In 2022, over 7.7 million people visited the Louvre museum in Paris. Its most well-known painting is the Mona Lisa, painted during the Renaissance by Leonardo da Vinci. But some guests prefer the works of Monet (Impressionism), Rembrandt (Dutch Golden Age), Picasso (Cubism), or Warhol (Pop Art).
Trash or treasure?
Which art style or artist is your favorite? There is no “correct” response to this question – the answer lies in the eye of the beholder. Similarly, your business is worth different amounts to different buyers. In my experience advising both buyers and sellers, I have found there is truly an art to selling a business.
Sellers need to consider how to package the business, the story to tell about it, and how potential buyers feel when they imagine owning it. Business value can be calculated mathematically, but there is a softer side to the sale.
As a prospective seller, you want to maximize the buyer’s perceived value of your four C’s (intangible assets). The difference between the market value of your business and the current value of your tangible assets is known as “goodwill” in accounting jargon. According to valuation experts, the intangible assets of a typical business comprise over 80% of its value.
Wealthpreneur Lesson
Tom Gayner’s Formula For Business Value
“What publicly traded companies are worth is roughly 90% dominated by the cash flows they produce over time and 10% by what the market will pay for these types of companies at any given time.”
– Tom Gayner, CEO of Markel Corporation
Pushed or pulled?
Business brokers, investment bankers, attorneys, and CPAs may view a business sale as simply a business transaction. But for a Wealthpreneur, the selling process is intensely personal. Your personal readiness to sell is just as important as your business’s readiness to sell.
Two types of factors can impact the timing of your business sale. “Pull factors” are actions you are excited to take after the sale of the business. What do I want to do post sale? is the most important question in the exit process, but many business owners never ask it. Surveys find that over 75% of former business owners regret exiting their businesses just one year after the sale.
In contrast, “push factors” are the things pushing you out of your business. These factors often stem from one or more of the 5 D’s.
What goes up must come down
Business owners often try to sell their businesses at the top of an economic cycle. This approach might initially seem wise since experts estimate the economic cycle can impact valuations by up to “two turns”. This means a business selling for 5 times cash flow at the peak of an economic cycle could sell for as low as 3 times cash flow at a low economic point.
But if you sell at the top of the economic cycle, what will you do with the business sale proceeds? Most asset classes you might consider investing in, such as equity securities and real estate, will be affected by the same economy. Consider what it is like to sell your house in a good real estate market. Unless you are downsizing, you would be buying your next home for an equally inflated price!
Now or later
Let’s compare two hypothetical business owners. Owner A and Owner B own identical businesses in the same industry. Both businesses generate $1 million in annual cash flow as of early 2007. To keep things simple, let’s assume they both use a tax planning technique to eliminate all tax upon the sale.
Owner A sold his business in late 2007 for $5 million, at a peak valuation of 5 times cash flow. He reinvested his exit proceeds into a Dow Jones index fund. Eighteen months later, in March 2009, most major market indices had declined by more than 50%. Owner A was left with less than $2.5 million.
Owner B missed her opportunity to sell at a peak valuation. She sold her business in early 2009 at the lowest point in the economic cycle for $3 million, at a trough valuation of 3 times cash flow. But despite selling at a trough valuation, as of March 2009, Owner B’s balance was 20% higher than Owner A’s.
This difference between Owner A and Owner B will grow over time. Let’s say both owners invested in a Dow Jones index fund from March 2009 through the summer of 2022. By that summer, Owner B’s account balance grew to $15 million, while Owner A ended up with only $12.5 million.
Another example of how timing can affect the value of your business is Rand Fishkin’s $400 million mistake.
Think Next Level
- Level 1 Wealthpreneurs work in their businesses
- Level 2 Wealthpreneurs work on their businesses
- Level 3 Wealthpreneurs work above their businesses
Level 3 Wealthpreneurs engage in timely business exits at favorable valuations and reinvest the exit proceeds in lower valued enterprises.
They might own multiple businesses in a Holding Company ownership structure. In this scenario, cash can be tax-efficiently moved within the legal ownership structure to fund the most advantageous venture.
These Wealthpreneurs focus on monitoring their business operators’ progress and evaluating capital allocation opportunities. Their goal is to grow their portfolio of assets, both in private and public markets
The boomerang effect
In The Godfather Part III, Michael Corleone remarks, “Just when I thought I was out… they pull me back in.” Wealthpreneurs who have exited a business will frequently find themselves in a similar position to this fictional crime boss – at least in a financial sense!
In many exit transactions, a portion of your sale proceeds will be tied to the future performance of your company. The transaction may involve seller financing when selling to an individual, rollover equity in a private equity (PE) transaction, or an “earnout” provision when selling to a strategic acquirer. In the earnout scenario, some of your sale proceeds are contingent on the business hitting financial performance goals after the sale.
I always recommend thinking and planning for the future sale of your business. Understanding the value of your business and its performance compared to other companies in your industry is a great first step!
The insights above were inspired by the teachings of John Warrillow. For those interested in additional information, I recommend his book, The Art of Selling Your Business.
