Eventually, all businesses will change ownership and the decision to sell a business can be viewed by the owner as the most harrowing or liberating event. Some homeowners are unprepared for a business transition and are caught off guard by declining health, unforeseen financial calamities, divorce, or personal stress. These owners are forced to sell without proper planning and are often paid less than optimally for their business. Other owners recognize that to maximize business value, similar strategic planning done during the years the business was built prior to selling the business is also required.
The goal of this article is not a crystal ball analysis of why selling a business now is the perfect time; The intention of the article is to review the factors that may influence the timing of this decision and the need to prepare well in advance for the eventual sale or business transition. Life circumstances are constantly changing and proper succession planning is the most important way for an owner to take control of the terms and conditions of a business exit. There are a variety of reasons for the transfer of business control and those who are proactive in implementing an exit plan can often seize greater opportunities to maximize business value, minimize tax liabilities, retain key employees and mitigate emotionally charged family issues. .
Determining the best “time” to sell a private company will depend on a number of factors, both internal and external. Ultimately, the timing decision is influenced by the reasons 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 contemplating a sale, it is often balanced against the personal goals and lifestyle needs of the owner. Some of the most common reasons for selling or transitioning a business include:
• Quality of Life/Retirement: Owning a private business consumes a considerable amount of time with attendant opportunity costs. Most owners reach a point where they become interested in other life activities, whether it be spending time with their spouse/children/grandchildren, pursuing a personal hobby, or taking time to travel the world.
• Diversification: A private business generally represents a significant component of family wealth, and the owner will be very interested in diversifying this asset into other investments.
• Burnout: Many long-term business owners lose the “fire in their stomachs” they once had when the company was founded. As a result, highly successful and functional businesses may show lower sales and profitability as a result of lower engagement and ownership drive. Most experts recommend that the right time to sell a business is before this condition threatens business operations and/or value.
• Illness: Encountering personal illness or illness of a family member is one of several “unexpected” reasons that may cause a business to be sought for sale.
• Divorce – The breakdown of a marriage has been responsible for the sale of many family businesses.
Business performance, tax implications, buyer activity and the economy all contribute to creating the “perfect timing” for a business sale. Scheduling a peak sale can be very difficult due to the unpredictable variability of many internal and external factors. Sales contracts are won and lost, new competitors enter the market, technology becomes outdated, and business expenses can skyrocket (for example, health care costs)… any of these events can affect sales and profits. and therefore have a material impact on the valuation of the company.
company performance
The profitability and cash flow of a company is one of the key factors in determining the value and marketability of the company. While buyers look for companies that have the potential to grow and generate reliable earnings in the future, valuation will in most cases be tied to past performance and achievements. A company with a strong earnings track record that is equipped with stable staff/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 company performed during the recent economic downturn relative to its competitors?
• Customer Concentration – What percentage of revenue is generated by the top 3-5 customers?
• Business/Industry Trends: What have been the trends over the last 3 years: revenue, COGS, expenses, and net income? What factors will positively or negatively affect future earnings?
• Areas of Growth: What new products, new markets, or economic factors will enable bottom line and top bottom growth?
Tax Implications (Current vs. Future)
Business owners should be well aware of the tax costs (income, capital gains, wealth, personal property, and payroll) involved in selling their business and how net after-tax dollars will be affected as these taxes increase. Understanding the effect of pending tax increases enables business owners to make informed decisions when it comes to maximizing net after-tax dollars through smart structuring and timing of the business sale transaction.
Bid/Ask
Understanding the conditions that create increased buyer demand can often help formulate timing decisions.
• Cost of Capital/Interest Rates: Third party financing is responsible for financing most private business sales. The level of interest rates has a direct impact on the cost of capital and will create more value for the target business when rates are low. A tight credit market can reduce the pool of qualified buyers, as it generally increases credit requirements and collateralized assets necessary for loan approval.
• Number of Buyers: A poor economy (although detrimental to profits for many companies) often increases the number of available business buyers, as displaced corporate executives seek to leverage their skills and retirement savings to acquire a business as future source of income and livelihood.
• Competitive Businesses for Sale: The number of businesses for sale in a given industry or geography can affect the prices that these businesses command in the marketplace. The much-discussed phenomenon of retiring baby boomers is predicted to put downward pressure on company prices as the number of companies available for sale increases.
It is important for business owners to continually evaluate their exit plan options at all stages of their business. The subprime loan crisis and financial market turmoil in recent years has caused more and more business owners to reassess their life goals and retirement plans against the opportunity cost of running their current business. For some business owners, a short-term exit is not financially possible. With the help of a competent business intermediary, they can develop a transaction that is structured to allow them to remain involved with your business in some way, after the sale. Getting professional assistance in determining the company’s current market value and setting the framework for an exit strategy ensures that “windows of opportunity” are not missed. Therefore, the transaction value of a going concern can be maximized as long as the business remains relevant, profitable, and has 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 an entrepreneur. In many cases, the best time to sell is when the owner doesn’t have to. Few owners contemplate selling the business when the business is growing rapidly and the company is clicking on all cylinders. When times are tough and earnings have receded, owners are also hesitant to sell due to a feeling that the specific dollar value they have in mind for their business may not be realistic in today’s market. In both cases, the “buying power” generated by the sale proceeds could be nearly equivalent given the efficiency of financial markets. During a strong economy, a higher transaction value may be realized, but the value of comparable assets (for example, real estate) will also be at a high level. Conversely, a business sold in a slower economy may generate fewer dollars for the seller, but could provide a greater level of purchasing power based on the value of comparable assets in which the proceeds are likely to be reinvested.