Dear Business Owner,
You’re thinking about selling your business and you’re excited. You were sitting in the club room after a round of golf last week-end and one of your fellow club members let drop that he had just sold his business for 10 times earnings. You’ve mentally applied that multiple to your earnings and bingo, a comfortable and care-free retirement awaits.
Slow down and take a deep breath.
Business brokers and investment bankers know this story all too well. About 70% of business brokers in a national survey rated sellers’ unrealistic price expectations as the number one barrier to successful business sales. The “Country Club Price” feeds that irrational exuberance. One investment bank goes for far as to suggest (tongue-in-cheek I suspect) that business owners quit their golf club memberships before beginning the business sale process. (For non-golfers, multiples you hear about at the health club, cocktail lounge, hair salon, barbershop or networking group serve the same purpose.) So why should we have doubts about the Country Club Price?
The multiple you heard may be overstated
Like fish stories and reminisces of one’s high school athletic prowess, the Country Club Price might be a wee bit inflated. Be even more suspicious if the story comes through a third party as speculation might well drive the story. Also, understand that sellers who got smaller multiples don’t brag about it. Don’t overestimate the overall multiples environment based solely on what you hear. The average is likely much lower.
Even if the multiple is correct, you usually won’t get the whole story. The price might include an earn-out, where a substantial part of the eventual pay-out depends on the business’s post-sale performance. The seller might have gotten a premium for taking some or all of the proceeds in buyer’s stock or debt, rather than from cash up front. The sale contract also might include a substantial seller’s indemnity, where the seller has to compensate the buyer for potential losses that the buyer might suffer after the sale closes. These factors make the agreement less valuable regardless of the stated multiple.
Your businesses might not be comparable
Sellers derive the multiples they offer by a mixture of art and science with no two businesses exactly the same. Context matters. A lot. Dozens of factors go into pricing any business. Factors that will certainly affect your company’s multiple include: your industry, your competitive environment, your customer concentration, your sales growth, your margin history, the strength of your brand, the uniqueness of your product or service, strong patent or copyright protection, stable vendor relationships and the perceived strength of your management team.
In general, companies with growing sales, expanding markets, stable margins, strong management teams, and sustainable competitive advantages generate higher multiples. Multiples contract for businesses in mature or declining industries. Multiples contract for businesses characterized by commodity pricing, intense competition, modest or flat sales growth, over-dependence on a few customers, narrowing margins or mediocre management.
A buyer’s motivations and their unique situation can affect multiples as well. I was involved with a situation where the buyer needed to acquire a certain company to complete a strategic initiative where they had already invested tens of millions of dollars. The buyer offered a multiple premium in order to make certain that the sale went through and that the seller would not be enticed by a competing offer. Unless your business is nearly identical to another, their sales multiple will yield little insight about what multiple your business might command.
YOUR PROCEEDS WILL NOT EQUAL YOUR PRICE
I put the last heading in all caps for a reason. The mental math owners do when they hear the “Country Club Price” often ignores this reality. Your adjusted earnings (usually EBITDA) times the multiple sets the upper limit of your potential proceeds. Several other factors will affect what you actually take home. First, the sale process generates fees from the professionals you use to help you complete the sale. You will compensate your lawyers, brokers/investment bankers, and other advisors you engage from your sale proceeds. Second, you will owe taxes on the proceeds. Your tax advisor and wealth manager can help you to manage the tax bite, but some of your proceeds will go to the taxing authorities.
Finally, you will have to pay off any debt other than trade payables from the proceeds. Buyers generally will not assume your bank debt, line of credit, promissory notes or other debt instruments. Occasionally a buyer might assume equipment leases but even then, they will adjust the price accordingly. In a recent Linkedin article, Enrique Quemada of One to One Finance Group tells the story of a seller meeting that nearly turned violent when he had to tell the owners of a highly leveraged business how small their sale proceeds would be after subtracting the business’s debt from the selling price. (I highly recommend that anyone on Linked interested in M&A follow Mr. Quemada. He’s my favorite M&A follow.) Never fool yourself into believing that you will put the entire selling price in the bank. Consider the fees, taxes and debt when you think about a potential selling price.
Take any sale price or earnings multiple you hear concerning somebody else’s business with a grain of salt, or better yet, a boulder of salt. The multiple you hear may not be right, it may not be relevant to your business and it doesn’t give any insight on what your final proceeds might be. If you’re considering a sale, a B2BCFO® Partner can help you to engage a solid Success Team™ of professionals who can help you to navigate through the process. I wish you a successful and profitable sale.
All the Best,
About the AuthorJeff Mann is a Fort Wayne, Indiana based Partner with B2BCFO®. He is a senior financial executive with over 40 years’ experience and has been the lead financial executive for several business sales and purchases. Jeff holds a BS in accounting from the University of Virginia and an MBA in finance and marketing from Northwestern University and is a Certified Business Transition Expert. See more articles at: http://www.indianab2bcfo.com/professional/jeffrey-mann/