- Oct 7, 2024
- 10 min read
Retirement can be daunting with so many emotions and priorities involved - this gets even more complicated when you own a business. When you’ve sacrificed so much into building a business you never thought you’d leave, the thought of “transitioning out” can be quite jarring.
While we don’t have extremely simple and clear steps for dealing with the emotions involved with selling your business, we have spent enough time as business owners and with business owners to know some things to keep top of mind among all the moving pieces.
Our team at Lighthouse comes from generations of entrepreneurs. Our history is rooted in forging our own paths and moving against the grain. We know how it feels when that go/no-go point comes for the decision of a lifetime and all the risks and feelings with it.
Let’s get to the brass tacks… you’ve been asked to or have naturally started thinking about “what happens next with my business”:
1. People
Small business success is the sum of a team’s commitment and sacrifice. There is nothing more heartwarming nor soul-crushing than going through a rough patch and having your team stick by you even with everything they’re facing in their own lives. These are people that matter. These are people who have made your company great. These are people who deserve to be taken care of.
When push comes to shove, more business acquisitions are lost to how a team is treated post-sale than to the selling price. Whether you feel this in your gut today or are just starting to digest this as you read this monologue, preserving the team you’ve tirelessly built over the years and protecting the culture you’ve forged between each other should be at the top of your priority list.
Here are some common team transition approaches between different types of buyers:
Strategic These buyers are usually made up of your competitors, people in similar industries, or a supplier or customer looking to expand into your space. Their focus is typically on your customer list and your capacity. Their objective is usually to take over your customers and expand their capabilities with your equipment. Their people alignment is typically very low since they have a pre-existing culture and team that will almost always overtake yours.
Private Equity These buyers are made up of career finance professionals who excel at quickly building companies up until they are ready to sell for a higher price. They come in with plenty of resources and will usually introduce a new CEO to run the business in your place. Their objective is to grow your sales as fast as possible through any means necessary, which usually includes buying other businesses and mashing them together with yours. Their people alignment is typically low since their priority is the bottom line, and layoffs are commonplace post-sale.
Independent These buyers are typically individuals who have spent their career in the same or another field but are finally ready to become business owners and take control of the rest of their lives. They usually come in by themselves with their own capital or money from investors to buy a single business, intending to keep everything the same and take over as the president/CEO/owner from you. Their people alignment is typically high since their priority is keeping business as usual, which means your team has to stick around! Turnover post-sale is usually very low.
2. Price
This is the second most common deal killer. Buyers prioritize historical performance (aka your financials from the last 5 years) while Sellers often prioritize potential performance (aka this business could be even bigger). You’ve spent so much time and energy building; people better recognize it, and the way to show their appreciation is based on how much they pay! Unfortunately, business transactions don’t work this way.
Business transactions are based on 3 important elements: EBITDA, Profit Margin, and Quality of Earnings. Each one of these warrants its own novella, but we’ll get to them later. Simply put:
EBITDA is how much real cash the business generates each year (Profits + Your Salary - Market Salary to Replace You + Amortization + Your Expense cough cough). This number is used to determine how much your buyer has to play with to grow the business after they take over. This single number is the most important piece in any transaction.
Profit margin is the next biggest priority. This is translated into a percent and showcases how much money you keep on each dollar you make; the higher, the better. For buyers, this indicates what the safety net is for the business. If it’s a low percentage, the business can’t afford many mistakes on each transaction, or else the cash flow becomes negative. If it’s a high percentage, the business has some breathing room in case the market changes.
Quality of Earnings (QoE) is often used by more technical buyers (independent and private equity) to determine how “safe” your revenues and profits are. Those economic buyers (who primarily use math for transactions) generally ask for a high proportion of “recurring revenue,” which loosely translates to contracted or subscription-based sales, low “customer concentration,” meaning less than 15% to 20% of your sales come from any one customer, and a “diversified customer base,” meaning your customers operate in different sectors so changes in the market don’t negatively affect all your customer demand at the same time. As you’ve probably guessed, a higher quality of earnings is generally preferred. This process is usually run by an independent accounting firm.
To tie everything together, buyers will often look at these three metrics to determine how the business is performing today and then ask themselves if the EBITDA level, profit margin, and QoE are sustainable into the future or if one-time events drive them.
For you, the question to ask is: “How much is my business worth?” as opposed to “How much do I want for my business?” — a difficult but important distinction. If you’re using a broker and they ask the second question, run. Experienced brokers often act like buyers. They come in with a plan and give you comps (comparable numbers) to determine what a fair selling price is for your business based on your EBITDA, profits, and Quality of Earnings.
This is how the different types of buyers approach this topic:
Strategic These buyers are usually more flexible on price because their intention is to buy very specific things from you and ditch the rest later. Their required time period to make their money back (payback/breakeven/ROR) is generally much longer than other buyers, and they are often able to reduce their fixed costs by sharing resources between their existing business and yours. These buyers are typically very price-aligned since their motivation is to grow their business and beat out competitors.
Private Equity These buyers are generally not flexible on price. They usually see many opportunities each month and only pursue a handful. They buy what the business is doing today, not what it could do tomorrow. Their required payback period is typically the shortest out of all buyers, with a 5-year timeline to sell. These buyers are typically less price-aligned in terms of flexibility but will usually give fair market value to spend less time going back and forth since their motivation is to quickly acquire and grow businesses.
Independent We hate saying “it depends,” but these buyers are usually a toss-up when it comes to price flexibility. Similar to private equity buyers, they usually have a very specific math equation in mind when it comes to pricing your business and will do a similar level of analysis to determine fair market value. They are very sensitive when it comes to the Quality of Earnings and will prioritize that and EBITDA over everything else. These buyers sit in the middle for price alignment and may go above market value if they think they are talented enough to bridge the gap over time since their motivation is to operate the business themselves.
3. Personality
The third priority in the massive list of considerations when it comes to selling your business is the right person for the job. This is where gut feel really comes into play, and where price usually goes out the window for sellers.
We talked about people at the top of the list, and you are part of that team as much as the next person should be. This means you’re not just selling your business, but you’re also hiring your replacement. Essential considerations here are whether this buyer will fit in well with the team you’ve built, will treat your brand name and logo with the right respect, and will be able to grow the business over the next decade to safeguard the team and legacy.
While we wish we had clear answers for you on how to fill out your preference sheet for a buyer, the key to remember is how you feel when speaking with them. How you feel with the potential buyer is how your employees will feel, how your customers will feel, and how your other relationships (i.e., suppliers, vendors, subcontractors, etc.) will feel.
Our opinion is that you shouldn’t differentiate on preference between buyer types, but it would be weird if we didn’t break things out in this section when we’ve done it everywhere else. Here goes…
Strategic When you’re considering selling to a strategic buyer, you should prioritize their team over their owners. In these types of acquisitions, the owner of the other company will rarely be involved in the operations or preservation of your business after the sale, so meeting and feeling comfortable with the buyer’s management team is the most important factor. You’ll need to know who will be taking over each part of your business and get a feel for how they align with your existing leadership team and employees. While strategic buyers can come off as cold and financially motivated, we’ve had the chance to work with many operators who “grew up through the ranks” of the industry and genuinely want to make the right decisions for the people they work with. Your “preference” evaluation of these buyers will come down to how you think the integration will go and how smooth the transition will be for your employees and customers.
Private Equity This can be a tough one to sell on preference. As you’ve probably seen in shows like Shark Tank or Dragon’s Den, PE buyers often come off as ruthless and driven only by profit, which can be a turn-off to a people-first leader like you. That said, many private equity buyers have started as entrepreneurs or have a long career history of growing teams, so don’t judge a book by its cover. The best way to “test” these buyers is to ask them for detailed information on their portfolio companies and how those businesses transitioned post-acquisition. Pay attention to their storytelling abilities (i.e., are they just talking numbers, or do they care about what happens to the people and customers in the long run?). This should give you a good sense of their values and, ultimately, their gut fit for you. When you’re considering selling to a private equity buyer, you should prioritize their “Operating Team” over their “Deal Team”. To make this more clear, private equity companies are usually split into two or three parts:
Deal Team: this is usually the partners and other people you’re working with to “close the deal”. These people run the fund and are in charge of investment decisions but are rarely involved with day-to-day operations in companies they acquire.
Operating Team: this is the most important team for you. Their operating team is usually comprised of industry professionals who have also worked in other companies that the fund had purchased. These will be the individuals responsible for running your business post-sale so understanding their approach and style is essential.
Finance Team: they do budgeting and reporting. They’re usually the ones who have determined your business is worth less than you hoped so you probably don’t like them anyway.
Independent The clearest win for preference-based sales. Independents usually have a very tight budget for acquiring a business, which can mean their bids aren’t always the highest, but the personal care and attention they bring to the business are second to none. These buyers are people who are genuinely ready to roll up their sleeves and work alongside your team as a new leader. Your job here is to ask about their experience in leadership and operations and how they plan to bring their own flavor of leadership to the team and culture you’ve built. This is the longest conversation you should have out of all buyer types. Think of it as an interview for your new replacement. You should prioritize how you feel with them. In summary, this person usually intends to own and operate the business after the sale so their style and approach will translate into the team. The pro: you only need to like one person to move forward, the con: you must like this one person if you’re going to move forward.
Now we’ve covered the three essential priorities of any transaction, we’re going to have to plug Lighthouse, for obvious reasons.
This is how we approach things and why we think we’re better:
People: We know exactly how important a great team is and this is something that we aren’t willing to risk nor sacrifice. We make no changes in the team outside of adding new functions. We want your seasoned managers to stay put and we want to reward your loyal employees for their ongoing commitment to the business. When we run businesses, we like to introduce equity-based and/or profit-sharing programs to reward your team in more standardized ways to take care of them for the next decade.
Price: We make our investment decisions in-house and always come to the table with ways to grow the business without changing the business. We can do this because we worked 9 to 5 jobs until we decided to break out and forge our own paths. We’ve built businesses from scratch ourselves, and our priority is to grow and protect family-owned, independent businesses - something that the world is losing rapidly. When we run businesses, we plan out clear ways to grow so we can take more risk on things like Quality of Earnings which makes us more flexible on price and the types of businesses we work with.
Preference: We obviously feel like we’re the most aligned with you. Everyone on the team comes from a lifetime of entrepreneurship from our families to ourselves. We know what it’s like to stress about payroll, to deal with a bad apple on the team, and how daunting game-changing bets can be. Our mission is to buy and build family names for the next generation, our journey when your journey finishes.
If you’ve made it this far, we hope you liked the Lighthouse part the best. If you did like us - you should reach out and have a chat to see if we’re the right partner for you, and if you didn’t like us - you should still reach out and have a chat to tell us why so we can see if we’re the right partner for you.