By Joy Jordan
Many people dream of owning their own business, and see it not only as a way to gain autonomy in their professional life but to establish a legacy and provide a nest egg. Often those with an entrepreneurial streak have big ideas and launch a business from scratch. Others choose to buy an existing business to build their empire. And whether you started your business yourself or purchased it, at some point you may want to sell.
The issues surrounding buying and selling a business are complex and interconnected. As part of our business conference series, we have brought together experts who can share their insight about the planning, preparation, and thoughtfulness that should go into buying and/or selling a business.
One theme that emerges is that it is never too early to starting thinking about these issues.
Chris Bond is Area Director for Murphy Business, a business brokerage firm in Franklin. When asked when business owners should start planning for the sale of their business, he said, “On Day 1 … or as close to that as reasonably possible. Whenever you start, be sure to look at it through your future buyer’s eyes.”
It’s important to take a wide view of your business, with an analytical eye, says Chris Mellen, Managing Director at Valuation Research Corporation. “Understand the value drivers of your business, focusing on those factors that help improve revenues, reduce expenses, and reduce risk. Prepare to be ready for sale when the economy and industry are growing, deal flow is high, the company is approaching maturity.”
Mellen also encourages a long view in terms of timing, ideally at least three to five years before you’d like to sell it. “This will give the business owner time to make improvements to the business so that it will sell more quickly, at a higher price, and for better terms.”
Beth Davis, founder of Planning What’s Next Reinvention Coaching, advises to always keep the end in mind.
“I always suggest planning to sell when you start the business − if you know what your end game is, you’ll have a better idea of how to grow,” says Davis. “On another note, planning annually allows you to get systems in place and have re-cast financials available in case someone inquires about your business.”
As a consultant specializing in enhancing performance in business and sport, Cynthia Adams Harrison, Ed. D., LICSW, owner of Adams Harrison Performance Consulting, focuses on the emotional connection an owner might have for his/her business as well as the organizational and employee impact − both are always important to the owner, whether or not they are completely aware of it.
“Any owner wants to maximize the return on their investment in their business and this takes planning and a solid exit strategy,” says Harrison. “Planning should start 36 to 48 months before an owner solicits buyers. Organizational health, employee satisfaction, and high morale add to the value of the business just as much, if not more, for the buyer as the P and L. Making necessary adjustments to enhance your organization’s health will benefit the owner and the employees. Getting sound advice from financial and organizational experts is well advised.”
Terence Shepherd of ROCG specializes in exit strategy planning for small and medium sized businesses, and his advice is that it’s never too soon to plan for sale.
“The industry’s general recommendation is a minimum of two to five years. But like retirement investment planning, the longer the timeline to plan and implement, the better the results,” says Shepherd. “I don’t think it’s ever too early to plan. I’ve worked with companies with 10-year-plus horizons, which helps ensure that their personal goals and financial objectives are met both while running the business and upon sale.”
What are some of the biggest mistakes owners make when selling their business? It’s important to be realistic about value, have complete information, and be ready to analyze it in detail.
“Value expectation is the single biggest issue and yet there is a simple fix: whatever you want to sell your business for, just ask yourself if you’d pay that number,” says Bond. “Most owners have to admit they wouldn’t.”
There are myriad possible missteps when preparing a business for sale, according to Mellen:
- Inadequate advanced planning.
- Not understanding company value drivers.
- Not being aware of all exit options available to the owner (e.g., sale to strategic buyer, sale to private equity, internal sale, ESOP, etc.)
- Not having a vision of the company’s short- and long-term growth potential.
- Selling when the owner has to sell as opposed to when the owner wants to sell.
- Not getting proper advice from a team of experts as outlined in the response above.
- Losing focus on running the business while trying to sell it.
- Not getting proper confidentiality agreements and procedures in place.
- Being ill-prepared for due diligence.
- Letting emotion get in the way of rationale decision-making.
- Not entertaining multiple offers.
- Being inflexible in negotiating deal structure and terms.
While it’s fine to have big goals for the sale of your business, it’s important to be realistic and flexible as well.
Davis notes that one mistake that can quickly derail a deal is price inflexibility on the part of sellers.
“They get a number in their head and then don’t budge. Also, they don’t have any idea of what they will do after the sale and then they sabotage the deal for what seems a very small amount of money.”
The pride an owner has in the business they’ve built can sometimes lead to unworkable assumptions of value – all of which can be tied in with the owner’s ego.
“One of the most common errors I hear about is unrealistic expectations about what the business is worth,” says Harrison. “Owners are so tied to their businesses for many good reasons, but often so are their egos. Obtaining trustworthy expert advice is essential to an effective sale.”
“Selling your business can be an arduous process and often comes with a variety of emotions for not only the owner, but also for their family,” Harrison adds. “A spouse may feel excited about spending more time with you and you may worry about how to secure the wealth for future generations. Creating an exit strategy that includes planning for the family’s future after the sale can be missed.”
It really all comes down to proper planning – both on the financial side and the emotional side.
“For a lot of business owners, they think it’s just the one-time sales transaction versus the process it really is and should be,” says Shepherd. “It’s about the transition of both ownership and management. Buyers are purchasing future cash flow. With the owner gone, are the earnings sustainable without him? Is someone trained to run the business or are there documented systems and processes that a new owner can easily follow? These questions are really connected to understanding the metrics of business value and my experience shows that most small business owners do not sufficiently understand them. The result? Money is left on the table.”
Buying a business
If you are buying a business, what are the most important things to know?
“That you shouldn’t take it the wrong way when a broker and/or seller is highly suspicious of your willingness and ability to actually complete a deal,” notes Bond. “Most buyer prospects talk themselves out of the deal somewhere along the way, most for good reason. It’s a rare soul that has the gumption, financial cushion, and wherewithal to own and operate a small business.”
Again, research and preparation is key, says Mellen. “Complete a thorough due diligence on the seller (see below), assemble a solid team of advisors, understand your company’s management and financial capabilities, make sure buyer expectations align with acquiring the target, negotiate for a win/win not for just a win, and make sure the acquisition is accretive to shareholder value.”
According to Shepherd, there are some key questions that should be asked when buying a business:
- What are the dependencies? Does revenue have a high reliance on one or a couple of customers? Employees? Suppliers?
- Are systems and processes documented and easy to follow?
- Are the owners proven management metrics documented?
- Are revenue and cash flow sustainable? Is there expanded market opportunity?
For a deal to be truly successful, it needs to be a good match for both the seller and the buyer. Harrison advises considering those issues as well.
“Is this a true match for the buyer? Evaluate all aspects of the business, history, liabilities, employee loyalty to the owner and ability to transition, organizational structure and most importantly, inherent operating core values,” says Harrison. “After a sale, transitioning the business under new leadership is a challenge. Synergistic and cohesive core values for both the seller and the buyer are important for the success of the transition.”
Doing due diligence
What sort of due diligence should you do before the purchase?
“Do what Chip and Dan Heath call ‘ooching’ – try out the business before committing to a purchase,” says Bond. “Intern, volunteer, take a part-time job – something/anything that’ll help you ‘ooch’ (trial period) your way to a good decision.”
As noted above, Mellen recommends a complete and deep review of a variety of data: “Analysis on the company’s operations, financial records and statements, marketing, customer mix, corporate culture, human capital, employee benefits, management team, agreements with and obligations to existing shareholders, environmental matters, existing and potential lawsuits, regulatory matters, risk exposure, intellectual property, etc.”
Shepherd’s advice? Trust, but verify.
“Get documentation for the items listed above,” says Shepherd. “Verify financial information presented in the offering memorandum. Talk to key management personnel (if the owner has made them aware of a pending sale and the future opportunity for them − depending on the circumstance, this may be a negotiating point with the owner if he hasn’t made disclosure and management retainage is critically important). Talk to key customers.”
In addition to research, Davis recommends developing the relationship as well.
“It’s great if there can be a partnering arrangement in advance to really get to know each other. If that’s not possible, understand what you’re buying (i.e., the cash flow, the client list, special systems or technology, a geography), and know the value of that to you and the ROI you are looking for.”
Your due diligence should not only cover numbers and reports, but also the more esoteric aspects of a company such as culture and mindset.
“Understand the culture and employee satisfaction of the business and what the motivation is of the owner to sell,” suggests Harrison.
“Are they ready to retire and move on to other adventures and the sale allows them to move forward, or are they tired and frustrated with the responsibility that comes with ownership? Many times an owner disengages from the business long before they make the decision to sell. Interview employees to assess the health of the organization and employee morale. Be aware of hidden resentments, obsolete business practices, compensation issues, and other liabilities.”
How can sellers and buyers ensure a smooth transition in the sale of a business?
“With some exceptions (e.g., an industry purchase),” notes Bond, “folks should plan on two months to two years of some sort of baton handoff.”
A long transition and input from advisers can benefit all parties, says Mellen. “Preparation, communication, and advice from a qualified team of experts. Buyers should consider having the sellers stay on for a period of time.”
Those experts can help guide you through a transition and avoid stumbling blocks.
“The best words of wisdom to offer is to know where your expertise begins and ends and don’t be shy about getting the advice and resources you need to be successful,” says Harrison. “Selling and buying businesses is not always consistent with the skill set required to lead them.”
As with most interpersonal dealings, communication is tantamount to getting a good result.
“Communicate a lot,” says Davis. “Talk about your values, legacy, future direction − all to be in sync about your priorities for the sale.
Planning for sale
We asked the experts: If you are a business owner, what should you know about any eventual sale of your business?
Chris Bond, Murphy Business “That it’ll be a long, complicated process riddled with frustration. Other than that, it’s very rewarding!”
Chris Mellen, Valuation Research Corporation “The owner wants to be proactive, not reactive. In planning for the sale, it is important that the owner assembles a team of qualified and experienced professionals that may or may not include their current advisors. This team of experts includes a valuation specialist with experience in valuing companies for M&A who can provide a range of values and an explanation of value drivers; a CPA with expertise in transaction tax who can map out the tax ramifications of the transaction; a transaction attorney (this is typically not a real estate attorney); a wealth manager who can manage the owner’s money after the deal closes; and a business intermediary (broker or investment banker) who will create a market of several potential buyers.”
Beth Davis, Planning What’s Next Reinvention Coaching “PLAN for it!! Know what makes a business in your industry attractive to potential buyers.”
Cynthia Adams Harrison, Adams Harrison Performance Consulting “One consideration that often gets overlooked is an owner’s emotional readiness to sell their business. After many years of building their businesses owners don’t anticipate the emotional toll selling a business can take. Selling a business is a loss, regardless of the motivation to do so. Owners need to expect that they will have to ‘grieve’ this loss. Understanding that this is a normal reaction is a part of selling your business.”
Terence Shepherd, ROCG “The more important question is not what the sales price is but what’s the net going to be after taxes. With effective tax strategy planning in advance a smaller sales price could yield more than a similar company sold for more.”
“After an owner sells their business, and assuming they are not retained, they will have a whole lot of time on their hands to fill. Many times I’ve heard, ‘Bring it on, that’s what I want,’ but people are shockingly surprised after of the huge void that needs to be filled. Business owners are identified with who they were in business, now how will they be recognized? The purpose and fulfillment they got from being part of the business is gone. It’s easy to see why there is a depression rate of over 60 percent within the first three years of retirement. For business owners, it comes a lot quicker. The solution to all this is awareness before the sale and advance planning. Business owners need to be warned and then take steps to plan what comes next in the next stage of their life so they have something to go to versus leaving something behind.”
How can you best evaluate the value of a business?
Chris Bond: “A reasonable multiple of its discretionary cash flow.”
Chris Mellen: “Valuation involves both a quantitative and a qualitative assessment of the business. This involves gaining an understanding of how the economy and underlying industry impact the business, the value drivers of the business, a SWOT analysis, the company’s historic financial performance, one to three forecast scenarios, etc., to develop a solid discounted cash flow analysis and a proper market multiple analysis.”
Beth Davis: “Have a professional valuation performed.”
Terence Shepherd: “Understand where the current transaction market is at. Looking at sales of companies in the same industry and/or revenue size, will provide you with a range of multiples on EBITDA (earnings before interest, tax, depreciation and amortization), revenue, and Seller’s Discretionary Earnings. Then assess the risks via the analysis referred to throughout the article and determine if the target company operates on the lower quartile range of the average transaction or the upper range. Absent any valuable proprietary assets or unique circumstances, the exercise will give you a great starting point with a realistic range of the current market value.”