The Baby
Boomers are retiring in large numbers and according to New Economy Week, over
the next ten years Trillions of Dollars of businesses will be changing hands.
The number of businesses that change hands will very closely mirror the number
of baby boomers that are retiring.
Price
Waterhouse reported in a Trendsetter Barometer Survey of Business Owners that
51% were planning on selling their
company to another company compared with 18% anticipating passing on the
business to a family member and 14% planning a sale to the company's
management.
The trends
point to more than a doubling in the number of businesses that will hit the
market looking for a buyer by 2020. Simple economics and supply and demand
would suggest that unless the number of buyers increases significantly, there
will be an erosion in valuations for business sellers during this rush to the
exits. Compare that to the relatively robust environment business sellers have
enjoyed over the past 3 years. This period was supported by unprecedented Private
Equity investments, in addition to the available cash from corporations
with rising profits, and very favorable interest rates.
Given this
backdrop, what is a business owner who is anticipating selling his business in
2020, to do? Move up your sale time frame, but
Too many
business owners view their business sale and their retirement as a simultaneous
event and end up delaying the sale to the day they want to stop working. That
mis perception can be very costly. Too many owners wait
too long and end up selling because of a negative event like a health
issue, loss of a major account, a shift in the competitive landscape, or just
plain burn out. As you can see, none of these major reasons for selling puts
you in a favorable negotiating position. As a general rule, the faster you want
to disassociate yourself from your business, the more the buyer will want to
deduct from his purchase price. Your desire to leave quickly is a red flag of
risk to the new owner.
Your best
outcome is to sell
your business near the top and stay involved as an employee or consultant
for a reasonable period. If you look at the transaction structures that are
popular in the acquisition of closely held businesses, this approach makes a
lot of sense. The more a business depends on the owner for its success, the
greater the risk to the buyer. The greater the percentage of a selling
company's projected earnings that is dependent on future new sales, the lower
percentage of transaction value that the seller will receive as cash at
closing. The greater the concentration of company sales to a small number of
customers, the lower the price and the greater the earn-out component of
transaction value.
Most
privately held family businesses have one or a combination of these value
detractors. Your selling strategy can mitigate the negative impact on selling
price. By exiting before the necessity of exiting, your sales trajectory will
more than likely be on the increase than on the decline. Buyers pay a premium
for growth and discount for flat or falling sales. Unless your entire
revenue stream is contractually committed over the next several years, most
buyers will introduce an earn-out as a component of the total transaction
value. This is a risk avoidance strategy that ties the total acquisition price
to the future performance of the business post acquisition. It is also designed
to keep the business seller engaged in the near term performance of the
business.
In spite of
the normal response from business sellers who want the entire sale price in
cash at close, we believe that under the proper circumstances and properly
memorialized in the definitive purchase agreement, earn-outs
can be a big win for a seller. We normally try to tie the earn-out to future
revenues of the acquired property. That is usually very easy to measure and to
audit if necessary. Earn-outs based on future EBITDA or division profitability
are more problematic because of the greater possibility for interpretation by
the buyer. You all of a sudden get an accounting entry of corporate overhead in
your financial reconciliation and your profit disappears.
Count on
your original champion who negotiated your agreement not being involved by the
end of the earn-out period. Make the agreement air tight in terms of how it is
interpreted. A subtlety that we negotiated into an earn-out for a client was
that the earn-out would be paid based on the greater of the sales price for the
seller's product or 80% of list price, whichever was greater. You see, we
cannot control how the buyer runs the business once he has the keys, but we can
control how the earn-out is calculated. This prevented the buying company using
the seller's product as a loss leader in combination with their other products
and shifting the revenue to other products at the seller's expense.
If you look
at this preferred structure in conjunction with your sell
now, exit later strategy, it can work in your favor. Wouldn't you want to
be fully engaged and energized during your earn-out period and drive the value
of the earn-out? As part of the new company, you now have 325 installed
accounts instead of 25. Your sales force is now 25 strong compared to 2 sales
people from your prior company. Your advertising budget is twenty times your
old budget. You now have a network of 50 manufacturers reps supporting sales.
Your new company's access to growth capital dwarfs what was available to your
little company. Do you think you have an environment where you can achieve a
sales growth far greater than what you could do on your own? The key is to
negotiate the earn-out that gets you to a transaction value comparable with an
all cash at close offer that assumes your company sales grow at their
historical rate.
For
example, your offer if you back the buyer into the all cash at close offer is
$5 million. Compare that to a deal that would provide you $3.5 million at close
and another $1.5 million in earn-out if sales grew at 10% per year (your
company's historical rate) for the next three years. Our contention is that the
earn-out deal could be far superior. Given the much greater distribution power
of the new owner, you could reasonably expect sales to jump by 25% per year,
driving your earn-out to $2.5 million and resulting in a $1 million improvement
in transaction value. You want to be fully engaged to achieve this result and
that is exactly what the buyer wants.
As a
business seller you have many factors that can greatly impact your selling price. Getting multiple buyers
involved is probably number 1. A very close second, in the near term future is
the timing of your sale. The economic trends are against you postponing the
sale part of your exit. You can always sell now and retire later.
Dave Kauppi is a Merger and Acquisition Advisor and President of MidMarket Capital, providing business broker and investment banking services to owners in the sale of lower middle market companies. For more information about exit planning and selling a business, click to subscribe to our free newsletter The Exit Strategist
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