Jul 16, 201908:00 AMExit Stage Right
with Martha Sullivan
Meet in the middle or risk not meeting at all
(page 1 of 2)
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 and sellers view it another, even when both parties work in the same business and want the same outcome.
One company vividly reminded me of this recently. Our client, John, the owner, is well past retirement age and ready to sell the business. Sue, a key employee, is potentially going to buy the business. John and Sue already agreed 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 even identified the timing of the desired transition as the beginning of 2019. It seemed that the two of them were on the same page.
As of last summer, John still needed to identify what price he wanted for the business and how that fit into his personal financial plan. Sue needed to agree to the price and prepare for the transition. They both wanted it to be fair, but they hadn’t started a price negotiation.
Sue wanted to have the conversation sooner than later. John felt it was straightforward and there was no rush. He was confident that the deal could get done in 30 days, and it’s his business, so it’d be done his way when he wanted to do it.
Houston, we have a problem:
- Seller’s expectations: Ask any advisor, investment banker, private equity group, or strategic buyer what the No. 1 challenge is in getting a deal done and they will say “unrealistic seller expectations.” John is a prime example.
- John assumed that his business was worthy of a reasonably strong multiple, although he had not obtained an independent valuation of it. I was skeptical of that assumption due to the size, antiquated state of technology, dependence on both Sue and John, and other issues with the business.
- He also assumed that Sue would agree with his price. Maybe, maybe not.
- Since he believed the deal could get done in 30 days, he was frustrated with Sue for pressing the conversation to the point of being defensive, testy, and shutting her down.
- 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, and more post close? (The business, under current ownership, was behind in technology given its industry trends.) What other operational changes needed to be made because John would no longer be there?
- How was Sue going to finance the purchase? Even with seller financing, Sue would have to make a substantial down payment at close. For her to begin arranging financing, she needed to confidently know what the price was and build her plan for presentation to the bank. Sue wanted to take a methodical approach to prepare for the transition over the course of the ensuing 12 months. She wanted to have her business, financial, and lending plans, and other elements, in place well in advance. Delays in the conversation were creating greater anxiety, which could have strained their relationship.
- Alternate options: It’s not a given that Sue would agree to whatever price John wanted. If she walked away from the deal, John had no other buyer lined up. He would have been at square one selling the business and finding a new buyer to pay his price may have been challenging given the characteristics of this business. The situation could have worsened if Sue decided to leave and go work somewhere else, which would be highly likely in this circumstance. The price someone else would pay for the business would then drop because Sue is as instrumental in the business, if not more so, as John. He’d have to stay on longer to transition the business. Under this scenario, it’s also likely he’d be subject to an earnout based on customer retention, which would only increase his risk of getting paid out.
John didn’t want to acknowledge the complexities inherent in preparing for a smooth transition. Like so many owners, he was oversimplifying and putting it off. In the process, he was 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 could have opened himself up to the conversation sooner rather than later, he could benefit as much, if not more than, Sue. But John wasn’t in the right frame of mind.