PCI

Traditional Exits

In the USA alone, every day over 10.000 Baby Boomers retire, of which 20% own a business, totalling about 12 MM businesses. Each year, 600.000 businesses hit the for-sale market, world-wide. Only 8% of those are actually bought.

A US data company noticed 26,000 private business sales in 2015. The average business sold had $100,000/yr profit and sold for 2.6 times that = $260,000. If they had managed to increase profit by 10% the numbers would have been $110,000 and $286,000. An increase of just $26K.

However, if they kept the post-tax profit the same and were able to get the multiple up from 2.6 to 3.6, the final amount would be $360,000. An extra $100K in their pocket. What about if they were able to change the multiple to 10x? Is that even possible for a normal ‘non-tech start-up’ company?

Annually, millions of entrepreneurs go into business with the idea that in 3 years’ time they’re going to sell the business for millions and retire. They get to the end of those 3 years and realize their business is in no position to be sold. 

Reality is that 50% fail within 1 year, 80% fail within 5 years, 96% fail within 10 years. 

Or if they try to sell their small business, what others offer is so hugely unappealing that they decide to go back, and try really hard to grow the business to a point where it becomes much more valuable. However that happens only in a few cases. In most cases these people have already hit their ceiling of competence as a pioneer businessman, mostly operating under a 'survival-mode mindset'.

A company trading on the stock market for over 10 times net profit, uses its shares to acquire other companies for only 5 times their net profit. Then they add that company into their balance sheet. The difference between the multiple they paid for a company and the multiple their own shares are being traded for is all additional value reflected in their own shares.

In effect, they have just made money by buying a company. The more profit they buy, the more valuable they become.

From a Chief Financial Officer’s (CFO’s) perspective, creating new stock to acquire added revenue or added profit for your own company makes an whole lot of sense: you create new shares, you acquire a company and as far as the market is concerned your revenues and profits keep growing.

Many CFO's do that, because they have to show revenue growth the end of every quarter. One of the easiest ways to do that is not to try and find new customers but go out and acquire companies that have those customers.

Once you realize this, you might ask why public companies don’t just go around acquiring anything they can lay their hands on. However, acquiring lots of companies through traditional Mergers and Acquisitions (M&A) causes huge disruptions to their core business, and their company would find itself with severe ''indigestion'' as they are trying to merge cultures, systems, processes, etc.

It is a real eye opener when you begin to understand how public market valuations work and you see how much wealth creation goes on at the other end, where investors, banks, VC's make their money by investing Trillions of dollars.

A world of which most entrepreneurs know little. Isn't your most important customer the one who buys your business?

What are the options a SME owner has for releasing the potential from their hard work and years or decades of labor? Let us look at the traditional exit methods first:

Summary of Traditional Exit Routes 

Shut up Shop

When a business owner gets to the point where she/he wants to leave, they put the business on the market for what they think it’s worth, because they have no concept of how to sell the business. They wrangle for years to get a buyer and negotiate a sale, but by then they’ve completely lost interest in the day to day running of the business.

One tactic that buyers often use is to drag out the process so long and tie up the founder’s time so much that over time the business gets worth less and so they can renegotiate the price down to next to nothing. By that stage the founder is just done with the process, wants out, and often ends up closing it down and walk away. Any value in the business is destroyed.

For the first time in history, the next generations are getting smaller in number. So, even less people who could be buying your business. There are plenty of businesses that have been going for decades, turning over millions of dollars, having great clients, great staff, but if the owners can not sell them, they will ultimately fade away.  

Most of your potential buyers are also disappearing, because why would someone buy a restaurant, an accounting firm, or any traditional businesses, if it is so much cooler to have a phenomenal virtual website serving everyone in the world?

Pure Trade sale for Cash

Another option is a pure trade sale, where a company or an individual buys you out. However, if you’re looking for a clean exit, you will get a lot less money for your company than if you are prepared to do earn-outs. Many entrepreneurs truly believe that somebody gives them a suitcase full of cash, and they walk away into the sunset.

Earn Out

An earn-out is the promise of a pie, linked to your future performance. A buyer says, "we’re not sure if the company is worth $ XX. So, stick around for 3-5 years, to make sure the company delivers, then we give you the rest of the money."

However, as soon as they own you and the company, they tend to change all the rules, like you having to adopt to their reporting standards, and them taking most of the cash out of the company's bank account, etc. etc. Then the first time you try and hire someone to actually hit those agreed upon sales targets, they say, “Oh sorry, there’s no budget for that.” They make it very difficult for you to achieve the promised results.

Their expectation is that the founder will quit before earning the full amount and thus they will end up with an asset at a discount, and they think through their own brand of entrepreneurial delusion that they can run it better anyway. They are too obsessed with control over results. However, results come often from giving control not taking it.

Grow by Merger & Acquisition

A genuine alternative to exiting is to grow by acquisition. Thus, you could try and raise money, and add some real value. But because of the challenges around scale and liquidity, any cash investor wants a belt and braces approach to the deal, to be absolutely sure to get their money back.

Thus, the investment looks more like ownership. Most investors want a ten-minute plan, instead of an organically growing ten-year plan, so you give them an impossible to achieve ten-month plan.

One way that people have tried to address this problem is through a ‘Roll-up’. A traditional roll-up brings a bunch of businesses of a similar industry together. Then they rebrand them all to the same name, and enforce the natural synergies that exist between them.

However, every manager suddenly stops thinking about how they would grow the business and starts thinking about what their personal role in the new enlarged organization is going to be. So you end up getting a lot of territory fighting and internal politicking.

Because this process tends to be ego driven, owners tend to be more obsessed with keeping their brand name on their building, than worrying about the business fundamentals, which is making sure more money comes in than goes out.

Lots of mergers and acquisitions fall through, because the top level cannot agree on who’s going to be the chairman and who’s going to sit on the board.

Do an IPO

If a company is growing well, they may choose to do an IPO themselves (Initial Public Offering, when you put your company on the stock market). IPOs have, until recently, been seen as the ultimate goal for ambitious entrepreneurs.

Before a Market Listing, you build your company to a point where it is big enough to take on public shareholders. This is seen as a validation of the business and allows you to raise money for your business at better valuations. The investors you have picked up along the way now have a public market to trade their shares.

With an IPO comes credibility. It should in theory be easier to attract good clients and staff because of the halo effect of being a public company.

Most of the problems faced by smaller businesses can be fixed by merging them and then publicly list the new group.

However, there are a few downsides to consider when looking at an IPO:

The average IPO costs $3.7 million, takes 18 months, and ties up your entire senior staff for the last 12 months of the listing process.

The above contains excerpts from the book Agglomerate

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