Month: January 2024

Death, Divorce, or Distress…the 3 main reasons owners sell.

“Why are they selling?’ is a common refrain from buyers as to why a seller would sell a successful investment or business. The decision to sell is never a decision that is taken lightly and is often influenced by 3 significant life events, death, divorce, or distress. I would like to take a moment to delve into how these three Ds shape the motivations and circumstances under which people decide to sell.

Death, while natural and a part of our lives, oftentimes happens unexpectedly. It often involves dealing with estates and inheritances, where properties or belongings must be sold to divide assets among beneficiaries. Not to mention if this is a business with employees and partners can throw a monkeywrench into operations. This selling is not just a financial transaction but an emotional process, as it involves letting go of items with sentimental value. Selling here can occur due to heirs wanting to cash out or simply lacking the knowledge required to run the business. The sale can be used to help a family transition to life after the passing of a loved one.

Divorce, another critical life event, often necessitates the sale of shared assets. This process is not only about dividing possessions but also about individuals starting anew, which often requires liquidating shared assets to facilitate this fresh start. The emotional turmoil of divorce can affect selling decisions, sometimes leading to hasty sales under less-than-ideal market conditions. This urgency to sell can impact the final sale price and the financial futures of the involved parties.

Distress, whether due to job loss, debt, tax situations, or several other types of hardships, can force sellers into the market. Businesses can be in distress as well but in this instance, we are looking at distressed sellers. In these situations, the need to quickly access funds often takes precedence over waiting for the best market conditions or price. Sellers in distress may accept lower offers, affecting market values and creating opportunities for investors.

The 3 Ds are life-changing events for owners and their families. These events require finesse and consideration that can lead to some uncomfortable conversations with sellers and their families. Lead these conversations with care and remember you are there to solve a problem for these sellers.

Buy, Don’t Build

What do companies such as Tesla, WWE, and even Coca-Cola have in common? Besides being behemoths in their respective industries (we can debate Tesla is more hype than it is fundamentals), they all were purchased from their respective founders and taken to the next level by the buyer. Before Elon came along, the Tesla prototype barely worked. WWE was a small rinky-dink company in a fragmented industry and Coca-Cola was still a fledging soda fountain drink.

Have Immediate Cash Flow Day One. Buy Don’t Build.

Sometimes the worst person for a company IS the founder. And once more, as the founder, they are often too close to a company to see what exactly the problem is that is preventing a company from scaling and hitting that next level. Many founders find themselves in a position where the business isn’t a business for them but a job. Instead of working on the business, they work IN the business.

I have firsthand experience in this. I started a cleaning company earlier this year. In the beginning, I was the one answering the phone, fielding customer emails, and sending out quotes in addition to handling all the marketing and strategy. I was working in the business and it was just a job for me (A poor-paying one at that. It’s not uncommon for founders to take reduced or no salary in the beginning). In the startup world, this is called going from 0-1. It’s a lot harder going from 0-1 than it is from 1-2 because at the 0-1 phase it’s not a business yet. You don’t have systems in place. And there is no capital. 1-2 it’s a business. You have capital and maybe even some employees so you can focus on the overall business strategy.

We are especially in a time where it can be more advantageous to buy rather than build. There are approximately 2 million businesses owned by baby boomers. Sure, most of these businesses aren’t suitable for ownership (probably just 1 guy doing gigs under an LLC), however, even then there is lots of opportunity for those who find themselves in a position for an apprenticeship buyout type of situation.

Many boomers don’t have heirs who wish to acquire and continue the business, opting for careers entirely independent from their birthright. This is an opportunity that as of yet, has not been overrun. Namely, because it’s difficult to find these owners. Of course, this can be wrought with landmines such as businesses being dependent on one client, poor or nonexistent financial statements making due diligence nearly impossible, or employees all quitting on day one. Acquisitions can require a finesse that can require professional experts. Explore working with M&A advisors or business brokers to get a beeline into the acquisitions space.

Make things easy for you. Reduce your brain damage. Have Cash Flow Day One. Consider buying a business.

The Owner’s Paycheck

“Cash rules everything around me. C.R.E.A.M. Get the money. Dolla, dolla bill y’all.”

-Wu-Tang Clan

In the world of lower market M&A, SDE is the principal reason a buyer acquires a company rather than build from scratch. It’s arguably easier to buy rather than build. Seller’s Discretionary Earnings (SDE) are the barometer of small businesses. It’s the metric that reveals the true profitability of a business, beyond what traditional financial statements might show. Whether you’re considering buying a small business or preparing to sell one, understanding SDE can mean the difference between a fair price and a great deal. Let’s delve deeper into what SDE actually is and its significance in lower middle market valuations.

At its core, SDE represents the total financial earnings a full-time owner-operator would realize from a business annually. This isn’t just a technical term for accountants to bandy about; it’s essentially the business owner’s annual ‘paycheck’ for operating the business. Seller’s Discretionary Earnings are what gets an owner up in the morning each day.

It’s important to note that SDE can vary significantly across different types of businesses. Tech/Consulting style businesses, for instance, often boast high SDE due to typically higher margins and lower direct costs. Conversely, Brick & Mortar style businesses tend to have lower margins, given the additional expenses such as rent, utilities, and other operating expenses that must be considered.

To calculate SDE, one starts with the net profit from the financial statements and makes adjustments for:

  • Owner’s Salary and Benefits: All personal expenses paid through the business.
  • One-time or Non-recurring Expenses: Such as unique legal expenses.
  • Non-cash Expenses: Including depreciation and amortization.
  • Discretionary Expenses: These may range from travel to entertainment expenses not essential to business operations.

For sellers, an accurate portrayal of SDE can significantly enhance the perceived value of their business. It provides a truer representation of a business’s earnings, reflecting what an owner truly gains from the business. If taking out a loan to acquire a business, SDE can give an owner insight into how much profit they will take home after loan payments.

For prospective buyers, SDE is a crucial measure of a business’s underlying profitability and potential for future growth. If taking out a loan to acquire a business, SDE can give a buyer insight into how much profit they will take home after loan payments.