How to Sell Your Business
It is not uncommon for baby boomers to see business sale as the logical end game over the next 5-10 years. But there's a dirty little secret when it comes to getting your business ready to sell.
The same things you have to do to maximize sales price are the same things that make selling your business a terrible idea.
To understand where I am coming from let's start with how businesses are valued.
HOW MUCH CAN I GET?
I tend to divide sellers (and therefore the businesses they sell) into two categories:
Those selling a job
Those selling a business
What's the difference? Job sellers are typically small "mom-and-pop" businesses doing less than $500,000 to $1 million in revenue. In these businesses the owner is usually the most highly compensated employee, and the person who does the most work. In these owner/operator situations the business literally will not survive without the day-to-day involvement of the owner in basic business operations (sales, service, production, bookkeeping, etc).
These businesses tend to be sold by less sophisticated business brokers who use an "Owners Free Cash Flow" valuation method. Basically they add up everything being paid to the owner whether it be salary, bonuses, benefits, car allowances, personal expenses, loan repayments or draws from retained earnings. The total is then multiplied by some rule of thumb to arrive at the asking price.
Sellers usually get about one year's worth of compensation out of the deal before taxes. This gives them some breathing room, but the clock is ticking. Unless they were already financially independent it is just a matter of time before the seller must find a job or start a new business.
Buyers of these "jobs" pay for the privilege of coming to work every day and "being their own boss," which is ironic because the newly minted small business owner quickly discovers that rather than one boss there are now scores of customers, vendors and employees that they must answer to. In essence they have traded one boss for many, along with the stress of keeping a business running.
Larger companies may buy up these smaller operators for their customer lists and a few key employees. This usually works out much better for the buyer than the seller since any administrative employees are redundant and will probably be let go. Meanwhile, the seller still has a short runway until the cash runs out.
HOW BUSINESSES ARE VALUED FOR SALE
A true business on the other hand is a much different story. These businesses can operate for weeks or even months without the owner's day-to-day involvement. And often the business owner isn't the highest paid employee. That distinction usually goes to a commissioned salesperson or a general manager responsible for day-to-day operations. The business owner does perform key managerial and leadership functions, but when it comes to getting products out the door or closing deals these owners have often been removed from that process for a while.
These businesses also distribute significant dividends to the business owner on a quarterly or annual basis. Dividends are the excess profits that the business can afford to pay out to the owner in their capacity as shareholder. They are separate from any compensation the business owner receives for their job responsibilities in the office (think W2 wages).
A business like this is valued much differently than a mom-and-pop business. Experienced business brokers will construct a discounted cash flows model that uses historic and projected dividends coming out of the business and a risk factor called the "discount rate" to estimate the net present value of the business. There is a formula for this, but it is beyond the scope of this post. Just be assured that it isn't difficult to setup an Excel spreadsheet to crunch all the numbers and test different assumptions.
The key takeaway is this:
The ability of a business to pay dividends determines the sales price.
HOW TO INCREASE DIVIDENDS
Dividends come from profits. So if we want to increase dividends we need to increase profits. We also need to increase the efficient use of capital in the business so it doesn't take as much cash to operate. Getting rid of old fleet vehicles with poor gas mileage and high maintenance costs in favor of newer vehicles with favorable lease terms is one example of this. Moving into a better equipped space to decrease turnaround times, and get jobs done faster is another example. Getting suppliers to hold inventory on a just-in-time basis rather than spending our cash to purchase and warehouse product is yet another example of using capital more efficiently.
There are a thousand things a small business can do to increase profits and dividends, but all necessitate long term growth in some form or function. That makes strategic planning and execution an absolute necessity. This means having a detailed 3-5 year plan and a weekly, monthly and quarterly execution discipline with your leadership team.
The strategic plan should include steps to remove the owner from day-to-day operations. This requires building a leadership team that can handle the day-to-day and installing a general manager who gets the owner's long term vision. Performance compensation goes a long way toward finding and retaining the right person for this key role.
MAXIMUM VALUATION
After 3-5 years of focused attention on building and executing a strategic plan, most businesses are in a very good place. The business owner is fulfilling a critical leadership function, but the leadership team and the rest of the employees are handling day-to-day operations. A good general manager even allows the owner to escape for a month or two at a time without any negative effects to the bottom line (and many times with significant improvements while the team is left alone to execute).
At this point the business is generating healthy dividends that are driving a high potential selling price. Since a management team is installed and running things the potential pool of buyers is also much greater. With no requirement for particular industry expertise or business operations background anyone can own the business provided they can afford to purchase it.
THE OWNER'S LIFESTYLE
Now comes the catch and the dirty little secret. If it takes every penny of the owner's salary and every penny of available dividends to keep up with the owner's personal spending we are really back to square one. There's no difference between this situation and the mom-and-pop business looking to sell. Sure, we may get some cash in the bank to provide some breathing room, but an owner with an exorbitant lifestyle will burn through that cash in no time.
But if the lifestyle can be paid for by the owner's salary we have a path toward financial independence and simultaneous business ownership. It works like this. Once the dividends exceed the owner's W2 compensation the owner is essentially financially independent. The owner has an asset (the business) capable of generating enough cash flow (dividends) to meet their needs. At this point if the owner installed a CEO (or promoted the general manager to CEO) it would be possible to step away from the business entirely and just live off the dividends.
Yes, there will still be responsibilities, but these are the responsibilities of a shareholder investing time in oversight, strategy and long term vision on a monthly, quarterly and annual basis. It doesn't require showing up at the office every day, or even every week.
WHY SELLING YOUR BUSINESS IS A TERRIBLE IDEA
To maximize your selling price you need to build and execute a strategic plan for growth that allows the owner to step out of day-to-day operations.
Here are the two choices facing a business owner who has successfully done this:
Turn over the business to a buyer for a one time check. Invest that money. Live off the principal and returns generated by the investment.
With zero financial pressure to sell the owner could choose to keep the business and it's perpetual stream of dividend payments. The owner also has the opportunity to retire without compromising the current lifestyle.
There will be objections about diversification and the risk of having all the business owner's eggs in one basket, but these are academic. The business has a high valuation because the risk factors have been mitigated through sound planning and execution. And the growth of the business yields excess dividends sufficient to invest in traditional vehicles like retirement accounts, rental properties, etc. The truth is that a business the owner has known for decades with a competent management team is far less risky than investment vehicles and advisors with whom there has been little experience.
I find that almost everyone who has a choice chooses option 2. It can take years to get there, but it’s also going to take years to get your business ready for sale if you want option 1. Don't be surprised if you decide to walk away from the closing table and keep a business you've grown to love. Get started today.