â€œIâ€™d be interested in selling for the right priceâ€ seems like a very reasonable position for a business owner to take. How can we reconcile that need with a buyer who says: â€œI am willing to pay a price which will yield a return on my investment, commensurate with the risk I am taking.â€
As a general rule, a buyer of a privately-held middle market company will look for a return of around 30% before tax. It follows, therefore, that privately-owned businesses are returning 30% IRR to the owners who â€œholdâ€ those investments. At the â€œmarketâ€ price, therefore, the seller must liquidate a 30% investment (in his business), pay taxes on any gain, and re-invest the net proceeds at a lower rate of return commensurate with the lessened risk and aggravation.
Letâ€™s look at an example. My company is growing at 10% and currently generates (adjusted) cash flow of $5 million after paying me a market salary as President. Buyers in the market will pay $25 million for my company to earn 20% from current earnings plus 10% from growth. I pay $5 million in capital gains tax, leaving me $20 million to invest at 10%. My new earnings of $2 million are less than half of the $5 million I was earning from my company!
Donâ€™t sell for money! So why would I sell? My exit plan should be concerned with:
- Reducing financial risk by diversifying my wealth
- Lessening or eliminating stress by stepping away from the management and ownership issues
- Changing my lifestyle
- Addressing health or personal issues
- Implementing a succession plan
You will know when it is time to sell and that will generally not be to increase your income stream.
One last thing, hire a professional to advise you. Selling your business is an important step.