When entrepreneurs come to me for advice, I tell them to keep two things in mind. One, always build a business to last forever. In other words, no shortcuts. Do what's best for the business long term. And two, build the business so that it can be sold for as much money as possible--even if selling is not part of the plan. Building this way will force you to adopt best practices, by which I mean practices that produce the best performance--like minimizing what you take out of your business and instead using that money to grow.
Unfortunately, most entrepreneurs don't follow these precepts. Very few businesses get the best price when they're sold. Often a company is worth so little, its owners are better off not selling.
For example, a married couple I know--I'll call them Hannah and Ted--are in their early 60s and have a company that rewires offices to permit the use of the latest technology. It's more than 30 years old, and has about $4 million a year in sales. They asked my advice about selling.
We started by talking about the business, their roles in it, what they liked, what they didn't like, their outside lives, their employees, and so on. They wanted to know what I thought their company was worth. I couldn't say for sure, but businesses are valued on the basis of a multiple of earnings before interest, taxes, depreciation, and amortization, or EBITDA. With a little research, they could find out the current multiple for a company like theirs. I guessed they might get as much as $4 million for it.
Wow, that's a lot of money, they said. "Well, not necessarily," I said. "You have to subtract debts. You'll also have selling costs and taxes. You may want to reward key employees. How much do you take out of the business?"
They said they earned a combined $200,000 a year in salary. "OK, but what else?" I asked. "Does the business pay your health insurance?" "Yes, of course," they said. "You have to include that," I told them. "And company cars?" They nodded. "What about car insurance, or restaurant meals?" They nodded again. "OK," I said. "I want you to go home and make a list of everything the business pays for. Be really honest. Then we can see the effect on your lifestyle if you don't own it anymore."
Hannah and Ted did the exercise--and found that the company was actually paying them almost double their salaries. I looked at the numbers and said, "So if you sell, you'll have to make some drastic changes, right?" They didn't understand at first. "Let's say you net $2 million after taxes, debt, and everything else," I said. "That's money you can't put at risk, because it's all you've got, aside from Social Security. If you invest in something safe, you may get a 4 or 5 percent annual return, or $80,000 to $100,000 a year. That's quite a comedown from almost $400,000 a year."
They exchanged nervous glances. "But, listen," I said. "You may have better alternatives than selling. You said you work only three days a week, and you have people who can run the business without you. You could take more time off. You also told me you like interacting with customers. If you sold, you'd probably miss what you're doing. You have a choice: Sell, and cut back your lifestyle; or hold onto the business, and make changes that let you do more of what you like."
They said they'd think about it. In the end, they aren't selling--which isn't bad. But if they'd built to sell from the start, and implemented best practices, they'd have more options now.
Norm Brodsky is a veteran entrepreneur. His co-author is editor-at-large Bo Burlingham. They are also co-authors of Street Smarts: An All-Purpose Tool Kit for Entrepreneurs. Follow them on Twitter: @normbrodsky and @boburlingham.