This is Part 2 of a 3 Part series in which we explore bringing a business to market and offer a framework that owners can use to determine their optimal sale timing. Part 1 discusses the application of forecasts for sale timing, and Part 3 will provide thoughts on economic trends and the impact of these trends on the odds that a sale process is completed.
Five Personal Reasons Owners Contemplate a Business Sale
Introduction: Navigating Sale Timing Beyond Economic Forecasts
In Part 1 on sale timing we explored the challenges associated with relying on economic forecasts to determine whether the timing is right for a business sale. The future is unpredictable, even for the most qualified economists and analysts. Absent a crystal ball, business owners should instead assess personal factors, business trends, and recent economic trends as inputs guiding sale timing. As we noted in Part 1, although forecasts are difficult to rely on, economic trends are an important consideration in the sale process. We’ll cover a framework in Part 3 that owners can use to assess industry and business trends and how those trends impact a sale process.
Personal factors are often leading contributors to an owner's decision to sell. Below we’ll discuss five personal factors that can result in owners electing to move forward with the sale process. Regardless of personal or economic circumstances, we want to reiterate the importance of preparation for the sale process. Sellers should take steps to prepare for a business sale, which we note can take many months, or in some cases years. Preparation will allow owners to maintain control over timing of the sale process, and in doing so to increase the odds that a sale outcome meets the seller’s goals.
1. Continued Growth is Too Risky or Capital Intensive
The Early Stages of Businesses Are Fraught With Risk
Founding a business requires comfort with taking an elevated level of risk. The formative years of a new business are rife with challenges as an upstart company quells concerns from customers and employees, both current and prospective, about the stability, or lack thereof, of a new product or service.
Beyond product concerns, startup financing is hard to obtain. Bank lenders won’t consider startup businesses, and equity investors selectively form conviction on early stage business ventures. Thus, the founder most likely coughs up the capital required to fund operations, in many cases draining savings or incurring debt in the form of home equity lines of credit, or traditional credit cards. Another expense to factor in the risk equation is the cost of a forgone salary, known as an opportunity cost. Founders not only come out of pocket to invest in a business, they may give up income from a salaried position to focus full time on starting a business. The opportunity cost further increases the entrepreneur’s risk.
Maturing Businesses Offer Opportunities for Risk Reduction
As a business matures beyond the startup stage and grows to a stable level of cash generation, founders can focus on preserving consistency of income. Take for example the hypothetical $1 million cash flow business. A business that is 100% owned by the founder and that generates $1 million of annual income can produce meaningful cash to the founder. But before that $1 million becomes true cash placed in the owner’s pocket, some portion of the $1 million is allocated to repay debt, and another portion is used to fund growth, such as adding employees, purchasing inventory, or buying equipment. Due to the need to pay debt and invest in growth, it can take many years for a founder to break even on an initial startup investment.
In the image below, we show a sample business that requires $325,000 of total owner investment in years one and two ($250k in year one and $75k in year two). By year five the business has generated enough cash flow for the owner to break even on the initial investment. Hardly a get-rich-quick operation, but this is the difficult reality faced by many entrepreneurs.
Once Cash Generation is Steady, Ramping Growth Re-Introduces Investment Risk
Should the business in the figure above desire to grow from $250k of cash flow to $1 million, the owner faces a decision like that contemplated at the startup phase. The owner can again step out on the risk curve and invest in growth, which may require an investment of $500k or more, or the owner can maintain the current $250k of cash flow and live a very comfortable lifestyle. For those owners viewing the investment risk of growing to $1 million of cash flow as unacceptable, an inflection point exists. Maintaining but not growing cash flow has its own set of risks, including erosion of competitive advantage, or products losing their luster. At this stage, owners will want to consider whether selling the business to a group that has the capital and risk appetite to drive continued growth is best for the company.
2. Management Inflection Point
Adapting to Growth: The Evolution of Management
As a business grows, the skills required to navigate strategic decisions will change. While some businesses opt to avert risk by protecting cash flow and forgoing renewed business investment in favor of distributions to shareholders, other businesses that attempt to scale may run into challenges associated with a lack of management expertise. Founders often have technical domain expertise, which is unique knowledge that serves a startup well as the founder’s new product idea is taken to market. At an early stage business, the founder’s understanding of a niche is key to getting the business off the ground. For instance, a background in mechanical engineering, computer programming, or sales could spur ideas for commercially viable products in those fields, and the founder’s technical expertise would be required to usher the product from an idea, to revenue.
Balancing Emotion, Legacy and Financial Well-Being
This is understandably an emotional topic, and founders may state that since the business is theirs it can be managed as the founder pleases. But an honest assessment of one’s capabilities is important in determining when to sell. Although it may feel like an owner is giving up on their legacy by pursuing a business sale, they are in fact preserving the legacy by seeking a transition to a team that is prepared to usher the business into a new phase. In doing so, sellers will also accrue significant economic benefit in the form of a liquidity event. Strong fit with the buyer and the ability to roll equity ownership into the acquired entity are a couple of ways that founders may grow comfortable with a transition to new ownership. For details about buyer types, expectations that buyers will have from a transitioning owner, and which buyer type best suits a seller based on the owner’s unique desires in a transaction, check out this post on buyers.
Shifting From Generalist to Specialist Management
As operations scale, the product remains a linchpin in the success of the business, but increasingly important will be the shift from generalist management tactics to specialized management tactics. A company with 20 employees will demand an all-hands-on-deck approach to running the business, including from the founder who has fractional exposure to every function, from sales, to product management, to finance, to account management and so forth. Successfully achieving scale and growing from 20 to 200 employees requires a founder to relinquish control of these areas to experienced managers and to shift focus to strategic leadership of the business. If the thought of elevating yourself to a manager of managers is daunting, or if attempts to do this have resulted in turnover among managers, then it may be time to contemplate whether the business would benefit from a new type of operator. The image below from the Harvard Business Review does a good job of capturing the shifting management needs of small businesses as organizations grow.
3. Retirement or Other Cash Need
Planning is Especially Important if a Sale Will Fund Retirement
According to the US Census Bureau, 51% of business owners are 55 years or older. Retirement, therefore, is likely to be a material consideration in many business sale scenarios. Owners should bear in mind that a sale process is lengthy and in some cases can take years. For those owners relying on an exit to fund retirement, advanced planning is essential. It’s rarely the case that a business with few ongoing conversations with prospective acquirers can suddenly market itself for sale and achieve a favorable outcome.
If an owner intends to fund retirement with a liquidity event, the owner should start planning early and begin having conversations with credible buyers well in advance of the desired close date. Even if those conversations are not meant to result in an immediate sale, they will be instrumental in uncovering facts relevant to the sale process, such as valuation reads, acquisition activity levels, and why buyers may, or may not, be interested in a particular business.
Other Cash Needs Are Also a Common Sale Catalyst
Outside of retirement, founders may have a unique need for cash that warrants consideration of a sale process. Scenarios that fit this description are many, ranging from healthcare expenses, to funding college tuition for a child, to seeking diversification of investments, to the desire to buy a vacation home and to begin reducing involvement in the business.
To the extent that owners can act with foresight in anticipating a cash need, it’s best to afford ample time for a sale process to play out rather than forcing a rushed sale process in an attempt to quickly generate liquidity. One, there’s no guarantee that the sale will take place at all, much less on the needed timeline. And two, if it does take place, the owner could leave substantial sums of money on the table, an especially painful reality for someone in need of cash. Regardless of the reason an owner desires cash, preparation is a key risk mitigant. Taking the steps to prepare the business for sale, especially before the need for cash arises, is key.
4. Other Entrepreneurial Interests
Shifting Focus Beyond the Business
Once an entrepreneur, always an entrepreneur. Many founders and business owners are passionate about entrepreneurship. Through professional networks, owners gain regular exposure to operators, upstart ideas, investment opportunities and mentorship programs with aspiring entrepreneurs. Commonly, this exposure results in commitments outside of the core business. Should any of these commitments demand time allocations that begin pulling an owner away from the core business, and should the owner not have a clear successor or manager in place, then the timing to consider a sale may have arrived.
The Benefits That Come From Stepping Back
A couple of potential benefits can arise from an owner’s interests outside of the core business. One, if operations suffer when an owner’s focus shifts away from the business, then a material consideration related to succession could be at hand. Spending time away from the core business is a good litmus test for the business’s ability to operate without the owner. Are there other employees who understand the product, customers and operations well enough to step in and run the company? If not, take notice. If so, good. This has implications on the type of buyer that may be suitable for the business, and the valuation that the business may garner.
The second benefit relates to the power of the network. The effect of consistent networking is the potential for organic conversations with prospective acquirers or investors. Whether conversations take place with competing businesses operating in the owner’s industry, or with institutional investors, one can glean many valuable insights during these conversations, including rapport building with prospective acquirers. As owners navigate networking conversations, be sure to have a clear understanding of buyer fit, key person risk and valuation, all of which are likely topics that prospective investors will surface during sale conversations.
5. Seeking Balance or Less Stress
Entrepreneurship is Hard
The commitment required to start, grow and exit a business is substantial. From the outside looking in, the public perception of entrepreneurial success is aligned with the fantastic image of a wealthy and liberated individual, free from the stresses of a 9 to 5 job. From the inside looking out, the entrepreneurial experience will occasionally leave the operator of a business longing for the stability of a job with a salary and benefits.
Cash shortages, employee turnover, competitive forces, the loss of key customers, equipment breakage, inventory spoilage and pandemics are a few examples of the stress an operator endures. There is no doubt that running a business is hard. If an owner reaches their wit’s end, or simply desires better balance with family or friends, then the timing to consider a sale process could be near. Importantly, and as touched on previously, the owner’s desire to sell and the owner’s preparation for a sale are mutually exclusive. Just because a business owner has reached their wit’s end and wants to sell does not mean the business is ready to be sold.
If Operations are a Challenge, Process Might be Needed To Prepare for a Sale
Finally, just as a lack of management succession can highlight vulnerabilities that impact the marketability of a business, so too can the operating challenges that may drive an owner to begin a sale process. In some cases, frequent and ongoing operating difficulties are a sign that a business lacks the proper systems or strategic plan to warrant serious consideration from buyers. Although leading a business is unequivocally stressful, owners must use discretion to discern those stressors that come with the ordinary course of business from those that stem from a lack of process or management acumen. The latter can create headwinds for a sale.
Concluding on Personal Factors
Navigating the lifecycle of a business from formation to exit is a challenging, multifaceted journey. Whether an exit is spurred by retirement planning, risk reduction, or simply a desire for less stress, the successful transition of a business from launch through a sale hinges on the founder’s ability to evolve their role, implement strategic plans, and recognize when the timing may be right to pass the torch for continued growth and legacy preservation. Personal factors often play a critical role in shaping the exit from a business, and given the potential for life-changing liquidity, sellers are wise to reflect on their unique circumstances to determine whether a sale process is, or should be, on the horizon.
Up Next
In Part 3 we’ll discuss economic factors and how sellers can think about the impact of business and industry performance on the sale process.
