Preparing your Business for Sale
Business Owners Eyeing Sale Need to Plan Years Ahead to Ensure Smart Transitions
We are at the start of a great transition in business ownership in North America. In November 2018, the Canadian Federation of Independent Business (CFIB) issued a report that suggested that 47% of all small and medium-sized private businesses (SMEs) will be sold in the next 5 years. The report went onto state that 72% of all SMEs will be sold in the next 10 years! We know from our experience that the majority of entrepreneurs are not well prepared to maximize their financial return, solidify their legacy and navigate through the “emotional and financial fallout” that follows a sale.
After spending so many years building their businesses, entrepreneurs need to plan ahead to ensure they maximize financial success upon sale. Five key points:
- Business owners need to understand their limitations. In most scenarios, entrepreneurs have spent their time as effective operators and builders. They’ve spent limited time, if any, looking at acquiring businesses and/or executing M&A transactions. Selling a company involves mastering a new skill, especially when it comes to negotiating with parties who are sophisticated and do this for a living like private equity firms. One needs to determine whether a 3rd party, be it a broker, an investment bank, or an accountant, may be helpful in enhancing the value net of fees, which leads to point 2.
- Selecting the right professional services firm is a job in itself. A few key learnings over the years suggest that by connecting with others who have gone through a sale will broaden one’s perspective and understanding of how to select a firm or even if it’s worth engaging someone. It’s imperative that entrepreneurs educate themselves on how deals unfold, what works and why, how and when deals can go astray. Entrepreneurs should leverage those whom they trust to open up their networks to access their valued advisors as a first step. They should be prepared to ask a lot of questions.
- In maximizing organizational value, owners MUST spend the time to fully understand their organizations’ core competencies in addition to where they play and how they play. Selling a business is like developing a strategy – in fact they go hand in hand. If properly planning a sale of a company, the leader is instrumental in creating various new strategic initiatives that play out a couple of years before exit, enhancing the company’s growth potential. This, in addition to pursuing efficiencies to maximize the bottom line, will drive the ultimate value of the organization.
- To be able to talk valuation, one must at least understand pricing fundamentals. Entrepreneurs may not be investment bankers but they certainly have to gain a basic knowledge of how companies are valued. This involves looking at other transactions in their industries and understanding what drives selling price. Was a discounted cash flow valuation model used? If yes, what were the key assumptions used for terminal value, discount rate, and growth? Alternatively, was there a formula in place based on a multiple of EBITDA or earnings and what were the key factors that drove the multiple higher or lower? For example, did the customer base, IP, the leadership team and employees (their age, knowledge, and experience) factor into the calculation of the multiple? I can’t tell you the number of times we’ve had discussions at the board level where we’ve looked at acquisitions to buy talent. Are earn-outs or residual equity ownership part of the deal? If yes, what are the benefits and risks?
- Taxes are essential to consider when selling a business and unfortunately not planning ahead costs dearly. Tax planning is not something that is done a few months before a sale. To maximize impact, tax planning is required years ahead of time.
Legacy and the importance of a succession plan are also vitally important factors to those selling their businesses. The CFIB report noted that only 8% of owners surveyed had a formal, written succession plan, 51% didn’t have any plan, and 41% only had an informal plan. Why is this so important?:
- Without a succession plan entrepreneurs are limiting the number of parties that may be interested in their organization. The fewer parties interested, the lower the price – a simple case of supply and demand.
- A succession plan provides an entrepreneur with alternatives. If they choose to delay the sale of their business, having great teams in place provides them with the opportunity to look at the business as a potential investment vehicle providing an income source through their retirement years. More importantly, if negotiations with a third party fall through there is a sustainable business that can be brought to the market another time.
- A succession plan with a strong management team provides an entrepreneur with another exit alternative in the future – a management buy-out.
- A well developed succession plan increases the likelihood that the business left behind has an opportunity to succeed going forward and thereby represent a positive legacy for the previous owner.
Finally, there is the very often missed “emotional and financial fallout” after a sale. It is imperative that entrepreneurs understand the importance of reenergizing themselves and creating meaning and purpose subsequent to a sale. It is also imperative that they wisely manage the post-sale financial windfall they receive.
When you spend years architecting your life around a business and suddenly it’s gone, it is only natural to have an identity crisis! The initial fulfillment of your financial success quickly wanes as you realize money isn’t everything, especially without direction, meaning and purpose. Playing golf and travelling extensively are often not enough. A significant number of entrepreneurs suffer from depression the first few months post-sale.
It’s essential that entrepreneurs develop post-sale game plans ahead of time just as they would for maximizing the value of their organizations. They need to spend time being curious about continuing to learn and keeping their minds engaged. This can mean starting another business, focusing on investing, exploring creative pursuits, and/or getting more involved in community and family. At PEO we work with leaders to not only on create success in their businesses but also in their broader lives, which means their relationships, their health, their wealth and their passions. We ask them to dig deep and uncover, and then go after, their life’s big dreams. People shouldn’t live to work, but work to live!
Hand-in-hand with financial success is the need to develop a financial plan. Operators of businesses have expertise that is quite different from investors in public markets, private equity and real estate. With wealth comes many knocks at the door with ideas, opinions, and solicitations. Entrepreneurs need to take the time to explore their options with informed views of risk and return. The adage “the rich get richer” is often true. This is because of greater access to opportunities to maximize and preserve wealth. Entrepreneurs need to educate themselves, get in the flow of investment opportunities, and leverage peers who are in the same situation, which can mean joining a peer group dedicated to learning about investments and how to best manage wealth so it has positive and long-lasting effects, ideally for generations.