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)

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?

Last night I ate “Hawaiian Fusion” at a restaurant called Roy’s in Los Angeles with a former client of mine who works at a big bank. Over sushi he asked me if I could help them develop a new strategy for marketing to small business owners.

It was the first time someone had asked me to get back into the same business I sold a few years ago (at Warrillow & Co., we helped big companies market to small business). When I sold the company, I signed a non-compete agreement, which bans me from providing advice on marketing to small businesses. Even if I had wanted to help my banker friend, I couldn’t.

I was surprised at just how repellent the idea of going back to my old business felt. Don’t get me wrong, I loved the years I spent at Warrillow & Co., the people, the clients, the challenge etc. but I have no desire – none – to go back.

Everybody told me that selling my business would be a hard transition, that I’d feel a sense of loss. They warned me I might feel bored or disoriented. Nothing could be further from the truth and I don’t think I’m alone. The business owners I know who sold their company before they were ready to “retire” are among the most engaged, energized and charged up, full-of-life people I know.

After my friend Greg sold his company, he moved his young family to Europe and has mastered ski touring in the Swiss Alps; Dean has taken a year off to learn about French cooking on campuses from Paris to Sydney; Bobby has thrown himself into angel investing and his charity work; David drops his girls off at school every morning before spending his days advising new entrepreneurs he has invested in.

My own experience coupled with that of other business owners I know has sent me off on a bit of a rant lately encouraging whoever will listen to consider selling their business sooner than later. I’ve included a couple of columns below and the essence of my argument is this: the longer you wait, the more your business becomes part of your identity and the harder it will be to separate yourself.  At some point, another zero in your bank account will not make up for lost time, or opportunities.

The people I’ve known who have had the toughest time adjusting to life after the sale of their business are the entrepreneurs who dedicated thirty years or more to their business and don’t feel they have an identity beyond their company.

I don’t want this post to sound sanctimonious; I just want you to know that despite all the noise, there is life after selling your business and you don’t have to wait until you’re ready to “retire” to get out. Here are a couple of the articles I’m referring to:

Are you an on-base hitter or a slugger?

~ published May 11, 2010 The Globe and Mail

The lead off batter is arguably the most important offensive weapon on a baseball team.

The job is to get on base; it doesn’t have to be pretty. A batter could make it to first with a lazy opposite-side hit that just outlasts the reach of the shortstop. He could get walked or bunt his way on base or make a mad dash for first base after the catcher drops the third strike. Success is measured not by number of home runs or even batting average but by “on-base percentage.” If success is achieved four out of every 10 times, the batter is doing extremely well (Ted Williams holds the record for on-base percentage at .4817).  »more

Your brain’s wiring may predetermine your fate

~ published May 12, 2010 The Globe and Mail

The baseball player’s position in the batting line up is largely determined by their physical attributes. The strongest player bats in the clean-up spot while the fastest, must cunning hitter leads off with hopes of somehow getting on base.

On-base hitters enjoy smaller, more frequent successes (getting on base) while “sluggers” go through long droughts punctuated by rare but large successes (home runs). Similarly entrepreneurs need to decide if they would prefer lots of little “wins” or one big one, which I wrote about in an earlier column. »more

Take the test: What kind of business owner are you?

~ published May 13, 2010 The Globe and Mail

Most growth-oriented entrepreneurs are wired for starting a business, not running one. I called them “on-base hitters” in a previous column because unlike “sluggers” in baseball, they focus on getting lots of little wins in the form of starting many small businesses instead of rare but fantastic successes.

Yesterday I described the Kolbe personality test, which allows you to measure yourself on four personality attributes that predict your success and happiness in running a business. People with a high Quick Start score on the Kolbe test thrive in the chaos of a start-up where every day brings new challenges and the need to think peripherally. »more

Twelve reasons to sell before you ‘retire’

~published May 26. 2010 The Globe and Mail

Have you ever noticed that the terms “retirement” and “exit planning” for business owners are often used interchangeably?

Sometimes it seems the only socially acceptable way to exit a privately held business is to hang on until you’re well past your prime, eventually giving the reins to your offspring so you can play golf for a few years before moving into a home and waiting to die. »more

I’m writing to you from The Association Of Corporate Growth (ACG) annual conference in Miami Beach where I was invited to be a panelist on Bo Burlingham’s roundtable about the pros and cons of accepting outside investment in your company.

Along with Bo, who is Editor-at-large for Inc. Magazine, my fellow panelists included Martin Babinec, founder of Trinet, which helps fast growth companies manage their HR issues and pay their employees.  Martin has raised a total of $100 million in outside capital through six investment rounds. JW Ray co-founded learn.com, which is a $40 million dollar software business that allows companies to offer their employees training via their computer at work. Learn.com accepted investment money from friends and family to get started and then took a private equity investment in 2005, which they lived to regret.

The audience was made up of private equity investors and venture capitalists who have a strange job: they need to bat away hundreds of companies that are desperate for money while trying to convince the one business that doesn’t really need their money to let them invest.

My job on the panel was to provide the perspective of a business owner who chose to grow a business more slowly without accepting outside investment.

Early on, Martin allowed a publicly held company to buy half of Trinet in exchange for a $4 million dollar investment. The chairman of the corporation joined the Trinet board and would only agree to sell his shares in return for a valuation typical of a public company (i.e. double digit multiple of earnings). Martin found a venture capitalist to pay the rich premium his strategic investor was asking for, only to go from the frying pan to the fryer. His new investor started pushing Martin to go public from their first board meeting.

At Learn.com, JW and his partner accepted a private equity investment in order to fund a growth-oriented budget they had prepared. At their first board meeting after the deal closed, their new private equity investor refused to approve the pre-agreed budget explaining they invested in “cash cows not pigs”.

Soon after, the private equity partner made a second investment in one of Learn.com’s competitors leaving them with a board member who was part investor, part spy for the competition. JW and his partner spent the next five years trying to get the investor off their board.

What struck me in listening to Martin and JW was how much their day-to-day experience of company-building changed once they accepted outside capital. They went from focusing on customers, products and employees to preparing for (and recovering from) quarterly board meetings, disputing budgets and obsessing over deal covenants.

It almost sounded like they had traded their business for a job.

To me, entrepreneurship is about creating something from scratch while bush whacking through the forest of problems and decisions on your own. It is a capitalist escapade of sorts and like any adventure, best enjoyed when you have the freedom to roam.

Contrary to popular rhetoric of the moneymen I met today, I’m happy I kept 100% of a smaller pie that I controlled rather than a potentially more valuable stake in a company I didn’t.

How about you? Would you rather own a small chunk of a big company or a big chunk of a small company?

Here are some new articles on building a company you could sell:

Time to Reset Your Business?

~ published May 4, 2010 The Wall Street Journal

I recently heard about a dentist offering Botox injections as a way to jumpstart his recession-weary dental practice. Last weekend, I jogged past a tanning salon offering teeth whitening. Dentists offering to tighten your smile and tanning salons offering to whiten it? What’s going on here? Increasingly, business owners are starting new product and service lines in a desperate attempt to pick up much-needed revenue.  » more

Is your Service Business Too Squishy?

~ published May 4, 2010 Inc.

David Ogilvy, the famous advertising pioneer, described the biggest problem with a service business in a memorable way. “The assets go up and down the elevator every night,” he said.

Because people are the main asset of most service companies, these businesses are vulnerable to human frailties: At times we all get sick, tired, cranky, fickle, and jealous. This makes the management and operation of a service business somewhat unpredictable—which makes selling it all the more complicated.

When you go to sell your business, a buyer will be looking for predictability, which is why service businesses can be tough to value.

To create a service business you can sell, do whatever you can to make your business look like it has a product and a formula that predictably delivers results.  For example, Peter Turpel went from consulting with companies about how they used their phone systems to developing the “Phone on Hold Marketing System,” which offers businesses various options for handling customer calls (e.g., music, call routing). Turpel moved from consulting personally with customers to creating products around his knowledge so that the business appeared more tangible. » more

The risks of selling companies to employees

~ published April 27, 2010 The Globe and Mail

One of the best parts of writing this column and my books is hearing from you, the reader. So this week, I’d like to turn the column over to your questions. Please use the comments area below to ask about building a company you could sell or to provide a comment you’d like me to address.

Q: “What are the risks involved in selling my business to my employees?”

A: When selling a company to employees, most business owners end up guaranteeing some of the loan the employees use to buy the shares. Your biggest risk is that your employees will not manage the business well on their own and your old business will end up in financial trouble. If the business defaults on its commitments with you as a guarantor of the loan, you could end up owning the business you thought you had sold. » more

When to say you’re selling

~ published April 28, 2010 The Globe and Mail

Q: “How and when do I tell my employees that I’m considering selling my business?”

A: I would recommend drawing a distinction between telling your management team and telling the rest of your employees.

In order to minimize an earn-out, you need to present a potential acquirer with a management team (not just you). That way, the acquirer can get comfortable with the team of managers who will be running the business after you leave. Before you start meeting seriously with buyers, you should tell your managers. To get them excited, you can offer them a “success bonus” tied to closing a deal, paid in two installments: one on the day the deal closes and a second tranche on a future date, provided they are still employed by your company and its new owners.  » more

Help! My company is a cash hog

~ published April 29, 2010 The Globe and Mail

Q: “You talk about charging up front as a key part of creating a valuable and sellable business. I sell to retailers, and charging up front would be a non-starter. My customers are insistent on 30-day terms at a minimum. What would you advise?”

A: Creating a positive cash-flow cycle is an important part of growing a valuable business because (a) it gives you the working capital to grow without having to dilute yourself with outside investors and (b) it bumps up the multiple you’ll get for your company because the acquirer will have to invest less cash to run your business. It’s also a lot more fun to run a business that has money in the bank.  » more

My trusty old Dell laptop blew a motherboard fan in the middle of a presentation last week, so this weekend I finally broke down and bought a Mac. I rationalized my decision by reminding myself that because Apple makes both the software and hardware, it would be a more reliable machine. In truth, I was seduced by all of that slick marketing.

Similarly, a lot of romancing needs to be done if you want to sell your business, so I thought it might be fun to deconstruct my Apple experience for you in the context of building a sellable company.

Once I had selected my computer, the salesperson (er, “concierge”) told me about “Apple Care,” a glorified warranty that gives customers access to a special support phone number (among other things) for $100. Now, I’m the guy who never buys the insurance—not from Best Buy, not from Hertz—so it was a surprise to me that I was seduced into buying Apple Care.

It got me thinking about how to make the intangible seem real. First of all, Apple branded its warranty in a unique and memorable way. The concierge avoided using the generic word “warranty,” opting for the word “care” instead. As she explained the benefits of Apple Care, she handed me a shrink-wrapped white box with a plump red apple on the cover. On the back of the box was a bulleted list of the benefits being described by the concierge.

I’m not sure there was anything in that little box. Clearly, Steve Jobs was not poking his head out between the seams ready to answer my every technical query, but somehow the box in my hand made Apple Care feel more substantial. In short, it felt like a product, not a service.

Making the squishy seem real is a big part of selling a business too. You need to make your:

• sales pipeline look real even though you may have no idea what will close
• budget projections look solid even though they may not be much more than an educated guess
• employees look like highly qualified experts even though some may be best characterized as generalists
• product or service seem tangible and scalable even though in truth it may be a malleable offering that you customize for customers at every turn

Running a business can be messy. What have you done to make your business look more concrete?

P.S. I thought you might enjoy a couple of my recent articles below….

Do you need a brain transplant?

~ published April 13, 2010, The Globe and Mail

Last weekend my wife and I were browsing the shelves of our local Rogers Video and couldn’t find anything to watch. We have seen The Blind Side , and I have no interest in watching the Michael Jackson movie. As we scanned the rest of the titles, nothing jumped out at us.

Fortunately, Toronto’s Beach neighbourhood is home to an independent video store run by a husband and wife team who offer an alternative experience to that of the traditional video store chain. After walking into their cluttered store, instead of scanning the new-release wall, the initiated head straight to the owners and ask for a recommendation. »more

Six reasons to stop charging by the hour

~ published April 14, 2010, The Globe and Mail

I received a bill from my lawyer and he itemized his time spent on my file last month. He spent four-tenths of an hour on an e-mail to a colleague and one-tenth of an hour leaving me a voice mail.

I have found billing by the hour to be a liability when trying to build a sellable business. Years ago I owned a small design studio that charged by the hour. We had $750,000 in revenue, of which more than 20 per cent was flowing to the bottom line, yet the business was worthless because we were simply four people hawking hours. »more

Lessons learned from a lame attempt

~published April 15, 2010, The Globe and Mail

We were having lunch at Bravi, an upscale Italian restaurant in downtown Toronto. Across the table was the head of corporate development for a large advertising agency holding company. Fifteen years my senior, he was perfectly turned out with a crisp shirt underneath a tailored suit. He had flown in from Montreal to discuss “a possible partnership.”

Once the lunch plates were cleared, he got down to the real purpose of his trip. “Have you ever considered selling your business?” »more

Make Your Service Business As Easy to Sell as a Bottle of Tide

~ published About.com

In the 1990s, he owned a graphic design studio and was approached by someone who wanted to buy his business. Excited, he met with the suitor only to find out he expected to buy the studio for nothing down with a promise of future payments if Warrillow hit targets in the future as a division of his company. Incredulous, Warrillow asked the buyer to justify his valuation methodology. He explained that service businesses are difficult to sell because the assets are the people and if the people leave, there is no more company.

The meeting inspired Warrillow to transform his service business into one that looked more like a product business. He reasoned that, to be valuable, his business needed to seem tangible to outsiders and not so reliant on people. Procter & Gamble is the granddaddy of product marketing so he picked up a bottle of Tide and followed their formula. Here are the five steps he recommends you follow if you want to make your service-related business almost as easy to sell as a bottle of detergent.  » more

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