Why business owners choose to sell
Selling a business can be a very emotional and physically demanding experience. Let’s face it, as humans, we put our families, finances, and ‘blood-sweat-&-tears’ into our most valuable assets. for the entrepreneur it is most often their business or at the very least a business that they have spent years building and operating. When it is time to part ways, it can be a difficult process.
Business owners sell their companies for an array of reasons. Regardless of the reason to sell, it is critical that the business owners know what they are getting themselves into, weigh their options and have reasonable expectations for the disposition process.
At Minerva, we have been fortunate enough to have had discussions about selling with hundreds of business owners who have shared their careers, thoughts and opinions with us. In this article we’ll recap what we have been told by these professionals as well as our own thoughts and viewpoints on the business selling process.
Due to significant investments made by business owners, running a business has become one of life’s routines and habits that can be very hard to break. Business owners are passionate, driven individuals who typically love what they do. When an entrepreneur has a sincere love for their business and ‘job’, they will stick with it until they can no longer physically keep up. As a result, many owners keep a business until it has finally come time for them to retire, lace up the golf spikes and hit the tee box. Unfortunately, many small business owners do not properly plan for the future by training or empowering an existing employee to take over the business. As a result, they are forced to sell the business due to inadequate successors.
The most common reason a business is sold is due to fatigue, boredom, and burnout. The ongoing, daily grind of managing small business stressors can be very tiresome. Beyond the actual stress, many owners simply sell because they are no longer challenged or interested in the business’ operations. Certain industries call for ongoing redundancy, such as retail operations like sandwich and pizza shops, leading to boredom and dissatisfaction with one’s work life.
Serial entrepreneurs & planning to sell
When the entrepreneur sets out to start a new business or purchase an existing one, many have a well mapped out game plan. Savvy business owners effectively plan for the short term and execute those plans to accomplish defined, long-term goals. One of these long-term goals may be to sell the business in a number of years. Whatever the time period, owners recognize the fact that plans are meant to change or be broken. If the entrepreneur does have a target exit date, trends show that business owners are determined individuals and abide by their own terms. As a result, many companies are sold because of a personal timeline set by that owner.
Many entrepreneurs will plan to start a business but then deviate from their plan part way through the journey. Whether they are enticed by a shiny new industry or believe they have found blue oceans elsewhere, they may put their current business on the market to pursue other ventures.
Opportunity presents itself
As business owners, we all have our price. An owner may also find themselves with an unexpected offer to purchase from a very motivated investment group, synergistic company, or aggressive competitor. Other times, business owners who have grown a successful business, often find themselves in a market that lends itself to roll-ups and selling. These trends come and go, from industry to industry; at times, many years apart.
Smart business owner will often times recognize these opportunities will strike while the iron is hot. With that said, it is important to understand that it is very difficult to sell businesses and there are a lot of moving parts. Unlike selling real estate, there are complex financing strategies, different purchase plans and contingencies that will arise during the sale.
What is my small-mid sized business worth?
The question on every sellers mind is “what is my business worth?” and it is remarkable how few business owners know this. Some may be fed a line by their accountant or CPA, some may compare their business to a larger, publicly traded one in the same sector, some may just look at the assets that it owns and come up with a ball park figure. However, none of these practices will determine value.
As we all learned in economics class, price is determined by supply and demand. How many businesses like yours are out there and how many buyers are there for these businesses. Simply put, the market sets the price. It is not recommended to buy a $30,000 valuation packet from a firm that won’t find you buyers at that figure. Or, to simply list your business with the broker who quotes you the largest valuation.
Sources have found that somewhere between 15-20% of businesses listed through brokers actually sell. Other sources claim that number is closer to 30%. Wherever that number really does fall, it is safe to approach the sales process with the knowledge and understanding that it is difficult to accomplish and often times takes years.
Asset value (liquidation)
While this isn’t the most ambitious number, liquidating your business for its assets is actually the most accurate methodology when it comes to valuation.
When valuing your business based on its assets, add up the value of everything the business owns, including all equipment and inventory. Subtract any debts or liabilities. The value of the business’s balance sheet is at least a starting point for determining the business’s worth.
Earnings multiple valuation
Valuing a business on a multiple of its cash flow is the most common way to value a small-mid sized business.
Simply stated, this means that the net profit of the business, plus the owners salary is given a multiple to arrive at the asking price. This multiple is determined by the market demand and the quality of the business.
This valuation methodology is similar to a public company being valued on its P/E ratio which is where the total equity value is divided by the companies net earnings. While the public markets trade for 14 – 18 X earnings (a P/E of 14 – 18), private markets trade for much lower multiples, 2-4 X in many cases.
Discounted cash flow analysis
The more complex cousin of the earnings multiple valuation is the discounted cash flow analysis valuation. Simply put, this means forecasting the future cash flows of a business and discounting them back to todays value. Several variables exist in this procedure which is why it is difficult to implement for small-mid sized businesses.
What discount rate is applied to future cash flows, what CAGR is used when forecasting cash flows, are add-backs implemented after the first year etc. Arguing over these variables is typically a task for business school professors, while deal makers and active brokers will explain that they are of little value for companies under $50mm in revenue.
- Your business is worth what someone will pay for it.
- This is most often 2-3X annual profit.
- Small-mid sized businesses are hard to sell. Many listings will take a few years to sell, while others won’t sell at all.
Selling a construction business
Selling a small-mid sized business is difficult for the many reasons we outlined previously. It can be even more difficult for asset heavy businesses or businesses that struggle with consistent cash flow. Because construction businesses often struggle with at least one of these criteria, if not both, they are notoriously difficult to sell. This is one of the reasons that we at Minerva Equity have chosen to focus heavily on investing in construction businesses.
If you are interested in selling a construction business that you run, you will likely find Minerva to be a competitive option. We typically look to purchase or invest in construction businesses with north of $1mm in annual earnings that have great reputations and year over year growth. Have a look at our guidelines on deal structure and complete our construction company valuation form to tell us a bit about your company.
Selling a manufacturing business
Selling manufacturing businesses presents unique opportunities and difficulties. Manufacturing can be a very competitive business that has been decimated in the US over the past few decades. There is rarely any intellectual property or patents that make one facility more reputable than the rest, therefore companies will opt to have their products produced for the lowest prices available. This price competition means then margins and slow cash flow.
Some of the benefits that manufacturing companies can enjoy when looking for a sale is that the buyer can often times finance both the business equipment and receivables. This is called a leveraged buyout and takes place on 90% of manufacturing company acquisitions. Here at Minerva, we have done a large amount of research on the manufacturing sector and feel comfortable investing in manufacturing businesses from $1mm to $5mm in annual earnings. If you are looking to sell your manufacturing business, tell us a bit about it by using our manufacturing business valuation calculator. We are active in the sector with business that have residual clientele, a strong management team and creditworthy clients.
Selling distressed businesses
Selling a business that is struggling to keep it’s lights on may seem like a lost hope. However, there is a robust industry of investment companies that will either purchase the business outright, renegotiate the business debt in exchange for a stake of equity or a fee, or even just make a cash infusion into the business so that some of the debt can be paid off in exchange for equity.
If you run a business that is near insolvency, the sooner you take action, the better. We put together an article on restructuring SBA business loans that is worth reading. If your business does over $5M in revenue each year, you should consider contacting us a Minerva to see if this is something we can work with.
If you have had the misfortune of using merchant cash advances to keep the lights on, there are a number of strategies to renegotiate and restructure those business loans. Most MCA lenders don’t have the ability to forclose on the assets that they have claim against and will settle for whatever they are given. It is, however, best to do this on your first MCA loan instead of taking out a second to pay off the first and so on.
Who buys small-mid sized businesses
Understanding how businesses are valued is a large part of the equation, understanding who will buy it is the second. Depending on your industry, business size and its assets, there may be buyers from various background interested in it.
Individuals with industry expertise may look to buy a business in their industry. A good example of this is a person who works at Google for a decade developing software who ends up rolling over their 401(k) into purchasing a small software business. Since they already understand the industry, they now have the ability (and obligation) of working for themselves and running a small business as opposed to working in a mega corporation. Instead of using a 401(k) rollover, some of these transactions can be funded with SBA acquisition loans, which we’ll discuss further later.
These individual buyers will invest in businesses doing under $2mm in profit in most cases.
Private equity companies
Private equity firms are investment companies that invest in private businesses with investor money. They often times will have capital from pension funds or endowments that they look to deploy in mid-market businesses. Most private equity firms are minority investors, but there are a handful that make majority investments or full acquisitions.
Most PE firms invest in businesses that do over $10mm in profit, however there are some that will look to invest in large companies and then add subsequent, smaller companies to it, these are called “bolt-on acquisitions.” These firms that look to make a number of small bolt-on acquisitions will look as small as $5mm in profit.
While many of these investment firms manage capital for investors and have substantial capital to deploy, it is not uncommon for them to also get financing on the target companies assets and track record in order to complete the transaction, this is called a leveraged buyout. Although this deal structure has been popular with large companies for decades, leveraged buyouts for small-mid sized businesses have become more prevalent over the past few years.
The third portion of investors in the lower mid-market are strategic investors. This means one company selling to a competitor or selling to a company that is in an adjacent industry and can strategically benefit from the acquisition.
Business schools refer to these strategic investments as either horizontal or vertical integrations depending if they are in the same sector or an adjacent sector. These strategic investors will vary in size of target from main street businesses all the way up to the public markets.
At Minerva, we typically invest in businesses that are smaller than private equity companies look to invest ($5mm+), but larger than individual buyers look to purchase (under $1mm).
Preparing to sell your small-mid sized businesss
One of the variables that determines if anyone is interested in purchasing your business and at what price is how smooth the operations are. If you have a management team in place with documented procedures, the buyers will be able to transfer ownership more seamlessly and they will therefore be far more likely to make an offer.
In order to receive an offer, your business should have:
A diligent buyer is going to want up to five years’ worth of profit and loss statements, bank statements, tax returns, leases, supplier and vendor contracts, and customer data, said Barbara Findlay Schenck, a business strategist and author of “Selling Your Business For Dummies.”
Make sure the paperwork looks clean, organized and clear so that it is representative of a well-managed company and so that you do not inadvertently mislead the buyer. “You can’t sell a business with records in a shoebox,” she said.
Properly titled and appraised assets
Once you know you’re going to sell, begin transferring assets into your personal name if they will not be sold with the business, such as cars, intellectual property and real estate, so they’re off the expense column of the balance sheet, Schenck said. This will show the buyer a clearer picture of cash flow potential.
It is also of great importance to have accurate values and accumulated depreciation on the business balance sheet. If these numbers are discovered to be exaggerated, it will only be the first of several dominoes to fall relating to asset value.
Management team in place
In order to be a sellable asset, you should build this business to the point where you no longer have to manage the day to day operations. There is a much smaller market for buyers who are looking to buy themselves a job than there is a market for people looking to invest money in a small business that gives them a return on investment.
For main street businesses (under $1mm in earnings) you may have to stay in the business to manage it on a day to day basis. For larger businesses, the owners role should be minimal.
Many businesses need licenses and/ or certifications in order to operate. The transfer of these licenses should be addressed pre-sale so it does not have to be dealt with by the buyer. This means that the business should get a manager to obtain certifications and licensure, or, the owner should be willing to stay on for a period of time after the sale in order to train a new manager and assist them in getting their license.
As with every other item that we are addressing in this section; The more work and risk required from a buyer, the less likely you are to find one.
Deal structures for small-mid sized businesses
Because small-mid sized businesses have more risk than larger companies, it is important to find deal structures that align the buyers and sellers interests for ongoing success of the business. That means that cash deals almost never happen for businesses this size. there will always be a component that is paid over a number of years or a contingency that the business must meet.
An earnout is a contractual provision stating that the seller of a business is to obtain additional compensation in the future if the business achieves certain financial goals, which are usually stated as a percentage of gross sales or earnings. If an entrepreneur seeking to sell a business is asking for a price more than a buyer is willing to pay, an earnout provision can be utilized. In a simplified example, there could be a purchase price of $1,000,000 plus 5% of gross sales over the next three years.
Explore how an earnout or royalty deal structure could be a fit for both the buyer and seller in a small business transaction.
A holdback is a portion of the purchase price that is not paid at the closing date. This amount is usually held in a third party escrow account (usually the seller’s) to secure a future obligation, or until a certain condition is achieved.
Holdbacks are very common in purchase and sale agreements. Most sellers require them to provide certainty around matters which are not fully known at the closing date. Most of the time, these holdbacks relate to achieving a specific working capital threshold or in the event there is litigation outstanding at closing.
seller financing involves the business’s seller essentially acting as a bank. The seller offers a loan to buyers that covers a portion (or all) of the total purchase price of their business. In turn, buyers repay the seller in installments, typically with interest. This method of financing offers benefits to both buyers and sellers. It also helps ensure that we, as the buyer are not buying a bag of hot air and that the seller believes in the prospects of the business moving forward.
Instead of acting as a bank and receiving nominal debt and interest payments for the business, there may be an opportunity for the seller to “roll equity” or take and equity stake in the new business entity that is being formed. In addition, it may make sense for the buyers to compensate the business employees with equity as a way to incentivize them to stay.
SBA acquisition loan
For businesses based in the US, the Small Business Administration (SBA) offers favorable financing terms to US based, creditworthy buyers. For businesses in the main street size (earnings under $1mm) this could be an attractive option for the buyer.
In order to qualify, your business needs to have clean tax returns and you’ll need to find a buyer that is ok signing a personal guarantee for 10 years and putting 10% down. They will also need to be able to demonstrate that they are capable managers and have success in the industry.
The old adage “time kills deals” is true in this arena as SBA backed deals will take a full 90 days after the asset purchase agreement has been signed.
Initial Public Offerings (also known as IPOs) are the optimal way for businesses to capitalize on the value that they have created and for the owners to get the highest price possible for their interest in the business. The problem is…if you’re reading this, your business is not large enough to IPO.
To qualify for NYSE listing, a company must have at least 400 shareholders who own more than 100 shares of stock, have at least 1.1 million shares of publicly traded stock and have a market value of public shares of at least $40 million. The stock price must be at least $4 a share.
Other countries may have exchanges that are easier to list on than the NYSE, but any way it’s sliced, it is a complicated drawn out process that only makes sense for businesses generating $100mm or more in revenue and/or private funding rounds that eclipse $500mm.
Asset Vs. Stock sales
While Most people are familiar with buying stock in a publicly traded business and understand that owning a share of stock means that they own a small piece of that companies equity.
Unlike buying a publicly traded corporation, buying a small business often means that you are buying the business assets as opposed to its equity or stock. Many securities attorneys recommend asset purchases as they are typically safer for the acquiring companies. When buying stock, there is the threat of past liabilities rising up again to bite the new owners in the behind.
A 338(h)10 sale may be another option. This provides the ease of an equity sale while allowing for the new owners to pick and choose which assets they want and which they don’t. However, contingent liabilities may still be a factor so it is recommended to discuss the transaction with a seasoned lawyer before proceeding.
The process of selling your small-mid sized business
We have addressed the factors that make your business sellable and those that will make your business difficult to sell. Once you get your financials, management team and asset titles in order, you’ll need to decide how to proceed in finding a buyer.
You have a handful of options when finding a buyer and structuring a deal. We’ll outline the most common here so that you can make an informed decision.
Sell direct to an individual
Depending on the size of business you have and how close knit the community is around this industry, you may already know a suitable buyer for your business. You’ll obviously still need to negotiate a price and terms for the deal structure with this individual. However, finding a willing buyer is more than half the battle, so if you already have one in your network, you’re miles ahead of other sellers.
There are still potential pitfalls in selling to a colleague and these deals will often fall apart in the 11th hour. For instance, does this buyer know how to get financed, what a fair price is, have licenses, know the difference between a stock or asset deal, want to buy the business with its receivables and payables or without. All of these factors make a difference and you may find this process harder than you initially thought.
Sell through a broker
Like any other complicated business process, there is an industry designed around advising in it. Using a business broker is not inexpensive however, most brokers charge between 10% – 15% success fee and often charge an up-front engagement fee or retainer as well.
While hiring a broker may be helpful, unfortunately, the good brokers are lost in a sea of the bad. There are many business brokers that will lead you astray on valuation in order to represent you. They may lead you to believe that paying your fee up-front will save you money in the long run. When looking for a broker, find someone who focuses on your industry and can show a track record of success. In addition, it is important to realize that retaining a broker does not mean your business is sold. In fact, the odds are greatly against it selling.
Studies indicate that less than 30% (and possibly as low as 12%) of businesses listed with brokers will actually sell. In fact, one publicly traded business broker franchise in the EU had its public books analyzed. After analysis, it was discovered that less than 15% of their revenue came from success fees (fees generated from selling a business). The other 85% was generated by charging clients retainers and up-front fees.
Sell direct to an investor
We are biased toward this option as this is how we at Minerva operate. We believe this brings the highest compensation for the business while also having the most seamless process and highest closing rate.
There are investment companies that focus on various types of businesses at various life stages. At Minerva, we focus on businesses generating $1mm – $5mm in annual earnings in one of a few sectors, primarily construction and manufacturing.