10 Things You Need To Know Today If You Want To Sell Your Business Tomorrow
(Note — This is the first in a series of 3 posts in which we will discuss in detail the 10 most important concepts, ideas and facts you need to understand if you want to sell you small business.)
One of the most often mentioned statistics in the world of small business goes something like this:
“4 out of every 5 new businesses fail in the first five years.”
Sometimes that “fact” is followed up with the additional claim that 80% of the survivors fail in the ensuing 5 years.
Trying to determine the success rate of new businesses has become a popular topic for journalists and bloggers to kick around. One researcher determined that after four years, 50 percent of new businesses are still open.
The Bureau Of Labor Statistics says 38% — 45% new businesses fail in the first 4 years.
And this post claims that only 29% of new businesses are still alive after 10 years.
Whatever the true survival rate is, the “4 out of 5” claim is pretty common. I think most people have heard it and many assume it is true. According to these articles however the reality doesn’t seem to be as bad as we assume it is.
But here is a fact about success and failure in small business that is rarely if ever mentioned:
Of those small businesses that survive, and even thrive, when it comes time to sell those businesses, owners succeed at a depressingly low rate.
Data collected from a multitude of sources over many years has consistently shown that when owners put their businesses on the market they fail to find a buyer about 80% of the time (much more detail about this claim to follow).
If the goal of owning and operating your own small business is to create security (let’s not even talk about wealth or riches, just financial security) then things are not going too well for most owners.
Sure, operating a small business has its rewards. Independence, pride of ownership, seeing your dream grow into reality. And yes, you can even make a decent living by working 6 or 7 days a week.
But if your ultimate goal is to eventually sell the business and pocket a life-changing amount of money …. well, that rarely happens for most small business owners. And as we will see, the smaller the business, the rarer that type of success is.
And for many older owners, selling the business is the cornerstone of their retirement plans.
This is a much bigger story than the alleged failure rates for new businesses. Yet it gets no attention whatever from our business media.
The result is that we have an entire class of business owners who spend their careers living with the false impression that they will be able to retire on the money they get from selling their businesses.
So the first thing (THING #1) you need to know is that you cannot just assume you will be able to sell your business. You must take specific, proactive steps to make the sale happen.
Faulty Assumptions Lead To Disappointed Owners
We assume that because most businesses fail early on, the ones that survive must be worth a lot of money.
Add to this the fact that our media and culture are in love with tech startups, celebrity entrepreneurs and entertainment shows like Shark Tank and what you get is a very distorted impression of small business.
Even business owners themselves have the wrong impression about how much money small business owners make — or can make from selling their businesses. (THING# 4)
One of the recurring themes in this report is that we use very inexact language when discussing “small business”. Politicians, journalists, bloggers — everyone throws the term around but they never describe how they define it.
Worse still is the tendency for journalists and others to invent their own terms without ever defining them. When you read terms like “small businesses”, “very small businesses” “mid-market businesses”, “intermediate-sized businesses” and “main street businesses” how can you know the differences between them?
If the blogger/journalist does not define what they mean when they use one of these terms, how do you know they are defining them like you are?
One of the most important things you need to know if you want to learn how to sell your business is that when the media talks about ”small business” they are probably not talking about you (THING #6).
Here’s an example of what I mean:
Each year BizBuySell.com releases their annual survey of businesses sold through their broker network. For the entire year of 2013 the businesses that sold had a median revenue of $405,580 and sold for a median price of $175,000.
Likewise, on a regular basis Gallup Polling publishes results of their surveys of small business owners. They define “small business” as any company with less than $20,000,000 in annual revenue.
The largest company in the Gallup survey is 50 times bigger than the median sized company in the BizBuySell survey.Yet they are all referred to as “small businesses”.
Most of what passes for small business coverage in our media (and in the culture at large) has a lot more to do with the $20 million dollar businesses in the Gallup Polls than with the $405,000 dollar businesses in the BizBuySell survey.
Our Media Defines “Small Business” The Way A 98-Year-Old Man Defines “Young”. Everybody Is Included
This lack of precision has led to a massive state of confusion among people who own businesses on the smaller end of the scale. Especially when it comes time to sell those businesses.
This report is specifically for the owners of those $405,000 businesses. And businesses of a similar size.
The Category Of Owners This Post Is Written For
Most of what I’ll talk about here is meant for owner-operated businesses that do less than $2 million in sales. Although in reality the vast majority of businesses in this category do less than $1 million in sales.
And except for businesses that have lots of part-time employees, such as some restaurants, most of these owner-operated businesses will have fewer than 20 employees. Most have less than 10.
I call this group of businesses The 1–20’s (less than $1 million in sales and less than 20 Employees).
The owners are usually very involved in the daily operation.
Their size and their owner-operator setup have a direct impact on how these businesses are sold and on how they are valued/priced.
1–20 businesses are valued and priced for sale in completely different ways than the $20 million small business (THING #4) and are bought by a different population of buyers (THING #5).
This 80% failure rate did not just fall from the sky. There are specific reasons why 1–20 owners are having trouble selling their businesses.
The high failure rate stems from confusion about how these smaller businesses are valued and the process by which they are sold.
This report is about removing that confusion.
It is about helping you understand the factors that make or break the sale.
It is about helping you get into that group of the 20% of owners who successfully sell their businesses.
Let’s get started.
THING #1 — It Is Hard To Sell A Business Of Any Size ….. And The Smaller the Business The Harder It gets
Earlier I linked to 3 articles that examine the survival rates of new businesses. I could have listed 103.
I compare the failure rates for startups to the failure rates for sellers because it points up just how overlooked the problem with selling is.
The funny thing is that calculating how many business owners succeed when trying to sell their business is pretty easy. But trying to figure out how many newly established businesses fail is impossible. That is why all the articles I linked to above have calculated a different survival rate for new businesses.
Most small business sales take the legal form of what is called an “asset sale”. The buyer only acquires a list of assets — the stuff that makes up the business. They don’t legally buy the business itself. Upon completion of the successful sale the seller shuts down his business and the buyer starts up a brand new business. The “new business” just happens to have the same location, employees and customers of the old business.
This is the definition of success for most small business owners. They started a business, ran it successfully for a number of years and then sold it for a satisfying payday to a new owner.
But the government records will show one business has closed down and a brand new business has started up.
Then there are all those DBA’s (“Doing Business As”) or non-employer firms. Businesses set up by individuals, often for temporary purposes. The laid off executive who does consulting work until another corporate job comes along, the college student or retiree who sets up some source of income on the side to get them through a specific period of their lives.
These businesses served their intended purpose. Then the owner moves onto the next phase of their lives and shuts the business down.
The endeavour succeeded from the perspective of it’s owner, but it counts as a “failure” in government statistics.
So determining the success or failure rates for startups is hard if not impossible. And meaningless.
Meanwhile if you want to sell your small business; and you want to know what the typical rate of success is for owners like you; a reasonable estimate is pretty simple to figure out.
We are talking very specifically about buying and selling 1–20 businesses. So we can define “success” very specifically.
Success is getting a buyer to pay you a satisfactory sum of money in exchange for taking over your owner-operated business
So what percentage of owner-operators who try to sell actually get this result?
There is no official or comprehensive data that addresses this question. To my knowledge no large government agency, such as the SBA or the Bureau Of Labor Statistics, has ever examined this question.
But because we have a very specific definition of success we have the capability to get a reasonable estimate of success rates.
Our best sources of information is the business broker.
A broker is under no obligation to list every business they consider. He or she will only take on a client if their business has some potential to sell — even if it is just a slight potential. But a broker is not going to list the handyman business where the person has a toolbox and lawnmower and has been paid 6 or 7 times by neighbors over the past 3 years.
When we look at success rates of brokers at least we are looking at a group of businesses that have met a certain minimum criteria for inclusion in any analysis.
Of course, not every business a broker lists is going to be a plumb opportunity. But I think it is fair to say that their listings are a representative sample of businesses that are viable candidates to be bought and sold.
So what is the success rate of the brokerage profession? Again, there are no “official” numbers available. But we can look at several sources to get a good estimate.
In The Complete Guide To Business Brokerage, Thomas West estimates that for general business brokerage operations — those dealing with businesses that have less than $2.5 million in sales and usually fewer than 20 employees — about 1 out every 5.5 listings sells.
That is a success rate of just over 18%.
Now to be completely accurate, that doesn’t mean 82% of business owners fail. Some owners, once they see that they can’t get their asking price, may take their business off the market so they can build the business to a higher level of value and try again later.
Others may transfer the business to a partner or family member. So while the broker may only sell 18% of the businesses he or she lists that doesn’t mean the other 82% met with total failure.
So it may not be fair to say that “82% of sellers fail”. Some will have a different but still positive outcome. But it is fair, and accurate, to say that “when trying to sell their small business on the open-market business owners succeed about 18% of the time”.
If selling to a partner, employee or family member is not an option for you then selling on the open-market is your only option.
Let’s look at it from a different source of information.
BizBuySell.com is the biggest business-for-sale marketplace on the Internet. Each quarter they survey the brokers who use their site and release data on all the sales that take place via those brokers. Because of their size they can provide data on a large number of transactions. It is by no means all-inclusive. But it is by far the largest survey of its kind.
BizBuySell boasts over 45,000 businesses for sale on their site as of this writing.
That 45,000 figure is just a snap shot. There is no way to know exactly how many businesses are listed each year in total. The 45,000 total at any one time will include businesses that drop off the listings next month. And new listing will be added next month to replace them.
In January of 2014 BizBuySell reported that 7056 business sales were completed by their brokers in 2013. That works out to about 15–16% of the 45,000 businesses listed at any one time. If 45,000 is the number of listings at one specific point in time then in the course of the year well over 45,000 will be listed.
So the percentage of successful sales is probably even lower than 15%.
But wait a minute you say!
You can’t rely on that number. Not all brokers use BizBuySell. And not all owners use a broker, in fact most go the for-sale-by-owner route.
And besides, how do you know a bunch of businesses included in the 45,000 didn’t get sold the day after the survey closed?
And then there is the very real possibility that some of those 45,000 experienced a positive outcome: an employee bought the business, a family member took over etc.
So that 15% figure is probably too low when we include all the positive outcomes that don’t include selling through a broker. But selling the business internally is not that common — especially for business that are publicly advertised. The only reason an owner or broker would advertise the sale publicly is because they don’t have an internal buyer.
So even if we settle on the higher 18% success rate reported by Tom West (1 in 5.5) we are still looking at a very discouraging reality.
Even if we round up to 20%, this is an alarming number.
After all, these are the survivors. These are all businesses that didn’t fail in the startup phase. And if a broker listed them they are at least “minimally viable”.
So this success rate of 20% is for businesses that have survived and met the brokers minimum standards for listing — which means they are a success. These businesses are exceptional.
Yet about 80% of these owners can’t find a buyer.
This Is A Non-Story In The General Business Media
There is this assumption among owners and the population in general that just about any good business can be sold for a significant amount of money. It is discussed in the media as if it were obvious that business owners are all cashing in big-time.
It is just not true. For most business owners it is quite possible to do everything right, to make a decent living running the business and then be unable to ever find a buyer.
The rate at which business owners fail to sell their business is a common topic of discussion on blogs and websites run by brokers, exit strategists and other professionals within the field.
But when you get away from sites run by experts, this topic (this reality) is literally non-existent.
Small business web sites, the business section of newspapers and personal finance websites don’t ever mention the fact that most owners never sell. At least I have never come across any articles that mention the topic.
It is usually assumed by those in the media that most business owners successfully sell their business and then ride off into the retirement sunset.
The result is that most owners enter into the sales process with false expectations about how easy the process will be. And they often have false expectations about how high a price they can demand.
It is rare that a person will go into business for themselves and not be aware that the failure rate for startups is high. But as the studies I linked to above show we actually overestimate the failure rate for new businesses.
Meanwhile, because it gets no coverage in the popular business media, we underestimate the failure rate faced by owners once they try to sell their successful business.
I know I am spending a lot of time on a very negative and discouraging fact. But it is the first thing you need to know about selling your business — you can’t take it for granted that the sale will happen.
You must take a proactive, even aggressive, approach if you are going to succeed..
We will go into the reasons for this high failure rate throughout this report. But one of the biggest reasons is that people don’t understand business valuation (or pricing ) and that leads us the the second thing you must know about selling your business…………
THING #2 — It Is Pricing Not Valuation That Matters
I recently came across an interesting article on the New York Times’ “You’re The Boss” Blog. Like a lot of How-To articles about selling a business this one offered several suggestions on how to make your business more valuable.
But more noteworthy than the article was the comments section. As with most “how to sell a business” blog posts, the comments are mostly from brokers and other professionals talking to each other. And when brokers, accountants and exit-strategists talk about valuation things can get very technical.
Brokers, Merger & Acquisition Specialists, Exit-Strategists and accountants all see the sale of a business from a different point of view. They all have their own expert opinion on how to value a business. Some will insist that “discounted cash flow” is the only way to value a business. Others will demand you use a method based on “comparables”. And others will recommend a multiple of sales. It is likely a business owner will come away from such a theoretical discussion more confused than before they started reading.
But here is the thing you need to keep in mind:
When It Comes Time To Sell Your Business, “Valuation” Is A Meaningless Term. You Need To Price Your Business Not Value It.
You don’t want to know the theoretical value of your business — you want to know what you can sell it for. How much money will a real person give you in exchange for the business?
We call that number a price not a valuation.
Thinking in terms of price instead of valuation will help to remind you that your business is a product that is for sale on the open market. The law of supply and demand applies to the sale of your business just like it does to your products and services.
The word “valuation” implies theory. It is what your business could or should be worth….. theoretically. Removed from any input from buyers.
The last thing 1–20 owners need is more theory.
Think about it like this: When you go into the grocery store, the box of Kraft Macaroni and Cheese does not display it’s valuation. It displays it’s price. Kraft knows exactly how to price their products because they sell millions of them each day. There is no theory involved. They are constantly adjusting the price on each of their products based on recent sales data, new competition and the cost of commodities like wheat and corn.
They do not “value” the box of mac and cheese and then forget about it. They constantly adjust to feedback from the market to maximize both price and sales volume.
You don’t have that type of detailed information about the market for your business, but your job is the same. Your job is to find out the highest price the market will bear for your business. You can’t do that in theory. You can’t do that with just a calculator and a pen and paper.
Your Business Is A Product That Is For Sale On The Open Market. The Law Of Supply And Demand Still Applies.
At some point you have to put your business in front of actual buyers. Ones who have enough money and qualifications to buy your business.
I posted a reply in the comments section to the blog post linked above and this is how I expressed this idea:
The business is a product that is for sale on the open market. Therefore you can’t ”value” the business independently of the market — which consists only of those potential buyers that have been located to this point. When it comes to divorce or settling an estate, the term valuation is appropriate. In those situations the worth of the business must be estimated separate from a buyer investing their own money.
We should talk in terms of pricing the business and then adjusting to the feedback we get from the market about that price. If we were talking to the business owner about any other product in the world they would understand the logic.
I am as guilty as anyone when it comes to getting caught up in jargon like EBITDA, multiples and “free cash flow”. But these terms and the calculations they describe are just the beginning of the pricing process. Your business is not worth X amount just because you have a calculation that says it is.
Your business is a product and it will be priced by the market in the same way all other products are. So do your valuation calculations. But then you need to get your business in front of buyers as soon as you can if you want to know what your business is truly worth.
THING #3 — The Idea That “Business Valuation Is More Art Than Science” Is Stupid
“Business Valuation Is More Art Than Science”
I’m sure you have come across this statement before. If you have been researching how to sell your business for any period of time you have probably seen this statement lots of times. It is almost a cliche at this point.
Unfortunately it is wrong. It’s misleading.
I would even go so far as to say it is a dangerous attitude to take.
As we mentioned in Thing #2 your business is a product that is for sale on the open market. You need to figure out what is the highest price a buyer will pay you.
You need to discover your company’s value not invent it.
Art is a subjective, creative endeavor. What is popular or respected today may change tomorrow. What is popular or respected in one culture may be despised or irrelevant in another culture. In art there are no absolutes. No right or wrong. What is true for one person may not be true for the next.
Valuation more than anything else is based on math. And math is a science. Obviously valuation is not a hard science like physics. But the process of determining your asking price is very much like a science or math question and almost nothing like an artistic endeavor.
Sure, you and your buyer may have to “get creative” when when arranging the terms and other details that will make up the sale. But when you sit down to determine the asking price for your business, creativity and self expression are not going to be the main tools you use.
Now you may be saying to yourself that this is just semantics. That no one literally views valuation as an art form. The phrase “Valuation is more art than science” is just a way to indicate that there are a lot of variables and unknowns at play.
That may be true.
But the problem is that in practice many business owners do treat valuation as an open-ended, guessing game. One where just about any price can be defended.
The truth is that very often imagination does play a big role when setting the asking price for a business. Owners literally imagine what their business could be worth in the future if a new owner came in and successfully made a series of changes to the business. Then they base their price on that imagined business of the future.
If that same owner priced his products and services that way we would all agree he is on his way to bankruptcy.
There Is A Logic To Pricing A Owner-Operated Business
Buyers are interested in buying a business for one overriding reason: they want to enjoy the benefits and perks that come with ownership. The main benefit of course is the earnings.
The buyer of a owner-operated business will likely run the business much like the seller has. Synergies and economies of scale typically won’t be a consideration for the buyer of the basic service/retail business. So the business will be valued based on its proven earnings.
The buyer will then consider several other factors: Have those earnings been growing or shrinking in recent years? What other businesses are available in this area in the same price range? Are the sellers of those other businesses offering to finance part of the purchase price?
In other words the buyer will ask themselves:
“Of all the businesses I can get into with the money I have available, which is the best choice for me?”
There is an inescapable logic underlying what a buyer can afford to pay for a smaller, owner-operated business. Nothing creative or out-of-the-box here. There is a lot of math and common sense involved and no art.
Logic dictates the buyer must do three things once he owns the business.
I call them The Big 3. On a monthly basis the new owner must:
- Pay himself a reasonable salary
- Make payments on the debt he took on to buy the business
- Set aside some money for operating expenses and expansion/improvement of the business
If a buyer can do all three of these things based on your asking price and terms, then he can afford to buy your business. If not, he can’t.
If you have only located 1 or 2 prospects so far and neither of them can afford the business then you can’t sell it for your asking price at this time.
You can offer the business at a lower price to one of those buyers or you can go out and find additional buyers.
Or, you could get creative.
If, originally you wanted all cash you could now offer to finance part of the sale price to make it more affordable for one of the buyers. You could agree to an earn-out which would mean you would have to wait to get all your money until the business met certain performance goals. You could offer to stay on for a training period. You could offer to provide free consultations for the first 3–6 months.
There are lots of things you could do to try to put together a deal with one of these buyers.
Every deal is different and every outcome has some unpredictable elements to it. There is a creative element in every sale — you could even call it the “Art Of The Deal”.
But the art of the deal is just working around obstacles as they come up.
Being creative or “thinking outside the box” is not the same things as believing “valuation is an art”. When it comes to selling your business valuation is just another word for pricing. And the price your market can pay is limited by the realities of The Big 3.
The Status Quo Is Bad News For Sellers
Again, this is not just semantics.
Recently the business school at Pepperdine University conducted a survey of business brokers to find out why some sales happen and some fall apart.
The brokers reported that “unreasonable price demands” was the number one reason sales fell through.
What does “unreasonable” mean? Well, in their survey they found that of deals that fell through because of price, in 69% of the cases the valuation gap was more than 20%.
In 26% of the deals the valuation gap was more than 30%.
Reasonable people can disagree. But when the disagreement over the asking price is greater than 30% in 1 out of 4 cases, that means there is a serious disconnect. The way many sellers price their business has nothing to do with what the buyer can reasonably pay. And what the buyer can reasonably pay comes down how much money the business has proven it can provide for its owner.
When you consider the fact that 80% of all small businesses never sell, this disconnect is hurting sellers much more than buyers. When there is a huge disconnect on price the buyer can always move on to one of the many other businesses that are for sale.
But you can’t.
This is why the “Valuation Is More Art Than Science” cliche is so dangerous. It implies that something other than market-based reality (supply and demand) is at work. If you ignore this reality you are going to end up in the 80% of owners who fail to sell.
For truly small, owner-operated businesses there is an unrelenting logic that asserts itself:
- When the owner-operator sells his business the buyer will almost always be another owner-operator.
- The new owner-operator will run the business much like the seller has.
- Therefore the historical earnings of the company will be the basis of the valuation.
- The new owner-operator will rely on his new business for his income. He is buying a job.
- All this means that the people who make up the market for these smaller businesses can only pay so much. Just like any product, you must price your business based on the market you are selling to.
Leave the artistry, creativity and outside-the-box-thinking for structuring and closing the sale. Maximize your chances of selling by pricing the business based on it’s proven profits.
Next Up: In our next post we will discuss 3 more Things you need to know if you want to sell your buisness, including how and why the size of your business has such a dramatic impact on the sales price you can demand froma buyer. Click Here To Read Part 2 Now.