John Hammett,
Cherry Tree Securities:
952.893.9012
jhammett@cherrytree.com
www.cherrytree.com
Right time to sell
is not arbitrary
date on calendar
IF YOU ARE like most private company owners, more than half of your total net worth is tied up in the value of your company. You have built this value through years of hard work and reinvestment in the business.
Have you thought through how and when to sell your company when it’s time to cash in?
Selling a company is usually a once-in-a-lifetime event. To get the maximum value from what you have built, you need to think differently about yourself, your company and the selling environment.
All about you
Personal timing. I have heard entrepreneurs say, “I’m going to stay in the game as long as I have my health.” Or they’ll say, “I’ll sell my company when I’m 65.” This kind of thinking leads to low value.
Is your business going to be worth more or less after you’ve lost your health? We all know the answer to that question.
Waiting for a certain time, such as age 65, doesn’t take into account the external factors that can affect the value of the business. What if there’s a recession that year or Congress raises taxes when you are 64?
You need to pick the right time to sell, not let it come creeping up on you as some date out there on your calendar. Sellers who take positive action at the right time get higher value.
You wouldn’t commit to sell any other investment (stock, real estate) at an arbitrary fixed date in the future, so don’t lock in the sale of your company with that limitation.
Protecting wealth. Two things happen as an entrepreneur grows a successful company: The company increases in value and the entrepreneur gets older. This means that the time gets shorter for recovery from bad events that can hit your largest asset.
Private companies are at risk every day from customers, suppliers, employees, government regulators, the economy and many other factors. Entrepreneurs are good at bouncing back, but bouncing back takes time.
Before you run out of recovery room, you need to think about selling all or part of the company to preserve your wealth. For those not ready to retire, a recapitalization with a private equity partner gets “chips off the table” while the owner still retains an ownership stake and still runs the company.
About your company
Sell from strength. Buyers pay for the future. The time to sell is when the future is brightest. Sell early and let the buyer pay you a premium for your “best year ever”. What kind of value can you expect if you wait until the year after your “best year ever”? The difference between these two scenarios can be as much as double the price!
Make yourself useless. Buyers don’t want a one-person band because they need management in place when the “one-person” is paid off and retired. Begin building a management team that buyers can rely upon to deliver continued strong performance long after you are sitting on a beach.
Pick strong managers and let them take charge. After the money, the second thing that buyers ask about is the management team. Both the value of the company and the likelihood of closing are increased by a strong team.
Find the high-value buyers. In order to maximize value, you need to find high-value buyers. These are always different from you. In fact, your cross-town competitor is probably one of the lowest value deals because you bring nothing to the deal that they don’t already have.
On the other hand, a company that is strong in an adjacent market sector can realize high value from combining your company with theirs.
About the outside world
Take advantage of economic trends. Sellers always project increasing sales and profits. It is much easier to convince buyers of that projection when the economy – or just your particular sector – is growing and profitable. Be prepared to sell your company when the market outlook is good.
Watch demand for deals. Valuations for private company sales can be driven significantly by supply and demand. Deal value multiples today are at historical highs because private equity investors have raised more than $130 billion to buy companies.
When hungry buyers compete, prices increase. At the same time, strategic buyers (companies already in your sector or adjacent sectors) are active acquirers. Their stock value is high and they aren’t reluctant to go use those high values to make strategic acquisitions.
Taxes drive your take-home. Sellers have always had one big advantage from the tax structure. While you own your company, your earnings are taxed at ordinary income rates of 40 percent to 45 percent. In contrast, most of the value from the sale is taxed at capital gains rates of roughly 15 percent to 20 percent.
This means that the proceeds from the sale of a company at six times pre-tax earnings may yield a net price after tax that is 10 times after-tax earnings.
Today, capital gains rates are the lowest in history. When they go up again, it will take cash out of the pockets of sellers.
Your company is probably your largest asset – treat it that way! Continue to grow the business. Recruit a strong management team that can run the company without you. Put good people in place and let them learn to work together effectively without you. Act when the outlook is strong, deal demand is high, and capital gains tax rates are favorable.
Cherry Tree’s quarterly deal tracking report shows that in the first half of 2007 deal multiples were still high. However, the market conditions are mixed, with the number of deals declining. Weak companies are not getting bought, but strong companies with good earnings are seeing strong demand from buyers with plenty of capital.
This is still a sellers’ market for private companies. For those owners planning to retire in the next 3 to 7 years, this may be the best time to make the deal that provides for your retirement.
