Quitting the business is rarely on the minds of entrepreneurs when they start technology companies. Refining smart products, researching potential customers and charting routes to market tend to dominate the early thinking of start-up founders. This article is the first instalment of our multi-part series on all the aspects to bear in mind when exiting a business.
What are the mistakes to avoid when planning for THE exit?
According to serial entrepreneur Debbie Allen, sellers typically make five mistakes in the sale of their business:
Mistake #1: Not planning or waiting too long to sell
Waiting too long, or not planning, can cause many business owners to miss their window of opportunity. It takes an average of two to four years to sell a small business. Therefore, long-term planning is key to any successful business sale. Keep updated records, a detailed business history and sales portfolio on hand at all times; your planning will pay off. These vitally important documents should preferably be filed in a cloud based data room for easy access to potential investors. You just never know when that perfect buyer may walk into your business and make you an offer you just cannot refuse.
Mistake #2: Not finding the right person to represent your business
Finding the right broker and/or consultant to help you sell your business is crucial to your success. Often business owners go with the first person they meet just to list their business and get the process going. This can cost you time and money in the end. Within a few months, you may see no results and have to go on the search all over again. Taking time to interview many brokers and looking at a realistic outcome of what is expected will get you started in the right direction. This is further complicated in South Africa where there is not an abundance of readily available business brokers with highly visible profiles.
Mistake #3: Thinking you do not have to promote or market yourself
Thinking a broker will do all the work in promoting your sale can be detrimental. You are the best promoter for your business. Who knows your business better than you do? No one is more motivated, passionate and knowledgeable about your business than you are! A broker may be getting you some activity, but you should continue to promote it as well. After all, the founder of any business should be the best salesperson on the team!
The trick of course, is to ensure that the prospective sale of the business does not leak out into your community, namely clients, suppliers and employees as that could prove to be detrimental to the business and ultimately may affect the price received for the business. Being transparent with your stakeholders could also prove to be a positive route, especially once you have explained to your employees your reasons for selling a profitable business. In most cases, the new owner would normally stipulate that the staff need to be part of the package. Good salespeople are typically motivated by money so they may be a good resource to harness to generate sales leads.
Mistake #4: Asking too much or too little for the business
Setting a very high or unrealistic price tag on a business can lead to a dead end street. Expecting to get top dollar for a business that generates little or no profit is simply using bad business sense. Consider your industry, similar businesses, the economy and your marketplace when pricing your business to sell.
On the other hand, a business that does not generate profits may do well with a going-out-of-business sale. This type of sale can generate instant cash flow and quick turn over. Too many business owners that have not turned a profit, or have cash flow problems, miss this wonderful opportunity. Some reasons they miss out is due to lost energy and/or motivation or because they may not want to admit defeat or failure. Remember it is business - don’t worry about taking it personally. Look for the most valuable opportunities for your business.
Another mistake is to price the business too low. Often business owners will price their business low because they are burned out, suffer from an illness or did not get good advice. Do your homework first! Listen to brokers and consultants. Do research about other business sales before jumping in with both feet.
Mistake #5: Selling to the wrong person
Taking the first offer may not be a wise choice. This may not necessarily be your BEST offer. Selling your business for the best price with little or no money down along with an extended contract may lead you to losing it all. Business sales often go bad after the new owner takes over. The new owner may lack business experience, have a closed mind or be a poor leader. The list is endless. A successful business owner makes it looks easy, but change that mix and disaster may strike. When this happens, the new owner ends up going out of business and leaves the previous owner holding an empty bag.
Evaluate your options and make the best selection for the long term. Ask yourself, is this the best person to buy and run my business? Or, can they quickly connect with my customer base and learn how to market effectively? When the business sale goes as planned, it creates a tremendous opportunity for both business owners and continued success.
Exiting your business is one of the most important decisions to make when your start up as an entrepreneur and the next instalment will explore the different ways in which you could consider exiting your business.
WHAT ARE THE DIFFERENT WAYS I CAN EXIT MY BUSINESS?
Lifestyling. One favourite exit strategy of some forward-thinking business owners is simply to bleed the company dry on a daily basis. This does not mean run it in the red—but rather means paying themselves a huge salary, rewarding themselves with a gigantic bonus regardless of actual company performance, and issuing a special class of shares that only they own that gives them ten times the dividends received by the other shareholders. Although we frown upon these practices in public companies, in private companies, this actually isn't such a bad idea. It's called a "lifestyle company.” Rather than reinvesting money in growing your business, in lifestyle companies, you keep things small, take out a comfortable chunk, and simply live on the income. In a memorable Harvard Business School moment, the owner of a small, fabulously profitable manufacturing company was asked why he didn't grow the business bigger and sell it for a gazillion dollars. His response: "Excuse me? You've had way too much schooling. What part of 30-hour work weeks and a $5 million personal income don't you understand?“ A lifestyle business is a legitimate reason to build a business that operates to support your surfing or (insert your particular penchant here) lifestyle!
The Liquidation. Even lifestyle entrepreneurs can decide that enough is enough. One often-overlooked exit strategy is simply to call it quits, close the business doors, and call it a day. While we may not know anyone who's founded a business planning to liquidate it someday, it happens all the time. If you liquidate, however, any proceeds from the assets must be used to repay creditors. The remainder gets divided among the shareholders - if there are other shareholders, you want to make sure they get their due.
Selling to a Friendly Buyer. If your local piano bar owner had only known, he might have wanted to sell the business to you, his loyal and devoted client. You see, if you've become emotionally attached to what you've built, it would be even easier than liquidating your business to pass ownership to another true believer who will preserve your legacy. Interested parties might include customers, employees, children or other family members. The fictional Willy Wonka handed off his chocolate empire to a little boy who was a loyal Wonka customer, someone who was chosen with great care through a selection process designed to weed out all but the most dedicated Wonka devotees. Wonka was able to choose his heir apparent and ride off into the sunset a happier entrepreneur.
The Acquisition. The acquisition was invented so that you can sell your business and leave your children with an inheritance, still spoiling them rotten, but at least sparing the business from second-generation ruin. Acquisition is one of the most common exit strategies: You find another business that wants to buy yours and sell, sell, sell. In an acquisition, you negotiate price. This is good. Public markets value your business relative to your industry. Who wants that? In an acquisition, the sky is the limit on your perceived value. You see, the person making the acquisition decision is rarely the owner of the acquiring company, so they don't feel the pain of acquisition cost. Convince them you're worth a billion dollars, and they'll gladly break out their employer's chequebook. If you choose the right acquirer, your value can far exceed what would be reasonable based on your income. How do you select the right company? Look for strategic fit: Which acquirer can buy you to expand into a new market, or offer a new product to their existing customers? We’ve all read the stories of the entrepreneur who started a company that was acquired during the Internet boom for $500 million when it was just 18 months old. He commanded a huge price because his acquirer thought the acquisition gave them critical capabilities faster than they could develop those capabilities on their own. But acquisition has its dark side. If there's a bad fit between the acquirer and acquiree, the combined companies can self-destruct. The acquired management team can end up locked into working for the combined company, and if things head south, they get to watch their baby implode from within. Time Warner recently announced that they're thinking of spinning off AOL, almost exactly five years after the two companies merged. What, exactly, did the merger accomplish? It made two CEOs very wealthy--and destroyed years' worth of work and billions of dollars. If you're thinking of acquisition as your exit strategy, make yourself attractive to acquisition candidates, but don't go so far as to you cut off your other options. One software company knew exactly whom they wanted to sell to, so they developed their product in a way that meshed perfectly with the prospective suitor's products. Too bad the suitor had no interest in the acquisition. The software company was left with a product so specialised that no one else wanted to buy them either.
This method of exiting is highly specialised and requires a lot of thought and hard work to establish the right “fit” between both companies. The Knife Capital Exit Conference to be held in Johannesburg in August will provide a lot more meat to this topic in the months ahead.
The IPO. The Initial Public Offering, the Holy Grail for start-ups, are sexy, they're flashy, and they get all the press. Too bad they make the lottery look good by comparison. There are millions of companies in the U.S., and only about 7,000 of those are public. And many public companies weren't even founded by entrepreneurs but rather were spun out from existing companies. Just AT&T and its spin-offs form a significant fraction of the listed exchanges! If you're funded by professional investors with a track record of taking companies public, you might be able to do it. Of course, the professional investors will also have diluted you down to the point where you only own a tiny fraction of your company anyway. The investors will make out great. And maybe, if you're the principle entrepreneur and have done a great job protecting your equity, you'll make some money, too. The South African public listed company is an onerous and costly affair, both financially and in emotional energy!
Of course, the ultimate goal would be to have a lifestyle business that is managed by a professional management team that allows you to go surfing when the surfs up, yet you have the confidence that the business will deliver a secure retirement and leave a legacy for generations.
WHAT SHOULD I BE LOOKING OUT FOR WHEN SELLING MY BUSINESS?
One of the most sought after exit strategies is to sell the business. Theoretically, this should have been thought through from the outset, but in reality, many founders decide to sell for a variety of reasons, from sheer exhaustion, to taking advantage of a willing buyer prepared to pay a decent price. The Microsoft Resource Centre has some interesting pointers for business owners who are thinking of selling their business.
1. Determine a value, factoring in your bottom line. The first step in selling a business is determining what it's actually worth. There are many formulae for valuing a business. Buyers may base a purchase offer at least in part on the value of the assets in your business, the cash flow, gross revenues, annual growth and other factors. No matter how many numbers are cranked into how many equations, sale prices typically depend on profits, says G.B. (Nick) Nicholson, a business broker based in Atlanta. "Usually, you can figure on the value of your business being driven by its bottom line," Nicholson says. "The sale price is almost always a multiple of the business's profit.” That multiple varies from industry to industry and business to business. However, the multiple will be considered whether the buyer is an individual who wants ownership of a company or a larger organization searching for strategic acquisitions. “When you're talking about smaller businesses with no more than 25 employees, you can probably figure that about three-quarters of the buyers are going to be people looking to purchase and operate their own company and earn [a living] from it," Nicholson says. Coming up with a value for a business is a little like coming up with a sale price for any product or service: There's a lot more to do before you actually make a sale.
2. Figure on recasting your financials. Many small businesses show little profit. That's good for tax purposes, but bad when it comes time to determine the value of what you've built. You want to show prospective buyers the business in the most positive and accurate light possible. Owners should have their accountants recast profit-and-loss statements to reflect adjustments for what the business owner takes out of the business in terms of salary, health care, vehicle expenses and other benefits. This can be especially useful when dealing with a buyer who would operate the business himself.
3. Don't count on a cash sale. Business sales professionals say that more than half of all small-business owners finance the sale of their businesses. You could find yourself lending as much as 70% of the purchase price to the new owner. Terms on these financing deals vary, but many owners and buyers agree on payoff periods of four to five years. Part of the process will involve getting information on the buyer's financial records and background, just as the buyer will need information on your business's history.
4. Keep it quiet. Letting other folks know that your business is for sale can be a big mistake. Small-business owners have had suppliers learning that the business was for sale, and lines of credit were pulled and all orders were filled only on a cash-on-delivery basis. There is a tendency toward letting key employees know that your business is for sale. What can happen is that they start telling other people, including other employees, and before you know it, your employees are sending out CVs and looking to leave the company. Since good, experienced employees are part of the assets that are transferred in a business, this can all be very costly.
5. Use a broker. A good business broker can help you determine a realistic price for your business. He or she also can identify and qualify appropriate buyers, put together a sales prospectus, negotiate terms of a sale, and maintain your business confidentiality so that only prospective purchasers know your business is up for sale. You will probably also want to work with your accountant, lawyer and other experts to make sure that all aspects of the sale are handled properly.
WHAT ARE THE KEY POINTS POTENTIAL BUYERS WILL LOOK AT?
Curtis Kroeker of BizBuySell has further insights into what potential purchasers of the business would consider important in making the buying decision.
1. Current Owner is not Indispensable. If you were hit by a truck today and could not work, could your business survive in your absence? Some businesses are so reliant on the current owner that they could not possibly succeed if the current owner were to leave. From a buyer's perspective, that' a huge red flag. If the business depends entirely on one person, whether it is the owner or a key employee that might leave, the business may not be saleable.
3. Strong Company Brand. If your company's brand has been damaged badly and irreparably by poor service or a business crisis, your business may have drifted into unsellable territory. While some buyers are willing to take on a troubled company, there is a point at which even the bravest business buyers will avoid your company. Ensure your brand is strong within the community and industry. This will benefit you in the negotiation process as well.
4. Future Revenues are Safe. Buyers do not like uncertainty. For example, if more than 50% of your revenue comes from one customer, expect buyers to be skittish. If they buy the company and that key customer leaves, you will have left them holding the hot potato. Similarly, if all your customer contracts have three-day termination notices, revenues can vanish on short notice and you are putting a would-be buyer's future earnings at risk. In short, buyers would much prefer a company that has a recurring revenue model where revenues are locked in for the future and there is limited risk of customer terminations derailing the business.
5. No Skeletons in the Closet. Legal liabilities, chaotic financials that reek of impropriety, labour problems, shareholder infighting and a host of other business stink bombs will quickly turn off would-be buyers. To be saleable, you not only cannot have these warts, you also have to be able to prove to would-be buyers that they don't exist.
CREATE INBOUND INVESTOR INTEREST
From a South African perspective, Keet van Zyl from Knife Capital shares the following pertinent points regarding an exit strategy, or as he phrases it, “creating inbound investor interest”:
“If you’re still pitching to investors and they’re not pitching to you, then you’re doing something wrong.”
1. Be awesome. Point number one is to make sure both you and what you have built are the best they can possibly be. “In a startup you don’t have the luxury to be mediocre”.
2. Build a business, not a product. The product might be extraordinary, but if your business affairs aren’t in order you’re going nowhere. “That goes with all the boring stuff of corporate governance,”
3. Build a solid platform for growth. Make sure you’re ready for your business to take off before it does. “The more solid the building blocks the more chance of success you have and people will smell that.”
4. Build traction. “Traction is momentum and momentum gets built in very different ways,” whether it is through PR, social media or various other means. “If you’ve sold one widget to Pick n Pay, they are a customer, their logo can go on your website.”
5. Scale proportionately. Make sure all parts of your business grow concurrently. Do not have too small a team to execute on too big a business model. Too little money or too much money can also kill a business.
6. Package the opportunity. Investors are inaccessible as it is, but too often startups fail to package and present themselves as well as they could. “We have a packaging crisis in the country when it comes to entrepreneurial contents.”
7. Build a partner universe. With partners come all sorts of opportunities. Enter into as many as you can.
8. Populate your data room. Once an investor has expressed an interest, startups need to make it as easy as possible for investment to follow. A full data room should contain all corporate, marketing, and financial information pertaining to your business. “We have to have that stuff anyway so you might as well put it into a data room folder, and if someone wants to invest in you and do due diligence, it’s done.”
9. Understand your value. Startups need to have a realistic view of their valuation, as too many times startups claimed a valuation that was not borne out by the two or three year projections. “You also need to understand your value to a potential acquirer. You need to understand what is going to be bought eventually, and then you need to build that.”
10. Build the right networks. Be sure help is at hand. “Make sure that you are aligned with the right partners to take you through the process.”
Of course, your exit strategy may simply be to build a splendid business, to run it for forty years and to get the business to fund your retirement.