The number one reason I hear people say they want to sell their business is burnout. They made something work, but now after a period of banging the head against a wall, they are tired. So they look for someone to buy it and take it over. Wanting “a good home” for it is the excuse I hear for not maximizing the returns.
This reasoning is emotional, and it presents a narrow frame: keep slaving away at your business, or sell it to someone else. We can do better. But to get perspective, let’s consider the world of selling one’s business.
I keep tabs on the business broker space, and particularly for tech companies. I hear “you’re just done” as a significant selling point expressed by these folks. They discuss the company as a mental tax on the founder/owner. Why not sell so you can do your next thing?
The phenomenon of the exhausted founder is not just in the smaller startup space where I possess some first-hand experience. In Bo Burlingham’s Finish Big, he discusses several nontrivial businesses sold by retiring founders. The inverse correlation between the financial outcome and the founder’s stated happiness surprised me.
The most lucrative sales were from positions of strength: the acquirer bought for more strategic reasons, paid a pretty penny, and the founder was liquid after. These also took less time - the process to create the asset the acquirer wanted was not a lifelong project. The acquirer took the company apart to extract the strategic value that would create big-company-sized returns. As an ongoing concern, the acquired company was either shut down or a shell of its former self. The book details how this made the founders sad.
In contrast, the smaller sales were financial and kept the team together. A typical characteristic of a “financial” deal is when the acquirer wants to operate the business rather than strip it for a strategic part. The founder sold out of what I would describe as a position of weakness: through age, lifestyle shift, or some other consideration they wanted out, and they accomplished this through a sale. The focus was on extricating the founder, generating a payout, and protecting the team they had built.
I looked into selling one of my companies a couple of years ago. I found financial buyers considering pricing based on shareholder discounted earnings - SDEs. One calculates SDE by taking the company cash flow (often on an EBITDA basis to keep the accounting simple) and subtracting the salaries paid to the shareholders. So if you own a breakeven $50,000/month business, and your salary is, say, $10,000 per month, the SDE is $10,000/month.
The multiple on earnings a company can fetch is based on a few factors, such as the type of offering. Assume a micro-business with a five-figure monthly recurring revenue, like what we have above. A content business might be saleable at an SDE multiple of 2-3. A SaaS might fetch multiples of 3-6. Multiples go up as the company has scale, sharp growth (30%+ annually), a reduced concentration risk, and reduced management risk. In the example above, a SaaS with these criteria might fetch $400-$500k.
When listening to private equity buyers, I hear they make their money lending a sympathetic ear to the founder and then making significant changes to the company they bought. They are good buyers and then change agents. Sometimes these changes are simple: double prices. Sometimes they are more subtle, like pooling staff to amortize overhead over a broader portfolio of companies. Another common one is introducing automation to reduce headcount in the second year of ownership after the acquirer has its sea legs.
The acquirer is in a position of strength. The prices have usually stagnated for a while. Tired founders looking to unload their businesses have not made great growth strides in recent quarters, which depress the valuations.
Why can an acquirer do the things the founder has not done? The difference is working in the business vs. working on it. The former is the work of an operator. The latter is that of the owner.
Turn back the clock in this story. The founder or founders started the company - they worked in it to make it happen. They began with a lot of slogging work, searching for market fit. Then a phase of growth and success. Finally, the business turns. Maybe this is a result of market saturation. Perhaps the founder has gotten set in their ways. Or time passes. The work wears them down.
When one is tired, emotions get the better of us. And emotions make us step back in time to a previous version of ourselves. It’s much harder to make changes.
Andy Grove tells a story about overcoming this kind of inertia with Gordon Moore in Only the Paranoid Survive:
“I looked out the window at the Ferris wheel of the Great America amusement park revolving in the distance when I turned back to Gordon, and I asked, ‘If we got kicked out and the board brought in a new CEO, what do you think he would do?’ Gordon answered without hesitation, ‘He would get us out of memory chips.’ I stared at him, numb, then said, ‘Why shouldn’t you and I walk out the door, come back, and do it ourselves?’”
Be the next CEO. If you were the acquirer of the business, what would you do? You certainly would not act out of emotional connection to what has already come to pass. You aren’t just the CEO in Moore’s story: you’re the board. What would you do? What would you tell your operator to do?
The hard part is letting go of your previous ideas about the business. I ask, “why is this so?” The answer is often a history lesson filled with intents and ideas that did not pan out. Make a clean break as an acquirer would - do what’s next.
What can be next? One possibility is hiring or promoting a manager. Hiring allows your SDEs and bottom line to move closer together since you are no longer as active in the business. Salary goes away, and your participation looks much more like a profit claim. Drive down your involvement to board-level conversations. You will add much more value for far less time investment. Further, the multiples improve should you sell in the future because you have eliminated much of the management risk.
A second road is taking on debt. Borrowing against the business’s earning power allows one to capitalize the gains much like you would in a sale. The balance sheet is the secret weapon of an acquirer - they borrow to pay for the company and service the note with your business income. Steal their move: the business pays off a loan over some months and years - and in the end, you still own the company! The federal government subsidizes small business interest rates in the United States. Taking on this kind of obligation involves some risk as one must repay the debt, but if you have a good business, you have inside information on how low-risk that can be.
A third road is driving a new initiative to add equity value. The idea of equity value is crucial: your marginal involvement as a principal should focus on increasing shareholder value. The blocking and tackling work that got you here does not do that. Initiatives could be about driving top-line growth or decreasing costs. One fun initiative in this phase is firing expensive customers - increasing earnings by reducing the top line! Improve equity value by moving metrics that the “old CEO” would not have accepted. Many possibilities await when the perspective is that of an owner rather than an employee.
I am all for building a saleable enterprise - and selling when the price is right. But sell from a position of strength. Tend to your health and wealth. Achieve what you want out of life next.
A founder is an owner. When it’s hard to remember that, try selling the business - to yourself!
Photo by Alexander Hoggard on Unsplash