There is nothing better than having buyer prospects knocking on your door eager to give you an offer to acquire your business, right? While the “dance” with buyers is exciting, you should determine before you step onto the dance floor whether the timing is right for you to sell your business.
One of the most important questions you need to answer during this decision making process is, “How much money do I need to sell my business?”
This is not an easy question to answer. It requires owners to understand their current financial situations, confirm how buyers will assess the value of their businesses, and determine what they want to do post-transaction. Talk about a life changing experience!
Understand Your Current Financial Situation
When assessing your current financial situation, many owners acknowledge that they support their lifestyles with the money they generate from their businesses. They also confirm that they would like to generate enough money from a transaction to sustain their lifestyles indefinitely without having to work somewhere else. This may mean living on the interest generated from the net cash derived from a transaction.
Given that the 30-year U.S. Treasury Rate is below 5%, owners would need to receive 20 times their annual expenses to achieve this objective. For those owners who have amassed a substantial retirement fund and have businesses that are generating positive earnings margins, this goal is certainly achievable. However, for those owners who have not yet achieved their retirement fortunes and have businesses that are barely covering their living expenses, some additional planning may be required before considering a sale.
Confirm How Buyers Will Assess Market Value and Deal Structure
Owners also tend to think of the value of their businesses in round numbers (e.g., $1 million, $2 million, etc.), typically around 1X their companies’ annual fee revenues. However, buyers do not assess value this way. They determine market value (otherwise known as enterprise value) based on a multiple of the company’s earnings (see my previous blog on how ARM companies are valued in today’s market). However, enterprise value does not necessarily mean cash at closing.
In today’s market, most buyers require sellers to accept some level of deal structure (seller’s notes, earn outs, or retained equity) because they are reasonably cautious about a company’s ability to sustain its performance post-transaction, particularly if the seller has been active in the business and is looking to retire or pursue other interests. Seller’s notes have become more popular over the past couple of years because they keep an owner interested in the performance of the business for a period of time post-transaction, and they enable buyers reduce the amount of debt financing required to pay for the transaction.
Retained equity is typically offered to owners who intend to remain active post-transaction in order to align their interests with the buyer. If there is substantial client concentration, or if a buyer’s cash offer is below what a seller needs to pursue a transaction, the buyer may try to bridge the gap with an earn-out based on future performance over a certain period of time.
While there are many factors that affect a buyer’s perspective on enterprise value and deal structure, all owners should remember that this is a negotiation process and the best way to maximize value and cash at closing is through competition – i.e. talking with multiple buyers simultaneously. Enlisting the services of a knowledgeable M&A advisor can be advantageous for owners because those specialists have access to additional pools of buyer prospects, and the existence of an external advisor shows buyers that sellers are committed to getting a deal done. An experienced M&A advisor can also provide you with information to confirm whether or not a given offer you receive is worth pursuing.
Determine What You Want to do Post-Transaction
So if you feel that you can generate a sufficient amount of annual income from your retirement funds and the sale of your business, then perhaps now is a good time to consider talking with buyer prospects. However, the other key item to address is what you intend to do post-transaction? Are you going to retire, start another business, or do something else entirely? If you are not going to retire, do you need capital for your other initiatives? Do you want to continue working for the company but in a reduced capacity? If so, what type of work do you want to do and what level of compensation do you feel you need in order to remain involved? Unfortunately, many owners wait until they receive offers and the concept of selling is suddenly very real before they address this issue. This is what causes seller’s remorse and is one of the biggest reasons why transactions get derailed (second only to unbridgeable gaps in value expectations between buyers and sellers).
Selling a business can be extremely exciting and rewarding (financially and otherwise), but it is a time consuming process with no iron-clad guarantees that the transaction process will go exactly as planned. The best course of action for owners is to begin thinking in advance about what you need (in a variety of ways) from a transaction and starting to determine whether or not you can achieve these objectives in today’s market.