The Legalities of Selling a Business, with Mital Patel
November 15, 2021What Happens to Cash When Selling a Business?
November 29, 2021When to Sell Your Business: A Business Owner’s Guide
For the past six or seven weeks, we’ve been discussing the question, “Should you sell your business?” This is such an interesting time to be a business owner because Covid has created a massive cash surplus for so many businesses. The abundance of cash has created greater business valuations. As a result, so many of you are being approached about selling your business. But how do you know if it’s the right time to sell? That’s the question I’m going to answer with today’s entry.
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TIME INDEX:
- 00:42 – The Legalities of Selling Your Business: Series Wrap Up
- 02:46 – The Wealth Gap
- 04:31 – The Value Gap
- 06:01 – How Value is Determined
- 10:41 – The Four Cs
- 16:16 – Ifs and Buts
- 19:36 – Summary
- 21:00 – Wrap Up
When to Sell Your Business: Based on Your Personal Goals
If you’ve been approached about selling your business, chances are you’ve felt a rush of emotions. It’s an exciting time in the life of a business owner. Whether you have been actively trying to sell your business or received an unsolicited proposal, you’ve got a big decision to make. But you don’t want to make such an important decision based on your emotions. So, how do you know if it’s the right time to sell your company?
There are a few things to consider when weighing the choice to sell or keep working on your business. Ultimately, this is a choice that comes down to your personal financial goals. Therefore, you should begin by measuring your wealth gap. In short, your wealth gap is where you need to be, financially speaking, versus where you currently are. If you need $2MM to retire and live the lifestyle you desire, but only have $750K then your wealth gap equals $1.25MM. In this case, selling your business only makes sense if you’re being offered at least $1.25MM.
Similarly, you need to consider your business’s value gap. If your business isn’t valued as best-in-class in your industry, you may want to hold off on selling. Take a few years to really work on growing the value of your business from a multiple standpoint. I have a client that came to me about five years ago, ready to get out of his business. I asked him to give me 3-4 years. He agreed and, in that time, we’ve seen his value grow to six times what it was when he first approached me.
Determining Value
I have discussed this topic ad nauseam for several years now. In fact, I’ve even written a couple of books that also discuss the business value and how to increase it. So, I’m not going to get too far in the weeds with this today. Instead, we’ll look at earnings before interest, taxes, depreciation, and amortization (EBITDA).
For this example, let’s assume you have a business that’s doing $100K in EBITDA. Along with this, we’ll say you’re operating with a current multiple of two times EBITDA. Therefore, your business’s value is $200K. Oftentimes, the first impulse business owners have is to try to drastically increase their revenue. But that may not be your best course of action. Assuming you are able to double your EBITDA to $200K, you’ve now increased your value to $400K. But you’re working twice as hard to accomplish this. Similarly, you’ve probably increased your company-specific risk.
However, by working to double the multiple (from two to four) and leaving your EBITDA at $100K, you can achieve the same $400K valuation without opening your business up to greater risk. The more company-specific risk you have, the lower your value multiplier. On the other hand, as you work to increase your multiple, revenue trends upward. Therefore, if you’re diligent to increase the value of your multiple (let’s say from two to four, once again) and your revenues increase by 50%, you suddenly have a business that’s worth $600K. This is why you may want to reconsider selling your business right now.
The Four Cs
Like business value growth, I’ve spoken on this subject a time or two before. I can’t take credit for the four Cs. That credit belongs to my dear friend and colleague, Christopher M. Snider. He is the CEO and President of the Exit Planning Institute, and the author of Walking to Destiny: 11 Actions an Owner MUST Take to Rapidly Grow Value & Unlock Wealth. It was in this book that I first read about the four Cs. The four Cs refer to four different types of intangible capital. They are:
- Human Capital. How strong is your team? Can they run your company without you? If so, you’re on the path to decentralization, which is one of the biggest things you can do to grow the value of your business. A business that requires you to be at its epicenter isn’t valuable.
- Customer Capital. Do you have customers that account for greater than 5% of your annual sales? This may vary across different industries but you don’t want to open yourself up to huge losses should you lose a customer. The more you’re able to spread your sales across a large base of customers, the less risk your business faces in its customer capital.
- Structural Capital. A buyer should be able to take possession with little to no impact on revenues. By having well-established systems and a fully integrated operations manual, you can mitigate that risk to a buyer.
- Social Capital. How is your business perceived within its sphere of influence? Oftentimes, you can tell how well a company is viewed by its new client acquisition. If you’re receiving a lot of referrals, more than likely your business has good social capital.
What this means to you…
Friends, now is an exciting time for many business owners. However, you must be careful not to allow your emotions to make this decision. Speak with your advisor and evaluate your unique situation. Find your wealth gap, measure how your business is valued in comparison to others in your industry, and make the decision based on hard numbers. Maybe you’re in a position to sell immediately. If that’s you, then congratulations! However, many of you will find that you should hold off so you can work to grow the value, and that’s good too.
Look, I know life is hard. These past two years have been some of the most difficult that I can remember, but life is still good. Knowing when to sell your business can be frustrating. Hopefully, this series has made it a little less so. By speaking with your trusted advisors and doing a few quick calculations, you can at least make the decision financially simple.
Does your business need a little more work (or a lot) before it’s ready for a sale? Reach out to us. The Financially Simple team has helped hundreds of business owners through the business value growth cycle.
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