Whether you are actively preparing for a liquidity event, driving your business in that direction, or just a fan of Shark Tank, mergers, acquisitions, and selling your business are hot topics in today’s market. Should you be looking outside venture capital? Is a strategic competitor or a private equity investor the right fit for you? How prepared are you should the ideal buyer/investor come along? Are your books and organizational systems at a level of sophistication where the ideal partner won’t be scared off or reserved about an acquisition or liquidity event?
All of the above, and much, much more, need to be answered when thinking about a transitional event for your business.
Now that you have prepared your thinking, it’s time to put these thoughts into action. This is far easier said than done circumstances beg the question, where does one start? At some point you will want to consult the services of a management consulting firm, your bank, an M&A attorney, and/or a business broker. All of these contacts and subsequent conversations will happen in time but let’s spend some time in Q&A mode with an expert who can get us thinking in the right direction.
I’m happily and luckily joined by Ralph Hunter, President of Brock Business Solutions, LLC, who has taken the time to answer some key questions when considering the sale of your business, liquidity event, and/or business transition.
Question: Do you have a written transition plan? (Remember, a plan that is not written down is just a wish)
Answer: Selling your business requires a commitment to both a physical as well as an emotional separation. You may have been building your business for 10 years, 30 years, or it could have been in the family for a generation or more. Whatever your tenure, you have doubtless built a strong connection with your business, with your employees, your customers and even your vendors. You may even look at the business as defining you in some way. Leaving it is going to be a difficult process. Not only for you but likely for your spouse, partner or significant other as well.
In order to have a “happy exit” it is in your best interests to have a well thought out and documented transition plan, irrespective of whether you are just starting out, or have already been in business for years.
There is plenty of literature about the fact that written plans have more chance of success than ones that are not written down. Your plan should highlight when you want selling your business to occur. Will it be immediate or over time? How much money are you expecting to make? What are your plans for investing the proceeds? How will your employees and their families be impacted? What are the tax consequences? What will you do with the extra time in your future?
The mere process of considering these things will bring a degree of comfort regarding your readiness to leave the business. Many business transitions fail due to the business owners backing out, not because of anything financial, or something discovered during due diligence, but because they decide they really weren’t ready to move on.
Question: Do you know who you will be selling your business to? A financial buyer, strategic buyer, competitor, management, employees, or family member(s)?
Answer: Knowing who your potential buyers might be is important for several reasons, not least of which is that you need to focus on what might be important to them and what motivates them.
Buyers may be external, perhaps a strategic buyer such as a competitor, customer, supplier or investor, or they may be financial, such as a private equity organization or other financial buyer. Alternatively, the buyer may be “internal”, such as a member of the management team, a family member, or the employees.
Each of these buyers will have their own objectives and will look at your business through their own lens:
- Where are the possible synergies with the buyer’s business?
- Does the buyer wish to retain employees? All of them, none of them, or just some of the key employees?
- Is the buyer looking for a “bargain” that they can then improve with their own team and sell on for a profit?
- Is there enough cash-flow for the buyer to fund future obligations?
Question: Do you know the value of your business? (hint: Value is in the eye of the beholder. Depending on your answers to #2, this amount could, and likely will, vary.)
Answer: First and foremost, value is in the eye of the buyer. What this means is that different types of acquirer will value your business differently, as they are looking at it through their own lens. A strategic buyer, such as perhaps a competitor, a customer, vendor, or investor, will likely assign a higher value as they are generally considering what sort of synergies and growth potential there may be by merging your business with theirs or others they own. A financial buyer, such as PE firm, will likely try to drive the price down since their motive is generally some sort of shorter-term financial gain.
If you are selling to a management team or employees, the price may also be lower, and in some cases you may end up holding a note as the seller in order to facilitate the transaction. Whatever the case and whatever your plans for your business it is always a good idea to know the range of values for your business and it is a good idea to employ an independent business valuation expert to help you figure this out.
But how is that range of values determined? Another great question. In addition to the different types of buyer, there are also many different valuation techniques that are used today. I will not get into all of them, but what you will find a lot of time is that the valuation will be driven by something called EBITDA – Earnings Before Interest Tax Depreciation and Amortization. Sounds complicated. But it really is not.
To calculate EBITDA, take your net operating income and add back any interest, tax, depreciation and amortization from your P&L. Your company will be valued a lot of time on a multiple of this EBITDA number. Many times, there will be a “normalized EBITDA” used. The process of normalization makes adjustments to EBITDA to account for some of those potential “personal expenses” that might have been running through the business. I know, not your company!! Normalization goes both ways though, there can be add-backs and deductions.
Question: Can the business run successfully without you?
Answer: Owners sometimes make the mistake of staying “too involved” in their business. But how can I be “too involved”? you ask. After all, it is my business.
As an owner you want to make sure everything is running smoothly and efficiently, which is fine when the business is in its early stages. Inevitably, as the business grows and you consider adding employees and other infrastructure, such as systems and processes, the whole thing becomes more complex.
One of two things generally will happen at this point:
- The owner continues to wear all the hats, making every last decision, delaying any infrastructure development, and oftentimes this ends up leading to burnout and growth stagnation.
- The owner realizes that there is a need for “delegation” and investment in systems and processes in order to set the foundation for continued business growth.
Which of the above two options do you think will result in the highest company value? Undoubtably, option 2.
In option 1 there really is no business to be sold. The owner has created what we refer to as a “lifestyle” business – it is really just a “job” for the owner. Once the owner leaves, there is nothing left to create value for a buyer. Under option 2 the owner has put in place a solid management team along with the infrastructure, systems and processes to support the future growth of the company. This growth can be achieved regardless of whether the owner is in the business or not.
Question: Can you show 2-3 years of consecutive, profitable revenue growth?
Answer: As discussed previously buyers will generally value your business using some multiple of EBITDA. This multiple depends on many factors, including your industry, the type of buyer, etc…
The EBITDA that is used as a basis for this valuation will likely be based on what is called a “trailing 12 months”, or more likely a “trailing 24 months” period. This means that when it is time to sell, the best way to maximize your valuation is to maximize your EBITDA over the previous 2-year period.
At the same time, showing a growing trend in both revenue and EBITDA will provide the buyer with maximum assurance that the business has the potential to generate future cash flows.
Unfortunately, when it comes time to sell their business, many owners will choose to tackle the process alone, without bringing in outside help. This is not a good idea for several reasons, one of the main ones being that a business sale is a complex process, and by shifting their focus away from the business and onto the sale process, owners can cause the business to suffer at exactly the wrong moment and revenue and EBITDA begin to decline.
Remember, because of the “multiple” effect, a small increase or decrease in EBITDA can drive a 4x to 6x greater impact in the value you receive for your business.
While this list is by no means exhaustive, if you can answer all of these questions you could be on your way to a successful business transitional event.
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