13 Sep When Should I Sell My Business?
After many years of working in the industry one of the most common questions that business owners often ask themselves is “When is a good time to sell my business?”. Some people on a personal level come to the conclusion that:
- When your hearts not in it anymore
- When you figure it takes new people or more money to stay competitive
- When you’re ready to retire
- Or numerous other reasons
All of the answers above are completely justified, however, it’s important to make sure you have an investment banker that knows how to time an exit from a business so you can maximize the value of your transaction. The last recession ended June 2009 officially and since then we’ve been dealing with business owners that have two or three years of growing earnings in the double digits. A lot of the owners we deal with are baby boomers considering an exit plan with a belief that they can earn one more year of solid growth. On the other hand, these owners don’t want to encounter the hurdles of another downturn so what we really need to ask ourselves is:
“Should I sell my business today or take the bet on another year of growth?”
The answer to this is that a buyer’s expectations increase the value of the transaction and one slow year can cause expectations to drop very fast. All buyers are investing in what they see to be future and historical earnings and growth rates are fundamental in setting expectations for these buyers. DCF (Discount Cash Flow) valuation models are the most common formula used to analyze future value. The example below shows why it’s important to sell with high expectations.
COMPANY FOR SALE – John’s Construction
1.) All earnings and revenues show an annual growth of 10%
2.) Buyers can finance 30% of the purchasing price based on the balance sheet and cash flow. The average weighted cost of capital is roughly 16.8%
3.) Fiscal year completed with $1,000,000 of operating income
1st Scenario – Sell it now
- The Buyer’s DCF model determines there will be a 10% growth annually for the next 5 years. After which 5% in perpetuity
- $6.2 million is the discounted cash flow valuation
2nd Scenario – Grow it for 1 year then sell
- A sluggish economy increases income by only 5% to $1,050,000
- The DCF model for the Buyer not decides an annual growth rate of 5% for the next 5 years and then a 3% perpetuity
- $4.9 million is now the discounted cash flow valuation
It’s always better to sell with a stronger growth outlook (Scenario 1) than to sell at a later time with greater profit but a lower growth outlook (Scenario 2), in most cases increases your transactional value to a Buyer. In our example above, the Seller could’ve gotten a $1.3 million higher valuation if they sold now with $1 million in profits and a 10% growth rate (Scenario 1) instead of selling one year later with higher profits of $1.05m but a lower growth rate of 5% (Scenario 2).
Both examples require Buyers that have certain expectations based on past experiences, but the higher the earnings doesn’t necessarily give you absolute certainty of sustainable growth in the long term.
When a Buyer values a company there are certain factors to remember. It’s often a major considering to consider Return on investment which is in the DCF analysis that discounts future earnings. With that being said, we answer your question of “when should I sell” with the following:
Sell only when you have strong growth rates. Don’t underestimate risks associated with adding more profits to your bottom line. If you know for sure that you’ll have strong growth for a few more years then negotiate an earn-out or retain equity so you are still present during the upsides, after you put money in your account and have managed the risk of a slowdown.
One more thing we like to remind all of our clients of is to plan one to three years from when you want to sell until the time you’re ready to sit on a beach. This also includes 6 to 12 months to fully complete the transaction and one to three years for your typical employment transition and/or earn-out.
Please note: There are a lot of reasons considered when an investment banker or a buyer gives a value of a company. DCF (Discount Cash Flow) model’s are commonly used and requires more variables that can be factored into the illustrations above. Buyers that seek to meet strategic goals through acquisition will often offer valuations that are above what is justified in DCF (Discount Cash Flow) modeling. The market is the only true force in determining what the market is really worth.
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