If we can determine that there is, in fact, a potential buyer for the company based on a number of attractive assets and an initial calculation of business value, we can then pursue additional constraints to realizing the preferred value.
An owner may not be satisfied by the initial calculation, believing that the company can be worth far more. This may be true. We can identify weak links or bottlenecks that impede a higher value. According to the Theory of Constraints methodology, common constraints that impede a goal (in this case, a favorable multiple for your business), can include the following:
- Physical – Equipment or other tangible items such as material shortages, lack of people or lack of space
- Policy – Required or recommended ways of working that are outmoded or restricting
- Paradigm – Deeply ingrained beliefs or habits that impede throughput
- Market – Production capacity exceeds sales
When we begin the conversation with a manufacturer — or any business owner — about some of the factors holding back a successful business transition, all four of these constraints can arise over time. An owner, for example, may strongly believe that a family member will take over the business, and that family member has not given the owner any reason to believe otherwise. This is a paradigm constraint in which the owner needs to be open to the possibility of a Plan B to mitigate the risk that this family member won’t or can’t take over.
Physical constraints may include workforce shortages or outmoded equipment; these require a longer-term and strategic approach to attracting and training talent as well as applying throughput improvements to the production floor. Market constraints may require diversification of product lines to maintain throughput that matches market cycles. And policy constraints can be addressed by looking at “how things have always been done here” to how they can be done better.
Policy constraints can be the biggest constraint to business transition planning because they tie closely to ingrained cultural beliefs about how things are done. It may require an outside advisor to identify policy constraints and to walk owners through a process of improvement. An open communication process can also support policy change when new employees come on board and are able to suggest improvements in process or production.
Of course, a big paradigm constraint is the constraint of time. Owners often say they don’t have time to think about business transition planning because they are too busy running the company. Perceived lack of time leaves owners with a lack of knowledge about their business value, which creates assumptions, misguided hopefulness and inertia. Transition planning is left to waste away in quadrant three of priorities: important but not urgent.
If time is a major constraint to business planning, the Theory of Constraints introduces the “five focusing points” to eliminate this constraint.
Beware of inertia creeping back in. Business transition planning is not a “one and done” activity. It will require regular attention over several years to monitor progress on business value improvements, delegation of owner responsibilities to experienced and stable team members, and development of contingency plans. Increasing your time to work on the plan is a big initial step toward committing to increased year-to-year profits and fair value for your business.
Continue Reading: Taking the Critical Path Towards Succession
Gary Jackson, CPA, is a tax partner at Cornwell Jackson. Gary has built businesses, managed them, developed leadership teams and sold divisions of his business, and he utilizes this real world practical experience at Cornwell Jackson and in providing tax planning to individuals and business leaders across North Texas.
Contact him at gary.jackson@cornwelljackson.com.
