Leaders are responsible for business strategy. The term strategy is confusing

because it is open-ended and there are seemingly endless books and articles on different

business strategies. But a strategy is simply a way of organizing activity.

The purpose of organizing business activity is to create value. The following is from the

excellent book Lean Turnaround by Art Bryne:

“Improving the way value is added in your company is the most

strategic thing you can do…improving all your processes will

profoundly boost your ability to execute on what you now consider to

be ‘strategic’ initiatives.”

The value creation skills relate to culture, operations, sales, and finance.

This white paper explains how these skills reinforce one another. In the

following sections, we’ll expand on each of the four value creation skill areas

as a beginning of your continuous learning, continuous improvement

journey. What you do and how far you go from here is up to you.

Now let’s dig into culture.

Culture

What Is Culture?

Culture is simply the rules by which a group operates.

Creating and maintaining the right culture is the responsibility of business leaders. A leader

sets the rules of the game, in this case, the game of how workers interact with one another

and with customers. A leader must choose to learn to build culture. Understanding that you

can build culture is a crucial initial step in developing leadership skills.

This first step gives a leader the confidence to then learn how to build a culture. Building

culture requires a leader to focus on the underlying principles of the business and on the

behaviors that need to become habits in the culture.

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An example of a simple team culture is the house league soccer team. The leader is the

coach. A coach has a lot of discretion in setting the rules, but most house league coaches do

not work out a solid, standardized set of rules for the team.

House league coaching is a part-time volunteer position. There is no time to develop a

training program. Generally, practices are haphazard and undisciplined. Players do their own

thing without being aware of standards or goals for the team.

Most businesses operate like house league soccer teams; there is no organized culture.

Leadership is a part-time activity that’s an unwelcome addition to a hectic “real” job. Most

employees are left alone to drift - to sink or swim - without standards or training. As a result,

they train themselves as best they can and develop silos based on their interpretation of

what the customer wants.

Here’s the true story (names changed) of a house league team that bucked that trend. Bob

Johnson was a high school teacher who coached his son’s soccer team. Bob had a plan. The

team started at the U-10 house league level. By the ninth year, the team was playing at the

highest provincial level, a level that included the professionally coached Toronto FC junior

team. That year Bob’s team won the Ontario U-18 championship and a week later beat the

Quebec champions, a feat never before accomplished by a team from Bob’s town.

Bob had spent the first two years with the team working on defense. The defense got so

tight that very few opposing players could get through. On offense, Bob’s team scored the

usual two or three goals per game. The differentiator was defense: the team’s opponents

could score only one or two goals per game. Against Bob’s team, that was not enough.

There’s a lot to learn here. First, Bob is a teacher, so training, lesson plans, and game plans

were second nature to him. But they are basic steps that create a winning culture. Second,

Bob had a simple but effective strategy: have the strongest defense. An excellent strategy is

simple, easy to understand, and easy to communicate.

Bob’s story reinforces the foundational point for managers that success is based on simple,

tried and true methods. There is no silver bullet. Looking for a sophisticated strategy is a

waste of time. Any manager in any business can use straightforward methods to engage the

work team and create value.

A Dramatic Example of Culture Change

Let’s look at an example of the differences that culture can make in business outcomes.

Gallup surveys demonstrate that the number one factor, worldwide, for employee

engagement is trust. Trust is an important element of respect. Trust and respect are the

most timeless of all value creation ideas. They are the theme of every story of every hero

since the stories were first told.

When you genuinely respect and care for people they will want to play on your team. If the

rules of the game are fair and it is fun to play then they will engage. The outcome will be

much different if people believe you will take advantage of them if you get the opportunity.

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A business system that puts respect for people first is Lean thinking. Lean thinking was first

developed by Toyota. Contrary to popular belief Lean is not a manufacturing solution. It is a

collection of the best ideas about the best way to engage teams in organized activity.

The underlying principles are respect for people and continuous improvement. A core idea is

that problems in the workplace emerge primarily from the system, not from the people.

Respect for people means that you work to continuously improve the system of work. When

you apply these two principles to every decision made by everyone in the business, over

many years, you see dramatic results.

A dramatic example of culture change occurred when Toyota took over management of the

General Motors plant in Fremont, California, in 1984. This massive facility, the worst-

performing GM plant in North America, had been shut down in 1982. Before the shutdown,

the underlying principles of the GM company and union culture were hard bargaining and

taking advantage in every way you could. GM and the unions

were at war. The line never stopped even if an employee fell

into the pit under the moving machinery line above. If you

stopped the line you were fired.

In response to this lack of respect, the workers would

sabotage vehicles, putting pop bottles in door panels to rattle,

thinking this was clever. There was a backlog of 5,000

grievances and a special staff cleaned the parking lot of liquor

bottles and drug paraphernalia after each shift change.

Criminal activity was rampant. In a discussion about the Fremont plant, Jeffrey Liker, author

of The Toyota Way, likened the conditions to those of prison culture, saying,

“…the workers could not find anything close to that level of job, and pay, and

benefits, at their level of education and skill. So they were trapped there. And

they also felt like, we have a job for life, and the union will always protect us.

So we’re stuck here, and it’s long term, and then all these illegal things crop

up so we can entertain ourselves while we’re stuck here.”

GM shut it down.

Two years after the shutdown Toyota started preparations to re-open the plant. 85% of the

previous union workforce was rehired. Many workers were sent to Japan to learn the Toyota

production system. None of them had been in an environment of respect for people. They

were deeply affected by the experiences they had and the people they met. After cheery

rounds of karaoke and sake, many of the union workers dressed in kimonos for photos and

a teary goodbye before flying back to the States.

Rick Madrid was an assembly line worker who trained in Japan. In Japan he saw workers

stop the assembly line to fix a bolt. “That impressed me,” he said. “I said, ‘Gee that makes

sense.’ Fix it now so you don’t have to go through all this stuff. That’s when it dawned on me.

We can do it. One bolt. One bolt changed my attitude.”

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Toyota began production in 1985. Matthew May’s book The Elegant Solution describes how

by the end of the following year, the NUMMI plant had the best quality and productivity of

any GM plant. Workers built cars in half the time it used to take. Defects fell from 12 to 1

per vehicle. Worker engagement and satisfaction surged and absenteeism reached a low

3%. Operational innovation blossomed, employee participation passed 90%, and close to

10,000 employee suggestions were put into action. These were the same people, in the

same union, using the same equipment, but the results were wildly different. And this was

achieved in less than two years.

Seven Drivers of Employee Engagement

It is important for managers not to view stories like NUMMI as anomalies never to be

repeated. You need look no further than Dilbert or Homer Simpson to appreciate how

pervasive the awful workplace is. At the same time there are also thousands of companies

that are Great Places to Work.

You can build a great workplace. The book Carrots and Sticks Don’t Work: Build a Culture of

Employee Engagement with the Principles of RESPECT prescribes an ideal workout regime

for you to follow in building the skills and habits that create great places to work.

Author Paul Marciano has a PhD in psychology from Yale. He has worked as a teacher,

therapist, group fitness instructor, and entrepreneur. Paul’s description of engaged

employees perfectly describes the attributes needed for a small business management

buyout:

“…they act as though they have ownership in the business. Like the small

business owner, such workers do whatever needs to be done, regardless of

their job title. They think about what they are doing and in the process come

up with remarkable ideas to improve your business and satisfy your

customers. They respectfully challenge you and their team members when

they disagree.”

What makes Paul’s RESPECT Model and his book so useful are his definitions of the seven

critical drivers he has identified that influence an employee’s internal assessment of respect

and subsequent level of engagement. These seven drivers are the underlying principles of a

respectful culture. Paul’s experience as a group fitness instructor over the

past 20 years has provided him with a mini-laboratory to test his ideas of

engagement and motivation.

One of the seven drivers of respect that Paul writes about is expectations.

Many workplaces have no clear expectations. Paul explains that clear

expectations must be communicated. Without clear expectations employees

are not sure what they should be doing. There is no way to measure what is

being done and no realistic way to provide incentives.

Trust is another driver. Paul describes trust as “a building block for all other drivers.”

Many managers learning leadership skills are confused about the right tone to set. They

wonder, “Am I being too harsh? Too soft?” This is normal. Respect resolves all those doubts

and provides a firm footing. The simple rule is to always be honest and respectful.

14

Respectful is always the right tone—not harsh, not soft. Learning and practicing the seven

drivers of respect will have a significant impact on your cultural outcomes and greatly assist

you in developing a great workplace.

Operations

The Most Successful Small Business in the World

But respect by itself is insufficient. A true high-performance culture can flourish only in an

operationally excellent environment. It is difficult to be engaged if operations suck. You

would be surprised if you showed up at an NFL practice and there was no trainer and no

practice schedule.

The McDonald brothers were lifestyle entrepreneurs. They ran off to Hollywood to become

movie producers. As with many Hollywood dreamers they worked in restaurants to pay the

bills. In 1940 they opened a slow-cook BBQ restaurant. They discovered that “the more we

hammered away at BBQ, the more hamburgers we sold.”

Being bright, artistic fellows interested in a big production, the brothers closed their doors

for three months. Drawing inspiration from Henry Ford’s mass production methods, they

simplified their menu and developed standard work for each step of hamburger assembly.

“Our whole concept was based on speed, lower prices and volume,” Richard McDonald said

about the new “Speedee Service System” they developed. Each of the 12-person crew

specialized in one aspect of the work.

The McDonald brothers built one of the most solid business foundations the world has ever

seen. Content with their accomplishment, they sat back to enjoy the fruits of their labor.

They were not interested in taking McDonald’s to the big leagues.

Ray Kroc recognized the elegant simplicity of the

Speedee Service System. Ray made a deal with the

McDonald brothers to become their franchise

agent. He set out to develop the ideal small

business, building on the foundation of the

Speedee Service System to develop a complete

business format that he then sold as a turn-key

franchise package.

At the time, most roadside restaurants were dingy

affairs. Ray developed the underlying principles of

quality, service, and cleanliness, or QSC, which

became the industry standard for restaurant franchises.

Ray also developed an extremely detailed operations manual. There’s a good description of

operations manuals here.

A critical aspect of a new business is how it opens and how it operates in its first few

months. Project managing the opening of a new McDonald’s outlet and managing its service

15

offering became as straightforward as it is possible for a business to be, resulting in a new-

franchise failure rate of less than 5%.

You see, Ray Kroc was not in the hamburger business. Ray sold small businesses to people

who did not want to fail. McDonald’s was not successful because it sold hamburgers;

millions of other restaurants sold hamburgers. McDonald’s was successful because it built a

complete business format on top of the Speedee Service System. Ray’s simple sales line

was:

“McDonald’s is the most successful small business in the world”

As a small business leader, it’s helpful to think like Ray Kroc. Find a solid business

foundation and develop a business format with a well-written operations manual. Develop

the most successful small businesses in the world, doing whatever it is you do.

Standard Work

The way you develop your operations manual, and with it, operational excellence is to

develop standard work. The operations manual is simply a record of the standard work you

develop. This is a definition of standard work given in the ISixSigma.com dictionary:

“Standard work breaks down the work into elements, which are sequenced,

organized and repeatedly followed. Each step in the process should be

defined and must be performed repeatedly in the same manner. Any

variations in the process will most likely increase cycle time and cause quality

issues. It typically describes how a process should consistently be executed

and documents current ‘best practices.’ It provides a baseline from which a

better approach can be developed, allowing continuous improvement

methods to leverage learning.”

This is the technical definition. The reality is no different than Bob Johnson showing up to

soccer practice with all the right equipment and a detailed breakdown of the two-hour

practice session into five-minute increments based on specific skill development.

The purpose of business is to create value. Value is created by work. How we work

determines success or failure. The purpose of leadership is to improve the quality of the

work. Standardizing work means collaborating on, understanding, agreeing on, and

documenting the highest quality of work known at the time.

Focusing on three practices helps develop standard work:

Division of labor

Interchangeable parts

Best practices

In craft-based production, artisans produce unique products from start to finish. These

products can be artistic and beautiful but the price is lower productivity. In 1913 Daimler

had 5,000 employees producing 1,000 cars a year. By using mass production methods,

within 10 years Ford was producing 10,000 Model T’s per day.

16

Division of labor means that work is divided into a sequence of tasks. Each task is assigned

to a worker who specializes in that task and becomes efficient doing it. Creating

interchangeable parts means that regardless of who does the work it can be used by anyone

else at any stage of production, be it a car part, or a patient intake form. These are simple

ideas but results are extreme when compared to everyone doing evertything their own way.

Best practices means that if 50 workers perform a task, one of them will do it the best. We

want to find that best way and train everyone else to do it that way. This best way then

becomes the standard work until we again find a better way. This is continuous

improvement.

The opposite of standard work is variation. Variation means all the workers are in their silos

doing their own thing. Studies have shown it is common to have a variance of up to 800% in

processing times between the fastest and slowest clerks in a large data entry department.

But this variance is not a people problem, it is a systems problem. It is a symptom caused by

a lack of standard work. Standard work eliminates variance and pulls everyone up to the

best standard.

If workers do not respect the leader, they will not agree to the standard work and the

workplace will revert to silo-based variation. Standard work is developed through

collaboration and consensus. It is a bottom-up system where the worker doing the work is

considered one of the most reliable sources of information and advice.

Standard work improves the seven drivers of respect that we discussed above. It allows you

to set expectations, provide recognition, give supportive feedback, and develop

empowerment and partnering, and it makes it easier to trust in the system.

One unfounded criticism of standard work is that it destroys creativity. The reality is that

many of the most creative, gifted artists in history continuously practice and strive to

improve the standard work of their practice regime. Standard work is not designed to make

people into machines; it is designed to create habits that eliminate wasteful thinking about

routine issues and create a powerful framework for flow and creativity.

Standard work ensures the best incentives. This is because we know what proper

performance is. Standard work also allows us to train people for proper performance and

reward them when they do it.

Lastly and most importantly standard work allows continuous improvement. You cannot

improve continuously of you do not know what you are improving. This means you have to

create an introductory version of the standard work and continuously improve that standard.

Sales

Commercial Teaching

A high-performance culture with standard work creates scalability and puts you in a position

to take the business to the next level. Listening to the voice of the customer and

understanding commercial teaching and the buyer’s journey allows you to communicate

your success story and create growth.

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It is common in small business to sell on a “cost-plus” basis, but this is not how customers

buy. Customers do not care what your cost is; customers care about value. Customers care

about a solution to their problem. They do not want a drill; they want a hole. Understanding

what the customer wants to achieve, what the customer values, is the basis of price.

“Selling” on a cost-plus basis is not really selling, it’s order-taking: “Here is a drill, here is our

price, take it or leave it.” This is not an informed way of dealing with a customer. If you do

not make an effort to understand what the customer values, if you simply push product, you

can never be informed. Understanding the customer and the solutions they are seeking

differentiates sales from order-taking.

Customer value is why you are in business. Focus on producing customer value, not just on

cost. The purpose of sales—as a skill—is to focus on customer value. Sales creates a layer of

value that can never be achieved in the cost-plus environment. Sales is an informed process

of discovering the solution the customer wants, including what they want to pay, and pricing

according to the customer’s gauge of the value of the solution.

Sales is communication with a purpose. The most engaging communication is teaching a

customer something helpful. But teaching can be a trap. If you simply alert a customer to an

opportunity, they will say thank you and then shop around for the best deal. Commercial

teaching solves this problem.

Commercial teaching is a sophisticated six-step process laid out in the book The Challenger

Sale: Taking Control of the Customer Conversation by Matthew Dixon and Brent Adamson.

The book is based on exhaustive research and turns up many helpful perspectives. It is no

surprise that in an “information everywhere, all the time” world, the selling process has

drastically changed.

Commercial teaching is designed for complex solution selling. Commercial

teaching alerts customers to problems they were not aware of or solutions

they had not considered. The strategic value is that the solution you offer

is unique. The commercial aspect is that you’re teaching the customer

about a solution they cannot get elsewhere.

To find a commercial teaching opportunity you must answer the question,

“Why should our customers buy from us over anyone else?” This can be a

difficult question, but it is one that can create a unique, high-value,

profitable business.

A famous value-added story comes from Grainger Industrial Supply. Grainger is a

maintenance, repair, and operations (MRO) supplier offering 1.6 million industrial products

from abrasives to welding equipment. All of these products were commodity items, meaning

customers could purchase the same or similar products anywhere. It is very difficult to

convince a customer that one hammer is better than another. Therefore the differentiator

ends up being price. So customers had no loyalty to Grainger. Each year customers would

come back for quotations. But customers are fickle and may jump to a new supplier over a

15¢ difference in a product price.

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Grainger wanted to break free from the slow death from the 15¢ price reduction on the $12

hammer. Grainger needed a way to show that a hammer could be worth an extra 15¢. To do

this Grainger had to position itself as a strategic business partner instead of a supplier of

commodities.

The problem Grainger identified was that most customers, even customers spending tens of

millions of dollars a year, did not view MRO purchasing as a strategic issue. MRO purchasing

was boring. The only criteria that MRO purchasers considered was the price. If an item was

out of stock, they would just call and order more without connecting the cost of ordering.

Grainger wanted to reframe the customer’s view and demonstrate that MRO purchasing also

had a value-added strategic aspect. Grainger conducted an extensive analysis of MRO

purchasing. Using customer data and tracking purchasing patterns, Grainger was able to

demonstrate that

- 60% of MRO purchasing was planned, and

- 40% of MRO purchasing was random.

A random purchase is any unplanned purchase that is postponed until the item is out of

stock. Some Grainger customers purchased millions of MRO items every year. 40% random

purchasing meant millions of unplanned purchases.

Grainger worked diligently and was able to develop convincing evidence that a random

purchase actually cost, on average, $117 more than a planned purchase. This $117 was a

result of many factors, including delay of work, requisitioning, freight and delivery, and other

costs.

Grainger came up with a particularly effective chart called the “pain chain.” In the pain

chain, the customer spends $117 and comes up with nothing: An employee notices

something that is out of stock, gets their manager to put a requisition in, and the purchasing

department goes to work. The telephone calls go like this:

Supplier 1: “It’s out of stock.”

Supplier 2: “We can’t find the product.”

Supplier 3: “We don’t carry it.”

Supplier 4: “We have it!” But they delivered a broken product, now obsolete.

The end.

Grainger developed an MRO solution for its customers that only Grainger could provide

based on its worldwide capacity and deep product line. Grainger would manage the MRO

process and pass the savings along to the customer. The conversation was no longer about

saving 15¢ on a hammer but about how much the customer could save by paying a little

more for a hammer.

It is not necessary to be a worldwide distributor to benefit from value-added solutions. It is

simply necessary to answer the question, “Why should our customers buy from us?”

Thinking about how your business can provide a unique value is very helpful. It takes your

focus off the relentless price grind and fixes it squarely on value.

19

Voice of the Customer

Value is in the eye of the beholder. The customer decides what value is. Properly cultivated,

the voice of the customer can be a powerful ally in your quest to identify value. There are

some ways to tap into this powerful stream; all of them involve listening, observing, and

asking questions.

As simple as listening seems, most employees are never asked to listen. How many times

have you asked for an item in a store and been told, simply, “We don’t carry that”? What

happens? Have you ever heard, “Great suggestion—I will pass it to our customer service

department”? This almost never happens. These customer-driven suggestions are uniformly

ignored. Why is that?

You are the customer. You walked into a place of business expecting them to offer what you

wanted to buy. In your mind you made a connection between their business and a product or

service you want and thought it might offer. This is valuable information.

We think of value in simplistic terms. We are thinking of point-of-sale value, standing at the

cash register looking at the price tag. But the point of sale is only part of the value story.

Value is intimately tied to the customer experience.

Tesla spends nothing on advertising: “Where I put all the money into and all the attention

into is trying to make the product as compelling as possible,” Elon Musk says. “The key to

selling a product is having something people love and will talk about…If you

love it, you’re going to talk and that generates word of mouth.” The question

then is, how do we find out what customers love in the products or services

that we offer?

Ernan Roman, author of Voice-of-the-Customer Marketing, has developed a

listening process based on highly structured one-hour interviews with

customers. Experience has shown that eight one-hour interviews gives a

fulsome picture of customer perceptions of value.

The key to lining up the eight interviews is the customer’s trust in the integrity of the

business and their trust that they will be heard and have a beneficial impact. The interviews

start with a list of prepared questions but the interviewers are trained to follow leads that

can extract more meaning.

These interviews deliver important benefits. Left to guess companies mistake customer

signals. An inactive customer might not actually have left, but instead simply changed their

buying patterns. Understanding the new pattern can open a door to opportunities. In-depth

interviews can prove that prevailing assumptions are off base. Most importantly, interviews

can identify powerful strategies for strengthening relationships by adding extra levels of

value and benefits that customers love—and are willing to pay for.

Standard Work in Sales

Sell, Learn, Repeat by Craig Ballard is a short book that sets out a straightforward process

for organizing the standard work of a sales force.

20

The hallmark of a good sales process is that it is measurable. Craig says, “If you have

salespeople and you can’t show me a report within 3 minutes of exactly what

they all did last month and exactly how it benefited your organization, then

you can’t measure what you are doing.” As discussed earlier, measuring is the

only way you can improve. “There is nothing more important to your sales

growth than the discipline of constant measurement...”

Craig argues that the traditional sales manager role no longer exists. The

most important sales role belongs to a person with no traditional sales skills:

the sales measurement leader. A sales management leader will cost less than a traditional

sales manager and provide better results to your organization.

The most practical takeaway from the book is Craig’s seven-step sales process:

1. Map

2. Target

3. Engage

4. Propose

5. Close

6. Adapt

7. …and Repeat

Finance

Financial Statements Are the Problem

Value creation is about designing an operationally excellent business that can scale up and

grow. The next building skill is finance. Financial skills allow you to acquire new facilities,

new product lines, and other businesses. These add-ons create the infrastructure for new

operations and new growth. In short, effective use of finance skills allows you to replicate

and expand the business foundation quickly.

Accounting information is an important aspect of proper business function. Learning the

right financial skills allows leaders to control the business better and add infrastructure to

the existing solid business foundation to allow further growth.

But most small business owners are not familiar with the benefits of financial knowledge.

This is because of the way finance skills are taught. The focus of MBA programs has been on

finance as a high-paying, big-business career. Most of the skills taught in such programs are

of limited practical use in a small business.

Most successful small business owners started their business because they had a

marketable skill like engineering or cooking. These businesses are bootstrapped, meaning

they are started with small amounts of personal savings and assistance from family and

friends. From there the business grows based on the owner’s skills and stops at a level the

owner is comfortable with.

Finance is a specialty discipline that is different from accounting. Accounting is about

recording the daily flow of money in and out of the business.

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Finance is forward-looking. Finance uses accounting information but also considers a much

wider range of information. Finance considers the costs and the uses of money, and the

acquisition of strategic assets for growth.

Most owners and managers do not understand financial statements. This is such a large

problem that up to one-third of managers return to school to get an MBA so they can learn to

do this. This is waste. There is no need to spend years learning about financial statements.

It is the financial statements themselves that are the problem. Financial statements are

designed for external users like banks and shareholders. But the principles used to ensure

the consistency and reliability of financial reporting have little relevance to the day-to-day

management of the business.

The solution to this problem is that your accountant has to move from

“bean counter to business partner.” This phrase comes from the classic

text Real Numbers by Jean E. Cunningham and Orest J. Fiume, which

describes a discipline called Lean accounting designed to make

accounting information accessible and useful in the business.

Accountants most often work in their own silos as skilled artisans. But

accounting and finance are not separate from the business. Accounting

and finance are integral to the business and need to be part of the

standard work of the business.

The primary benefit of accounting information is feedback, a continuous flow of reporting on

what is happening in the business. Picture any bustling workplace full of moving people and

equipment. It could be a tool shop, a law firm, or a coffee shop. Now reframe this moving

picture and see that it is also a picture of moving financial activity. Every task, every job,

every piece of material or paper has a cost attached to it. What are you seeing? Can you

visualize the cost meter of your business in the same way a Fitbit tracks your heart rate?

Luis Socconini, founder and director of the Lean Six Sigma Institute, told Industry Week that

the primary benefit of Lean accounting is this: “A company is able to know what is the real

cost and with this knowledge, they…are able to define correct prices for their products or

services, decide which products or services are contributing profits and which of them are

losers, [and] prepare quotes with realistic information…”

This moving financial picture plays out in the form of simple metrics that measure both

financial and non-financial information. These metrics should be posted for all to see. They

are unique to each business and arise out of the standard work of the business.

Accountants are already familiar with financial metrics and are able to assist in devising

meaningful financial metrics. Operational metrics can be developed by the teams doing the

work. These metrics will give a real tempo to your operations. Now let’s consider some financing basics.

22

Debt and Equity Financing

Debt financing

Leveraging is the strategy of using borrowed money. The essence of entrepreneurship is to

identify business opportunities. When you are borrowing, the classic business formula of buy

low, sell high becomes borrow low, invest high. This is what banks do. They take deposits

and then lend out the money at a higher interest rate than they pay on the deposits, creating

a “spread.” Spread creates value.

The traditional view was that “he who has the gold makes the rules.” This was true for

millennia, but today there are trillions of excess dollars floating in the system. Capital itself

has become a commodity and interest rates reflect that. The formula is changing to

“whoever can create the gold makes the rules.” This change reflects a desire by regulators

to encourage wealth creation through productivity gains rather than paper gains.

In spite of regulators’ desire to increase productivity, traditional bankers can be quite hostile

to growth. Bankers see high growth as highly risky. Fortunately, there is a very large industry

of private lenders who understand business risks and are looking for quality businesses to

invest in.

Businesses can leverage from a variety of sources, such as investors, private equity,

strategic partners (e.g., vendors or customers), family offices, or banks. A wide array of

commercial terms are available: short term, long term, secured, unsecured, guaranteed, not

guaranteed, mezzanine, multi-tranche, special purpose vehicle borrowing, etc.

The disadvantages of borrowing include the obligation to repay the loan, restrictive

covenants, burdens on prospective cash flow, and insolvency risk. An increasingly viable

option for Canadian businesses is U.S. private debt lenders. Because of the vast amount of

money available in the U.S. and the relatively limited number of transactions, many of these

financial institutions are looking for opportunities outside the U.S.

Many business owners think a few big banks control the lending in Canada. This isn’t so,

there is an opaque lending market with 140+ lenders in Canada. Opaque means very little

information is publicly available on rates, terms, etc. so it is useful to work with an

experienced investment banker to learn about your options and negotiate the best terms.

Equity investments

Private investors are also interested in acquiring equity investments in good-quality

businesses. Small business owners and their advisors often consider 100% ownership and

complete control as crown jewels to be protected at all costs. But this is literally a small-

minded belief.

Harvard studies have shown a direct correlation between the amount of equity and control

that start-up founders give up and the business’s ultimate value. None of the founders of

the top five companies of all time—Apple, Amazon, Microsoft, Google, and Facebook—have

even 20% of the equity (the highest being 17% as of 2018) and most do not have control.

The reality is that equity and control are currency you can use intelligently to acquire talent

and other critical value-creating resources.

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Private investors will consider both minority and majority investments. Minority investors

tend to be passive partners who can help the business to grow and are looking for superior

returns. Many private equity firms are looking for profitable companies with owners who

want to use capital to create value. The private equity firm provides the liquidity. The owners

continue to operate the company. Warren Buffett explained in 1996 why investors should

consider “minority positions in wonderful businesses…you simply want to acquire, at a

sensible price, a business with excellent economics and able, honest management.

Thereafter, you need only monitor whether these qualities are being preserved.”

Assuming your business has excellent economics and able, honest management you can

attract this kind of investor, whether the owner would like to take money out of the business

as part of a buyout or to capture a larger opportunity, such as buying another business.

There is big demand among investors for this kind of investment, so you can be choosy and

find the right partner.

We now know why an investor would take a minority stake, but why would the owner and

management team give up a majority of the equity and hand control over to a private equity

firm?

The primary reason is that you have seen a big opportunity that requires a lot of capital to

chase. Assuming you have excellent economics and able, honest management plus an

intelligent, collaborative private equity firm, you can do very well.

The classic private equity investment has a five-year holding period with a 300% increase in

the value of the investment. Private equity investors are masters of leveraging the balance

sheets of the businesses they acquire.

Private equity can be demanding and some owners do not have the energy to work the extra

hours to meet the demands such an investor may make. But if the owner has properly

delegated the responsibility of running the business to the management team, then the

management team can do the hard work to build the value required by the private equity

investor. Many managers welcome an opportunity to work hard for five years to get a large

payout.

Sometimes the owner wants out and the management team wants to finance a large

management buyout. Dan Lioutas, Managing Director of Transactions for Grant Thornton

LLP, explains how they arrange financing for a management buyout:

“What we do is map out a five-year plan, including financial projections, like a

private equity firm would. Then we look at all the financing options, starting

with the least expensive forms of financing (i.e., senior debt) and moving

progressively to costlier sources until enough financing can be secured to

complete the transaction. The reason to look at a private equity control

investment is they usually have a more sophisticated understanding of the

capital structure than managers do, and strong relationships with lenders. The

banks tend to be very aggressive on deals where a private equity investor is

involved.”

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Small Business Management Buyout Example

A management buyout is a sound business decision for an owner. This section gives an

example of the excellent economics of a small business management buyout.

As shown earlier, the HBR Guide offers an example of the return on investment based on a

real search fund case. In that case the business was worth a little more than $10 million,

the searcher was able to obtain bank financing of $7.5 million, and the investors put up

$3 million. After 10 years the investors expect to receive $26 million for their investment.

For financing in Canada there are a number of lenders active in the MBO market. These

lenders will finance up to 70% of the purchase price. The remaining 30% can come equally

from the owner providing 15% financing and the managers coming up with 15%. When you

press and ask what happens if the management cannot afford 15% up-front the lending

people squirm a bit and then say “we look at all aspects of the deal and if a situation makes

sense we will proceed.”

There are no rules for how a management buyout must be structured and every situation is

different. For our management buyout example we will use a company value similar to the

starting value used in the HBR Guide. In this example the two managers will purchase 50%

of the shares up front in Year 1.

These are the facts:

The owner is selling the business for $10 million.

The business generates a yearly distributable profit of $2.5 million (this is the profit

level used in the HBR Guide based on a real-life example. A management buyout will

work with much lower profit numbers if the business foundation is solid, See the

second example below).

This means that $1.25 million is available to be distributed to the owner and $1.25

million is available to be distributed to the managers,

The managers buying the business borrow $5 million guaranteed by the business.

The owner is paid $5 million (for 50% of the shares) on closing in Year 1.

The managers now own 50% of the shares and the original owner retains 50%.

The managers make interest and loan payments out of their share of the profits.

Managers receive the same salaries as before the transaction, and run the business

for 10 years.

With the value creation plan, the business is assumed to grow at 15% per year.

To make it simple we assume that any necessary investment in the business comes

from freed up capacity due to operational efficiency.

The table below shows an annual dividend amount of $1.25 million growing by 15% per

year. This is the amount that is available to the owner and management team is:

25

Year-end 50% of profit,

growing at 15%

per year

Cumulative

0 1,250,000 —

1 1,437,500 1,437,500

2 1,653,125 3,090,625

3 1,901,093 4,991,718

4 2,186,257 7,177,975

5 2,514,196 9,692,171

6 2,891,325 12,583,496

7 3,323,024 15,906,520

8 3,823,779 19,730,299

9 4,397,393 24,127,692

10 5,057,001 29,184,693

This means the owner may receive the following:

Year 0 Closing date for first 50% of shares $5 million

Years 1–9 Dividends $29 million

Year 10 Closing date for second 50% of shares $20–50 million

The range of price for the second 50% of shares depends on the multiple. The range of

multiple used is 4x–10x. The “multiple” is based on the quality of the business. The point of

a value creation exercise is to increase the quality of the business, thereby increasing the

multiple. There is a good explanation of multiple here.

For our second example we consider a much smaller business with EBITDA of $250,000. In

this example the owner may receive the following:

Year 0 Closing date for first 50% of shares $0,5 million

Years 1–9 Dividends $2.9 million

Year 10 Closing date for second 50% of shares $2.0–3.0 million

This will provide a secure retirement for most owners.

Conclusion

Value creation is a very powerful tool. When you develop a scalable, operationally excellent

business that you know how to finance you are ready for the big leagues.

The best strategy is simple: Keep it simple. Learn leadership. Be respectful. Continuously

improve, create standard work, then apply sales skills to build the flow, and finance skills to

monitor the work. Then replicate the operations. That’s it.

If you would to find out how management buyout coaching can help, please let me know.

Good luck.

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Culture

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Catmull, Ed; Wallace, Amy. Creativity, Inc.: Overcoming the Unseen Forces That Stand in the Way of True

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