May 31, 2013

The Bob Barker Challenge: How to figure out when to sell

How would you like to be Tim Cook these days? Soon after he took over from a demigod, Apple was the world’s most valuable company. Nine months later, everyone wants a Galaxy S4 and Apple stock is being valued at less than seven times EBITDA. That’s in the space of less than a year. Three lousy quarters.

In 2006, MySpace surpassed Google as the most visited website in the United States. Twenty four months later, Facebook sailed passed and never looked back.

People used to think Blackberry was cool.

And it’s not just big technology companies that ride down the roller coaster. In 2004, Blockbuster had 9,000 stores worldwide. Nine years later, they’re down to 500 in the U.S.

Small companies lose it just as fast as big ones. Last week I was speaking with someone who had an ice-making business serving the fishing boats off the shores of Goa, India. They sold large blocks of ice so the fishermen could keep their catch cool while at sea. To make ice in India, your main input cost is electricity and his family bought theirs legitimately at commercial electricity rates.

Unfortunately, a number of small, home-based competitors got into the ice making business illegally, using subsidized residential electricity, which is two-thirds cheaper. My friend’s company was bankrupt within months.

So when should you sell?

Spectacular reversals of fortune like these should strike fear into the heart of every entrepreneur. There’s no guarantee your business will still be relevant a year from now – which begs the question: when should you walk away from the poker table?

You’ve heard all of the popular theories: you should sell when your business is still growing and before you really feel like it is time to go; you should sell when the after-tax proceeds of a sale are able to generate enough income to fund your retirement; etc.

I think you should sell when you lose the stomach for it – when the idea of starting over seems just too hard. In other words, when the fear of loss is greater than the desire for reward.

The Bob Barker Challenge

Only you will know when that time has come, but a simple test can help. Grab a calculator and estimate what your business is worth today. You could have a formal valuation done, but for the sake of this exercise, I’d recommend using a simple valuation formula of four times last year’s pre-tax profit so you can make an apples-to-apples comparison to your value in the future.

Now think about the plans you have and imagine how much profit your business will be making five years from now if all goes well. Apply the same multiple and look at the number. Would you rather have a 100% chance of today’s number or a decent shot at the bigger number in the future, knowing you could end up with nothing?

It’s the same game Bob Barker played on The Price Is Right. After the contestant won a game, Bob would turn to the contestant and say “Okay, you’ve won a loveseat. You can go home as a winner now, or you can play for a chance to win a NEWWWW CAR.…”

Punt or go for broke

Any business can become the next Blockbuster Video. One day you are happily selling ice on the beach in Goa and the next day you’re broke.

You decide to sell when the fear of losing what you have built exceeds the desire for something more.

  • TH says:

    Great advice. This was one of the factors I used in my decision to not sell to a PE firm earlier this year that wanted to merge us with a company in their portfolio. Since I would have been part of the management team for 2-3 years I also included the new compensation I would receive for 2-3 years in this new position vs. the income and perks I currently receive in my business. Our sales and EBITDA are growing at a good pace, so in my case the potential upside was worth the gamble. Time will tell if I made the right decision.

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