12 top challenges trying to sell a company with a valuation that you “deserve” and how to overcome them

Photo by Sharosh Rajasekher on Unsplash

We recently sold our company. It was quite an experience. If you are interested in hearing about how we grew and sold a custom software development company in 5 years, please do read the article.

I have spoken to many owners of similar companies that have or are finding it challenging to get a transaction that they really liked. Some of them have found buyers, strategic and/or financial, but they feel that they deserved a lot more for all the hard work and sacrifices they have made building their business and growing it over the years. Some have settled because the process was too excruciating and they did not want to continue dragging it on.

The reasons are surprisingly similar given the diversity of these organizations. After going through the process ourselves, plus, over the last 10 years, that of several of our partner companies and some of our customers, and having gone through it scholastically in my entrepreneurship studies, I thought I share my experiences, challenges and how I believe they could be overcome, specifically in the small and medium sized segments of most industries.

I have written this with a viewpoint of you the business owner. That owner can be one or more than one partner — all of this applies in either case.

1) The exact reason to exit is not analyzed properly

It is important to soul-search why an entrepreneur wants to exit his/her business. Is it because the business is drying up? Want to pursue other dreams and/or careers? Burned out? Health reasons? Want to cash out during a growth spurt? There could be many reasons. It is important to ask the following questions and write out the answers.

What is the number 1 reason for me to sell the business? Is the reason compelling or are there any doubt(s)? What? Why?

Most likely a non-compete with the new owners will prevent building a similar organization. If I have to continue working past the sale (for whatever reason) will I be o.k. to work for another owner and/or start another business in a different industry / different market?

If there was no option to sell the company, what other options could there be? Management buy-out? Hire a CEO/COO to run the day-to-day?

Is it a personal and / or environmental reason or a business reason? If it is not a business reason, can the personal challenges be overcome in some other way? Are the environmental challenges going to impact the sale?

Doing a deeper analysis almost always brings out underlying problems, hidden challenges and even new opportunities that were never explored.

2) Proper exit planning is misunderstood or not done

Proper exit planning entails staging your business, understanding the different types of deals that can be structured with prospective buyers, understanding the type of buyers and then starting the process so that the business can be sold easily with the valuation that you are seeking.

Kevin Nye has written an informative article on exit planning that I would highly recommend reading to understand this point.

3) Brand value is not defined or not clear

If you are able to sell to a strategic buyer the value you will get is much more than a financial buyer who will only look at your financials and pay a certain multiple based on the industry, the risks, opportunities and future profit possibilities. A strategic buyer will place a goodwill value on top of the financial value which can bring the valuation of the company to what you are seeking or even higher. If your business has a clear brand, you are able to articulate that brand clearly and you have brand evangelists that will corroborate your brand you are in great shape.

The best way to get there is to create a clear brand for the business. I am not talking about colors, themes, cultural artifacts that overflow beyond the walls of your organization. I am talking about the identity of your business as it will relate to the strategic buyer.

There are numerous ways to brand a company, especially to stage it for a sale. But most small bizz, especially those that are in the services sector, suffer from a distinct brand awareness. As such any sale becomes strictly financial in nature which can greatly minimize the value of such businesses.

Here is a quicker way to build a brand during staging.

Riches are in the niches

• Scan through your customers (including prior), partners, associations, network and that of your key employees and try to find a common industry as well as a segment in that industry. For example law firms in the insurance segment. Suggest staying away from geographic limitations as it might thwart off buyers that are not in that region or are looking to expand beyond certain geography.
• Next re-brand your website, marketing, messaging, email signatures — basically anything that could be touched during a search and due diligence with that niche. It can be scary if you have not done this —” what if I ward off the other segments, industries?” You can always mention that you focus on this niche, but also service generality.
• Next join more forums, networks, groups, associations in your niche and start being a thought leader by sharing articles, tid-bits, nibblers, pointers, vlogs, blogs, comments and re-posting similar material from industry thought leaders.
• Basically you are now creating a path for a strategic buyer to come in and grow the brand and/or complement their business with the brand.

If anything, re-branding your business will most likely help you build a stronger business and get you focused more on bigger growth.

4) Growth plans cannot be verified

Does your business have a proper growth plan? If there is no proper document with assumptions, projections, marketing plan, plans on how to scale sales team(s), operational improvement planning, service offering evaluations, vendor management, risk planning and competitive analysis, then most likely the growth plan that you may have is not good enough.

Most buyers that will offer a premium for your business above and beyond the financial value, would like to see significant growth over the next few years. During the presentation of the CIM (confidential information memorandum) and the executive summary, this will be a key component in the screening of your business by such strategic buyers.

It is not difficult to create a comprehensive growth plan. Just one or two weekend retreats, with your leadership team can get you more closer to it than you know.

If anything your team have a good chance to bond and bring our differences if any or other ideas that you may not be thinking about, especially at a time when you will be consumed with the additional burden of staging the organization.

5) Competitive analysis is incomplete

A competitive analysis starts by understanding the USP of your business, the niches it services and plans to service. Based on that you should find out industry numbers, facts, figures — through web search and/or buying reports.

A great source is just asking your loyal customers if they have been solicited by any other vendor for your business. You can just mention that you are trying to understand your markets and industries. If you are looking to buy industry reports, there are many sources where you can buy such reports. I am happy to give you such sources if you need them. A simple Google search will provide you such sources. Based on the data you should have a good starting block to do a thorough competitive analysis.

• Who are the competitors and more importantly why are they are a competition?
• What is the possibility that they can take away key customers from your business? Why? How can you protect your business from that?
• What is the possibility that they will encroach on your growth plans? Again — why? What are the mitigation steps from such risks?
• Can you build any barriers to entry for new entrants, especially bigger organizations that may encroach on your space? Could be through a partnership or strong relationship with an industry association or better still through trademarks, patents etc.
• Can your competition create better vendor relationships that you may have and offer your services in a more optimal manner?
• If nothing then, is there any way to make your competition a partner in the business? Reach out by saying you can both play in the field and offer complementary services?

If anything, a good competitive analysis will help you learn more about your business, your industry, allow you to grow, especially in a crowded space and protect your customers, partners and vendor relationships that you have grown so painstakingly over the years.

6) Operational dependencies are not ironed out

No business operations is perfect. All buyers expect skeletons in the business closets after the purchase.

Having said that, it is important to iron out as many deficiencies as possible in your operations. The best way to identify deficiencies and plan for them quickly is to create a risk register.

It is really simple — list out all the functions in your operations, basically everything that is needed to be done on a daily / weekly / monthly basis to ensure you are bringing profits to the business.

Next for each function, list out areas of strengths and weaknesses as perceived by you and your leadership team. For each strength list out risks that can make that strength into a weakness. For each weakness list our risks that can erode profits if the weakness is not fixed.

Next to each risk put in a probability of that risk happening as well as the impact it will have if it happens on a scale of 1 to 3–1 being least impact, 3 being the most, in the next 2 years (beyond 2 years is hard to project).

If you multiple the probability by the risk impact, you get a risk number . Then assess a rough estimate of cost and time to fix each as best as you can. If you multiple the risk number by the cost and sum it all up, you will get a good indication of your operational exposure. Sorting the list will get you an idea of the big risk items. You can then choose to eliminate some or all, especially the quick-wins / biggest bangs, or accept them as is but have a good answer or see if you can transfer them — outsource, eliminate, renegotiate.

The number one reason why this is so important is that you will get an idea where you have a big dependencies on a particular resource (employee, vendor, customer, system, process, regulation, legal, environmental, even political). That will become a sore point during due diligence if not already identified during screening. It is best to have a back-up / contingency plan, eradicate the dependency (best course of action) or at least have a good answer.

One such good answer can be that if your business has some key resources like key employees, vendor relationships, partnerships or industry associations it can be used to your advantage when structuring a deal. These could be difficult to imitate by competition or new entrants. You have to see how you can provide confidence to a potential buyer that such relationships and dependencies are extremely strong and will remain strong once the business changes hands.

7) Financials are not up to the standards of lenders

This trips up most sellers.

Firstly, if you are not very confident about business math it is key that you get yourself up to date on that. Just search Udemy or Coursera or LinkedIn and you will find many such courses. It is not enough to have your CFO or finance person play this role — because ultimately you are liable for all the aspects of the sale as well as the beneficiary.

If anything, definitely know some of the basic numbers like revenue growth, seller’s discretionary earnings (most likely to be used for valuation by a buyer right off the bat), monthly accounts receivable, spread of revenue across customers / segments / product lines, total debt etc.

Next it is important to have stellar books. If you have the means, getting a financial review by a CPA of the last 3 years financials (an audit is the best but can be expensive) is a big plus and will save a lot of time during due diligence. Most small business buyers will be seeking financing through lenders that will also do a financial due diligence and most likely will seek SBA guaranteed loans. These will have more stringent guidelines for assessing your financials.

If you are confident about your books — beyond just the prepared financials which include contracts, purchase orders, sales orders, invoices, payment records, vendor bills, payments, draws made from the business, loans, debt details, investment details and schedules that can be verified then you are in good shape. Otherwise it is highly recommended to get a CPA audit and if not affordable at least a review and statement. This is money well spent!

8) Tax returns tell a “very” different story

Every business does and should do tax planning every year. This is important to ensure the financials are clean, there are no liens, the business title is clear and more importantly everything is done “above the table.” Obviously, this is just good business practice. During the sale process, the strategic buyer, who will pay a premium on your business, will, most likely, look much more under the covers than a financial buyer. Typically when staging the business, the general tendency is to present the financials as good as it can be done — people can get very creative. The problem becomes when the tax returns tell a very different story.

Reality is that tax folks will work around loopholes to reduce taxation. On the other end, you will have a tendency to showcase the numbers far better than it really is during the sale. The important thing here is to ensure that there is a good explanation across different line items in your tax returns and your presented financials. If you have add-backs to normalize your EBITDA it should be verified and bulletproof. If you have depreciation that may look problematic you need to have a proper reasoning behind them. If you have deductions that are out of the norm, there needs to be reasonable explanations.

A buyer will be inheriting your business wholly including the taxation. So it is important that you are able to make the buyer comfortable that he/she/they can continue on with similar structures.

9) Legal structure of the business is complex

The same applies to the legal structure of the business. A lot of companies are formed as LLC-s, C or S corp. Some are minority owned or and / or female owned. Some structures helped the organization with taxation, some structures helped in getting certain types of contracts, grants, benefits. Some companies have partnerships across country lines, some have passive ownership, minorities interests — the possibilities are endless. While staging the organization, it is good to analyze each of the complexities. Is it worth it now? Can it be simplified? If you remove any dependency or complexity, will your business suffer that much that you are willing to thwart of a whole set of buyers that might pay a bigger premium for all your hard work and sleepless nights?

Your business license, articles of organization, filing with the state, director compensation, non-executive directors, if any— all such partnerships, documents and ownership will be scrutinized. It is like the title search for a house you want to sell. The more complicated the title, the more time it takes, the more expensive the search process, the less number of buyers you will attract.

10) The rush to sell and the “decent” offers

Any business is the heart and soul of the business owner. If it is not, then most likely it is not a very successful business. Letting go is not easy. So when the decision to sell is made or being dabble upon, there is a reason why and that reason has greater value than that heart and soul that was poured into the foundations of the organization. As such, the rush to sell and move on to something greater or different is quite big.

The reality is that most small businesses will take an average of 9 months to get sold. This is an average — you can check various reports, statistics that will give you details by industry type, organization type, buyer type and a lot will depend on the environmental conditions like economy, political etc. So it is very important to keep discipline during a sale process.

Ask yourself these questions:

• What is the drop dead number below which I will not budge even 1 dollar (remember the net amount you will receive is much lesser than the offer after capital gains taxes, brokerage and attorney fees as well as paying off liabilities).
• If I get just this amount, will I be able to move on to what I want to do after the sale? If not, can I continue working with this buyer?
• If I look at the total amount I have earned from my business in the last decade and add the drop dead number, does it justify all my hard work and sleepless nights?

Of course, there are situations where you have to sell the business due to unforeseen circumstances. Even then, you should ask yourself these questions and maybe your drop dead number is lower, but it is important to go through this exercise. If you are not sure, speak to someone your trust implicitly or seek counsel.

11) Due diligence terms are not established clearly in the LOI

The excitement of getting an offer and a letter of intent is so much, that most business owners will merely read the LOI for objectionable items, the numbers and proposed structures post-sale.

It is equally, if not more, important to understand what the due diligence process will look like. There will be a date after which the LOI will become void. However there are many situations where the prospect of a good sale is so high that the seller will go beyond any such dates —” we have come this far why not some more weeks / months?”

I would advice that before you sign the LOI, you ask your buyer exactly what will be done during due diligence, who will do the due diligence, for how long, what is required from your end and how any potential impacts will be handled (e.g. key employees find out, key customers get wind of the sale). Next, you should have a complete project plan for the due diligence laid out in the LOI. If a plan cannot be made because the buyer does not know your business yet, work with the buyer so they know more.

Some LOIs will prevent you / your broker from marketing the business further till the LOI expires. Such exclusivity also comes with a significant price. Such buyers better be extremely lucrative to you.

It is also important not to be uncomfortable negotiating anything with a buyer, especially the one that you really like. It is important to remind yourself constantly that there are many buyers that are out there and unless you have a dire need, the current business is still providing for you, your family and that of all your employees, vendors and even customers.

Eventually all due diligence process will have unforeseen items. I have gone through many of these and not once was it clear cut. The only ones that were better were the ones where both the buyer and the seller had a bigger impetus to make the deal happen. How can such a match be guaranteed? That is why I mentioned that it is important to work as much as possible with a prospective buyer prior to signing the LOI.

12) Not going over the final paperwork in detail

The due diligence is done. Everyone is excited to get to the finish line. The final agreement is drawn up and all is required are signatures. This is the time where a lot of things can be thrown into the mix, especially if the buyer is very experienced at doing this and the seller is not, which happens more often than not.

Firstly get yourself an extremely good lawyer. Ask around in forums, talk to your broker. Question the lawyer while screening them — how many similar businesses have they sold, what challenges have they faced, how many deals fell through and why. I cannot stress how important this is going to be. The final set of paperwork will be massive compared to all other documents and there will be a lot of legal language that can have lasting consequences beyond the sale for you. Some of the items that you have to go through over and over again.

• Actual terms of the sale — amounts, types, structures, who gets paid what, when, how and why
• Non-compete clauses — how does that impact what you will do next
• Confidentiality agreements
• Any post-sale contractual agreements for you and/or your key employees, vendors, partners
• Any customer impacts
• Any legal, regulatory, compliance issues that may arise post sale based on the terms set in the closing documents

This is so crucial, especially after a lengthy and tiring process, the rush to do the last set of signatures is massive. But the consequences are permanent.

Conclusion

Selling your business is actually not that hard, especially if the macro environments are in your favor. There is always someone that will want to buy your business at some price. The important thing to remember is that the value someone pays and you receive are not the same. You will get a value based on years of hard work and your buyer will pay a value based on years of expected hard work. The closer your can bring those together, the more successful the transaction will be.

Hit me up with questions, thoughts and comments. I would love to hear your story.