Benjamin Franklin said “By failing to plan, you are preparing to fail”, and nowhere is this more evident than in preparing to exit your company. If you own a business and have NOT thought about how you’ll exit, now is a good time to create a plan. Whether you intend to sell your business in 3 – 5 years or plan to stay in it for the long haul, the best way to grow intentionally, quickly, and profitably is to grow with an eye to sale or acquisition.
You didn’t start your business without a plan – why would you sell it without one?
Many mid-market business owners are unclear about their business value, how they can maximize their business value, and how they can determine their business valuation. As you create a plan for your business, your CFO will likely highlight the importance of well-structured debt, access to the right kinds of investment (VC, PE), and the importance of GAAP accounting and the kind of well-run finance and accounting department an acquiring company is looking for. If you do not have a finance executive on your team, getting those and other areas of your company’s Finance & Accounting (F&A) department in order will be essential to getting the maximum valuation for your business.
Timing is yet another factor that must be taken into account in order to maximize the value of your business for a sale. We often see owners reacting to a buyer who makes an unsolicited offer; this puts the buyer in the driver’s seat, not the owner. Being proactive in the process will yield substantially better sale prices than letting a buyer dictate the offer price. Additionally, proactively improving the areas of your business that drive value and eliminate risk in your company will be beneficial regardless of your decision to sell. Finally, understanding the marketplace will help set your expectations and give you a basis to manage toward the value you want.
Whether you plan to sell or just want to work toward having the kind of company someone would want to buy, you can be sure that your value is going to be higher if your company’s financials are in order. Having accurate, timely, and relevant financial data supports better business valuations and ultimately higher profits upon exit.
When should I start to plan to sell my business?
Exit planning ideally needs to begin 3 – 5 years before you plan to pass over the keys to the kingdom. The considerations that dictate this timeline range from tax planning and middle management leadership development, to timing markets and working with investors. Whatever your plan for exit, any potential acquiring entity will certainly do their due diligence, starting with your company’s financials.
Over 40% of owners plan to exit their business in the next 5 years. However, a majority of business owners do not have a formal exit strategy established.
If you’re thinking about timing the sale of your business, get started now in order to maximize the value of your business.
Start with why.
Understanding why you want to sell will help you get focused on the timeline and the asking price you will be aiming for. Whether you want to retire, are seeking a better work-life balance, are interested in starting a new career, or searching for a new purpose, the choice to sell a business you have built should not be taken lightly or executed hastily.
Questions you may want to consider:
- Is the business ready to be sold?
- Who do I want to sell the business to?
- Am I ready to sell the business (emotionally)?
- What will I do with the proceeds of the sale?
- Am I prepared from a legal standpoint?
- Do I have/need a wealth manager or other advisor?
- How much could I sell the business for?
- What will I do after I sell the business?
- Am I willing to work for the new owner for a period of time?
- When is the right time to sell the business?
How do you get the highest valuation for your business?
No one wants to sell to the lowest bidder. So what can you do to attract the right buyers willing to pay the highest price?
Understanding revenue streams and having underlying clean data is essential to maximizing your business value. Quality of earnings and/or financial statement audits are important pieces when a buyer does their due diligence for a deal. Think of ways you can create visibility into the profitability of your business for a buyer.
Business valuation is typically tied to the type of industry your company is in. As you work to maximize your business valuation, consulting with an expert in Mergers & Acquisitions (M&A) will be an asset to your process. They understand the value drivers from an acquiring entity’s perspective and can highlight areas of strength and weakness for you to address pre-listing. They also are experts in marketing your business to a broader range of potential acquirers.
Minimize risk to maximize value
Buyers value limited risk in the businesses they buy. There are business structures and revenue opportunities that can be addressed before the listing of the business to reduce risky business structures.
Reduce the concentration of earnings:
Don’t put all your eggs in one (or 3) baskets. If your revenue is high but it is largely from a small number of customers, the risk is that on sale of the business those customers leave and the revenue that was core to the valuation is no longer coming in. Spreading revenue among many customers ensures that no one account’s loss can negatively affect your company or your valuation. Better to have 50 mid-sized clients than 3 massive ones from a concentration of earnings perspective.
Implement Reliable Financial Reporting
When a buyer is looking to purchase a business, they want to know how it is performing. The price is often based on the trailing twelve months’ financial results and GAAP-based reporting. For a buyer, seeing clean financials builds trust, allows them to make decisions decisively and quickly, and provides insights into opportunities for growth that may increase their offer based on their plans for the future of the company.
Build a recurring revenue model
Subscription-based companies (where customers sign up and pay monthly) like Spotify, Blue Apron, and Dollar Shave Club have very high multiples and valuations because businesses with recurring revenue are more stable.
With this ongoing recurring revenue, these businesses have consistent income to rely upon and forecast against. Project-based businesses face more risk because as projects end, that revenue must be replaced. This typically requires more sales effort and expenses to grow overall revenue.
If your revenue is project-based or retail sales, you can develop a recurring model. For project companies, are there ongoing consulting engagements or other services that can be offered to develop a recurring model that can be offered to your client base? Building stable recurring income is positive for the business, whether you choose ultimately to sell or to hold on for the long term.
Bolster middle management and reduce reliance on the owner
If an entire business is based on the owner, e.g., the owner is running everything, has all of the relationships with the clients, and makes all of the sales then there is far less appeal for a potential buyer.
As an owner, it can be hard to disconnect from the day-to-day of running the business. One way to put structures in place to support the slow extraction of the owner from the daily running of a business is to build up the management team. By building a team that can run the business without you, you create business value that can transfer once you, the owner, are no longer involved.
A multi-level succession roadmap allows the company to fill gaps in skills and competencies for the entire company. There are several other ways a buyer may limit their risk on this issue, including requiring that the owner stays on board for another 3-5 years, paying a lower price, or reducing the upfront payment and creating an earn-out clause that pays out over a period of time -based on the business’ performance post-acquisition.
Build structures that scale
A business’ infrastructure includes such things as people, processes, tools, equipment, technology, approach, and culture that enable the business to service its customers. An owner who’s built a solid infrastructure that supports growth and scalability with efficient, repeatable, and consistent processes will find that their business has a higher value.
Benchmark your performance
Companies that generate stable, above-industry-average earnings are more valuable. To measure that, you need to understand the industry standards and measure yourself against them. If multiples in your industry are typically based on revenue, a higher net income supports a higher revenue multiple. If your industry valuations are typically off of EBITDA, then a higher EBITDA will be worth more under the same multiple and many times can even attract a higher multiple.
Regardless of the valuation methodology, there is always a strong case to improve your bottom-line margins. This can be done through active management, good key performance indicators (KPIs), accurate, relevant, and timely (ART) financial reporting, creating efficiencies in your business, outsourcing non-critical tasks, and building to sell.
Who Will Buy Your Company?
When you’re looking to sell, there are a number of potential buyers: strategic (competitors), private equity/venture capital, outside 3rd parties, insider (employee), or even having an employee stock ownership plan (ESOP).
Strategic Buyer (Competitor):
Selling to a strategic buyer may land you the highest potential sale as they might see value in a new geographic market, customer base, etc. When selling to a strategic buyer a consequence may be that your business becomes a part of a bigger whole. Often, the acquirer will look to cut the costs of your business by combining back-office support (accounting, HR, etc.), which may lead to some of your employees losing their jobs.
Private Equity / Venture Capital:
This may give you an opportunity to cash out and accelerate your business’ growth; however, as the owner, you may not only lose control, but you will also likely remain involved in the business for a specified period of time. This option may also give you the chance to “have a second bite at the apple.” Meaning you only sell a part of your business and help the financial buyer grow it. When the business is sold in the future, you get to reap the benefits from the growth in the second sale.
Outside 3rd Party:
Selling to an outside 3rd party can result in a high sale price; however, because the buyer may not know the industry, they will likely have the owner remain involved in the business in some capacity.
Selling your business to an employee is typically the most painless transition; however, employees usually do not have significant resources to purchase the business, and this could result in the lowest sale price.
Employee Stock Ownership Plan (ESOP):
This option allows an owner to cash out, and the employees of the business become owners. This option typically works for steady, cash-producing businesses. There are unique challenges with ESOPs, and they are highly regulated.
Before choosing a buyer, it’s important to understand what you want to achieve. What do you, as a business owner, want to do with your life or your career?
Your personal objectives should help define how much you need from the sale, along with the timeline of when you would like to sell the business. Four million dollars now may meet your goals. Or working hard, improving your business, and taking on the risk of time may lead to a future valuation of a larger, more attractive business worth $10 million. Neither answer is right or wrong. It depends on you.
According to a survey by Exit Planning Institute, Failing to plan for considerations beyond those of finance when planning to sell your business is the cause for 76% of business owners who exit regretting the choice a year after the sale:
Life doesn’t end after exit. Being clear on your personal and family goals and what comes after your sale is just as important as being clear on the steps needed to maximize the value of your business before a successful exit.
For more information about how we support business owners as they create business value, contact us.