According to a Wall Street Journal (WSJ) article I read not long ago, more business owners are delaying retirement because they cannot sell their companies for what they need to comfortably retire. I ask you, as both a business owner and a business buyer, when did that become the valuation criteria?
Fair Market Value
The WSJ article focused on business owners who state that they cannot obtain what they believe is fair market value for their businesses in the current economic environment. It is true that the average price paid for businesses ranges from 3-5x (three to five times) EBITDA (earnings before interest, taxes, depreciation, and amortization). It is also true that this multiple can increase to 6 or 7 (or even higher for publicly traded companies) in frothier markets. Therefore, there is some basis to these business owners’ complaints.
However, I say this over and over (and perhaps it is a good thing that I am brown skinned so you cannot see that I get a little blue in the face!): As a business owner, you MUST create value that others appreciate in order to sell your business for a price that is suitable to you. I frequently encounter business owners who have an extremely inflated view of their business. The owners’ view is based on how much time he spent building the business and working on it. It is often NOT based on how much money the business is generating over and beyond the salary paid.
Obsolete Inventory / Bare-bones Salary
I see business owners with obsolete inventory that has not turned over in 3 years expecting a buyer to pay full price for that inventory. I see business owners that are barely able to pay themselves a salary after 10 ten years who expect to receive 3 times revenue. Of course, they never get it. So they keep working in their businesses. At other times, I’ve seen people wait so long to get “fair value” for their business that their health fails and, without their focus, so does the business. Then ultimately, they receive pennies on the dollar.
Therefore, my purpose here is to establish and manage expectations. What you can expect to receive for your business is what a buyer will pay. If you build a strong business with significant promise that runs without you, or build a steady, reliable business that runs well without you, you can expect multiple buyers and higher offer.
How Do You Create Value?
How do you create value? you ask. Your business must work well without you. Buyers often like to lock up the seller in an employment contract for 1-3 years, but this is to transition the business (and reduce your motivation to breach the purchase contract and open a new business to compete against the buyer!). Unless you intend to sell to a competitor that will fold your business into theirs, your business needs to run without you. Therefore, you must install professional management – a CEO, COO and/or CFO and a VP of Sales, if your company has sufficient size or a GM and Controller, if not.
Why is it so vitally important that you move yourself out of the top job? If you have all the relationships and run the company without help at the highest levels, as a buyer, I am simply buying a job. In addition, I am buying a greater risk that you (the seller) will become my greatest competitor and, because the business relies on you significantly, I will not be able to compete. As the buyer, there went my investment!!
If you transfer customer relationships to the CEO, COO or head of sales, the risk drops. If you do this 2-3 years or more before you sell, the buyer’s risk plummets! Alternatively, you can transfer relationships and lock your customers into 3-5 year contracts. This drives even greater value for your business because you are providing a guaranteed revenue stream to the buyer.
Many of the owners in the WSJ article were working 12 – 16 hour days and/or had not taken a vacation in years. Come on now. With that description, would you want to buy the company? If you’ve run the company for 15-20 years and that’s where you are, what makes you think someone else can come in and do better? And if they can, why should they pay you for the growth the new owner will bring to the business? This is why those companies are not selling. Make your company’s fundamentals – including the management and employee reporting structure – more attractive and begin revamping your business into a salable asset, and it will sell. This may take a few years to accomplish but, believe me, it will be well worth it!