There are a number of methods to receive the value from the sale of your business. Cash sales, cash plus seller financing and earn-outs are some of the most common.
The opportunity to sell a business is frequently unexpected. Because it is a difficult event to predict, planning your exit strategy in advance is an important consideration. Begin by knowing the value of your business and knowing how you plan to cash-out of your investment some day. Taking these steps is the surest way to negotiate from a position of strength and receive the highest price in the shortest time.
Most entrepreneurs start businesses to earn a profit and create value. Financial statements measure the former, but not the latter. They don''t include an estimate of your business'' market value - the cornerstone of your exit strategy. Take the initiative yourself and learn to develop a good sense of your business'' value. Then update this indicator of performance no less than annually. This will prepare you to answer the fundamental question, "How much would you take?" when an opportunity to sell arrives.
A Valuation Primer
Businesses are valued for many different reasons including liquidation, book, estate, insurance, exchange, and sale. It is important to select the method of valuation that is linked to the intended purpose, in this case...a sale of the business.
We often recommend using a value derived from several approaches to valuation. The Capitalization, Excess Earnings and Leveraged Cash Flow Methods are three common approaches to valuation. These methods are simple and can help you quickly establish a sense of what your business is worth. Other methods, such as comparable sales, can be added to diversify and enrich the quality of the valuation. Each approach will produce a range of value. For each approach you can select one value from the range, possibly the Mean or Median. Combining the results from each approach with the proper weighting, results in a good approximation of a business'' value.
After a value has been established you must next focus on how you will take your money out of the business. The following are some common exit strategies.
A Cash Sale
A buyer with cash has the best chance of neutralizing a seller''s argument for a higher price because an upfront cash payment provides the most certainty. Consequently, a cash price is usually less than most other types of sales, but it offers sellers the liquidity to pay off any business debt and taxes due upon the sale of a business. In addition to the seller receiving his or her money at closing, he or she is usually relieved of virtually all continuing responsibility to the previous business. For many owners of a small business this benefit is very desirable. From the buyer''s perspective, a cash sale may come at the expense of financial leverage.
When a seller chooses to finance a portion of the purchase price he or she offers an attractive benefit to a buyer. Compared to commercial lenders, sellers normally offer more lenient terms so financing costs are reduced. Therefore, the business'' earnings can service and pay off a larger debt. In addition, seller financing is easier to secure. Accordingly, buyers will often pay more for a business when seller financing is available. The buyer employs financial leverage and the seller gets "mostly" cash.
However, a seller does not need to provide all the financing. Many commercial lenders will finance a business acquisition provided the seller is also providing financing. Generally, the seller''s lien is in a subordinate position. When this occurs, the inexpensive financing portion still allows the business to command a premium price versus the cash price.
An earn-out is akin to a seller financed exit strategy. The transaction structure incorporates a down payment, as well as ongoing payments. The ongoing payments are similar to seller financing, but instead of receiving payments on a business loan the seller receives payments based on continuing business earnings. It can be tied to some standard indicator of performance such as revenue, gross profit, units sold, profit margins, or a combination of these. Typically a seller might receive this benefit for one or more years provided it does not exceed a set amount.
With earn-outs, a seller often accepts continued operating responsibilities to ensure business results are undisturbed after it is sold. An important caveat to sellers considering this option is that if business results decline, earn-out income may also decline. Likewise, they will generally be appropriately rewarded if results improve.
Sometimes entrepreneurs own both the business and the real estate it occupies. Many buyers are not able to buy both. Other buyers are not willing to buy both. Because the business itself is the core earnings driver it can make sense to sell it separately from the real estate. In this way, a buyer''s equity is used only to acquire the business.€
A property split can be a valuable exit strategy because the business typically produces greater returns than the corresponding real estate. When sold together the real estate can bring down the business'' overall financial results, thereby reducing the business'' value. This effect can be diminished when the business is separated from its real estate. When judged on its own merits, the business'' higher return can provide a higher value for the business when sold separately. To execute this strategy, the seller retains ownership of the real estate and leases it to the buyer. The real estate can then be held for the long term as an income producing investment or sold to another person.
Combine Value and Strategy To Produce Results
It should be obvious that building an effective exit strategy takes planning and execution long before a sale occurs. In addition to the issues discussed above, other important issues to consider include evaluating the tax consequences of a business sale and attempting to institutionalize your business'' base of intellectual capital so the buyer knows that the business'' goodwill will not leave with you. Successfully taking the steps discussed in this article will enhance your opportunity to receive the second benefit of entrepreneurship when your business is ultimately sold?alue creation.
Copyright © 2000 by Chad Simmons
|Chad Simmons is an author and consultant to small businesses. He writes The Entrepreneurial Attitude, a monthly news column. He also hosts The Biz Stream, an Internet Broadcast of interviews with entrepreneurs. His books include the Business Valuation Bluebook, How Entrepreneurs Buy, Sell and Trade and The Anonymous Entrepreneur.|