Will Jobs Return with Owners Focusing on Exit?

The politicians in Washington seem to be finally asking the right questions about job creation . . .  i.e. how can small business begin to hire again.  Well, amongst other reasons why small businesses are reluctant to begin staffing up again, one of the primary reasons is that lower costs means higher exit values.  And with so many owners having a ‘value gap’ to fill, it is imperative that they protect and drive value through profitable bottom lines.

Let’s discuss the concept of a value gap.  This begins with the amount of money that an owner needs to declare financial independence.  Typically, an owner’s illiquid business is their primary asset so a liquidity event needs to take place to turn the business into cash.  The value of that business, for the most part, will be driven by the company’s cash flows.  And, lower expenses and higher, per-employee productivity is what makes a business valuable.

Now, the recession has increased the value gap for many owners as they realize that both their liquid and their business values have declined.  Worse yet, owners were likely to have contributed personal assets into their businesses as credit tightened and these owners needed to capitalize their businesses.  The answer, of course, was to reduce expenses by laying off employees – an unfortunate plan to enact but a necessary one for survival. 

So, where does the baby boomer owner go from here?

Well, with a business recovery under way, the owner’s are seeing recovery of their businesses and, with the help of technology, they are getting more done with fewer people.  Moreover, as the owners begin to measure their value gaps, they see that they need to extract a high value in order to meet their personal needs. 

Let’s look and an example.  An owner lays off four (4) workers during the recession that reduces labor costs by $300,000.  During the recovery, revenues are coming back and lower labor costs have this owner projecting higher profitability.  Cash flow, or EBITDA (earnings before interest, taxes, depreciation, and amortization) improves by $300,000.  And, as a typical business will be valued as a multiple of this cash flow – let’s assume a four (4) times cash flow in this example - this translates into an addition of $1,200,000 to the value of the company at the time of the owner’s exit, forecasted to occur in the next few years.

The owner is focused on the exit.  And, the higher value substantially contributes to closing the value gap to meet their personal goals.  The quick translation is that the owner will reduce their value with new hires, unless those new hires are immediately accretive to the business.  And, after all, productivity can take time and cost additional dollars in training, benefits, vacation time, and the typical ramp-up as the new employee needs to integrate and assimilate in the business.

Is the owner thinking growth or exit?  Will value be achieved through expansion or through high cash flow?

It is simply the case that no owner will forget this most recent Great Recession.  This is where human nature kicks in.  What is the motivation to hire when a successful exit is moved to the forefront of owner’s attention?  Not too much.  In fact, there are many owners who are enjoying this economic recovery but are more interested in not experiencing another recession.  This means that they want to exit in the next few years and cash in and turn the business over to someone else.

Having a high cash flow is the shortest path to a higher value.  New hires detract from that value.  And, since many businesses have learned to live with less, it is hard to see where the jobs will come from.  Bankers who would not extend credit over the past few years are now finding owners reluctant to take the credit that they are offering.  The market has changed and it is not in favor of risk-taking and aggressive hiring.

This market change of risk taking should translate into your post exit future.  Use the increased value of the business and cash flows to close your value gap and lay the framework for your exit.

It has been a struggle, to say the least, to get through this recession and not being financially prepared for your future when the next one hits, is a risk not worth taking.

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