Start early if you’re eyeing the exit at your business
Call it an exit, a liquidity event, retirement or some yacht money—selling a business can be a major life-changing moment. And like other big life moments, it takes a lot of planning.
Few people would wing their wedding or sell their home willy-nilly, but plenty of business owners wake up and decide they’re going to try to sell a business with shockingly little preparation. The outcome? Low valuations on a life’s work.
To get top dollar, there are a handful of preparations and best practices. But the key is starting early—very early, advises John Sensiba of Sensiba San Fillipo, an accounting and advisory firm based in California.
“I’d argue that you shouldn’t go into a business unless you have an exit, and that sounds silly to entrepreneurs, but you should really have that in mind. Most don’t,” said Sensiba. “As soon as you have a profitable business I think you should start thinking about a sale and how to enhance valuation.”
To do that, there are a number of steps. First, know the industry or find someone who does. Operators often think they are the most knowledgeable people about their respective industry, and certainly an operator in Massage Envy knows a lot about the massage industry and a KFC operator knows plenty about QSR chicken. But selling a business is an industry in its own right, and one that is tricky to fully grasp when rumors and braggadocio dominate the conversation.
“Even the announced numbers and the final numbers are very different,” said Eric Gagnon, founder of the franchised We Sell Restaurants brokerage firm.
“If you have five franchisees at a conference from the same brand, everybody’s restaurant is worth $1 million. After a few cocktails it’s $1.5 million,” said Gagnon. “But the problem is nobody is writing that check.”
Do not go it alone
A dizzying array of factors go into a realistic valuation. Is the brand on-trend? Is the location still good? How saturated is the market? And then there are things like leases; if an owner is nearing the end of a lease and rent is about to rocket to market rent, that’s going to be a big factor.
“If the seller has a good relationship with the landlord, that makes it a lot easier to get the leases signed,” said Scott Jasinski, CFO at the growth-minded, M&A-savvy GPS Hospitality Group in Atlanta. “When a seller has no relationship, the landlord will always want something added on the lease.”
Getting a clear picture of all that while operating a business is difficult. That’s why smart operators hire professionals. “Remove yourself from the middle of it, and find somebody you can trust,” said Gagnon.
Even if that valuation isn’t the $1.5 million an operator was daydreaming about, knowing what a buyer will actually pay is key. It might be shocking, but it’s better to find out early, explains Terry Kelm, president of Sunbelt Franchise Sales & Re-Sales. “The time to find out what it’s worth is not at the closing table,” Kelm said.
Certainly both Kelm and Gagnon are a little biased given their field, but no matter the adviser or broker, they’re there to move businesses and the best make money when the seller makes money.
After dialing in on that valuation, sellers should patch any holes in the business. That starts with not doing anything illegal. It seems obvious, but little foibles here and there from employment to tax dodges are the fastest way to kill a deal and are surprisingly common. Sensiba said he sees plenty of legal issues cross his desk, and it’s something to dig deep to find.
He starts ticking off potential problems. “Anything contractual; what restrictions there are to transfer; any HR issues; have you complied with labor laws? That’s potentially huge. If you’ve got people working split shifts or working more than eight hours, even not out of choice but you didn’t know,” said Sensiba. “Hold out until those are remedied.”
Then it’s up to sellers to fix anything sapping dollars from the valuation. For instance, many operators employ a few extra staff members, like a daughter off at college that pulls in $35,000 but only works during the summers or a spouse that looks over the P&L every few months and pulls in a salary. While they are perfectly legal ways to spread the tax exposure around and something a broker can add back to the business documentation, they make the business look less profitable when it comes time for the buyer to get financing.
A no-hassle premium
Getting the business on track also means taking care of deferred maintenance and pondering that upcoming remodel. Just like selling a house, there is a no-hassle premium for businesses. If a seller has a remodel or reimaging commitment within a couple years, it’s more that just the cost of the remodel, it’s also the non-operating time and all the hassles that come with construction.
Even GPS, which has a strong track record of buying franchise operations and updating them in the Burger King system, could use a break. The group will be 80 percent done with remodels by year’s end, but a lot of hardhats and headaches exist between here and there. “It would be nice if we could get into a transaction without a big remodel commitment just because of our current commitments,” said Jasinski.
More and more, strategic buyers like GPS will be sitting at the closing table. “We are seeing a growing number of platforms out there that are just looking to be the next Flynn, for example,” said Cristin O’Hara, managing director and market executive at Bank of America Merrill Lynch, referring to Greg Flynn, the mega-franchisee on the West Coast who tops Franchise Times list of largest franchisees published each August.
“A lot of folks are angling for that path,” said O’Hara. “The franchisors are getting more and more used to that too.”
The next step for sellers is getting all their documents in order. Three years of full financial records is typical, so buyers can see seasonality and performance in at least slightly different macroeconomic climates.
“There are decisions I should make like, ‘Should I take my whole firm to Mexico because we had a great year?’” said Sensiba. “Maybe if it means retaining top people, but if it’s within three years of an exit, you might not want that expense.”
Everything on that P&L will sap the bottom line, and in a transaction, even the nicest buyer will certainly point to such expenses as rationale for a lower price. Beyond purely financial documents, operators need to make sure the differentiators are well documented.
“If someone is going to buy a business, they want to make sure the business is not overly dependent on a very small number of the management team. Not only do you want your financial house in order but also have your processes documented,” said Sensiba. “You want to make sure you’ve diversified your risk. Really, acquisitions on both sides are about mitigating risk.”
Roger Matthews, an investment banker and managing director at Bank of America Merrill Lynch, said those three things are a lot of work, but they’re critically important, even now at what is arguably the top of the business cycle and valuations.
“Do the prep work up front: get yourself organized, think through a set of projections, organize information. Don’t be in such a rush to market that you do it in a sloppy way,” said Matthews. “If you do those three things, in general, you’re going to be successful.”
After all that, it’s just a matter of finding a buyer.