Exit Planning: Which Way Out?
Posted Apr 28, 2011 in Management
Seven million U.S. business owners will retire from their businesses over the next 20 years as post WWII and baby boomer generations approach retirement. Joining those millions will be many members of our community, about half of whom are now 55 years or older. Here, LMT offers advice on how to enhance the value of your laboratory in the eyes of a buyer, strategies for the solo and small laboratory owner, and real-life stories of lab owners who have strategically planned their transitions out of their labs to enhance retirement.
With retirement on the horizon for so many laboratory owners, selling a laboratory is going to become an increasingly competitive situation. In this buyer's market, operating a well-run, profitable lab, maximizing its value and standing out from your peers is going to be essential to your exit planning strategy.
Unless you own the building, the hard assets of a dental laboratory aren't worth a significant amount so what buyers are really looking for are solid reputations, strong client relationships and people who can keep the business flourishing even under new circumstances. "Without question, this is still a people business. We look for good folks, good product and reasonable profitability. We're not interested in yesterday; today is sort of relevant but tomorrow is what's really important," says Dave Brown, president and CEO of National Dentex.
When looking at a multi-technician laboratory, buyers want a strong infrastructure, one in which the owner does not control every aspect of the business and competent, long-term staff members can effectively operate the lab without the owner. "No buyer has experienced people just waiting to be thrown into a laboratory. The seller has to reassure the buyer that his business can continue its earning stream without him," says Bob Ditta, CDT, CEO of Dental Services Group. Also see Transition is Paramount for Small Laboratory Owners
Retirement experts say you should be planning your exit strategy from day one and--while that's not the reality for many owners--there's a very good reason to be thinking about your exit well in advance. Building an infrastructure is not an overnight process; it takes time to get the right people in place who the owner can entrust to run the lab in his absence and for the owner to feel comfortable delegating responsibility. "This is at least a five- to seven-year process so it needs to start well before you want to retire. Within that timeframe, the owner should be able to step back and function as a CEO without being hands on. You'll know it's working if you can comfortably leave the lab for two weeks, confident it will operate smoothly without you," says Rob Gitman, president of Gitman Marketing Associates, a York, Pennsylvania-based laboratory consulting company.
Most buyers want the owner--as well as key employees--to remain for a transition period of six months at the very least and usually longer. Group laboratories, for example, ideally want the owners to stay on as managers for the remainder of their careers. The length of the transition period will depend on the individual laboratory and the buyer's needs. "If the owner has effectively created an infrastructure and has a second in command, the transition will be easier than if the owner is the business. If the owner does everything and has all the relationships, the transition will inevitably be longer," says Chuck Yenkner, president of Business Development Associates, a laboratory consulting firm in Glastonbury, Connecticut.
It's also important to distinguish your laboratory from others in the market. "There are a lot of good labs out there, yet many are pretty much the same. Buyers want a unique proposition, a unique strategy that sets the lab apart from others, such as a focus on automation, a niche in cosmetics or high-end clientele," says Ditta.
The buyer's goal is to minimize his risk and financial outlay. Statistically, even if all goes smoothly, he's going to lose 10 to 20% of your accounts so prior to the sale, he's going to be looking carefully at your customers: Where are they located? Is there an overlap between your two markets? Are the majority of your clients close to retirement age?
Also remember the 80/20 rule: generally 80% of a lab's business comes from 20% of its clients. "As a seller, the more you can increase the percentage of clients from which your work comes, say 30 to 40%, the more comfortable the buyer will be about his risk level," says Gitman.
The million-dollar question
The question on the minds of many laboratory owners approaching retirement age is, "How much is my business worth?" The answer can vary greatly depending on market conditions, sales and earnings trends, the state of the business and the buyer's needs so determining a price is not an exact science.
However, Yenkner offers a general guideline using the EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization) method of valuation. He bases the value on a multiple of cash flow, which is calculated by figuring the net profit and adding back any perks the owner takes such as personal cars or extra health insurance. That multiple changes depending on the size of the laboratory. For example, if a lab has annual sales of $250,000 and a cash flow of 20%, or $50,000 a year, the business might be worth two to three times its cash flow, or $100,000-$150,000. A larger lab with $1,000,000 in revenues might see a multiple of four times the cash flow. "This is not a hard and fast formula. Every laboratory is different and you also need to consider the trends in the individual business, such as a shift in sales in comparison to the previous several years," says Yenkner.
Before the valuation, there are some key steps the lab owner should take to maximize the value of his business in the eyes of the buyer:
Most closely held private companies do all they can to limit their taxes by reducing profits. However, prior to the valuation, owners need to recast the profits by removing the perks they take out of the business. For example, if the owner's salary is inflated, it should be substituted with an amount that's more realistic if he were to hire a replacement. Or, if he owns the building and he's paying himself rent that's higher than market value, it throws off net profit and should be adjusted. "The overall goal is to give the buyer a more realistic view of the profitability of the laboratory," says Bill Neal, president, AMG Creative in Fort Collins, Colorado.
During the due diligence phase, a buyer will want to examine financial statements--including income statements, balance sheets, income tax returns and aging reports--and your sales history for at least the past three years so make sure they're up to date and that everything is posted. "It doesn't take long to perform a financial due diligence as long as the information is readily available. But if the lab operates out of a checkbook, it's going to be hard to determine how well it's doing," says Brown.
Consolidate outstanding bills and resolve accounts receivables issues prior to the due diligence phase.
Look on your P&L statements for one-time costs such as legal settlements, fines or severance payments that can affect your profitability and identify them as such.
Clean up the laboratory. "Get rid of broken furnaces in the corner, miscellaneous boxes and old papers, etc. A clean environment gives the sense of a tight organization which makes a good impression on the buyer," says Yenkner.
Clearly document your compliance with OSHA, Right to Know, EPA and FDA regulations.
Identify which of your contracts, such as purchasing, employee agreements and software, are transferable to the new owners. "Contract transferability takes a level of uncertainty away for the potential buyer," says Gitman. LMT
Editor's note: For additional information on exit planning and specific exit strategies--including selling to a third-party, partner, group laboratory or your employees--click here for our coverage from January 2002.
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