When is the Right Time to Sell a Business?
From time-to-time many owners find themselves thinking about selling their business and cashing out. Thoughts of selling can be stimulated by a variety of factors. Regardless of the reason, an owner needs to pause and ask if now is the right time to sell the business.
How does an owner determine if the time is right to sell? Is there a systematic approach? How important are instincts and gut-feelings? Should an owner wait until approached by a prospective buyer? What needs to be considered when determining if it’s the right time to sell?
In general terms, there are three conditions which indicate that the time is right to sell. The time is right to sell if the owner: (i) has a compelling or motivating reason to sell, (ii) is reasonably confident about the chances of meeting his or her objectives through the sale, and (iii) is psychologically prepared to relinquish ownership control.
A Compelling or Motivating Reason
Occasionally an owner has no choice, and must sell whether or not the timing is right. For example, divorce, the dissolution of a partnership, or the untimely death of a major shareholder can necessitate a forced or involuntary sale. In such cases the question is not whether to sell, but rather how to make the best of an unfortunate situation.
Assuming that an owner is not forced to sell, there are a variety of motivations to sell. Such motivations fall into three general categories: (i) personal reasons, (ii) investment reasons, and (iii) strategic business reasons.
(i) Personal motivations are essentially non-economic and non-business reasons for selling and can include major disagreements with co-owners, the lack of heirs, retirement of the owner or a key manager, the possibility of relocation, a desire to try something new, health problems, divorce, family problems, or the death of an owner. In some cases, the owner simply feels emotionally burdened by the business, a condition frequently referred to as “burn-out.”
When a privately held company borrows money, the lending institution will frequently require that the owners sign a personal guaranty. The personal guaranty places the owner’s non-business assets at risk. In order to eliminate the stress and uncertainty associated with a personal guaranty, some owners decide to sell.
(ii) Investment Factors include the owner’s need for liquidity, desire to minimize risk, and required yield or return on investment. These three factors apply whether the business is closely held or operated as a subsidiary or division of another company.
Liquidity: Unlike the stock of a publicly traded company, an ownership interest in a privately held company is not immediately convertible into cash. It is difficult for an owner to raise cash by borrowing money using stock as collateral. In addition, a leveraged recapitalization may raise tax concerns, negatively impact the company’s balance sheet and credit position, and, if a personal guaranty is required, increase the owner’s degree of risk. The sale of the business, whether effectuated through the sale of assets or stock, can provide the owner with needed liquidity.
Risk: The biggest risks that an owner of a privately held company faces are bankruptcy, exposures under personal loan guaranty, and the inability to quickly convert the asset into cash. For many owners, their business represents their largest and most significant asset. At first an owner may be very tolerant toward risk; however, in time the owner may grow uncomfortable with the risks of ownership.
To reduce their level of risk, an owner might elect to sell the business and then invest the proceeds into a more diversified portfolio or another investment perceived to have less risk.
Yield: To the owner, yield represents the expected return on the investment. Yield or return can take many forms including dividends, interest payments to owners, above-market salaries, and appreciation of the company’s value. The rate of return is usually expressed as a percentage of the owner’s actual investment in the company.
In some cases the yield on the investment may fall below the owner’s minimum requirement. As a result, the owner may choose to sell their company in order to achieve a higher yield in another investment opportunity.
(iii) Strategic business factors include raising expansion capital, gaining access to technologies or distribution channels, and securing needed management expertise. As traditional banks become increasingly stringent in their lending practices, owners may contemplate selling all or a significant part of their companies in order to raise additional expansion capital.
Each company has a life-cycle through which it passes. Under one model, there are five discreet stages through which a company may pass: (a) initial development, (b) introduction/early growth, (c) growth/accelerated development, (d) maturity, and (e) decline. As a given company matures and passes through the initial development and early growth stages, various problems and challenges can arise which can sometimes be addressed through the sale or merger of the company.
(a) Initial Development Stage: The force behind a “start-up” company is usually an entrepreneur with a vision. The company’s focus is on getting the product or service designed, tested, and ready for market. The venture is very dependent upon the entrepreneur. Companies at this stage are regarded as unknown quantities, can be very difficult to value, and are seldom sold as going concerns.
(b) Introduction/Early Growth Stage: Once a company has progressed beyond the initial development stage, it can be characterized as: (i) experiencing an increase in sales, (ii) operating at break-even or slightly better, (iii) working capital consists of trade credit and the founder’s initial investments, (iv) having a “home grown” management team, and (v) still concentrating on entering the market and securing distribution.
As with companies in the initial development stage, early growth companies are not prime candidates for acquisition, although it is possible for strategic alliances to form in the early stages of development.
(c) Growth/Accelerated Development Stage: A rapidly growing company is primarily concerned with developing its market and may experience any one or more of the following conditions: (i) dramatic increases in sales, (ii) high operating margins, (iii) working capital and credit lines that are being exhausted by the cash required to fuel the growth, (iv) the company is expanding beyond the capabilities of existing management, (v) the possibility of increased competition, and/or (vi) having difficulty entering certain segments of the market.
The right buyer can provide a company in the accelerated growth stage with the resources needed to sustain growth. The buyer can provide much needed working capital, management expertise, competitive strength, and expansion into new markets.
Companies in the accelerated development stage make attractive acquisition candidates. At this point in the company’s development, sales and earnings are still on the upward side of their curve, a situation which supports a higher valuation.
(d) Maturity Stage: A mature company is primarily concerned with maintaining its share of the market and may experience: (i) a leveling off of sales, (ii) some erosion of operating margins, (iii) excessive leverage, (iv) under-valued or nonperforming assets, (v) a sense of systemic managerial complacency, and/or (vi) more extensive competition.
The right buyer can provide a mature company with the spark it needs in order to return to growth. The buyer may be able to provide more effective channels of distribution, improved operating margins through combined operations (economy of scale), expansion capital or credit enhancement, opportunities to increase facility utilization, a fresh managerial perspective, and a strengthened competitive position.
Companies in the maturity stage also make attractive acquisitions even though they may lack the appeal of a growth company. The company has established itself in the market, has a record of earnings, and provides a foundation on which to build with the assistance of the right buyer.
(e) Declining Stage: A declining company is primarily concerned with maintaining its customer base and may experience: (i) a decline in sales, (ii) marginal or break-even operating profits, (iii) difficulty servicing debt, (iv) a pressing need for capital to fuel a turnaround, (v) difficulty retaining talented personnel, and (vi) intensive competition.
The right buyer can provide a declining company with the time and resources needed in order to effect a turnaround. The declining company will likely need an infusion of capital and managerial talent. In addition, the right buyer can help provide a sense of direction and stimulate renewed commitment on the part of key personnel to help them face the immediate challenges, identify and address the cause(s) for decline, and defend the company’s share of the market.
Companies in the declining stage can be attractive to turnaround specialists with a special set of skills and sufficient resources to effect the turnaround. This tends to narrow the field of buyers.
Regardless of whether an owner decides to sell for personal, investment, or strategic reasons, it is important that the owner be motivated. The sale of a business is not something to be approached halfheartedly. If an owner is not sure that he wants to sell or that his objectives are capable of being fulfilled, then he should think twice about putting the company on the market.
Confidence in Meeting the Owner’s Objectives
Whatever the owner’s motivations, he or she should be reasonably confident that their objectives are achievable. How likely is it that the sale can be consummated? How reasonable are the owner’s objectives?
The probability of successfully completing the sale of a given company increases when: (i) the company is properly marketed, (ii) at a realistic price, (iii) under favorable external and internal conditions.
(i) Proper Marketing: A properly orchestrated marketing plan for a given business will protect sensitive information and keep the identity of the company confidential. A sound marketing plan also: (a) identifies and targets the ideal buyer, (b) effectively and credibly communicates the advantages of ownership to prospective buyers, (c) identifies and manages potential risks, and (d) minimizes barriers and obstacles to agreement.
(ii) Realistic Price: If the owner’s minimum acceptable price is considerably higher than what the market is likely to pay, the owner’s chances of success are decreased accordingly. Conversely, if business is priced below market, the chances of a sale are dramatically increased, but at the owner’s expense! The company’s market value should be estimated before deciding to sell. If the estimate of value meets the owner’s objectives, it’s prudent to proceed. If the estimate is below the owner’s objectives, he may want to defer the sale or reconsider his objectives.
(iii) Favorable Conditions: Conditions which affect the likelihood of the owners achieving their objectives can be found (a) within the business and (b) within the environment in which the business competes. Obviously, favorable internal and external conditions increase the probability of success.
(a) Internal Influences: Factors within the business which affect the probability of success include (1) the overall sales and earnings performance of the company, (2) the quality and stability of management and personnel, (3) technology and proprietary property, and (4) the quality and adequacy of the facility.
(b) External Influences: External factors which affect the probability of success include (1) the general performance of the national and local economy, (2) the market outlook for the company’s products or services, (3) the performance of the company in relationship to the performance of the market, (4) the company’s competitive position within that market, and (5) the legislative and regulatory environment.
Psychologically Prepared to Sell
After an owner has determined that there is a compelling reason to sell and is reasonably confident that their objectives can be realized, the owner needs to take some time and make certain that he or she is emotionally ready. For the most, part the issue of emotional readiness to sell is a concern for individual owners. When the ownership group consists of a holding company, venture capital group, or a larger operating company, the process of “letting go” is generally oriented toward business issues.
While the seller’s motivations may act to carry the deal forward, at some point in the process, the owner is going need to face the emotional reality of severing his or her ownership-bond with the business.
The emotional bonds of ownership can be strong. The ownership-bond encompasses issues of (i) identity, (ii) lifestyle, (iii) family relationships, and (iv) financial security. The best time to come to terms with these issues is before engaging in active discussions with buyers. Otherwise, an owner may find that instead of focusing his full attention on the substantive aspects of the negotiations, his attention is diverted to emotional issues—a situation could obscure the owner’s view of the process and lead to errors of judgment.
(i) Identity Issues: In our culture, what we are is often defined by what we do. If we own a business, it is natural to think of ourselves as “owners” and entrepreneurs. Being an owner can become part of how we define ourselves, part of our self-image.
Ownership pays certain emotional dividends. It can provide a general sense of self-esteem, pride, and feeling of control. It can bring recognition by the community. For some owners, their business and social lives are interwoven, making letting go all the more difficult.
An owner needs to ask himself if he is prepared to let go of the business and open a new chapter of his life. Take an inventory of the emotional benefits of ownership. What is more important, the emotional benefits of ownership or the anticipated benefits of selling?
(ii) Lifestyle Issues: An owner enjoys a sense of independence and self-reliance. He’s his own boss. Ownership can provide a sense of focus, direction, and productive purpose to one’s life.
After the sale, the owner may find that they are suddenly retired or working part-time on a consultant basis. If the seller remains with the company as an employee, he will have to adjust to being an employee and the time demands placed upon him by the new owner.
The owner should consider the likely impact of selling on his or her lifestyle. If the owner plans on remaining active in the company after the sale, is he prepared to account for his actions and report to the new owner or his representative? If the owner exits from the business, how will he spend his time?
(iii) Family Issues: A successful business can provide many benefits to the family. The business can provide opportunities for family members and help keep the family together.
If the owner sells the business, the family will be impacted. Opportunity or higher-paying jobs may be lost. The bond of the “family business” will be broken. Some members may be disappointed that the business will not remain in the family, especially if they had expectations of one day buying or inheriting the business.
An owner should consider the impact of selling on the family. How will those family members who relied on the business for a living be effected? What will replace “the business” in the family system?
It is important that the family be given an opportunity to discuss the sale as a family and work through the individual issues involved in order to minimize unnecessary and potentially damaging conflicts.
(iv) Financial Security Issues: A successful business can provide an owner with a generous income frequently structured to minimize tax. In addition, the value of the business remained within the owner’s estate.
If the sales price is paid as a lump sum amount, the owner will need to adjust their financial plan. The steady income previously derived from the business through salaries, dividends, and perks will no longer be available. While a revision of the owner’s financial plan can address these matters, the selling owner needs to recognize that future income may be derived from investments rather than the company. The time to begin developing a new financial plan is prior to the sale.
An owner should consider the possible effect of selling on family finances. How does he plan to use the proceeds from the sale? How will the money be invested? Will earnings on the invested proceeds be the owner’s primary source of income? If so, will that require a change in spending patterns?
By and large, owners and entrepreneurs are resourceful and resilient people. Facing the emotional realities of selling should pose no great challenge. Selling is going to change the owner’s life. Before starting the process, the owner should ask himself if he’s ready for the change and what will his new life look like? If he is comfortable with the anticipated change and has a clear vision of “life after sale,” then he is probably emotionally ready to let go of the company and move on to the next chapter of his life.
When you are thinking about selling, you need to pause and take an inventory of the situation. Do you have a compelling reason or motivation to sell? Do circumstances within the company and the general business climate favor selling at this time? Are you emotionally prepared to sell? Although the above outline is not all-inclusive, you can use it to help you arrive at a decision. If the answers are yes, then perhaps it’s a good time to sell. If the answer is no, then turn your attention to building your business and increasing its value so that when the day comes that it is right to sell, you’ll get the best price and most favorable deal.
© 1992 – 2010 Robert B. Machiz. All rights reserved worldwide.