Rushing down a mountain can kill you, rushing to sell a business can cost you a fortune.
By John E. McNellis, Principal at real estate developer McNellis Partners, for WOLF STREET:
Thirty-eight years ago, friends went on a day hike near Yosemite. The couple took the wrong fork up a dry creek bed and, instead of the picnic spot they sought, soon found themselves bouldering ever higher against a steepening slope. Finally, the alarmed woman insisted they stop and await help. Embarrassed by his faulty wayfinding, her boyfriend ignored her pleas, and started down the mountain. He fell to his death within minutes. She spent two nights shivering in the wilderness awaiting a helicopter rescue.
Only 15% of Mount Everest’s 212 climbing deaths between 1921 and 2006 occurred on the way up. Almost all happened on the descent. British Medical Journal 2008
No better metaphor for business exists than mountain climbing. Both are challenging, exhausting and, on occasion—say, cresting a ridge—exhilarating. And if you don’t pause every so often to smell the edelweiss, to admire how far you’ve come, you’ll miss the magic of both endeavors.
As with mountaineering, the way up in business is grueling, but it’s also satisfying and often enjoyable. Going down—selling a successful family company—isn’t much fun and can be dangerous. Three basic routes lead off Biz Peak: a sale or gift to heirs, a sale to key employees, and a sale to a third party. Naturally, there are countless variations on those three descents.
A family transfer may be ideal…if you happen to have bright heirs who are interested in your business. The catch is that, for the sake of those bright heirs’ sense of self-worth, they should learn the business elsewhere, to know in their hearts that they could succeed without being handed the combination to the company safe.
That takes time. Paraphrasing Eric Clapton, it takes 10,000 hours to learn any job worth having. This means your heirs should spend five years working elsewhere. And, once they start working for you, you need to stick around for another handful of years while—here’s the hard part—letting go of the steering wheel.
The age old problem with family transfers is that one heir typically runs the business while her siblings are mere shareholders, often creating insurmountable conflicts of interest; the CEO heir wants to reinvest the cash flow and take the business to its next level while the others are demanding fat dividends.
A sale to key employees has curb appeal; after all, they’re the faithful Sherpas who bundled you to the summit. The catch—there’s always a catch—is this: While they likely have the expertise to run your business, they never have the cash to buy you out. Your sale must be on such generous terms that it borders on giving the company away: e.g. nothing down and a pay-out from the company’s cash flow over five years.
This means you’re keeping your corner office until you’re paid off. One friend sold his financial services company to his employees at book value in exchange for an annual salary of $250,000 and twenty percent of the company’s profits over the ensuing five years.
By the way, “book value” is accountant speak for not much; the book value of a service company consists of its accounts receivable and the depreciated value of its few hard assets (e.g. the antiquated computers and worn-out couch). It’s been said a thousand times: The real assets of a service company go home at six o’clock.
If you’re lacking talented heirs or employees, a third-party sale is your way out. Google has dozens of paid ads by eager business brokers and even more formulations for determining the value of your business. A little research will reveal that six months is warp speed for the sale of a business and that they often take several years.
Worse, if your business depends on income from clients that can walk tomorrow (that is, virtually every business), then chances are—once again—you’re sticking around after the closing. Your buyer will likely insist on an earn-out that keeps you on the bench long after your name is no longer on the team jersey.
This is all a way of saying that, whether you sell to family, friends, or strangers, you need to plan years ahead if you want to cancel that subscription to the Wall Street Journal and devote yourself to snorkeling on Maui. Rushing down a mountain can kill you, rushing to sell a business can cost you a fortune. Put another way, selling a little early—going out on top—is how you maximize your return.
Final bit of advice: Hire an advisor, whether a broker for smaller companies or an investment banker for substantial businesses. Hire this advisor three years before you want to close the sale of your business to give him the opportunity to prepare it for sale.
Chances are you’re expert in your chosen field, but also pretty fair that you know little about evaluating your business, and next to nothing about the process of selling a company. And nothing like a savvy broker to drum up competition, even when there isn’t any. Now, if I would just follow my own advice… By John E. McNellis, author of Making it in Real Estate: Starting Out as a Developer.
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