What does your business need to sell at a high exit price?
If you’ve read anything I’ve written or heard me speak, you know I don’t agree 100% with Dave Ramsey because savvy investors use leverage to build wealth. Without leverage, what could take 5 years can take 25 years.
Yesterday, a business partner and I were on a Zoom call with a seller. The company was a unique online Shopify store, and the sellers were seeking $300K cash for the business. It wasn’t a bad deal at $300K; the company showed just over $210K in SDE (seller’s discretionary earnings). But the seller asked why don’t we write a check for $300K?
I explained that although the returns seem favorable, for the most part, we use leverage to acquire companies in which we invest. There are many reasons, which I’ll dive deeper into in the article. Still, I explained that if we cut a check for $300K, would we rather invest in a business with $210K in SDE or use leverage to buy a company for $3 million with $1 million in SDE? Even if the payment is $500K annually, the latter would produce $500K in profit. That’s a 138% higher return per year.
Why on earth would we pay cash when leverage pays so much better?
The challenge in selling any business is making sure the buyer has the ability to finance most, if not all, of the transaction. Otherwise, you’re going to be the bank, or chances are, you’re not going to sell.
If you want to sell and want all cash, you’ll need to have your ducks in a row from a lender’s viewpoint so that a buyer can get the financing required to pay your asking price.
The beauty is that when you get this right, you’ll never have to worry about attracting buyers when it’s time to move on.
Let’s examine what you can do to ensure you’ll have all the buyers you need to achieve your exit price.
Increase Sales By Acquiring More Customers
The key word in that sentence is acquire. I didn’t say get more customers because if you are the salesperson, that’s not a benefit to the buyer because it’s a proven statistic, the person running their business now is almost always a better salesperson than a new buyer.
Acquiring customers means getting them to come to you by advertising.
Advertising does not necessarily mean spending money on ads, but it does mean getting your message in front of the public to entice them to buy from you. The highest probability of failure for a new buyer comes when the selling business owner is the company’s best salesperson. It’s nearly impossible to top the confidence, product knowledge, and trust in the company’s systems like a founder. Knowing this, if you are your company’s top sales rep, you’re not replaceable, BUT a great sales and marketing system can fill the gap enough to satisfy a lender that your company can live on without you.
Even though you may be the best closer your company has ever seen, a well-designed marketing system can attract more than enough leads so that salespeople with lesser skills can close enough deals to replace you.
Show a Profit
It’s a fact that many small businesses don’t look great on paper.
One of the benefits of owning a small business is the tax deductions, so naturally, it’s not out of the ordinary for owners to show little or no profit on their tax returns.
These “lifestyle” businesses tend to pay the owner a sizeable salary, which allows the seller to pay income tax through payroll and not have to write a big check at the end of the year. The S Corporation election helps to create this scenario because profit (or loss) is transferred to the shareholder’s personal tax return through a Schedule K.
By paying a large salary and paying taxes through payroll, the owner takes the stress out of filing their taxes, something that’s typically learned over time.
It’s hard to understand the pain until you’ve had to sweat writing a large check to Uncle Sam with money you don’t have.
However, when you’re getting ready to sell your business, the new owners want assurance that the business can pay someone to take your place, have enough profit to pay all the bills, make a payment on the note to acquire the company, and keep enough to make owning the business worthwhile.
When acquirers look at companies, we’re looking for companies with at least a net 10-15% profit margin.
Show more profit, and you’ll attract buyers.
Even small price increases can elevate profits to make the business look much better on paper. If you pay some of that in taxes, that’s okay because taxes are added back to the final valuation number. If you paid $50K in tax, and companies in your industry are selling for 3x multiple, the $50K will add $150K to your valuation at exit. If your gross sales are between $2 and $5 million, I can show you how to increase your exit price by $1 million with minimal changes to sales and operations.
Dilute Large Customer Concentrations
Customer concentration is a significant challenge for lenders. If you have any single customer that makes up 15% or more of your business, you’re making it extremely challenging for a buyer to get financing.
Contrary to popular belief, word of mouth is not a marketing method.
Why? Because the buyer may not have the relationship you’ve built with your customers over many years. There are almost always changes when a new owner steps in. If the customer doesn’t like the changes and takes their business elsewhere, the company may not survive.
We recently took a pass on acquiring a fairly profitable defense contractor. Naturally, as a defense contractor, the business is highly dependent on government contracts to supply them with most, if not all, of their company sales volume.
The valuation was not the problem; this company had real estate and other assets that usually made financing much easier.
During due diligence, we found that 84% of their annual sales came from two governments, the US and Israel. Although both countries are doing well financially, losing one contract would mean failure for most buyers.
It’s a lot of work to obtain financing to buy a business. It can take 4-10 months to get any deal to the finish line when bank financing is involved and it is especially long if SBA backs the loan. Unlike most real estate transactions, lenders charge fees in advance to cover some of their underwriting costs. On top of legal and accounting expenses, a buyer can expect to cut a $25-$50K check before the deal is fully approved.
We understand the challenges and the costs associated with financing, so if we like a company but know a lender is not going to finance it for the asking price, we walk away unless the seller is willing to carry some of the risks and offer favorable financing.
So, what should you do to dilute your customer concentration?
Ideally, you invest in systems that bring in a lot more customers and spread the risk. Work to get large customer concentrations down to under 15% for the largest customers. If you do this a year or two before selling your company, any lender will see that your company can pivot and attract new clients, and doing so shows your buyer that the business has growth potential.
But the sad truth is that most business owners won’t take the time or invest the money necessary to pivot from their high customer concentrations. If that sounds like you, I get it. Consider bringing in an outsider to assist. It can be the difference between a sale that barely closes and a seller that walks away with millions more.
Eliminate High Vendor Concentration (Whenever Possible)
Another deal killer, although not as high as the previous three, is high vendor concentration. However, high vendor concentration can, at times, be impossible to eliminate.
If you’re not the manufacturer, having multiple sources for your products is best. One would think single-source vendors are a good thing, especially if the arrangement is exclusive. But high vendor concentration can be just as risky as high customer concentration. If you depend on a few vendors, they can force you into a corner because a new buyer won’t have a long-term relationship with the vendor like you have.
In the late 1990s, I was a distributor of a line of unique power quality products, and I had an exclusive territory in Florida. I built a statewide sales force, and in 2 years, we were the largest distributor for this manufacturer.
But instead of the vendor showing all the love for the high volume we’re doing, they continued to raise our prices annually. In December of 2000, they raised our cost by 50%. They notified me of this price increase two days before Christmas. Either I signed a new contract without outlandish monthly minimums, or the prices were going up by 50%.
They had us over a barrel, and my choices were extremely limited because they only had one other competitor.
In all transparency, this was one of the most stressful times I’ve had in business. I signed the agreement, but we ended up in a 6-million-dollar lawsuit one year later.
$120K in attorney’s fees later, we successfully defended the suit, and my company survived, but companies fail every year from similar actions from manufacturers and distributors.
So, if you have a high vendor concentration and have a good relationship with the vendor, you’ll likely need to get your buyer a long-term contract with the vendor, or else it’s going to be tough to get bank underwriters to agree to loan your buyer money to acquire your company.
Naturally, there are exceptions, but understand that if a lender is going to be a part of your sale, you’ll need to have a clear answer to satisfy the underwriter, or your buyer will not get the loan at your anticipated exit price.
Decrease Owner Involvement – The 6-Week Vacation Test
If you plan to sell in the next 1 to 3 years, and you are active in your business 30 hours per week or more, your buyer will have a tough time getting a lender to believe that the company can survive without you.One question I ask sellers in early conversations is, would your sales increase or decrease in your absence if you go on vacation for 6 weeks without a cell phone? How long would it take your business to recover from such a trip?
Many owners who’ve been around a while can get to 3 or 4 weeks of vacation, but 6? When you can vacation for six weeks, and your company does great without you, you own the company; you no longer work there. If you can vacation for six weeks or longer, and the company makes lots of profit while you’re gone, you eliminate 99% of lender challenges. Banks make money when they lend.
When your company is profitable, whether you’re there or not, lenders and investors will open their checkbooks for qualified buyers and pay extreme multiples of profit.
Why?
Because the business success has less to do with the buyer and more with how well the business is built. A well-built business can make you wealthy when you sell it, but you won’t have to sell because your company can make money without you.
A business worth selling is a business worth keeping.
If you’re ready to exit in a year or two, we’d love to make you a fair offer. You (and your company) may not be ready for a sale, but I’ll show you the current market value based on the financability of your company. And if the current market value isn’t enough for you to exit on your terms, we’ll show you what to improve to get the price you need to live happily ever after.
Book a confidential call today.
A comfortable retirement may be closer than you think.
About the Author: David Mulvaney moved to Florida from Wisconsin in 1987. In 1992, he acquired a home services company with 98% seller financing. By 1994, Dave converted the company to 75% commercial services and sold the company in 1998 for over 10 times the original acquisition cost. Since then, Dave has owned or owns controlling interest in profitable companies in the following sectors: manufacturing, engineering, global distribution, home services, commercial services, e-commerce, SAAS, residential, and commercial real estate. His companies have grossed over 250 million in top-line revenue over the past 33 years.
Dave buys and builds great companies and advises entrepreneurs on how to exit profitably on their terms. To Book A Call, Go Here.