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Selling your Business is a Process, not an Event
The post WW II baby boom (1946 – 1964) has frequently been described by demographers as a pig passing through a python. The baby boomer’s impact on our society has created a myriad of opportunities and impacts as they’ve travelled through their different life phases. With this demographic currently making up the majority of SME ownership, many business owners are anticipating the sale of their business will be the source of their retirement income. On the basis of the pig and the python analogy, the market for SME sales will soon be bulging with owners wanting to exit their business.
NZ has approximately 471,000 enterprises, of which nearly 320,000 are one man bands. A further 145,000 enterprises employ between 1 and 50 employees. A recent survey by accounting firm Grant Thornton revealed that 70% of NZ business owners were expecting to sell their businesses in the next decade to fund their retirement – nearly three times the global average of 25%. This creates a significant problem for NZ business owners in an economic environment with a low appetite for risk combined with tight capital markets and a shrinking market of buyers.
WHAT IS AN EXIT STRATEGY
Most good entrepreneurs often make the bulk of their wealth by maximising the sale price when selling their venture. A well-orchestrated exit strategy is a critical component of their business plan and is produced well in advance of starting the business. Most business people are not entrepreneurs however and haven’t started their business with the intention of strategically maximising the sale price. The majority of business owners only consider their exit when it comes time to sell. They tend to view their business sale and their retirement as a simultaneous event, often postponing the sale until the day they want to stop working; OR, they end up selling because of a negative event like a relationship split-up, a health issue, or a significant change in their business operating environment. None of these selling triggers create a favourable negotiating position for the owner. As a general rule, the faster the owner wants to exit the business, the more the buyer will try to force a reduction in the purchase price. The desire to exit signals either risk or opportunity to the buyer, both of which will impact the price. This often results in the seller accepting whatever they can get, which is significantly less than if they’d had a well-planned exit strategy.
Putting an exit strategy in place sooner rather than later is simply common sense. Leaving it until you’re desperate to get out, and then attempting to sell your business at short notice rarely works because you’ve given up control of the sale. When preparing your exist strategy, always start with the end in mind. Determine what it is that you want from the sale, and what you’re prepared to do to achieve this. If your plan has always been to build equity in your business that you can one day transform into cash, you’ll need to start planning that transformation process now. Your exit strategy is the plan you will use to sell your business, release your equity and harvest your investment.
WHAT ARE YOUR SELLING/EXIT STRATEGY OPTIONS?
There are several options for selling your business, but for our purpose we’ll stay focused on those applicable to SME’s. Options include:
- Become a Business Acquisition Target – The process of acquiring a business to build on strengths or weaknesses of the acquiring company. The end result is to grow the business in a quicker and more profitable manner than normal organic growth would allow.
- Appeal to your Competitors as a Merger Option – A merger is similar to an acquisition but refers more strictly to combining all of the interests of both companies in to a stronger single company.
- MBO (Management Buy Out) – Is a form of acquisition where a company’s existing manager(s) acquire a large part or all of the company with options to buy additional shareholdings at set intervals or on achievement of performance targets. This might also extend to critical staff who are offered options which are only convertible after the final transfer of the owner’s shares has been completed. This is designed to ensure that key staff remain with the business.
- Business Buy Out – The outright sale of the business to a third party. Buyers generally have some industry knowledge or are attracted by the financial returns of the business.
- Succession – Handing the reins of the business over to a family member or pre-determined successor. The previous owner frequently retains a shareholding or an influential role as a Director or board member.
- Liquidation – Close the door sell off the assets and cease trading. An unfortunate default strategy for the unprepared.
Identify and understand where the real value in your business lies. Is it your unique product or service, is it your customer database or supplier relationships, is it your IP or your brand, or is it simply the value of your physical assets? Maybe it’s the quality of your staff and the relationships they have with your customers? Whatever your critical assets are, identify how you can capitalise on them and who would be prepared to pay you for them. It may be as simple as running a well organised, well managed business with fully established business systems that would be easily transferred to a new owner.
Always be buyer ready. It’s never too late to prepare your exit strategy.
BUYERS – WHO ARE THEY?
Based on the reasonable assumption that an increase in the number of business sales is imminent, and irrespective of the sizes and types of business, the question remains: Who is going to buy them? From a generational perspective, a lot of the early business sales will most likely transfer to the late baby boomers who are currently just turning 50 and seeking opportunities for growth, expansion or financial independence. For example, they may be managers of an early baby boomer’s business willing to consider an MBO, or they may be seeking to expand a business they already own through acquisition. As the volume of businesses for sales increases, the market of buyers will start to shrink as the late baby boomers appetite for risk reduces and generation X buyers, who are currently in their prime income earning years, begin to enter the market. The problem here is that as the shoulders and hips of the pig pass through the python, generation X buyers will be represented by that tiny dessert that followed the main course. Add to this that they’re well educated and savvy, and they’ll be picking the eyes out of whatever’s on offer. If it doesn’t stack up they’ll move on because they’ll be spoilt for choice. Don’t count on generation Y buyers, they have high student debt and they’ve just entered their working lives at a time of high unemployment and are wondering how they’ll ever afford a house, let alone a business. They’ll be starting their own businesses or they’ll be thinking about how they can attract your market with a more sophisticated offering. You might consider employing a generation Y person, get them to reengineer your business, and then offer them a shareholding. Failing this, the government’s immigration policy may be your only remaining hope.
Unless the number of buyers increases significantly there will be an erosion in valuations for business sellers during this rush to exit.
WHAT DO BUYERS WANT?
Buyers can be distilled into two categories:
1. Strategic – Strategic buyers look for a purchase to compliment, expand or diversify an existing business and may be prepared to pay a premium.
2. Financial – Financial buyers are more interested in return on capital than the industry the business operates in. In today’s low interest investment environment, many buyers are looking for a vehicle to provide them with reasonable returns. These buyers are more price driven and are careful not to over pay.
Either way, all buyers will be looking for the following in their search for a good business:
- Quality Information – the more transparent the business information, the more trustworthy it is. Buyers won’t make decisions if the quality of information is poor.
- Realistic Price Expectations – Most sellers have unrealistic expectations of their business’s value and believe it’s worth more than the market is prepared to pay.
- Well Presented Sales Collateral – A complete business presentation document with comprehensive details about the business, the industry, its resources and its future opportunity for growth or expansion. This document needs to make an impression so you can ‘sell the sizzle’.
- Owners Who are Prepared to Stay Involved After the Sale – Plan your sale date and your exit date to be different. Expect buyers to want to retain owners for a period of time to ensure a smooth transition and to download all of their knowledge and contacts to the new owner. Depending on how your deal is structured, your final payment from the Purchaser may be determined or incentivised by future business performance which you’ll want to ensure is optimised.
Business buyers are only prepared to exchange hard earned cash for a solid income that is well above what they could achieve from passive investments. Businesses valuing themselves on the basis of one year’s EBIT figures don’t deserve an investor’s money. Give potential business buyers credit for being at least as smart as the sellers. After all, a significant number of buyers have probably business owners that have successfully cashed up their previous business.
DO YOUR OWN DUE DILIGENCE
Most business owners review their financial performance on an annual basis and judge the ongoing performance through their business bank account. Compliance, contract and employment documentation is often poor or nonexistent, and the value in documenting business processes and operating systems is never even considered. When the time comes to sell, there is no documentation to demonstrate the value of the business aside from annual accounts which have often been prepared to minimise tax rather than demonstrate financial value. A failure to identify business weaknesses in advance can often lead to the withdrawal of an offer or be cause for a price reduction when uncovered.
Prospective buyers typically review every detail of the business in a process called due diligence. As a seller, you’ll need to anticipate the buyer’s questions and scrutiny and prepare your answers and arguments in advance. In order to do this, the owner needs to be their own biggest critic. This is usually the first time since starting the business that such a detailed review has been performed. After completing this process, many owners have a much more comprehensive understanding of their business – some even identifying that had they known what they learned through the process, they might have been more successful.
If you want to sell your business to create retirement funds in the future, take the time now to create an appropriate business exit strategy. Identify your critical assets and your potential buyers. Carefully structure your plan so you understand what liquidity should be there for you. Make it an objective to run your business in a manner that if you received an irresistible offer today, you would be confident that the buyers due diligence wouldn’t uncover anything that would cause them to withdraw their offer. Once or twice a year look at your business as though you were interested in buying it.
Time will tell whether retiring Baby Boomers exit their businesses dancing into retirement or shuffling into uncertainty. Either way, as a generation, the Baby Boomers have managed to re-shape entire Industries. Their retirement may just be the catalyst that transforms exit strategy planning from a last minute scramble to a business best practice.
Article Written by Dave Morgan, General Manager, LINK Wellington