Most successful entrepreneurs and business owners are great at negotiations and sales, but few are well equipped when it comes to selling their business. They can become overwhelmed by the process which can lead to some very costly mistakes. While selling a business can be daunting, the process can be managed with the right amount of preparation and guidance.
Where to Begin
The first step is to ask yourself why you even want to sell. Before you get too far into the process, examine your reasons for selling. You don’t want to make a decision that you will later regret. There are many reasons to sell a business including:
- Retirement – one of the best reasons to sell a business;
- Lack of operating capital – usually results in selling the business in a hurry and at a valuation discount;
- Lack of growth capital – can be a good reason if the business is profitable and you can still dictate the sales terms;
- Burnout – might want to consider taking some time away first (even a four or five day getaway trip) to think of ways to reduce stress before selling simply because you are burnt out;
- Boredom – business is no longer a challenge or exciting;
- Partnership issues – irreconcilable differences;
- Divorce – a very difficult situation if spouses have been working together;
- Declining business – identify the reason why…new owner can possibly fix;
- Too many assets tied up in the business – might be ready to diversify risk;
- Lack of time for family and friends – “no one ever said on their deathbed that they’d wish they’d spent more time at the office”;
- Health – usually not a good time to sell, but all too often this is the reason; and
- Regulations – business does not have the critical resources to manage.
You should have a well thought out reason to sell your business. Selling for the wrong reason hurts the seller on multiple counts. For one, you are subject to receiving a below market purchase price for your business. Frequently, this also means that your future options are limited by your age and financial situation. You might wind up selling without getting enough money to retire on and then needing to seek employment where you’re making a lot less than if you had simply kept the business! In any case, if you are convinced that your reason to sell is viable, the next key step is to get started.
Who Are the Buyers and Why Do They Buy?
A seller needs to first understand what type of buyer the business can be sold to. Each buyer type has its own objectives and preferences which needs to be considered when constructing a buyer list. There are seven categories of buyers that may be interested in your business including:
- Competitors/suppliers/customers;
- Individual investors;
- Investment groups (i.e. private equity firms);
- Public companies;
- Foreign buyers;
- Employees; and
- Family members.
Once you know which buyer category you are dealing with, you need to think like a buyer so you can sell your business at a valuation premium. From a financial perspective, the buyer will be looking for the following key results from the purchase price:
The one thing that all buyers want is to maximize their ROI. In very simple terms, the ROI is calculated by dividing the net annual return from the investment by the dollars invested. However, this calculation is anything but simple when it comes to the sale of a business.
The Components of ROI
The buyer wants the highest ROI which implies paying as low a purchase price as possible, while the seller wants to maximize the sales price. Since the buyer is looking to maximize the ROI, it is useful to understand what the key components are. These components include the cost of money, the degree of risk, greed, liquidity and future expectations of profits.
- Cost of money -The cost of money has an inverse relationship with the denominator in the ROI calculation. As the cost of money rises, profits fall and earnings multiples also decline. A lower cost of money leads to higher profits and higher earnings multiples. Interest rates for the cost of money are set by the government and market forces.
- Degree of risk – The more risk that is perceived by the buyer, the higher the expected return will be. If your revenue and earnings have been erratic in recent years, the buyer may perceive the purchase of your business to be a higher risk than it would be to buy one with stable sales and profits. If so, the buyer will likely demand a higher return (which means a lower price).
- Greed – Pure greed may motivate the buyer to try to drive the price down.
- Liquidity – The easier it is to convert an investment into cash, the lower the expected ROI and the higher the earnings multiple. In other words, a potential buyer is going to expect a much higher return buying your business than he could get putting the same amount of money into treasury bonds.
- Future expectations of growth and profit – The buyer will be more likely to pay a higher multiple of earnings for a company that has a believable forecast.
Now that you understand how buyers assess targets within the context of ROI, I will explain how companies are typically valued, the importance of recasting your numbers, and how the deal structure is put together. These three topics are explored in Part 2 of One Chance to Get It Right.