How To Avoid Disappointment When It's Time To Cash Out

How do you avoid not being disappointed with the money you make from the sale of your company?

Perhaps you’ve heard that companies like yours trade using an industry rule of thumb or that companies of your size sell within a specific range, and you want to get at least what your peers have received.

While these metrics can be useful for tax planning or working out a messy divorce, they may not be the best ways to value your company.

The Only Valuation Technique That Really Matters

In reality, the only valuation technique that will ensure you are happy with your exit is for you to place your own value on your business. What’s it worth to you to keep it? What is all your sweat equity worth? Only when you’re clear on that will you ensure your satisfaction with the sale of your business.

Take Hank Goddard as an example. He started a software company called Mainspring Healthcare Solutions back in 2007. They provided a way for hospitals to keep track of their equipment and evolved into a slick application that hospital workers used to order supplies.

Goddard and his partner started the business by asking some friends and family to invest. The business grew, but there were challenges along the way: Goddard had to fire his entire management team in the early days, product issues needed to be solved and operational issues needed to be resolved.

At times, it was a grind, so when it came time to sell in 2016, Goddard reasoned that he had invested more than half of his career in Mainspring and he wanted to get paid for his life’s work. He also wanted to ensure his original investors got a decent return on their money.

He was approached by Accruent, a company in the same industry, who made Goddard and his partners an offer of one times revenue. Accruent had recently acquired one of Goddard’s competitors for a similar value, so presumably thought this was a fair offer.

Goddard brushed it off as completely unworkable. Goddard had decided he wanted five times revenue for his business. Even for a growing software company, five times revenue was a stretch, but Goddard stuck to his guns. That’s what it was worth to him to sell.

A year after they first approached Goddard, Accruent came back with an offer of two times revenue and, again, Goddard demurred.

Mainspring had developed a new application that was quickly gaining traction and he knew how hard it was to sell to the hospitals he already counted as customers.

He told Accruent his number was five times revenue in cash. Eventually Goddard got his number.

Being clear on what your number is before going into a negotiation to sell your business can be helpful when emotions start to take over. Rather than rely on industry benchmarks, the best way to ensure you’re not disappointed with the sale of your business is to decide up front what it’s worth to you.

Which is Better, a Financial Buyer or Strategic Buyer?

If you decide to sell your business to an outside acquirer, you’re going to have to decide between a financial and a strategic buyer—understanding the different motivations of these two buyers can be the key to getting a good price for your business.

A financial buyer is acquiring your future profit stream, so they will evaluate your business based on how much profit it is likely to make and how reliable that profit stream is likely to be. The more profit you can convince them your company will produce, the more they will pay for your business.

But there is a limit to how much they will pay, because financial buyers are playing the buy-low, sell-high game. They do not have a strategic rationale for buying your business. They don’t have an army of sales reps to sell your product or a network of retailers where your product could be merchandised. They are simply trying to get a return on their investors’ money, so they tend to buy small and mid-sized businesses using a combination of this investment layered on top of a pile of debt, and they want to buy your business as cheaply as possible with the hope of flipping it five or ten years down the road.

Because financial buyers are usually investors and not operators, they want you and your team to stick around, so they rarely buy all of a business. Instead, they buy a chunk and ask you to hold on to a tranche of equity to keep you committed.

A strategic buyer is a different cat—usually a larger company in your industry, they are evaluating your business based on what it is worth in their hands. They will try and estimate how much of their product or service they can sell if they added you into the mix. Because of their size, this can often lead to buyers who are willing and able to pay much more for your business.

Tom Franceski and his two partners had built DocStar up to 45 employees when they decided to shop the business to some Private Equity (PE) investors. The PE guys offered four to six times Earnings Before Interest Taxes Depreciation and Amortization (EBITDA), which Franceski deemed low for a fast-growing software company.

Franceski was then approached by a strategic acquirer called Epicor, which is a global software business with a lot of customers who could use what DocStar had built. Epicor offered DocStar around two times revenue—a much fatter multiple than the PE firms were offering.

How Do I Begin Planning My Exit?

Business owners frequently approach exit planning much like a new fitness routine. They know it is necessary, but it always seems to be something that can be put off until tomorrow.

For the Baby Boomers, tomorrow is already here. Business owners who were born between 1945 and 1964 make up 25% of the population, but own over 60% of the small businesses. This is the result of their surge into the job market in the 1970s, and the lack of room in corporate America to absorb a much larger and better educated employee population. From 1975 until the middle 1980s, Baby Boomers opened new businesses at a rate never seen before, and not duplicated since.

Today, over 5,000,000 Baby Boomers are preparing for retirement. Just as when they all went to college, started new businesses, and became prolific consumers, they will create a flood of small business sales in the United States.

The generation that is now reaching ownership age is much smaller, and less inclined to entrepreneurship than the boomers. They are also being hotly pursued by corporate America, which needs to replace their retiring generation of Boomer managers and executives. These three factors combine to create a “perfect storm” of competitive pressures when marketing a small business for sale.

Exit planning is quickly becoming a buzzword in the legal and financial communities. Although boomers are healthier than prior generations, they will all retire eventually. Tens of thousands of professional advisors are positioning themselves to provide tax, risk management, wealth management and contract preparation services to this flood of sellers.

The most effective and efficient approach to exit planning is to select a single professional who can manage all the others in the process. Creating new entities or sale agreements is pointless unless the tax implications are first understood. Planning to reduce the impact of income taxes may be rendered moot if a company is not in position to sell. Putting the company up for sale may be a disaster if an owner doesn’t understand what buyers are looking for, and how much they’re willing to pay.

An effective and lucrative exit plan frequently takes up to five years to plan and execute. It starts by examining the strengths and weaknesses of the business, IT systems, management team, and customer base. With that information, you can realistically set expectations about who a likely buyer might be and how much you will realize after taxes. If you would like to have a preliminary conversation about starting your exit planning process, please contact us. 

 

© 2014, MPN Inc.