Have you ever wondered, “When should I sell my business?”
Business owners often peg the timing of their exit to some milestone in their life or the life of the business itself. Perhaps their goal is to sell the business when they reach retirement age (whatever age that may be), or when they land a whale of a client that will make the business more valuable to investors.
But does the timing of when you sell your business really matter? Yes. Identifying the right time to sell can literally mean millions of dollars in your pocket, upward or downward.
When’s the right time to take a business to market?
It’s the right time to consider selling when two things are true:
- You’ve built a business with a high level of transferable value, which makes your business marketable.
- The mergers and acquisitions market cycle is in a seller’s market and delivering high multiples.
If these two criteria are true, sell the business.
If they’re not, run your business as if you’ll run it forever, but be prepared to sell it tomorrow by understanding the internal and external factors that will influence your timing.
Three internal factors that influence timing
Business owners can control three internal factors that will influence the timing of a sale:
- Human capital. Can your business be sold and continue to run successfully without you in it? A common weakness of privately held businesses is an underdeveloped team.
If you’ve created a strong team within your organization—positioning your business to no longer be owner dependent—this is an indicator that you’ve built high transferable value and marketability. Human capital is one of the greatest intangible assets. So much so, we’re seeing “aqui-hiring” deals in which investors are buying businesses solely for their talent.
- Strong projected cash flow. Is your business positioned for strong growth? Buyers are interested in investing in businesses they believe can provide a return on investment through future growth—and this is evidenced by increasing cash flow projections.
If your business has grown to the highest level possible with the resources available to you, both in capital and talent, but you have a strategic plan that shows additional investments could fuel growth, then the time is right to go to market. Sometimes owners think they need to drive the business to its peak, but a word to the wise: an investor is always looking for future growth potential. Don’t make the mistake of waiting until you’ve driven your business to its highest level; it will leave no potential ROI for a buyer.
- Opportunity cost. What are you risking by continuing to own your business? Analyze the value of your business as an owner as opposed to selling it. If you were to sell your business and invest the proceeds net of tax, would the investment gains be more than the benefits you receive as an owner?
Taking this one step further, consider the risks involved in running your business. As a business matures and the owners get older, risk tolerance frequently decreases, making the opportunity cost of ownership untenable.
Three external factors that influence timing
The economy will always expand, peak, retract, and trough. These cycles are as old as time, and they’re a leading indicator for the mergers and acquisitions cycle.
When we’re in a strong economy, there’s capital available to get deals done, which leads to higher sale prices. But when our economy falters, capital dries up, leading to a retraction in prices.
The three C’s—cash, credit, and capital—are the economic indicators a business owner needs to keep a pulse on to understand where we are in the M&A cycle.
- Cash. The availability of capital drives deals, and fiscal policy impacts the availability of cash for investors. So, if we’re in a low tax rate environment and buyers have more cash on their balance sheets, they’ll need to identify opportunities that will produce a return on their capital. This stimulates deal activity as investors are motivated to put their cash to work.
Of course, if tax rates increase and the pool of cash shrinks, the sales price of businesses will shrink, too. In recessions, we see businesses selling for pennies on the dollar.
- Credit. Monetary policy moves the cost of credit. If interest rates are low and the cost of debt is cheap—which is the most common way to finance a deal—business values are driven upward.
Conversely, if interest rates are increasing to stave off inflationary pressures, the cost of financing increases, dampening the availability of capital and deal value.
If we see an inversion in interest rates—in which short-term interest rates are higher than long-term rates—this is a red flag. It means the near term is perceived to be risker than the long term. Yield curve inversions have historically been a signal for an impending recession, which means prices for businesses will retract.
- Confidence. Throughout history, we’ve experienced low tax rates and low interest rates, yet the economy drags. Think of the years after the Great Recession, when a lack of investor confidence kept the economy down.
Many events can shake investor confidence. Geopolitical events, which are often unpredictable, can make the global economy seem tenuous. An unforeseen disruption can impact the health of entire industries. Economic cycles, which investors and sellers don’t control, are always dynamic and greatly influence investor morale.
When investor confidence is high, this indicates a seller’s market, and we see premium prices being paid for businesses. Conversely, low confidence moves the cycle into a buyer’s market, and discounts are given. Economic confidence will always drive investor behavior and be a guide as to when the timing is right.
The key takeaway
Gauging market timing will always depend on the health of the economy, your industry, and, specifically, your business. Be sure your company is ready to go to market at a moment’s notice when capital is available, the cost of credit is low, and confidence is high.
Written by Chris Vanderzyden.
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