When It's a Seller's Market
Business for Sale Update
Thinking of cashing out? It seems that now may be the time to do it--or so the sellers featured in our monthly Business for Sale columns have discovered
Megamergers have been grabbing headlines for the past few years. And no wonder--in 1998 the value of large-scale mergers and acquisitions shot up to an all-time high of $1.2 trillion, with the average deal weighing in at $394 million. But does that mean that M&A prospects for small companies have been equally robust? Or has all the heated activity among large businesses monopolized whatever financing capital might otherwise have supported small-business sales?
The rule of thumb for small private companies is that under normal market conditions, one-quarter to one-third of those on the selling block actually get sold. That means that when most small-company owners are ready to cash out, they're unable to sell their businesses. (See "No Sure Thing" below.)
Because the marketplace for selling small businesses is so vast, fragmented, and underpublicized, it's tough to come by any statistics about earlier years to compare the current market with. But as a starting point, we contacted the 22 companies that Inc. featured in the Business for Sale column from June 1997 to March 1999. We hoped the experiences of those companies--which represented a broad spectrum of industries and had annual sales ranging from $125,000 to upwards of $13 million and profitability levels spanning all shades of the rainbow (or at least ranging from a big splash of red ink to black)--would help us understand what's been selling and why.
Our survey revealed that 9 of the 22 companies were sold--a 41% success rate. In almost all cases, the deals were closed within striking distance of the owners' target sales price. And if we add to this mix the four companies whose owners decided to take them off the market and pursue alternative growth strategies, 59% of our group of 22 reported a happy ending to their for-sale stories.
Other evidence supports that positive trend. According to VR Business Brokers, a network of 50 business-brokerage firms across the United States, the average price for small businesses sold last year increased by 9%, from $146,000 in 1997 to $160,000 in 1998. (On average, $160,000 bought a company with $455,000 in sales.) Thanks to a strong market, not only did more companies sell, they sold more quickly. With the exception of two or three months last autumn (when banks clearly did become more cautious about backing sales of small companies), there's been more than enough capital around to support an active marketplace.
Marc Dosik of VR Business Brokers' office in Columbia, Md., sums it up this way: "It's just a great time to sell. We're getting more and more calls from people who are looking to buy good small businesses. And what I see again and again is that if you've got a company that's well priced and there's any kind of dynamic supporting industry consolidation, you'll wind up with two or three strong bids and sometimes even a bidding war."
Although a fair number of our Business for Sale companies seemed ripe for consolidation plays, only one--the computer reseller--was sold to another company in its industry (a competitor, in fact). In that case, the buyer kept the deal hush-hush and decided to maintain separate operations after the sale rather than merge the two businesses outright.
That's not to say, of course, that big companies didn't come calling at some of our other businesses' doors. The child-care center attracted a decent amount of initial interest from other players in its industry. "The problem was, it was probably a bit too small to make the deal worthwhile for a bigger company that wasn't already operating in the area," concludes broker Bryan Keys Hands.
Then fate stepped in to aid the $430,000 (in 1997 sales) business. One of Hands's colleagues mentioned the center to someone from his church, piquing that person's interest. Through local connections, the prospective buyer was able to raise financing from regional economic-development organizations that support minority business owners and the day-care industry. A closing is scheduled with the selling price at $250,000, just $20,000 less than the asking price.
It's not surprising that the Internet service provider also attracted interest from would-be consolidators. Given the frenzy that's surrounded many Internet-related businesses during the past year, one might well have expected a gold-plated bidding war, even though this $150,000 company (in 1997 sales) was operating in the red. (If the initial public offering market is any indication, that's practically a selling point for Internet companies.) But this company ended up getting sold for a paltry $25,000, just 12% of its original asking price of $210,000.
While the owner did receive some higher earlier offers, they were all below his asking price, and he turned them down. "This was a case where the seller just wasn't being realistic, because he should have learned something from the fact that all the offers were coming in at roughly the same lower level," notes Dosik, who represented the seller. "He ran into a situation where his manager was going to leave, some other events turned against the company, and it was either close it down or sell it at a bargain-basement rate. That's what he ended up doing."
Indeed, if there's a common thread that runs through most stories of successful sales, it's that realistic pricing pays off. Take the experience of the stained-glass-window restorer, which may well epitomize the kind of company that a national consolidator would never come calling on. In fact, given the tiny market niche of this $201,000 (in 1997 sales) company, the labor-intensive nature of its business, and the lack of real estate to sweeten any prospective deal, the business might well have languished on the for-sale racks.
But, reports broker John Barnard of SVI Corp., in Nashua, N.H., "one of the first calls I received after the Inc. article ran was from a certified public accountant. He thought it would make a great acquisition for a client of his who was currently operating in the home-improvement business. Because the company was priced right and the owners had maintained meticulous financial records to support its value in the marketplace, the sale went through at close to 90% of the original listing price."
That's not to say, of course, that everything proceeded without a hitch. (It seldom does, given all the unpredictable variables that can affect the sale of any small company.) The prospective buyer's CPA audited five years' worth of the company's financial records. "The buyer visited the company and made an offer in September. We didn't actually close the sale until four months later," Barnard recalls.
If the experiences of the 22 featured companies are any indication, the more unusual or difficult a company's situation is, the more essential it is to set the right selling price. Consider the nursing home. In a rapidly consolidating industry, the business has attracted a large number of would-be suitors but no offers; its $1.4-million price tag probably just seems too high for a small, outdated facility that will take big bucks to upgrade.
Another company--which has understandably requested anonymity on this issue--likewise has attracted plenty of interest. But its relatively high price failed to take into account a substantial ongoing dispute with one of its largest customers over outstanding accounts receivable. That caused at least one bidder to retract its offer during the due-diligence phase.
Still, as sellers, brokers, and even buyers agree, it's sometimes hard to figure out what the right price should be, especially when a company is healthy, its growth prospects are strong, and the M&A market is as robust as the current one.
That's a lesson Don McMichen (the seller) and Charles Dobozy (the buyer) learned last March after their deal closed on the $270,000 (in 1996 sales) car wash. Dobozy had formerly owned a self-service car wash and had been thinking about buying a full-service facility for some time. He got hooked on this one after reading about it in the classifieds of a local newspaper. "We closed the deal for about $360,000--just $40,000 less than my original asking price--on March 6, 1998, which was a Friday," recalls McMichen.
That same day he received a letter from an Inc. reader who had called earlier requesting a marketing package. "I hadn't heard from that company, which was based out of state, so I hadn't thought they were interested. Then they sent me this letter. I just passed it on to the new buyer, telling him, 'This is for you."
Despite its delay in responding, the company was interested in McMichen's--no, make that Dobozy's--business. After a couple of weeks of back-and-forthing, the company offered the new buyer a price that was more than twice what he had just paid for the business. Dobozy turned it down. "It did make me feel good," he recalls. "But this was all so new, plus there were all those short-term capital-gain issues I would have had to worry about. And I was really enjoying owning the car wash."
Fortunately, McMichen (who was still on the scene, since he spent six weeks training his successor) didn't feel too terrible, either. "I might have underpriced my company," he acknowledges. "But the truth is, I bought it myself from some older people at a very good deal. When I priced it to sell, I added in a 50% profit, plus something extra to cover the interest an alternative investment might have brought in. Now I have to say to myself, I got what I wanted. And whenever both people in a transaction are happy, you can't ask for more than that."
But if coming up with the right selling price is hard, an even more difficult issue for some entrepreneurs is figuring out when--and, more important, if--the time is right to cash out.
Mike Art, of the hot-springs resort, is one of the four Business for Sale subjects who pulled his family-owned company off the market, ostensibly so that he could concentrate on expansion efforts and perhaps prepare for a sale at some later point. But to talk to Art now, a future sale seems highly unlikely. "I just turned down an offer the other day," he notes. "The truth is, I don't want to sell. There are practical reasons--the tax bite was going to be so big--but there are also emotional ones. I love what I do so much. And it's such a great business. I finally said to myself, 'What the hell am I doing trying to sell this company?"
Although some aspects of selling--or not selling--your company never change, the experiences of Inc.'s 22 featured businesses make it clear that major shifts have been taking place in the M&A market for small companies, and most people haven't even noticed.
Perhaps the biggest change is in the way prospective buyers now shop for businesses. Traditionally, shoppers have located leads by reading advertisements in trade or general-interest publications, consulting business brokers, or relying on a personal network of lawyers, accountants, or colleagues. The haphazard nature of those searches means that willing buyers and motivated sellers often just don't hook up with one another.
But the Internet has started changing that. "What we've begun seeing is huge," says Kris Karlson, a broker with Bowman/Hanson, in San Francisco. "People are visiting Web sites to find out about the companies brokerage firms have listed there. By the time they call, they are serious, knowledgeable, and motivated to proceed. I think this is going to have major implications for the way we're going to sell companies in the future."
The Inc. 22 have had mixed results with the Internet, perhaps because the trend is so new. The owner of the historic events house tried to sell her company on the Web nearly two years ago and didn't receive a single serious inquiry. On the other hand, that is exactly how the camping retreat found its buyers.
Julie Beeck, who bought the retreat with her husband, reports: "We had always done a lot of camping. We were tired of our corporate jobs and knew that we wanted to make this kind of lifestyle change and specifically wanted to be in Oregon. So we just started exploring the Internet to see if we could find Oregon resorts that were listed for sale."
What at first seemed a lark quickly turned serious when they found a broker's Web site full of promising prospects. "We E-mailed him for more information and loved what we learned about this particular property," says Beeck. Thanks to the Internet, the transaction proceeded at a rapid clip. Beeck and her husband first learned about the resort in April 1997; by July it was theirs, a month before the issue of Inc. in which it appeared hit the stands.
Perhaps the big cash-outs some entrepreneurs have earned by selling their companies to strategic corporate partners, roll-ups, or national consolidators have helped broaden the perspective of other small-company CEOs. Some are recognizing that the size of a company really does matter when it comes to its selling prospects.
Three owners of the Inc. 22 turned down offers and decided to pursue aggressive growth strategies instead, in part because they recognized that larger companies sell more easily and tend to command higher prices. Justin Talerico, the owner of the multimedia-ad-design firm, was one of the three. Despite receiving several solid bids and inquiries from about 150 prospects, he and his team decided to opt for a strategic merger with a software developer.
"We carried out a stock swap, expanded our roll of clients, and positioned our combined company for accelerated growth," he reports. "What we're thinking is that 12 to 18 months from now, we'll be ready to start contemplating a sale again, one that we'll be able to carry out on a much larger scale."
Dissimilar though their companies may be in all other respects, the owner of the rodeo event-marketing company opted for a similar course. His broker, Jim Zipursky of Corporate Finance Associates, in Omaha, calls the company--which had $2.7 million in 1997 sales and a $1-million price tag--a "classic 'tweener." "It's too big and expensive for a guy who's retiring and is just looking for a lifestyle change. But it may be too small to make a deal worthwhile for one of the big entertainment companies. So the owner's plan is, keep growing and signing up more corporate sponsors and TV deals. He's saying, 'If we're too small for the big guys, then let's get bigger."
Then again, as any M&A expert knows, there are some companies that are perfect for sale exactly the way they are. They're profitable--or at least profitable enough to support a deal when the deal is priced right. They've got such a large, loyal, even passionate, customer base that they don't need the Internet to drum up potential buyers. New owners are right there (at least figuratively speaking), waiting on line at the company's cash register.
The nudist resort was one such candidate. It sold to its new owners, Vern and Jill Sorensen, before Inc.'s article even came out, for a figure within 10% of its $525,000 listing price. "We'd stayed here before. We were friends of the owners. It had always been a dream for us to own a place like this," Vern says. A former banker, he and his wife, also a refugee from the corporate world, decided to make their fantasy a reality after she called him one day from her car phone, stuck in yet another (clothed) commuters' traffic nightmare.
So the Sorensens ended up fielding the 40-plus telephone calls that came from Inc. readers ready to shed their own business suits. "People were stunned when they called and realized the company had just been sold," Vern recalls. "They'd ask me, 'Well, would you sell?' And I'd say, 'What would you pay?' because, after all, everybody always sells at the right price."
That was the ex-banker talking. But then the new business owner in him would take over the conversation. "I'd always tell those callers, 'You'd have to pay pretty dearly for this business, because I just bought my dream."
Jill Andresky Fraser is Inc.'s finance editor.
BUSINESSES FOR SALE
COMPANY: Southern car wash
DATE FEATURED: July 1997
ANNUAL SALES: $270,000
ASKING PRICE: $400,000
NUMBER OF INQUIRIES: 30+
RESULT: Sold in March '98 to a local car-wash owner for $360,000
COMPANY: New England stained-glass-window restorer
DATE FEATURED: August 1998
ANNUAL SALES: $201,000
ASKING PRICE: $155,000
NUMBER OF INQUIRIES: 25+
RESULT: Sold for within about 10% of the asking price in January '99 to a remodeling contractor
COMPANY: California nudist resort
DATE FEATURED: March 1998
ASKING PRICE: $525,000
NUMBER OF INQUIRIES: 40+
RESULT: Sold to a loyal customer for $495,000 before Inc. article hit the newsstands
COMPANY: Northwest camping retreat
DATE FEATURED: August 1997
ASKING PRICE: $550,000
NUMBER OF INQUIRIES: n.a.
RESULT: Sold in July '97 for close to the asking price, to buyers who found it on the Internet
COMPANY: Rodeo event-marketing company
DATE FEATURED: November 1998
ANNUAL SALES:$2.7 million
ASKING PRICE: $1 million
NUMBER OF INQUIRIES: 24
RESULT: Got plenty of initial interest, but no offers yet. Owner's strategy is to increase sales.
COMPANY: East Coast nursing home
DATE FEATURED: December 1998
ANNUAL SALES:$1.4 million
ASKING PRICE: $1.4 million
NUMBER OF INQUIRIES: 50+
RESULT: Got lots of interest from industry players but is still on the market
COMPANY: West Coast manufacturer of laminated boards
DATE FEATURED: February 1998
ANNUAL SALES:$2.7 million
ASKING PRICE: $3.4 million
NUMBER OF INQUIRIES: 20+
RESULT: Received several low offers, but owner decided to relocate and restructure
Business for sale: No sure thing
Conventional wisdom holds that only one-quarter to one-third of small companies on the market are ever sold. At first glance, it's hard to fathom why the rest--many of them healthy businesses--cannot find buyers, or if they do manage to sell, why they command such relatively low prices. The explanation lies in some powerful marketplace realities.
The biggest problem, perhaps, comes from the inefficiency and fragmentation of the small-business merger-and-acquisition market. Although the Internet may help change that, traditionally it's been difficult for would-be buyers and sellers to find each other, unless they happen to hook up with the same regional business-brokerage firm or patronize the same classified-advertising venue. Another problem is that small private companies often thrive in lucrative but tiny market niches, exactly the kind that are easy for potential buyers to overlook.
Finally, one key business formula that measures cash flow often works against the small-business seller (unless he or she is selling a lifestyle business, in which other factors can help outweigh financial matters for potential buyers). Although most buyers look for a company with good growth prospects, they will price deals based upon prior financial performance and pay special attention to the previous year's cash flow.
A buyer is usually looking for a company whose cash flow can cover its current operating expenses plus three other numbers: 1) the salary that the new owner hopes to earn or plans to pay an on-site manager, 2) projected annual financing costs to cover the amount he or she must borrow to make the purchase, and 3) an annual investment return on whatever cash the new owner puts into the deal. Savvy buyers probably realize they could earn at least 10% a year just by putting their savings in a mutual-fund portfolio. Most hope to better that performance, with an investment return that covers the additional risk associated with buying a business.
That formula sets a high standard for any company's cash flow. After all, the current business owner may be drawing a below-market salary or may not need to pay any financing costs at all after starting the company from scratch. The notion of investment return has probably never entered into his or her thinking, at least not until it comes time to price the company for sale.
And there's the rub: If the company's cash flow can't meet the standard described above, its selling price will have to drop until it reaches a point at which lower projected financing costs help close the deal. And in some cases--especially for those companies in obscure niches or industries without any consolidation activity to help spark a bidding war--the numbers won't ever pan out to support a sale.
What can potential sellers do to increase their prospects? Here are three tips that might help close profitable deals:
- Consider setting up an employee stock ownership plan. Because ESOPs have tax advantages and are likely to get bank financing, it's relatively easy to start the process of selling out to your employees (who may well be your company's most motivated buyers). One advantage is that you will have more control over the selling price, at least initially, since the ESOP's stock value will be tied to the independent valuation that you, as the business owner, obtain.
- Don't talk to strangers. Instead, focus your sales pitch on the companies that already know your business--and its prospects--best. Those might include key suppliers, large customers, and potential strategic corporate partners.
- Make friends with enemies. Although this ploy takes some finesse, it sometimes helps to put out feelers to competitors. As the featured computer reseller learned, a merger with a rival business can often pay for both parties.
Where are they now?
A listing of additional companies that appeared in the Business for Sale column from June 1997 to March 1999
|Company||Date Featured||Annual Sales||Asking Price||Number of Inquiries||Result|
|WESTERN HOT- SPRINGS RESORT||June 1997||$3.3 million||$7.2 million||26||Postponed sale and expanded business|
|PACIFIC NORTHWEST COMPUTER RESELLER||Sept. 1997||$14 million||$6 million||41||Sold in spring '98 to a competitor (terms not disclosed)|
|COLORADO OFFICE- SUPPLY STORE||Oct. 1997||$1.4 million||$945,000||50+||Sold in Dec. '97 for close to the asking price, to an Inc. reader who bought it for his son|
|SOUTHERN DIRT- TRACK SPEEDWAY||Nov. 1997||$410,000||$680,000||12||Drew interest from lots of "romantic would-be buyers" but no offers yet|
|NORTHERN CALIFORNIA RECYCLER||Dec. 1997||$4.5 million||$6 million||25+||Received two offers, but seller couldn't agree on terms with buyers|
|FLORIDA MULTIMEDIA- AD-DESIGN FIRM||Jan. 1998||$1.8 million||$2.2 million||150||Carried out strategic merger instead with a software developer|
|MID-ATLANTIC INTERNET- SERVICE PROVIDER||April 1998||$150,000||$210,000||80||After owner nixed several offers, sold for a lowball bid of $25,000|
|WEST COAST EQUIPMENT- RENTAL COMPANY||May 1998||$5.6 million||$6 million||44||Received plenty of offers, but owner decided this fast-growth company was too good to sell|
|HISTORIC SOUTHWESTERN EVENTS HOUSE||June 1998||$132,700||$795,000||10+||Remains on the market, but profit margins have tripled and the price is down to $744,000|
|NORTH CAROLINA CHILD- CARE CENTER||July 1998||$430,000||$270,000||25+||Closing scheduled for a sale at $250,000|
|ROCKY MOUNTAIN HUNTING OUTFITTER AND GUEST RANCH||Sept. 1998||$402,000||$1.5 million||140||Received several offers, but because sales have doubled, the owner is considering repricing|
|WESTERN CREDIT- REPORTING AGENCY||Oct. 1998||$1.5 million||$1.2 million||42||Remains on the market, but with sales and earnings up, the price is too: to $1.6 million|
|MAIL-ORDER CATALOG COMPANY||Jan. 1999||$2.1 million||$1.9 million||138||Sold in March for $1.8 million|
|WELSH HUNTING LODGE||Feb. 1999||$412,000||$1.3 million||25||Got lots of interest, but with sales up and profitability within reach, the price is now $1.32 million|
|SOUTHWESTERN MOVING AND STORAGE COMPANY||March 1999||$1.3 million||$600,000||15+||After an accepted bid fell through, seller lowered price to $450,000|
The brokers' dog list
Although the market has generally been strong for small-business sales, certain types of companies are languishing. What follows is an admittedly random sampling of the industries in which, brokers tell us, for-sale signs currently fail to attract much attention:
- travel agencies
- hair salons
- mailing/packaging companies
- semiconductor-related businesses
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