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As the team at 48North Partners knows, picking the right time to sell your business is one of the hardest things to do. While there’s already enough complexity associated with market trends, macroeconomic factors, and other financial implications, there is an emotional component undeniable to making a transition. Yes, the dollars are important and should be exciting but questions like “who is going to be a good shepherd for the legacy I have built?” and “is the next owner going to take the same or maybe even better care of my team than I have been able too?” undoubtedly run through your mind. So maybe the right question isn’t so much “when is the right time to sell” but more “who is the right group to sell to and how do I find them?”
In this article, Chapin Newhard and the team at 48North Partners will be looking through the lens of a Private Equity backed (PE) buyer, but that is not to say this is your only option. There are almost as many options of buyers as there are businesses out there so if you don’t think PE is the right group for you, you might be right, but it’s worth talking to groups like 48North or any trusted advisor on what the pros and cons are of the different options available to you. Hopefully, the following will give you some insight into how to begin thinking about a transition, no matter the structure.
The short answer to our first question of “when is the right time to sell?,” says Chapin Newhard, is nobody knows for sure and anybody who claims to is likely acting behind ulterior motives. That being said, if you are asking yourself that question, it is probably worth beginning to have conversations as the process takes a lot longer from start to finish than many expect. Across all the deals 48North Partners has done in the 48North works in daily, on average, it takes just under 10 months (9.49 to be exact) to go from the first conversation to a closed deal. This is not meant to give you pause about beginning the process as it will be long road, but more to make you aware that any deal, no matter the size, does not happen overnight so it’s best to know what options are available to you when you are beginning to grow curious about an exit. With that in mind, let’s dive into some things to consider when thinking about timing.
If you are someone who is looking to sell and exit your business or looking to just gain some extra firepower to accelerate your growth trajectory and maintain some ownership, the question of how the legacy of your business will be maintained, or even strengthened, and how your team will be treated following a change in ownership is more than likely just as important. In many industries, the dollar amount you will receive for your business (this is often referred to as the Enterprise Value) is relatively equal across buyers. Not to say that all buyers will offer the exact same amount, but most of the time the difference is much less than folks expect. Knowing this, it is important to take the time to develop a relationship with the group or groups that are interested in your company often even before you plan on making a deal. The biggest thing to remember with any transaction is you, as the business owner, are in the driver’s seat. The timeline is completely up to you so don’t interpret agreeing to an introductory call as placing you on any timeline. According to the team at 48North Partners, some questions that might help you figure out if it is the right group for you are a) do I believe in the vision and path to growth; b) are these people I could see myself being challenged by in a professional sense while all parties remain respectful and committed to a common goal; and c) can I see myself enjoying working alongside these individuals or team from a personal standpoint (the classic “if I was stuck in an airport would we grab a drink and share a laugh or sit silent at the gate on our phones” thought experiment). If you are comfortable with the answers to all three of these questions, it is likely you have found a group that could be a good shepherd for your business and team.
While it is impossible to cover everything having to do with timing from a macroeconomic sense in this article, as it varies substantially across industries, Chapin and 48North will touch on one piece that owners often overvalue and one piece that is often overlooked when thinking about an exit. First, with the piece that is often overvalued.
The belief that having a huge year of growth and doubling revenue / net income from your previous year will allow you to sell for double the amount. This is something Chapin and his team have heard time and time again and while the sentiment of the statement is true, larger businesses sell for more, it is not quite that simple. Oftentimes, when a business achieves an abnormal amount of growth in one year it is met with more questions than excitement, especially when it is not in line with the historical trends of the business. Every buyer will look at this type of expansion through the lens of how was this growth achieved, is it likely that it can / will be replicated next year and in the years to come, was it due to a change made by the business or some uncontrollable factor (think a heavy storm year in the residential roofing world that drives an oversized number of jobs and thus revenue but is unpredictable whether this will happen again). No matter the answers to these questions, it is important to remember that PE buyers are looking to grow your business from the point that they buy it and so instead of giving you credit for only the most recent and largest year in your company’s history, they will more than likely look at the last 2 – 3 years in an attempt to normalize the financials and establish what the true and predictable size of the business is and pay you on that number. While this might not seem fair, it is the case almost 100% of the time. Now let’s move to the piece that is often overlooked.
The idea that the first sale of your business must be enough to retire on or it is not worth it. As a fellow entrepreneur, I understand firsthand the value that comes from working for yourself both financially and emotionally and how hard it is to decide to lose that complete control. However, in almost every transaction owners, and often times key employees, are given the chance to maintain some ownership in not just their business, but the entirety of the businesses under the PE backed portfolio company’s umbrella. This concept is commonly referred to as rolling equity.
To understand the value associated with rolling equity, says Newhard, it is first crucial to understand the PE strategy at a high level is to string together multiple assets in various locations, integrate them to operate on paper as one entity, and then sell the collection or family of companies for more to a larger PE group to continue growing with a similar strategy but at a larger scale. The idea, in the most basic terms, is the sum of the parts, when properly integrated, is worth more than any of the individual businesses. Typically, PE firms will look to complete this inorganic growth model or growth via M&A (purchasing and/or partnering with other businesses) over a five-year period. This idea of integration is not to say that the name or branding of your business will change or even that you will have someone telling you what to do in the day-to-day. Usually (Chapin would argue is the case in the most successful scenarios) businesses remain operating autonomously to the extent they want to / makes sense but receive the capital and back-office resources (such as HR, benefits coverage, payroll, accounting, recruiting and training, etc.) to be able to grow faster and with less headache.
Now that we understand the strategy, we can return to the principle of rolling equity and to illustrate the value created by choosing to do so, let’s imagine your business is worth $100. In this example, PE fund is backing portfolio company A that offers you $100 for your business and you decide that you are excited by the growth potential available by partnering with this group and choose to roll let’s say 30% back in. What this means mechanically is portfolio company A will buy 100% of your business and you will roll 30% or $30 back into the holding company that holds ownership in all the businesses purchased to date as well as all the businesses to be purchased in the future. Said in another way, you are obviously not the sole owner of your business anymore, but you are a partial owner in not only your business, but all the businesses under PE fund A’s umbrella and by doing so you open yourself up to what is commonly referred to as “the second bite of the apple.” The idea with the second bite of the apple is when the entirety of portfolio company A is sold after experiencing both organic and inorganic growth and you would be paid out again based on the increase in value from when you sold your company and rolled equity to when the entirety of the company is sold (this is commonly referred to as “multiple arbitrage”). Chapin wouldn’t claim that this happens 100% of the time, it is an investment like any other, but the idea is that the $30 or 30% of proceeds that you rolled into the entity is worth more than the 70% or $70 that you put in your pocket on day one. To maximize this multiple arbitrage, we can finally return to our question of timing as there are ways to increase your chances of achieving the highest second bite of the apple as possible.
To maximize the dollars you receive with the second bite of the apple you first want to think about the value of the company that is looking to acquire your business. Are they in the early stages of consolidation and have expressed desire to continue growing for a few more years or are they nearing the time of an exit? Throughout the hold period, the value of the portfolio company will be raised in accordance with the growth achieved so the earlier you get involved, the lower your entry value will be, and thus the larger difference you will see between the dollars you rolled back in and the dollars you receive when the entity is eventually sold. The second piece to consider in terms of timing is in reference to the larger market trends true to your industry. Has a large amount of consolidation already happened or is your industry still fairly fragmented with independently owned businesses that are well-run and established in their communities with great teams and reputations behind them? To understand the value of a still largely fragmented industry, we need to remember what was mentioned before that the next buyer is more times than not, a larger PE fund that is looking to grow with a similar strategy centered around M&A. With that in mind, the next fund must believe that they can successfully scale via acquisitions over their 5 year hold period and the level of confidence they have in that endeavor will play a large role in the multiple they are willing to pay for the business or the exit multiple your second bite of the apple will be based on.
While the beginning of this article might have led you to believe Chapin was going to give you the answer of when is the right time is to sell, hopefully you understand that the unfortunate answer is nobody really knows, and it is important to remember that it is completely up to you. The Enterprise Value you receive for your business should be exciting as you have worked for years, maybe even generations, to build the business you are operating today. If there is anything Chapin and his team hope you take away from this article it is this: if you are thinking about making a transition of any kind or receiving support and some extra firepower to achieve growth faster than is possible alone than it is best to begin having conversations sooner rather than later so you can get a sense of the opportunities available to you.
If that is the case for you, feel free to reach out to us at 48North Partners (link website) or shoot us an email at [email protected] to have a conversation. 48North Partners is here to help folks like you sort through the noise that comes with selling your business and are completely free to those navigating the confusing time of transitioning their business so reach out and the team can throw some time on the calendar for a confidential conversation about what could be available to you.