Every business will eventually change ownership and the decision to sell a company can either be viewed by the owner as the most agonizing event or the most liberating. Some owners are ill prepared for a business transition and are caught off guard by deteriorating health, unanticipated financial calamities, divorce, or personal stress. These owners are forced to sell without proper planning and often receive less than optimal remuneration for their company. Other owners recognize that in order to maximize the business value, similar strategic planning done during the years the company was being built is also required prior to selling the enterprise.
The goal of this article is not a crystal ball analysis as to why selling a business now is the perfect time; the article’s intent is to review the factors that can influence the timing of this decision and the necessity to prepare well in advance for the eventual business transition or sale. Life’s circumstances are ever changing and proper succession planning is the single most important way for an owner to take control of the terms and conditions of exiting a business. There are a variety of reasons for business control transfer and those who are proactive in an exit plan implementation are often able to realize greater opportunities to maximize the businesses value, minimize tax liabilities, retain key employees, and mitigate emotionally charged family issues.
Determining the best “time” to sell a privately held business will depend upon a number of factors, both internal and external. Ultimately, the timing decision is influenced by the reason(s) behind the sale, especially given the fact that not all business sales are pre-planned. While value maximization is historically near the top of the wish list when a sale is contemplated, it is often balanced with the owner’s personal goals and lifestyle needs. Some of the most common reasons for a business sale or transition include:
• Quality of Life/Retirement – Owning a privately held business consumes a considerable amount of time with corresponding opportunity costs. Most owners reach a point where they are interested in other life pursuits, whether that be spending time with a spouse/children/grandchildren, engaging a personal hobby, or taking the time to travel the globe.
• Diversification – A privately held business typically represents a significant component of family wealth and the owner will be keenly interested to diversify this asset into other investments.
• Burn Out – Many long term business owners lose the “fire in the belly” that they once had when the company was founded. As a result, highly successful and functional businesses can show lower sales and profitability as a result of reduced ownership commitment and drive. Most experts recommend that the proper time to sell a business is before this condition poses a threat to the business operations and/or value.
• Illness – Encountering a personal or family member illness is one of several “unexpected” reasons that can cause a business sale to be pursued.
• Divorce – The break-up of a marriage has been responsible for the sale of many family run enterprises.
Company performance, tax implications, buyer activity and the economy are all contributing factors involved in creating “perfect timing” for the sale of a business. Timing a sale at the peak can be very difficult due to the unpredictable variability of the many internal and external factors. Sales contracts are won and lost, new competitors come into the market, technology becomes obsolete, and business expenses can skyrocket (e.g. health care costs)…any of these events can affect future sales and earnings and thereby have a material impact on the company valuation.
The profitability and cash flow of a business is one of the key drivers in determining the company’s value and marketability. While buyers are looking for companies that have potential to grow and generate reliable earnings in the future, the valuation in the majority of cases will be tied to past performance and achievements. A business with a solid earnings history that is equipped with stable personnel/management in an attractive industry will be highly marketable and should capture a fair price regardless of the economy. Other business specific factors that can influence valuations and play a role in the timing decision include:
• Competition – How has the business performed during the recent economic downturn relative to its competitors?
• Concentration of Customers – What percentage of revenue is generated by the top 3-5 customers?
• Business/Industry Trends – What have been the trends for the trailing 3 years – revenue, COGS, expenses, and net income? What factors will positively or negatively affect future earnings?
• Areas for Growth – What new products, new markets, or economic factors will enable top & bottom line growth?
Tax Implications (Current vs. Future)
Business owners should be well versed in the tax costs (income, capital gains, estate, personal property, and payroll) involved in the sale of their business and how the net after tax dollars will be affected as these taxes are increased. Understanding the effect of pending tax increases, enables business owners to make informed decisions as it relates to maximizing the net after tax dollars through the intelligent structuring and timing of the business sale transaction.
Understanding the conditions that create increased buyer demand can often help formulate timing decisions.
• Cost of Capital / Interest Rates – 3rd party financing is responsible for funding a majority of privately held business sales. The level of interest rates has a direct impact on the cost of capital, and will create greater value to the targeted business when rates are low. A tightened credit market can reduce the pool of qualified buyers as it typically increases the credit and collateralized asset requirements necessary for loan approvals.
• Quantity of Buyers – A poor economy (while detrimental to many companies earnings) often increases the number of available business buyers, as displaced corporate executives seek to leverage their skills and retirement savings to acquire a company as a future source of income and livelihood.
• Competitive Companies for Sale – The number of companies for sale in a given industry or geography can impact the pricing that these companies capture in the marketplace. The much discussed retiring baby boomer phenomenon is predicted to put downward pricing pressure on businesses, as the number of companies becoming available for sale increases.
It is important for business owners to continually evaluate their exit plan options throughout all stages of their business. The subprime lending crisis and financial market turmoil over the last several years has caused more and more business owners to reassess their life goals and retirement plans and compare those to the opportunity cost of managing their current business. For some business owners, a near term exit is not financially possible. With the help of a competent business intermediary they can develop a transaction that is structured to enable them to stay involved with their business in some capacity, post sale. Obtaining professional assistance to determine the current market value of the business and establishing the framework for an exit strategy provides that ‘windows of opportunities’ are not missed. Thus the transaction value of a going concern business can be maximized while the company is still relevant, profitable, and possesses viable growth prospects for the future.
The question of “when” is the right time to sell the company is probably one of the most frequently asked questions by a business owner. In many cases, the best time to sell is when an owner does not have to. Few owners contemplate selling the company when the business is rapidly growing and the company is clicking on all cylinders. When times are lean and earnings have pulled back, owners also become hesitant to sell based on the feeling that the specific dollar value they have in mind for their enterprise may not be realistic in the current market. In both instances, the “buying power” generated from the sale proceeds could be nearly equivalent given the efficiency of the financial markets. During a strong economy a higher transaction value may be realized but the value of comparable assets (e.g. real estate) will also be at a high level. Conversely, a business sold in a more sluggish economy may net fewer dollars for the seller but could provide a higher level of buying power based upon the value of comparable assets in which the proceeds are likely to be re-invested.