Be an Ethical Entrepreneur, Marketer, and Business Builder

Your business DOES need an exit strategy!

September 13, 2010 by Leave a Comment

In the last few days I read an article on Entrepreneur.com and the book Rework where people have said buying or starting a business with the idea of selling it is horrible. They gave various reasons why this disgraceful practice will hurt your business including it leads to a lot of bad things, you won’t focus on customers, and you will be too distracted by cashing out to do a good job.

Respectfully, I disagree with Jason Fried, David Heinenmeier Hansson, and Michael Mothners. Firstly, it seems obvious that all of them have only been involved in growing or starting their own businesses so I’d suggest their experiences in different types of businesses with different owners is a bit limited. For instance, Fried and Hansson suggest that business owners looking to sell are generally trying to get acquired. Huh? In the 100 plus business owners I’ve worked with I don’t recall ever hearing about someone wanting to get acquired. That’s just a bit of the authors projecting their experience as a software company and of the software industry overall to all businesses and it just isn’t that way for businesses outside the technology realm. Mothners also owns a technology company so I’m guessing his disdain for exit strategies is based on the idea of companies popping up just to get bought out by Microsoft or Google.

In the real world of brick-and-mortar businesses few owners have that vision. As a matter of fact, most owners have no idea when they should sell their business, how to sell it, or even what it’s worth. What’s worse is few appreciate that if they’re working IN the business everyday instead of ON it their business is worth significantly less once they stop working there. My point is that why make a statement such as, “building a business to sell it is a bad idea” when the negative situations that they are concerned with are probably less than 1/10th of 1% of the total transactions and businesses? There are nearly 250,000 businesses sold in the US each year and that only represents about 20% of the total businesses listed. In other words, only 1 in 5 businesses grossing under $10 million/year will sell. It doesn’t sound to me like building to sell is the problem or you think more people would be able to actually find a buyer.

So what are the real problems small business owners face?

  1. They don’t know how to build a business. In Built to Last: Successful Habits of Visionary Companies, Jim Collins discovered that businesses that remain profitable for decades (even centuries) remain that way because they are great BUSINESSES not because they have great products. Most business owners focus on delivering a certain product or service without figuring out how to build a great business.
  2. They don’t know how to distance themselves from the business. In other words, they make the business completely dependent on themselves. If they’re not there working, selling, servicing or whatever, the business isn’t running. That means when they go to sell the business it’ll be worth a whole lot less without them there. Not only that, the only people interested in buying it will be buyers who also want to work in the business not investors. Working buyers generally don’t have as much cash as an investor looking for a steady return on his money.
  3. They don’t know what their business is worth or how to increase its value. The result of that is they always want more money for it than anyone else is willing to pay.

So what’s the solution to fix all of these real problems that I would estimate nearly 80% of business owners have? An exit strategy, of course. Here’s why an exit strategy is so important:

  1. It forces the owner to look at how to make the business great. Few people (myself excluded) want to buy a business that isn’t run well. They generally want a business with a strong, steady history of cashflow with minimal headaches and issues. If your primary focus is simply to grow and work in your business it’s very hard to step back and look at the big picture of your business being a finished product that runs so smoothly someone else would love to own it.
  2. Owners will need to figure out how to remove themselves from the business. You can’t sell the business if you’re required to run it, so an exit strategy will help you focus on working ON the business more than IN it.
  3. They will have to come up with a reasonable value for their business. Most business owners have an idea of how much they’d like to get for their business when they sell it. Unfortunately, that number doesn’t usually correlate with what it’s actually worth. With an exit strategy you need to look at a reasonable value for your business today and then set a game plan for increasing it’s value to the point where you can sell it for what you want. No exit strategy and chances are you’ll never really look at it’s value. This is very sad because most business owners only sell when they’re ready to retire. In essence, their business is their retirement plan. So if they go to sell and find out their business is only worth half of what they thought, that makes for either a tough retirement or a lot more years of work.
  4. It forces a time table for the 3 items above. Without an exit strategy with a specific time frame, few owners will ever do the things above even if they know they should. “There’s always tomorrow, or next month or next year to get that done… I have customers to take care of today.”
  5. Buying, building and selling businesses is generally a much faster system for creating wealth than buying, building and keeping. I’ve explained this in previous blogs so I won’t address it again here. This philosophy is probably what is thought of as a “bad idea” however, in my experience, this generally greatly benefits the businesses being acquired and resold. Why? Because people who are doing this understand how to make a business better. Not just a shell game of cleaning up the books, but a business that takes care of its customers, employees, vendors and owners better. Truly an improved business comes out the other end when an experienced person takes over to increase the value of a business to sell. I’ve written a 5-part series of blogs outlining how someone can go about buying a business and quickly improving it.

In summary, be wary of advice from business experts who have only owned or run 1 business or in a single industry and then attempt to extrapolate their experiences and lessons to all businesses in all industries. The real world, where over 5 million businesses exist in the US, is quite a vast landscape. More importantly, if you’re ever looking to retire or sell your business, you need to work on an exit strategy immediately. Make it a priority to get done this week! Contact me if you have any questions on how to structure a reasonable plan.

To your successful exit strategy, Bryan

Filed Under: Business Books, Business Buying/Selling Tagged With: , , , , , , ,

The fundamentals of Buying, Building, and Selling a business

October 30, 2009 by Leave a Comment

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To my knowledge, there is no other blog or book or lesson or presenter who shows someone the basic pieces necessary to generate wealth with real world experience as I will. It’s the nuts and bolts of the whole buy, build, sell process.

There are basically 4 steps:

  1. Preparing – What you need to know prior to getting started.
  2. Buying – How to find, value, negotiate, and purchase a business.
  3. Building – What you can do quickly to increase the value of the business.
  4. Selling – The ins and outs of selling your business.

Preparing

Ironically, as my most recent blog has pointed out (it’s ironic because it took me 18 months to write the blog that I should have written first), the most important part is your mindset and your attitude. Next, you’ll also need to take the first 3 steps to becoming wealthy including, always spending less than you earn, understanding the difference between where you are and where you want to be is education, and framing your goals into  Do x Be = Have context. Possibly most importantly, you need to have a clear motivation for being an entrepreneur (even if it’s different than mine) and you need to appreciate that the ethical route is always the most profitable. And make sure you’re able to get over your fear of failure in trying new things.

It’s important to understand that there’s no better, quicker way to go from very little money (let’s say less than $5,000) to a lot of money. You can even take it to the next level and setup a business to generate $1,000,000 per year if that’s your desire. Recently, as part of another blog, I’ve outlined a basic plan for how someone can go from $5,000 or less to $1,000,000 primarily through business. To stress the point even further that buy, build, sell is the best way to generate wealth for the average individual, review my suggestion to skip getting your MBA and just buy a small business for your business education.

Buying

In the buy, build, sell strategy, the part that will have the greatest influence on your profit is the purchase price so learn as much as you can for this stage.

First, you’ll want to know some basic questions to ask the seller about their business and maybe even what questions to ask about any given business idea. Then you’ll have to understand how banks value a business in case you need to go to them for financing and also how EBIDTA can tie into business values (since sellers and business brokers may reference it). As you start looking for businesses, you need to have some ideas of where to find businesses for sale for little money down and how to deal with the business brokers once you find one you’re interested in.

Before you start making any offers, it’s very important that you get the seller (or broker) to like you since then they’ll be more likely to accept your business valuation. It’s very simple to turn someone down you don’t like anyway. Once you’re ready to make an offer, make sure you only purchase the assets and then put them into an LLC filing as an S-corp. If you do that, you won’t have to spend nearly as much time fighting with lawyers. But since you may need one anyway here are a few tips for getting the best rates from your lawyer.

When you’re just starting out you may be considering a partner but make sure you don’t take on a business partner unless absolutely necessary.

Building

In the building stage you’re going to need to know what to do your first 2 weeks onsite at a business you’ve just purchased. If you don’t already know the difference between profits and cashflow, I’m sure you’ll learn very quickly.

Immediately you need to work on polarizing your company’s culture, improving teamwork, and communicating effectively. Right out of the gate you need to start setting up your business for running without you through the effective use of technology, incentives, and empowering your team. If you don’t do that immediately, you’ll soon be asked to do lots of things “in” the business that will take away from you working “on” the business. This is vitally important because if you’re not working on the business you’re not taking the time necessary to double profits, improve marketing, teach your team the importance of NLP, create systems, processes and scripts, or improve closing ratios. In other words, your primary focus for building value in your business is going to entail 3 parts:

  1. Increasing Sales – through new and improved marketing and better conversion rates. In other words you have to make sure your system for taking a lead and converting it to a customer is top-notch. Don’t forget that your back-end sales (sales to existing customers) will always be your most profitable business. With that in mind, if you can buy an already profitable business that’s horrible at back-end sales you can quickly increase its value.
  2. Cutting Costs – look at all of your expenses and simply cut those that aren’t needed. We reworked our accounting and phone costs alone to save thousands of dollars per year.
  3. Improving Efficiencies – this is primarily about scripts, systems, and processes for every aspect of your business.

Don’t make the mistake I did and wait until cash gets tight to realize that cashflow is king and then start building recurring revenue while looking for quick, easy, cheap ways to generate immediate cashflow.

Chances are you’re going to run into some issues with team members so it’s helpful to know the proper way to fire someone without having to pay unemployment and effective ways to get your team members to do what they do best.

As you’re building your business you need to work on getting it to achieve critical mass by, in particular, hiring or training the 3 leaders every business needs to succeed.

In summary, you need to have a game plan from day one including an exit strategy or else you might end up like one of the 300 businesses in NYC who failed because they failed to plan for success.

Selling

Since this blog is getting long and selling isn’t much different than buying I’ll keep this short. You need to basically understand 3 things:

  1. How to value your business just the same as discussed in buying so you can justify your price.
  2. Where to list your business which is again the same places where you’d go to find a business for sale (such as bizbuysell.com)
  3. How to foster relationships so that when it’s time to sell, you have a few personal contacts in mind.

With regards to the 3rd, you may want to get to know other business owners in your area who have complimentary (or even competing businesses). You may also consider hiring a leader who would like to take over and own their own business some day. If you have a franchise like mine, you will also want to stay in touch with owners in other areas as they might want to expand their operations.

The goal with this post is to organize and direct the many varied posts I’ve written about my adventure buying, building, and now selling my business over the last 18 months. As I add more posts I’ll try to keep this summary updated so you can always reference it for new material.

To your generating-wealth-through-business success, Bryan

Filed Under: Business Buying/Selling Tagged With: , , , , , , , , , , ,

Business Valuation 2 – EBIDTA can eat my shorts…

February 29, 2008 by 11 Comments

Ok, so maybe that’s not the most professional way to title a blog… We can discuss that another time.

In the last blog we discussed the 2 main criteria a bank looks at for approving a commercial (and theoretically personal) loan.

  1. Cash Flow – do you make enough money to afford the payments?
  2. Tangible Assets – if you don’t make enough money what can we sell to pay off what you owe us?

Since that blog was written a banker educated me concerning listing revenue and a customer list as an asset “There is no way to assign a value because that customer base can decide to go away on a moment’s notice. They are not required to do business with you. So that value in the business is actually a part of the “blue sky.”” So you know I’m not making this stuff up. To think that customers are just going to disappear when, on average, each one has been with you over 8 years AND new customers are going to stop buying from you when you’ve had a successful revenue generating strategy in place for nearly 40 years is kinda silly. For most people their business’ are their lives. With that kind of track record how/why in the world would they all of a sudden sabotage it. That just seems like a ridiculously minor risk.

Does anyone know if banks are “forced” to not consider revenue or customer base as an asset because of some strange banking or FDIC regulations?

At any rate, we’ve spent enough time on valuing a business based on tangible assets so let’s consider valuing a business based on EBITDA. Firstly, EBITDA and cashflow are NOT the same thing. If you’re buying a business, you should always value it by looking at profits. Secondly, EBITDA in no way approximates or represents profits. I only point that out because if you’re trying to buy a business and someone tells you that it’s worth $1 million because EBITDA is $200k and the standard multiplier is 5 then you should indicate that EBITDA doesn’t tell you anything about the business and you need to look at profits instead. Let’s look at each piece piece of EBITDA so we can see why its only helpful when you sell your business (because it’ll drastically inflate the business’ value).

  1. Earnings – depending on who’s doing the evaluation this can be either Net Operating Income or Net Income. In essence, this is your “book” profits. Except there’s one problem. If your business is based on Accrual accounting (which over 95% are) then earnings are based on sales, not on deposits. Just because I made a $1000 sale, doesn’t mean I’ve actually collected $1000 and have that cash in my bank account to spend. In other words, this tells me what earnings should be but not how much of that is cash in my pocket.
  2. Interest – The theory goes that when you buy a business you’re not buying the business’ debt so you have to pull out its interest. That makes sense as long as you add back in the interest you’ll now be paying for whatever loan you need. If you’re just using EBITDA to measure “free cashflow” in a public company, you definitely don’t want to pull out interest because they have to pay that every month and that certainly affects their cashflow.
  3. Depreciation – The basic idea is that if you buy a truck, car, building, computer, or office equipment for your business, you can’t write-off that expense all at once and so have to depreciate it over 3,5,7, or 21 years depending on what it is. Well you had to pay for it upfront, so now you have a non-cash expense (i.e. an expense that shows up on your income statement that isn’t a part of payables) and more cash in your pocket every month, right? There are 2 problems with that.
    1. You generally still have mortgage or car payments to make that don’t show up on your Income Statement. So in this instance some portion of that depreciation IS actually decreasing your cash flow every month.
    2. Depreciation is designed to expense an item over it’s lifetime. However, at some point you’ll have to replace that item again. If its your habit to pay for everything up front without a loan then every month you’ll have to be setting some cash aside to replace that item when its useful life expires.
  4. Taxes – This one is similar to Interest in that when you buy the business you’ll have a new accountant and and so the amount you pay in taxes is going to be different. That sounds reasonable to me. So figure out how much in taxes your super-accountant will be able to save you and subtract that. Don’t just assume taxes are going to disappear and base your business valuation on that assumption. One way or another you will pay taxes – or end up like Al Capone.
  5. Amortization – The whole concept of amortization is probably the one I understand the least but here’s my explanation anyway. Admittedly, this one can be a very legitimate non-cash expense. I’ve discussed this one with business owners, accountants, lawyers, and bankers and, though they all seem to have a slightly different explanation, from what I can tell, it’s a GREAT accounting gimmick. Here’s how it works, it’s basically the same as depreciation except for non-tangible assets. For instance, let’s say you pay $1 million for a business but through certain accounting practices you can show the business is worth $600k. You now may have the ability to amortize that $400k “blue sky” asset, that has no “tangible” value, over the next 15-20 years. Now, if you are the one who is making payments on a $1 million loan then the amortization is just like the depreciation. It’s not really a non-cash expense since you’re making loan payments against it. However, if you buy a business where the previous owner was amortizing from his purchase, now you could potentially have 10-15 years left of that non-cash expense to write-off. This is most common when the previous owner bought the business when it was losing money (if you pay any money for a business that is losing money you should have some “blue sky” to amortize) and then made it profitable and sold it to you.

The Bottom Line

EBITDA has it’s place. In fact, it’s great when you want to sell your business. Most people in the business and banking world use EBITDA multiplied by some arbitrary number (generaly 3-9) to come up with the value of a business. Since that value will always be higher than valuing the business based on profitability, then why wouldn’t you try to sell your business based on that?

On the other hand, I’m not sure I can think of one solid business reason to evaluate a business based on an EBITDA, EBITA, or EBIT number. Maybe that’s why EBITDA is not a GAAP (generally approved accounting practice) calculation.

Nonetheless, you have to give it to the first guy who invented EBITDA by highlighting it in a corporate report to show how well his business was doing. We all bought into it and now he even has the banks and accountants using his inventive, creative, and pointless calculation.

Just make sure the next time you’re looking to buy a business or just some stocks, you’re not spending too much time on EBITDA.

To your success, Bryan

Filed Under: General Business Tagged With: , , , , , ,