Most business owners think selling their business is a sprint, but the reality is it takes a long time to sell a company.
The sound of the gun sends blood flowing as you leap forward out of the blocks. Within five seconds you’re at top speed and within a dozen your eye is searching for the next hand. Then you feel the baton become weightless in your grasp and your brain tells you the pain is over. You start an easy jog and you smile, knowing that you did your best and that now the heavy lifting is on someone else’s shoulders.
That’s probably how most people think of starting and selling a business: as something akin to a 4 x 100-meter relay race. You start from scratch, build something valuable,measuring time in months instead of years, and sprint into the waiting arms of Google (or Apple or Facebook)as theyobligingly acquire your business for millions. They hand over the check and you ride off into the sunset. After all, that’s how it worked for the guys who started Nest and WhatsApp– right?
But unfortunately, the process of selling your business looks more like an exhausting 100-mile ultra-marathon than a 100-meter sprint. It takes years and a lot of planning to make a clean break from your company – which means it pays to start planning sooner rather than later.
Here’s how to backdate your exit:
The first step is to figure out when you want to be completely out of your business. This is the day you walk out of the building and never come back. Maybe you have a dream to sail around the world with your kids while they’re young. Perhaps you want to start an orphanage in Bolivia or a vineyard in Tuscany.
Whatever your goal, the first step is writing down when you want out and jotting some notes as to why that date is important to you, what you will do after you sell, with whom, and why.
When you sell your business, chances are good that you will get paid in two or more stages. You’ll get the first check when the deal closes and the second at some point in the future — if you hit certain goals set by the buyer. The length of your so-called earn out will depend on the kind of business you’re in.
The average earn out these days is three years. If you’re in a professional services business, your earn out could be as long as five years. If you’re in a manufacturing or technology business, you might get away with a one-year transition period.
Estimate: + 1-5 years
The next step is to figure out how long it will take you to negotiate the sale of your company. This process involves hiring an intermediary (a mergers and acquisitions professional, investment banker or business broker), putting together a marketing package for your business, shopping it to potential acquirers, hosting management meetings, negotiating letters of intent, and then going through a 60 to 90-day due diligence period. From the day you hire an intermediary to the day the wire transfer hits your account, the entire process usually takes six to 12 months. To be safe, budget one year.
Estimate: + 1 year
Next you need to budget some time to operate your business without making any major strategic changes. An acquirer is going to want to see how your business has been performing under its current strategy so they can accurately predict how it will perform under their ownership. Ideally, you can give them three years of operating results during which you didn’t make any major changes to your business model.
If you have been running your business over the last three years without making any strategic shifts, you won’t need to budget any time here. On the other hand, if you plan on making some major strategic changes to prepare your business for sale, add three years from the time you make the changes.
Estimate: + 3 years
The final step is to figure out when you need to start the process. Let’s say you want to be in Tuscany by age 50. You budget for a three-year earn out, which means you need to close the deal by age 47. Subtract one year from that date to account for the length of time it takes to negotiate a deal, so now you need to hire your intermediary by age 46. Then let’s say you’re still tweaking your business model – experimenting with different target markets, channels and models. In this case, you need to lock in on one strategy by age 43 so that an acquirer can look at three years of operating results.
It certainly would be nice to make a clean, crisp break from your business after an all-out sprint, but for the vast majority of businesses, the process of selling a company is a squishy, multi-year slog. So the sooner you start, the better.
This month’s article looks at the recent announcement that Facebook has acquired messaging service WhatsApp and uses it as a platform to discuss the topic of strategic acquisition. The article also shares five ways your clients can position their company to be bought by a strategic.
Did you see the news that Facebook has recently acquired Internet messaging service WhatsApp for $19 billion? It represents the largest-ever acquisition of an Internet company in history.
WhatsApp is a pearl for sure. The messaging service allows users to avoid text-messaging charges by moving texts across the Internet instead of the mobile phone carrier networks. This can save people who travel, or who live in emerging markets, hundreds of dollars a year, which is why WhatsApp is adding one million new users per day.
At the time of the acquisition in February 2014, WhatsApp had acquired some 450 million users. Their business model is to charge a subscription of $1 per year after their first full year of service. Even if all 450 million WhatsApp users were already paying, that is still less than half a billion in revenue. Why would Facebook acquire WhatsApp for a number that is somewhere north of 40 times revenue?
Nobody know for sure what is in Mark Zuckerberg’s head, but we can only assume that at least part of the opportunity Facebook sees is the opportunity to sell more Facebook ads because of the information they glean from WhatsApp users. Global advertising giant Publicis estimates 2013 online advertising spending in the US alone to be around $500 billion. Presumably Facebook believes they can get a larger chunk of the global online ad buy because they know more about its users by owning WhatsApp.
And therein lies the definition of a strategic acquisition. Most acquisitions run a predictable pattern of industry norms, but a strategic can pay a significant premium for your business because they are looking at your business for what it is worth in their hands. Rather than forecasting out your future profits and estimating what that cash is worth in today’s dollars, a strategic is calculating the economic benefit of grafting your business onto theirs.
There can be many strategic reasons why a big company might want to buy yours. Here are a few to consider:
In 2011, Starbucks announced it had acquired Evolution Fresh, one of their providers of juice drinks, for $30 million. Now Starbucks is no longer beholden to one of its suppliers.
Also in 2011, AOL announced the acquisition of The Huffington Post for $315 million, even though HuffPo had just turned its first modest profit on paper. AOL wanted to give its advertising sales people more inventory to sell and HuffPo had 26 million unique visitors a month.
Microsoft bought Skype for $8.5 billion dollars even though Skype was losing money. The good folks in Redmond must have assumed they could sell more Windows, Office and Xbox by integrating Skype into everything they already sell.
Herman Miller paid $50 million to acquire China’s POSH Office Systems in order to get a beachhead into the world’s fastest growing market for office furniture.
Facebook reportedly acquired Internet start-up Hot Potato for$10 million, largely to get hold of the talented developers working at the company.
Most acquisitions are done for rational reasons where an acquirer agrees to pay today for the rights to your future stream of cash. You may, however, be able to get a significant premium for your company if you can figure out how much it is worth in someone else’s hands.
Curious to see what your business is worth and how you might improve its value to both strategic and financial acquirers? Complete the Value BuilderScore questionnaire today and we’ll send you a 27-page custom report complete with your score on the eight key drivers of company value. Take the test now:
You may be years away from selling your business, but it’s never too early to understand what the process involves.
If you have ever promised your child a treat in return for good behavior, you know all about negotiating leverage. When selling an attractive business, you also have leverage—but only up to the point where you sign a letter of intent (LOI), which almost always includes a “no shop” clause requiring you to terminate discussions with other potential buyers while your newfound “fiancé” does due diligence.
After you sign the LOI, however, the balance of power in the negotiation swings heavily in favor of the buyer, who can then take their time investigating your company. At the same time, with each passing day, you will likely become more psychologically committed to selling your business. Savvy buyers know this and can drag out diligence for months, coming up with things that justify lowering their offer price or demanding better terms.
With your leverage diminished and other suitors sidelined, you are then left with the unattractive options of either accepting the inferior terms or walking away.
Here are seven things you can do—before you even put your business up for sale,and before signing an LOI—to minimize the chances of your deal dragging on for months and becoming watered down:
Have customers sign long-term, standardized contracts, including a clause stating that the obligations of the contract survive any change in company ownership.
Acquirers will want to ask your customers why they do business with you and not your competitors. Before you sign the LOI, cultivate a group of customers to act as references.
During due diligence, acquirers will want to interview your managers without you in the room. They want to find out if everyone in your company is pulling in the same direction.
An acquirer will have more confidence in your numbers and will perceive less risk if your books are audited by a recognized accounting firm.
Every company has some risk factors. Disclose any legal or accounting hiccups before you sign the LOI.
Most acquirers will ask for a period of 60 or 90 days to complete their due diligence. You may be able to negotiate this down to 45 days—perhaps even 30 with some financial buyers. If nothing else, you’ll alert the acquirer to the fact that you’re not willing to see the diligence drag out past the agreed-to close date.
Explain that, while you think the acquirer’s offer is the strongest and you intend to honor the “no shop” agreement, there are other interested parties at the table.
If you take all seven of these steps, you will protect the value of your business as the balance of power in the negotiations to sell your company swings from you to the buyer.
One of the most intimidating aspects of selling your business can be facing the barrage of questions during the various management presentations you’ll be doing for potential acquirers. Be prepared to be grilled on all facets of your operations. Of course every meeting will be different, but here are some questions you can expect to be asked when you’re in the hot seat:
It’s a slippery question because if your business truly does have a bright future—and you want the buyer to believe that’s the case—the obvious question is: “Why do you want to sell it, and do would you want to sell it now?”
The potential acquirer wants to find out if you have a predictable, economical and scalable formula for finding new customers.
The acquirer, with an eye to future growth, is trying to understand how big the potential market is for your product or service and what part of the field remains to be harvested.
The acquirer wants to understand the breadth and depth of your team and determine specifically which members need to be motivated and retained post-purchase.
Strategic buyers will be searching for any possible synergies between what you sell and what they sell. The more you know about your customer demographics, the better the buyer will be able to assess the strategic fit. If your customers are other businesses, a buyer will want to know what functional role (e.g., training manager, VP of sales and marketing) buys your product or service.
This question is asked in an effort to size up the uniqueness of your formula for creating your product or service. Potential buyers want to know if you have any proprietary systems that would be hard for a competitor to replicate. For various reasons, they will also want to understand if the creation of your product or service is dependent on any one person.
A buyer is trying to understand how big the moat is around your business and what kind of protection it offers from competitors who may decide to compete with you in the future. What have you done to safeguard yourself against the competition?
Most buyers will try to understand how easily they can integrate your back office into their operation. They’ll want to know what bookkeeping and billing software you use, how customers pay, and how you pay suppliers.
Of course this is not an exhaustive list, but it’s a good start when you’re preparing to represent your company to your potential buyers.
Deck: Business valuation goes beyond simple mathematics, but to get some idea of what your business might be worth, consider the three methods below.
Your business is likely your largest asset so it’s normal to want to know what it is worth. The problem is: business valuation is what one might call a “subjective science.”
The science part is what people go to school to learn: you can get an MBA or a degree in finance, or you can learn the theory behind business valuation and earn professional credentials as a business valuation professional.
The subjective part is that every buyer’s circumstances are different, and therefore two buyers could see the same set of company financials and offer vastly different amounts to buy the business.
This article provides the basic science and math behind the most common business valuation techniques, but keep in mind that there will always be outliers that fall well outside of these frameworks. These are strategic sales, where a business is valued based on what it is worth in the acquirer’s hands. Strategic acquisitions, however, represent the minority of acquisitions, so use the three methods below to triangulate around a realistic value for your company:
The most basic way to value a business is to consider the value of its hard assets minus its debts. Imagine a landscaping company with trucks and gardening equipment. These hard assets have value, which can be calculated by estimating the resale value of your equipment.
This valuation method often renders the lowest value for your company because it assumes your company does not have any “Good Will.” In accountant speak, “Good Will” has nothing to do with how much people like your company; Good Will is defined as the difference between your company’s market value (what someone is willing to pay for it) and the value of your net assets (assets minus liabilities).
Typically, companies have at least some Good Will, so in most cases you get a higher valuation by using one of the other two methods described below.
In this method, the acquirer is estimating what your future stream of cash flow is worth to them today. They start by trying to figure out how much profit you expect to make in the next few years. The more stable and predictable your cash flows, the more years of future cash they will consider.
Once the buyer has an estimate of how much profit you’re likely to make in the foreseeable future, and what your business will be worth when they want to sell it in the future, the buyer will apply a “discount rate” that takes into consideration the time value of money. The discount rate is determined by the acquirer’s cost of capital and how risky they perceive your business to be.
Rather than getting hung up on the math behind the discounted cash flow valuation technique, it’s better to understand the drivers of your value when you use this method. They are: 1) how much profit your business is expected to make in the future; and 2) how reliable those estimates are.
Note that business valuation techniques are either/or and not a combination. For example, if you are using Discounted Cash Flow, the hard assets of the company are assumed to be integral to the generation of the profit the acquirer is buying and therefore not included in the calculation of your company’s value.
A money-losing bed and breakfast sitting on a $2 million piece of land is going to be better off using the Asset-based valuation method; whereas a professional services firm that expects to earn $500,000 in profit next year, but has little in the way of hard assets, will garner a higher valuation using the Discounted Cash Flow method or the Comparables technique described below.
Another common valuation technique is to look at the value of comparable companies that have sold recently or for whom their value is public. For example, accounting firms typically trade at one times gross recurring fees. Home and office security companies trade at about two times monitoring revenue, and most security company owners know the Comparables technique because they are often getting approached to sell by private equity firms rolling up small security firms. Typically you can find out what companies in your industry are selling for by asking around at your annual industry conference.
The problem with using the Comparables methodology is that it often leads owners to make an apples-to-bananas comparison. For example, a small medical device manufacturer might think that, because GE is trading for 20 times last year’s earnings on the New York Stock Exchange, they too are worth 20 times last year’s profit. However, if one looks at the more than 13,000 businesses analyzed through the The Value Builder System, it’s clearthat a small medical device manufacturer is likely to trade closer to five times pre-tax profit.
Small companies are deeply discounted when compared to their Fortune 500 counterparts, so comparing your company with a Fortune 500 giant will typically lead to disappointment.
Finally, the worst part about selling your business is that you don’t get to decidewhich methodology the acquirer chooses. An acquirer will do the math on what your business is worth to them behind closed doors. They may decide your business is strategic, in which case back up the Brinks truck because you’re about to get handsomely rewarded for your company. But in most cases, an acquirer will use one of the three techniques described here to come up with an offer to buy your business.
Curious to see what your business might be worth? Get a free valuation here: questionnaire
How do you avoid not being disappointed with the money you make from the sale of your company?
Perhaps you’ve heard that companies like yours trade using an industry rule of thumb or that companies of your size sell within a specific range, and you want to get at least what your peers have received.
While these metrics can be useful for tax planning or working out a messy divorce, they may not be the best ways to value your company.
In reality, the only valuation technique that will ensure you are happy with your exit is for you to place your own value on your business. What’s it worth to you to keep it? What is all your sweat equity worth? Only when you’re clear on that will you ensure your satisfaction with the sale of your business.
Take Hank Goddard as an example. He started a software company called Mainspring Healthcare Solutions back in 2007. They provided a way for hospitals to keep track of their equipment and evolved into a slick application that hospital workers used to order supplies.
Goddard and his partner started the business by asking some friends and family to invest. The business grew, but there were challenges along the way: Goddard had to fire his entire management team in the early days, product issues needed to be solved and operational issues needed to be resolved.
At times, it was a grind, so when it came time to sell in 2016, Goddard reasoned that he had invested more than half of his career in Mainspring and he wanted to get paid for his life’s work. He also wanted to ensure his original investors got a decent return on their money.
He was approached by Accruent, a company in the same industry, who made Goddard and his partners an offer of one times revenue. Accruent had recently acquired one of Goddard’s competitors for a similar value, so presumably thought this was a fair offer. Goddard brushed it off as completely unworkable. Goddard had decided he wanted five times revenue for his business. Even for a growing software company, five times revenue was a stretch, but Goddard stuck to his guns. That’s what it was worth to him to sell.
A year after they first approached Goddard, Accruent came back with an offer of two times revenue and, again, Goddard demurred.
Mainspring had developed a new application that was quickly gaining traction and he knew how hard it was to sell to the hospitals he already counted as customers.
He told Accruent his number was five times revenue in cash.
Eventually Goddard got his number.
Being clear on what your number is before going into a negotiation to sell your business can be helpful when emotions start to take over. Rather than rely on industry benchmarks, the best way to ensure you’re not disappointed with the sale of your business is to decide up front what it’s worth to you.
Big public companies trade at a significant premium over small businesses in the same industry because investors perceive big, sophisticated companies as a safer bet than small, owner-dependent companies.
Let’s take a look at the professional services industry. Although most consultancies are a small collection of experts, there are also a handful of big publicly traded professional services firms. Omnicom (NYSE:OMC) is a massive marketing services company with a market capitalization of around $18 billion. For all of 2013, Omnicom reported pre-tax income of $1.66 billion, meaning they are trading at around 11 times pre-tax income.
Smaller service businesses trade at much lower multiples. We know this because at our firm we offer The Value Builder Score questionnaire which asks smaller business owners (our typical user has between $1 million and $20 million in sales) if they have received an offer to buy their business, and if so, the multiple of their pre-tax profit the offer represents. When we look at the professional services segment, we find the average multiple over the last two years was 3.81—almost three times lower than Omnicom.
When we isolate professional services companies with at least $3 million in revenue, the multiple being offered goes up to 4.97 times pre-tax profit, but it is still less than half of Omnicom’s 11 times.
And in case you thought this phenomenon was unique to the marketing services vertical, take a look at the IT services giant Accenture (NYSE:ACN). Accenture reported pre-tax income of $4.3 billion in 2013 and currently has a market capitalization of more than $52 billion, meaning they are trading around 12 times pre-tax profit, which is more than double the price we see being offered to smaller professional services firms.
So how do you get a public company-like multiple for your business? One approach is to look for a strategic buyer. Unlike a financial buyer that is looking for a relatively safe return on their capital invested (which is the reason investors place a premium on big, stable companies trading on the stock market), a strategic buyer will value your company on how buying you will impact them.
Let’s imagine you have a grommet business predictably churning out $500,000 in pre-tax profit. These days, a financial buyer may pay you around 4 or 5 times earnings – in this case, roughly $2.5 million – if you can make the case your profits are likely to continue well into the future.
Now let’s imagine that a company that sells a billion dollars worth of widgets starts sniffing around your grommet business. They think that if they integrate your grommets into their widgets, they can sell 10 percent more widgets next year.
Therefore, your little grommet business could add 100 million dollars of revenue for the widget maker next year – and that’s just year one after the acquisition. Imagine what your business could be worth in their hands if they continued to sell more widgets each year because of the addition of your company.
The widget maker is not going to pay you $100 million for your business, but there is somewhere between the $2.5 million a financial buyer will pay and the $100 million in sales that the widget maker stands to gain next year that is both a good deal for you and for the widget maker.
Premium multiples get paid to big companies, and also to the little ones that can figure out how to make a big company even bigger. If you’d like to know how your company performs on The Value Builder Score, simply complete the 13-minute questionnaire here Value Builder Score
A great business is bought, not sold, so, if you look too eager to sell your business, you’ll be negotiating on the back foot and look desperate—a recipe for a bad exit.
But, what if you really want to sell? Maybe you’ve got a new idea for a business you want to start or your health is suffering. Then what?
As with many things in life, the secret may be a simple tweak in your vocabulary. Instead of approaching an acquirer to see if they would be interested in buying your business, approach the same company with an offer to partner with them.
Entering into a partnership discussion with a would-be acquirer is a great way for them to discover your strategic assets, because most partnership discussions start with a summary of each company’s strengths and future objectives. As you reveal your aspirations to one another, a savvy buyer will often realize there is more to be gained from simply buying your business than partnering with it.
For example, look at how Charles Jolley played the sale of Ozlo, the company he created to make a better digital assistant. The market for digital assistants is booming. Apple has Siri, Amazon has Alexa and the Google Home device now has Google Assistant built right in.
Jolley started Ozlo with the vision of building a better digital assistant. By 2016, he believed Ozlo had technology superior to that of Apple, Amazon or Google. Realizing his technology needed a big company to distribute it, he started to think about potential acquirers. He developed a long list, but instead of approaching them to buy Ozlo, he suggested they consider partnering with him to distribute Ozlo.
He met with many of the brand-name technology companies in Silicon Valley, including Facebook, which wanted a better digital assistant embedded within its messaging platform. They took a meeting with Jolley under the guise of a potential partnership, but the conversation quickly moved from “partnering with” to “acquiring” Ozlo.
Jolley then approached his other potential partners indicating his conversations with Facebook had moved in a different direction and that he would be entering acquisition talks with Facebook. Hearing Facebook wanted the technology for themselves, some of Jolley’s other potential “partners” also joined the bidding war to acquire Ozlo.
After a competitive process, Facebook offered Jolley a deal he couldn’t refuse, and they closed on a deal in July 2017. Jolley got the deal he wanted in part because he was negotiating from the position of a strong potential partner, rather than a desperate owner just looking to sell.
How do you know the right time to sell your company? One answer to this age-old question is that the time to sell is when someone else is willing to invest more in your business than you are.
When you start a business, nobody is willing to invest in its success more than you. You’ve already worked a 40-hour week by Wednesday and, if you’re like most founders, you’ve invested a big chunk of your liquid assets to get your business going.
You’re all in.
In the early days, you are willing to risk your business on a new strategy because the business is pretty much worthless. As the Bob Dylan lyric goes, “When you ain’t got nothing, you got nothing to lose.”
As your business grows and becomes more valuable, you may find yourself becoming more conservative, unwilling to risk the equity you have created inside your business on your next big idea. You have reached a point where someone else may be willing to risk more time and money for your business than you are.
David Will is the founder of Peach New Media, which he started back in 2000 as a reseller of web conferencing. In the early days, Will changed his business strategy frequently, trying to find an idea with legs. After a number of pivots, he landed on selling learning management software to associations.
The business grew nicely and by 2015 Peach New Media had 40 employees and then received an attractive acquisition offer from a large private equity company. Will was conflicted. He loved his business and treasured the team he had built. At the same time, the acquirer was offering him a life-changing check.
In the end, Will realized that he had become somewhat more conservative as his business had grown and the potential acquirer was willing to make a big bet on integrating Peach New Media into another one of its acquisitions. Will realized he had reached a point where his appetite for risk in his own business was lower than his potential acquirer’s. Will decided to sell.
The point where a buyer is willing to risk more than you are happens at a different stage for everyone. Let’s say you have a business worth $1 million today. Would you be willing to risk the entire thing on a new strategy for a shot at making it a $10 million company? Many entrepreneurs would take that bet.
Now imagine you have a company worth $10 million and your business represents the bulk of your net worth. Most would argue $10 million is life-changing money. Would you be willing to risk your entire company for a chance to make it a $100 million company? The marginal utility of an extra $90 million is minimal—we all only need so many cars—but the risk is significant. Fewer owners would bet $10 million for a chance at $100 million.
What if your business was worth $100 million? Would you risk it all for a long shot at becoming a billion-dollar company? It is hard to imagine any one person betting $100 million dollars on anything, but if you’re the CEO of a billion-dollar corporation with ambitious growth goals, $100 million is a bet you may be willing to make.
When someone else is willing to invest more in your business than you are, it is probably time your company finds a new owner.
Many business owners believe the act of selling their business is similar to passing the baton in a 400 meter relay: once you’re finished running, you get to relax. In reality, buyers will insist that you stay on for a transition period – anywhere from six months to five years – during which time you continue to work in your business to help the buyer capitalize on the investment they’re making.
At some point in the process of selling your business, a prospective buyer will ask you – oftentimes casually – “Why do you want to sell your business?” These eight seemingly innocuous words have derailed more deals than any others.
Buyers ask THE question to evaluate how likely and willing you are to stay on or if you already have one foot out the door.
Obviously you don’t want to lie, but there is a right and wrong way to answer THE question. Answers like “I want to slow down a bit” or “I want to travel” or “we’ve got a baby on the way and I want to spend more time at home” communicate to a potential buyer that you plan on winding down when they take over. However, what they want to hear is your intention to help them realize the potential locked inside your business.
If you’re under 40, you clearly aren’t ready to “retire” so you need to communicate that you see an upside in merging your business with theirs:
“In order for us to get to the next level, we need to find a partner with more <insert sales people, distribution, geographic reach, capital or whatever the partner brings to the table.”
If you’re between 40-55 years old, most people will understand the need to shore up your personal balance sheet:
“I’ve reached a time in my life where I want to create some liquidity from the value I’ve created so far, and at the same time I want to find a partner who can help us get to the next level.”
If you’re over 55, you can start to talk about retirement, but you want to make sure you communicate that you still have lots of energy and passion for your business.
“I’m at a stage where I need to start thinking about retirement. It’s a long way off yet, but I want to be proactive.”
Rehearse your answer to THE question so it becomes a natural response when you are inevitably asked THE question by a potential acquirer.
The very best time to sell your business is when someone wants to buy it. While it can be tempting to continue to grow your business forever – particularly when things are going well — that decision comes with a significant downside.
Take a look at the story of Rand Fishkin who started his entrepreneurial journey when he joined his mother’s marketing agency as a partner:
When Fishkin realized how much his Mom’s customers were struggling to get Google to display their company in a search, he immersed himself in the emerging field of Search Engine Optimization (SEO).
The company began to grow 100% per year and by 2010, Moz was generating around $650,000 in revenue each month, attracting the attention of Brian Halligan, co-founder of marketing software giant HubSpot.
HubSpot wanted to buy Moz and was offering $25 million of cash and HubSpot stock – an offer almost five times Moz’s $5.7 million of revenue in its last complete financial year.
But Fishkin wasn’t satisfied. He believed a fast growth Software-as-a-Service (SaaS) company was worth four times future revenue and was confident Moz would hit $10 million by the end of that year.
Fishkin counter offered, saying he would be willing to accept $40 million. HubSpot declined.
Instead of selling Moz, Fishkin raised a round of venture capital and started to diversify away from SEO tools into a broader set of marketing offerings. The further Moz veered away from its core in SEO, the more money his business began to lose.
By 2014, Moz was in full crisis mode, and Fishkin had begun suffering from a bout of depression. He decided to step down as CEO, describing his resignation as a “lot of sadness, a heap of regrets and a smattering of resentment.”
Fishkin became a minority shareholder in a company he no longer controlled where the venture capitalists had preferred rights in a liquidity event.
In the ensuing years since turning down Halligan’s offer, HubSpot went public on the New York Stock Exchange and had been worth nearly 20 times as much.
Fishkin revealed that today, his liquid net worth is $800,000 – much of which he was about to spend on elder care for his grandparents. The Moz stock he holds may or may not have value after the venture capitalist get their preferred return. At the same time, Fishkin estimated HubSpot’s offer of $25 million in cash and HubSpot stock would now be worth more than $100 million (based on the increased value of HubSpot’s stock).
Fishkin’s tale is a cautionary reminder why the best time to sell your company is when someone wants to buy it – a story that is shared in his book Lost and Founder: A Painfully Honest Field Guide to the Startup World.
What if an offer was made for your business today? Would you be ready to sell? Would you regret if you said no?
One of the biggest mistake owners make in selling their company is being lured into a proprietary deal.
Acquirers land a proprietary deal (or “prop deal”) when they convince owners to sell their businesses without creating a competitive marketplace. Acquirers running a proprietary deal know they don’t have any competition and tend to make weaker offers with more punitive terms because they know nobody else is bidding.
Many founders become the target of a proprietary deal without even knowing they have been duped. First, someone senior from the acquiring company approaches the founder, complimenting them on their business. The acquirer suggests lunch, and then high-level financials are exchanged. Soon, the owner starts going down a path that is difficult to come back from.
As the parties in a proprietary deal get to know one another, founders often share information with the acquirer that puts them in a compromised negotiation position. The interactions are set up as friendly exchanges between two industry leaders, but many founders reveal key facts in these discussions that end up being used against them when negotiations turn serious. Business owners also become more emotionally committed to selling the more resources they invest in the process and the more time they spend thinking—perhaps dreaming—of what it would mean to sell their business.
Savvy sellers avoid the proprietary deal by creating a competitive process for their company. Take for example Dan Martell, the founder of Clarity.fm, among other companies. When Martell decided to sell Clarity, he knew the likely buyer was one of five New York-based companies. Instead of negotiating with one, he invited all five to an event he hosted in New York. The five CEOs—all of whom knew one another—saw a room full of their competitors and realized that if Clarity went on the market, they would have to out-bid the other buyers in that room.
Hosting the event was Martell’s way of communicating to all the potential buyers that a proprietary deal was off the table and that if they wanted to buy Clarity, they would have to compete for it.
It’s flattering to receive a call from an executive at a company you respect. Just know that if you accept their invitation of lunch, you run the risk of becoming the latest casualty of the proprietary deal.
The other day I was speaking with a successful CEO in his fifties who runs a heating and air conditioning company generating eight million dollars in revenue and over one million dollars in profit before tax.
Even though he was tired and nearing burnout, he was planning to wait another five to seven years before selling his business because he “wanted to sell at the peak of the next economic cycle.”
On the surface, his rationale seems to make sense. If you speak with mergers and acquisitions professionals, they’ll tell you that an economic cycle can impact valuations by up to “two turns,” which means that a business selling for five times earnings at the peak of an economic cycle may go for as low as three times earnings at a low point in the economy.
The problem is, when you sell your business, you have to do something with the money you receive, which usually means buying into another asset class that is being affected by the same economy.
Let’s say, for example, you had a business generating $100,000 in pre-tax profit in an industry that trades between three times earnings and five times earnings, depending on the point in the economic cycle.
Furthermore, let’s imagine you sat stealthy on the sideline until the economy reached the absolute peak and sold your business for $500,000 (five times your pre-tax profit) in October 2007. You took your $500,000 and bought into a Dow Jones index fund when it was trading above 14,000. Eighteen months later – after the Dow Jones had dropped to 6,547.05– you’d be left with less than half of your money.
Even though you cleverly waited till the economic peak, by March 9, 2009, you would have effectively sold your business for less than 2.5 times earnings.
The inverse is also true. Let’s say you waited “too long” and sold the same business in March 2009. And because you were at the lowest possible point in the economic cycle, you only got three times earnings: $300,000. Notice that’s 20% more than if you’d sold at the peak and bought an index fund at the top of the market.
Just like when you sell your house in a good real estate market, unless you’re downsizing, you usually buy into an equally frothy market. Which is why timing the sale of your business on external economic cycles is usually a waste of energy.
External vs. internal economic cycles
Instead, I’d recommend timing the sale of your business when internal economic factors are all pointing in the right direction: employees are happy, revenue and profits are on an upward trend, and there is still lots of market share for an acquirer to capture.
When internal economic factors are pointing up, you’ll fetch a price at the top end of what the market is paying for businesses like yours right now, which means that – for good or bad – you get to use your newfound cash and buy into the same economic market you’re selling out of.
We get to see a lot of company founders who are contemplating an exit. Some of our customers get lucky early in life, but in the vast majority of examples where a founder is getting a seven- or eight-figure offer, it is not their first rodeo. In fact, most owners have had multiple failures and modest successes before their first big exit.
One of the most compelling reasons to consider selling your business is to give yourself a clean canvass for designing your next business. You can take all of the lessons you’ve learned building your current company and apply them to a new idea.
Michelle Romanow partnered with two friends from her engineering class and together they founded Evandale Caviar in their early 20s. The trio’s idea was to sell caviar to high-end restaurants around the world.
The partners built a fishery and had just started to get the business off the ground by the summer of 2008 when the luxury restaurant industry started to wobble. By fall of that year, high-end restaurants around the world were suffering, and by the end of 2008, the industry was on its knees.
Evandale Caviar failed.
The partners licked their wounds and came together to start a new business, a deal-of-the-day website called Buytopia. They had learned from their Evandale experience and were building a good little business— call it a single, to use a baseball analogy—when the partners started to tinker with a third idea.
Romanow saw big companies wasting millions of dollars printing paper coupons and reasoned that there must be a more efficient way to distribute them. They dreamt up a mobile app that would notify the shoppers in a grocery store of special offers and let them snap a picture of their grocery receipt and receive money back on the products being promoted. The SnapSaves business model was to charge the company advertising its offers through the app.
Romanow and her partners poured more than $100,000 a month of Buytopia cash into SnapSaves, and within six months they had a product they could take to market. They launched SnapSaves in August 2013 and the company was a quick hit with consumers and advertisers. Within a year, the founders were entertaining venture capital investment offers with an implied valuation of around $25 million for their young company.
That’s when Groupon called and said they wanted to buy SnapSaves outright. The partners haggled with Groupon and got them to double their offer in the process. Less than a year after launching SnapSaves, they agreed to be acquired by Groupon.
Third time’s a charm
A casual observer of the SnapSaves story would likely chalk it up to luck: a couple of friends leave school, start a business and become an overnight success. That’s a convenient story, but it’s not true.
SnapSaves would never have happened without the lessons the partners learned from Evandale. And therein lies the secret to many successful entrepreneurs: they got their first few businesses out of the way early in their working lives to make the time, room and capital for a true success.
If you decide to sell your business to an outside acquirer, you’re going to have to decide between a financial and a strategic buyer—understanding the different motivations of these two buyers can be the key to getting a good price for your business.
A financial buyer is acquiring your future profit stream, so they will evaluate your business based on how much profit it is likely to make and how reliable that profit stream is likely to be. The more profit you can convince them your company will produce, the more they will pay for your business.
But there is a limit to how much they will pay, because financial buyers are playing the buy-low, sell-high game. They do not have a strategic rationale for buying your business. They don’t have an army of sales reps to sell your product or a network of retailers where your product could be merchandised. They are simply trying to get a return on their investors’ money, so they tend to buy small and mid-sized businesses using a combination of this investment layered on top of a pile of debt, and they want to buy your business as cheaply as possible with the hope of flipping it five or ten years down the road.
Because financial buyers are usually investors and not operators, they want you and your team to stick around, so they rarely buy all of a business. Instead, they buy a chunk and ask you to hold on to a tranche of equity to keep you committed.
A strategic buyer is a different cat—usually a larger company in your industry, they are evaluating your business based on what it is worth in their hands. They will try and estimate how much of their product or service they can sell if they added you into the mix. Because of their size, this can often lead to buyers who are willing and able to pay much more for your business.
Tom Franceski and his two partners had built DocStar up to 45 employees when they decided to shop the business to some Private Equity (PE) investors. The PE guys offered four to six times Earnings Before Interest Taxes Depreciation and Amortization (EBITDA), which Franceski deemed low for a fast-growing software company.
Franceski was then approached by a strategic acquirer called Epicor, which is a global software business with a lot of customers who could use what DocStar had built. Epicor offered DocStar around two times revenue—a much fatter multiple than the PE firms were offering.
