How do you imagine life after selling your business?

Are you travelling? Europe maybe? Patagonia, or somewhere nice and warm?

If you’re like most of the business owners I know, you imagine selling your business, having a going-away party, and riding off into the sunset.

Increasingly, it’s not working out that way.

In a shaky economy, with banks shy to lend, the proportion of cash that business owners get when they sell is sinking with the proportion of the sale price put “at risk” in some sort of “earn-out” or “vendor take back” loan is going up.

Recently, I hosted a workshop in Toronto and invited an M&A professional who spoke about the typical deals she is doing these days. She shared the story of one buyer who is acquiring marketing services businesses for as much as ten times earnings before tax. The fine print? They only pay three times earnings upfront and leave the possibility of the other seven in a five-year earn-out.

The seller sees the finish line; the buyer fires the starting gun

Buyers and sellers come at the M&A process from totally different points of view.

The seller is usually just willing their tired old body to the finish line. On the other, you have a buyer just about to fire the starting gun. But the buyer isn’t planning on doing any running; they expect you to hear the gun and run faster than you ever imagined possible.

Is it just me, or is there something wrong with this picture?

Note to buyers: we’re tired, not stupid

I think buyers need to stop being greedy. I saw a deal recently where a rental business had grown to twelve million dollars in sales and more than two million in EBITDA. They were being offered six million dollars upfront and another six million dollars available through a complicated, five year earn-out formula.

Are you kidding?

Do you know what it takes to build a business from scratch to a point where it is generating two million dollars of profit? Have you any idea how burned out and tired the business owner must feel? This owner has built the business to the equivalent of a Picasso and you want to steal it for three times earnings?

For a gem like this, you need to pay a decent multiple upfront and put a reasonable set of goals together for a one or two-year earn-out. I don’t care what your spreadsheet says; a victory lap is okay but indentured servitude is not.

Note to sellers: move up your “sell by” date

Sellers – I like you. A lot. I consider myself on your side, but you have to understand that the days of driving off into the sunset on closing day (unless maybe you own a technology business that runs itself) are over. As a seller, I would tell you to plan to sell WAY earlier than you think you want to, so that you still have the energy, ideas and passion for the business to get you through the earn-out.

Yes, if you do everything right (recurring revenue, management team, unique niche, double digit EBITDA growth etc.), you can increase the cash proportion of your take from a sale from maybe 40% cash upfront to something closer to 65 or 70%; but you’re still going to be leaving at least a third – if not much more – of your money on the table if you plan to take your foot off the gas after closing day.

If you think you want out in five years, my advice is to plan to sell in two, so you have some juice left to get you over the finish line, which is moving ever further away.

(photo courtesy of Flickr/Nordea Riga Marathon)

A friend of mine from Miami called me the other day wanting to talk. He’s not much for chit chat so I knew something must be up with his business.

He runs a very successful importing company with forty people across the U.S. He has fat profit margins, hedges his currency risk and has actually been able to grow through this recession. In short, he’s one of the lucky ones.

As our conversation unfolded, he revealed that, even though he’s more than a decade away from “retirement age”, he has decided to sell his business.

He started our conversation by giving me the strategic reasons for getting out now: he’s in a growing, consolidating industry and they’re coming off their best year etc. but I could sense there was a deeper rationale for why he wanted out. Finally, he came clean:

“I guess I just want to take some chips off the table.”

As soon as he uttered those words I was reminded of one of the strongest reasons I wanted to sell my last business: the desire to stop gambling.

The bigger the business, the more risky it feels

They say starting a business is risky but I don’t see it that way. When you have nothing to lose, you’re not risking much. Sure, smaller businesses have a higher failure rate than larger ones, but I think they are actually less personally risky for the owner. If the start up you’ve sunk $50,000 in fails, you’re out $50,000. Not fun, but also not a death knell.

As my last business grew, I started to get the sense I was gambling more than I would like. It was a subtle feeling that started innocently enough but grew as time went on. I had most of my financial eggs in one basket and every day I went to work, I was gambling it.

The more successful our business became, the more nightmare scenarios I imagined:

• What if xyz company starts competing with us?
• What if xyz person leaves us?
• What if we have a fire?
• What if our network gets hacked?

These thoughts kept going through my mind – usually in the middle of the night — to a point where eventually it was worth selling to stop the little voices in my head.

The risk that feels heavy to you, is light to somone else

And there is someone out there who is happy to take on your risk.  A business ten times your size might happily absorb the threats that feel heavy to you as a small price to pay for a chance to grow. For them, gambling on your little business might be fun money.

If you want to make the voices stop, consider these four strategies:

Option 1: Milk the cash cow

One tactic is to put the breaks on your growth and squirrel away enough cash outside of your business that your company becomes a smaller proportion of your overall nest egg. Usually this means shunning growth opportunities in favour of maximizing your profits, but if you do it right, you can reduce the feeling that your gambling and hang on to your entire business. Just make sure you keep your cash in a separate account outside of your company so that it is safe from creditors and law suits.

Option 2: Limit your risk on a vendor take back

The only thing worse than gambling on yourself is letting someone else gamble your money. When you sell a small business with less than a million or two in revenue, you typically have to finance part of the sale so you’re taking a risk that the buyer knows what they’re doing.

Take a hypothetical case of a business that sells for one million dollars. The buyer might scrounge up $600,000 and ask you to finance $400,000. You get an interest rate better than you would at the bank but you also get your business back – albeit in much worse shape than when you left it – if the buyer defaults on your loan.  The best way to limit the proportion of cash you lend the buyer is to get multiple offers for your business (use a broker to drum up the bids). Also do whatever you can to ensure a monkey could run your business (systems, tools, templates, manuals etc.). That way, even if the buyer is an idiot, they can’t screw your business up too badly before you get your money out.

Option 3: Take a second bite of the apple

Recently, some private equity companies have condescended to come “down market” and are considering businesses with “as little as” one million dollars in EBITDA. They used to consider $3 million in EBITDA the floor but they’re becoming desperate to invest the cash they raised in 2007 before they have to give it back. Taking money from a private equity company can allow you to pull some chips off the table while remaining in the game.

For example, you might sell 50% of your business to a private equity company for four times EBITDA and continue to hold 50% with the hopes of getting a better multiple on the second half of your shares. You get to pay off your house, and buy a boat (or ski chalet or whatever) and – at least in theory – get to sell your second tranche of equity at a premium multiple (maybe six, seven or more depending on the industry, your growth potential etc.) because the private equity folks have helped you scale up.   You sleep better and stay in the game. I say “in theory” because working for a private equity company is not for the faint of heart. More on that later.

Option 4: Sell

Of course, the very best way to stop gambling is to get liquid and sell. It’s not a fool proof solution because you’ll still have to leave some of your money in the business in the form of an earn out. You’ll also have to  leave about 10% in an escrow account for a year just in case the buyer discovers something they think you lied about during diligence.  But if stopping the voices is your number one priority then selling free and clear is probably your best option.

PS. If you’re thinking about options 2 – 4 in the next couple of years, consider coming  to the workshop I’m hosting in Toronto and Chicago week after next. I think it will be worth your while.

Flickr photo courtesy of JulieFaith

You’ll get the most for your business if you sell it to a “strategic acquirer”.  A strategic may think it can sell your product to its customers, thereby tripling the size of your business in a few months. Or maybe it sees your company as the perfect complement to one of its existing business units. Or it wants to enter the city where you dominate, and acquiring you is easier than battling you for every new customer. Or perhaps you’re snapping up its customers, and rather than compete, it figures it’ll buy you.  Microsoft made a strategic acquisition when it paid $8.5 billion for Skype even though the free calling service was losing money.

16 people climb inside the black box of selling to a strategic

If you’d like to position your company to be acquired by a strategic, I’m hosting a 16-person workshop on September 28 and 29 at the Four Seasons Hotel in Chicago.

The Sellability Workshop is an intensive, two-day program designed for business owners running profitable companies with between $500,000 and $7 million in annual revenue who want to make their business attractive to a strategic acquirer. I’m accepting just 16 people into this workshop.

Selling your business to a strategic acquirer is hard work, and only a small fraction of business owners who want to be acquired ever get an offer from a big fish. But just because something is hard, doesn’t mean you shouldn’t try. Like climbing Everest, selling your business represents the top rung of your entrepreneurial adventure. There is no magic formula or recipe book on how to do it. But, based on my experience, there are some things you can do to improve your odds.

If you’re one of the 16, you’ll learn how to:

• Prepare your business to be an attractive acquisition candidate:
  • Create a recurring/subscription revenue model (how to implement, mistakes to avoid)
  • Increase your valuation multiple
  • Create a positive cash flow model
  • “Productize” a service
  • Tell your employees you’re selling and get them to help you in the process
• Negotiate a deal to sell your business:
  • Reduce or eliminate an earn-out
  • Get multiple, competitive offers for your business
  • Handle management presentations to potential buyers
  • Evaluate a letter of intent (things to look for, mistakes to avoid)
  • Shorten the due diligence period
  • Increase the likelihood that your offer will survive from letter of intent to closing day

Being part of a small group is a luxury. You’ll have the opportunity to address your specific situation, questions and challenges. I’ll lead the conversation in a workshop format, but there will be lots of Q&A, time to reflect on your own business, and plan your takeaways from the session.

Confidentiality

Your identity will be kept in strict confidence. The attendee list will not be published before or after the event, and attendees will be introduced by first name only in the session.  The decision to reveal your full name or your company name to your fellow attendees will be left at your discretion.

Who is the Sellability Workshop for?

The workshop is for business owners running profitable companies with between $500,000 and $7 million in gross annual revenue and interested in positioning themselves for a strategic acquisition in the next five years.

Who is the Sellability Workshop not intended for?

This is not an exit-planning event.

I assume you have evaluated your exit options and made the decision that you want to position your company to be acquired. Therefore, if you’re considering passing your business on to your kids, this session is not for you. If you’re considering selling your business to your managers, this session is not for you. If you’re hoping to attend to pitch your services to the business owners in the room, please do not apply.

Please note, I’m not a mergers and acquisitions professional, lawyer, exit planner or insurance salesman. There will be no sales pitch or veiled agenda. You won’t be asked to buy a time share, either. My only goal is that the 16 participants walk out with confidence, inside knowledge and an action plan to position their business for a strategic acquisition.

Grab one of the 16 spots now

To apply, scroll down to the bottom of this page and complete the application form.

Drive your first shot into the woods and most friendly golfers will give you a “Mulligan” which allows you a second chance to start out right. Lately I feel like I’ve been handed The Entrepreneur’s Mulligan.

Don’t get me wrong, my last business wasn’t a disaster, but there were things I would have changed:

• Over the years, I had painted myself into a corner by having employees on a hodgepodge of bonus plans which reflected my latest thinking on incentives at the time of hiring them. Hire enough people over a long enough period and you have a labyrinth of employee agreements to juggle.
• I had longstanding suppliers we stuck with out of inertia, not because they offered the best of what we needed.
• I had given one-time favours to some customers, only to have them taken for granted as long term elements of our relationship.

And because all of those things involved people and emotions and drama, they weren’t as easy to change as it was to write them just now. Over time, my business began to feel like how I imagine an artist feels mid-way through a painting when she realizes she selected the wrong-sized canvass: it’s too late to turn back, but it will forever be a flawed piece of work in the artist’s mind.

Starting fresh

And that’s one of the things you can look forward to after selling your business: you will get a blank sheet of paper and some time to design your next company. I think we entrepreneurs are creative souls and every artist is striving to create their masterpiece.  Can you name a song writer who wrote only one tune? How about a legendary architect who designed just one building or a photographer who took just one picture?

So why would an entrepreneur want one business as their legacy?

Scribbling on my blank sheet

I for one have started to jot down some ideas about my next business. My first few baby steps have been to:

• Develop a long terms vision and a set of values for my company which I personally find motivating and I think will resonate with people who come to work with me.
• Write an analogy for my new business which will quickly communicate the business idea to people who want to get involved.
• Quantify a 10-year goal and a basic strategy.

I’m sure I won’t get this business completely right either. And nor does the golfer who gets a second chance at their tee shot hit a hole-in-one. But that’s not the point. I’m just savouring that sense of excitement you get when someone gives you another chance to do it all over again.

So, have you taken your Mulligan?

About a year before I sold my last business, I started working with a friend — let’s call him Rick — to help me prepare my company for sale. Rick had sold his own business and had gone on to lead M&A for a public company.  He had seen the guts of a lot of deals.

Our first few conversations were frustrating because I wanted to focus on how to maximize the multiple someone would pay for my business and Rick always responded in the same way:

“Multiple of what?”

“Multiple of earnings of course” would be my response, annoyed because I knew he was acting dumb.

Over time, I came to appreciate what Rick was talking about. It took me about a year — call me a slow learner — but I finally got it. So in this post, I’ll try to pass on Rick’s wisdom to you.

A multiple of course is M&A parlance for the multiple of your Earnings Before Interest Taxes, Depreciation and Amortization (EBITDA) that you’ll fetch for your business when you go to sell it. Smaller businesses use something called Sellers Discretionary Income (SDI). Like fishing stories, cashed-out entrepreneurs often brag about the multiple they got for their business leading owners to a distorted view of what their business is worth.

Like a golf handicap or a marathon time, it’s tempting to fixate on getting a certain multiple for your business. It’s natural to want an objective measure for the value of your business and your multiple looks clean and simple to calculate.

But just like any other number on a spreadsheet, multiples can be manipulated.

Let’s say you’re having lunch with a potential acquirer and you ask her how much she thinks your business is worth. To answer your question accurately, she would likely do a discounted cash flow analysis.  Instead of making your eyes roll with complex financial equations, she responds by saying  “four times”. That sounds like a straightforward offer but, as the example below illustrates, there is a lot of room for interpretation:

Time

Let’s say you expect your business is going to generate $500,000 of EBITDA for the year ending December 31, 2011. Therefore, you might assume her offer of “four times” would equate to $2,000,000.

However, most buyers would argue that they’re going to peg their offer on your most recent completed financials.  If you only did $300,000 in EBITDA last year, then her “four times” offer now amounts to $1,200,000 – almost half of what you thought.

What’s more, some buyers will take a blended approach and average the last three year’s EBITDA. Assuming you just broke even in 2009, and you can get them to include your current year forecast, your average would be $266,000 and their “four times” offer is half of what you were expecting.

“Normalized expenses” – the market rate effect

Not only can an offer of four times vary on when you calculate EBITDA,  the price you get for your business will also go up or down depending on how you keep your books.  A buyer will want to “normalize” your earnings which means they will want to figure out how your business would perform if you stopped using it as a tax shelter.

For example, you might pay yourself a below market salary to minimize your personal tax bill. An acquirer will argue that, if they buy your business, they will have to install a manager with a market rate salary and will therefore recast your Profit and Loss statement with a fatter salary for the manager and corresponding lower EBITDA.  Therefore, if you’re paying yourself $100,000 a year but it would cost $200,000 a year to replace you, then your “normalized” EBITDA is going to be $400,000, not the $500,000 you told the buyer. Their “four times” offers will go down from $2,000,000 to $1,600,000 (4 x $400,000).

“Normalized expenses” – the piggybank effect

Normalization can work the other way too. Let’s say you’ve been running your business like a personal piggy bank (don’t worry, I won’t tell). Your spouse is on the payroll and the kitchen renovation you did at the house last year found its way on to your list of business expenses as an “office renovation”. You can argue to an acquirer that these costs should be deducted from your expenses when calculating EBITDA. So maybe, once you eliminate the piggy bank effect, you actually make more like $600,000 of EBITDA which means an offer of “four times” should garner more like $2,400,000.

Hard assets

When you’re talking about multiples you also have to take into consideration any hard assets. If your motel is generating $500,000 a year and you get offered “four times”, $2,000,000 may sound like a fair price until you take into consideration the land your motel is sitting on (that you own) is worth $1,000,000.

Working capital

Sometimes buyers will offer you an abnormally large multiple only to take it all away with an overly stingy working capital calculation. Working capital is the money you need to leave in your business at closing. If you’re able to pull out $200,000 in excess cash based on the working capital calculation a buyer proposes in their offer, you’re putting an extra $200,000 in your jeans even though the multiple the buyer is offering has not changed.

Fully loaded

Some buyers casually refer to a multiple they would pay including an earn out. For example, let’s say for a business generating $500,000 in EBITDA an acquirer offers $2,000,000 at closing with another $1,000,000 in consideration available if certain performance targets are met in the future. Most would agree that the acquirer is offering “four times” based on the cash changing hands at closing. But a sly buyer, looking to optically inflate their generosity, may choose to characterize their offer as “six times” basing the multiple on the full price paid if the earn out is achieved. That’s a big if.

Savvy buyers know that we entrepreneurs get fixated on getting a certain multiple for our business and the smart buyers use our obsession to their advantage.

Before you agree to discuss a potential acquisition based on a certain “multiple”,  peel back the layers of the offer to understand the details.

Just curious, how else have you seen multiples manipulated?