This week’s entrepreneur blog is from our guest blogger Cliff Oxford, CEO of the Oxford Center for Entrepreneurs and entrepreneur blogger for the New York Times. Cliff takes a look at the dangers of the amateur exit.
Successful entrepreneurs take an idea to fruition and build a thriving business. They make decisions, build teams and execute strategies to realize their dreams. And then they often drop the ball at the one yard line by falling into the trap I call the “Amateur Exit.”
The Amateur Exit involves a fairly quick negotiation – maybe a few months – between the business founder and the one buyer, who is often a family member. Sometimes the founder is ready to move on from the business and accepts a price that he or she “can live with.” By taking a more professional approach to this step in the business life cycle the entrepreneur can earn the financial rewards he or she has rightfully earned.
So how do you accomplish a “professional exit?” The process has clearly defined stages:
• Determining the business value by working with independent 3rd party experts
• Enhancing the business value prior to sale
• Developing buyer prospects
• Evaluation/negotiation with multiple potential buyers
• Negotiating a deal with the support of expert representatives
• Closing the deal, which can take several months
This process may not sound revolutionary – frankly it isn’t – but somehow when selling their business many entrepreneurs give in to the temptation of a quick solution and don’t work through these stages.
What are the hallmarks of an amateur exit? Let’s look at some of the most common mistakes.
Top Three Mistakes Sellers Make
ONE. Not determining the value of the business. There is no universally accepted way to define the value of a business, so you should come to the negotiation prepared to defend your idea of the value. Determining the value of a business is a very complex exercise that involves the overall industry, economic trends and every aspect of operations. This analysis is best done by working with an independent, third party with substantial experience. The valuation may make the entrepreneur look at the business in a different light. You need to not overvalue based on your emotional ties to the business, but also not undervalue by taking an offer without doing your own due diligence.
Often you hear of multiples or ratios of price to earnings, price to book value or price to EBITDA. This gives you some guidance regarding comparables but there may not be any legitimate comparables. If the comparables are too old, didn’t share some of the key strengths of your company or weren’t opening new markets in the way your company is, you need to make those points in your negotiation. I can’t say it often enough, getting the help of experts who have done this before will vastly improve your position in the upcoming negotiations.
TWO. Not doing homework regarding financials. Buyers will look ask for three years of financial statements. The sale of the business requires you to look at financials somewhat differently than you did as the business operator. Financials used in the sale negotiation should look at the business as it would be sold. This means separating out items such as non-recurring bad debt, discontinued product lines, owner-related expenses and other non-recurring expenses or income.
This is another situation in which having an independent party oversee the financial statements is the professional way to approach this critical step. Someone who has done this repeatedly and is not emotionally invested will see opportunities that may otherwise be missed. Your goal is to produce an Offering Memorandum, which includes financials, forecasts, market research, etc. The Offering Memoradum will be your initial sales document that will be sent to prospective buyers and the more work you put into it the stronger your position will be at the start of negotiations.
Failing to consider options for prospective buyers. There are two types of buyers: those who will pay a premium price and those who will be highly price sensitive. Premium buyers include “strategics” – companies who are rounding out their company somehow through the purchase. They may want to enter a new market or buy your technology or grab market share, but the purchase has more strategic value for them than simply the value of your business. Also in this category are investor groups, who are experienced in looking at business transactions and are willing to pay a fair price for a business with potential to build greater value.
Non-premium buyers are a completely different ballgame. These include family members, non-qualified investors, competitors and the employee/management team. Many of these buyers do not have the money to pay the fair value of the business and the entrepreneur is virtually guaranteed to minimize his/her profit on transaction. Intergenerational transfers can also be a rough road for the founder, who often takes a big price cut and then winds up continuing to run the business. There are other ways to take care of your family financially and an astute wealth planner can help you navigate that road in a way that ultimately maximizes the financial benefits to the family.
Non-qualified investors are individuals will less than $1 million in assets and less than $2 million in net worth. They will gobble up the entrepreneur’s time and then often cannot write a check when the time comes. Ask to see personal financial statements, speak with their banker, etc. A serious and qualified buyer will understand you are doing your due diligence. Imagine the horror of realizing you’ve put running the business on the back burner for months while working with someone who was never qualified to buy the business in the first place.
AND MANY MORE. These are just three of the pitfalls entrepreneurs need to consider. There are many other factors involved in positioning your company for sale, such as the timing of the transaction, and the deal structure. Deal structure is an extremely complex negotiation that needs to consider earn outs, non-competes, licenses, retained equity, tax implications, etc. etc.
The sale of your business should be a highly rewarding experience as you move on to the next stage in your life. Don’t drop the ball at the end of the game, do the work and make sure you have a professional exit.