There stands about one trillion dollars of private capital currently sitting idle in the US.
The market’s recent volatility has produced a flood of investors seeking acquisitions in well-run, profitable, positively trending businesses. Currently, buyers far outweigh the number of sellers ready to sell their businesses. Laws of supply and demand will tell you that right now is a great time to sell a company, while there’s little competition. However, we’re at the beginning of a sustained cycle of baby boomers who own businesses and are nearing retirement, so the current imbalance in supply and demand is not likely to continue. Timing your exit is going to be critical and may have a tremendous impact on the value of your business. How can you take advantage of having time to plan if you’re not quite ready to sell?
Allow Enough Time to Prepare a Company for Sale to a Third-Party
When done right, the decision to sell a business is made over an extended period of time. With the luxury of time and advanced planning, you can maximize the value of your company and dramatically increase the odds of being able to sell your company when you want to. Buyers base their initial interest in a company on the most recent 4-5 years of financials. If you’ve been running the company in a way that minimizes the tax burden on the corporation each year, you likely strive to profit. Maximizing the reported profitability of the company in the years leading up to a planned exit, however, can have a profound effect on its valuation. Let’s use the owner of ABC Corporation as an example. Currently, he averages $500,000 in reported net income. Assuming market data shows that companies in this industry have been trading for approximately five times their average earnings, the owner of ABC Corporation can probably expect an offer to purchase the business for approximately $2,500,000. Now let’s contrast this with a strategic approach to preparing ABC Corporation for sale in five years from now. The owner stopped prepaying expenses at year end, only bought the amount of inventory needed for customer demand and stopped expensing owner perks that weren’t essential to sustaining current sales levels. As a result, he has been averaging $1,000,000 in reported Net Income. Now the five years have passed and he’s ready to find a buyer. We find that applying the same 5X multiple on $1,000,000 makes his company worth $5,000,000. He’s just doubled the value of his company. Admittedly, he will be paying more in taxes on the increased Net Income in these 5 years, but even in the highest tax bracket, the increase in valuation far outweighs any short-term increases in taxes. This example grossly simplifies the evaluation process; however, it demonstrates the potential impact advanced planning can have on the value of your company.
A company’s historic financial performance tells only part of the story and is very subjective. Three different buyers getting ready to make an offer on the same company will likely have three distinctly different offers. Each buyer evaluates the deal by factoring in their own unique risk tolerances. Besides financial performance, important factors that weigh into a business valuation are: the strength of the management team, having customer diversity, having contracts or recurring revenues, having competitive/technological advantages, the scalability of the company and growth potential. Small businesses are perceived as risky investments, so let’s examine the basic types of buyers you’re likely to come across and the primary motivations of each one.
What Type of Buyer Would be Interested in Acquiring My Company?
A buyer that is currently operating in your industry (or has a desire to enter into it) is a Strategic Buyer. A strategic buyer is often willing to pay more for a business if they can realize some form of synergy through the acquisition that a financial buyer may not have. Synergy can be realized in future revenues by cross-selling product lines or complementary services. Cost synergies can be realized through restructuring the organization or reducing costs through volume discounts or more favorable credit terms available to the larger company. If appropriate for the size and type of business, a Strategic buyer is almost always going to yield the highest offer for a target company. Financial buyers investing in a business have a singular motivation – getting a return on that investment. The most important issue to a financial buyer is the predictability of the earnings. These investors often seek or even require that a seller stay invested in order to keep management focused on growing the business profitably. Financial buyers are seeking businesses that can continue operating independently with the existing management team. This could be an especially attractive option for a business owner that is interested in taking some of their “chips off the table” or that is in need of capital for future growth. Individuals are typically seeking a business that provides an opportunity to be actively involved in the operations of the company while maintaining a certain lifestyle. Currently, a high number of individual buyers are in the market due to dissatisfaction with corporate employment or having been right-sized out of a job with a larger company. The most important issues to an Individual buyer are the size of the company, the ability to obtain financing for the deal and acquiring a business whose products or services don’t require specialized expertise. It’s critical to think about the sale of your business from the perspective of the buyer and identify who is likely going to be interested in acquiring your company. Realistic deals are ones that generate a reasonable return on investment for the buyer. If the business is strong, generates predictable cash flow and the buyer envisions ways of improving the business, they will require a lower rate of return (yielding you a higher offer). If the business performance has been volatile and has other built-in risks, the buyer will require a higher ROI, resulting in a lower offer to purchase your company. Regardless of your timing or the type of buyer you find yourself negotiating with, having the right advisors, setting realistic expectations, and planning ahead will go a long way in securing your financial future and protecting your company’s legacy.