Dec 12, 201711:53 AMExit Stage Right
with Martha Sullivan
Same company, different expectations for transition
One of the wonderful aspects of my job is getting to know different people and how they view the world. Two people can look at the same thing and see something very different.
This is particularly true when talking about transitioning a business. Buyers view the world one way, sellers view it another — even when both parties work in the same business and want the same outcome.
This past week, I was vividly reminded of this. Our client, John, the owner, is past retirement age and ready to sell the business. Sue, a key employee, is potentially going to buy the business. John and Sue already agree that when the time comes, Sue gets the first crack at buying the business. They have an executed agreement documenting that opportunity and high-level terms. They have even identified the timing of the desired transition of ownership as the beginning of 2019. It seems that the two of them are on the same page.
However, John still needs to identify what price he wants for the business and how that fits into his personal financial plan. Sue needs to agree to the price and prepare for the transition. They both want it to be fair, but they haven’t started price negotiation.
Sue wants to have the conversation sooner than later. John feels it is straightforward and there is no rush. He’s confident that the deal can get done in 30 days. Houston, we have a problem.
Here we have a clear distinction between the expectations of the seller and the buyer:
- Seller’s expectations: Ask any advisor, investment banker, private equity group, or strategic buyer what the number-one challenge is in getting a deal done and they will likely say “unrealistic seller expectations.” John is a prime example.
- John assumes that his business is worthy of a reasonably strong multiple, although he has not obtained an independent valuation of it. I’m skeptical of that assumption due to the size, state of technology, and other issues with the business.
- He also assumes that Sue will agree that his price. Maybe, maybe not.
- Since he believes the deal can get done in 30 days, he is frustrated that Sue keeps pressing for the conversation, to the point of being defensive.
- Buyer’s expectations: Buying a business takes time and planning regardless of whether it is an internal or external sale. With an internal sale, the buyer needs to deal with unique fact patterns:
- Life as an owner is very different than life as an employee in terms of roles, responsibilities, risk, and so on. The mindset, use of time, and deployment of resources changes dramatically. For the prior owner, there is relief and simplicity. For the new owner, there is more life-altering complexity.
- Cost dynamics in the business will shift. To what degree can the post-transaction cash flow provide for growth, reasonable rate of return on investment, and debt service?
- What additional investments does the new owner need to make in terms of personnel, technology, facilities, etc. post close? (The business, under current ownership, is behind in technology given its industry trends.) What other operational changes need to be made because John is no longer there?
- How is Sue going to finance the purchase? Even with seller financing, Sue will make a substantial down payment at close. For her to begin arranging financing, she needs to confidently know what the price is and build her plan for presentation to the bank. Sue wants to take a methodical approach to prepare for the transition over the course of the next 12 months. She wants to have her business, financial, and lending plans and other elements in place well in advance. Delays in the conversation are creating greater anxiety, which may potentially strain their relationship.
- Alternative options: It’s not a given that Sue will agree to whatever price John wants. If she walks away from the deal, John has no other buyer lined up. He will be at “square one” selling the business. Finding the buyer to pay his price may be challenging given the characteristics of this business. The situation worsens if Sue decides to leave and go work somewhere else, which is highly likely in this circumstance. The price someone will pay will drop because Sue is almost as instrumental in the business as John is. He’ll have to stay on longer to transition the business. It’s also likely he’ll be subject to an earnout based on customer retention, which increases his risk of getting paid out.
John doesn’t want to acknowledge the complexities inherent in preparing for a smooth transition. Like so many owners, he’s oversimplifying and putting it off. In the process, he is creating more risk around achieving his and Sue’s mutual end goal — a fair and completed transaction as of the beginning of 2019. If John can see his way to open up to the conversation sooner than later, he will benefit as much, if not more than, Sue will. But last week, he was not in the right frame of mind.
John is not alone. There are many other business owners in his shoes, unfortunately. The question is whether you are going to be one of them.
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