The Right Time to Sell Your Business

By Deven Desai

You may be thinking: Why should I sell my company when I have grown and built it from the ground up with years or decades of dedication and intense effort? The fact is that if money is the primary object and you have a business that is generating a lot of cash, you'd probably be better off not selling. That said, there are certainly situations and changes in life circumstances that present good reasons to sell your business. Here are a few of them:

• Retirement — At a certain point in life, you may think about retirement and taking on a relaxing lifestyle. In order to retire comfortably, you might put your company up for sale to earn a large chunk of cash at once that you can use to relocate or fund other retirement activities like travel. In addition, the release of stress and responsibility from running a business would allow you to truly enjoy the rest of your life. Spending time with family and friends or pursuing passions can be even more rewarding than running a business.

• New Opportunity — As the world is constantly changing and there are so many new problems arising, you may realize that you want to pursue a solution to a different issue. Instead of completely changing your current company, you may decide to sell your current business and start a new one from the ground up. Some entrepreneurs enjoy moving from business to business and the excitement of pursuing different ideas instead of sticking to one company. Building and selling business after business can be quite profitable as well.

• De-risking — There are high risks that come with running a business because of the ever changing political, economic, and cultural climates. An economic crash or change in industry regulation could seriously impact a business and cause it to go bankrupt in the worst case scenario. Consequently, if you are averse to risk, you may decide to sell your business when it is strong and still growing to exit and earn a solid valuation. You can then invest your profits in mutual funds to further de-risk and watch your money grow over time without the relative uncertainty that comes with running a business.

• Industry Strength — The industry your business operates in might be attracting a lot of M&A activity with high EBITDA multiples. For example, during the depths of the pandemic, healthcare software and telehealth M&A activity was quite strong because of the focus on more contactless options to receive healthcare. As a result, many businesses within the healthcare software industry had good exit opportunities because they could command high valuations based solely on industry strength. Being in an industry that is booming due to current events and changing cultural/societal trends can influence you to put your business up for sale and try to maximize their profits while the timing is right.

• Burnout — Running a business can be an extremely draining process, both mentally and physically. You may decide to sell your businesses to relieve yourself of stress, anxiety, fear, and other negative emotions. Stepping outside of an operational role and enjoying the big payout from selling a business allows you to enjoy life and take some time before finding another endeavor to pursue.

For perspective, the below chart shows the reasons why owners of business worth $5 - $50 million have decided to sell. (The information is pre-pandemic).

Everett, Pepperdine University — 2020 Private Capital Markets Report, page 80

While there are many reasons to consider selling a business, you should also be mindful of selling a business too soon or for the wrong reasons. You should also not sell your business too soon to earn some money when you believe in the long term growth potential of your company; in an extreme example, Snapchat’s Evan Spiegel refused a $3 billion dollar from Facebook because he believed in his company, and this paid off when Snapchat later filed for an IPO. In addition, if you enjoy running your business and being your own boss, you should continue to run it.

See also:

• Pepperdine University — 2020 Private Capital Markets Report (See page 80 for Reasons for Seller to go to Market.)

What is EBITDA and Why is it Used by Financial Professionals?

EBITDA — earnings before interest, taxes, depreciation, and amortization — is a measure of a company's operating performance that is not affected by financing decisions or non-cash expenses.

As the chart below indicates, EBITDA is a relatively new financial metric, having gained popularity over older modes of analyzing financial performance.

EBITDA has become an increasingly popular financial metric. Source: Google Ngram Viewer

EBITDA is often used by financial professionals to compare companies across industries because it provides a more consistent measure of profitability. For example, two companies in different industries may have different levels of debt, which could affect their reported earnings. EBITDA is not affected by debt, so it can be used to compare the profitability of these two companies on a more equal footing.

In addition, EBITDA is not affected by non-cash expenses, such as depreciation and amortization. These expenses are incurred to reflect the wear and tear on a company's assets, but they do not represent a cash outflow. As a result, EBITDA can be used to get a better sense of a company's true profitability.

The applicability of EBITDA across companies with different financial characteristics allows it to be paired with company valuations to produce a multiple. A company's EBITDA multiple is equal to its Enterprise Value divided by its EBITDA. Companies with higher rates of growth, higher quality revenue, and stronger competitive positioning tend to have at higher multiples.

Whereas a construction company may trade at a 3x multiple, a fast-growing technology enabled services company with recurring revenue may trade at above a 10x multiple. The size of the company also matters — larger companies trade at higher multiples than smaller ones because larger companies are generally regarded as safer investments due to their scale and perceived financial stability.

There are a few limitations to using EBITDA. First, it does not take into account a company's capital structure. This means that two companies with the same EBITDA could have very different levels of debt, which could affect their financial strength.

Second, EBITDA does not take into account a company's taxes. This means that two companies with the same EBITDA could have very different levels of tax expense, which could affect their profitability.

As a result, some investors do not think highly of the incorporation of EBITDA into the financial lexicon, including Warren Buffett, who noted in a 2003 annual shareholder meeting that, "Any management that doesn't regard depreciation as an expense is living in a dream world."

Despite these limitations, EBITDA is a useful measure of profitability that is often used by financial professionals to compare companies across industries.

Further Reading:

• Michael Mauboussin, What Does an EV/EBITDA Multiple Mean?

• Overview of EBITDA by the Corporate Finance Institute

SBA 7(a) Update — Partial Changes of Ownership

U.S. Small Business Administration (SBA) offers a number of loan programs to support the financing of small businesses. For those interested in acquiring an existing business, the SBA’s 7(a) loan guaranty program is the agency’s flagship program. It derives its name from Section 7(a) of the Small Business Act of 1953 (P.L. 83-163, as amended), which authorizes the SBA to provide business loans and loan guaranties to American small businesses.

For a sense of scope, in FY2021 the SBA approved 51,856 7(a) loans totaling $36.5 billion. The average approved 7(a) loan amount was $704,581. Loans can be up to $5 million and require as little as 10% down by the buyer.

In the past, the SBA did not allow sellers to roll over equity into the acquired business. This meant that sellers of small businesses were unable to "roll equity" as part of the sale of their business if an SBA 7(a) loan was involved, meaning that they were unable to maintain an equity stake in their business and have the opportunity for a "second bite at the apple" in the case that their business is subsequently sold at a higher price than they sold it for.

The U.S. Small Business Administration (SBA) has announced an update to its 7(a) loan program that will allow sellers to roll over equity into the acquired business by allowing "partial changes in ownership" that were once forbidden. This change is designed to make it easier for buyers to acquire businesses, especially those that are owner-operated.

The seller equity rollover update to the SBA 7(a) loan program is a great opportunity for buyers and sellers. Buyers can now acquire businesses with less cash or financing, and sellers can exit their businesses while still retaining an ownership stake.

Additional Information:

• SBA update (page 6)

• SBA 7(a) overview

• SBA 7(a) Terms

• Congressional Research Service overview of SBA 7(a) loans

• Legal overview of rule change allowing partial changes in ownership