Why every company should be doing scenario planning

Editor's Note:
I have had a number of conversations with  companies in recent months about the duration of the economic upturn and the direction of their markets. Do we really know how this is going to play out over the next few years? No, there could be several very different views of where the markets and economy may go. But we all need a direction. 

With great uncertainty and multiple different views of the future, a company needs to do scenario planning, so that it thinks about the different possible views of the future and how it would move or adapt to best position itself.

The Mead Consulting Group utilizes scenario planning to help clients build flexibility into planning and execution and to help leaders think broader. This last recession was a game-changer. While scenario planning was once conducted primarily with our larger clients, today, over half of our clients (owner-operated, strategic, and private-equity- backed) have discovered the benefits of scenario planning.  - DPM]
  
 Why every company should be doing scenario planning

If your business or industry is predictable, you need not continue reading. If, however, there is uncertainty about the future of your markets or industry, then your company should examine the way it plans. It isn't just healthcare companies, either. I would submit that there is little predictability in most industries.

Making assumptions gives us a false sense of security and puts blinders on us. What is the old line about the word "assume" making an "ass out of you and me?" Not to be profane, but traditional strategic planning totally botched the economic downturn/recovery of 2008 - 2015. Traditional strategic planning is based on assumptions. The planning group makes certain assumptions about the future - about variables such as economic, political, social, technological, regulatory, environmental, etc. Making assumptions is just another way of saying we are attempting to predict the future.

Really? I would suggest that there are situations where economic, social, political, technological, regulatory, and environmental factors will drive fundamental change in every business and industry of every person reading this e-Letter. It's really only a question of degree, pace, and timing.

Various organizations (e.g. Blockbuster, Kodak, Encyclopedia Britannica, print media, broadcast media...the list goes on...) could have avoided significant market pain by utilizing scenario planning. Without being overly critical, these organizations were complacent - and they made assumptions about the future that proved to be very wrong. Each was overtaken by forces that were not within their traditional industry competitive analysis.

Have the courage to consider the tough questions. How will your business be impacted by the following?

•    Technology - How much will technology change your industry?
Will your business or industry be affected by any of the following:

• Mobile ordering; Mobile product/ price comparisons
• Mobile payments
• "Showrooming" in brick and mortar stores and buying online  (e.g. Best Buy and Amazon)
• Contextual offers/specials, loyalty programs, other specific knowledge about customers
• Social commerce
• Apps for everything
• Efficient visibility and management of supply chains (from end user order entry - directly impacting each step of the supply chain)

•    Social/Environmental

• Power moving to the consumer (away from institutions)
• Buyers have equal or greater knowledge than sellers

•    Changes in culture, attitudes

• Will today's 20-something millennials abandon the desire for home ownership?
• What long-term impact will the "green" movement have on markets, products

•    Demographics - Is your customer base affected by demographics?

• Aging population in certain markets
• What does the negative birth-rate and aging population mean for European economies like Greece, Spain, Italy, or Iran and Iraq
• Baby boomers retiring, selling businesses, eldercare, etc.

•    Economic

• Is the U.S. facing a period of structural high unemployment?
• Long periods of "stagflation" or inflation
• Will increasing labor rates continue to make China less competitive? How will outsourcing look in 5-10 years?
• What will happen to Europe?

•    Regulatory - The list is endless...

• Affordable Care Act
• FDA
• EPA
• Trade
• Tax reform (Elimination of subsidies, elimination of deductions (e.g., mortgage interest), business expenses, etc.?)

Some organizations will say scenario planning is too difficult and elect to take a simpler course.  Most organizations perform traditional strategic planning or business planning/ budgeting because it is comfortable and addresses a short timeframe. However, we now know that the world is uncertain and interconnected. Companies can no longer ignore uncertainty or try to assume it away.  As author H.L. Mencken is quoted, "For every complex problem, there is an answer that is clear, simple, and wrong."

That is your opportunity. Since 2008, we've seen the number of our clients that are doing scenario planning more than tripled.  Companies that are scenario planning are examining different possibilities of the future and determining their competitive response. They are modifying the trends and information that they monitor so that they can develop "early warning" signs. These companies are building flexibility into their planning and adaptability into their leadership and culture.

If you want more information on the Mead Consulting approach to scenario planning, please contact me.

Prepare your company to be bought

Editor's Note: As we entered 2015, three of our clients received unexpected offers to sell their businesses. Because they were prepared, they held the line and the prospective acquirers significantly bid up the offers to a range that the owners decided they could not refuse. Two of them closed in 60 days. The third company decided to run a competitive process and is generating exceptional interest from additional buyers. This is a sellers' market. Well-prepared companies are receiving very high selling prices.

Many business owners fail to prepare their businesses for a sale either because they believe that a potential sale is far off in the future or because they are focused on current issues and do not consider preparation to be a priority. We would submit that companies need to be "prepared to be bought." Sometimes lucrative offers come unexpectedly for companies that are well-positioned. We typically recommend that a company engage an experienced investment banker to assist them in a sale - often even if they have received an offer - in order to generate a competitive environment.

Some business owners who have tried to "time the market" at some point off in the future have found that unpredictable events such as the 2007-2012 recession, credit and stock market crunches, tech bust(s), 9/11, industry issues, etc. can derail their ability to sell at maximum value. We recommend to our clients to work each year to make certain that their companies are currently desirable to buyers. - DPM]

How best to position a company to be attractive to buyers:

1.    Demonstrate Strong Financial Performance
 
 a. Historical Financials

• Consistent revenue growth (at least upward trend)
• Recurring revenue is a plus
• Strong operating margins
• Increasing profitability
• Importance of last twelve months

  b. Operating Cash Flow

• Focus on hitting projected revenue and earnings numbers
• Review net profitability of customers and products

2.    Maintain "clean" financials

  a. Audited or "auditable" Financial Statements

• Have your financial statements audited with a reputable firm to add credibility
• Use GAAP accounting. If not, identify how practices differ from GAAP
• Understand cash vs. accrual accounting - timing differences can be material

  b. Income Statement Adjustments and "Add-backs"

• Buyers are skeptical of earnings that rely on substantial add-backs (one-time, non-recurring charges, private company expenses, etc.)

3.    Diversify your customer & supplier base

• Diversification signifies a healthy business and reduces risk
• Buyers will pay less for companies dominated by one or two customers
• Examine what % of sales your top 10 customers represent?
• How stable are your top suppliers? How stable are their terms?
• Do you have multiple suppliers for critical components/services?
• What % of total purchases does your top supplier represent? Top-5 combined?
• What % of the company's sales are related to a few key employees?

4.    Develop a Strategic Growth Plan

• Maintain a clear strategy and be able to demonstrate your history of execution
• Be able to articulate specific future growth opportunities
• Position your company to take advantage of them

5.    Build a capable Management Team

• Invest in training and key strategic hires, if needed
• Motivate management to add value to the company through a potential sale
• Focus on building a deep management team that can thrive without your continued leadership

6.    Eliminate potential "Gotchas"(these are items that could result in significant discounts to value)

• Maintain legal documentation (licenses, regulatory filings, contracts, intellectual property, incorporation, etc.)
• Clear title to all assets
• Document processes and procedures
• Resolve legal disputes

7.    Build a team of Qualified Advisors

• Minimize distractions from running your business effectively
• Get advice from professionals who have expertise in areas you do not and have done it before
• Beware of advisors that outstep their areas of expertise

Are you and your company ready if a buyer appeared on the radar?
Most business owners who have executed a successful sale of their business will tell you the most important thing is: BE PREPARED.

Selling a business is very different than operating a business. As a business owner you know your industry, your product or service, your customers and your markets. Most business owners will only sell a business once in their lifetimes - and it can be by far the most important financial transaction of their lifetime.

Minority Recaps - A great option for some business owners (Capital is available for growth or stabilization)

Many company CEOs and CFOs today spend a good deal of time working the banking environment.  Many of our client companies are performing at very good levels. Some are interested in taking advantage of acquisition opportunities; others in growth plans with new products and new markets. Some are looking for the opportunity to hedge the risk and perhaps take a few chips off the table. Other have good performing companies, but have issues with their balance sheet.

I have been surprised at how few business owners, CEOs and CFOs are aware of MINORITY RECAPS as a potential means for growth capital, taking a few chips off the table, and possibly providing for balance sheet stabilization. We recommend consideration of minority recaps.
Minority recapitalizations (Minority Recaps) - Owners of mid-market and family-owned companies can sell less than 50 percent of their shares at minimal, or no, minority discount and still retain control.

Owners of mid-market and family-owned companies can sell less than 50 percent of their shares at minimal, or no, minority discount and still retain control; they can receive cash for their shares; they can use debt, as well as equity, to enhance returns; they can keep a significant equity tranche for a second exit - when market conditions might again be peaking; and they can pursue an aggressive and ongoing business plan designed to stimulate organic growth and finance acquisitions. This allows private company owners to lower risk by lowering the personal financial concentration they have in their business through diversification.

Common Myth
A common myth is that all private equity firms want control. While that may have been true ten years ago, in today's environment, many PE firms are enthusiastic about teaming up with management to grow good companies with less than a controlling interest.

Minority recaps are not an appropriate for every business owner
The company needs to have the following characteristics:
•    Good operating performance (cash flow and revenue growth
•    Good management team
•    Strategic Growth Plan (tangible opportunities for growth)
For those companies that meet these parameters, it might be just the ticket.

Second bite of the apple can be better and sweeter than the first.
For those companies that sell a minority stake with opportunities to grow, the results can be compelling. In many cases, partnering with the right private equity firm can provide growth that is many times higher than the company could have achieved without outside capital. When the company is ready to sell in an additional five years, perhaps, the owner can reap significantly higher returns.

Example:
Five years ago a client of ours was doing $26 M in revenue with good margins and cash flow. The owner wanted to expand beyond the region into other markets with new products, but lacked the capital and financial expertise. We helped the company develop a strategic growth and execution plan and shored up some weaknesses to present the company in its best light. We assisted the company in finding experienced, knowledgeable resources to help. The company sold 35% interest to a private equity firm. The owner was able to take a few million of his ships off the table ( his family was very happy that his exposure was lowered) and still had significant capital to expand. The private equity firm assisted with introductions, and recommended the addition of a terrific CFO and a strong VP of Operations. The company last year recorded over $130M in revenue. That second bite 65% share was worth a lot more than it was five years ago. The owner had this to say: "I had heard terrible things about private equity. But these guys really became our partners and helped us become a better company. Thanks to Mead Consulting for helping us get it done with the right team."

Market Challenges
The current market offers interesting challenges. But some companies will be able to navigate these waters and put themselves in a lasting competitive position. Think about how your company could gain with capital to acquire and grow during a period when everyone else is in the bunker with their heads down. One caution - before embarking on this path, seek help from those professionals with experience working with mid-size companies in your position. If you would like more information on minority recaps please contact me.