29 December 2014

Selling in a seller's market

From residential housing to Uber's dizzying $40B capital round,  asset valuations have never been so high. Understandably, many small business owners looking to sell expect to write their "own number."  While it may be possible in a few situations to do so, these expectations along with other perceived business risks have created substantial difficulty in executing deals in the small to mid market space.  As we wind down the year, I thought I would write about some tips (from a buyer's perspective) to prepare a small business to fetch top dollar while minimize the risk of remaining on the sidelines.

Grow, Grow, Grow: Even though most deals are based on a multiple of earnings, top-line growth is probably the single most important characteristic that increases business valuations.  Layer in two or three years of steady gains and a seller will see much more cash in a sale.   In any market, buyers struggle to find growth; they particularly recognize the premium required for entry in today's climate.  Smart buyers know how to cut costs and and improve profitability; finding sustainable growth avenues are much harder to manufacture.  This is why growth stocks yield a larger P/E ratio than dividend or stable companies.

Stay in (sort of):  Most owners know not to wait to sell the day he or she is ready to walk out the door.  By that point, the business has probably declined as would the valuation.  But even more importantly from a buyer's standpoint, they need people to run acquired businesses.  Some may claim they can bring in experts or leverage existing operations, but they all recognize the importance of keeping the existing entrepreneurs involved post-close  By keeping even a sliver of equity in the business (even 5-10%), buyers will be willing to increase their purchase price due to reduced risk.  A go forward interest may be viewed as an insider continuing to invest in the business and a seller might pick up some are all of the reduced cash upfront through increased valuations.  Timing is key; at least two to three years prior to exiting the business is ideal.

Address customer concentration proactively:   Many small business owners dance or try to conceal the fact they have one or two customers that drive much of the company sales.  If this is the case, it's best to discuss this early and openly with a potential buyer.  If you have a strong relationship with the customer, talk to them about a potential deal.  Even offer to introduce a serious buyer to them.  Trump up the fact that you have penetrated a large customer and have the savvy to do this with other similar ones.  Buyers often use this as a way to structure deals so that sellers take most of the risk (i.e. earnout, minority investment).  If this is not ideal for you as a seller, get the buyer involved in the customer relationship to get them comfortable with taking on some of the perceived risk.

Keep the books clean:  A common piece of advice, but it's very important.  It's very easy to use your business account to pay for college, vacations, and cars.  Sellers take pause in this advice because doing so will increase tax bills.  Too many personal expenses will raise red flags.  Buyers see this as increased risk and bankers sometimes do not allow all of it to be considered when potentially financing a transaction.  Conversely, a "clean" company will often be seen as easier to transition and yield a greater valuation.

Know your industry: I often hear that the buyers that show interest are not the ones originally anticipated.  A successful business should be courted by a host of different types of buyers.  If utilizing a banker or formal process, make sure the firm understand the full industry dynamics and are open minded to explore different types of potential partners. Also,  when in discussion with a potential buyer, understand their endgame. Ask them a lot of questions. By doing so will help in negotiations (i.e. is this a stretch deal or blank check situation).

With most markets at an all time high, it is a good time to get your small business ready to take to market.  As we've seen before, an economic downturn usually has a magnified effect on small businesses.  What's most important is to find the appropriate partner to make sure that the enterprise will continue to have a lasting impact in the space it operates;  a successful business will find lots of suitors, so it's good to pick wisely.   By following a few simple steps and keeping your eyes wide open, you can actively participate in this white-hot seller market.