Why You Can’t Sell Your Business
In our line of work we see a lot of deals, but we also pass on the vast majority of them. To put some numbers around that, we invested in three companies in 2019 after looking at well over 1,000 opportunities.
While looking at all of those businesses is time consuming, it’s probably not as time consuming as you might think. That’s because most that hit the cutting room floor are fast passes. Right off the bat it is apparent that either we’re not the right fit or there is at least one glaring and insurmountable obstacle to close.
These challenges run the gamut. They can be people problems, money problems, math problems, business problems, or timing problems. And while they are not always unsolvable, what’s usually lacking is a willingness by a seller to confront them head on.
That willingness, however, is the only path to successfully sell your business.
With that in mind, here’s a short list of the most common issues we see. If one or more of these is true of your business, remediate the issue as best you can before bringing it to market.
1. You have unrealistic expectations
If we had a nickel for every time we heard that a seller or intermediary was looking for “8 times,” well, we’d have a lot of nickels. The first observation here is 8 times what? Earnings can be measured in lots of ways, and a seller needs to be clear about how he or she is measuring the true earnings power of his or her business rather than glorifying a multiple.
Second, unless you’re running a fast-growing SaaS company, 8 times is not market for smaller companies. While what is market is always changing, don’t enter a process without familiarizing yourself with the relevant data. Pepperdine’s Private Capital Markets report is a worthwhile read to this end. But even then, be open-minded to the offers that come in. Some may have nuance or structure, so do your best to understand them. Ask questions. Push buyers to articulate what they value or discount. Just as you’re not guaranteed to get Zillow’s Zestimate for your house, you’re certainly not guaranteed to get an all cash at close average multiple offer for your business.
Additionally, recognize that transactions don’t all close at an average multiple. An average is not a constant, but a blend of transactions that closed higher and lower. What’s more, plenty of data is unavailable given that these businesses are private. Where your valuation shakes out will depend on the specific characteristics of your business. A capital-intensive business with seasonality, cyclicality, and customer concentration is worth less than a capital-light business with a stable and growing diverse base of customers. If you’re interested in getting feedback on what factors might influence the valuation of your business, you can get an estimate from our Instant Appraisal tool free of charge.
2. Your books are a mess
We invest in the lower middle market and are willing to do a lot of financial legwork to understand the reality of a business, but if no one can reconcile your bank statements to your financials or if you don’t have historical financials, the business is unbuyable. Additionally, if you’re keeping a secret bank account somewhere that’s now showing up on the books or otherwise siphoning money, stop doing this before you go to market. While some number of add-backs are common to a financial presentation, too many is cause for concern. Each one is going to be scrutinized and the amount of financial puffery you engage in is inversely correlated to the amount of trust you build.
This goes back to the simple fact that investors invest in order to make money and if it’s impossible to discern how much money -- and we’re talking cash, not adjusted paper profits -- a business makes, it’s impossible to invest in it. Additionally, sloppy books raise all kinds of other questions about whether or not a company has been paying taxes correctly, understands all of its liabilities, or has slippages elsewhere in the operation. Before you go to market, work with an accountant or other financial professional to get your books in order and put your best financial foot forward.
3. Your business can’t exist without you
We also see a lot of businesses that make lots of money but can’t exist without their founder/CEO sitting at the top. That’s typically because this person holds all of the key customer relationships, hasn’t delegated the most important roles and responsibilities, or trained a replacement, and has staffed most senior positions with family members. This business is likely to stop making money as soon as that CEO retires, loses interest, or gets hit by a bus, and no outsider will want to own a business where that’s a major risk.
If this is you and your business, cast a cold eye on this reality and begin to hire competent outsiders to join the business and delegate key authority to them. This is harder than it sounds. Humans are hard-wired to preserve their social esteem and status at almost any cost, and it can be tough on the ego to become obsolete. It can also be expensive -- good talent isn’t cheap.
But it’s worth it. If you can demonstrate to a buyer that leadership is sustainable, distributed, and professional, you will get more interested buyers and a much more desirable valuation.
4. Your cap table is messy
It’s hard enough to negotiate a deal with one person, but when three, four, or five have to get involved in order to approve deal terms, you can rest assured that deal is dead in the water. While it may seem smart to sell or give equity to key partners or other employers, complicating your cap table in that way may prove to be a mess when it comes time to sell. Instead, consider phantom equity, earn outs, or cash incentives. And no matter what you do, don’t reduce your ownership below 50.1%. Businesses that lack a controlling shareholder are very difficult to navigate during the deal process.
5. Your business is in California, New York, Etc.
Yes, California is an easy target here because of its onerous taxes, high levels of regulation, inability to enforce non-competes, and recent issues with blackouts and wildfires, but the fact is that any business that operates within the context of a higher risk environment is going to be harder to sell — all else being equal — than the same kind of business that doesn’t. Having said that, we own businesses in California. Selling a Californian business can be done! But sellers need to recognize reality about the things that burden their business and adjust expectations accordingly.
6. You exaggerate
There’s a lot of pressure when it comes to selling a business. After all, if it’s your life’s work, it’s natural to want to get top dollar. But here’s the thing: don’t stretch reality to the point of fiction. We know every graph is up and to the right and every projection is rosier than reality, but there’s a fine line between being excited about the future and being ridiculous. If the former, we can have a conversation. If the latter, we’re bound to turn skeptical on much of what you tell us and price that skepticism in to any offer. Ultimately if you’re thinking about selling your business for seven, eight, or even nine figures, you’ve been a success. You’re in the 99th percentile. A massive outlier. There’s no reason to overstretch from there because it only leads to disappointment.
In other words, be proud of what you are and realistic about what you are not and the right buyer will reward you for that.
7. Your advisors don’t want you to do a deal.
Virtually everyone has a tough time helping a cause that goes against their self-interest. This happens often with lawyers and accountants for small companies. If the deal closes, they are often replaced. So, by working to help get a deal done, they’re effectively firing themselves and reducing their client base.
This plays out often in subtle ways, with advice that’s not entirely true or always pushing a judgment call to be negative. Sometimes, it’s overt hostility. Regardless, consider your advisors and how they’ll react to a sale. And if the transaction is large enough to support it, we recommend bringing in deal-specific advisors.
8. You or your representations are dishonest, breaking the law, and/or an a-hole.
Enough said.
9. Some combination of the above
We get it. Running a business is hard and people are messy. But if you’ve been frustrated or failed as you thought about selling your business, that may stem from one or more of the above factors. Not all of them can be fixed overnight, but if any apply to your situation and you spend time being thoughtful about resolving them, the deal process will go smoother and you may end up successfully selling to a great long-term partner.