Many of the blog posts I’ve written over the last year are principally focused around two key themes:
- Entrepreneurs who are looking to expand their business, grow revenues, and profits
- How to build wealth and develop a wealth-generating mindset.
Regarding the second point around building wealth and cultivating a wealth-generating mindset, I mention in my book that the entrepreneur needs to invest their assets into thirds with ⅓ going to real estate, ⅓ staying liquid in cash, and ⅓ as the value of the business itself.
It’s fine to look at your business as a wealth-generating vehicle, and yes, profits are the lifeblood of any business. But the reality is that in order to take advantage of the ⅓ value equity in your business, you eventually need to sell your business.
If you’ve attached a value of $1 million to your business, for example, and you’re unable to sell the business (for whatever reason), or your valuation is completely unrealistic, then it’s possible you’re sitting on an asset that isn’t tradeable.
I had a conversation with an entrepreneur/friend recently, who has been running his successful small business for over 10 years. His business is doing approximately $3 million in revenues with about $400,000 a year in profits. The business has afforded him, and his family, a very comfortable lifestyle.
If you use a standard valuation of 5 times EBITDA as a rough gauge of the value of the business, my friend is sitting on a business worth $2 million.
Sounds great, right?
Except, his business doesn’t produce any recurring revenue, he’s the primary salesperson in the business, and without him, the business would be lost.
Is his business worth $2 million?
I’m not sure who would pay 5× EBITDA for a business that doesn’t have a guaranteed stream of recurring revenue, a management team in place to take over when the owner sells, or the ability to sustain itself when the owner is no longer around.
Considering most of the businesses in North America are small businesses, this is a problem that plagues most entrepreneurs.
The Move Towards a Business Sale
I’m going to state the obvious.
If you want to set your business up for an eventual sale, you need:
– growth (an upward trajectory of earnings)
– a decent level of profitability (north of 12% EBITDA to revenue)
– a business with a large percentage of recurring revenue
– a strong management team in place
– clean income and cash flow statement and balance sheet
– a well-run organization with advanced ERP and technology
Give yourself 1 point for each of the above. If you’re hoping to sell your business in a few months and have just come to realize that you scored a 3 of 6 in the above mini-test, then good luck with the sale.
According to the BDC, over 40% of business owners are expecting to sell their business in the next five years, most of whom expect to sell the business outside the family. According to the same study, over 70% of the business owners are reluctant to take the risks required in order to sell their business, and over 50% are reluctant to expand.
Hopefully, you understand the dilemma, yes?
Most entrepreneurs are unprepared for a business sale and aren’t willing to take the necessary risks required in order to maximize value.
When I met with my first investment advisor four years prior to the business sale, I was quite dismayed to find how unprepared I was for an eventual sale. Not only did I not have my personal affairs in order (family trust and tax planning), but I was completely overwhelmed with the list of items that needed to be ready when I decided to pull the trigger.
The List Was an Excel Document with 140 Line Items
140 line items! That’s how many things the M&A advisor needed to see, and the business needed to have in order, prior to even going to market.
I glanced at the list, made a mental note of some of the top things that needed to be done, and got to work.
It took me four years to organize the business and get things prepared enough so a buyer would be willing to consider the business.
For starters, I was one of the primary sales reps in my business. I didn’t have someone running the sales department, the accounting statements weren’t accrued monthly, the business didn’t have a large percentage of recurring revenue, and there was no management team in place.
My business was me.
No me, no business!
If you’re that person who thinks their business is worth millions, and you scored a 0/6 in the mini-test, then you, too, need a heavy dose of realism medicine. It’s time to hunker down, get to work, and swallow that bitter reality pill.
Before you go, and on a related note, if you liked this blog post, I think you might find this one relevant as well: How Do You Know When It’s Time to Sell Your Business? It’s Not All About the Money.
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