Many business owners struggle with whether to sell their business or hold on a bit longer. Their trepidation is rooted in their uncertainty over which option yields the most rewarding outcome. We often see this level of doubt creep in with business owners who have a letter of intent in their hands from a prospective buyer. I hate to use the Kenny Rogers cliche, but it rings true here.
The final numbers, as outlined in the offer, get the business owner thinking: if the purchase price is 4x EBITDA (for a simplistic example), it’d take just a few years to put that same amount of money back into my own pocket, and I’d still have a company to sell.
This train of thought will lead the business owner to believe that his company would then be worth even more in a few years than it is now … so why not delay selling?
Clearly this isn’t always the case. Sure, the value of a company can increase over time; but the inverse is just as true. But more importantly, it’s unlikely that the owner will be able to put the same amount of money into his pocket over just a handful of years that he would’ve made from a sale. More realistically, that owner would have to hold onto the company for a decade more, or longer, to reap the same benefits that selling can offer.
That length of time isn’t necessarily possible for some owners (depending on age, health, etc.) and likely not ideal for many others.
This owner is failing to consider certain elements when assuming he will come out on top by holding onto the company a few years longer:
–You must subtract the cost of capital expenditures and interest paid
–You must also subtract all federal, state, and local income taxes
–EBITDA is not free clash flow to the shareholder
–EBITDAY must be adjusted for any changes made in working capital
EBITDA and a company’s value – more than meets the eye
One of the issues at hand here are two misconceptions about EBITDA:
Both of these misconceptions are incorrect, and lead owners to makepoor decisions when it comes time to sell.
What really is at play here is FCFF (Free Cash Flow to the Firm) and FCFE (Free Cash Flow to Equity). FCFF is the true determining factor in valuation and FCFE is the benefit the owner gains.
By determining both FCFF and FCFE, a business owner will have a clearer picture of how long it would truly take to generate the same numbers as a sale would produce. More often than not, the length of time it would take to generate that same number is longer than the owner would have assumed.
But the story doesn’t just end there. The money the business owner acquired from the sale isn’t going to just sit around untouched. Chances are the owner will invest it, meaning that money can generate yearly returns for the owner in the same manner as his business generated returns. It’s quite possible, in fact, that these investments will yield higher returns (certainly if the owner is willing to venture into higher risk investments).
When you factor in the amount of returns that could be earned from the money acquired after the sale, it becomes clear that it’d take a lot longer than a few years to make up the difference of what could have been earned from a sale.
The argument against ‘I still have a company to sell’
One of the arguments used to delay a sale is that, if an owner holds on for just a few more years to put more money in his pocket, he’d still have a company to sell.
There’s no question that this is true; however, if the proceeds of the sale were converted into an investment, the owner would still have an investment to sell. In other words, arguing that it’s worth not selling because you have some type of asset to play with later on is moot, seeing as your alternative investment (that you made from the sale of your company) can easily fill the role of that asset.
Not only that, but selling off part, or all, of an investment is a far easier feat to accomplish than selling a company. Often times, the sale of an investment can be done in a day, versus up to a year (or more) for a company.
When is it a good time to hold on?
Deciding to hold onto your company is a decision worth making if you have a concrete and realistic plan to grow your business specifically to increase the benefit of business ownership over alternative investments.
If no such plan is in place, the owner should strongly consider both the risk and reward of selling now, and using that money toward more liquid investments.
RC Victorino contributed to this article.