The 8 Components of the Sellability Score

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Eight ComponentsWe’ve reviewed John Warrilow’s book Built to Sell in our book club series and many of our case studies are taken from accounts shared on his Built to Sell podcast. In many of those interviews John goes over the same ground with business owners as they share their stories of building, growing, and exiting. Over time, John has developed a “sellability score” that we think captures some key metrics all potential sellers should take note of.

Financial performance

This metric is about your history of producing revenue and profit as well as how consistently and professionally your books have been prepared. In a certain sense, every business transaction starts here and it’s something we can never say enough about: pay your taxes and keep accurate financial records.

Growth Potential

If someone were to come into your business as a new owner, what rate of growth could he/she expect with regular effort? With nights + weekends effort? This can be gleaned not just from the trends your financials show, but products/services you have not yet implemented for various reasons. Could the business expand geographically? Could new customers be created from unused capacity?

Switzerland Structure

For Switzerland to have been neutral for centuries, it has had to learn to be very self-sufficient. Neutrality may keep you out of conflicts but sometimes it isolates you as well. So too with your business and dependence on a single customer. A general rule is that no more than 15% of your company’s revenue should come from a single customer. The more diversified your revenues are, the more attractive your business is to buyers.

Value Teeter-Totter

Can your business finance its growth from its own cash flow or does it need to rely on outside capital? A buyer will pay more for a company that has less need for outside financing, and will pay less for a company that has more need for it (hence the “teeter-totter”). Two quick ways to make adjustments here would be to reduce your collection times from your customers and increase your payment times to your vendors.  

Recurring Revenue

Do you have recurring revenue? Is it in the term of subscriptions or long-term contracts? What is your churn/cancel rate? The clearer your answers to these questions, the more a buyer can be assured of some “guaranteed” revenue.

Monopoly Control

How well are you differentiated from your competitors? The greater your competitive advantage, the likelier you are playing in a blue ocean, in which you define the rules your competitors play by. The more differentiated a business is, the more valuable it is to an acquirer.

Customer Satisfaction

In a previous article we discussed Fred Reichheld’s Net Promoter Score and how it could help you better understand how happy your customers are. In a certain sense, customer “satisfaction” is simply a baseline. You want them not just to be happy with what you’ve delivered, but happy enough to share your company with others.

Hub and Spoke

What does your management team look like? If you were incapacitated or unable to work for a period of weeks or months, how would your company perform? Employees that can be counted on are a major driver of confidence (and value) for potential buyers.

These factors are not a definitive list of key things a business owner should look at before considering a sale, but they are a very good list. And one that, if seriously attended to, will make a business incalculably better. Even if selling is not on the immediate horizon.  

Unhappy about how any of these components in your business at the moment? Give us a call so we can help you improve and get on the path to a possible exit.

4 Financial Ratios to Better Understand Your Business

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Financial RatiosSome business owners confine their working knowledge of finances to what’s in the bank today vs. what needs to be paid today. Others will give a quick glance at monthly financial statements their bookkeepers have given them. But the most savvy business owners take those financial statements and examine some simple financial ratios in order to keep tabs on and improve their small businesses. These ratios should be compared to industry standards. (Don’t worry, there won’t be a test at the end!)

Quick Ratio

Also known as the acid test, the quick ratio is a way to understand how much money you have to deal with your current liabilities. It’s calculated by taking your current assets (excluding inventory, which is not quickly convertible to cash) and dividing it by your current liabilities. 

A ratio of 1.0 is acceptable, but it means that you have only $1 of cash on hand to deal with each $1 of liabilities. Anything north of 1.0 means that you have at least a bit of cushion in case of a cash crunch.

Gross Profit Margin

This is often considered a “tell-all” metric and is something that should be monitored month-to-month and year-to-year as you want it to stay consistent. You calculate GPM by taking your gross profit (total revenues minus costs of goods sold – COGS) by your gross revenues.  

What the margin is will depend on what kind of business you have. If you are selling a premium product, you typically see a higher margin, whereas if you are competing on cost, a low margin is more likely. As we said, it’s a number that should stay consistent so if your margin goes down it could indicate:

  • Your costs have increased but you have not increased pricing to match
  • You have a problem with shrinkage/unauthorized free giveaways

Net Profit Margin

This is a more granular version of the Gross Profit calculation. In the numerator, you will take total revenue and subtract COGS, but this time also take out operating expenses to arrive at net profit. Divide that by total revenue and you get your net profit margin.  

If you’re unhappy with the number, there are a few remedies:

  • Raise prices
  • Decrease COGS
  • Review your operating costs. Can you improve business productivity?
  • Analyze your sales mix – is it diversified enough?

Average Customer Sale 

If the previous three ratios examined your business at a macro level, this ratio examines it on a micro level by looking at each transaction with a customer. It is calculated by taking the total amount of sales divided by your number of customers. This number will allow you to identify what each customer is spending with you, on average. If this number is much lower than you expect, then there might be missed opportunities for add-on sales or associated products/services at the point of sale. If it’s much higher than you expect, it’s a great opportunity for you to see what is going right and lean into it!

There are a select group of people who live for numbers, but we know that most business owners don’t. If you need some help with these ratios, give us a call so we can help you better understand your business!

2020, Elections, and Capital Gains Taxes

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PoliticsThe new year is upon us, and it happens to be an election year. While the ups and downs of politics may seem to be, at first glance, unrelated to the buying and selling of businesses, the 2020 election promises two different visions for the country in relation to taxes and wealth. That said, it’s always smart to think ahead when it comes to tax consequences for selling a business, so let’s take a moment to examine a few ideas.

Capital Gains Tax

The capital gains tax is assessed on the increase in value between the cost basis of an asset and its eventual sale price. Long-term and short-term capital gains carry different tax rates and are classified based on whether an asset has been held for more or less than one year. The federal long-term rates are currently 0%, 15%, or 20%, depending on your tax bracket.

Taxes in an Exit

TaxesThose who have not sold a business before are frequently under the impression that almost all of the proceeds from the sale will be taxed at the long-term capital gains rate, but that’s not necessarily true. Many business owners are surprised by “depreciation recapture” that is taxed at ordinary income rates. The allocation of the purchase price between hard assets, goodwill, and other asset categories will be part of negotiations between buyer and seller and will have tax implications for both parties. An entity’s legal structure may also impact taxes. What’s good for the seller tax-wise is often bad for the buyer (and vice versa) so these points are often traded during negotiations.  

Time to Sell?

Whatever your political principles or betting tendencies for the 2020 election, it’s important to note that capital gains, like any tax policy, is a frequently targeted item. In 2003, President George W. Bush reduced capital gains to 15%. In 2013, President Obama raised capital gains to 20% for those making more than $400k annually. It was expected that President Trump might push for some capital gains cuts, but no progress on that so far.

We certainly did see a surge in sellers in 2012 as they anticipated an upcoming increase in the capital gains rate. And if you think there might be a change in presidency, many of the opposing candidates are on the record supporting an increase in taxes across the board, including in capital gains. While the election is at the end of 2020, and any legislation will need time and a willing congress to pass, it’s important to think about the tax impact of a sale sooner rather than later, in advance rather than in a panic. The exit is the most important financial decision you will make in building your business, so it’s important to work closely with an accounting professional to consider and plan your tax strategy and how you will structure that into the transaction.

Not sure what your tax consequences will be from a sale?  We can put you in touch with specialists who can help you decipher that.  Give us a call today.

Selling Strategies

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Selling StrategiesSometimes businesses come to us that need a bit of creative spark to sell properly. This is often because the business is in a unique situation. These are often fun for us as advisors because it gives us the opportunity to deploy our creativity and find solutions that get us offers. In this article, we will share a few of those solutions with you.

Reframe Your Situation

Some time ago we were asked to represent a veterinarian who was looking to sell his small-town practice and the associated real estate including his house. When the listing broker recognized that it would be difficult to find a veterinarian who was interested in acquiring both the house and the practice, she got creative and re-framed the listing as a pet boarding facility. This allowed the buying audience to be expanded beyond licensed veterinarians, resulting in more inquiries and ultimately a successful transaction.

Not Everyone Wants Your Other Assets

In a previous article, we’ve discussed the importance of being proactive when it comes to the disposition of real estate within your business. As with the previous example, someone might not have wanted a vet business and a house. Sometimes people look at companies that have a lot of vehicles and some of those vehicles were simply bought by owners because of personal tax strategy, not because the vehicles are particularly relevant to the business.

This is why business owners always need to consider two things when looking at asset purchases in relation to current tax liability: how will it help me now AND how does this affect our ability to sell later. Too often, people look at the former and forget the latter even exists, when the reality is that sometimes a considered look at the “later” consequences will convince you that the “now” benefits simply aren’t worth it.

It’s also important to remember that when you encumber a business with real estate and or less usable assets, you’ve narrowed your buyer pool. You always want as large a buyer pool as possible.

Be Creative!

While our advisors work hard to have a curated list of trusted buyers and sellers handy, sometimes a business needs other strategies beyond emailing reliable people. Recently we were dealing with a home health care business in a rural area. Because that industry is consolidating, we thought it would make sense to put together a basic flyer and direct mail other home health care companies in the region. Sure enough, that flyer stirred up some interest, which led to offers and an eventual transaction. Direct mail still has its uses!

Participate in the Transition

A similar approach was utilized when we were representing a very niche energy consulting firm. The sellers recognized due to the nature of their business, a longer transition period would likely be required and that the buyer was probably someone already in their industry. They decided to put the business on the market a few years before they reached retirement age, allowing them a great deal of flexibility for transition. Direct mail was again used to proactively contact potential industry buyers, resulting in a transaction where the buyer’s synergies create greater profits than the sum of the parts and where the sellers’ post-transaction participation will allow them to share in the financial benefits of these synergies.  

Do you have a unique business or know someone who does? We can come up with a unique strategy to sell it!

Three Keys in a Recurring Revenue Business

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Recurring RevenueRecurring revenue businesses, particularly those built around subscriptions, are becoming more and more popular in the internet era. Even better for those interested in selling, they often fetch a higher multiple than businesses that do not have subscription/recurring revenues. There are three numbers that anyone building such a business should spend a lot of time refining and correlating, and if they do those tasks well, they will quickly have a business they can sell.

1. Gross Margin per Customer

This is pretty straightforward. Given your costs to service a client with either a product or a service, what margin do you make? This doesn’t have to be an impressive number if your volume is high, and conversely, if you’ve got great margins, you don’t necessarily need overwhelming volume. This is a number that every business owner should know.

2. Lifetime Value (LTV)

Another number that every business owner should know is the lifetime value of the average customer. If they are selling products, this number can be sampled over a period of time if it’s not clear that a customer ever stops buying from you forever. If you are selling a service, you would look at the revenue gained before the customer cancelled the service and average that out against all of your customers.

3. Customer Acquisition Cost

Customer Acquisition Cost becomes a really important part of this trilogy of keys, because it tells you whether your business model is viable in the short and long term.

If your customer acquisition cost is paid for either within the gross margin or over lifetime value, you’re in the black. But if, for example, your customer acquisition cost is $100, your lifetime customer value is $100, and you have a margin of 20%, you’re losing money every single time you get a new customer.

Customer acquisition usually isn’t just one single cost, but is a combination of all your marketing efforts across all your channels, as well as the salaries of your team that drive those channels.

As soon as you have proven your model in such a business, you are actually in a prime position to sell.

Unless you want to push forward with new growth or sit back and take it easy for a while (both options that would keep you in the driver’s seat and not selling) you should seriously consider selling a proven recurring revenue business. The newer a business is, the more opportunity there is for growth and new market share, which is very attractive to an incoming buyer.

Whether you have a recurring revenue business you’d like to sell or you’d like to buy one, we can help! Give us a call.

“Call Me When You Have a Buyer”

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Call Me When You Have a BuyerAs part of our job as business brokers, we cultivate long-term relationships with buyers and sellers. We do so with the latter because sometimes we plant the seed of possibly selling a company years and years before it may happen. With the former, it’s a question of earning trust by consistently bringing solid opportunities.

Sometimes on these calls or emails, we will get into a conversation with a seller who has tried to be his own broker in the past. And as such has (predictably) had bad experiences with looky-loos and tire kickers. “I’m only interested in serious buyers,” the seller will grimly state. “Call or email me when you get one.”

If only it were that easy.

The reality is that buyers are reasonably savvy about the acquisition process. They are going to want a fair amount of information about the business upfront. Furthermore, we as brokers want to exclude tire kickers from bothering our clients, so we ensure that they have the financial ability to close a transaction of the size they pursue. We aren’t interested in finding one serious buyer, but rather half a dozen or more.

Confidential Business Review

The process begins with a Confidential Business Review (CBR) that details business operations and historical financial information. This briefing allows buyers to quickly see whether a particular business suits their needs and if their transaction goals are in line with what the seller is offering.  

Once a very simplified form of the CBR (brief description of the business, approximate revenues, net owner benefit, and asking price) has circulated among our internal buyers and the confidential marketing channels we use, we will get a number of interested parties who submit Non-Disclosure Agreements along with proof of financial fitness. For the sake of argument, let’s say that a given broker may reach out to 500 and get 50-75 interested parties for this first step.

NDA and Balance Sheets

Once we get their NDAs and balance sheets, we will then get them the CBR. From that step perhaps a dozen of the original 50-75 decide they want to go further and have a phone or in-person conversation with the seller. Of the dozen, perhaps half decide to visit the business in person and of those, perhaps three make bonafide offers.  

See the difference? At each step of the way, we have continued to qualify the buyer both in terms of financial ability and knowledge of the business. And at the end, instead of “one buyer” we may have several, and these people have come to this step with serious knowledge about the business opportunity.  

Save yourself from the tire kickers and leave the work (only a fraction of which is detailed above) to us. That leaves you free to run your business and keep it growing and profitable until you’re ready to pass it on to the buyer whose offer you ultimately accept — after a screening process that ensures it’ll be a serious offer.

Common Characteristics of Businesses That Sell Quickly

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Moving QuicklyWhile every business sells for different reasons, the businesses that sell quickly here in our offices — and by quickly we mean within 24-72 hours — all have a few traits in common. These traits happen to work well in the case of selling a business, but they are always present at the heart of the most successful businesses. By keeping an eye on these fundamentals, business owners are actually ensuring that should they want to sell, they will get several full price offers, and in a very short time horizon as well.

Clean Books and Taxes

You’ve heard us discuss this in past articles: have clean books, or face the possibility of not being able to sell. But successful business owners aren’t interested in having clean books just in case they want to sell. They know that current financial statements are essentially an up-to-the-minute health snapshot of their business. By regularly perusing clean and current financials they are able to see trends and make adjustments or trim spending in underperforming divisions. Clean books and current tax payments are simply by-products of a successful business. They also happen to be essential to a business sale and are an immediate shine on any new business listing.

Stable and Up-trending Revenues

Successful business owners look at financial statements to see if they are growing revenues and profits month-to-month and year-to-year. This helps them properly forecast and hire. Buyers love to see the same. An off year with context will be explainable: we had a lot of businesses that sold in past years that either had slow growth, flat-lined, or even contracted a bit in the 2008-2010 time period because of the financial crisis. But because buyers saw stability in the numbers before and after that time period of crisis they were confident that they too could weather a storm if it came.

Consistent Cash Flow

Savvy business owners aim for consistent cash flows. This doesn’t mean that there’s no seasonality in the business, but that the seasonality is clearly pinpointed and planned for. This makes financing easier, should it be required. Again, as with clean books and taxes, consistent cash flows are the by-product of a successful business, not something that someone has to quickly put together in order to sell one.

Delegations

If business owners haven’t read books like Built to Sell or The E-Myth they have usually built their businesses around the concepts discussed in those books just by doing their homework.

  • Have systems in place so that the business can run without you
  • Have clear job descriptions for all the key members of your team and have solid people in those positions
  • Make sure it’s clear whether a potential buyer is buying a job or buying a business.

Reasonable Price

A business is only worth what someone will pay for it, but more importantly, a business is, outside of a strategic acquisition, only worth around what a professional valuation rates it. An owner who builds a company to sell may have a number in his/her mind, and that’s certainly a point around which to build a conversation, but unless the business provides evidence to get to that number, such a number is a fantasy.  

Remember that only 20% of businesses are ever successfully sold. Here at Apex, we have a much better track record, and part of that success is getting to the right price for both buyers and sellers. Successful business owners have been setting prices for their clients for years and letting the market, not their ego, tell them what products/services are worth. The sale of the business is only the last decision in a number of previous sensible pricing decisions.

If you only have three of these characteristics in your business, we should have a conversation about what you’d like to do in the future. If you have all five, you should be having a conversation with us about why and when you should sell.  

Anxiety before Closing is Normal

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AnxietyOne of our brokers was recently asked to be part of a panel at a conference. The panel topic was about experiences in selling a business and in preparatory slides she saw a focus on the stress, emotion, and anxiety that came with a business sale.

Being a rather no-nonsense type herself, she thought it was too focused on the emotional side of the transaction, until a timely email from her to the buyer and seller (and the responses) reminded her this is indeed something that both buyers and sellers deal with during a transaction. Rather than run away from it, it’s important to discuss it openly.

Delayed Closing

While the two attorneys involved in this deal seemed dedicated to trading punches regarding deal points, both buyer and seller remained amiable and engaged with each other. They took the delay in closing with stride, but even the delayed date seemed optimistic. To add to the regular challenges of taking over a business, the new owners would be moving to Kansas City from out of state.

In response to our broker’s asking about how both parties were feeling, the seller noted that there were still many unknowns. But they were continuing to take one step at a time and were excited to get to the closing date. They were looking forward to introducing the buyer to their whole team.

The buyer responded similarly, noting that a great part of his peace of mind in the transaction lay in the team he had surrounded himself to shepherd this deal to closing. His accountant, his attorney (who we had introduced him to), and other mentors were making sure that all the relevant questions were being asked and we, as the broker, were ensuring that those questions got answered.

Stay Calm and Carry On

During diligence, a lot of “why” questions can come up: “Why did you spend on this?” “What possessed you to do that?”

It’s important not to get emotional or assume the worst. Realize that diligence isn’t a “necessary evil” but rather a “necessary good” (even though many days it doesn’t feel that way!)

Often, the questions answered during this period of diligence lead to long and interesting discussions about the business and operations. The overall philosophy about the company (and life) could not have come up over a perusal of income statements and tax returns. Indeed, this is going to be a significant event in your life, so you should take the time to enjoy the journey and feel all the feelings. But don’t get lost in those feelings to the detriment of the transaction. Assume the best, have a constant and diligent attitude about the questions you ask (and that are posed to you) and move towards a successful transaction.

Should the Buyer and Seller meet in person?

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While we do a fair number of transactions locally between buyers and sellers, quite often neither buyer nor seller lives in the same state. Often, they don’t meet until closing, and sometimes even then they don’t meet. In-person meetings can sometimes close a deal, but other times they can break one. It all depends on the level of communication and what was said prior to that meeting.

The Whole Truth

Buyer and Seller Meeting in PersonA seller who worked in home improvement had a lot of his team out in the field, but he worked out of his home, mostly dealing with customer-facing issues. He had represented to the buyer that he worked roughly 50 hours a week. The buyer was coming from corporate America and didn’t mind “buying a job” that he could systematize over time so this seemed reasonable to him.

He came over one day to see the setup of the home office and walk through some routines with the seller. When chatting with the seller’s wife about the work, they were surprised to hear her say, “Oh he’s down there all the time!” The seller remarked that 50 hours a week wasn’t really that much time, which she corrected by saying, “It’s way more than that!”

The buyer, as you might guess, walked away from the deal. Not because the seller’s wife was candid — she had every right to be — but because the deal had been misrepresented. Fifty hours a week is an entirely different commitment than eighty.

And Nothing but the Truth

But if there’s been honesty and transparency before an in-person meeting, a face-to-face can go a great way towards alleviating concerns.

One of our clients was buying from a husband and wife team out of state. The husband ran the customer-facing side of the business and the wife managed the back office. The buyer began to get anxious about some delays during the due diligence period. In this particular instance, we thought it best for him to meet with the seller and work through some of those issues together. They ended up meeting for several hours and everyone walked away delighted.

The buyer was more comfortable: he now had context for the delays he had been experiencing.

The seller was more comfortable: he got to know the buyer even better and felt more comfortable selling the business to him.

The process accelerated, including a segment of having the titles for 24 vehicles included in the sale. The improved buyer/seller relationship made that go even smoother. When the deal closed, the buyer flew in and they all went to happy hour together to celebrate.

We think that, overall, a face-to-face meeting, if it can be easily arranged, is a major plus in a transaction. It gives faces and voices to emails and contracts, and can help to give personal context that may smooth deal points later in the process. The only time it might undermine you is if you weren’t transparent in the first place. In that case, whether a spouse is present or not, you might unintentionally reveal what you should have shared in the first place, and (understandably) have a buyer walk away as a result.

Sometimes Liquidation is the Best Option

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LiquidationWe’ve shared before various reasons that businesses don’t sell, but sometimes the advice we give to sellers after we’ve looked at everything is not to sell, but to liquidate and close. This isn’t because we’re excited about possibly missing a commission, but because what might be a short-term gain for us, it probably won’t give the seller enough or work out to be a long-term win for the buyer.

An example we’ve seen before is when a family owns the real estate that a business operates on, and another family member owns the business that is located on that property. Very often the party that is operating the business is getting preferential rent treatment. Sometimes the rent might be delivered late, but more importantly, often the rent is below market rates.

This creates an imbalance – a business can then seem to be far more profitable on paper because one of its key operating costs is artificially kept low. Higher profitability leads to a higher valuation and higher listing price. But in this case, the profitability is simply inaccurate. If the party that holds the real estate is perfectly happy to accept below market rates (we’ve seen as low as 50% of market value – sometimes more) for whatever reason, they aren’t trying to harm the business – but it functions as a de facto rent control. By not forcing the business to compete in market conditions, it has given it an artificial environment to thrive. While this may work out for both parties, sometimes for decades, it often dooms the business when it comes time to sell, for two reasons.

Fake Pricing

Again, as mentioned above, the value of the business will have to be adjusted to take into account actual market pricing. This is the only way to discover whether the business can actually be run once that’s taken into account, or if the business is even profitable.

Inability to Resell

Part of the reason any buyer buys a business is because he/she too wants to, in time, sell on as well. A business that has this sort of risk attached – what happens if there’s a conflict with your landlord? Everything could be at risk – is less attractive to buy and even more difficult to resell once you are one owner removed from the original arrangement. Sure, perhaps the party that has the real estate is happy to keep taking checks from you, but perhaps the reason they were okay with the lower rent was because the other party was family…and you’re not.

In cases like these, when we do a recalculation and see that there’s not enough meat on the bone to entice a buyer, we encourage a managed liquidation of the business. This allows the party to at least cash out those assets that can be sold, and also frees up the party holding the real estate to either rent at market rates or to sell the real estate and perhaps get into the same arrangement with the business operating party somewhere else or into a new business/real estate holding entirely. Whatever happens, we’ve done our role as brokers, which is not always to sell businesses – sometimes our job involves telling someone the hard truth that they can’t sell a business. While that’s never easy, it does ensure we’re always doing right by every party to our transactions.

Want to know if your business can pass muster to be listed? Give us a call today!