Cautionary Tale #7: Excess Inventory Blocks a Sale

Excess InventoryWe all make mistakes in business. Sometimes it costs us money immediately, other times in the long term. In the worst cases, all the way through and including the sale of your business. Particularly when an owner is ready to sell and is in the mindset of “cashing out”.

Not that long ago, we were working with a Main Street interior design/contracting business with $800k in annual revenues. The total owner benefit was $300,000. He had $1.8M in real estate and $1.5M of inventory tied up with the valuation of the business. The problem was, not only was that 4 years of inventory… But more than $1M of that inventory was a particular type of natural stone that the owner loved and had “gotten a deal on” some years ago. But never really moved.

When we asked him about it, he responded by saying he “wanted more display options” and that “it would sell eventually.”

While the latter might be true, it may be across an unacceptable time horizon for the buyer. The display options statement was a smokescreen to avoid dealing with the embarrassment of a bad call. The reality was as the years continued on, this type of stone would only be more out of style with current trends, making it even more difficult to move. He was right that it would give “more display options,” but the reality was the obsolete inventory in the display made new stuff look that much better!

There were a few options here:

  • Liquidation of the outdated stock wholesale in a one-time event. This would result in some tax-loss harvesting benefits for the current owner and could be easily demonstrated as a one-time write-off for a potential buyer. This would also serve as a useful “cautionary tale” about operating that particular kind of business.
  • Drastically mark down the pricing to make it attractive for buyers. This could lead to more cash on hand for the current owner as well as demonstrate that at a certain price the inventory can move.
  • Exclude the obsolete inventory from the business. If the current owner really believes the inventory will move, then he can strike up a deal with the buyer in which the stone would be sold on a consignment basis over a fixed period of time.

It’s no failure to make mistakes in business. The real failure is in not admitting those mistakes or dealing with them so they don’t cost you yet again. In this case, it could obstruct an exit.

Don’t be that type of owner. Own your mistakes so that you can move on to what you’d like to do next.

Cautionary Tale #6: Accounting Woes

Accounting WoesWhenever we discuss commonalities in successful transactions, inevitably “clean books” will be one of the first three things mentioned. Numbers don’t just matter for your valuation, or for tax purposes, or just to track where the money has gone: without clean books, a buyer can’t know whether he/she is looking at a solid business.

Here are three examples of people who came to work with us who didn’t accept that basic premise:

Bad Books, Buyer Balks

We had a seller who was looking to sell a car wash, but had inconsistent and sloppy books. The buyer understood this and was willing to wait as the books got cleaned up. For some reason, the seller had been using a tax attorney to do the accounting. $20,000 and some months later, the seller had clean books and was square with the IRS. But in the process, the buyer had long since flown the coop because of the time lag and lack of responsiveness from the seller. To compound his woes, the previous accountant/attorney was suing him for non-payment of previous bills.

Don’t put yourself into this situation. Startup owners do it all the time by handing a shoe box of receipts to their new accountant/bookkeeper. Don’t do that. Start on the right foot from the start.

Full Disclosure Matters

In another situation similar to the one above, a seller was not as responsive as she could have been with her books, and the buyer started to get uncomfortable. At some point, it came out that there had been a $180,000 bad debt write-off from an old account. The situation was completely explainable as a one-time occurrence that shouldn’t affect the value of the business, but the seller had already been slow in responding. The buyer saw this disclosure as only the first in what might be more shocking disclosures, even though the reality was that this was the only real accounting issue to discuss.

The seller had created an atmosphere of concern and doubt, so it didn’t take much more to dissolve that confidence entirely. Always show and tell all the warts of your business to your broker. We’ve seen them all, and one thing we can say for sure; when you lead with honesty, you create and foster trust with your buyer.

Lying to the IRS

Another time we had a seller with a business that took in $2.2M in annual gross revenues, which led to $400,000 of declared owner benefit. But the owner also took $200,000 of unreported cash for himself, which was obviously not declared to the Internal Revenue Service. When we told him that he couldn’t get what he was asking for for the business since the books didn’t back the narrative, he insisted that we list the business anyway. “I’ll get audited if I go back and fix it now, anyway,” he said. While that has happened in certain circumstances, we told him that this wouldn’t be attractive to buyers.

Unsurprisingly, he got precisely zero offers, for the simple reason that potential buyers thought, “if he’s willing to lie to the IRS, which will run over your grandmother to collect what it’s owed, what else is he willing to lie about… to me?”

Honesty is the best policy. It is one of those lifelong bits of wisdom our mothers taught us long ago.

We all make mistakes – if you haven’t been straightforward with your books in the past, there very well may be ways to fix them and prepare your business for a successful sale.  Call us and let us connect you with people who can help you do precisely that.

Cautionary Tale #5: “I’m an Owner – You’re an Operator”

One of the key pieces of advice we give to all our new owners is: “Don’t change too much too quickly.” In fact, you should guard against any kind of changes in those early days. You should be soaking up everything you can about the business, learning why it’s gotten so successful such that a person like you has come along to buy it in the first place. But as you might guess, not everyone takes our advice.

A recent cautionary tale came in the form of a business that was open for sixty years. It only took eighteen months for the new owners to put it out of business.

Attitude

CautionAs brokers, we can dispense business advice but often we have to give life advice as well. We could see that the two incoming owners had a “know-it-all attitude”. You can gently try to offer some correctives, but at the end of the day, it’s their life and their business to do with as they wish. But from the get-go, the outgoing owners and the entire company saw that attitude on display.

It started in the morning. The owners would be in at around 7:30 each morning, usually slightly before any other staff arrived. This allowed them some quiet time to do work before the office got busy, but it also allowed them to demonstrate to their team that they took this at least as seriously as everyone else did.

Not so with the new owners. They made sure to get to the gym — not an early morning session — but one that allowed them to roll into the office around 10 or 11. When they did arrive, they didn’t ask for training or orientation, they were just happy to assume the title of management without earning the mantle of leadership.

A perfect example happened when the new owner called out to a staff member to come into their office. When the employee came in, he was handed a sheet of paper: “Please fax this to so-and-so.” After the employee left, the old owner leaned over and said, “We usually do those sorts of things, no need to bother the staff.” Without skipping a beat, the new (and soon to be former) owner replied, “That’s the difference between you and me.  I’m an owner – you’re an operator.”

Departures and Decline

As I’m sure you can guess, that sort of attitude wasn’t confined to private remarks in an office, but leaked out to how the staff was treated, and before long, people started leaving. The front line staff were the first to go, almost all of them left within 90 days. Some months after that, the management team followed suit. As the cash flow dried up, the new owners couldn’t take a salary and worse, had to take high interest loans (without their bank’s knowledge or permission) to stay afloat. From that point forward the death spiral accelerated and before long they had crashed, largely because of their own hubris.

Perhaps being an operator so that you could learn how to be an owner of that business might have been in order?

Whether you consider yourself an owner or an operator, you’d be wise to pay attention in those early days at the helm of a new business. Continue to write down and note exciting ideas you may have for change and growth, but wait until you have a real sense of the business, instead of relying on perhaps your (too healthy) sense of self, before making any changes at all.

You bought the business for a reason. Give yourself time to understand the business completely.

Bad Deal or No Deal?

Bad Deal or No DealOne important reason you hire a broker to help you sell your business is the addition of a person to the transaction who is not emotionally tied to the business. We are there as your representative – to make sure you get the best deal possible at the time you are listing your business. And sometimes that advice will be to walk away from a transaction if we don’t think everything lines up in your interests.

Sometimes, no deal is better than a bad deal.

Bad Deals

There are many reasons why a deal may be a bad one, but there are two in particular that we see often that we try to deal with as soon as we can.

Price: this is before an offer is made, of course, but we try to make sure that the price we market the business for is not just in line with the financials and tax records of the company and the growth trajectory, but also with what the market is currently paying for businesses in your industry. That’s why it’s always so important to get a true valuation for your business. It’s objective, unemotional, and has nothing to do with what you “think you deserve” for your blood, sweat, and tears over the years.

But apart from a marketable price that we are confident will sell in a reasonable time, there also has to be consideration for the seller’s financial situation. For example, will the sale, after taxes, clear all the business debts of the seller? If not, would it make more sense to operate the business for some more time in order to be free and clear at closing?

Terms: this is after an offer to purchase and will usually be part of a package of negotiable deal points.  Almost all successful transactions have a fairly balanced allocation of financial risk.

On the seller’s part, some financing may be in order, whether as part of SBA requirements or simply because of the buyer’s need. The buyer may also ask for some assets to be classified in such a way that will result in more taxation for the seller.

On the buyer’s part, some personal funds may be included as part of the purchase, and income statements scrutinized to make sure he/she is not overextending him/herself to buy the business.

As we’ve said often in these articles, successful transactions also usually leave both buyers and sellers feeling that they did sacrifice something they would have preferred.  That’s why it’s called negotiation.

No Deal

It’s important to note that just because there’s not a deal doesn’t mean there isn’t a good reason for it.

On more than one occasion we have seen exceptional growth in financials for the current fiscal year and have advised our clients either not to list or to de-list their business so that we can get one more corporate tax return and thus boost the valuation of the company. Sometimes no deal is a strategic retreat rather than giving up.

But sometimes no deal happens because we’re not dealing with a motivated seller, or because the client doesn’t trust what we are telling him/her.

In our experience no deal is often better than a bad deal, because you can always try for a new transaction, trading on the lessons learned in the previous attempt, whereas a bad deal leaves you stuck with the consequences.

If you’ve got questions about pricing your business to sell, give us a call!

Cautionary Tale #4: Waiting for the Next Best Offer

WaitingSome time ago, we had a seller who had a wildly profitable business in medical equipment. He was one of the first to market, and as such had a great competitive advantage and enviable cash flow. In fact, when we first took on his business, he had several serious offers, one as high as $12M.

Unfortunately he was always looking to trade up. Instead of seeing the offer for what it was, which was more than fair given the circumstances, he kept thinking he could get more. He never really got serious with any of these offers. Despite having engaged with us as brokers, he also hated the idea of paying a commission, and so was looking to make his own deals so he wouldn’t have to pay us. We can tell you from experience that doesn’t usually work out well for the seller.

And then…reality happens

The market knows. That’s why it’s the market. Any time someone is making a lot of money, competitors are going to be attracted to the opportunity.  Competitors mean slimmer margins and the end of complacency.

Worse, the technology improved and what he was selling was no longer the newest/best. He hadn’t prepared properly for the upcoming changes and got a bit left behind. When he did end up selling some time later, it wasn’t for the $14M that he wanted or the $12M that he could have had if he had taken our advice. It was for less than $4M. That’s not shabby, for sure, but it was $8M less than he could have had.

To review:

  • When you hire a broker, you’re hiring a professional who has a vested interest in helping you sell your company. Yes, we will get paid for doing so, but that’s part of the deal. If you want to sell on your own, you’re welcome to try, but it’s going to be a lot more work than you expect, and not nearly worth what you think it will be in “savings” of your time or money.
  • Be aware that sometimes you’re making money hand over fist not because you’re special, but because you’ve hit optimum market conditions. Unless you’re going to dig in and make a career of it, it’s wise to take great offers when they come your way instead of chasing the mythical “next best offer.”

Cautionary Tale #3: The Answer You Want Isn’t Always The Answer You Need

Questions and AnswersThis is a continuing series of stories we want to share with our clients so they don’t make the same very costly mistakes.

One of the many reasons you hire a business broker to help guide you through a sale is because we will tell you important truths without fear. We want a successful transaction and that can’t be done by hiding things or not being fully truthful. But that sometimes means that a client will want an answer you simply can’t give.

One of our clients had retired from a twenty year career in a field, and had decided to get into a food franchise. The first location that he picked was about thirty minutes from his home, so he had a general manager in place. The location wasn’t losing money, but it wasn’t making money at the rate he expected.

He also bought a second location of the franchise much closer to his house, which he had great expectations for. He wanted to get rid of the old location so he could focus all his energies on the second location. There was a problem, though. He didn’t have a sellable business.

There are many reasons to buy a franchise, but once you’ve committed and bought one, you simply have to put in the work.

Because the business wasn’t in a strong position, the sale price wouldn’t clear the debt that already existed. This meant that the deal couldn’t be financed. Worse, he still had an existing lease obligation that had some strings attached.

We told him the numbers had to be better so that we could help him sell his business. He disagreed.

Not only did he disagree, he went around asking for second and third opinions. Word kept coming back to us from friends and colleagues that he wanted someone to look at his business and give him the answer he wanted. We couldn’t give him that answer because it would have been a waste of everyone’s time.

Any business owner starts with dreams about possibilities. But once the business starts in earnest, those dreams meet with reality. Once you are ready for a sale, that reality has to pass the smell test of our team here at Apex before we will put it out on the market with our name behind it.

Sometimes, having a broker serves the purpose of telling you that you don’t have a business that’s ready to sell…yet. But if you take our advice about what to improve, you can have one sooner than you think. But that means you have to be willing to hear the answer you need, not the answer you want.

Want to avoid being part of a cautionary tale?  Give us a call so we can discuss implementing better systems in your business so you’ll be in a position to sell when you want.

Cautionary Tale #2: No Systems in Place

PlanThis is a continuing series of stories we want to share with our clients so they don’t make the same very costly mistakes.

We’ve discussed before that if you do well in one industry and decide to come back to it after a non-compete has ended, that there’s every likelihood you will do well again. You’ve already have a good position in knowledge and network against your competition. One of our recent clients had a seven figure exit from an equipment company over a decade ago. Once his non-compete ran out, he got back into the same business and in only six years he had grown the company from zero to $100M in annual revenue, against a 20% net profit.

That sort of business and that kind of profitability gets a lot of attention, and before too long he had an offer for a cool $100+M on the table from a serious buyer.

There was only one problem, the seller wasn’t serious. The reason we know he wasn’t serious was twofold.

Firstly, he wasn’t responsive. There was a period of eight weeks from when the offer came in before he even responded.

As we’ve said numerous times in various articles, successful transactions aren’t born, they’re made from cooperation, communication, and responsiveness to requests. If he was serious about selling the business and not just testing the waters, he would have reacted more appropriately to an offer that paid such respect to the hard work he had put in for the last six years (and even longer, as he didn’t mentally start from zero, but was building on previous experience, when he started the second business.)

Second, his lack of responsiveness didn’t come from a lack of seriousness alone. The reason he was gone for weeks at a time was because he was very busy working in the business instead of on the business.

He had a “management team” but it was really more for show than for go. He had a stranglehold on operations and no systems in place. This had already spooked the buyer early on, but the buyer thought about requesting an extended transition time, perhaps over a couple years, in order to ensure a successful handover.

Multiple Buyers

We encourage having multiple potential buyers looking at your business at any given time so that we don’t have to bet on one candidate.

In this case, the seller refused to allow us to market his business more broadly. He put restrictions in place about who could be shown the business. Also, he had to pre-approve every person we wanted to show the business to before we could move forward, waiting weeks for an approval. When the buyer withdrew his nine figure offer after a lack of responsiveness on the part of the seller, as well as an unanswerable fear about inability to transition, we had no other buyers we could offer to the seller… even if we believed he was serious, which we had come to realize he wasn’t.

This all goes to show that a successful build and exit in an industry can and does put you in the driver’s seat to do it all over again, but with that increased success can sometimes come a detachment from hard truths:

1) A business that can’t run without you is just a job you own. It’s not a sellable asset.

2) Your actions, not your words, dictate how serious you are about selling your business.

3) Your best chance of selling a business comes by having it be available to the largest number of serious buyers.

Want to avoid being part of a cautionary tale?  Give us a call so we can discuss implementing better systems in your business so you’ll be in a position to sell when you want.

Cautionary Tale #1: No Transition Plan… Ever

Time for ChangeThis is the first in a series of stories we want to share with our clients so they don’t make the same very costly mistakes.

Look, maybe it’s not time, let’s talk in another 4 months.” This is a quote we’ve heard many times before, and in itself, it’s totally neutral. But once you understand the context, you realize how strange it really is.

The call came from someone we had been speaking to for the last three years, who has a printing business in the Midwest. He’s in his early 80s, as is his wife. He has a daughter who is on the board of the business, who was only told about the idea of a sale in the last year. She has expressed a lack of certainty as to whether she would want to take over the business. But even if she did, there is no transition plan in place.

This is a failing that is common in family businesses, but in this particular case, we had been talking about a possible sale for three years already.

Because we’ve been doing this for many years, we can tell you the likely ending of this story.

We will get a call from a family member or from the client from a hospital bed, informing us that we need to sell the business quickly, or worse, that the client has already passed. Unfortunately, we will be working with a probate court to sell the business. It’s not our place to tell this client what to do with his life. If he thinks, in his early 80s, that with no transition plan, no clear family succession, and a wife who just had a second major surgery, that it’s “not time to sell,” then clearly it isn’t.

What we can do is use his story to caution our clients: have a plan or plan to fail, and don’t think you have guaranteed time. Every moment in this life is a gift. Take opportunities and options when they come your way.

Want to avoid being part of a cautionary tale?  Give us a call so we can discuss your transition plans.

Case Study #2: What to Be Aware of in an Earnout

Jason Swenk In 2012 Jason Swenk sold his digital advertising agency, Solar Velocity.

Solar velocity helped with websites and web applications for brands like Aflac, Coke, and LegalZoom. At the time, he took 50% of the sale in upfront cash and took the remainder in a 50% earnout.

What is an earnout?

An earnout is another way for a seller of a business to receive payment that is based on future performance of that sold business.

Why do some buyers offer them?

Sometimes they lack the cash or capital to buy the business for the entirety of the selling price, so asking the seller to, in a way, finance the deal through an earnout is a strategy. Many times there may be some skepticism as to the viability of the firm without the seller in position, the business may have customer concentration issues, or are using aggressive projections, so this helps “steady the ship” during the transition time as the seller is incentivized to do what he can to make his earnout provisions.

Why did Jason decide to sell the business in the first place?

It had been 12 years in the making, and at the $10M revenue milestone, he knew that the next level for the business would be $50M, and he didn’t have the desire to push on to that level. He wanted to do something new.

What were the terms of his earnout?

He had to stay on for two years and the company needed to hit certain markers throughout that time.

What went wrong?

The company that acquired Jason’s company was itself acquired nine months after Jason sold. The new company then construed the earnout timelines across those 9 months instead of the 24 in the original agreement, and he didn’t get any of the earnout.

The major failure here was from Jason’s lawyer and M&A firm that didn’t foresee the possibility of another acquisition and how the terms of the earnout would survive in such a transaction. That’s why it is so critical not only to get help in structuring your deal, but to think about every possibility, particularly in an earnout.

Before that, however, you must realize that when you’re bought, you no longer control the reins of leadership in the company, and when you make suggestions which will improve the likelihood of your targets being hit, those suggestions may be disregarded. Even if you have yourself covered on the contract side, you can’t control how management will work with you.

So if you have to do an earnout, what should you consider?

Given this experience, it’s not hard to imagine that Jason’s policy is “no more earnouts” should he sell a business in the future. But what if an earnout is part of a deal you are involved in?  You should realize that the best earnouts provide incentives for the buyer, not just the seller.  If you can make it equally beneficial for a buyer to hit an earnout marker, they may stay on the front lines with the seller to make sure those targets get hit.

And, as we noted above, make sure that you account for every circumstance during the earnout, including an acquisition of your acquirer.

Words of Wisdom

Jason’s gone on to bigger and better things since the sale, including authoring a book and creating a smartphone app, so this case study isn’t solely a cautionary tale.  “Build to sell, but treat your business like you never will” and “The grass is greener…on the side you water!” are quotes that indicate that Jason is the sort of person who learns from his mistakes. We hope you will learn his lesson, so you don’t have to re-learn it on your own.

To learn more about Jason, Solar Velocity, and this sale, click here.

Apex is actively looking for Advisors to join our team. If you or someone you know would like to learn more, contact Doug Hubler at dhubler@kcapex.com or 913-433-2303.

Selling Your Business without an Intermediary: A Cautionary Tale

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Recently, when a buyer handed us his financial statement along with his completed nondisclosure agreement, we realized that he was severely undercapitalized.   Even if we considered the backing promised by his father-in-law he would hardly be eligible to acquire a business bigger than a lemonade stand.

Surprisingly the same buyer described extensive conversations he’d had with a business owner who was seeking a buyer for his $1 million business via a blind online ad.  The business owner spent a significant amount of time discussing the prospect of selling his business to this supremely unqualified buyer.  Time wasted.

Worse still, in relating his story the buyer supplied adequate details about the target business for us to identify the business for sale.  Not only had the seller wasted his time talking to an unqualified buyer, but he had inadvertently granted this buyer the privilege of broadcasting his intention to sell the business.  Potential jeopardy.

What is your time worth?  How important is a confidential process to you? Apex Business Advisors applies a rigorous process in marketing, vetting buyers, and maintaining confidentiality throughout the transaction.  Having sold hundreds of businesses over some 16 years we know how to achieve the seller’s objectives; efficiently and with reduced risk.

Contact us if you would like additional information about buying or selling a business.

Paul Temme
Senior Advisor