What is different about planning a business for growth versus planning a business for exit?
I’ve read that you should be planning to sell your business from day one. Even though there may be some truth to that statement, let’s be realistic. During the first few years of business ownership, there are way too many more pressing issues than thinking about selling something when you haven’t built anything worth selling to anyone yet. But if you are fortunate and resilient enough, it’s almost inevitable that you will sell the business one day. So with that in mind, how does it affect your decision making? In other words, what is different about planning a business for growth versus planning a business for exit? Let’s examine some of the key issues:
Most small business owners are control freaks. It goes with the territory especially in the early years when you are wearing many hats and delegation is not an issue since there are few to delegate to. But to grow a business you need to grow a team. The only way to attract and retain talent is to provide people with opportunities to grow. When we were approached by our eventual buyer, the first items they asked for were financials and an organization chart. The key question they kept coming back to was who held the customer relationships. If the answer keeps coming back to a single person (especially if the answer is You!), the red flag goes up. Put people in positions of authority in both customer facing and internal roles. If you don’t feel comfortable going away for a two week vacation, something is wrong.
Diversified Customer Base
It’s not uncommon for small and middle market businesses to follow the 80/20 rule: 80% of your revenue comes from 20% of your customers. Most of us like having large customers but as we know they also come with a certain amount of risk. While the risk is real, it’s perceived differently by you and a potential buyer. You know the customers, the decision makers, the competitive issues, so in your mind you are able to manage the risk. A potential buyer will focus on the downside and, in most cases, more risk to a buyer translates to a lower multiple in the valuation. Larger existing customers that are more in a maintenance mode may require a different level of selling than what it takes to close new deals. One strategy that we used was to incent our sales team more generously for new customer acquisition. It’s difficult to control who buys from you and who doesn’t but recognize the risk/rewards to both the current business and a future owner.
At a minimum, potential buyers will want to see three years of financials. The size of your business and management plans of the buyer will determine if your valuation is based on SDE (Seller Discretionary Earnings) or EBITDA (Earnings before Interest Taxes Depreciation and Amortization). If you have consistent growth rates in revenues and profits consider yourself fortunate. One issue that some owners are faced with when it comes to planning for growth versus planning for exit is investment decisions. For example you see a new market opportunity to sell one of your existing services but it will require investment in a new sales team. You estimate a four to six month lead time before the new sales team is paying for itself. Or you are considering a hardware or software upgrade that may have a short term bump in expenses. What will the hit on profitability do to your valuation? Buyers are smart business people just like you. The large majority of buyers don’t have the in depth knowledge of your market that you do. They will trust your judgement and take that into consideration when analyzing the numbers.
Books and Records
The buyer’s team is made up of top management, due diligence staff and other professionals (Legal, IT, HR, Risk, etc.). Top management will be making the final decisions but your job is to impress everyone. How organized you are and how efficiently you run your business makes a big difference. If you haven’t seen a due diligence checklist before prepare yourself. Get in the habit of closing your books on a timely basis, probably no more than five business days into the next calendar month. Make it a standard process to scan all of your important documents so they can be easily transmitted. This includes financial statements, tax returns, HR policy manual, employment agreements, lease agreements, customer/vendor contracts, shareholder agreements, intellectual property documents, etc. etc. Especially for small and middle market businesses, the due diligence process can be a major distraction to running the day to day business. Confidentiality is also a major consideration and the ability to share documents electronically is a major advantage. At the end of the day you want every member of the buyer’s team to be singing your praises.
At a minimum you will need three trusted advisors – Lawyer, CPA and Business Broker/Intermediary. Similar to hiring a real estate broker to sell your house, a business broker/intermediary has the resources and experience to help you identify a pool of buyers which gives you the opportunity to get the highest value. And although we had used lawyers and CPAs throughout our business life, never did they earn their money and my appreciation more than when it came time to sell the business. A business purchase agreement is a complex document and you need an attorney who has experience with business transactions working closely with a CPA who is an experienced tax specialist.
Bottom line: With minor exception, when it comes to decision making, if the decision is good for the growth of the business before an exit, it’s good for the growth of the business after an exit. And start thinking about who is on your team of trusted advisors well in advance of game time.