Categorized | the strategy notebook

Selling a business in a recession

I have always counseled every client I’ve dealt with that business planning, even from the start, needs to include how the business will close (this is equally true of business planning for individual products or brands). Perhaps because businesspeople are eternal optimists or because no-one wants to face mortality at birth, few have the good sense to plan out their exit. However, planning how a business will close, sell, or liquidated helps you to minimize losses or, better, actually make a return on your investment and time. Handling the complicated scenario of selling or closing a business when you’re forced to handle it virtually guarantees failure.

The key to business closing planning is to always have a good handle on the value of your business at any given time. Now business valuation is complicated, byzantine, and difficult to learn even at the best MBA programs. While it’s easy to value hard assets such as inventory and buildings, a business’ value primarily consists in cash flow, loyal customers, client lists, customer databases, brand equity (we should be so lucky), and a host of other factors. But when it really comes down to brass tacks, a business is worth the highest price someone will pay for it.

Which is why selling a business in a recession is a particularly bad idea. For a veritable hogspile of reasons, the price fetched rarely approaches even the book value of the assets. For that reason, the Los Angeles Times’ report yesterday on the difficculties small business owners are having selling their business is must reading. To which I offer a few modest bits of advice on avoiding and planning for a business sale in a recession.

It doesn’t take a rocket scientist to figure out that you don’t sell your business on the downside of a business cycle. Valuation multiples go down the toilet, financing goes right with it, and buyers are less willing to take risks. If you’re forced to sell in a downturn, then you’re in for some pretty tough sailing. Tough luck, you take your knocks.

While your business planning targets boom times for selling your business, there are a few things you can do to lessen the shock if you have to sell in a downturn. But, like all things in business, you have to plan — you don’t wait until the smoke reaches your room to see if there’s a way to exit.

Plan your exit continually
When you end your involvement with a business, you have two choices. You can close the doors and liquidate the assets or you can sell the business. The first will almost always mean a loss, but the second has the promise of recouping your investment with some extra money left over. If you plan your exit as a closing, then you need to have all the pieces in order to maximize what you get from the company’s assets. For instance, the time to set up a relationship with a liquidator is not when you’ve suffered several quarters of losses and are desperate for a door.

Develop, implement, and revisit a cash flow plan
Small businesses gain most of their value from cash flow (this is for the most part true in the M&A world, as well). Here’s how we describe the problem in our book Shoestring Venture: The Startup Bible:

If, on the other hand, you intend to “bootstrap” your venture by
financing your business through the revenues the business generates, then
the number one concern of your business plan is cash flow. You get to skip
worrying about business valuation, but you’re definitely not off the hook.
Your job in the business plan is to figure out as realistically as possible where
the revenues are going to come from, when they’re going to come, and how
much cash you can expect. Here’s a simple truth: nearly 100% of business
failures are due to more cash going out than comes in. It’s not about profits;
unprofitable business stay in business every day. It’s the folks that bleed cash
that are swept into the dustbin of history. Everything in the business plan,
every part and every piece, needs to set a credible blueprint for getting more
cash coming into your start-up than goes out. To put it simply, a business
plan for a bootstrap start-up is always a cash flow plan.

In other words, if you ever plan to sell your business, you need to keep working on and honing your cash flow plan.

While major mergers and acquisitions focus on free cash flow, the number rarely has any value for small businesses unless they are involved in significant capital expenditures. For instance, if you’re running a heavy equipment rental shop, you’re most likely relying on huge loans to purchase the heavy equipment. Free cash flow — which is what you get when you subtract your capital expenditures (paying your loans) from your operating cash flow –in that case, is the only valuable metric in selling your business.

Changes in SBA loan requirements this year, however, is making cash flow less important. SBA loans are now based solely on the underlying value of the book assets (cash flow is considered “good will” in financial accounting and is not part of the “book value” of the business). The SBA will approve loans with good will valued at either equal to the book value or $250,000, whichever is greater. Money quote from the LA Times:

. . . a business valued at $1 million based on its cash flow that has $250,000 in assets has, by definition, $750,000 worth of goodwill. But the SBA recently capped goodwill at half the amount of the loan or $250,000, whichever is higher. Previously there was no limit . . .

Many shoestring ventures, such as our own, are asset-poor but cash flow rich. Relying on SBA loans to sell these business may mean taking a far lower value for the cash flow than may otherwise be justified.

Save money to sell your business.
It seems counterintuitive, but the more money that you can put upfront in financing, the more likely you’ll sell your business and the more likely you’ll sell at a price closer to your valuation rather than the sellers. Typically, small business owners often finance the sale with 10, 20, even 30% of the final sale value of the business. For all practical purposes, this makes you an investor in the new small business, so you’re putting your money at risk. But, considering that only 30% of small businesses that go on sale actually end up getting sold and considering that we’re in a serious recession, that risk may be a small price to pay.

It is incumbent on you, then, if you plan to exit your business by selling it to another small business owner, to put together and husband the resources necessary to finance part of the sale. The ability to kick in some financing often makes a critical difference in realizing the full value of your “good will” assets such as cash flow and customer loyalty.

If you wait for a business downturn, you’ll be too late.

At the worst, the resources you’ve saved to finance a sale may be sufficient to see you through a downturn.

Become an expert at the entire process of selling a small business
The time to learn how to sell a home is not when you need to sell a home — particularly in a recession. The time to learn how to sell a small business is not when you forced to sell it. That’s why 70% of small businesses for sale never get sold. From the moment you decide that selling your business is part of the plan — or could be part of the plan — then you need to impose on a broker and learn the ins and outs of selling a business. You may be planning to be in a business all your life, but if you’re running it with plans to sell it, then you’ll be ready when you need to pull the trigger. And it doesn’t hurt to have the relationship with a broker and a Rolex full of possible suitors.

Transition your business away from dependence on you.
One of the most common mistakes small business owners make is centering the entire business around themselves, making their presence critical to the success of the business. I call it “Steve Jobs Syndrome” and it has the potential to make your business completely valueless in spite of in-your-dreams cash flow and profits. When someone buys your business, they aren’t buying you, they are buying the business. So it’s incumbent on you to plan on shifting more of the critical functions and responsibilities to a team of people. The less involved you are in critical activities, the more likely the business will sell. And the worst possible scenario is to make your business solely about yourself, to make you the entire brand (see, for instance, Srimana Mitra On Strategy. Great blog, great little business, but if Srimana Mitra gets hit by a truck, the value of the business is exactly zero.

Be Sociable, Share!

Leave a Reply

Shoestring Book Reviews

Shoestring Venture Reviews
Richard Hooker on Jim Blasingame

Shoestring Fans and Followers


Categories

Archives

Business Book: How to Start a Business

Shoestring Book

Shoestring Venture in iTunes Store

Shoestring Venture - Steve Monas & Richard Hooker

Shoestring Kindle Version # 1 for e-Commerce, # 1 for Small Business, # 1 for Startup 99 cents

Business Book – Shoestring Venture: The Startup Bible

Shoestring Book Reviews

Shoestring Venture Reviews

Invesp landing page optimization
Powered By Invesp
Wikio - Top Blogs - Business