FEBRUARY 2007
IS AN EXIT STRATEGY WORTH THE TROUBLE?
By Tony Mulkern
Every business is either sold or dies. To decide which, when and how is to have an Exit Strategy. Why is this important, if you believe you are years from leaving the business? The short answer: The earlier you implement an exit strategy, the more control you have. The longer answer is that it will help you build market value.
About 75% of all businesses put on the market never sell, and for smaller businesses the rate is worse. Your chances of disappointment increase if you procrastinate on the assumption, “When I am ready to sell, then I will worry about selling.” By then, an owner has often burned out and the company has entered a steep decline. Or an unpredictable health crisis requires immediate divestment. Either scenario can lead not only to financial loss but also to family divisiveness.
There are a number of financial goals at which your exit strategy might aim, and most are dependent upon other “softer” factors or values, such as those discussed below.
What does the business mean to your family? To some owners, it is no more than a proprietary job, while raising a family and saving for retirement. When many relatives work in the business, however, it may be the glue that holds the family together. In other cases, if family has owned the firm for many generations, it might feel disloyal to divest yourself of it. Some entrepreneurs see their employees as part of an extended family, and selling the company would feel like selling their own children.
What degree of loyalty do you have to your customers? A recent client invented and sells equipment important to national security, and sees his product as the best in the industry. He feels a moral obligation to provide and market the equipment. If he ever sells the company, he said, he would require an agreement with the buyer giving him the right to buy the company back if they ever discontinued this product line. If your name or reputation would continue to be associated with the company after the sale, more is at stake than who makes the highest bid.
If you wish continued family ownership, how committed are family members to continuing the business? How can you objectively decide if a son or daughter has what it takes to be CEO? What is the best preparation for this role? If you wish your children to share equally in the future earnings, is this fair if only one of them is working in the company and growing it? If a family member is not competent or interested, are you willing to hire an outside CEO to run the business? What would you pay such a CEO, and what kind of long-term incentives would you offer if equity will not be available?
Making objective assessments of executive potential of one’s relatives may be the most difficult and crucial decision you will ever make. One company owner was forced to interrupt retirement and fire his CEO/son to avert bankruptcy of the firm he had founded many years before.
Once you have settled these value questions and still decide to sell, you need to become familiar with market value—or what buyers will actually pay. Our client was in the structural testing business and mentioned that over the years he had invested over $16 million. On that basis he mentioned that he and his wife expected to get at least $16 million when they sold the company one day. It was painful to break the bad news: market valuation is a multiple of earnings, which in his case translated into about one million dollars he could expect from a sale. They might get a little more in an orderly liquidation, but not much.
Lesson: Decide what proceeds you want from a sale and build earnings to achieve them. For businesses in the $2 million to $20 million annual revenue range, you might expect a multiple of 3 to 5 times EBITDA, or earnings before interest, taxes, depreciation and amortization. The larger the company in a given industry, all other things being equal, typically the larger the multiple possible, up to 16 or more in the mega-acquisitions.
If you need to grow to hit your target earnings, decide whether to grow organically, that is internally, or through acquisitions. If the latter, be sure to take into account costs in reaching the earnings target to decide if it is worthwhile.
Market valuation can vary dramatically over time, depending upon contracts, growth potential, proprietary products, patents, human capital, concentration of business among clients, litigation, competitive position, skilled management team, owners’ availability after the sale, among other factors. Another client company received a generous buy offer of $14 million, but the husband and wife owners wanted more to support their love of fine art acquisition. As negotiations dragged out over twelve months, a key contract was canceled, and earnings went negative. Market value went from $14 million to zero overnight, and the offer was withdrawn.
Do you plan to exit the industry or do you want to continue to work in the firm? Some owners prefer acquisition by a larger publicly traded corporation in which they can hold a senior executive position—maybe regional President. If you sell outright, you will need to sign a non-compete and will have to exit the industry in the relevant geographical area for many years.
Do not rely excessively on brokers or “intermediaries,” whether selling or acquiring. If you retain one, first do your research and learn all you can about buying and selling a business. Many brokers have solid experience selling small, storefront businesses. The most successful mid-market investment banking firms will typically agree to represent a company only if the market value justifies a minimum “success fee” or commission of $500,000. For businesses in between, many brokers are either neophytes or retired executives, who have little or no experience marketing businesses and negotiating deals.
Some factors, such as how to best structure the deal in regard to some combination of cash, note, and earn-outs, are probably best made closer to the time to actually sell, in consultation with your CPA and legal counsel. Other decisions require longer term planning. For example, some sellers wish they had never changed from an S-corp to a C-corp years earlier. If your CPA recommends this change, ask for a thorough disclosure of tax and market price implicatons upon selling. Also, you might decide some years ahead what you want to do with the targeted proceeds of a sale. Is it to retire in leisure, to create a family foundation, to provide capital for a new venture, or something entirely different?
Perhaps one of the biggest advantages of developing an exit strategy is that it forces you to engage in strategic planning. This means you have to address the issues of mission, values, marketing, growth, customer service, human capital, and earnings that are essential for a thriving, growing and dynamic firm. So even if when the time comes you throw the exit plan away, it will have served you very well indeed if it has impelled you over the years to create a more thriving, valuable enterprise, in countless ways.
****************************************************************
Your Comments?
Please e-mail your thoughts using our contact form.
Copyright, Mulkern Associates, 2007
|
