Specializes in governance, strategy, finance and M&A. Author & Experienced Outside Director. Kona Advisors LLC.
If you are serious about selling a business, then you need to prepare for the process. I find that smart owners begin positioning for exit as long as three to five years before they want to get out. Then you may need up to a year to transact.
Many buyers are looking to acquire discounted future cash flows on a favorable basis. When looking at your business, they will be focused on revenue growth, EBITDA and the quality of the management team. The discount rate reflects their opinion of the risk in the deal and their IRR objectives.
If the business is well-run and nicely profitable, the books and records are up to par, and there is a complete management team with adequate succession plans, there may not be much to prepare.
To get the most realistic assessment of what your business may be worth and the type of buyer who may want it, I recommend running your own assessment before going to market. Investment bankers can help in this process; they can do some of this work for you as part of their efforts to win the assignment, so don’t be shy. This is also a good way to determine what it will be like to work with them for the six to nine months that a typical exit process requires.
Below are some steps to take when preparing your business for a favorable exit.
Have A Strong Growth Story
Time and again, it has been proven that you get more for your business if you have a strong growth story in a good market. To get the most value for your business, you want to give buyers a strong growth story that they can corroborate. Your future forecast needs to hold water, though, as buyers will confirm each of the assumptions in your forecast.
For this growth story, you will need to have granular knowledge of your market position and industry dynamics. An easy way to organize this is to use Porter’s Five Competitive Forces, which include competition in the industry, the potential of new entrants into the industry, power of supplier, power of customers and the threat of substitute products. While in some ways dated, I find that these forces still convey what buyers want to understand. You want to project your competitive position today versus what you expect to see five years forward. After all, that is what buyers are trying to figure out.
Improve EBITDA
The decision to sell is often anchored but your expected net proceeds and your earnings before interest, taxes, depreciation and amortization (EBITDA). If you don’t like the number, you still own the business, so I recommend that you take actions to improve the business before selling.
If you fix the business, then the buyer should pay you for the improvement. If you don’t fix it, you will take a discount since the buyer bears the risk of making the improvement. This needs to figure into your timeline for selling.
Your choices are either more revenue or less cost but preferably both. The growth story and the quality of your assumptions should address the revenue opportunities. Whether it is new products, new geographic markets or new distribution channels, take the time to map out these plans.
It is common to overestimate potential cost reductions. Buyers will typically reduce your savings estimates to some degree. This will vary depending on whether the buyer is strategic or financial in nature.
Strengthen Management
Sellers typically do better when they deliver a complete management team to the buyer. But that assumes the team is composed of high-performing executives who are committed to staying as long as the buyer wants them. Reality is rarely that convenient.
Some of the team may be close to retirement or not desire to continue under new ownership. Some may not be performing well. Smart sellers analyze the team and either rebuild it before going to market or create a story that is appealing to the buyer.
You may also need to do some convincing to get the team to stay for a new owner. Your ability to get the deal done could be limited by one or two uncooperative individuals. This is when deal-specific incentives make sense to consider.
Make An Informed Decision
The above points help to assess the marketability of your business but do not provide insight on whether you should sell it. At this point, you should have a forecasted P&L and balance sheet. You should focus on the future cash flows, purposely answering questions like: How much capital is needed to grow the business? What are the working capital requirements? What is the borrowing capacity of the business?
Growing businesses typically consume capital, so as you push the growth story, you will likely need more capital, which can impact which buyers will come to the table.
The Net Present Value (NPV) analysis plays a crucial role in determining net proceeds and is likely to be a key driver in the decision to sell a business. NPV is calculated based on the discount rate, which represents the perceived risk associated with the business.
Assuming a discount rate of 5% (similar to a savings account) implies that there is little risk involved in achieving the business’s financial targets. However, I find that potential buyers evaluating your business are more likely to use higher discount rates, typically ranging from 15% to 30%.
While most people don’t spend the time to build out the NPV and Net Proceeds models, I find that smart sellers always do.
If you have the energy, desire and access to capital, then you may consider keeping the business to exit later at a much greater value. But market windows open and close, so you will need to balance the trade-off between the time needed to materially improve the business (typically a few years) and when the market is best to sell your business.
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