Most privately held businesses have been or will be sold. There are exceptions—failed businesses that shutter, enterprises that transition to family members and the rare case of a company that goes public—but the norm requires most business owners to have a sound strategy to sell to a third party.
At the RSM Center for Business Transition, we focus on consulting with entrepreneurs on how to successfully exit from their businesses. We often find that business owners don’t sufficiently evaluate the right time to sell their business in order to maximize the return on their investment.
After all, the equity in a business typically is an owner’s most valuable asset. And many times owners rely on a sale to help fund the next phase of their lives. Owners may do good work planning the start of their businesses or growing them, but rarely do entrepreneurs expend appropriate effort in evaluating the best time to sell and successfully monetize their asset.
In attempting to understand why this blind spot exists, we have observed that many successful business owners seem to have certain attributes in common:
- Their singular passion is on improving the operations of the enterprise
- Their personal self-worth is intertwined with that of their company
- They have minimal interests outside of the business
- They would be lost without the purpose of being in charge of the enterprise they have dedicated their work life to building
- All of their work time is focused on working “in the business” rather than gaining insights about the environment in which the business operates today and in the future
Owners of privately held companies should consider early in a company’s life that businesses are created to be sold. One of the habits espoused by Stephen R. Covey in his book “The 7 Habits of Highly Successful People” is that such people “start with the end in mind.”
I was surprised recently when we received an inquiry from a group of 30-somethings who own a growing, highly profitable business. They sought to retain the RSM Center for Business Transition to advise them on their exit strategy. Our clients are typically in their 60s or 70s, and maybe some are in their 50s. Certainly, entrepreneurs in their 30s and 40s view their business through different lenses than more seasoned business owners. However, these particular less-experienced entrepreneurs had the foresight to recognize that understanding and preparing for a potential sale at the peak value was a critical part in the stewardship of their company. Significant value can be lost if a business owner does not understand the right time to exit.
Too often, business owners start to think about monetizing their business equity when they feel personally ready. Maybe they just don’t wish to continue working, or they have suffered an illness, or they come to the realization that they have become stale and the business would be better served in the hands of others. Many never come to a point of being personally ready to exit. Unfortunately, an owner’s readiness does not necessarily correspond to the best time to extract value from the business.
The right time to sell is based upon external and internal factors. Often, owners place emphasis only on internal factors. Before a business has an exit event, it is critical for it to become attractive to potential buyers. Most buyers want to be confident that a business has created a reliable and sustainable free cash flow, an efficient and effective infrastructure, a strong management team that will perpetuate once the owners are removed, valued and differentiated products or services, unique strategic positioning, etc. Obviously, the bigger and better these attributes are, the more valuable an enterprise should be.
Business owners are more likely to understand the need to address these internal factors in order to consummate a positive exit. However, there is more to consider: the external factors.
External factors are forces not in the control of the business owners. And they can be just as important as internal factors to driving a financially satisfying event. Here are critical ones to consider:
Multiples of earnings or revenue for which companies are sold directly correlate to the general economy. The volume and the value of transactions tend to fall as economic conditions falter. Acquisitive companies will often retrench and try to maintain funds to address problematic financial results. Not only do values tend to follow the economy, but the anticipation of a recession suppresses overall values as former acquirers try to get ahead of a downturn. These macro factors can materially influence the best time to sell.
View of the industry
Multiples of earnings or revenue can vary widely by industry. Not only that, those multiples can fluctuate within an industry over time. According to Kesh Iyer, principal in RSM’s valuation services practice, “how economists and securities analysts perceive where an industry resides in its life cycle generally has an impact on market value. Are these experts anticipating significant industry growth, or is this industry becoming commoditized?”
Their viewpoints can cause certain industries to go in and out of favor, causing access to capital to ease or tighten for acquirers. More capital drives up multiples because demand increases. There is a ripple effect from all of this to middle market companies, and owners need to be aware of these industry trends.
Potential market disturbances
Imagine owning a taxi company. In New York City, taxi medallions as recently as 2015 sold for more than $1 million per cab. With the onslaught of ride-sharing apps, however the market per medallion has plummeted by more than 40%.
Retail businesses also have been severely affected by technology through Amazon and other companies. More industries will be affected by technology, changes in buying habits, international competition, environmental issues, regulatory changes, etc.
For example, a company that distributed products to retail outlets in the region engaged us at the RSM Center for Business Transition. Their core products were shopping bags—from plastic bags used in the millions by grocery stores to expensive bags used by high-end retailers. In order to protect the environment and diminish utilization of landfills, local jurisdictions began to place a small tax on all disposable bags, which retailers were mandated to collect from customers. The bottom dropped out as consumers changed their habits. Many avoided using retailers’ bags to avoid paying a few cents more. The company went into rapid decline, and ultimately it was unloaded in a fire sale.
Many of these sorts of disturbances are a long way off, but they are certain to influence company values in the future. It is a daunting challenge to understanding the future state and how the new world order will function. But it is crucial to be in front of change and realize that an early exit may preserve company value.
Much of what is outside a business owner’s immediate control can materially affect a financially successful exit. Being savvy about such factors should influence an owner’s timing of this important event. Owners can be proactive by educating themselves.
Here are three ways you can evaluate external factors when considering when to sell:
- Develop relationships with investment bankers who understand your industry and geography
Good bankers have insights on trends with respect to earnings or revenue multiples for the industry. They understand whether consolidation may be taking place. They know if acquirers have an abundance of available money, and they have a sense of supply and demand for companies in the industry. Most investment bankers are very willing to establish a long-term relationship with their target clients and don’t pressure owners to sell their business. They are typically very patient in hopes of being there when a business owner is ready.
- Periodically conduct a fair market value analysis by a credentialed business valuation specialist
Frankly, I am surprised as to why business owners don’t have such an analysis prepared more frequently. It can provide them insights into the critical value drivers of their business and a benchmark value for the business. Owners track the value of their personal investment portfolios regularly. Why not do the same for their businesses? Such information is important to appropriately plan for one’s financial future. One can learn a great deal about the market’s appetite and recent trends for acquisitions overall and in one’s specific industry.
- Become a continuous learner about the world around you
There is a plethora of articles, books, seminars and videos about the future state, business trends, how technology will change our lives, emerging economies, potential tax law changes, movements in available private equity and corporate cash, international trade, etc. Take advantage of these resources.
Evaluating general trends in the economy is also of value. A few important leading financial indicators to track are the short- and long-term interest rate outlook, trends in housing starts, changes in deployed capital in the private equity industry, and the magnitude of transactions in mergers and acquisitions.
It may seem daunting, and trying to stay abreast could overwhelm you. But I find it surprising that so many business owners pay very little attention to these subjects, when insights on such matters have such an important strategic effect on every business today. If you haven’t spent time gaining needed insights, start by searching the internet on relevant topics.
Overall, exiting one’s business is not just about when the business owner is personally ready, or when the owner believes the business is ready. Owners need to understand what drives market conditions and when the market conditions are most favorable. Not doing so could very well lead to a suboptimal and disappointing business divestiture.