10 critical factors to evaluate before selling your small business
Chris Younger, author of “Harvest: The Definitive Guide to Selling Your Company,” will give it to you straight: “Every entrepreneur will exit their business, either vertically or horizontally.”
He explains that the options are limited. If you aren’t passing the company on to family or employees, you’ll sell it, shut it down, or leave it to be liquidated with your estate.
“Sale has the potential to be a rewarding choice,” he says. “How rewarding, personally and financially, will depend on how well prepared the owner is for the sale process and what comes after.”
Kevin Trout, who sold his medical equipment distributorship at an opportune moment, agrees. “There’s a lot to selling a business,” he says, “so the sooner you start planning, the better.”
In their opinion, most business owners wait too long to think about an exit strategy. For better results and greater flexibility to deal with whatever may come, entrepreneurs should continually evaluate their companies’ market-readiness.
What factors are there to consider? Here’s a top 10 list to get you started.
1. When to sell
Younger says three aspects affect sale timing. Most business owners he’s worked with as an investment banker come in asking about economic conditions.
But, he says, “it’s almost impossible to time the market perfectly. Even if things look great today, when a company reaches the market six or nine months later, conditions could be completely different.”
He suggests focusing on two other factors, over which the entrepreneur has greater control. Personal timing, which may take into account age, health, financial expectations, family demands, and interests beyond the company, should play a large role in the decision.
Also important is business timing. Preferably entrepreneurs will sell after a period of steady growth, well before a company has plateaued or the owner has grown tired or frustrated.
2. The “number”
When looking at finances, Trout suggests working backward. “Rather than start by asking what your business is worth, ask ‘What do you want your lifestyle to be?’” he says. “Go from there to make sure there is enough money as the result of the sale to support your lifestyle of choice.”
A financial planner is a valuable resource, according to Younger. “A professional can help you evaluate your current ‘burn rate’, the cash you require each month just to live, along with your desired level of discretionary spending. They can also help you determine how different discretionary spending assumptions affect the number you need to exit, so you can settle on a realistic target, based on the company’s current value and your preferred timing.”
3. The first year after
Many business owners view a sale through rose-colored glasses, only to find themselves lost, unmotivated or downright depressed within a few weeks or months after letting go.
“It’s a little bit like being shellshocked,” Trout confesses. “Owners are so wrapped up in the details and the minutiae of due diligence, they haven’t given much thought to what retirement is going to look like.”
Unfortunately, if you don’t think about it until the day after closing, he says, “it’s already too late. You’re likely to fall into a funk.”
To avoid this outcome and ensure you’re selling your company for the right reasons, Younger recommends mapping out the first 12 months after the sale. “The plan should include goals, objectives, and major activities, like travel,” he says.
Don’t stop there. Make a similar outline of what life would be like if you continued to own the company, then compare the two. Ask the tough questions.
Would a year of mostly playing golf be truly satisfying? Or would you be happier fitting in a two-week golf vacation and then coming back to your team?
4. The search for meaning
If the one-year plan is about managing the emotions that inevitably accompany a sale, a long-term plan is about maximizing what Trout calls “quality time remaining.” He pushes exiting entrepreneurs to contemplate the big question, “What are you going to do with the rest of your life?”
Consider mental engagement, physical engagement, and your plan for giving back. “We owe it to society as a whole to give back in some area that we are passionate about,” he opines.
Trout found his opportunity in executive coaching, helping other leaders achieve their maximum potential so they can positively influence others as well.
Younger agrees that entrepreneurs are, by nature, builders. When the time to build this company is over, most will need to know where they can contribute next, whether that’s by founding another enterprise, engaging in charitable activities, or teaching at the local college.
“Understanding in advance how a sale contributes to your larger mission will ease the transition,” he says.
5. The team
With an understanding of why you are selling and when it might make sense to do so, you can start looking more closely at the sale process. The first step should be to assemble experts to guide you.
“We can have the greatest positive impact if we are brought to the table early, even years before a target sale timeframe,” says Younger, referencing his team at Class VI, a family of companies that includes pre-transaction advisory services and an investment bank.
“By performing our own due diligence on the company well in advance, we can identify and resolve issues that will otherwise cause problems during a sale — sort of like getting the test ahead of time. That translates into higher valuations and a less stressful process for the owner and team,” he adds.
In addition to an investment bank or business broker, a full team will include an attorney, preferably one specializing in mergers and acquisitions, as well as an accountant, financial advisor, and other specialists such as tax and insurance professionals.
“The misconception is that all you need is your attorney and your financial planner. I think that’s completely inaccurate,” says Trout.
6. The valuation
We referenced above the “number” needed for an exit, and many business owners will initially rely on rules of thumb, such as the multiple of revenue or EBITDA common in their industry, to get a general sense of what the company is worth.
Before proceeding to market, however, it’s essential to get a more formal estimate, based on recent comparable sales in the private markets and values of publicly traded companies in the industry.
Almost every business broker or investment banker will offer a valuation estimate in initial conversations. Younger offers a word of caution: “Beware of the ‘big number sales tactic.’”
Some brokers and investment bankers will float a high valuation as a form of flattery, in an attempt to win your business. “This is a time when honesty matters most,” he says. Interview potential advisors and ask them to defend their estimate with data, so you aren’t disappointed down the line.
You also need to consider the importance of deal structure, Younger advises.
“Even if the purchase price is $50 million, you will not likely get all $50 million in cash at closing,” he says. “Some might be placed in an escrow, some might be based on future performance, and some might be in equity of the buyer.”
The structure can make a big difference in the financial picture, says Younger.
Potential buyers will examine your company from top to bottom, so be sure that everything is shipshape. Compile financial reporting, contracts, and other documentation.
Did you trademark your brand elements or patent your technology? Be prepared to prove it.
A pre-sale cleanup is about more than paperwork. Take a hard look at your storefront, offices or other facilities, as well as your equipment. Is there anything that needs to be upgraded, repaired, or removed?
A complete makeover may not be possible, but it’s typically worth investing some time, energy and even money in a touch-up.
“I like to use the example of going to a Michelin 3-star restaurant. Imagine sitting down for a great meal and noticing a dried piece of pasta stuck to your knife. No matter how good the food is, your overall impression will be negatively affected,” Younger adds.
8. Risks, growth and positioning
Younger has developed a simple recipe for maximizing company value at sale. First, reduce risks, like poor financial controls that will give buyers pause. (Younger has developed a list of more than 90 of these issues collected throughout more than 100 transactions.)
Then build a credible growth plan, backing it up with performance that hits the projections right up to closing day.
Cap it all off with the right positioning. “Tell the story about what makes your company unique, and uniquely valuable to buyers,” recommends Younger.
As part of this story, you may need to position around remaining risks or problems that couldn’t be fully resolved in the lead-up to the sale. With transparency and a good head for messaging, you can minimize these issues’ effect on your purchase price.
9. Communications plan
Confidentiality is the watchword until the sale is final.
“Sometimes it’s necessary to include members of the senior team in the process or to allow a buyer to contact a customer or supplier very late in due diligence,” Younger says. “But otherwise, it’s best not to mention a transaction to employees, customers, suppliers or other stakeholders until the ink has dried on the closing papers.”
This not only prevents anxiety during an already fraught time, but it also protects against the effects should the deal fall through.
Wait to tell others but don’t wait to plan how you will inform them about the change. What questions are most likely to come up and how will you address them? Another tip from Younger is, “Make sure you’re on the same page with the buyer on the messaging.”
Also prepare for the chance that word does leak. How will you manage the fallout and answer their concerns?
Before going to market, familiarize yourself with the entire process, from bidder list development and marketing outreach through due diligence and purchase agreement.
Fortunately, if you’ve followed the points above, you will have in place a personal vision and a team to guide you through each step.
Be aware, the typical transaction takes six months or more to complete. The process is always stressful and emotionally draining, so gird yourself for the long haul.
Preparation helps prevent poor outcomes. Younger says that “if you’ve done the up-front work, things with most likely turn out well.” Nonetheless, don’t expect perfection.
“I wish I knew then what I know now,” Trout says, even though he’s satisfied with his deal. Younger also admits that owners will usually need to give a little in negotiations.
He stresses the importance of the big picture — be pleased with the $10 million payday rather than disappointed you didn’t squeeze a few more dollars out of the consulting agreement with the new owner, for example.
Some jitters are natural as closing day approaches. But if you can revisit your plans for life after the sale and feel the excitement, anticipation and comfort in your financial security, you can take the final step with confidence knowing that the next chapter of your story will be a happy one.
Life After the Sale [Vistage Perspectives magazine]
Planning your business exit: Asset protection for the sale [Webinar on demand]