Many businesses we work with are not only profitable, but are also experiencing increased profits.
Why sell if the business is doing well? Here are some common considerations for those contemplating a sale or recapitalization.
- Receiving a large upfront cash payment. The first economic reason a business owner may consider selling or a leverage recapitalization is how much cash they are receiving. The higher the amount of cash one would receive relative to the amount of cash a business owner could take out of the business will obviously determine their interest in the transaction. There are other forms of consideration that can ultimately add to this upfront "cash" payment, including receiving a "seller" note as part of a sale whereby the business owner becomes a "lender" back to the business and over time, the principal and interest on the loan will be paid to them. Another form of consideration could be an "earnout," whereby the business owner would receive additional value to the purchase price if the business were to perform and meet certain goals and expectations the parties agreed to. Lastly, the business owner could receive stock back in their incumbent business or the acquiring business. Ultimately, the No. 1 driver in determining whether a business owner will sell or recapitalize comes down to: "How much guaranteed upfront money and/or other consideration am I receiving vs. the current cash flow that I will be giving up?" If the ratio is high enough, then the business owner will sell/recapitalize. If it is too low, the owner will keep the business or wait.
- Diversifying assets. For many business owners, most or all of their wealth is in the value of the business, which is an illiquid asset. Selling all or part of the business is like taking chips off the table in a game of cards. Selling a piece of one's business to recreate liquidity in an otherwise illiquid holding is called recapitalization. This investor is also the source of more capital for growth and/or payment for other acquisitions.
- Capital needs. A growing company, even a highly profitable one, may require more capital than the business generates from operation cash flow. For most companies, cash flow lags behind revenue and even further behind expenditures. A company in growth mode constantly needs reinvestment. Because of this, the growth company has the capital needs of a much larger enterprise. Owners will often reach a point where they don't want to put their own money at risk to achieve growth they otherwise foresee as achievable. This may be a good reason to sell, but it is a better reason to recapitalize.
- Let someone else take the risk of taking the company to the next level. There is a natural transition during the lifecycle of a company that occurs as it needs more people and infrastructure to handle larger volume. By necessity, it has to shift from an owner-centric business into a management-led, highly structured entity. Sometimes an owner may even be bored. An owner selling his business so someone else can take it to the next level isn't indicating he can't run the business; he may be setting his sights on his next business venture. Many owners simply don't have the interest or ability to design, implement and run a highly structured company. Bringing in a new owner or partner may be the best way for the company to continue growing.
There is a common thread we see in many of our clients who are interested in selling their businesses: They tend to have built their businesses over a long period of time. Many business owners start to get tired of the same routine after 30-plus years. As they age, their priorities change. Business owners feel like they have reached business heights as far as they want to go and want to risk. At the end of the day, there is one aspect out of the business owner's control: When the window of opportunity to sell/recapitalize the business opens, a business owner needs to recognize this opportunity and should work to sell/recapitalize before that window closes if they are able (i.e., the 2008 financial crash, 2014 oil crash or 2020 COVID-19 market).
If you would like to confidentially discuss the valuation of your business or considerations for selling or buying a business, contact Thomas Brinsko at (281) 538-9996 or tbrinsko@bicalliance.com.
