When to Create an Exit Strategy

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There is the old saying that the time to develop an exit strategy is the day you open for business. Sounds good, but it’s not very realistic. Further, it also isn’t very optimistic. On the day you open for business, thoughts about how you get out of it aren’t pleasant, or helpful, thoughts. However, as you get the business to a place where you have a bit of extra time to plan, you will find that the things you need to do to improve your business are some of the very things you will need to work on to plan an exit strategy.

You can’t predict misfortune, but you can plan for it. One never knows when an accident or illness will force one to sell. When the drive to your business becomes filled with dread, maybe it’s time to consider selling. The following ideas will improve your business, even if you’re not currently considering selling. Dealing with these areas will also supply the information a buyer will most likely be looking at when the time does come to sell.

Buyers want cash flow.

This, at least on the surface, is the thing a potential buyer will want to look at.

Appearances are important.

You may think everything about the business looks fine, but the two letters on the neon sign that don’t work indicate to a possible buyer that the seller may have lost interest in the business, causing them to also wonder what else doesn’t work or has been neglected.

There is probably more value than you think.

Business owners often don’t look at things that do create real value such as: customer lists, secret recipes, specialized computer systems, programs, customer loyalty programs, etc.

Eliminate the surprises.

Make sure the lease is transferable and that your landlord is willing to cooperate.  Resolve that issue with town hall.  Resolve the problem with that angry customer. Minor problems and issues will often raise their ugly heads during sensitive times, spooking a possible buyer. So, the time to resolve them is before going to market.

Five Kinds of Buyers

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Buyers are generally categorized as belonging to one of the following groups although, in reality, most buyers fit into more than one.

The Individual Buyer

This is typically an individual with substantial financial resources, and with the type of background or experience necessary for leading a particular operation.

The individual buyer usually seeks a business that is financially healthy, indicating a sound return on the investment of both money and time.

The Strategic Buyer

This buyer is almost always a company with a specific goal in mind — entry into new markets, increasing market share, gaining new technology, or eliminating some element of competition.

The Synergistic Buyer

The synergistic category of buyer, like the strategic type, is usually a company. Synergy means that the joining of the two companies will produce more, or be worth more, than just the sum of their parts.

The Industry Buyer

Sometimes known as “the buyer of last resort,†this type is often a competitor or a highly similar operation. This buyer already knows the industry well, and therefore does not want to pay for the expertise and knowledge of the seller.

The Financial Buyer

Most in evidence of all the buyer types, financial buyers are influenced by a demonstrated return on investment, coupled with their ability to get financing on as large a portion of the purchase price as possible.

Almost all the purchasers of the smaller businesses fall into the individual buyer category. But most buyers, as mentioned above actually fit into more than just one category.

© Copyright 2013 Business Brokerage Press, Inc.

Why Deals Don’t Close

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Sellers

  • Don’t have a valid reason for selling.
  • Are testing the waters to check the market and the price. (They are similar to the buyer who is “just shopping.â€)
  • Are completely unrealistic about the price and the market for their business.
  • Are not honest about their business or their situation. The reason they want to sell is that the business is not viable, it has environmental problems or some other serious issues that the seller has not revealed, or new competition is entering the market.
  • Don’t disclose that there is more than one owner and they are not all in agreement.
  • Have not checked with their outside advisors about possible financial, tax or legal implications of selling their business.
  • Are unprepared to accept seller financing or now unwilling to accept it.

Buyers

  • Don’t have a valid reason to buy a business, or the reason is not strong enough to overcome the fear.
  • Have unrealistic expectations regarding price, the business buying process, and/or small business in general.
  • Aren’t willing (many of them) to do the work necessary to own and operate a small business.
  • Are influenced by a spouse (or someone else) who is opposed to the purchase of a business.

Seller Financing: The Basics

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Seller financing has always been a mainstay of business brokerage.  Buyers don’t have the capital necessary to pay cash, are unable to borrow the money, or are reluctant to use all of their capital.  Buyers also feel that a business should pay for itself and are wary of a seller who wants all cash or who wants the carry-back note secured by additional collateral. What sellers seem to be saying, at least as perceived by the buyer, is that they don’t have a lot of confidence in the business or in the buyer or perhaps both.  However, if you look at statistics, it’s apparent that sellers usually receive a much higher purchase price if they accept terms.

Studies reveal that, on average, a seller who sells for all cash receives only about 80 percent of the asking price.  Sellers who are willing to accept terms receive, on average, 86 percent of the asking price. The seller who asks for all cash receives, on average, a purchase price of 36 percent of annual sales while the seller who will accept terms receives, on average, 42 percent of annual sales.  These are compelling reasons for a seller to accept terms.  Business brokers have long been aware that reasonable terms are necessary if sellers are serious about selling their businesses.

The primary reason sellers are reluctant to offer terms is their fear that the buyer will be unsuccessful.  If he or she should stop making payments, the seller will be forced to take back the business, hope that the buyer can resell the business, or forfeit the balance of the note.  Another reason is that sellers feel that they can do more with cash than with the receipt of monthly payments. How often do sellers say that they need cash so they can buy another business?  That is probably not the real reason, but selling their business (or house) may be the only time that they can get a “chunk of cash.â€Â  A business broker can help alleviate these fears by pointing out some of the ways sellers can protect their investment and by explaining some of the advantages of carrying the balance of the purchase price.  Equally important is how the deal itself is structured.

Let’s first take a look at the advantages to the seller of financing the sale:

  • The chances of the business actually selling are much greater with seller financing.
  • The seller will achieve a much higher price for the business with seller financing.
  • Most sellers are unaware of how much the interest can increase their actual selling price. For example, a seller carry-back note at 8 percent carried over nine years will actually double the amount carried.  $100,000 at 8 percent over a nine year period results in the seller receiving $200,000.
  • With interest rates currently low [at this writing], sellers can get a much higher rate from a buyer than they can get from any financial institution.
  • Sellers may also discover that, in many cases, the tax consequences of accepting terms are a lot more advantageous than those on an all-cash sale.
  • Financing the sale tells the buyer that the seller has enough confidence that the business will, or can, pay for itself.
  • The seller may be able to borrow some cash using the note and security agreement as collateral.  It may not be as easy as borrowing against real estate notes, but it’s still better than nothing.

What Would Your Business Sell For?

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There is the old anecdote about the immigrant who opened his own business in the United States. Like many small business owners, he had his own bookkeeping system. He kept his accounts payable in a cigar box on the left side of his cash register, his daily receipts – cash and credit card receipts – in the cash register, and his invoices and paid bills in a cigar box on the right side of his cash register.

When his youngest son graduated as a CPA, he was appalled by his father’s primitive bookkeeping system. “I don’t know how you can run a business that way,†his son said. “How do you know what your profits are?â€

“Well, son,†the father replied, “when I came to this country, I had nothing but the clothes I was wearing. Today, your brother is a doctor, your sister is a lawyer, and you are an accountant. Your mother and I have a nice car, a city house and a place at the beach. We have a good business and everything is paid for. Add that all together, subtract the clothes, and there’s your profit.â€

A commonly accepted method to price a small business is to use Seller’s Discretionary Earnings (SDE). The International Business Brokers Association (IBBA) defines SDE as follows:

Discretionary Earnings – The earnings of a business enterprise prior to the following items:

  • income taxes
  • nonrecurring income and expenses
  • non-operating income and expenses
  • depreciation and amortization
  • interest expense or income
  • owner’s total compensation for one owner/operator, after adjusting the total compensation of all other owners to market value

Here are some terms as defined by the IBBA:

  • Owner’s salary – The salary or wages paid to the owner, including related payroll tax burden.
  • Owner’s total compensation – Total of owner’s salary and perquisites.
  • Perquisites – Expenses incurred at the discretion of the owner which are unnecessary to the continued operation of the business.

Developing a Multiplier

Once the SDE has been calculated, a multiplier has to be developed. The following (just as a guideline) should be rated from 0 to 5 with 5 being the highest. For example, if the business is a highly desirable business in the current market, “desirability†would be rated a 4 or 5. If the business is in an industry that is quickly declining or nearly obsolete, “industry†would be given a 0 or 1 rating.

  • Age: Number of years the seller has owned and operated the business.
  • Terms: Is the seller willing to offer terms?  For example, will the seller accept 40 percent as a down payment with the seller carrying back 60 percent at terms the business can afford while still providing a living for the buyer?
  • Competition: Consider the local market.
  • Risk: Is the business itself risky?
  • Growth trend of the business: Is it up or down?
  • Location/Facilities
  • Desirability: How popular is the business in the current market?
  • Industry: Is the industry itself declining or growing?
  • Type of business: Is the business type easily duplicated?

The average business sells for about 1.8 to 2.5. Obviously, if the SDE is solid and the multiple is above average, the price will be higher. Keep in mind that the price outlined includes all of the assets including fixtures and equipment, goodwill, etc. It does not include real estate or saleable inventory. The price determined above assumes that the business will be delivered to the buyer free and clear of any debt.

Veteran Wisdom

When all else fails, the words of a veteran business broker will work.

Asking Price is what the seller wants.

Selling Price is what the seller gets.

Fair Market Value is the highest price the buyer is willing to pay and the lowest price the seller is willing to accept.

Sellers should keep in mind that the actual price of a small business is about 80 percent of the seller’s asking price.

Selling Your Business? Expect the Unexpected!

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According to the experts, a business owner should lay the groundwork for selling at about the same time as he or she first opens the door for business. Great advice, but it rarely happens. Most sales of businesses are event-driven; i.e., an event or circumstance such as partnership problems, divorce, health, or just plain burn-out pushes the business owner into selling. The business owner now becomes a seller without considering the unexpected issues that almost always occur. Here are some questions that need answering before selling:

How much is your time worth?

Business owners have a business to run, and they are generally the mainstay of the operation. If they are too busy trying to meet with prospective buyers, answering their questions and getting necessary data to them, the business may play second fiddle. Buyers can be very demanding and ignoring them may not only kill a possible sale, but will also reduce the purchase price. Using the services of a business broker is a great time saver. In addition to all of the other duties they will handle, they will make sure that the owners meet only with qualified prospects and at a time convenient for the owner.

How involved do you need to be?

Some business owners feel that they need to know every detail of a buyer’s visit to the business. They want to be involved in this, and in every other detail of the process. This takes away from running the business. Owners must realize that prospective buyers assume that the business will continue to run successfully during the sales process and through the closing. Micromanaging the sales process takes time from the business. This is another reason to use the services of a business broker. They can handle the details of the selling process, and they will keep sellers informed every step of the way – leaving the owner with the time necessary to run the business. However, they are well aware that it is the seller’s business and that the seller makes the decisions.

Are there any other decision makers?

Sellers sometimes forget that they have a silent partner, or that they put their spouse’s name on the liquor license, or that they sold some stock to their brother-in-law in exchange for some operating capital. These part-owners might very well come out of the woodwork and create issues that can thwart a sale. A silent partner ceases to be silent and expects a much bigger slice of the pie than the seller is willing to give. The answer is for the seller to gather approvals of all the parties in writing prior to going to market.

How important is confidentiality?

This is always an important issue. Leaks can occur. The more active the selling process (which benefits the seller and greatly increases the chance of a higher price), the more likely the word will get out. Sellers should have a back-up plan in case confidentiality is breached. Business brokers are experienced in maintaining confidentiality and can be a big help in this area.

Rating Business Buyers in Today’s Market

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Making the initial decision to sell is tough, but once that decision is made, there are many diverse options.  Small businesses are more sophisticated than ever, and the individuals purchasing these businesses are complex and come from varied backgrounds.  Here is an overview of the most active categories of business buyers in today’s market:

Groupings of Family Members

People within a business owner’s own family often opt to buy the family business. In fact, this stands as one of the more common types of small business buyers.  One reason is that business owners are more comfortable with a relative taking over the prized business, as they often built it up from nothing.  Quite often the family member looking to take over the family business has been carefully groomed and tested over the years to ensure that he or she is ready to be the true “heir apparent.”  In this kind of situation, the family member truly is the best person to buy the business.

However, there is a downside.  Family dynamics can be quite complex, and a variety of conflicts may develop.  Issues may quickly arise ranging from whether or not the departing business founder and family member can really leave the business to whether or not the new buyer actually has the funds to make the purchase.  These, and similar issues, can cause significant disruption in the transaction of the sale.  In short, families come with histories and their own, and often complex, internal issues and discord can arise.  This means that an outside buyer is often the best possible option.

When it comes to determining whether or not a family member is the right buyer for a given business, it is necessary to look at three vital issues: the ability of the family member, the financial standing of the family member and the agreement amongst the family.

Selling a Business to a Business Competitor

Business competitors are frequently overlooked when it comes time to sell a business.  Why?  Usually there is a concern that a competitor will take advantage of the knowledge that a business is up for sale and may try to attract existing customers or clients away from the selling business.  Yet, if the business meets the needs of a competing company, they may be willing to strike a very good deal in order to acquire the business and expand.

When it comes to selling a business to a competitor, a business brokerage professional can prove to be quite useful.  One reason for this is that they can use confidentiality agreements so that the name of the business being sold is only revealed after contacting the seller and further qualifying the competitor in question.

Selling to a Foreign Buyer

Foreigners love the idea of buying a business in the United States.  There are many reasons why they find this notion to be attractive.  For example, by opting for an existing business many foreigner business owners are able to bypass difficulties such as licensing, finding a job in their own profession and issues with a language barrier.  Many of these types of concerns can by circumvented, to an extent, by opting for an established entity.

Commonly this kind of buyer is accustomed to working very long hours and is already a successful business owner in his or her own right.  Yet, this does not mean that their business acumen will coincide with that of the seller.  Once more, this is where the expertise of a company can come into play.

There is one additional note to consider when selling to a foreign buyer.  Small business owners often believe that foreign companies and independent buyers will “pay big” for their business.  However, the fact is that foreign companies are usually only interested in acquiring businesses or companies that already have sales in the millions.

Dealing with Synergistic Buyers

A synergistic buyer is one that believes that a given business would stand as a perfect fit for his or her own existing business.  Part of the thinking is that by acquiring the new business, this buyer will be able to lower costs, gain new customers and incur other important benefits and advantages.  It is interesting to note that synergistic buyers often will pay more than other buyers due to the fact that they see tangible, and perhaps even immediate, benefits for making the purchase.  Similar to working with a foreign buyer, synergistic buyers rarely look at small businesses, but instead seek out mid-sized companies that meet their overall criteria.

Financial Buyers

In short, financial buyers can be quite demanding as they potentially have a long list of demands.  The bottom line for these buyers is that they want maximum leverage.  Yet, they also fall into the right category for a seller who wants to continue to manage his or her company after it has been sold.  Financial buyers frequently play “hardball” and will make an offer that is lower than other types of offers.  However, they often make non-financial provisions that could be important to the seller, such as the location of the business, the retention of key employees and a myriad of other factors.

Financial buyers are only interested in a business that is able to yield enough profits to support both the existing management and provide a return on the investment to the owner.

The Individual Buyer

The majority of sellers of small to mid-sized businesses want to deal with the individual buyer if possible.  Quite frequently these buyers are mature, ranging in age between 40 and 60, and are experienced veterans of the corporate world.  For these buyers, owning a business not only is a dream, but also it is something that they now can afford.  Understanding what this kind of buyer wants is a key component in making the deal happen.

In general, any buyer that is looking to replace an existing job is a very good prospect.  Owning a business is clearly much more involved than being someone else’s employee, and these new responsibilities and potential risks can frighten many prospects away.  Yet, this category of buyer has a deep internal need or “drive,” which may help make the deal happen.  Further, the individual buyer may approach the deal with fewer strings and other assorted complications than many other types of potential buyers.

One Final Thought

Sifting through the various potential buyers to find the right one can be complicated.  As a result, it is best to leave this process in the hands of professionals  who have the experience and know how necessary to decide on the best possible prospects.

Why Sell?

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There are a number of different reasons why selling a business can be an emotional event. The business may have been in the owner’s family for generations. The owner may have built it from scratch or bought it and then poured the necessary energy into it to grow it into a successful, profitable business. For these and many other reasons, “seller’s remorse” is actually one of the major causes of a deal falling through. However, despite the emotional ties to a business, there are times when selling is the best course to take. Here are just a few examples of those times.

Burnout

According to industry experts, burnout is a major reason owners consider selling their businesses. Over time, the long hours and 7-day workweeks can take their toll. On the opposite end, business owners who thrive on challenge may get to the point that the business has just become boring – the challenge of creating it or growing it has been replaced with the mundane daily activities of running it. Losing interest in one’s business usually indicates that it is time to sell.

No succession option

Sons and daughters may be disenchanted with the family business by the time it’s their turn to take over. They may have their own dreams to fulfill that do not include the family business.

Unexpected circumstances

This is the number one reason a business owner should make plans about selling even if he or she is not planning to sell for many years. A good question for a business owner to ask is, “If an unexpected circumstance should occur tomorrow that would require me to sell my business, what would I wish I had already done?†Unexpected events include such things as accidents, illness of owner or family members, divorce, and partnership issues. Unfortunately, these events are seldom predicted, and too many times, a forced sale does not bring maximum value.

Need to cash out

The need to cash out may be caused by an unexpected circumstance, such as a costly accident or illness. Many company owners have much of their personal net worth invested in their business. This can present a lack of liquidity. In such situations, an owner in need of additional cash has two options: borrowing against the assets of the business or selling the business.

Outside pressure

Successful businesses create competition. There are times when a business owner discovers that the competition has built to the point where it is easier to join it than to fight it.

An “out of the blue” offer

There are times when a business may not even be on the market, but someone or some other company sees an opportunity and makes an unexpected offer. This may be a great time to sell as the owner is likely entering the negotiations from a position of strength.

There are obviously many other reasons why businesses are sold. The most important factor is that the owner is convinced that it is time to sell and has a clear understanding of his or her reasons. And, whether that time is now or many years in the future, the wise owner will consider the following: “The time to prepare to sell is the day you start or take over the business.”

Is It a Good Time To Sell Your Business?

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It is no secret that the recent economic conditions have had a significant impact on most privately-held businesses over the past year or to. Not surprisingly, these same challenging economic conditions have also had a negative impact on merger and acquisition (M&A) activity. Thankfully, many privately-held businesses are beginning to see stabilization within their industries if not the beginning of a slow recovery. As a result, M&A activity appears to be on the rise. This is a good sign for all business owners, but particularly for those who are contemplating retirement in the next few years. Even so, there are a number of factors that impact the structure, timing, and valuation of a business sale. This includes the quality of the business, the number of qualified buyers, and the availability of financing.

Current Environment

Business quality – The quality of a business is still a key factor for attracting buyers. Now more than ever, acquirers are attracted to profitable companies with strong gross margins, loyal customers, tenured employees/management and attractive growth potential.

Many companies have been cutting costs to improve profits, but cost cutting has its limits. Once costs are optimized revenue growth is going to be the engine that impacts profitability. For example, we have seen businesses that have maintained their customer base over the past couple of years and have even gained new customers. Although their overall revenue and average revenue per customer is down from previous years, it is expected that the pent up demand from these customers will have a significant impact on future profitability as the economic environment improves.

Availability of qualified buyers – Some prospective acquirers perceive the current economic climate as an opportunity to expand or diversify their own business. And while some business owners believe that the only buyers right now are bottom feeders, this is definitely not the case. EBITDA multiples have decreased somewhat since 2007 according; however, strong companies are still being fully priced – because the demand for high-performing companies is definitely higher than the supply. In our own practice, we are currently negotiating deals that have multiple interested buyers.

In addition, private equity groups have cash to spend and are looking for opportunities. The amount of capital available for investment from U.S. private equity groups is at an all-time high with a gap of $400 billion between the amount of funds raised over the past few years and the equity invested.

Finally, some companies/industries have become even more attractive because they have proven their ability to perform well during the economic downturn. Health care, technology, and certain manufacturing companies are all enjoying this kind of increased attention.

Financing – Acquisition financing is more difficult to obtain than it was two years ago, but transactions are still getting done as lenders seek to finance deals that make sense. However, lenders are being more particular when it comes to approving buyers. They are looking for buyers who have relevant experience, a clear business plan and collateral assets.

Positive trends are important, and some lenders are interested in seeing a full-year on the books in 2010 – with improved performance over 2009 – before they will approve financing. In some cases, transactions may require more seller financing than was required in the past, so factor this into your planning. Even so, your goal should be to be substantially cashed out at closing.

Going Forward

The time to sell is when the business is steady or growing, the employee base and/or management team is stable and (perhaps most importantly) when an owner is ready based on his or her personal and financial objectives. This means sellers should understand what the market may be willing to pay for their business, and should plan ahead with a professional adviser to help determine the best time to sell.

Waiting a few years as the economy continues to recover is a valid strategy if the owners have a longer term retirement horizon. However, this may be an ideal time for planning an eventual sale. Business owners cannot control the external economic environment, so they should focus on the internal factors that can make a business more attractive. These factors include management succession, diversification of revenue, competitive or strategic advantages, opportunities for growth, asset base, and transparent financial records among others.

Trends are important when determining the right time to sell. If you do not have a system for tracking certain metrics and trends then this is a good time to implement one. Positive trends can demonstrate predictable or recurring revenue streams, and the ability to track such trends on a quarterly or even a monthly basis can be very valuable. The exact metrics to track depend on the type of business, but in general you should have the ability to track sources of revenue by customer, product/service and geography, as well as detailed costs and any other metrics that may be unique to your particular industry.

If you are contemplating a transition –  structuring a buyout by employees, or selling it to a third party – you should be asking and answering a host of specific questions. In our experience, we have realized that planning ahead and following a well-executed process can increase the value of a business by 10-30%.

I invite you to contact us if you are interested in planning a future sale. Our conversation will be strictly confidential, and I am sure it will be worth your time.

Sales Price vs Asking Price

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A recent survey by BizBuySell, using their data, makes for not only interesting reading, but is very informative. BizBuySell, one of the leading websites which list businesses for sale, is providing a valuable service to all sellers by providing this date.

One  figure is significant because it bears out a figure from other sources. The chart in the BizBuySell report on small business sales price versus asking price came out at approximately 84 percent for 2011, just about the same as many other indexes.  This is a very valuable statistic. The BizBuySell report represents thousands of sales and therefore the percentage of asking price versus selling price is very meaningful.

When an offer is presented to a seller and is only 20 percent less than the asking price, the information in this report can help make a deal. And, certainly if the offer is only 10 or 15 percent less than the asking price, the results of thousands of closed deal should make a seller grab the deal. It’s pretty hard for a seller to argue with thousands of sales. What this figure strongly suggests is that businesses are listed for about 15% more than what they are really worth in the market place.