Deciding to part ways with your business is a mentally, physically and emotionally challenging decision. The process is rarely clear, the future is foggy, and emotions run high. Family, friends and shareholders all want their say and often hold competing opinions. One of the top questions a business owner struggles with throughout the process is, "When is the right time to sell?". The "right" time to successfully exit typically resides at the intersection of the performance of the business, the performance of the economy, and your own personal goals.
I have had the privilege to work with many business owners as they navigate these waters. I have also represented buyers and understand what they demand and take into consideration when looking to acquire. With this unique perspective, I have prepared a guide to help business owners make informed decisions. By taking a methodical and objective approach to the decision-making process, you can ensure that you're well-prepared to navigate the complexities of a sale and achieve the best possible outcome for yourself, your business, and the people who depend on you.
The Business
Profitability
Prospective buyers will assess whether the business generates consistent profits and achieves desirable financial performance. Thus, the profitability of your business is the number one influence on valuation during a sale. Higher profitability translates into a higher valuation because most businesses are valued based on a multiple of EBITDA. Therefore, your EBITDA is your starting point and everything else covered in this article influences the multiple placed on your EBITDA. A strong track record of profitability indicates the business's ability to generate sustainable earnings. Typically, buyers will analyze a trailing twelve month (TTM) EBITDA, where more recent months carry greater weight. It is important to note that the majority of buyers will not consider forecasted EBITDA. While a strong forecast will influence the multiple, it will not serve as a starting point for buyers.
In addition to evaluating the overall profitability, buyers and valuation experts will consider certain adjustments known as add-backs. These add-backs include owner compensation that exceeds a typical CEO salary, which is regarded as a discretionary expense. Such adjustments recognize that the owner's compensation may be higher due to their dual role as owner and executive. By adding back this excess compensation, the true earnings potential of the business can be accurately reflected, resulting in a higher valuation.
Furthermore, one-time costs or expenses not expected to recur in future years may also be considered add-backs. These expenses could include consulting fees or special expenses incurred by the owner, such as personal expenses that are not directly related to business operations. By excluding these one-time costs, the add-backs reflect the normalized earnings of the business and enhance its profitability, consequently increasing its valuation.
It is crucial to present a clear picture of profitability and highlight any relevant add-backs that can improve valuation. By demonstrating consistent profitability and justifying add-back adjustments, you position your business as a desirable investment opportunity for potential buyers, maximizing its value in the marketplace.
Revenue
The next most important aspect hitting valuation is revenue, but not all revenue is viewed the same. Understanding the impact of recurring revenue versus project-based work on valuation is crucial. Recurring revenue, particularly through scheduled maintenance contracts, holds immense value in the eyes of potential buyers. If your business has established contracts for scheduled maintenance, this significantly enhances its valuation. These contracts provide a steady and predictable income stream, showcasing the reliability and stability of your business to prospective buyers. The longer the duration of these contracts, the higher the potential for increased valuations, as they demonstrate long-term customer relationships and revenue sustainability.
On the other hand, project-based work introduces a certain level of risk for buyers. When evaluating project-based revenue, factors such as project size in terms of monetary value, project length in time, and the type of work involved come into play. By its nature, project work is often perceived as more uncertain and volatile than recurring revenue streams. As a result, buyers may view new construction and one-off retrofit work as riskier due to its reliance on securing individual projects and the potential for fluctuations in revenue. However, it's important to note that project work can also offer opportunities for growth and profitability, depending on the specific market and industry dynamics.
Acknowledging the interplay between recurring revenue and project-based work is essential when assessing the value of your services business. By recognizing these dynamics and positioning your business accordingly, you can make informed decisions about the ideal timing for selling your business and maximizing its value in the market.
Customers
Another crucial aspect impacting valuation is the nature of customer relationships. Strong connections with customers enhance the business's worth, indicating loyalty and recurring revenue. Conversely, weak ties raise concerns and lower valuations. It's important to determine who owns these relationships and ensure their transferability. Skilled management or technicians staying with the business post-sale instill confidence in customer retention.
The composition of customer relationships also matters. Relying on third-party intermediaries like general contractors or help desks/dispatchers requires evaluating partnership strength and reliability. Consistently winning projects with contractors and maintaining long-term agreements with help desks/dispatchers can positively influence valuations but still do not carry the same weight as direct customer relationships.
Customer concentration is an ultimate factor impacting valuation of the business. Heavy reliance on one or just a few customers raises risk and greatly reduces not only valuation but also interest of many buyers. Diversifying the customer base mitigates risk and should be a top priority. Strive for no single customer contributing over 17% of total revenue.
End markets where customers operate also impacts valuation. Buyers seeking to enter or expand in the markets you serve value businesses higher— buyer reservations or volatility in your target end markets lower valuation. Understanding market dynamics helps position the business strategically and attract the right buyers.
Assessing customer relationships, concentration, and end markets maximizes the valuation of a services business. Mitigating concentration risks and aligning with attractive end markets position the business for a successful sale at its true market value.
Organizational Design
Several key factors come into play when evaluating the organizational structure of your services business for a potential sale. First and foremost, the transition timeline regarding the owner's involvement is a critical consideration. Different buyers may have varying preferences regarding how long they expect the owner to stay in the business post-transaction. While some buyers may require the owner's presence for several years to ensure a smooth transition, others may only want a shorter period to observe a successful handover. Understanding and aligning these buyer preferences with your plans will facilitate a more harmonious negotiation process.
The need for the owner’s involvement in day-to-day operations is a major aspect that impacts the transition timeline and valuation of the business. Buyers will assess the extent to which the business relies on the current owner for its daily operations. If the business is highly dependent on the owner's involvement, it can lengthen the transition timeline and potentially raise concerns for buyers. On the other hand, if the business has a capable and empowered leadership team in place, with individuals who can step up into more senior roles, it enhances the value and attractiveness of the business. A strong leadership team not only reduces the perceived risk for buyers but also indicates the potential for the business to thrive under new ownership.
Moreover, the revenue-generating capabilities of your team plays a significant role in valuation. Buyers will assess the presence and effectiveness of sales representatives in winning new business. If the business has proactive and successful sales reps who consistently bring in revenue, it positively impacts the valuation. Conversely, if there is a lack of adequate sales representation, valuation suffers. Similarly, the quality and availability of skilled service technicians should be considered. The ability to attract and train new talent is crucial, demonstrating the business's capacity to grow and adapt. Additionally, whether service technicians are direct employees or subcontractors can influence the valuation, with direct employees typically commanding a higher valuation due to greater control and stability.
Assessing the organizational structure of your services business is essential when preparing for a sale. By addressing these factors and positioning your business with capable leadership and revenue-generating mechanisms, you increase its appeal to potential buyers and pave the way for a successful transition.
The Economy
Understanding the state of the market and the overall economy is vital when considering the sale of your services business. Evaluating the sensitivity of your business to economic changes can provide valuable insights into its stability and future prospects. One aspect to consider is the relationship between your customers and the end markets they operate in. Assessing whether your customers' industries are more or less affected by economic fluctuations can help gauge the potential impact on your business's performance. Industries with higher sensitivity to economic changes may introduce greater volatility and risk to your business, potentially impacting valuation.
Another vital factor to consider is the availability and cost of labor. Labor market conditions can have a direct influence on the operations and profitability of your business. Therefore, understanding the labor market dynamics, such as the availability of skilled workers and prevailing wage rates, is crucial for assessing the potential risks and opportunities associated with your business's labor requirements.
Evaluating the broader economic outlook is also critical. An analysis of whether your end markets are expected to experience growth or decline can provide valuable insights for potential buyers. Buyers who perceive positive growth in your end markets place a higher valuation on your business. Conversely, if your end markets are anticipated to face challenges or decline, it may lead to a lower valuation due to perceived risks and limited growth potential.
Furthermore, buyers want to see a track record of success. Therefore, if your business has experienced 3+ years of consistent growth the timing may be optimal- especially if the future looks grim. Unfortunate as it may be, even a single down year can influence a buyer to lower valuation or even walk away from the deal out of fear.
By carefully considering the sensitivity of your business to economic changes, the characteristics of your customers' end markets, labor market conditions, and the overall economic outlook, you can provide potential buyers with a comprehensive understanding of your business's position within the broader market. This analysis enables buyers to assess the future prospects and potential risks associated with your business, ultimately allowing you to strike while the iron is hot.
Personal Goals
The business owner's personal goals play a profound role in the decision to sell a services business. One key consideration is the possibility of the next generation taking over the business. For owners with family members or individuals within their organization eager to assume ownership, the opportunity to pass the torch can hold significant sentimental value. The prospect of keeping the business within the family or ensuring continuity among dedicated team members can be a compelling reason to not pursue a sale at all. However, many owners do not have family in the business and would like to pass ownership on to a new entity who shares similar values.
Equally important is the well-being of the people within the organization. Many business owners prioritize the protection and support of their employees during the transition process. Selling the business with the intention of preserving jobs, providing growth opportunities, and maintaining a positive work environment demonstrates a genuine concern for the team that has contributed to the business's success. Such considerations can generate a sense of loyalty and goodwill among potential buyers, further enhancing the business's appeal and value. It is also important to have candid conversations with potential buyers early on in the process to see alignment with your intentions are met before the deal is too far down the line.
Another aspect that holds meaning for some business owners is the legacy of the name and reputation they have built over the years. A strong and respected brand carries intrinsic value, representing the hard work, integrity, and quality associated with the business. Preserving the legacy of the name becomes an essential objective, ensuring that the business's identity and positive standing in the market endures even after the ownership transition.
Valuation expectations are a crucial element in the decision to sell a business. Every owner has a desired financial outcome from the sale, whether it is to fund retirement, pursue new ventures, or secure their family's future. Understanding the realistic value of the business and aligning it with personal expectations is a critical consideration. Owners must assess whether their valuation expectations are attainable in the current market or if further growth and strategic positioning are necessary to meet those goals.
Ultimately, the personal goals of the business owner, encompassing the aspirations for the next generation, the well-being of the organization's people, the preservation of the business's legacy, and the desired financial outcome, shape the entire process of selling a services business. By integrating these personal goals with the broader considerations of the market, profitability, customer dynamics, and organizational structure, owners can make well-informed decisions that honor their legacy while ensuring a successful transition to new ownership.
The Right Time to Sell
To ensure a successful sale of your services business, taking action now is crucial. Evaluate the key factors discussed - performance of the business, market conditions, and personal goals. Assess your business objectively, identify areas for improvement, and implement strategic measures. Seek professional guidance if needed. By proactively addressing these factors, you can position your business for a successful sale that maximizes its value. Don't wait - start preparing for a lucrative exit strategy today.