EXIT STRATEGIES: When to sell your business

EXIT STRATEGIES: When to sell your businessThere are very few entrepreneurs who would say they sold a business at the right time. Many will tell you they sold the business and then discovered the market improved and they would have received more if they had hung on longer. Others will tell you they sold the business after the market peaked and received less than they would have earlier. So when is the right time to sell your business?

Economic cycles are somewhat predictable, although few economists would be willing to state exactly when the downturns will occur. Layered on top of general economic cycles are industry trends which can confuse the picture. This is further complicated when you try to predict the possible future performance of the individual firm. There are numerous internal and external pressures which can influence both short-term and long-term profitability of any business.

For most businesses, the future cannot be predicted with any degree of certainty. You only have to read the daily financial press to see how often public corporations miss or exceed their forecasts.

You might argue that you run a very effective, growing and profitable business and that you should hang in there for a higher valuation, however, you would be overlooking factors beyond your control. Recall the impact the terrorist events of September 11, 2001 and the Bali bombings had on various national economies.

Natural disasters are unpredictable but can devastate sectors of our economy. There seem to be regular natural disasters such as tornadoes, cyclones, droughts, floods and earthquakes. While your business may not be in the geographical location of the disaster, it can affect your customers and suppliers, thus disrupting your business. Few of us would have predicted the fall out from the collapses of WorldCom, Ansett, HIH, BICC, Enron and Arthur Andersen. Basically, no matter how well you manage your business, you can still be seriously impacted by bad luck and events outside your control.

Your business can also be seriously affected by new competition, the loss of key employees, government or industry regulation, a major cost imposed by changes in regulations or by a major customer being acquired and switching to a competitor. Business is about risk. You can sit there and take the risk of the business increasing in value or you can sell and take whatever value has been achieved to date and then think about taking it easy or putting some of the money back into a new venture.

The bottom line – you probably have an equal chance over the next several years of growing the business or suffering some form of setback. Predicting the state of the business in the next few years should not be the major determinant of when to sell the business.

Example:

Select Travel International and Select Line Holidays of Leith have ceased trading, leaving debts of more than £700,000, after Aimquoted World Travel Holdings said the companies “did not perform
to expectations.”

In a statement, the company said it had decided to shut the Scottish businesses “given the poor financial state of Select Line revealed following completion.” The chairman of World Travel, John Biles, admitted the decision to pull the plug so soon after buying the group may appear unusual but he declined to comment further on what had gone wrong in such a short time.

“The wording in the statement was carefully chosen,” he said. When asked if the liquidation of the companies was the end of the matter as far as World Travel was concerned, Biles said he expected so.

The liquidation move came just eight months after the companies were acquired in the all-shares deal. Liquidators are now trying to sell on domain names owned by the companies containing the ‘241’ brand name in a bid to repay creditors who are owed a total of £738,000. Debbie Harvey, of Reading-based insolvency practitioners Harrisons, said the failure of the companies had been blamed on the effects of September 11 and foot-and-mouth on tourism. “World Travel was faced with a choice of having to invest large sums of money into the businesses which they didn’t have or walking away.”

Source: http://www.business.scotsman.com/ accessed 7, September 2003

Think back over the last few years of the household names which are no longer in existence. Large companies have more resilience than small companies but they still fail. Small companies generally have a much higher probability of failure.

If you sell to a listed corporation, the state of their share price and price earnings multiple (PE) can certainly influence their willingness to undertake an acquisition. If the public markets are receptive and the PE is relatively high, an acquisition by a public company can have an additive effect on the valuation of the acquiring corporation. For example, an acquisition which is done on an EBIT multiple of, say, six into a corporation which has a PE of 14 will add the additional multiple of eight to the benefit of their own shareholders. So a public corporation trading at a PE of 20, they may be willing to pay a higher EBIT multiple. This may be a good time to sell.

Many business owners are concerned about whether they will have enough funds to finance their retirement and how they will spend their time when they do. Imagine how sad it must be to reach retirement and find you left it too late and you ended up with a fire sale. Sometimes it is better to take what you can and have the comfort of having the money in the bank or other low risk investments. You can always work for someone else or spend your time working in the not for profit sector as a volunteer.

You might consider what your next best alternative is if you were to seek paid employment. If you currently take $150,000 in benefits from the business, what could you earn if you became an employee? Let’s say, $90,000. After tax you are worse off by about $30,000. If you could sell the business and pick up $300,000 net, it would take you 10 years to equal that. If the net proceeds were greater, this may mean a good standard of living for the rest of your life. Take the money!!

Alternatively, you might be bored or the business may have outgrown your ability to manage it effectively and the business may be suffering as a result.

Not everyone is suited or has the desire to manage a larger business. Your skills may be more effectively employed by selling this business and starting again. Many entrepreneurs are best at business creation where their passion and energy are best utilised. They are often not good at the detail or the day to day management. If you are not having fun any more, then sell and start again.

Even where the business has considerable potential, you may not be the right person to manage the business or you might not be able to capture the potential. Every business has to change dramatically as it grows in order to cope with the increasing complexity of the operations. You may not want to manage a more formal and more bureaucratic business. At the same time, the potential of the business might be limited by your ability to manage or to finance the growth. Sometimes it is better for the business and for its employees to sell to a corporation which can better exploit the potential and perhaps offer the current employees better career prospects.

Growth businesses go through considerable changes as they grow. I discovered large transition points in my own businesses at 12, 50 and 100 staff. One business went through a huge organisational crisis when it undertook an acquisition 12,000 kilometers away.

There have been several well-accepted theories defining the organizational changes which occur with different stages of growth in a new business. Larry Greiner published an article in the Harvard Business Review in 1972 entitled Evolution And Revolution As Organizations Grow. Neil Churchill and Virginia Lewis developed this further in a 1983 article entitled The Five Stages Of Small Business Growth, also published in the Harvard Business Review. Mel Scott and Richard Bruce looked at growth crisis points in their article The Five Stages Of Growth In Small Business, published in Long Range Planning in June 1987.

These models all show that important changes will occur within the business as growth occurs. The main factors creating complexity are the number of staff, the number of customers, the number of products and the number of locations. To achieve five times the level of business you have now, most of these parameters will have to change. What is not so obvious to most entrepreneurs is that the business will need to be managed differently with each additional level of complexity.

In the early days, the entrepreneur is able to run the business with sheer energy, passion and vision. They know everyone and staff are motivated because they are part of the grand adventure. As the company adds staff, however, new people come into the business who were not part of the grand vision. Their motivations and needs are likely to be different. They may see it more as a job than a mission. They will have different needs and management styles will have to change. At the same time, the growth brings with it specialisation of tasks and more formal organizational structures. Reporting lines become clearer, job descriptions become the norm rather than the exception and performance targets and monitoring are introduced. Soon there is a new layer of management between the chief executive and the operations. What began as a project has now turned into a business.

As the business grows further, communication becomes more formalized as communication lines become longer. The left hand no longer knows what the right hand is doing. Customer service quality often falls because new customers do not have the advantage of personal links with the founders.

Problems tend to increase with a second location as daily face-to-face communication becomes physically impossible. External shareholders and/or external directors force more transparent decision-making, which means the entrepreneur can no longer make decisions on the fly. Many more staff, customers and other interested parties, depend on the business for their livelihood.

There are important strategic insights which can be gained from predicting what your business might look like and how it should be organised as it goes through these transition stages. Almost certainly you will discover you have the wrong organizational structure and the wrong information technology systems to support a larger business. What can be more surprising is that you will also discover that some of your best staff are unlikely to make the transition. They may lack the skills, personality, work ethic or experience to work effectively in a more complex situation.

Many entrepreneurs simply are not able to make the transition, or they do not want to. This is very confronting, but it is better to recognise it and plan to delegate more responsibility or to sell the business and move on to something for which you are better suited. With time on your side, you can restructure the business so that the business is no longer dependent on you, you can bring the business up to a state of sale readiness and then you can find the right buyer to take over.

Often business owners find they have reached a point in the size of the business where they need to make a substantial investment in order to move to the next stage of growth. This may be an expansion of capacity, investment in another location, re-equipping a manufacturing or warehousing facility, installing a new accounting system or taking on full time specialist staff. The cost of doing so may be beyond the ability of the firm to finance and, therefore, the entrepreneur has to incur sizable new debt and/or dip into life savings. This new investment may be somewhat risky as the anticipated revenue may not be assured. What might have been a very comfortable business might suddenly turn into a high stress activity. Maybe this next stage is not for you. Maybe it would be better for you to sell to a corporation which is able to take it to the next level and exploit the future opportunities better than you.

You might have another opportunity you wish to pursue. It may be more exciting, more fulfilling or simply more financially attractive. However, in order to undertake it, you might need to release funds from your current business.

This would be a very good reason for selling. Selling the business is not always about failure. In fact, in most of these scenarios, they are about understanding what you are good at, where you wish to spend your time and how you want to manage your life. However, you do need to be able to answer the question, “Why do you want to sell?”

There is nothing wrong with wanting a better life or simply being exhausted with keeping a business going or just losing interest. Owners sell for lots of reasons including divorce, ill health, family problems, lack of capital to expand the business and so on. If the business is in trouble, you wont be able to hide it – you will lose more by covering up a problem which will certainly be found out during the investigation phase. The key here is to be prepared to sell the business and to know what value the buyer can extract from the business and to ensure you have multiple potential buyers.

Tom McKaskill is a successful global serial entrepreneur, educator and author who is a world acknowledged authority on exit strategies and the former Richard Pratt Professor of Entrepreneurship, Australian Graduate School of Entrepreneurship, Swinburne University of Technology, Melbourne, Australia. A series of free eBooks for entrepreneurs and angel and VC investors can be found at his site here.

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