We all have different reasons for starting our businesses and different goals for our projects in the short, medium and long term. A lot of small businesses are there to provide an income that also gives the owner an opportunity to live a lifestyle and do a job that they love, or at least enjoy. The goal remains the same, to enjoy the daily work and the challenge of running a business while paying the bills, with a hope that all of it will lead to a retirement at some point. What a lot of these small businesses have not considered is the exit, the end point. There will come a day when you can no longer run your business or have no desire to continue doing so. Long gone are the days when you can expect the next generation to take on the family business, although the current lack of viable jobs and careers for young people could well bring that trend back.
It is always worth thinking about what the end goal might be. Is this a business that you can pass on to a manager at some point in the future, with you retaining ownership and dividends, or does it depend on you being there? Is the business one that could be expanded, opening more shops, moving to new regions or new sectors, and giving you a chance to take on a more supervisory role in the future and eventually just be a shareholder taking a return and ultimately selling?
If you are going to be able to sell it, what is a realistic return and how will you find someone to buy it? A lot of companies sell to competitors. Lots of well run businesses with a lot of potential sell to private equity or venture capital funds who will invest for growth and then sell again.
For businesses that cannot be sold, if you want to be able to get your value out then you need to think about one of two main options. Option one is to make it saleable. Look at why it isn't a business that can be sold and work on each of the issues so that you can eventually cash out. Or accept that the business ends when you decide to stop and come up with a run out plan, which will include minimising investment and costs towards the end and working out what can be sold to realise some value, like assets or intellectual property.
For a business that is preparing for sale, it may be necessary to make a few changes to how you run, particularly if it has been more of a lifestyle business previously. You need to understand what makes your business an attractive opportunity for a buyer and work to maximise those elements and minimise any spend or effort on the areas that potential purchasers do not value. For example, if your value is in your strong repeating customer base that a competitor wants to get hold of, then spending money on marketing and business development may deplete your cash whilst not adding much value. If you are manufacturing then it may be that delaying an upgrade to your machinery makes sense as the purchaser might not see the same value in it that you do.
It is also worth understanding how a purchaser will think. This will depend on who is buying the business and also how they are advised, but a fairly standard approach to looking at buying a business is to consider the current profit, the trend in that profit, the opportunities to improve the business that are already known about, the changes you could make if you owned it and the risks there that something might come along and change things dramatically for the worse. Once you have an adjusted profit value, that is multiplied by a number. That number will depend on a lot of factors, industry, general economy, category risk. A typical multiple for a stable business in a stable industry that is not growing will often be 3-5 times the profit figure. A fast growing business in a trendy market that looks like it has a lot of growth potential could be 10+. It is not unheard of to see a multiple of 20, but don't expect it to get anywhere near that without a really good reason! If you are looking at long term planning, hedge your bets for now and think about getting a 5+ as a decent outcome, unless your business is pretty special and growing well.
You also need to be aware that most sale processes include the concept of normalised working capital. The working capital of a business is the total of the current assets and liabilities involved in the trade of the business - debtors, creditors and stock primarily. Normalised working capital involves reviewing the working capital over a longer period, twelve or twenty four months being fairly standard, and looking at what the balance should be during normal trading. This can have a seasonal curve in a lot of businesses. Once the normal level has been agreed, the ending cash balance in the business is adjusted on paper to account for the extra working capital or the lack of working capital. For example, if you normally have £100k of debtors but you only have £1k on the day of the sale, then the final sale accounts will adjust the theoretical cash balance downwards by £99k, the assumption being that you have, deliberately or otherwise, artificially increased your cash balance by getting your debtors to pay.
The reason that this is important is that a sale will often happen on a "cash free, debt free" basis. That means when the sale concludes, the current owners actual cash received on sale is effectively increased for the value of cash in the business and decreased by any debt in the business. So if you sell for £10m, with a cash balance of £1m and debts of £2m, then you will actually receive £9m. If the working capital has been artificially reduced in order to build up the cash balance, you don't get to keep it!
When considering the current profits, the base figure is generally EBITDA, not statutory profit, this is adjusted for one offs, to get to a profit that shows the true underlying business performance. For example, if you make a huge gain by selling a property that you've held for years, you aren't going to then get to multiply that by 5, as the new owner isn't going to get that benefit ever again. The period of interest to a buyer is generally around three years. Much more than that and you are getting into financial ancient history. Any less than three years and you have no trend. That means that, any changes you make that are going to impact future periods but haven't yet hit for a whole year, e.g. a new machine that reduces production time, are unlikely to be fully priced in, as the buyer doesn't have a reliable set of figures to show it has worked. It might make more sense to keep the cash and tell them about the idea as a reason why the multiple should be 5 and not 4, or make the investment and delay the sale, pushing up your profit, giving a nice upward trend and potentially increasing the profit as well as the multiple.
Obviously you can use these same points when looking at an acquisition. Have they pushed up their profit with one offs? Have they drained the working capital to push up cash? What can you do to the business to make it more profitable.
Whenever you are buying or selling a business, make sure you involve the right people and go through the process properly. Due diligence can highlight good news as well as very bad news. You may find out something that shows that the deal has a lot more risk than you thought and you are better off walking away. You might also find that their figures have something more positive for you than they realise, which will let you push up your bid, safe in the knowledge that you are making a good acquisition while they see a bigger number and are more likely to sell quickly.
If you want to talk about planning towards an exit or support for an acquisition or sale, get in touch.