Selling your business is potentially the most important thing you’ll ever do and hopefully will be the moment when you realise great financial returns from your efforts over the years. It’s the time when you actually make money from all the hard work that’s gone into building the business over the previous years.
The trick is not to mess it up: selling a business is a complex process with many moving parts and it frequently goes sour, mainly due to the unpreparedness or unreasonable expectations of the seller.
This article is part 1 of 2 that aims to briefly cover the most common mistakes sellers make, and show you how best to prepare your business so that it’s attractive to the right buyer when you’re ready to sell.
Shift happens: always be ready to sell:
In the ideal world we build a business over a period of several years and plan to sell it at a certain milestone: normally the age of the owner, a valuation target, or a certain profit target. The hard fact of owning a business is that accidents happen and people (business owners or major shareholders) are disabled or die. The other thing that happens (albeit less frequently) is that someone walks off the street and asks to buy your business. Either way, you need to be prepared to sell your business at any time, and you need to make sure that your business can be sold even if you’re the one who is dead or disabled. Life happens. Death happens. Make sure the assets of your loved ones are secured by preparing your business for sale and also making sure that you carry key-man insurance so that if any major shareholder dies the business can buy them out.
Transactions cost you time and money:
Selling a business, buying a business, or raising capital can be very expensive transactions. They take time away from running the business and also cost money in terms of specialist advisors who are there to make money by guiding you through a process and other transaction fees as money actually changes hands. The advisors will cost more money if you are unprepared simply because there is more work for them to do and you will also not know enough to stop being taken advantage of. The more preparation you can do in advance the lower your transaction costs will be both in terms of distractions and advisory fees paid. From an advisory perspective, the amount of work done to conclude a deal in the $1M range is not very different to that of a $100M deal, so advisors will charge a much higher percentage fee for smaller deals. Research I’ve seen suggests that smaller businesses pay total transaction costs of up to 25% of the deal, for deals under $500K, whereas total costs on a $100M deal are more likely 2%.
An independent valuation serves as a guide, but it’s different to price:
The goal of an independent valuation is to determine the price at which a business would change hands in a free and fair market, where a deal is concluded by a motivated buyer and a motivated seller with all facts about the business known to each party. The calculations that go into an independent valuation are useful, and it’s good to always know the current valuation of your business and use valuation as a long-term management metric. However, the actual price you get will depend on negotiation. The best possible position you as a seller can be in is where you don’t have to sell the business and probably don’t actually want to, yet have several competing parties bidding for your business. Most sales are concluded in less than ideal conditions – the business needs capital investment, the owners want to retire, someone is ill, etc. In most times this lack of preparedness leads to a buyers market, but it doesn’t have to be the case – you just need to treat your business and investment.
Treat your business as an investment from the start:
The value of a business to you is the value of the cash flows you expect it to generate for you (through dividends, expenses that it covers, or excess owners income) discounted back to today by a factor that accounts for the risk to the capital used to generate those returns. The trick to getting a fair price for your business when you come to sell it is in being able to compare how its risk/reward combination compares to other investment choices you have, or your buyer has. If you’ve treated your business as an investment from the start, then hopefully you’ve taken every step to increase returns and reduce risks. This includes employing a suitable manager and paying him/her the market rate (or paying yourself the market rate if you are that manager too). What this means is that when someone offers you X for your business, you’ll be in a immediate position to know if that deal makes sense or not. Alternatively, if a buyer asks you to justify the price you want you’ll be able to show them how your business offers better returns for less risk that other’s they’re looking at, and is thus worth more. Sadly, if you don’t treat your business as an investment then odds are that you’re not managing it like one, and when it comes to sell you wont see investment-grade returns. You’ll be lumped with the majority of naïve foolish entrepreneurs who accept a multiple of 3x PAT when you could make far more by showing the buyer how much cash your business generates and what that’s worth now.
We’ll cover another 5 tips in next weeks article. Don’t sell before then!