How to Develop a Flawless Exit Plan for Your Business — George Deeb

Transcription:

Jim Fitzpatrick:
So George, thanks so much for joining us, because this is a red hot topic right now. Especially as we come out of COVID for those business owners out there, they’re going, “I don’t know if I want to go through this again.” Sometimes that was a close call. There are some businesses that, as you know, we’ve talked about it before on previous shows, that actually did pretty good through COVID, but then there’s a number of businesses that said, “That was way too close for comfort.” And then there’s some that didn’t make it, which is very unfortunate.

So, this is definitely a topic out there that people are talking about. Maybe it’s time to sell. Maybe I should pack it in and head for the beach, as they say. So, when is the right time to sell your business, George, from your point of view? I know this is something that a lot about.

George Deeb:
Yeah, I’ve gone through this process a couple times myself. I think part of it is, you know when it’s the right time, either you’ve been living in the details of this business enough and you know it’s got some potential challenges in front of it that you want to get ahead of and get the business sold before those challenges come, or you want to sell now because you’re personally tired, you don’t have the energy or the enthusiasm that you used to have, or maybe you’ve run out of growth ideas, you’ve taken it as far as you know how to take it and you’re coming off of a strong growth year, but you don’t know what to do next. Well, that would be a good time to sell because you can speak to your historical sales growth and then hand it off to somebody else that knows how to grow it from there. So, there’s lots of different reasons to potentially sell the business. And you often know one is the right time to sell.

Jim Fitzpatrick:
Sure. So, having said that it’s kind of like my wife and I knew that we didn’t need this big house anymore. We’re empty nesters and the kids that we have moved out, went to college and beyond and such. However, we were staying in the house for that peak. Some founders try to sell at the peak of the business and what’s out there in the environment. Is that a good strategy? Or should we sell when we’re ready to sell that and move on?

George Deeb:
Yeah, selling at the peak is good for you as the seller. The problem is, the buyer’s going to look at that and they’re going to say, “Well, I feel like this business is at the peak. I’m not exactly sure where it grows from here.” So, whenever you put the company up for sale, you want to put on the lens of the buyer and give them a path on, okay, if you were going to buy this business and take it to the next level, let’s say you’ve grown up from zero to 10 million and then the next guy’s got to grow from 10 to 20, they’ve got to got clear visibility in how that incremental 10 million is going to come. Because if you tell them, “Nope, 10 is pretty much all this market can afford.” You’ve just dramatically restricted the amount of potential buyers that are interested because they won’t know what to do with it from there.

Jim Fitzpatrick:
Yeah, very good point. Very good point. What are the typical exit options available to a company and to an owner?

George Deeb:
Yeah, there’s a handful of things here. I would say, first and foremost is selling the business outright for cash. That’s the most typical sale route. The second would be merging with another company. And whether you take cash off the table now, or roll that equity into a bigger company and you sell it later, merger’s another potential path. Recapitalizing the business, let’s say you raised some venture capital and you wanted to get your investors an exit, but you weren’t quite ready to sell yourself. You can find a new investor to buy out the old investor or portion of your equity at the same time and recapitalize the business—

Jim Fitzpatrick:
Is it okay at that point in time too, for the owner to take money off the table to say, “Look, I don’t want to sell the business in its entirety, but bringing in new money, I will sell a portion of my stock as well.” So you have the best of both worlds. If that business owner says, “Gee, I’d like to have 500,000 or a million out of the business, but I don’t want to give it up entirely, but I could then buy that boat or that beach house that I want.”

George Deeb:
Yeah, I think that’s perfectly fine. Then what the new investor will say is they just want to make sure you have a meaningful investment in the new company. So, I wouldn’t sell yourself down to one share with a very immaterial stake, but you could sell half of your stake and keep the other half, roll it into the new company. I think that’s perfectly fine. The last exit option is you could take a company public and very few companies get to that stage, but if you’re big enough and growing fast enough and you think the public markets is a path for you, that’s certainly an option as well.

Jim Fitzpatrick:
Yeah, that’s a very, very involved process too, right? Can be very expensive at the same time and pretty … You got to have all of your Ts crossed and your Is dotted in that situation. And it changes things, but it can be very lucrative. Is there a preferred path of these options?

George Deeb:
I think I always go down the path that’s the easiest and the simplest. Getting a direct sale altogether buttoned up and sealed and delivered up front is usually the simple and cleanest path. That would be my preferred path, number one. When you start talking about mergers and getting different executives or different cultures involved, it just adds a layer of complexity to the business that, you might like each other during the dating phase but now that you’re married, you may hate each other, kind of thing. I’ve seen a few of those mergers go wrong with that kind of mindset. And going public, as you just said, is a complete pain. The quarterly filings and all your competitors know your financials and you’re managing for the next quarter, not for the next five years. It’s just a completely different animal altogether.

Jim Fitzpatrick:
That’s right, that’s right. And then you hear a lot about the term out there as business owners, you’ll hear them say, “Well, I sold my company and I have an earn out. So, I sold it for $10 million, but now I have an earn out of a possible another $3 million if over the course of the next three to five years, I hit certain objectives and goals that were set between myself and the new owners, which gives me an opportunity to make even more money on the sale of my business.” Explain that a little bit better than I just did. And tell me, is that a viable way for business owners to sell their business and consider that as part of the sale on these earn out programs?

George Deeb:
Yeah, typically an earn out comes into play where there’s a delta in valuation between where the buyer thinks the business is worth today versus where the seller thinks the business is worth today. So, one way to bridge that gap is, “Listen, I is the buyer think you’re worth $10 million. I know you think you’re worth $15, but I’ll tell you what, if your future forecast does what you think it’s really going to do, then I will put an earn out in place that if you hit that target, you will earn that incremental $5 million additional payout down the road or some pro rata portion, depending on how you hit that target at some midpoint in between.”
Now, that’s the concept. The reality is very, very few earn outs actually get paid out. So, if you’re doing the deal because you think the earn out is actually going to materialize and it’s going to get to the finish line and you would’ve been completely upset if the earn out didn’t take place, well, then don’t do the deal, because there’s a lot of things that can get in the way of the earn out. Some of them are not in your control. COVID hits and your industry gets stuck and now what you thought was going to be a boom year, turned into a bust year, and now you don’t have the cash you thought you were going to have because of the economic conditions that were out of your control. So, earn outs are more window dressing than substance in terms of actually getting paid out.

Jim Fitzpatrick:
You’re allowed to say then at the country club that, “I sold my business for $15 million.” When in reality, you sold it for $10 million with a hopes to get that other $5 million.

George Deeb:
Just that.

Jim Fitzpatrick:
A friend of mine sold his business and the new company came in and offered an earn out. And over a three year period of time, they said, “If you hit these different plateaus, then at the end, we’ll give you another … ” I think it was $3 million, whatever it was. And he worked like the Dickens to get that earn out. In the final year, they canceled one of the launches that he was going to implement. The majority stakeholder in the company said, “Yeah, yeah, we’re going to postpone that till next year.” So, they were really in control of making sure that that business owner didn’t hit that earn out because they knew what they were doing. And he told me that, he said that was all strategy that because we were cranking and cranking and cranking, they knew they were going to have to pay that extra money. But they were the ones that put the kibosh on the new launch that he said, “Definitely would’ve gotten us past the finish line.” Have you heard of things like that happening too?

George Deeb:
I’ve been a victim of that happening to my own businesses.

Jim Fitzpatrick:
I’m sorry to hear that.

George Deeb:
I had a business, a travel company that had two revenue streams, one from selling travel, vacations, and one from selling advertising on our largely traffic website and the real profitability of our business was on the advertising side. It was just printing cash and I wanted to invest more and more into that advertisement business. And the owner of the business was a travel company and they controlled the business at that point. All they cared about was the vacation sales and they did everything they could to make sure that we weren’t scaling the advertising piece of it because they knew if it did, the earn out would have to get paid out and they didn’t want to have to deal with that.

Jim Fitzpatrick:
That’s right, that’s right.

George Deeb:
So yeah, I’ve seen that firsthand.

Jim Fitzpatrick:
Is it safe to say that George, that for business owners that are listening, sell the business for the dollar amount that you’re going to get in that first closing and just look at that earn out as just the icing on the cake. If you get it, great. If you don’t get it, no big deal. Don’t fret over it because you really got the sale price and what you wanted at that first level, right?

George Deeb:
That’s the best way to think about it. I couldn’t have said it any better. So, just be happy with what you get upfront. Anything on top of that will be a nice to have, not a need to have.

Jim Fitzpatrick:
Sure. So, the big question that I think a lot of people have out there that are thinking about buying, I mean selling their businesses, is who are the most logical buyers of your business and what does that entail, trying to find that person or company?

George Deeb:
Yeah, typically there are two categories of buyers. There are the strategic buyers that are in your industry. They either want new products or services, or they’re trying to expand their team, or they’re trying to expand their market share and get more penetration to the market. That’s one base of potential buyer. The second base of potential buyer are financial buyers. They are looking for an investment. They are largely private equity funds that are in the business of buying and selling companies. And your pitch to them is, you’ve got a valuable business today that you can make a nice financial return on. And whether they’re in your industry or not, some people are industry specific investors. Or no, they’re just generalists. They’re just looking for good companies and good teams that they can invest in, knowing that they’re going to sell it four or five years down the road.

Jim Fitzpatrick:
How do you make your business most attractive to potential buyers, George?

George Deeb:
I think the biggest mistake the entrepreneur makes is whether they’re trying to sell their company and get it sold, or raise capital to a venture capitalist, is they’re speaking to it from their perspective. How is this going to help them, or get their exit, or whatever it is? The reality is you got to speak to it from their perspective as the buyer. How are they going to benefit from this transaction and how is it going to help them grow their business, or make it more efficient, or improve their customer experience, or drive their profitability, or whatever it is? So, throw out your pitch deck on your business and what it means to you and build a new deck on if this business was an asset inside of your buyer’s company, what can it do for it and how can it scale its revenues to the next level? So, I think that’s the most important thing.

Jim Fitzpatrick:
And then, should most business owners that are selling expect to stay on for a year or two, because that new buyer is probably going to want to see that, where they don’t want that person walking right out the door that’s grew the company over the last 10 years to profitability and such and okay, “I got my check, goodbye.” It’s not like a closing of a house where it’s like, “Okay, it’s your house now.” That new owner wants you to stick around for a little while typically, right?

George Deeb:
Yeah, there’s at least some sort of transition period. That transition period could be short, a few months. It could be long, a few years. Depends on the nature of the business whether or not that executive is planning to stay involved in a new co or not. So yeah, there needs to be some transition, but there have been examples where no, we don’t need you. We’ve got a team of people just like you, that can do exactly what you do. And we want to get a clean exit and we know what to do with it from here. It depends on the business and is it a service-oriented, business, or a widget and a product-oriented business? And if you’ve got the right product, people on staff that are going to be part of new co, they may not need the CEO to go along with it.

Jim Fitzpatrick:
That’s right, that’s right, yeah. So, don’t let it hurt your ego if somebody comes in and says, “No, we’re good. We don’t need you to stay any longer. Here’s your check. It’s our business you can move on.” So, I spoke to a friend of mine that sold a company that way. And he walked around in shock for the next six months going, “What do you mean they don’t need me? That always used to be my company.” It was like this founder funk that he found himself into. And it took him a lot to snap out of it. So, what if you were not growing or you’re not profitable as a company? Is it still appealing to buyers out there, because I know that there’s some business owners that get down on themselves and say, “Who would want this? We’ve plateaued for the last five years. We haven’t really done much. We’re making a million bucks a year, sure, but we’ve been making a million bucks a year for five years and who would want this business?”

George Deeb:
So, these are two very, very important points. The faster your company is growing and the larger your profit base is, the more valuable your company is. And it’s really what buyers are looking for when they’re buying companies. So, if you’re pitching them a slow growth business, or a no profit business, you will either reduce the number of potential buyers that are interested in your business, or you will reduce the valuation at which the larger base of investors are willing to pay for it.
Now, that’s not a hard set rule, a lot of variations to a theme here. Let’s say you’re a private equity firm family office. And you’re looking for just consistency in cash. It doesn’t matter that you haven’t grown for 10 years, but you’ve proven that you’ve got the same revenues and the same profit for 10 years in a row. We like that predictability, we’re a family office. We’re looking for alternative ways of investing our assets. We like that business. Whereas the flip side, a private equity firm is specializing in growth, they may not like that business because they are telling their investor base, their limited partners, that the assets they’re investing in will have some sort of growth story and it won’t appeal to them.

Jim Fitzpatrick:
Yeah, I gotcha, okay. So speaking of valuation, how do you figure out what your business is worth? I mean that can be a very difficult task and sometimes it depends on the person that’s buying it, or the company.

George Deeb:
Yeah, for sure. I mean, evaluation is a huge topic, you and I could probably do a whole episode just on valuation, but it’s largely dictated by multiple of your revenues or a multiple of your cashflow, that’s usually the way these businesses are valued and the bigger your revenues, the bigger your cashflow, the faster you’re growing, the higher the multiple would be.
So, as an example, let’s say you’re an e-commerce business and you’re doing a million dollars in cash revenues and a hundred thousand dollars in cash profits. That’s going to get a very small multiple. So, someone might be willing to pay two or three times cashflow for that particular business, $200,000 or $300,000 with a two times multiplier. Let’s say you’re a $10 million eCommerce business and you’re putting $3 million to the bottom line. And now, the investors are saying, “Wow, that’s a pretty material, healthy cashflow stream. I want to inherit. And I’m not going to pay you two times for that. I’m willing to pay you four or five times cashflow for that business.” Because they want the scale of the profits and the growth of the business. So, it varies wildly based on those metrics.

Jim Fitzpatrick:
The things that you’re talking about, you’ve got a lot of experience in. You’ve purchased and sold businesses and exited companies successfully and you’ve seen all of this. Is it a good idea for business owners, because we’re in the media business, we know media, we know broadcasting, we know what goes into that, but we don’t know the buying and selling of businesses. So, when it comes time for me to sell, I’m going to be looking for a professional perhaps like you, that can take us through that path. I highly recommend that to people, that they need to find that professional out there, that can navigate through this process or help you navigate through this sale process. Because if you try to do it yourself, you could really either get into trouble legally or maybe leave some money on the table, or maybe a lot of money on the table when selling the business, it’s kind of like trying to sell your home and trying to do it yourself and you find out that uh-oh, I made a mistake here. I really need a pro that’s going to represent me. Good idea, right? To find somebody, to find a George Deeb out there that says, “Hey, I’ll been there before. I can help you with this process.”

George Deeb:
And there’s two types of experts that I think you need to get engaged. The first expert is the business broker or the investment banker that’s going to manage the sale process. They’re going to help you build your pitch deck. They’re going to help you identify the hundred potential buyers. They’re going to reach out to those buyers to assess interest. They’re going to help you with the negotiation, help you through the M and A process, that’s one expert. The second expert is the M and A lawyer. And most likely that’s a different person than your general business council that you’re using for your everyday needs.
So, the complexities in an M and A transaction are significant and somebody that lives and breathes, mergers and acquisitions and has seen a lot of companies fall on swords before, they know what to get into these agreements, that will be in your best interest to protect you. So, that if something goes wrong, you’ve got the protection built into the agreement. So, you need a good business broker and you need a good M and A lawyer and you should be in good shape.

Jim Fitzpatrick:
Well, that is so true. And for people that are listening, that are on that verge of taking that next step and selling your business, that is really, really good advice because this is not something that you want to go at alone or say, “Well, I’ve learned enough or I’ve seen enough YouTube videos, or I’ve watched the Atlanta Small Business Show enough to know how to sell my business.” Nope, not even close. So, George Deeb, I want to thank you so much for joining us once again on the show, that your information to our viewers is invaluable. So, thank you for that and looking forward to the next time.

George Deeb:
Great seeing you again, Jim. Thanks.