Over half of the businesses in the United States are owned by people over the age of 50 according to a survey prepared by Guidant Financial and Lending Club. Based on this data, it is likely that many businesses will change hands in the coming decade or two. If you own a business and are over the age of 50, chances are that you have thought about selling up. The exit planning process starts with understanding the current value of your business, what your goals are for exiting, and how to bridge any gaps between the two.
In this article, we discuss the topic in detail to help business owners gain a better understanding of what to expect when it comes time to sell their business. As well as some suggestions for how business owners can manage the exit planning process to get the best results.
Remember that mastering the storytelling side and how you are positioning your business is critical when it comes to engaging and speeding up the process. This is done via your acquisition memorandum. This is super important to reach a successful acquisition. For a winning acquisition, memorandum template take a look at the one I recently covered (see it here) or unlock the acquisition memorandum template directly below.
Business Value Data
DealStats (formerly known as Pratt’s Stats) compiles financial data from acquired private companies. Most of the transactions are reported by business brokers, and the database is primarily used by business valuation professionals.
Every transaction in DealStats is thoroughly reviewed in real time by a specialized team of financial analysts. Find comparable data for evaluating a business, determining a selling price, comparing performance, or conducting fairness of opinion research. Resources like these make an excellent point of reference for those looking to sell their business.
Deal stats can help you:
- Set realistic expectations
- Feel confident with your asking price
- Become knowledgeable about industry and value
You can find statistics that cover main street businesses, middle-market transactions, and larger M&A transactions. Businesses that sold for $1,000,000 or less account for 60% of the deals in the DealStats database, while businesses that sold for $1,000,001 to $500,000,000 account for 38%.
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What Multiples Can You Expect When Selling Your Business?
Many factors will impact the multiple of EBITDA (Earnings before interest, taxes, depreciation and amortization) or revenue that a private business owner will receive when selling the business, including:
- The industry the company operates in
- General economic conditions
- Risks and opportunities specific to the company
- Size, with larger companies generally fetching higher multiples
Many middle market transaction advisory firms will regularly publish data on transaction multiples.
The size definition of “middle markets” varies depending on who you ask. However, transactions ranging from $5M to $500M are generally targeted by advisory firms operating in the middle markets.
Over the past few years, many of these advisory firms have reported average transaction prices in the 7-8x EBITDA range. Many multi-billion dollar publicly traded companies trade at above 10x trailing year EBITDA.
A potential buyer of a private company is going to consider trading multiples of similar public companies and transaction multiples on similar private company sales (collectively known as relative valuation) as well as the present value of the future expected cash flows of the company discounted at the company’s weighted average cost of capital (known as intrinsic valuation).
A professional valuation analyst can help you understand the ways a potential future buyer of your business will view your company, including relative valuation and intrinsic valuation.
Through recurring valuations, the analyst can also help identify ways to reduce risks, enhance margins, and increase liquidity, which should lead to potential buyers eventually associating your company with higher multiples.
It is never too early to start, and if you plan on exiting your business in the next five to ten years you should have an initial valuation of your company performed by a qualified valuation analyst now.
Will You Get the Price You Ask For?
During preparation for selling a company, a valuation analyst can help determine a fair price for the transaction. However, the potential buyers of the company have the only opinions that matter for the price you will receive. By starting with a “fair” value from a valuation analyst, you can then adjust your asking price upwards as a starting point for negotiations.
How much to mark up your original asking price will depend on several factors, including
- Size of the company.
- What types of buyers your company will attract
- General economic conditions
- How well you can sell potential forecasts
Larger companies will likely attract more highly qualified buyers. If it is likely that your company will be bought by a strategic buyer, then a price higher than the “fair” value is likely. Strategic buyers will see additional value in your company due to synergies, or opportunities for additional revenue through cross-selling to your client base or cost savings through sharing administrative expenses.
When the economy is growing or near a peak, a higher price is also more likely. Having some or all of these factors going in your favor would support a higher markup than the “fair” value determined by the valuation analyst.
Increasing the Attractiveness of Your Company
Potential buyers of your company will look at many factors while doing their due diligence before making an offer. Margins, returns, leverage and asset turnover will all impact how your company will be viewed by potential buyers, through the historical trends in those metrics as well as how they compare to industry medians.
Additionally, industry specific metrics will be reviewed. For example, if you are a bricks and mortar retail store, the trends for your company in sales per square foot, traffic, average number of items purchased and average price per service sold will likely be considered by potential buyers.
Potential buyers will also consider risks specific to your company, like if one customer makes up a significant portion of your revenues or if a small group of customers make up the majority of revenues. This adds to the overall company risk and decreases a company’s value in the eyes of potential buyers.
If one supplier is used for a key input for your business, a competitor could buy that supplier and no longer sell the input to you or sell at increased prices, thus adding risk and lowering the value of your business.
If the company is heavily reliant on one manager, the potential risk of that individual leaving the company could also lower the value.
Buyers Will Take a Deep Look at Your Company
Expect thorough due diligence, including:
- Your company’s financial ratios in comparison to industry medians and similar companies
- Specific risks, including concentration of revenues among a small group of customers
- Risk related to suppliers
- Risk of concentration of management with one or a couple of key managers
- Your company’s tie to one geographical area
- If your company’s revenues are tied to one or a few products
Depending on your business and industry, some of these metrics and risks will be out of your control and others are within your control. A good valuation analyst should be able to help you compare the metrics to industry medians and identify risks to your business. The valuation analyst can also help figure out which of these items are within your control, and which of the controllable items would have the greatest impact on valuation if improved.
If you are years away from selling the business, the recommendation is to pick the top two or three metrics or risks that need improvement. These would have the greatest impact on your company’s overall value to potential buyers, so you should focus on improving those items.
The sooner you start the process, the more time you will have to maximize the attractiveness of your business to potential buyers when the time comes to sell. It is recommended to start exit planning 5-10 years ahead of the planned exit date, but it is never too early to work on improving the value of your business.
How Much Will the Transaction Cost?
Fee structures can vary for business brokers, investment bankers and M&A advisors across the United States and world. Generally, the larger the transaction, the lower the fee in terms of a percentage of the transaction value. For example, a business that sells for $1.5M may pay a fee of $140k ($100,000 for the first million and 8% or $40,000 of the next half million).
A good business broker will help identify qualified buyers, market the business to them, assist in the due diligence and negotiation process, and bring in other legal, accounting, valuation or other consultants as necessary.
In addition to the broker fees, there can also be legal, accounting, valuation, and other consulting fees related to the transaction. So the total costs associated with the transaction will be a few percentage points higher than just the broker fees. Don’t forget your taxes either.
The value of your business likely represents decades of hard work. The services you get from your business broker, valuation analyst, accountant, and legal advisors related to the transaction should help to make sure you maximize transaction value and ensure the process goes as smoothly as possible.
While total transaction costs can be high, especially for smaller businesses, in most cases the services you get from your valuation analysts and legal advisors related to the transaction will be well worth the fees.
This will be the same thing when you are raising capital. In this regard for a winning pitch deck to help you here, take a look at the template created by Silicon Valley legend, Peter Thiel (see it here) that I recently covered. Thiel was the first angel investor in Facebook with a $500K check that turned into more than $1 billion in cash.
Remember to unlock the pitch deck template that is being used by founders around the world to raise millions below.
Beginning Your Exit Plan and Process
If you are thinking about selling your business, the first step in the planning process is gaining an idea of the current value of your company. A business valuation analyst can prepare a valuation to suit your needs, as well as help with benchmarking your company’s important metrics against industry medians. You should seek updates through periodic or annual valuations and benchmark them to measure and track progress as you move closer to your exit.
Exiting & Negotiating The Deal
A formal strategy for collecting first-round offers can be made once potential purchasers have been identified and marketing materials have been prepared. From this point forward, handling interactions with potential buyers will be crucial to your success. To guarantee that competitive tension is generated, a clear deadline should be established from the start.
It’s crucial to put yourself in the buyer’s shoes throughout these negotiations to get a sense of what matters to them and how they compare to what matters to you. You’ll have more control over the process and will be able to see any possible roadblocks. An expert business adviser will assist in guiding these critical discussions, offering advice and assistance on best practices for maximizing the selling price.
Finalizing Legal Documentation
When selling a business, you’ll need to draw out a number of legal contracts. The purchase agreement is the definitive document outlining the conditions of the sale and will describe all of the transaction’s details. Other transaction documents, such as a non-compete agreement or an earn-out clause wherein the seller stays with the company for a set period of time, are often included. All of this will likely be precluded by a LOI.
Managing The Profits From The Sale
Following the completion of the sale, it is important to get the appropriate financial guidance in order to map out your financial goals and choose the best way to invest your funds. It’s also important to go over the tax structures you set up at the start, and speak with your tax adviser about any changes you might need to make.
Keep these tips in mind as you work to build trust with your potential buyers, as well as assist them in coping with the difficulties of the purchasing process and to help prevent miscommunication.
You’ve put in a lot of effort to build a successful business. Selling your company is a monumental task. The benefits of careful and early preparation will be well worth the effort.
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