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How to create a winning exit strategy

In business, nothing quite beats that warm inner feeling that business owners experience when everything is going swimmingly and the money continues to roll in as expected, day in day out, week in week out and month in month out … with no surprises upon approving and signing off the year end accounts.

They confidently, and perhaps smugly, review another successful year of trading and look forward to a repeat performance in the subsequent year.

From your aspect it’s a satisfied client and a “nice” bill paid promptly.

Ongoing upgrades

Many SME owners have already made the majority of their investment into their business some years previously and with the exception of ongoing upgrades and maintenance of buildings and plant there are few, if any, demands for a substantial cash injection over and above anything that can be met comfortably out of retained profits.

Sometimes the business owner reflects upon the current value of a lifetime’s work, usually in their own mind or perhaps because they have received an unsolicited approach in the post from a business transfer agent seeking to drum up business.

The thought of selling up is usually a fleeting one which is soon brushed aside by the notion of losing a steady and reliable  income.

Entrepreneurs

There are typically two sorts of entrepreneurs and where they are on the scale will likely determine their approach to selling.

First, there is the serial entrepreneur who may be starting-up or buying and reselling businesses every few years, typically after turning around a problem company or consolidating.

Secondly, comprising the majority of successful businesses, are those founded or built up by an individual over a period of decades and are the main focus of their owners’ lives. Within this category are people with two divergent needs.

Most common is the business  owner who will be selling with a view to retiring, there being no “next deal” nor any participation in the labour force or wealth creation, but there is also the one who has enjoyed their time at the helm but is too young to retire and fancies doing something less demanding, what we now refer to as a lifestyle business.

Crux of the problem

Here’s the crux of the problem that is responsible for so much lost sleep.

When is it time to hit the big red button and bale out, whatever one’s ongoing income requirements?

Let me be clear on one point here. I am not discussing a case of “calling the top of the market”, where there is a frenzy of consolidation taking place at eye watering multiples. Such scenarios are often quite simply almost always “no brainers”.

The heart of this discussion is through the lens of making sure the business owner has not left it too late to extract maximum value out of their business.

But what is meant by too late?

Let’s start from the aforementioned premise that we are dealing an SME built up and developed over 25 years by its owners without any outsiders in the boardroom. It is turning over £3m per annum and yielding a net profit before tax of £0.7m with a balance sheet worth a net figure of £2.35m.

Very nice indeed but as with everything else nowadays the world is changing quickly and the old certainties have never been less certain in a shorter timeframe. Like their competitors this business has to run hard just to stay still and survive, let alone find ways to innovate and adapt in order to continue thriving.

So what is this business actually worth on the open market?

Balance sheet

Assuming a healthy exit multiple of 4.5x it would fetch a very handsome £3.15m for its owners which is in excess of the balance sheet.

But that would mean an instant end to the income of £0.7m per annum so our business owner will be sucking hard on his or her  teeth and reckoning that it’s probably worth waiting another 2  or 3 years THEN banking the £3.15m.

After all,  what sort of return will £3.15m generate? A pedestrian 1.5 per cent on deposit or a heart-stopping racy but riskier 10 per cent if reinvested in another venture. Either way a far cry from the current 29.8 per cent return on capital employed being enjoyed.

Surely a fair assessment?

However, how certain is the business owner that the coming years will see profits maintained in the face of external headwinds? Brexit, Political earthquake at Westminster, Tariff Wars, Sector disrupter.

I am sure you can think of more scenarios to keep you awake at night. Not forgetting that our business owner is in their early 60s and not quite got the same drive and energy as in former years to keep thing running at full pelt, let alone grow earnings.

Okay, so perhaps these doomsday scenarios won’t happen.

But in a few short years he or she will be heading for 70  and health tends to worsen with age, not improve as it would with a good Scotch.

Industry circles

So let’s take a compromise view and hang on for 2 more years then and see how things look, while making tentative enquiries to business brokers and keeping a closer ear to the ground in industry circles.

Let’s say in the intervening two years the steady rise in profits splutters, even just slightly and profits come in at £0.68m and £0.595m respectively . Nothing major has occurred on the macro economic front, just the loss of a couple of good contracts and the failure to replace them.

Well, the owner’s lifestyle certainly won’t have felt the dips but prospective buyers will certainly have taken notice.

We get to market 24 months later and the offers are coming in for what is a fundamentally sound business but the multiples offered are dropping to 3.75x 3 years average earnings – £2.47m . Not too bad because we’ve had the benefit of the two years’ worth of earnings in the interim.

Fair enough, so let’s tweak our scenario. The storm clouds have gathered on the economic front as well and profits come in the next year at £0.425m. Oh dear.

Trend of profitablity

Now the trend of profitability is heading south in an established pattern and best offer is coming is at 3x the average of the past 3 years net earnings – £1.7m. OK, so our resilient business owner looks back and sees that he or she has still come away with more overall –  £3.4m instead of £3.15m.

Now let’s chuck in a wildcard. The owner’s health has suffered as a result of the stress of falling profits and market uncertainty.

As the deal stretches out and it becomes clearer that the seller is getting much keener to “do the deal and be done with” , the due diligence will throw up all sorts of “issues”.

And eventually our seller will be taking a multiple of 2.5x net profits, which, by the time it comes round to signing the contract have, fallen yet again to £0.295m  and the average profit over three years has now dipped to £0.438m .

The proceeds from the sale are now £1.095 . The total over three years is now £2.665m  against £3.15m  but what if there is no buyer?

Remember – buyers face the same storm clouds and may have battened down their own hatches.

Far fetched

Far fetched? Not in my experience but why not ask your clients what they think?

Nobody knows what the future holds and often if pays to keep going but eventually there comes a point where that no longer holds true.

So, the take home here is to understand that just when you don’t need it to happen, events can and do move against businesses to create the perfect storm. Many buyers out there specialise on sniffing out such opportunities and pouncing just at the right time. Our SME owner may no longer be “in the money” and possibly no longer “in the game”.

So perhaps when it comes to “calling the top of the market” sellers need to look much closer to home. That’s where sound advice from a trusted outsider, such as an accountant comes into its own.

Planning the exit for a business is always going to be more of an art than a science, with a hefty dose of good fortune but it pays to have the conversation with clients sooner rather than later, even if simply to get it on the radar for a future conversation, because you don’t want to be “too late”.

The table below uses the figures in this article and the yellow background is where the seller will reinvest at 10 per cent, the red being proceeds put on deposit at 1.5 per cent.

 

Multiple Proceeds Income  Income  Income  Total
Sale time: Of sale Year 1 Year 2 Year 3
Now 4.5 3.15 0.047 0.048 0.049 3.294
0.315 0.347 0.381 4.193
End Year 2 3.75 2.468 0.680 0.595 0.056 3.799
0.680 0.595 0.374 4.117
End Year 3 a) 3 1.7 0.680 0.595 0.425 3.400
b) 2.5 1.095 0.680 0.595 0.295 2.665

www.henleybusiness.com

 

About the Author

Norman Younger

Norman is director at Maximiti and Henley Business Group

At Maximiti, Norman brings his unique blend of accountancy background and business experience to bear in brokering the sale of accountancy practices, as well as other niche businesses turning over in excess of £1m via Henley Business Group.
He also advises and mentors small businesses requiring specialist input and is an experienced troubleshooter who likes a business challenge that demands a creative and focused solution. Norman is also a qualified commercial mediator and trained negotiator who enjoys solving a good challenge.

Online Profiles: |   https://www.henleybusiness.com/

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