We recently spent a long weekend cleaning out our family cabin, which recently sold. As we thought about all we did over the years, we realized it was about a five-year project, which ties very well to what business owners should do when planning their exit.
It was about five years ago when we made an effort to get rid of junk. The cabin’s been in the family for almost 60 years and my dad was a hoarder. If one tool was good, three of the same were better. We got rid of five winches, and I don’t recall seeing one in use for decades. We estimated at least one ton of stuff went to the dump.
In my ACTION Plan* ™ to sell a business the “A” stands for arrange all the affairs of the company. Like with our cabin, it starts with cleaning. Cleaning the facility so it looks like you care. Cleaning up the books so they paint a true picture of the company’s performance. Making everything (operations, finance, marketing, etc.) look as presentable as possible to a pair of (skeptical) buyer eyes.
Once we decided to sell it was a full effort to “have it ready.” This meant quasi-staging (there’s only so much you can do in 700 square feet). This meant getting rid of glasses, plates, area rugs, furniture, and anything else that made the place look cluttered or smaller (it’s small already). We cut and trimmed the grass a lot more often, touched up the paint, removed an old storage building, and kept it clean and tidy.
What we learned is no matter what you do, a buyer will find things you didn’t do. And believe me, a home inspector will find even more of those things. Just like business buyers approach companies with a skeptical eye. And the bank looks at it with a completely different set of eyes, given they really want to get paid back. (Given we don’t live near the cabin, we really didn’t have the time to get to the little things, like we all should at our homes and owners should do in their business).
The “C” in my ACTION plan stands for counsel the company, its people, and processes. This means keep everything up-to-speed, like we did with the cabin once we put it on the market. In a business this means pay attention to the non-financial factors. Its customers, employees, suppliers, market conditions, and anything else that influences the numbers.
I learned some interesting lessons selling a cabin in a soft market, from 2000 miles away, and not having the ability to be there enough to manage the little things. Given owners are around their business daily it’s not a good excuse to not pay attention to the things making a business more attractive to a buyer.
“Don’t ever think you’ve succeeded. Always try to do better – otherwise, drop dead.” Arturo Toscanini
* Arrange all the affairs of the company
Coach and counsel the company; its people, process and systems
Transmit and teach all the good “things” about your firm
(and those “things” are)
Intricacies that make your company special
Operations and management systems in place that will make a transition smooth
Numbers, all the financials in understandable form, straightforward with no “tricks”
Somewhere over the rainbow… is the successful sale and exit of your business. But who will buy it? What will make them want to pay more? Should I really worry about these things because it’s such a great company?
Let’s cut to the chase. Almost all buyers are going to look at multiple companies, anywhere from a handful to a few dozen. They compare, contrast, look for opportunity, a fair deal, and, above all, are skeptical by nature (all you have to do is look at the online ads and see the platitudes heaped upon businesses that are losing money). So, you have to be ready, and you have to be ready for your logical buyer.
Types of Buyers
There are two classes of business buyers, strategic and financial. Financial buyers tend to want a return on investment based on the current operations. Strategic buyers often look at synergies, reduced overhead, etc. to boost the return.
Within those classes there are seven types of business buyers; although each type has its unique features, there is some overlap:
Individuals (or partners)
Family and/or management team (different but similar characteristics)
Small business owners (growth by acquisition)
Large companies (strategic buyers)
Private equity groups
Family offices and fund-less sponsors
Most of the above are self-explanatory but you may not be familiar with some of the buyer types, so I’ll explain a few. Search fund buyers are (usually) individuals who want to buy a larger business than they can afford on their own. They work with investors, who fund their search, i.e. a salary while looking for a business, in return for the opportunity to invest in the deal. This is quite popular and is now taught in numerous MBA programs.
Family offices are very wealthy families that often want to diversify their holdings by purchasing operating companies. Fundless sponsor buyers are a cross between private equity and search fund buyers as they find the deal, then raise the money, often from family offices and private equity (these funding sources are quasi-financial buyers as they often want a return based on performance, not synergies with their current operation).
Financial buyers tend to be individuals, family, management, small-business owners, and sometimes search funds. They tend to be interested in:
A fair-market salary for the job of company president.
Scalability—most buyers want a business they can work on versus work in.
Profits in addition to salary—this is how the buyer will pay off acquisition debt, fund growth, and cover any hiccups to the business.
Not only income, but also net-worth increase (like you have achieved through business ownership)—every payment they make on the acquisition debt increases their personal net worth because those payments come from the profit the business generates.
A deal structure that allows them to make a down payment from their personal funds (this can include the help of friends and family) with the rest of the price covered by a bank loan and/or seller financing.
A business that is salable in the future—something they feel can be grown, in an industry that has a future, and is attractive to buyers.
Manageable risk—people who buy businesses are usually more risk-averse than people who start businesses.
Financial buyers who are individuals, small business owners, family, or management typically make acquisitions up to about $10 million, with the majority of the deals at $6 million or less.
A friend was selling his profitable business. He told me there were three potential buyers, including one strategic buyer and one pure financial buyer. The financial buyer made the best offer!
Just because a company is seen as a strategic buyer doesn’t mean it will automatically pay more. I recently was involved in negotiations for a large industry player to buy a “small” business in the same industry. The buyer’s starting point for pricing was the value of the assets. Like with my friend’s situation, strategic buyers are just not throwing money around.
Goals are an ongoing task, not just for a calendar year.
Many years ago I was a regular at a pretty cool restaurant in Minneapolis, when I traveled there about once a month on business. I remember the manager telling me, as he propped up my wobbly table, unstable tables have always been, “The bane of the restaurant industry.” And he’s right. Invent a table that doesn’t wobble and you’ll have quite a business.
So, what’s the bane of your business? Is it:
Marketing – this is a common one. I’ve talked to so many owners who say something like, “If only we knew how to market better.”
Sales – too often there are more order takers than true salespeople. And, finding a good salesperson is one of the toughest hires there is.
Inefficient operations – growth, and I mean profitable growth, can mask a lot of problems. But if there’s not growth or when it stops, it’s time to get an expert in to improve productivity. Improve gross margin by 2 points in a $5 million business and it’s $100,000 to the bottom line.
Poor culture – let’s face it, most problems have to do with the people. Don’t believe it? Just look at all the articles, podcasts, etc. on management, leadership, culture, and similar. I always find it amazing when we do “focus group” type meetings with employees. Very insightful (and usually the owner is surprised by the results).
A dependency (key customer, an employee who if they left would create a huge problem, or you, the owner, can’t get away without risking catastrophe) – easy to spot, tough to fix (quickly). But when it comes time to sell, a large dependency will scare buyers away or reduce the price.
It’s time to figure out the bane of your business and deal with it (or them).
“The main dangers in this life are the people who want to change everything – or nothing.” Nancy Astor
This was originally written for the blog on www.ibainc.com.
An interesting title of an article about how the author helps his company’s clients, isn’t it? Immediately telling readers the subject might not be for them. It’s because I’m not a salesperson, one size doesn’t fit all, etc. In fact, I start out speaking engagements on buying a business by telling the audience (usually management and executive level people0 there’s a good chance it’s not for them.
But when it is for you, be sure to do it correctly. And that means don’t jump in without a plan and when it comes to growth by acquisition that means know why you’re doing it.
In my book, Company Growth By Acquisition Makes Dollars & Sense I have a list of 19 reasons to consider growing by acquisition. I’ll list them here and go into detail on six of them.
The cake – 16 solid reasons (in alphabetical order)
Acquire great talent, including the seller
Assets are cheaper as a package
Competitive Advantage (fill a weakness)
Diamonds in the rough
Diversify your product offerings
Integration is easier
Location, location, location
Make a competitor go away
Psychology – Employees like to be part of a winner (growing firm), just like sports bandwagons
Risk, it’s a lot lower
Overhead the same, volume higher
Vendor relationship strategies
The icing – the top three
Customers (efficiency vs. make more calls)
Yes, we can!
The bigger you are…the better
Acquire great talent
Good employees are hard to find and often are not in the job market. Just talk to any executive recruiter. While all buyers want capable employees, most strategic buyers (that’s you) also prefer to see a solid management team in place.
Great employees with industry knowledge and experience are in the job market even less. When you are looking for great salespeople, I believe this is amplified. They won’t change if they’ve got a good thing going. Here are some statistics from an executive recruiter, which explains why it’s tough to find good people.
82% of people aren’t searching for a job.
Leadership, or the lack thereof, is the top reason management people switch jobs (not money).
46% of millennials left their last job because of the lack of career growth.
If you acquire their company and create an atmosphere of growth, those employees will want to stay. While I can’t comment on the culture in all companies, I do know that many small family-owned businesses have owners who are coasting. They are doing very well, they aren’t working too hard, and they don’t want to disrupt the nice moneymaking system they have.
Dependencies are a huge issue in most small businesses. By being larger you can reduce most or all of the following:
Not too much explanation is needed. More customers over your expanded revenue base, more employees, deeper management, less product concentration, and most importantly, there’s more talent to take a load off the owner. And an owner dependency is often the brightest red flag for most profitable small businesses. Of course the owner has to be willing to take advantage of the deeper bench by delegating to them.
Psychology – Be part of a winning team
Employees want to be part of a winning team. They want to feel they’re contributing to a winning effort. It’s very much like sports, the more the team wins, the greater the number of fans it has.
I’m thinking of a young man in his early 20’s whom I know. He took a while to figure out some things in life and is now steadily employed and has been for the last few years (with the same company). He’s proud of his job, his contribution, and showed disdain when a new, younger employee (whom he called “the kid”) flaunted the rules and wasn’t dedicated. (But let’s be honest, some employees at this level don’t care, but they’re not the ones who are important anyway, like “the kid.”
Now elevate this to the more experienced people including the management team. In one company there was some doubt about the general manager accepting new ownership. However, this doubt was unfounded as he’s leaped at the chance to implement quality controls, better processes, and accountability.
The icing – the big three
Now here are the top three reasons to grow by acquisition.
“This would be a great business if it wasn’t for those darn customers” was a semiserious comment someone made to me years ago. Of course it’s the annoying (bad) customers he was referring to. It’s good customers we all want more of—customers who are loyal, steady, in good financial shape, growing, pay their bills on time, appreciate the value you offer, and consider you part of their team.
An ideal situation is where there are some overlapping products, so there is some continuity and synergy to be achieved. The figure below shows this. Your salespeople now have an easy transition to discussing, and selling, their products, and their salespeople have an easy transition to discussing, and selling, your products.
In simple terms, if your primary motivation is acquiring a customer base, you are acquiring market share. You may have many other reasons (above), but the bottom line is you are buying customers, and that means top-line growth.
Yes, we can!
This is not about ego; it is about building an exit strategy in order to get a higher selling price. Buying another company, assimilating it into your operation, and showing that the combined profits are greater than the two individual companies’ profits demonstrates to potential buyers that this can be done. It proves you have the team that can integrate one operation into another.
This integration could be their assimilating your firm into theirs or it could be a signal that growing your business (or now a division of theirs) is possible by further acquisitions. A management team that can successfully integrate other firms without major disruption and with immediate efficiencies is a valued team. Too many big mergers and acquisitions fail. Up to 95 percent of public mergers do not live up to expectations. A savvy buyer will appreciate this talent and experience associated with past integrations.
Why larger firms sell for more than smaller ones (all other things being equal)
The bigger your business is, the more it will sell for, all other things being equal. A $50 million (revenue) company with 10 percent earnings will sell for a higher multiple (of profit, earnings, free cash flow, or whatever metric you use) than a $25 million company with 10 percent earnings, which will sell for a higher multiple than a $10 million company, and so on.
There are generally accepted ranges for multiples of earnings based on the range of companies’ revenue. However, too many small business owners see in the Wall Street Journal that a $300 million company in their industry sold for ten times earnings and assume their small business will also sell for ten times. That won’t happen; there’s more risk in smaller businesses than larger, so the desired return on investment is higher.
The fastest and safest way to grow from $5 to 15 million is by acquisition. Buy another firm in your industry—a supplier, customer, or unrelated company that provides diversification—to have an immediate revenue increase and a larger platform from which to grow organically. See more profit and a higher multiple when you exit.
“It’s not bragging if you can do it.” (Dizzy Dean, 1934)
A lot of business owners talk about their company’s potential or the growth that will occur if the buyer just “does some marketing.” Of course, most of this is just talk. Business buyers of all types and sizes are a skeptical lot. When buyers hear too much about potential they think the seller has tried every conceivable way to grow and can’t.
So prove you can do it. Grow organically and also go out and buy another company. Show that you can integrate the people, processes, financial systems, customer service, and everything else into your operation. Private equity groups and large corporations make multiple acquisitions. If you can buy another firm and successfully assimilate it, you become more attractive to these buyers. They will assume you can do it again and that your management team is capable. Strategic buyers and equity group buyers highly value management teams—it can even increase the multiple (compared to having the same size company that has not made acquisitions).
We’ve covered just six of my 19 reasons on why it makes sense to grow by acquisition. I realize most may not apply to your business. It’s the few that do apply that are the reasons why this strategy may make sense. Heck, your catalyst may be a reason not mentioned here. The point is this has worked for many companies and you should always have your eyes open looking for opportunities as there are a lot of good reasons to do so.
At the same time I must acknowledge there are pitfalls you need to avoid, but they can be avoided if handled correctly. How you handle the cultural integration makes a huge difference. Letting (most of) the employees, with both companies, know their jobs are safe is important, as with any acquisition. And you will be taking on debt, but this debt comes with good things like customers, good margins, cash flow, etc. If it makes sense to buy another company these pitfalls are easily overcome. As a very wise executive once told me, “Growth hides a lot of operational warts.”
As we experience the holiday season with Peace on Earth, Goodwill to All, Thanks(giving), and the meaning of all this, I want to share my thoughts on what I consider to be one of the best codes of ethics around. It’s Rotary’s 4-Way Test and how I see it applying to politicians and businesspeople.
The 4-Way Test is:
Is it the truth?
Is it fair to all concerned?
Will it build goodwill and better friendships?
Will it be beneficial to all concerned?
Is it the truth?
Politicians – I think I could stop here because we all know they all lie, about everything. We have a President who sets the standard with over 12,000 verified false or misleading claims. Politifact states Obama made about 14% the number of “pants on fire” lies as Trump (yes, Democrats and Republicans, they all lie). Here in Seattle a Seattle City Council member, on the Berkeley “ban natural gas” bandwagon, stated a natural gas stove poisons the air in the house. A University of Washington scientist debunked that one pretty quick.
Business – My experience is most businesspeople are pretty truthful, other than owners who blend their business and personal checkbooks. They may write off some personal expenses but do report their income. When it comes time to sell, most care about their legacy (they want the buyer to succeed) and really care about their employees thriving with the new owner.
Is it fair to all concerned?
Politicians – Again, pretty simple as they only care about getting re-elected and the people who can help them accomplish that. This means donors and lobbyists not you or me.
Business – Most really care about their employees and customers. Yes, some (way less than 50%) are greedy, pay low, don’t provide benefits, etc. One telltale sign is often the retirement plan. If it has 95% going to the owner, you have to watch out for that person.
Will it build goodwill and better friendships?
Politicians – Yes, if you’re a donor, a donor’s business, or a donor’s cause. Otherwise, you’ve got to be kidding.
Business – Small business is relationship business. You can’t succeed if there’s not goodwill between employer and employees, the business and its customers, vendors, and service providers. Face it, customers usually have options. In today’s labor market employees have a lot of options (on my list of the top four things an owner can do to prepare the business for sale is, “Show you can attract and retain great talent.”
Will it be beneficial to all concerned?
Politicians – You know my thoughts on this. See the above three sections. If it’s beneficial to the politician they’ll do it (often meaning they’ll do what the Party tells them to do).
Business – If you’re in business, large or small, you must be able to solve problems, meaning beneficial to your customer, your vendors, and you. Try making a promise like a politician and not delivering on it (we’ll have your order out by the end of the month but when it’s two months late you’ll lose the customer). Things must be beneficial to employees also, or they’ll leave. Most want career advancement and want to be able to take pride in their work.
It’s the holiday season and this is a fun essay. I’m sure you picked up on the general theme, we businesspeople have a higher ethical standard than those we elect. As you give thanks on Thanksgiving, wish friends and family Merry Christmas, Happy Hanukah, and Happy New Year, realize it’s best to carry all those feelings throughout the year, not just in December.
This is something I sent to our clients recently and realized it has good lessons for all.
I’ve been involved in a real estate buy-sell transaction as over the last 18 months we’ve been trying to sell our family cabin in the Midwest. In this part of the country it is not a red-hot real estate market, with only one exception and the exception is places on a chain of lakes, which our place is not.
Bottom line, it’s been slow. About one year ago we had a verbal “offer” about 25% below the asking price. Our agent told them not to even bother writing it up, which was the right decision.
All of a sudden, this fall, after no serious interest all summer, we got two offers. One was another lowball offer, which definitely hurts one’s feelings. The other was in the negotiable range, so we negotiated, and reached agreement.
Lesson one: lowball offers destroy all faith and trust. You don’t even want to deal with the person.
After hundreds if not thousands of online views, scores of people looking at the place in-person, two lowball offers, and one negotiable offer, we came to realize the following, which business sellers often don’t want to accept:
Lesson two: the market was speaking to us about what the value really is.
At the same time, we realized, and this applies to business buyers:
Lesson three: no buyer (maybe a very naïve one) makes an offer they expect to be accepted.
In fact, if a seller accepts the first offer a buyer makes the buyer should wonder what’s wrong. Because rarely is the asking price what a seller really wants and rarely is the first offer the limit of what a buyer is willing to pay.
Summary, in business deals it’s very much about relationship. In business and real estate, emotion and feelings play a big part.
“Promises only bind those who believe them.” Jacques Chirac
I was recently talking to a business buyer about what he was looking for in a business. What he said all made sense; a B2B business, logical size range, wide geographic area, etc.
Then he said he needed a business on which he could pay off the debt (SBA, 10-year term loan) in half the time. That’s 25% annual growth, from day one. And yes, 25% can be achieved. A recent client grew 25% the first year. But over five years? If it takes one year to figure things out, all of a sudden, it’s about a 33% growth rate. But then came the kicker:
“And I don’t want to have to make any investment in the business (to achieve the growth).”
No new (additional) equipment, vehicles, marketing, or people. All the earnings go to debt reduction. This is fantasy land. And it makes me wonder what other fantasies are out there. Some that come to mind are:
A business seller believing his or her business is so special traditional valuation methodologies don’t apply to their business.
Owners thinking it’s easy to find good salespeople.
Advisors (and salespeople) figuring because they know what they’re doing the phone will ring.
Business buyers thinking an owner with no family in the business has no good options, other than selling to them with a low down payment (actually this owner has all the options).
Company founders believing a bank will lend them money based on their great idea.
I’m sure you’ve seen many more fantasies.
“We are living in a world today where lemonade is made from artificial flavors and furniture polish is made from real lemons.” Alfred E. Neuman
I’m working with a private equity firm to find add-on HVAC, plumbing, electrical, or refrigeration companies for their plumbing construction firm in the Seattle area (so if you know of any doing at least $5 million in sales who want an investor let me know). The founder of the PE firm has a distinct term for the earnings/income of a company.
He calls it “real income.” What this means is, it’s the income after allowing for all the expenses required to run a business. This means expenses for:
A CEO at fair market salary.
A CFO type, not just a part-time bookkeeper who doesn’t know what a KPI (key performance indicator) is.
Anticipated capital expenditures.
Operating interest (a working capital line of credit).
About 15 years ago I started using the term “free cash flow,” which is pretty much the same as what’s above. I would add together profit, owner salary, depreciation, and interest and subtract fair market owner compensation, anticipated capital expenditures, and operating interest.
What I didn’t include was the CFO/controller role and compensation, even though I’ve seen hundreds of businesses with crappy financial systems and crazy financial statements. Not to mention no management reports, no metrics, KPIs, etc. It took a while, but I now understand that’s a role we need to account for when adjusting earnings.
I like the term “real income.” It conveys trust, non-fantasy, and sincerity. It’s now my go-to term.
“The trouble with having an open mind, of course, is that people will insist on trying to put things in it.” (Author) Terry Pratchett
On September 8, 2019 the Buzz column in the Seattle Times was titled, “Seattle Cider sues founder, former CEO” and dealt with a lawsuit against the founder of Seattle Cider and Two Beers Brewing initiated by Agrial, a French company that acquired them. In simple terms, the plaintiff alleged the books were cooked to increase the price.
More about the above later and it fits with a quote I saw this summer from Richard Parker, “Numbers don’t lie, sellers do.” I wrote him and told him how I had seen a case where the owners/sellers (creatively) made the numbers lie, at least temporarily. Richard’s response was something like, it’s amazing how creative people can get with this stuff.
The Seattle Cider case involves the seller supposedly doing “channel stuffing.” He allegedly had his top distributor accelerate orders, so sales looked stronger than they really were and then, post-sale, orders declined because the distributor had months and months of product. Oops, the buyer is now getting no orders and had the privilege of paying the seller an inflated amount (again, alleged).
It seems so easy, but this stuff always comes out (at some point). For example, a seller ripped a letter off a bulletin board as she gave the buyer a tour of the business. Turns out the letter was from their top (30%) customer informing them a change in strategy meant they were ending the relationship. The buyer later found out from an employee.
Or many years ago when a buyer sabotaged himself by letting the seller convince him he couldn’t talk to the customers because the industry was so tight word of the sale would somehow get out. Even though his attorney and I told him to “kill the deal,” he agreed (to not do customer research, even as a reference check). Turns out the top, 25%, customer was doing a “test kitchen” of new systems without inviting their current provider (the seller’s firm) to participate. No wonder the seller didn’t want any customer related due diligence. (By not talking to the customers a buyer risks not knowing about damaged relationships. If the customer has already stopped doing business and is still disclosed in the purchase and sale agreement as being an active customer there should be protections in the representations and warranties in the agreement, although it’s still deception and a major hassle.)
And this is not confined to the small business and lower middle market. Just look at what’s in the headlines about We (WeWork).
When it comes to integrity and ethics, 99% of business owners have a high level (unless you count blending the personal and business checkbooks). But the other 1%…
“Don’t look back. Something might be gaining on you.” Satchel Paige
This is a little different than our regular memos, but I feel it’s an important subject for Washington business owners.
I recently sent past and present clients a fantastic summary of Washington State’s new non-compete law, taking effect January 1, 2020, which I received from Jeanette Adams Gorman with Socius Law Group in Seattle.
I received a lot of “thank you” and “interesting” comments but the best was, “Wow! this is distressing.” I was a bit surprised so many business owners hadn’t heard much about this.
I won’t get into the details (and I’m glad to send you Jeanette’s report) but will give you my top takeaways.
Non-competes will only be applicable to people earning $100,000 or more with the threshold for independent contractors is at $250,000.
Non-solicitation agreements and non-disclosure agreements, including sharing of trade secrets, are not affected.
Non-competes when the business is sold are still valid (the seller is bound by it).
There may have to be compensation to a terminated employee if the company wants to enforce a non-compete.
I encourage business owners to get professional advice on this, so you’re prepared for 2020. Advisors, make sure your clients are aware of this.
“An ounce of prevention is worth a pound of cure.” Benjamin Franklin