One of the most critical decisions an entrepreneur makes is determining the best time to bring in outside investors or sell the business entirely. Similar to investing in stocks or playing a game of poker, you need to have a strategy in place to know when to cash in your chips and maximize payout. Getting the timing right is key to getting the highest return for the business you've worked so hard to build.
Here are five points to keep in mind as you evaluate your options.
1. Know Which Factors Impact Valuation
A business is an attractive acquisition target when it is growing and has a track record of success. Regardless of what has been invested in the business, its valuation is always changing based on market conditions and its competitive positioning. Ultimately, a company's value is driven primarily by its relevance in the marketplace, operational strength, and ability to generate cash flow going forward. Specifically, factors that impact valuation include:
- Cash flow
- Client / customer relationship quality
- Growth opportunities
- Potential synergies with strategic buyers
- Competitive market positioning / sustainable competitive advantages
- Balance of the management team and reliance on the owner
- Macroeconomic factors, including availability of affordable debt
2. Set Defined Goals
Experts view business growth as a stepwise function in which each incremental capital investment allows for growth potential with a maximum limit. Weigh whether you have optimized the business performance given the resources (time and people) in place. Set specific targets that you'd like to hit (revenue, financing, enterprise value, etc.) so that as the business grows, you have concrete objectives to serve as an indicator that it may be time for an exit or potential next round of investment.
3. Know the Current Valuation
Communicate regularly with a trusted professional for perspective of the market transaction multiples, potential sale price, best practices for preparing financial statements for potential buyers, and the general market landscape of potential buyers. Advisers can connect you with their network of potential buyers and help you gauge the appetite of public markets for your business.
4. Evaluate the Opportunity Cost
Many entrepreneurs feel inclined to retain their business given the potential for independently driving growth, the annual cash flow streams, and the sense of purpose from their greatest endeavor. However, if you're planning to sell at some point and current exit conditions are favorable, it may be wise to forego this perceived security. Connect with your wealth adviser to project the expected returns if proceeds from the sale were invested across different asset classes. Evaluate the opportunity cost of keeping your wealth tied into the business, as the returns can be greater--or the risk of holding your investments in a concentrated portfolio is diminished--if the capital is invested in alternative ways. Investments in fixed income and equity markets will likely free your time and enhance liquidity options in the face of market changes, mitigating idiosyncratic risk.
5. Find Capable Buyers
Many buyers require that the seller stay vested in the business post-transaction in the form of minority stake, options, or some form of advisory service to ensure an effective transition. Accordingly, seek a buyer equipped with the skills and resources to execute on their business plan so the value of any remaining stake is preserved.
Selling a business is both an art and a science, and this is particularly true in terms of valuation. There are many reasons a founder may want to retain ownership, including the optimism that a better bidder could be around the corner. Given that business valuations may fluctuate, it's important to stay informed of current valuations to exit successfully. Sometimes the greatest risk of all is not letting go at the right time.
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Associate Alicia Raisinghani contributed to this article.