11 Things You Absolutely Need to Know About Selling Your Business
By John F. DiniiUniverse, Inc.
Copyright © 2010 John F. Dini
All right reserved.ISBN: 978-1-4502-5024-5Contents
1. When Should I Sell My Business?.................................................................92. The Boomer Bust.................................................................................113. The First Thing You Need to Know: Understand the Process of a Business Sale.....................154. The Second Thing You Need to Know: What Will You Do Tomorrow?...................................245. The Third Thing You Need to Know: Value and Pricing.............................................286. The Fourth Thing You Need to Know: Buyers.......................................................467. The Fifth Thing You Need to Know: Presentation is (Almost) Everything...........................608. The Sixth Thing You Need to Know: Taxation Drivers..............................................679. The Seventh Thing You Need to Know: Financing...................................................7710. The Eighth Thing You Need to Know: Seller Notes................................................8711. The Ninth Thing You Need to Know: Business Brokers.............................................9212. The Tenth Thing You Need to Know: Doing the Deal...............................................10213. The Eleventh Thing You Need to Know: The Roles of Professionals................................11114. The Other Thing................................................................................114Glossary of Terms..................................................................................117
Chapter One
When Should I Sell My Business?
Selling your business is the most important single financial transaction of your life. For a very few of us who were born with great wealth, are successful serial entrepreneurs, or who hit the lottery that may not be true; but for 95% of us there will only be one exit from the company you built. The years of effort have hopefully paid well as you went along, but most of us are planning a good portion of our retirement around the proceeds from selling the business.
There is an old saying that goes "When is it the best time to fire a salesman? ... It's the very first time you think about it." The idea is similar when it comes to selling your business. The first time you have a rough day and think ... "I don't want to do this any more.", the first time that you look at your employees and wonder ... "Are they better off than I am?", the first time you look at an opportunity to grow and think ... "Being bigger would just mean more work and more responsibility.", it is time to start planning for the sale of your business.
Selling is much more than a transaction. It is the process of making your company presentable, desirable, marketable and financeable. It's knowing who your buyer is and how much he or she can pay. It is understanding what is valuable in your company, and what isn't. Selling your business starts with the decision to sell ... someday. From that point on, you should be preparing for the transaction phase, but the transaction phase is the end game, not the whole game.
Hundreds of small business owners have asked me "What do I have to do to make my business ready to sell?" Fortunately, the answer is very straightforward. To get the most value when you sell your company, do everything that you should be doing anyway to make your business more successful. What is good for you is good for the buyer. It is that simple.
What do you think is worth more to a buyer: a business that depends on the owner for every decision, or one that doesn't? Would you pay more for a company that had every procedure documented, so that a new owner could look up anything he or she needed to know? Would you perceive more value in a bunch of employees who did only what they were told, or ones who could make good day-to- day decisions while you were on vacation?
Would you be more likely to buy a business that had strong financial statements or one where the owner could only verbally describe (wink ... wink) all that he was taking "off the books"? Would you prefer increasing to shrinking margins? Would you rather have a diversified customer base, or one big customer that dictated terms?
The answers are so plain that it probably sounds comical just asking the questions, but many business owners don't think that way. They control every aspect of the business personally (and maintain a crushing personal workload,) by hiring the cheapest talent with which they can possibly get by. They load up the company expenses with personal items to save a few bucks in taxes. They skimp on sales and marketing unless revenues begin to slide, and then skimp on it some more because they don't have any "extra" money.
The best time to sell your business is when you don't have to. Many business owners are reluctant to sell in good times because they are making a lot of money, and won't sell in bad times because they can't get full value. The best time to sell any business is when you want to. If you have made the business attractive to the right buyer; that time can be any time you choose.
Remember; every business owner will exit his or her company sooner or later. It's up to you whether you want it to be on your terms, or on someone else's.
Chapter Two
The Boomer Bust
Much has been said about the coming glut of retiring Baby Boomers. The generation that began in 1945 started reaching 65 years old in 2009. The United States Boomers represent the biggest financial event in history. By some estimates, they will transfer over ten trillion dollars in assets ($10,000,000,000,000) over the next twenty years.
I know that a trillion dollars isn't what it used to be. Before the latest Wall Street bailout and government economic stimuli, we seldom heard the term trillion. Now it has become commonplace in the daily news. It is still a lot of money for people like you and me, however.
The Boomers impacted everything with a pig-in-the-python effect. When they were born, their mothers bought millions of copies of Dr. Benjamin Spock's 1946 book Baby and Child Care, which told them that children should be raised as individuals. Dr. Spock taught that parents should be flexible regarding their children's needs. Discipline was to be used sparingly, and without anger. The Boomers were raised to believe that they were the center of the universe. In many ways, it was true.
As they grew up, the Boomers triggered explosions in school and highway construction, drove the expansion of suburbia, and made mega-industries out of toys (Mattel) and children's entertainment (Disney).
Time passed, and the Boomers enrolled in college at unbelievable rates, pushing growth in community colleges and universities. Then they entered the job market. Corporations which were previously bastions of the nine-to-five workday and the gold watch at retirement were inundated with ambitious and educated young men, and for the first time young professional women, who all expected to climb to the corner office with a big expense account.
There wasn't room for everybody in the big corporations, but the Boomers had come to expect that they could have it all. So they opened businesses in record numbers. Many did not have the basic business skills to be entrepreneurs. To serve this growing market, franchising was born and quickly became the dominant business model in many retail and service markets. For the first time, you didn't have to know everything about a business to own one. Small business ownership could be taught.
The Boomers became consumers. Suburbia pushed out to Exurbia. Savvy marketers catered to Boomer wealth with ranchettes and McMansions. Boomers worship youth and vitality, so the self health market once limited to One-a-Day vitamins mushroomed into exotic supplements, health clubs and personal trainers. Retail space per person in the US increased by over 250% between 1986 and 2008.
Now the Boomers are preparing to retire. They own more businesses than any generation before them, or probably than any in the future. The Baby Boomer business owners face a challenge like none other. Just as they have done everything else together, the Baby Boomer business owners are all going to sell their companies at the same time.
Whether you took Economics in high school or not, you've heard of the Law of Supply and Demand. It says the more that is available to sell (supply) the lower the price becomes. It also says that the fewer buyers there are (demand) the lower the price becomes.
What happens when the supply (Baby Boomer Sellers) goes up a lot and at the same time demand (Generation X Buyers) drops off rapidly? It isn't going to be a pretty picture for sellers of small businesses, but you can still beat the odds.
It is easy to understand why the Boomer owners selling in lock step would raise supply, but why would the demand fall precipitously at the same time? Let me introduce you to Generation X.
Generation X, or GenX as the marketing folks would say, is the group immediately following the Boomers. Logically, they would be the next generation of business owners. That isn't going to happen for most of them, and there are a number of reasons why.
GenX was raised by the Boomers. Focused on their own success, the Boomers married later and had fewer children. So a generation of 78 million people is being followed by one of only 46 million. Demand is naturally lower when you have 40% fewer buyers.
Fewer available bodies means that there will be growing competition for employees. As the Boomers retire from the corporate world, they will have to be replaced. Large organizations can offer far greater benefits and compensation than a small business could possible offer and, in many cases, more than even the typical small business owner receives. Those who search for business buyers will be competing with those searching for business executives.
The most important issue, however, is the preferences of the GenXers themselves. GenXers have not been raised as entrepreneurs. They don't find the same gratification in owning a business, are less inclined to take risks, and have different priorities than the Boomers.
Most Boomer business owners have complained about their younger employees from time to time. Some say that GenXers don't have the same work ethic, or they don't have the same ambition. What the Boomers don't understand is that GenX was raised differently from the Boomers, and has a different set of core values.
GenXers are more comfortable in their skin than Boomers. Raised by Boomer parents who made sure that they each got a trophy just for being on the team, GenXers expect to be appreciated for anything they do. They were taught to expect love for who they were, not for what they did. They were told that work wasn't life; it was merely the means that funded the rest of their lifestyle. For the "I am what I do" Boomers, it often doesn't make a lot of sense.
Logical or not, GenX doesn't have the numbers, the need, or the inclination to do anything that takes too much effort, pays too little, or stresses them out. They look at the hours, the compensation and the pressure of being a small business owner, and they simply don't get it. There are so many easier ways to make a living.
Add those three factors together and you will have a buyer base that shrinks dramatically over the next 20 years, just as the supply of businesses for sale explodes.
Until now, Boomers have been buying businesses for a second career, and selling their businesses to other Boomers. Once the boomers finally stop buying, the world of small business sales will change dramatically. Like any market under pressure, quality rises to the top. If you want to be a successful seller, you'll need a business that GenX will want to buy.
That will have to be a business that provides a good living without killing the owner. To rephrase what I said in Chapter One, the best way to prepare your business for sale is to make it into the kind of business that you wouldn't want to sell.
Chapter Three
The First Thing You Need to Know: Understand the Process of a Business Sale
Valuing Your Business
Business valuation is not an exact science, but arriving at a reasonable price is the first step in selling any business. Different valuation approaches estimate the market value of a business from different points of view. The most common methods, discounted cash flow analysis, multiples of earnings, multiples of cash flow and comparisons with prior sales of similar businesses (comparatives or "comps") are widely used and easily calculated.
Most small companies are sold as a multiple of the amount of benefit the owner is taking from the business. This is commonly termed Seller's Discretionary Cash Flow (SDCF), Seller's Discretionary Earnings (SDE) or sometimes just "free cash flow." All three terms mean the same thing, and we will stick with SDCF for this book. SDCF is the amount of money that the owner takes out of the business including salaries, bonuses, taxes and any other benefits received by the owner and his or her family plus interest, depreciation, amortization, and the net profit shown on the Profit and Loss Statement. Using a multiple of SDCF has long been the most common practice in small business valuation.
There are other terms frequently used in business valuations. EBITDA is Earnings before Interest, Taxes, Depreciation, and Amortization. This is a measure of a business' ability to generate cash from operations, but doesn't encompass salary or any additional benefits being taken by the owner. EBIT is a stricter measure which assumes that depreciation and amortization are normal costs of doing business, and thus ignores them in profitability.
These earnings measurements are more commonly used for larger companies where ownership is clearly divided from management. SDCF is appropriate in businesses where the owner is the principal manager, and the buyer is assumed to be an individual who expects to make his or her living by operating the business personally.
The most frequent argument of small business buyers (and their attorneys and accountants) is that the SDCF earnings need to be adjusted for the cost of a manager. The counter argument is that businesses that have separate ownership and management sell for higher multiples of EBITDA than the multiples used for SDCF- based transactions.
The two approaches aren't interchangeable. One is appropriate for one kind of business, and one for the other. In this book we are discussing the sale of your business, which you presumably own and operate personally. In a few areas where there might be a difference for larger, professionally managed companies, I will point it out.
Setting Your Price
Once you have arrived at a realistic estimate of market value for your business, you can make a more informed decision about your asking price. Business owners frequently confuse the value of the business with their desire to walk away with a specific amount in their pockets. They ultimately ask a price based more on their feelings than on any objective estimate of what the business is worth to a prospective buyer.
It is customary to advertise the asking price of smaller businesses. As the size of the business reaches "middle market" (businesses selling for over $3,000,000), the common practice is to ask for bids from interested buyers, rather than advertising the asking price, and let the market set the price, preferably by competition between multiple buyers.
For sales where the target buyer is an individual who will run the business as his or her livelihood, the asking price should pass a "Buyer's Sanity Check." The sanity check is a means to determine whether the asking price will make economic sense to the purchaser. The SDCF of the business should cover debt service from any loan used in the purchase, provide a reasonable return on investment for the buyer's invested capital, and leave sufficient excess to provide the new owner with a decent living. I will further discuss the details of pricing strategy in Chapter 5.
Defining Your Strategy to Sell
Setting your price is only the beginning. In order to navigate a successful sale process, you'll need to figure out the following:
Recognizing and qualifying your prospective buyers (Chapter 6)
Preparing effective marketing and sales materials for your business (Chapter 7)
Understanding the underlying tax issues that drive negotiations (Chapter 8)
Comprehending the parameters and hot buttons of third party lenders (Chapter 9)
Collateral and security for seller financing (Chapter 10)
Deciding whether to use a business broker (Chapter 11)
Structuring the mechanics of a deal (Chapter 12)
Due Diligence (Chapter 12)
Managing professional advisors and other stakeholders in the sale (Chapter 13)
(Continues...)
Excerpted from 11 Things You Absolutely Need to Know About Selling Your Businessby John F. Dini Copyright © 2010 by John F. Dini. Excerpted by permission.
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