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“You think running a business is hard? Try selling one”.
That’s what one of my mentors said to me when I approached him in 2017 with the idea of selling my business the following year. His goal wasn’t to dissuade me from pursuing an exit, but rather to open my eyes to the inevitable challenges that lay ahead if I did indeed pursue a sale. In retrospect, he was right, as he always seemed to be.
Though I took his statement very seriously, it was nonetheless an opportune time to pursue an exit: Borrowing rates were at historical lows, capital was flooding into our industry, and multiples that were being paid for software companies were at all-time highs. In addition, I found myself quite tired after sprinting at a relentless pace for upwards of five years. The stars had finally aligned: It was time to sell.
From start to finish, the process took upwards of 12 months. It started with our financial advisor approaching almost 100 potential suitors on our behalf, which resulted in 13 bids for the company. Eventually, we distilled these 13 offers down to a single buyer with whom we chose to work exclusively for 90 days. During this 90-day period, we completed the extensive financial, legal, technical, and commercial due diligence process, and just as we were beginning to draft the final purchase agreement, the transaction fell apart when the buyer elected not to proceed any further.
At the time, this felt like a big personal failure. I felt as if I had spent a full calendar year pushing myself to the brink of exhaustion with nothing to show for my efforts. With the benefit of time however, I’ve come to realize how enormously valuable this experience was for both myself and my management team. Indeed, without the knowledge and experience that we had acquired, we almost certainly would not have successfully sold the business in 2020. This process taught me lessons that couldn’t have been learned anywhere else, and the experience will forever color the way in which I think about M&A, from the perspective of both buying and selling.
With that in mind, what follows are some of the major lessons that I learned during my first (unsuccessful) attempt at selling my company. I hope you’ll find them to be useful.
First, A Caveat
Selling a company is a subject that could occupy an entire book all on its own, so my observations and lessons should by no means be considered exhaustive. No two exits are ever the same. Lessons learned, observations gleaned, and mistakes made were idiosyncratic to my specific situation at that time. Your own lessons, observations, successes and failures will likely differ from mine, though I suspect there will be at least a few similarities.
Valuing a Company: Some Science, Mostly Art
Of the 13 bids that I received for my company, I was surprised to see that there was a 471% difference between our lowest and highest bids (no, you did not read that wrong). The other 11 bids that we received were also widely dispersed around the median value, despite the fact that all parties were working with identical information. Though the range of valuations that we received may have been wider than what is typical, there are still some lessons that you might infer from my experience:
- Each business will naturally have a valuation range within which most reasonable buyers are willing and able to transact. However, that range may be wider than you think, as different suitors are likely to ascribe different values to the same business based on their own unique circumstances and considerations. In this way, businesses don’t have an absolute, objective, unambiguous value, but instead have relative value. There are countless variables that can explain why a company may be more valuable to one buyer versus another. For example: Does the target company present possible EBITDA synergies (reductions in costs and/or redundancies for the combined company)? Does the target present possible revenue synergies (e.g., the target’s product fills a void in the acquiror’s product line that can be upsold to existing customers)? Is there competitive pressure for the acquiror to buy a company that offers a product like that of the target instead of building it on their own? How much debt is the acquiror willing & able to utilize to finance the acquisition? Is there any complimentary or overlap between the respective customer bases? And so on.
- A good M&A advisor will spend a lot of time seeking out those specific parties for whom your company has high relative value. A mediocre M&A advisor will offer the opportunity to anybody with capital to deploy, which inevitably includes those buyers for whom your business has low or neutral relative value.
- There is a high opportunity cost to spending undue time speaking with potential buyers for whom your business has low or neutral relative value. In my experience, there were diminishing marginal returns to speaking with a greater number of potential buyers. Quality was more important than quantity.
- Though I solicited multiple bids via a competitive auction process when attempting to sell my company, many business owners do not, instead electing to work with a single buyer on a more proprietary basis. Neither approach can be said to be objectively better than the other, but if you choose the latter approach, know that you’re only getting a single view of relative value as opposed to seeing the entire range.
- Don’t congratulate yourself too thoroughly when you receive a valuation that comes in above your expectations. Similarly, don’t get too dejected when you receive a valuation that comes in below your expectations. Such deviations should be expected.
- From the perspective of the seller, Indications of Interest (“IOIs”) and Letters of Intent (“LOIs”) often aren’t terribly meaningful: Of the 13 IOIs that we received, only a small handful translated into LOIs. Of the LOIs that we received, none of them translated into an actual transaction. Other than the confidentiality provisions, the only legally binding term in an LOI of any real value is the “exclusivity period”, within which the target company is prohibited from speaking to other potential acquirors. This obviously asymmetrically benefits the buyer, with the seller typically not receiving any real benefit of a similar magnitude.
- Smart and experienced people, even when working with identical information, can (and often do) disagree with each other.
The Importance of Thoughtful Forecasting
When you begin the process of selling your business, in addition to evaluating your past performance, prospective buyers will naturally want to see your forecasts for the next few years of operation, and understand the sentiments and assumptions behind those forecasts. As a seller, it’s worth being quite thoughtful about the forecasts that you present, particularly those that are approximately 6-18 months into the future: If they’re too aggressive relative to past performance, they will naturally create meaningful pressure for you to actually hit those numbers as the transaction progresses across as many as 6 – 18 months (transactions almost always take longer than you think they will). Failure to hit these near-term numbers may kill your transaction entirely, or at the very least lead to a large downward revision in valuation (and/or give the buyer more negotiating leverage to change other material deal terms). Sometimes entrepreneurs set aggressive forecasts in an attempt to solicit higher valuations, and sometimes aggressive forecasts simply reflect their eternal optimism.
On the other hand, if your forecasts are too conservative relative to past performance, you may have less pressure to hit those numbers, but buyers may grow to wonder if they’re buying a business that is plateauing or is approaching a state of decline. Especially when selling SMBs, there is often a large asymmetry of information between buyer and seller (in favor of the seller), and the buyer may wonder if the seller sees something negative on the horizon for the business that they don’t. In fact, the buyer is likely to ask you several questions attempting to tease out whether or not this is the real reason why you’re looking to sell. In this way, overly conservative forecasts may lead to no deal at all, or at least a deal done at a lower valuation and/or a less favorable structure.
We got too aggressive with the forecasts that we had presented to potential acquirors. When the transaction (inevitably) took twice as long as we thought it would, and with myself and my management team spending more time on the transaction than on the actual operations of the business during that period, our performance slipped, leading to two consecutive misses on our quarterly forecasts. This ultimately proved to be one of the primary reasons why our deal fell apart.
For these reasons, don’t get too creative when presenting your forecasts: Use reasonable and thoughtful assumptions based off logic and experience, and don’t artificially inflate or deflate them. Instead, present numbers that accurately project the direction in which your business is headed, and ensure that you have a high degree of confidence in your ability to hit those numbers over the coming 6-18 months.
Intensity of Time & Effort Required of the CEO (and/or Management Team)
Selling a company is a full-time job. Running a company is also a full-time job. In my experience, whenever anybody attempts to do two full-time jobs at once, they inevitably do a poor job at both. Unless you are thoughtful and deliberate about your time allocation, the exit process will become a “whirlwind” by which you (and/or your management team) will get continuously consumed. This in turn may have negative impacts on the day-to-day operations of your business. I fell into this trap, justifying to myself that it was acceptable to spend more time on the transaction than the operations of the business, because it soon would be owned by somebody else anyways. What I failed to recognize however is just how frequently these transactions fall apart, which mine did. You should go into yours prepared for the same. Here are a few things that you can do from now to ensure that you don’t get as personally consumed by the transaction as I did:
- Hire (and/or retain) an excellent CFO (or Sr. Controller, or VP of Finance/Accounting) from now. I had a superstar VP of Finance when we actually sold the company in 2020, and he did a Herculean job in getting that transaction across the finish line so that I didn’t have to
- Build and maintain a clear, easy-to-follow 3-statement financial model, with clear and logical assumptions, updated at least quarterly. Build it now, well before you plan on selling.
- Get your records and documentation house in order from now. During diligence, you will be asked to produce an endless stream of contracts, documents, and analyses. You cannot afford to waste time searching blindly around your network drive when that time comes
- Make “good information hygiene” part of how you evaluate (even compensate) your leaders: They should all have clear and accurate dashboards with all relevant departmental KPIs, should all be able to speak to them intelligently at any given time, and should be able to fulfill any of your information or documentation requests within a matter of hours
- Perhaps most importantly: Hire a good M&A advisor (more on this specific issue in the blog post “Considerations in Selecting Your M&A Advisor“).
Price is NOT the Only Variable That Matters
When business owners receive an Indication of Interest or a Letter of Intent from a prospective buyer, naturally the first place where their eyes wander is to the valuation. Though price is certainly an important component of a transaction, it is only one of many important components. If the valuation of Acquiror A exceeds that of Acquiror B, that does not necessarily mean that Acquiror A’s deal is superior to that of Acquiror B. There are countless other variables that must be considered, beyond price, when comparing multiple offers. A good advisor will help you think through these variables. A small fraction of them include:
- Is the compensation in the form of cash or stock?
- Is the seller asking you to finance a part of the acquisition via an earn-out or seller note?
- Are you required to roll-forward any of your equity into the new entity? If so, what share class, information rights, dilution provisions, and other terms will govern your new equity ownership?
- What percentage of the purchase price will be held in escrow, and for how long?
- What is the amount and calculation of the working capital peg that the buyer has proposed?
- What reps and warranties are you being asked to agree to?
- Do you want to stay with the business post-close, or do you want out entirely, from day one? Is your desired end-state even possible under the contemplated transaction?
And the list goes on. Many of these considerations can equate to real dollars and cents for the seller, though none of these are reflected in the headline price.
For more information on important non-price-related components to an M&A transaction, please see the following post: “Busting the Biggest Myth About Selling Your Business”
“So, Why Are You Selling?”
I was asked this question more than any other question throughout the entire process. Indeed, it was often the first question that I was asked when meeting with each new party for the first time. Before your first meeting with a potential acquiror, you must have a very clear and concise answer. As somebody who has both asked and answered this question as both a buyer and a seller, I can tell you this: Buyers will smell bullshit from a thousand miles away!
Not All Shareholders are Necessarily Treated Equally
If you have other investors in your business besides yourself, it’s important to realize that not all shareholders are necessarily treated equally in exit transactions. Most frequently, the ownership interests of the owner/CEO (or the individual who otherwise occupies an important operational role within the company) are treated differently than the ownership interests of other, more passive shareholders. This is a reality that isn’t discussed terribly frequently, in spite of how common it is. As a result, it tends to catch many owner/managers by surprise.
Though I was the CEO and largest shareholder of my own company, I also had about a dozen individual investors who occupied passive, non-operational roles. Of the 13 bids that I received for my company, over 70% of them proposed to treat my ownership interests in a manner different to those of every other investor. Specifically, in order to get a deal done, these acquirors required that I personally:
- “Roll” 50% or more of my sale proceeds back into the business (akin to taking half of my exit proceeds and immediately reinvesting them back into the new corporate entity that would created when my company merged with the acquiring company); AND/OR
- Required me to remain with the business as an employee for 2 or more years after the sale’s closing date
Some offers required that I do one or the other, and some offers required that I do both. Theoretically, all other investors should be indifferent to either option, yet both options were highly unappealing for me personally. As a member of the company’s Board and as somebody who took the trust and confidence of my investors very seriously, I found myself highly conflicted: If I accepted any of these offers, I will have fulfilled my fiduciary duty to my investors, yet I would have to pay a very meaningful personal price to do so. These are not easy decisions to wrestle with, and they are far more common than you may think.
As mentioned above, when selling a SMB, there is often a large asymmetry of information between buyer and seller (in favor of the seller), and the buyer understandably wants and needs the help of the existing CEO and management team to facilitate a smooth transition. Moreover, as a way to get more comfortable with the risk that they’d be assuming in acquiring your company, many acquirors want owner/managers to retain “skin in the game” (aka an ongoing ownership interest in the company) to signal that they still fundamentally believe in the future prospects of the business. Indeed, buyers often interpret an unwillingness of the existing CEO to retain an equity ownership interest in the company as a potential sign of trouble on the horizon for the company.
Timing and Emotions
It is generally safe to assume that:
- Selling your business will take longer than you think it will; &
- It will be more emotional than you think it will
There are exceptions to these generalizations, however these tend to be true more often than not.
With respect to time: For purposes of self-calibration, it may be worthwhile to create a reasonable timeline that you think will suffice for getting a deal done. Then double it. The result is the timeline that you should realistically expect.
With respect to emotion: I found selling my business (once unsuccessfully, once successfully) to be one of the most profound emotional roller coasters that I have ever been on. Discussions with other entrepreneurs have shown me that most others experience something similar. A few reasons why the process can be so emotionally depleting include:
- The incredible amount of time and effort that it can demand of you
- The very real prospect of the transaction not being successfully consummated, despite the time and effort that you’ve dedicated towards it
- Almost all deals feature 1-3 major inflection points, during which the transaction is at a high risk of falling through. These inflection points could result from a surprise in due diligence, a change in the state of the market, or a disagreement on a fundamental deal term, among other reasons
- All of your friends and family constantly asking you “how is the sale coming along?”, and at times you feel like you’re not making much meaningful progress
- The fact that you are contemplating voluntarily parting ways with “your baby”: The thing that has consumed your every thought for countless years, the thing in which you base a lot of your own self-identity (and perhaps self-worth), and the thing which has historically provided you with a sense of meaning and structure in your life
- The process can make you “fall back in love” with your company and its future prospects, as you’re likely to spend an inordinate amount of time “selling” others on “the art of the possible” within your business & your industry
- During a long process, you may find yourself regularly oscillating between “high confidence that deal will get done” and “low confidence that deal will get done”, which ultimately grows to become quite draining
- How will a sale impact the people who built the company alongside you? Will your management team keep their jobs? Will your employees keep their jobs post-close? If they don’t, will that be your fault?
- Before the sale is closed, who should you tell about it internally, and who should you not?
- What happens if one of your employees finds out about a pending sale before you tell them?
- What happens if a competitor gets wind of a pending company sale and starts to use that against you in competitive customer acquisition processes?
- How will you tell everybody if or when the deal closes? Will they interpret the sale as you “giving up” on them?
- What will you do with your time afterwards? The temptation is often to say something like “play golf” or “go to the beach”, but after a few months, such things often lose their allure and meaning. Are you sure the grass is greener on the other side?
I don’t mention these things to dissuade you from pursuing an exit. Instead, like my mentor did to me, I mention them so that you can begin thinking through these questions from now, before (presumably) these considerations are forced upon you by circumstance. Don’t be surprised if you find yourself pondering these (and other) questions when you’re going through your own sale process. It is perfectly normal. What’s important though is that you recognize the impact that such questions and worries can have on your own personal well-being, and put deliberate strategies in place to continue to prioritize your mental health at a time where such strategies will likely be needed most.
As my mentor once said to me: “You think buying a business is hard? Try running one. You think running a business is hard? Try selling one”.
The process of selling your business can be difficult in many ways, because in the absence of having done it before, there’s really not a lot of experience that you’ll be able to lean on. The skills that allow you to buy a business don’t necessarily make you a good operator of a business. And the skills that make you a good operator of a business don’t necessarily make you good at selling a business.
However, countless entrepreneurs and CEOs have been through this process before, and have learned innumerable lessons in the process. My intent in this section of the blog, “Selling Your Business”, is to share as many of those lessons with you as I can.
If you’re interested in learning more:
Many years ago, I came across a great podcast called Built to Sell, hosted by John Warrillow. Each episode, John interviews a new entrepreneur about the sale of their business, including the mistakes that they made and the lessons that they learned. I listened to dozens of episodes during my exit process, and continue to enjoy them. I hope you will too.
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