The Owner’s Journey, a newly released study commissioned by US Trust, at the Eugene Lang Entrepreneurship Center at Columbia Business School, assessed and measured experiences and lessons from eight entrepreneurs who successfully sold or transferred their businesses to family members.
This whitepaper explores how founders or their successors created financial value in their businesses and prepared them for ownership change. Below are just a few of the early planning takeaways you can glean from their experience and apply today.
The stories of the entrepreneurs showcased provide rich insight to a wide range of exit options that worked for them:
- Transferring ownership from father to daughter
- Transferring ownership from a couple to their children
- Selling to a strategic buyer
- Selling a dental practice to a strategic buyer
- Selling to a financial buyer
Introducing the report, Keith T. Banks, President of US Trust, Bank of America Private Wealth Management stated:
“The most successful transitions require entrepreneurs to orchestrate finely tuned exits……Taking the time to initiate the planning process early is often neglected…. Without this planning, ‘business owners are often forced to exit on other people’s terms.’”
Early Planning for a Transfer of Ownership
Two-thirds of business owners who responded to the 2014 US Trust Insights on Wealth and Worth Survey do not have a formal succession plan. And for those who do have plans, many never ‘get around to’ implementing them.
With the greatly increased inventory of small businesses for sale (e.g. businesses listed on www.bizbuysell.com ) multiples for smaller businesses have been eroding. Smaller sellers are now lucky to receive only 1-2 times earnings equal to only couple years of the income they have been taking out of the business.
In the middle market, sales were robust in 2014 and are expected to be the same in 2015.
Exit Strategy Options for Owners of Privately Held Companies
For the purposes of this whitepaper, they considered these six exit options:
- Going Public
- Transfer of Ownership to employees management or partners
- Transfer ownership to family members
- Transfer ownership to financial or strategic buyers
The first two are acknowledged as being unappealing options. The last two are recognized as the most plausible options.
Other Insights from The Owner’s Journey
- Not all businesses are saleable. Even long-standing, successful businesses will face challenges if they are not been deliberately managed for sale.
- One family said: You must do the best you can to protect your assets, to protect your family. If nothing is done, one is leaving one’s situation to chance, the government and God.
- One owner was so passionate about his mission and building the company that he had little thought for anything else. He never pondered the endgame.
- Before one puts a business up for sale, one should streamline business processes and audit all costs and contracts.
- Be as firm and detailed as possible in your letter of intent. It is the time to list everything that is important to you … The purchase agreement then easily flows from the letter of intent.
- Find out how other deals were structured. Know your bottom line position. And don’t be afraid to ask for much more than your advisors recommend.
- [My favorite] Start working with professionals years before you want to sell. Have a valuation done years before selling. Learn what you can do to make your company more valuable.
- Unexpected things, both challenging and fortune, will happen. The trick is to be prepared for both.
Tips from experience
These entrepreneurs shared their hard-won advice on numerous topics. Every tip in the table of ‘Tips from experience’ is a golden nugget owners should take to heart. This advice is from the study participants, not advisors. Here are just the categories they cover:
- Selecting advisors
- Understanding the real value of your business
- Selling a company is complex and can take time
- An owner cannot always count on his/her children as the exit plan
- When events move quickly
“The unknowability of the future bedevils every decision maker, not just those selling a business…. Planning can sometimes be difficult and time consuming, but it’s the best tool we have. And the earlier it is started, the greater the likelihood of a favorable outcome.”
The last point I want to highlight is not part of the study itself but what the advisors ‘caught’ along the way:
“Our advisors…were hearing a consistent and passionate message that early planning and enhanced education about exit options and the exit process were in great need.”
That’s our mission at This Way Out Group LLC. That need is growing daily. We help owners start planning early to give them greater exit options, choices and control; we prepare them for and guide them through the exit process (it’s not just an event). Call for a free consultation.
Advisors and buyers speak in a language most business owners have never heard before. Their term, ‘a liquidity event’ is a euphemism for many transaction options.
In financial terms, a liquidity event can be the merger, purchase or sale of an enterprise or even an entrepreneur’s Initial Public Offering. For established lower middle market business owners, a liquidity event is any exit strategy that converts ownership equity into cash for owners and investors.
Regardless of what type of exit transaction you choose to pursue, it is advisable to prepare well for that liquidity event. That preparation entails maximizing enterprise value now. It is essential to start early to produce and prove the maximum value your business should command in a liquidity event.
Preparing for the Transaction
Timing is Everything
You want to be in a position take advantage of any trends and growth opportunities in your market. This can also mean being open to recapitalizing the business, not just cashing out.
Lifestyle and Personal Goals
Business success offers a lifestyle and standard of living that are comfortable. Defining your personal goals, criteria, pursuits beyond the business takes time and often entails planning ahead. Without a clear plan for your reinvention, even if it’s the right time or right opportunity, you may not be ready to take that step.
The terms of a deal are unique to every buyer/seller agreement. But unlike selling a house, there are strings attached to the deal you sign at closing for your business. Those commitments or responsibilities can impinge or constrain your transition plans. For example, the successful integration of your company, your team into the buyer’s organization or culture may require your assistance for months before the transaction as well as more time and involvement after the transaction itself.
The time to plan and prepare your retirement/reinvention financial requirements is long before the liquidity event, in parallel to preparing you and the business for this transaction and transition. For example, pre-transaction (before any type of liquidity event) establish your:
- Retirement goals and ensure they are engaging you and compelling you forward beyond the business
- Gifting plans and execute them
- Preparations for letting go – owners are often surprised how hard this is to do
Identify your potential suitors, or types of potential buyers/acquirers – at least 2, preferably 5 years ahead of your target date in order to be in a position to maximize value throughout the company:
- Strategic Buyers – they could be customers, distributors, vendors, even your management team.
- Financial Buyers – Financial buyers will look first at your cashflow, growth, management team, risks of ownership, fit in their portfolio, and any transition issues/difficulties they could face
- Industry Relationships and Associations can be great sources to explore the right fit, the best fit to achieve your goals for the company, your team, your timeline and your financial future.
Your Management Team
- Objectively assess the depth of your team, their tenure and experience, and their (not your own) customer relationships. – In a liquidity event, the buyer or investor wants to know that the company can thrive even more, without you at the helm, with a strong committed leadership team.
- Strategic Suitors and Financial Suitors will look at your management team differently. One will value their contributions through the transaction and integration. The other will be depending on them to perpetuate your success and growth well beyond the transaction.
- Buyers and acquirers expect that you have many legal elements current and in place to ensure your team will stay with the business including:
- Non-compete agreements
- Non-solicitation agreements
- Employment Agreement – that doesn’t expire for a number of years
- Transaction Compensation – These are financial incentives for them to stay (stock options, phantom stock, bonuses, a percentage of the transaction itself, etc.
If a liquidity event appeals to you and if your objective in that liquidity event is to maximize value to command the highest multiples, start planning now. It takes time to get ‘all your ducks in a row’. And since timing is everything, if you aren’t always preparing to maximize enterprise value, you could miss the window of opportunity when a liquidity event does appear.
If your company is growing, it will have a tendency to continue to grow because you’re doing things right. Conversely, a company that is going backwards or shrinking has a tendency to continue to go backwards or shrink until acted upon by an outside force or you choose to make a change.
When we read about the concept of business growth in the top business periodicals, they always reference the multi-national corporations. That context isn’t relevant to small and medium size businesses. For you, business growth requires individual effectiveness.
In your business, you hold the office of president or CEO of the corporation, and you’re responsible for its success or failure. You and the members of your team are invested in your corporation, and it’s your responsibility to see that the value of the business continues to increase in the years ahead.
Growth vs. Death
All responsible company officers know that unless the company is growing, it’s showing the first signs of death. As the head of your corporation (be it 1, 50 or 500 people), you must realize that this applies to you as well.
However, because you are also a person, you have a tremendous advantage over even the largest corporation. In a large multi-national corporation, can it double its production in a single day? Of course not. Can it double its sales in a single day? Of course not. It might like to, but its growth options can be gated by the complexities of such a large organization. Yet an individual person can double, triple, quadruple his/her effectiveness in a month or less. As a smaller business, you can implement flexibility, control and responsiveness to get immediate results which is very difficult for corporate giants to do.
Can you grow and improve as a person at least 10% a year? Of course you can. In fact, experts estimate a person can increase his or her effectiveness anywhere from 50% to 100% and more within 30 days. Now apply that to each person in your entire business.
History is filled with people who exceeded their previous performance to an almost unbelievable extent (artists, athletes, musicians, orators, military and political leaders, not to mention the corporate rags to riches stories).
Cost of Wasting an Hour
Think about it. If you waste even an hour of productive time every work day, it adds up to 250 hours a year. If you had an employee who wasted that much time, would you keep him on the payroll or fire him?
What is your time worth per hour [the burdened hourly rate it costs the company]?
If your salary is $150,000 and your burdened hourly rate is 1.5 then your hourly cost to the company is $108 (assuming a straight 40 hours/week).
Multiply this by 250 and you can see what you’re throwing away. $108 x 250hrs/yr = $27,000/yr.
The effect is compounded when you tally the cost for each member of your team.
If even 5 people (at $50,000 salary) waste an hour a day, that’s $36/hr x 5 = $180/day x 250 hrs/yr = $45,072/yr.
Salaries are sunk costs. That’s $72,000 you can’t recoup and you have nothing to show for it.
What can you do now to improve the effectiveness of every member of your team, to get better results/person? How would that improve your bottom-line?
Here’s the challenge from Earl Nightengale:
“How much are you worth right now, today, as a corporation? What’s your value today, to yourself, your family, your company? If you were an outside investor, a stranger [e.g., a potential acquirer], would you invest in this corporation?”
Effectiveness, Performance, Productivity
Business growth requires individual effectiveness from the entire team. Wasted time equals lost opportunities and a direct reduction in net profits to your business that can be measured daily. Measure these three factors: effectiveness, performance, and productivity, to track the value each individual on your team contributes to your corporate growth.
Business valuation goes beyond simple mathematics.
To get some idea of what your business might be worth, consider these three business valuation methods.
Your business is likely your largest asset so it’s normal to want to know what it is worth. The problem is: business valuation is a “subjective science.”
The Science Part
The science part is what people go to school to learn: you can get an MBA or a degree in finance, or you can learn the theory behind business valuation and earn professional credentials as a business valuation professional.
The Subjective Part
The subjective part is that every buyer’s circumstances are different, and therefore two buyers could see the same set of company financials and other value drivers and offer vastly different amounts to buy the same business.
Below we’ll look at the basic science and math behind the most common business valuation techniques. Keep in mind that there will always be exceptions, outliers that fall well outside of these frameworks. These are strategic sales, where a business is valued based on what it is worth in the acquirer’s hands. These strategic acquisitions, however, represent the minority of acquisitions, so use the three methods below to triangulate around a realistic value for your company:
Assets-based Valuation Method
The most basic way to value a business is to consider the value of its hard assets minus its debts. Imagine a landscaping company with trucks and gardening equipment. These hard assets have value, which can be calculated by estimating the resale value of your equipment.
This valuation method often renders the lowest value for your company because it assumes your company does not have any “Good Will.” In accountant speak, “Good Will” has nothing to do with how much people like your company; Good Will is defined as the difference between your company’s market value (what someone is willing to pay for it) and the value of your net assets (assets minus liabilities).
Typically, companies have at least some Good Will, so in most cases you get a higher valuation by using one of the other two methods.
Discounted Cash Flow Valuation Method
In this method, the acquirer is estimating what your future stream of cash flow is worth to them today. They start by trying to figure out how much profit you expect to make in the next few years. The more stable and predictable your cash flows, the more years of future cash they will consider.
Once the buyer has an estimate of how much profit you’re likely to make in the foreseeable future, and what your business will be worth when they want to sell it in the future, the buyer will apply a “discount rate” that takes into consideration the time value of money. The discount rate is determined by the acquirer’s cost of capital and how risky they perceive your business to be.
Rather than getting hung up on the math behind the discounted cash flow valuation technique, it’s better to understand the drivers of your value when you use this method. These value drivers are: 1) how much profit your business is expected to make in the future; and 2) how reliable those estimates are.
Note that business valuation techniques are either/or and not a combination. For example, if you are using Discounted Cash Flow, the hard assets of the company are assumed to be integral to the generation of the profit the acquirer is buying and therefore not included in the calculation of your company’s value.
A money-losing bed and breakfast sitting on a $2 million piece of land is going to be better off using the Asset-based valuation method; whereas a professional services firm that expects to earn $500,000 in profit next year, but has little in the way of hard assets, will garner a higher valuation using the Discounted Cash Flow method or the Comparables technique described below.
Comparables Valuation Method
Another common valuation technique is to look at the value of comparable companies that have sold recently or for whom their value is public. For example:
- Accounting firms typically trade at one times gross recurring fees.
- Home and office security companies trade at about two times monitoring revenue,
Most security company owners know the Comparables technique because they are often getting approached by private equity firms rolling up small security firms to sell theirs. Typically you can find out what companies in your industry are selling for by asking around at your annual industry conference.
The problem with using the Comparables methodology is that it often leads owners to make an apples-to-bananas comparison. For example, a small medical device manufacturer might think that, because GE is trading for 20 times last year’s earnings on the New York Stock Exchange, they too are worth 20 times last year’s profit. However, in one study of more than 13,000 businesses, it’s clear that a small medical device manufacturer is likely to trade closer to five times pre-tax profit, not 20 times.
Small companies are deeply discounted when compared to their Fortune 500 counterparts, so comparing your company with a Fortune 500 giant will typically lead to disappointment.
Finally, the worst part about selling your business is that you don’t get to decide which methodology the acquirer chooses. An acquirer will do the math on what your business is worth to them behind closed doors. They may decide your business is strategic, in which case back up the Brinks truck because you’re about to get handsomely rewarded for your company. But in most cases, an acquirer will use one of these three techniques to come up with an offer to buy your business.
Curious to see what your business might be worth? Get a free valuation here.
From a personal or emotional perspective, it is understandable why you might avoid both succession planning and how you will monetize the wealth you’ve built in your business. To build your legacy now takes time. Yet, in every survey of owners since 2005, 80-90% of all owners of private and family run business admit that they avoid, deny, postpone and procrastinate on these strategic planning efforts.
It’s personal, it’s emotional. Which means it’s messy.
You Can’t Build Legacy Overnight
Universally, they keep ‘kicking the can’ down the road saying they don’t need to start planning for at least another ‘five years’. However, failing to embrace long-term strategic planning for your business, your family and your financial future; can have a critical impact on the outcome you achieve vs. the outcome you envision as your legacy. You can’t build legacy overnight. You can’t ensure your dynasty will safeguard and preserve your legacy just because you want it.
Building, protecting and preserving your legacy is your responsibility long before you pass on ownership, control and/or responsibility for your business and its asset value. Personal and emotional objectives and obstacles take time – years not weeks – to work through.
‘Do-Nothing‘ Owners Risk Everything
The owners who avoid or procrastinate structuring their business and other assets to provide a legacy, are the same ‘do-nothing’ owners who risk everything because they never monetize their business for themselves or the next 100 years of their family. It’s much harder if not impossible for your spouse or children to build and preserve your legacy after your demise.
Putting your family, your employees and all your stakeholders at risk is preventable, if you take action. You can avoid a range of dire consequences of not planning for and preparing your legacy if you start now. They include:
- If you don’t define your legacy, how will others know your wishes?
- If you don’t plan for the assets to sustain your legacy, your executor may not be able to fulfill your wishes.
- Specify ‘what if’ conditions and your decision-trees.
- Without communication with the family and business stakeholders now, the business and the family objectives may clash – putting both at risk without you to mediate.
As a business owner, you probably were like me when you started your business. You had at least an inkling of the legacy and dynasty you wanted to leave behind when you pass on; even if you never put it into words to share with anyone else. Now, it’s time to hone that legacy to a luster to last 100 years for you and generations to come. The sooner you start planning, the easier it is to execute, the simpler it is to communicate and perpetuate; and the greater results you can anticipate.
It is possible do that with some early business and personal planning, and taking strategic decisions in terms of growth, value, exit options, succession, ownership, reinvention, and your future lifestyle.
Look at some of your options when you take control:
- You can prepare the business and the next generation for continued success in a family business
- You can establish a family foundation and/or a family office to preserve your legacy
- You can sell your business for maximum value
- You can explore a range of strategic partnerships
- You can retain ownership but pass on control and/ or responsibility
- You can lay out a 100 year plan for the business and for the family
There’s no single solution for all business owners. But there is a process to make sure your chosen transition occurs on your timeline to protect and preserve the legacy you imagined.
Don’t let personal or emotional baggage hold you back. Don’t kick the can down the road even one more day. Start today to build your legacy now.
In an analysis of more than 14,000 businesses,
a new study finds that the companies with the most value,
take a contrarian approach to the boss doing the selling.
Who does the selling in your business?
Who does the selling in your business? My guess is that when you’re personally involved in doing the selling, your business is a whole lot more profitable than the times when you leave the selling to others. How you spend your time is critical to maximize the value of your business.
In some ways, that makes sense because you’re likely the most passionate advocate for the products and services your business provides. You have the most industry knowledge and the widest network of industry connections.
If your goal is to maximize your company’s profit at all costs, you may have come to the conclusion that you should spend most of your time out of the office selling, and leave the dirty work of operating your businesses to your underlings.
However, if your goal is to build a valuable company, one you can sell down the road, you can’t be your company’s number one salesperson. In fact, the less you know your customers personally, the more valuable your business becomes.
The Proof: A Study of 14,000 Businesses
Another analysis of a pool of 14,000 businesses at the end of 2014, asked if owners had received an offer to buy their business in the last 12 months, and if so, what multiple of their pre-tax profit the offer represented. They then asked the following question:
Which of the following best describes your personal relationship with your company’s customers?
- I know each of my customers by first name and they expect that I personally get involved when they buy from my company.
- I know most of my customers by first name and they usually want to deal with me rather than one of my employees.
- I know some of my customers by first name and a few of them prefer to deal with me rather than one of my employees.
- I don’t know my customers personally and rarely get involved in serving an individual customer.
2.93 vs. 4.49 Times
The average offer received among all of the businesses we analyzed was 3.7 times pre-tax profit. However, when they isolated just those businesses where the owner does not know his/her customers personally and rarely gets involved in serving an individual customer, the offer multiple went up to 4.49 times pre-tax profit.
Companies where the founder knows each of his/her customers by first name get discounted, earning offers of just 2.93 times pre-tax profit.
Therefore, as counter-intuitive as it is for owners to let someone else be the face of their company to their clients and customers, it is essential to let go if your goal is to add value that will command higher multiples when it’s time to cash out.
When Value Is the Enemy of Profit
Who you get to do the selling in your company is just one of many examples where the actions you take to build a valuable company are different than what you do to maximize your profit today.
If all you want is a fat bottom line, you likely wouldn’t invest in upgrading your website or spend much time thinking about the squishy business of company culture. You would not reinvest profits to grow the business.
To make your business more valuable, you can no longer limit yourself to measuring revenue and net profit.
Obviously, how much money you make each year is important. But how you earn that profit will have a greater impact on the market value of your company in the long run.
Owners, do not spend your valuable time building your personal relationship with your company’s customers. Hire and train others to do that so you can focus on what will make the business more valuable to potential buyers.
Diversification is a sound financial planning strategy, but does it work for company building?
There are good reasons to diversify to achieve your objectives. There are also really good reasons not to diversify when you are growing a business to maximize value.
One Big Bet
How does Vitamix get away with charging $700 for a blender when reputable companies like Cuisinart and Breville make blenders for less than half the price?
It’s because Vitamix does just one thing, and they do it better than anyone else.
WhatsApp was just a messaging platform before Facebook acquired them for $19 billion US. Go Pro makes the best helmet mounted video cameras in the world.
These companies stand out because they poured all of their limited resources into one big bet.
The typical business school of thought is to diversify and cross sell your way to a “safe” business with a balanced portfolio of products – so when one product category tanks, another line of your business will hopefully boom. But the problem with selling too many things – especially for a young company – is that you water down everything you do to the point of mediocrity.
Here are six reasons to stop being a jack-of-all-trades and start specializing in doing one thing better than anyone else:
- It will increase the value of your business
When you sell one thing, you can differentiate yourself by pouring all of your marketing dollars into setting your one product apart, which will boost your company’s value. How do we know? In one study analyzing an assessment of more than 13,000 businesses, they found that companies which have a monopoly on what they sell get acquisition offers 42 % higher than the average business.
What one product/service you offer will set you apart creating a monopoly where you can command a higher offer?
- You can create a brand
Big multinationals can dump millions into each of their brands, which enable them to sell more than one thing. Kellogg can own the Corn Flakes brand and also peddle Pringles because they have enough cash to support both brands independently, but with every new product comes a dilution of your marketing dollars. It’s hard enough for smaller businesses to build one household name and virtually impossible to create two without gobs of equity-diluting outside money.
What will you focus your marketing dollars on to create brand recognition?
- You’ll be findable on Google
When you Google “helmet camera,” Go Pro is featured in just about every listing, despite the fact that there are hundreds of video camera manufacturers. It’s easy for Go Pro to optimize their website for the keywords that matter when they are focused on selling only one product.
What keyword(s) will make you, your product/service, or your business ‘findable’ on Google?
- Nobody cheered for Goliath
Small companies with the courage to make a single bet get a bump in popularity because we’re naturally inclined to want the underdog – willing to bet it all – to win. When Google launched its simple search engine with its endearing two search choices “I’m feeling lucky” vs. “Google search,” we all kicked Yahoo to the curb. Now that Google is all grown up and offering all sorts of stuff, we respect them as a company but do we love them quite as much?
Leverage what you do best to win. What do you do best, to bet the house and win?
- Every staff member will be able to deliver
When you do one thing and you do it well, you can train your staff to execute, unlike when you offer dozens or hundreds of products and services that go well beyond the competence level of your junior staff. Having employees who can deliver means you can let them focus and get the work done, freeing up your time to think more about the big picture.
How can you streamline your offering so your staff can execute without your day-to-day oversight?
- It will make you irresistible to an acquirer
The more you specialize in a single product, the more you will be attractive to an acquirer when the time comes to sell your business. Acquirers buy things they cannot easily replicate themselves.
Go Pro (NASDAQ: GPRO) is rumored to be a takeover target for a consumer electronics manufacturer or a content company that wants a beachhead in the action sports video market. Most consumer electronics companies could manufacturer their own helmet mounted cameras, but Go Pro is so far out in front of their competitors – they are the #1 brand channel on You Tube – that it would be easier to just buy the company rather than trying to claw market share away from a leader with such a dominant head start.
What will make your business irresistible to a potential acquirer?
Diversification is a great approach for your stock portfolio, but when it comes to your business, it may be a sure-fire road to mediocrity. Mediocrity does not maximize value or make your business attractive to potential buyers or acquirers.
Most business owners have not put a lot of thought into planning for their eventual exit from their business. Many many owners, of established as well as startup companies, don’t see any value in planning for an exit that is years if not decades into the future. If they can’t see immediate benefits and consequences for their actions and decisions, they leave it for ‘someday’.
You may not need an exit strategy if you intend to die at your desk and leave a mess for your family and team to clean up.
So let’s suppose. Do the following points describe you?
You Don’t Need an Exit Strategy IF You:
- Want to liquidate your business upon closing even if it means getting only pennies on the dollar
- Want to maximize your tax bill to the state and Uncle Sam, minimizing the return to your family
- Do get to sell in the end (maybe a firesale) and you enjoy paying your technical/transaction advisors at their highest premium fees
- Are willing to walk away from 30-50% of the value of your business
- Are willing to let the business lose clients when you depart
- Don’t feel responsible for your employees after you’re gone. Will they still have a job, will they move, will they have to take a pay cut?
- You and your business are not a community partner, in donations, sponsorships or time, and your closing will not hurt the community
You Don’t Need an Exit Strategy IF Your Family, Your Spouse, or Your Children:
- Can and will jump in and run the business your way, without any need for some development and succession planning in advance
- Can salvage or sell the business on their own while you are indisposed
- Do not need or expect the business to be liquidated in some way to secure their future
- Do not expect or deserve a return for all the sacrifices they made for you to build that business
These statements are a bit exaggerated. ‘Yes, But my situation is different…’ is not enough. Without a Framework for your exit; you, the business, your team, your family, your finances and your future will all be shortchanged. Is that your intention? Is that your plan?
- Everyone needs a Master Plan – for their business and their life
- Every owner needs contingency planning – ideally before you opened the doors to your business – sooner rather than too late
- Every owner needs to start exit planning early – years earlier than any transaction advisor every required of you
- Exit planning and execution take time and a team to maximize your return and optimize your exit transition
If not now, when?
Call us for your free consultation.
“Attracting a buyer is like preparing for a beauty contest” – Gary Miller
Dog owners and breeders know that it takes years of discipline, training and preparation for their pure bred champion dog to stand out from the crowd and win the blue ribbon at the Westminster Kennel Club dog show. They know that the dog that ‘shows best’ will win ‘first’. They know the decision is in the judge’s hands.
To show best and win first in selling your business, it’s up to you to make your business both buyer ready and buyer attractive.
To Prepare Your Business, Think Like a Buyer
Before you enter the market place of potential buyers, preparation is essential not optional. Plan on at least 1-2 years of preparation efforts before you begin the 6-9 month transaction process. Yes, years. This preparation means all the difference in the value of your business and the price it will command in the market place.
Preparation is a choice far too few owners take seriously. Preparation makes your business stronger, more attractive and more valuable. Without preparation, you give (gift) all the leverage in a negotiation to the buyer and the buyer’s intermediary.
To think like a buyer, there are a few key steps that will make your business more attractive and appealing to potential buyers. They include:
- Getting a base-line valuation performed by an independent valuation firm to quantify the current market value of the business.
- Documenting all assets and inventory accurately. Dispose of any obsolete materials or expired inventory to get to a true accounting of what you have.
- Cleaning up all financial records to show current market value of assets and inventory now to avoid any issue for your buyer. If you wait until you have an interested buyer and they discover that your financial records show a higher value than market value at that late date, it will weaken your negotiating position or worse, put the deal itself at risk.
- Investing in an audit of your financials now, done by an independent accounting firm. This will give you time to clean up/correct any errors or concerns identified. It also establishes a pattern of good business management.
- Bringing all legal requirements and records up to date. Revisit all vendor and client contracts before you pursue any buyer opportunity.
- Implementing and document all systems and processes for operating your business. If you’ve never documented anything, you have no leverage to say what it’s worth. If the entire business is in your head, a buyer will not pay the full potential value of your business if they have to depend on you to achieve it. This step in itself adds value to the bottom line and drastically reduces business continuity risk.
- Deciding now who on your management team will be essential to the successful transition of the business to new ownership. Tell them your plans now and what you’ll do for them because they help you through the transaction process. Without them, your business is much less attractive to your buyer. You need them on board to champion the business when your potential buyer arrives to do their due diligence.
- Executing your own internal due diligence now to identify what is ready, what is not ready, where you are strong and where there are holes in what a buyer would expect to find in the due diligence process. With a timeline of years, you give yourself the luxury to methodically clean up, resolve and eliminate any potential red flag. The more complete, transparent and prepared you are, the less likely the buyer’s team are to dig for hidden problems.
Your All-Star Team of Advisors
To prepare you, your business, and your team to take your business to market, you need an all-star team of advisors, not just one or two. The most successful transactions close when you surround yourself with a cooperating, collaborating coordinated team of advisors to ensure your business is buyer ready and buyer attractive to achieve the outcome you want on your terms. In addition to your current business attorney and accountant, your core team must include at least:
- An exit strategist to manage the preparation of your business for you and orchestrate your transaction team; so you can stay focused on what you do best – accelerating growth and maximizing the value of your business.
- An attorney with significant transaction experience in the type of transaction you want to close. A divorce attorney or real estate attorney or a litigation attorney may not have the experience to give you the leverage to negotiate the best deal.
- Your Chief Financial Officer – even if you’ve never had a CFO on your team in the past. Even a part-time CFO will help position your business in the best light for a buyer.
- An investment banker with substantial transaction experience in your industry can be invaluable in negotiating the deal and moving the process to closure.
- A tax accountant experienced in major transactions who can evaluate and guide you to minimize the tax impact of the deal by preparing years in advance.
- A specialist wealth advisor to help establish your wealth preservation plan beyond the business, long before that plan will be funded by a successful sale to your buyer.
You need the entire team, not full-time, but all on board early and engaged to advise you through the preparation stage and right through the transaction to your ideal buyer.
Select the best advisors you can find, not the cheapest. The best, who deliver the most value, will pay for themselves many times over in the returns you receive.
Think like a buyer. When you and your team analyze your business through the eye of your ideal buyer, over time, you will add value and increase the leverage you can command in the deal. That’s how you attract the best buyers, “show best” and “win first”.
If you’re wondering when is the right time to sell your business, you may want to wait until your company is generating $1 million in earnings before interest, taxes, depreciation, and amortization (EBITDA).
What’s so special about the million dollar mark?
Hitting the million dollar mark is a tipping point at which the number of buyers interested in acquiring your business goes up dramatically. The more interested buyers you have, the better multiple of earnings you will command.
Since businesses are often valued on a multiple of earnings, getting to a million in profits means you’re not only getting a higher multiple but also applying your multiple to a higher number.
For example, according to research at www.SellabilityScore.com, a company with $200,000 in EBITDA might be lucky to fetch three times EBITDA, or $600,000. A company with a million dollars in EBITDA would likely command at least five times that figure, or $5 million. So the company with $1 million in EBITDA is five times bigger than the $200,000 company, but almost 10 times more valuable.
There are a number of reasons that offer multiples go up with company size, including:
- Frictional Costs
It costs about the same in legal and banking fees to buy a company for $600,000 as it does to buy a company for $5 million. In large deals, these “frictional costs” become a rounding error. In contrast, they amount to a punitive tax on smaller deals.
- The 5-20 Rule
I first learned about the 5-20 rule from Todd Taskey, M&A Advisor at Potomac Business Capital in the Washington, D.C. area. He discovered that, in many of the deals he does, the acquiring company is between 5 and 20 times the size of the target company. I’ve since noticed the 5-20 rule in many situations and I believe that your natural acquirer will more than likely indeed be between 5 and 20 times the size of your business.
If an acquiring business is less than 5 times your size, it is a ‘bet-the-company’ decision for that acquirer: If the acquisition fails, it will likely kill the acquiring company.
Likewise, if the acquirer is more than 20 times the size of your business, the acquirer will not enjoy a meaningful lift to its revenue by buying you. Most big, mature companies aspire for minimum top-line revenue growth of 10 to 20 percent. If they can get 5 percent in organic growth, they will try to achieve another 5 percent through acquisition, which means they need to look for a company with enough clout to move the needle.
- Private Equity
Private Equity Groups (PEGs) make up a large chunk of the acquirers in the mid market. The value of your company will move up considerably if you’re able to get a few PEGs interested in buying your business. But most PEGs are looking for companies with at least $1 million in EBITDA. The million-dollar cut-off is somewhat arbitrary, but very common. As with homebuyers who narrow their house search to houses that fit within a price range, or colleges that look for a minimum SAT score, if you don’t fit the minimum criteria, you may not be considered.
So When Is The Right Time To Sell Your Business?
If you’re close to a million dollars in EBITDA and getting antsy to sell, you may want to hold off until your profits eclipse the million-dollar threshold, because the universe of buyers—and the multiple those buyers are willing to offer—jumps nicely once you reach seven figures.