In Verne Harnish’s recent Fortune Magazine article “Selling the Business: Games Buyers Play”, he points out that the game of exiting your business is complex and you are usually dealing with sophisticated people who know how to play. In my experience, CEO’s and owners do not think enough about their exit strategy, and when a buyer appears, they are not ready to handle the game well. This article will point out the 4 deadly exit strategy sins, and what to do about them.
1. Not Planning Your Exit In Advance.
Business owners and executives get so focused on the care and feeding of the company that they forget to think about the ultimate goal of entrepreneurship: selling the business for enough money to live comfortably for the rest of their life. Regardless what your company sells to your customers, your key product is your company, and selling it someday needs to drive decisions in your business every year. The worst time to sell your business is when you are not doing well and selling is your only option. You will get pennies on the dollar. Keep your company bottom line strong and top line growing – this will position you for a top dollar exit when the time comes.
At least annually, the owners should gather to discuss the exit strategy. What do each of the owners want in compensation on exit, and what does the company need to do to be worth that much money? What is the minimum amount of compensation you need before consummating a deal? Decide as owners how far into the future you want to sell the business, and begin getting the company ready now for the exit process in that timeframe. If you are not ready to sell the business, don’t take too much time talking to potential buyers who knock on your door. No matter how intoxicating it feels to talk to a person or company who is interested in acquiring your business, if you are not ready to sell, it can become a giant distraction.
Also – start getting comfortable with the exit process. When I was in my late 20’s, a competitor made an offer to buy my business, and I remember going to the first meeting and being confused by terms like Merger & Acquisition (M&A). There are swarms of good resources on the M&A process. Get comfortable with the terminology and the process before you find yourself in your first meeting with a potential buyer.
2. Not Having Your Team Ready.
At least two years before you are ready to sell your business, you need to start getting your team in place. This is both an internal and external process, because your exit strategy team will need to consist of strong leaders inside your company who can run the company in your absence, and external professionals who have M&A experience that you most likely do not possess. At a minimum, you will need an experienced and strong M&A attorney to help with negotiations and paperwork that accompany every deal, and you will need to form a team of people who can march into a potential merger candidate’s offices and know what to look for in a due diligence process. This team might include a CPA and accounting people, operations experts, and sales & marketing experts. Have them ready when the time comes.
Inside the company, you will need strong leaders for two key reasons. First, your company’s value will go up if you are not a key ingredient in its success (yes, this runs counter to the beliefs of most business owners who like to be integral to their company’s success). Second, M&A activity is incredibly time consuming if not exhausting, and if you need to work 40-60 hours per week just to keep the company on the rails, you will not survive the long days and nights of negotiating the exit of your business.
3. Negotiating With Only One Buyer, Or With Only Financial Buyers.
The common scenario of small business exits is a company owner entertaining an offer from a buyer who appears out of the blue when the business owner isn’t ready. Verne’s article describes some of the games that buyers play effectively and some strategies to avoid them. At the heart of it, business owners put themselves at a huge disadvantage when they are only dealing with one buyer. There is no competition, and there is no “walk away” power if you don’t like the terms/conditions that are being offered. Have one or more companies bidding at the same time. How does this happen? Rarely by accident. You need to first position your company for sale (see points 1 & 2), and then intentionally invite several purchasers into discussions. If you have a great company that is growing and profitable, you will have many possible purchasers.
Keep in mind that there are two types of buyers – financial and strategic. A financial buyer will value your company as a cash generation machine, and will offer you some multiple of the cash that your company generates. A strategic buyer will see more value in your company than just the potential of cash generation because your company fits somehow into their strategy. Specifically, the sum of your combined companies is worth more to them than just the additional cash flow that your company generates.
4. Not Getting Cash As Compensation.
Of all the principals in this post, this is the most important to remember. When doing a merger or acquisition, the buyer will want to put out as little cash as possible, and will try to entice you into taking some combination of other compensation such as stock or notes. The best advice I got in the process of selling my business was to “only count the cash in the deal as real compensation”, and no matter what else was offered to ask, “if I only got that much in cash, would my exit strategy criteria be met?”
Let me share two quick stories on this topic that both happened to me that illustrate how this advice became incredibly valuable. We were approached when I was in my mid 30’s by a publicly traded company that was growing like crazy in our market. They offered us an all stock deal for well more than our company was worth at the time. It looked like a great opportunity, but there were restrictions on when we would be able to sell our stock even though the company was publicly traded. Based on this advice, we decided to turn down the deal, and before the timeframe would have been up, the publicly traded company was bankrupt and their stock price collapsed.
When we eventually sold our company to a competitor in our industry, we took a combination of cash and stock, but we were comfortable that the amount of cash was fair compensation for our company, and if the stock grew in value, it would just be icing on the cake. As it turns out in many mergers, the combination of the two companies did not go well, and the stock that was part of our deal became worthless over several years. We fared well, even though the stock in the deal became worthless.
If you work year-by-year on improving your business and getting the business (your most important product) ready for sale, you will position yourself for a successful and lucrative exit.