Maintaining Control while Exiting in a Buyer’s MarketChia-Li Chien
Chia-Li Chien, PhD, CFP®, PMP® Apr. 5, 2018
The wave of baby boomers exiting their businesses can put a lot of pressure on basic supply and demand. A recent study found that “1.36 to 2 million baby boomer–owned businesses would be for sale” from 2012 to 2022 (Bronza, Auslander, & Ma, 2015), but the number could grow substantially to 3.8 million by 2032 (McMann, 2012). The “large supply on the market will [put] downward pressure on pricing” (McMann, 2012). The supply and demand condition in the merger and acquisition market can cause the selling cycle of a business to be unpredictable.
A business owner wants to be in a seller’s market to avoid pricing pressure from market transactions. A seller’s market is “a situation in which demand exceeds supply and owners have an advantage over buyers in price negotiations” (Investopedia, 2018). Figure 1 illustrates how a seller’s market is often clustered in the larger deal size (selling price) such as above $1 million. Selling prices that are less than $500,000 often occur in a buyer’s market. However in 2018, selling prices between $500,000 and $1 million constitute a seller’s market compared to the 2017 buyer’s market. Hence, smaller selling-price firms have a lot more pressure on their desirable selling price.
Owners considering selling to third parties need to have understand whether they are in a buyer’s market or a seller’s market. This will help determine the likelihood of closing the deal within a reasonable timeframe. Please keep in mind that “approximately 19% of business listings/engagements terminated without closing in the last 12 months,” according to the 2018 Private Capital Markets Report from Pepperdine University (Everett, 2018). There were 264 participants in the broker survey, and the majority of these business brokers worked on deals valued at less than $1 million selling price or deal size.
Figure 1 Buyer’s vs. Seller’s market by Deal Size 2017 v 2018
Source: Author’s computations. Buyer’s 18 and Seller’s 18 are 2018 Private Capital Markets Report from Pepperdine University (Everett, 2018 Private Capital Markets Report, 2018). Buyer’s 17 and Seller’s 17 are 2017 Private Capital Markets Report from Pepperdine University (Everett, 2017).
Selling price can be determined by an appraiser based on many factors of the business such as industry trend, overall buying and selling activities, and economic conditions. In my experience, a business that has more than $5 million annual revenue often uses EBITDA (earnings before interests, taxes, depreciation, and amortization) as selling multiples. The business that has less than $5 million annual revenue often use multiples of annual revenue or SDE (seller’ discretionary earnings). EBITDA is closest to cash but is not cash. SDE is an estimate of the total financial benefit a full-time owner-operator would derive from the business on an annual basis” (Offerdahl, 2015).
Figure 2 Common Selling Multiples by Deal Size 2018 vs. 2017
Source: Author’s computations. SDE is Seller’s Discretionary Earnings. EBITDA is Earnings Before Interests, Taxes, Depreciation, and Amortization. SDE x 18 is the SDE selling multiples for 2018. EBITDA x 18 is the EBITDA selling multiples for 2018. SDE x 18 and EBITDA x 18 came from 2018 Private Capital Markets Report from Pepperdine University (Everett, 2018 Private Capital Markets Report, 2018). SDE x 17 and EBITDA x 17 came from 2017 Private Capital Markets Report from Pepperdine University (Everett, 2017).
Figure 2 illustrates the comparison of 2017 with 2018 Private Capital Markets Report from Pepperdine University (Everett, 2017) (Everett, 2018). The selling prices of less than $1 million have multiples in SDE and EBITDA ranges from 2.0 to 2.8. However, the higher the selling price, the higher the EBITDA is. Hence, there is an incentive for owners to focus on business value–building activities. The higher selling price is favorable if the owner uses the sales of business proceeds to fund their retirement. The number one reason why owners sell their business is for retirement—regardless of the deal size (Everett, 2018). Worse yet, seller financing often is part of the financing structure of the deal. In a deal size that is less than $1 million, the seller’s financing can range from 26% to 29% of the selling price. That means that the seller may not get the entire sales proceeds when the sale is finalized.
The vast majority of sellers did not have any formal exit planning in place before engaging the business broker or putting their businesses on the market. Forty-three percent of sellers of firms with deal size $5 million and above tend to work with advisors such as CPAs, CFPs, attorneys or business brokers to discuss their retirement needs. But only 4% engaged professionals to address retirement needs when their deal size is less than $500,000. Of those who took time to plan for the exit, most spend about one year planning before putting their business on the market.
The business owner should get the highest possible selling price to fund his or her retirement. Exit planning is not required, but with careful exit planning in place to build a viable and sustainable business model, the owner will have the edge in pricing negotiation. Having an exit plan may help avoid failure to close the deal and minimize the need for seller financing.
Investment guru Motley Fool co-founder David Gardner often looks for ”rule-breaker” companies for acquisitions and mergers: “It’s about recognizing the companies that are already succeeding in creating a new niche — and identifying the ones that are going to keep succeeding tomorrow.” In my experience, owners who spend more than three years diligently working toward their exit plan, results are splendid.
Remember, you have a lot of control to make the most out of selling your business if you plan, implement early and remain agile.
Bronza, T. K., Auslander, P. H., & Ma, A. H. (2015). The Central Role of the Planner in Business Liquidity Events. Journal of Financial Planning, Aug: 18-21.
Everett, C. R. (2017, Apr 1). 2017 Private Capital Markets Report. Retrieved from Pepperdine University Graziadio School of Business and Management: https://digitalcommons.pepperdine.edu/cgi/viewcontent.cgi?article=1009&context=gsbm_pcm_pcmr
Everett, C. R. (2018, Mar 23). 2018 Private Capital Markets Report. Retrieved from Pepperdine University Graziadio School of Business and Management: https://digitalcommons.pepperdine.edu/cgi/viewcontent.cgi?article=1010&context=gsbm_pcm_pcmr
Investopedia. (2018). What is a ‘Buyer’s Market’. Retrieved from Investopedia: https://www.investopedia.com/terms/b/buyersmarket.asp
McMann, C. (2012, Sept). Baby Boomer Business Owners: Will There Be A Mass Sell-Off? Retrieved from SME Research LLC: https://www.google.com/url?sa=t&rct=j&q=&esrc=s&source=web&cd=1&ved=0ahUKEwi37o2CjNbRAhWj8YMKHZtoD8UQFggcMAA&url=http%3A%2F%2Fwww.exitrak.com%2Fdownload.php%3Fname%3DBaby_Boomer_Sell_Off.pdf&usg=AFQjCNGp3Se3PWdUJxFOCEmZRFQRAVfRIg&sig2=WPlSn0CZ0X6NfSFxPwU1
Offerdahl, J. (2015, Apr 7). Seller’s Discretionary Earnings Explained. Retrieved from Viking Mergers & Acquisitions: https://www.vikingmergers.com/blog/2015/sellers-discretionary-earnings-explained/