The following video from the Kauffman Foundation exposes some myths about entrepreneurship but they excluded one of the most significant myths: 7 out of 10 businesses fail in the first five years. This tired old misperception stems from confusion about the difference in the definitions of "non-survival" and "failure". Non-survival isn't the same as failure. Many businesses that don't survive are far from being failures. Contact Codiligent business brokers if you'd like to learn the truth about business failure rates (which are significantly lower than commonly perceived).
You may have heard people talk about "quality of earnings" when valuing a company or deciding whether to make an acquisition. What does this mean? Generally it refers to how consistent a company's earnings are with its cash flow, so that things like accounting practices, the way inventory is accounted for, working capital requirement, and accruals aren't overly distorting those earnings. However, in practice, many business buyers also use this term to describe the degree to which they can rely upon and predict earnings - and this can be impacted by factors such as: whether financial statements are compiled, reviewed, or audited by a CPA; whether client revenue is recurring, repeat, or one-time; and whether there is a stable cost structure (i.e. the degree to which inventory prices fluctuate; is there a long-term lease in place that provides a predictable rent expense; are employees at market rates of compensation so that when there is turnover payroll expenses will stay the same; etc.).
How do quality of earnings relate to value? I'd first point out that valuing a business is a surprisingly complex and nuanced process, and theoretical value can't be allowed to overshadow common sense. For example, a business that is generating Earnings Before Interest Taxes Deprecation and Amortization (EBITDA) of $200,000 may be worth $1 million if using an income-based approach to value, but if such a business has assets that could be auctioned for $1.2 million and has no debt, then, of course, it would be worth more than $1 million as long as there is a market for its assets. Nevertheless, for the majority of financially well-performing businesses, value will be impacted by three primary factors:
A business with a higher level and/or higher quality of earnings is going to be worth more than a business that has a lower level and quality of earnings, assuming similar risk factors and growth prospects.
Following is a link to an article that describes some of the things that buyers look at during due diligence to determine the quality of earnings: Quality of Earnings: A Critical Component of Due Diligence
A while back when I was getting ready to close a business sale transaction a client was confused by why he would owe a commission on inventory that was being acquired by the buyer. The listing agreement clearly states that a commission will be owed on all assets acquired by a buyer. However, I understand what caused the confusion.
When I help clients negotiate a Letter of Intent (LOI), often we will show a base price of the business plus the inventory at wholesale cost, with the combination of the two being the total price of the business. The inventory is an asset of the business that's necessary for its operation. Buyers expect that a business will come with inventory consistent with what's been carried in the past so that there is continuity of the business when the transaction closes.
The only reason that we delineate the inventory in the LOI and Purchase Agreement is to prevent perceptions of game playing and disagreements between a Buyer and Seller about inventory levels at closing. In other words, had we said that the price was $1,750,000 for the business (without breaking out the inventory, which at time of LOI was $500k) then when closing rolled around if the actual inventory ended up being $600k, a seller would be inclined to say "wait a second - when we signed the LOI the inventory level was only $500k, now it's $600k, Mr. Buyer you need to pay me an extra $100k for the business - I'm not going to sell for $1.75 million." In contrast, if at closing inventory was only $400k a buyer would be inclined to say, "Mr. Seller, I wonder if you've intentionally depleted your inventory. You should have been replacing the inventory you consumed to keep it consistent with the levels that were present when we signed the LOI. We need to amend our agreement to decrease the price by $100k." However, by saying the price is $1.25 million plus inventory it results in a total price that naturally adjusts.
Of course, there are other ways this could also be addressed in the language of the documents, for example, saying that $500k of inventory would be included and that if it was more or less at time of closing the overall price would simply adjust. Regardless of how it is addressed, most buyers expect to acquire inventory needed to operate the business and will want the overall closing price to be adjusted to reflect any changes in the level of inventory that occurred from the time the LOI was signed until closing.
Some sellers may say, "OK - but if we are showing inventory as an additional deal component but only at our cost - that shouldn't be subject to the commission we didn't make a profit on it." However, the base price of the transaction is where the intangible business value is captured, and a buyer will need sufficient inventory to operate the business. If a seller said, I'm just going to sell the inventory on my own and the buyer can acquire their own inventory there would be a number of issues:
About the only time that inventory may not be included in a sale, or where a commission might be negotiable (which should be negotiated at time the listing agreement is signed) is if there is significant excess but marketable inventory beyond what is required for the normal operation of the business.
It's fun to own a business when times are good. You're selling in-demand products and services, gaining appreciative clients, creating new jobs, growing revenue, the bank is patting you on the back, you're receiving awards and accolades, the economy is growing, and you are making more money than you ever dreamed possible. That makes it a perfect time to sell!
Many business owners make the mistake of putting off selling for a few more years. Perhaps you know you want to exit within about five years but think "with things going so well, I'll wait a little longer before attempting to sell." But what if something unexpected happens? What if you lose two of your key clients? You lose a key staff member? A group of former disgruntled employees sues the company? A key supplier dramatically increases prices? The economy goes into recession? New regulations are imposed that are incompatible with your business model? Such changes could make your business entirely unmarketable in the short-term, negatively impact value, and may require waiting far longer to sell in order to correct the problems and develop enough of a track record afterwards that it won't have a significant impact on business value and marketability. Your plan of selling within 5 years? That may now be 10 years.
However, there's another reason that waiting to sell may not be such a good idea: we're in a seller's market, but it's not likely going to last. There are estimates of $1-2 Trillion of investment capital (between private equity groups and corporations) currently sitting on the sidelines looking to be placed in acquisitions. Given the low yield on US Treasuries (which set the minimum benchmark return as a very safe investment) the correlated return expected on equity investments is also low, and the cost of acquisition debt capital is low. The result of the massive amounts of investment capital and low interest rate environment has been higher prices being paid to sellers of successful businesses. Who knows how long it will be before interest rates start increasing, but there's certainly not much room for them to go any lower.
Right now the US Census Bureau indicates that over 70% of businesses that employ at least one person are owned by people over 53 years of age. Do you think some of those baby boomers are going to want to retire in the not too distant future? What's going to happen if you wait to sell when the bulk of other small and medium size business owners also decide to sell? I think you know where I'm going with this: it is likely that within a few short year the "seller's market" is going to become a "buyer's market", which will likely result in lower valuations and may even render some businesses unmarketable. Perhaps a business owner who today could sell for 7x earnings will only be able to achieve a price of 4-5x earnings in the buyer's market.
Following is a link to an article that describes the upcoming demographic shift in the business sale market: There's a Perfect Storm Approaching for Exiting Business Owners
"Exit Planning - Maximizing Wealth & Avoiding Common Pitfalls" - Panel Discussion in Portland, Oregon on Tuesday, May 19, 2015 at 7:30 am
Are you a business owner or a professional who serves business owners? If so, please join us for a presentation and panel discussion about exit planning including common pitfalls and ways to maximize wealth. The event will be held in Portland, Oregon on Tuesday May 19, 2015 starting with a continental breakfast from 7:30 - 8:00 am, followed by the presentation from 8:00 - 9:00 am, with a Q&A panel discussion from 9:00 - 9:30 am.
The panel of experts includes: Frank Dane and Dan Jackson of B2B CFO; Nick Mesirow of the law firm Moomaw Mesirow & Godfrey; Brad Buchholz of Banner Bank; Mark Baker & Lisa Brumm of AXA Advisors; and Eric Williams of Codiligent.
Advance tickets are required ($10). All attendees will receive the book "The Exit Strategy Handbook" a $17.99 value. For location details and to reserve a space use the following link: Buy a Ticket
One of the biggest risk factors for a business buyer is turnover of key employees in the company after the business is acquired. One of the biggest risk factors for a business seller is that around the time he wants to sell a key employee will leave the company, which may not only cause a decline in performance of the company but may also increase buyers' perceptions of risk. The greater the risk that a business buyer perceives when contemplating an acquisition, the less likely they are to complete the deal and pay a premium price.
Is there really much that can be done about this? After all, you can't force key employees to continue working for the company. You can, however, create attractive incentives for key employees to stay. If you structure it the right way it may help you sell your business, and possibly get a higher price.
How to do so? Create a bonus for key employees who remain employed after the business is sold. Codiligent business brokers are not experts at compensation or bonus programs. However, we would encourage you to discuss the following ideas with professionals who have deep knowledge of employee compensation plans:
What's an appropriate amount for a retention bonus? Here are some of the factors to consider:
Is your business designed to be sold? Let's look at two nearly identical businesses. Each is selling the same product or service into the same market. Each business is grossing $5 million in sales and netting $500,000 in profit. Each pays the same salary and benefits to its owner.
The owner of Company A works 70 hours per week, works most weekends, and has never taken a vacation longer than a week. The owner of Company B works 20 hours per week at his company, is a leader of his professional trade organization, and volunteers in multiple community organizations. He is regularly off visiting his grown children and grandchildren in other cities around the country, spends a month every winter in the tropics, six weeks every summer at a cabin in the mountains, and plays golf or skis at least one day a week when he is in town.
Which business would you pay more to own? Which is most like your business and your life?
Chances are that Company A is so dependent on the owner's presence in the business to close sales, solve problems and make every-day decisions that most buyers will have great difficulty replicating the performance of the business once the owner has sailed off into the sunset.
Company B, on the other hand, likely has systems that control most day-to-day activities, long-term employees who are incented to support the vision that the owner developed for the business, and are empowered to make decisions for the business and take actions that are aligned with that vision. The owner simply provides guidance and monitors development of the business and his employees according to the plan, and works with his key staff to evolve that plan as business conditions change.
And business sale price and sale potential is not the only issue here. What would happen to each company if the owner suddenly died or became incapacitated? Not only may Company A be more difficult to sell at a good price, the entire company is at risk of quickly failing. Without the expertise of the owner, that business is probably unsellable.
If your business and the time you spend in it is more like that of Company A than that of Company B, then the time to develop and begin implementing a plan for change is now. One of the best ways to make that happen is to work with an experienced coach who can guide you through the planning and implementation process and connect you to an advisory group consisting of other owners and CEO's who meet in a peer coaching framework. As peers, other CEOs can offer you a "been there.... done that" perspective. There is a level of trust and belonging with these CEO peer groups such as TAB (The Alternative Board) that is difficult to gain in other ways.
Following is a short video that illustrates the value of a peer group.
Phil Fischer is a principal at Stratyx Business Value Consulting and The Alternative Board of Greater Portland. He offers a range of business assessment, leadership development and operational development programs designed for family-owned businesses & other small business owners. He can be reached at 503-806-2218 and firstname.lastname@example.org
Ever wonder how small business owners collectively view political issues? You might be interested in reading the National Small Business Association's report "The Politics of Small Business". If you know many small business owners then many of the results may not surprise you. For example, small business owners are independent, critical thinkers with only less than 18% voting a straight party ticket.
Some of the other results include:
How would you like to see city, state, and local government help small businesses?
Many business owners underestimate the nuances and complexity of exit planning. Unfortunately, this is often exacerbated by some professional advisors who strive to overly control the process or who want to be the sole representative of the business owner in assisting with the process. For example, a contract CFO, wealth manager, CPA, or attorney may be keenly interested in exit and transition planning and may have significant experience, formal education, attended seminars, and read books on the subject. However, I would argue that it would be the rare individual who will have expertise and skill in all areas necessary to help a business owner optimize their exit.
Rather, a business owner should be looking for advisors who play well with others. So, yes, an attorney plays a vital role in the exit process, but they aren't an accountant and may not possess some of the knowledge of a CPA. Likewise, while the attorney may be good at helping protect clients through appropriate legal documents, and the CPA may have invaluable advice on the tax implications of the deal structure, neither of these professionals may have the skill set that an investment banker or business broker has of analyzing, valuing, and packaging the business or of finding and screening the best buyer and negotiating a win-win deal. And what about planning for what a business owner will do after the sale? Is a business broker, investment banker, attorney, or CPA going to be the best person to provide advice on what type of assets you need to own to securely provide for your long-term financial needs and reach goals in the next chapter of your life? Or might a wealth manager be better equipped to provide this type of guidance?
Following is a link to an article published by Axial Market that provides some ideas on the value of a good Exit Team: How Deal Teams Increase the Odds of a Favorable Exit.
How important is economic freedom? Are less free and more regulated people, as a whole, just as well off as those with more economic freedom? Are all types of economic organization equally good but with different pros and cons? Or does economic freedom truly lead to a higher quality life? Which countries' people have the lowest quality of life and what is their level of economic freedom? Do property rights really matter? Is a smaller or larger role for government better?
Check out the following 60-second video that provides a perspective on this topic. What do you think?
Buy and Sell Well
Codiligent Business Brokers' blog on entrepreneurship, capitalism, and successfully buying and selling businesses.
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