The Dos And Don’ts Of Selling Your Business

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(00:49): Hello and welcome to another episode of the Duct Tape Marketing Podcast. This is John Jantsch. My guest today is David Barnett. He's an author, speaker, educator, consultant, business buy, sell process coach who works with people to help them prepare and sell their businesses privately or buy a business privately or via business broker. So we're gonna talk about selling your business. So if you're one of those business owners out there that you think maybe someday you wanna do that, listen in today. So welcome David. Hey, thanks for having me, John. So let's just start with that, you know, business owner who has the notion, gosh, I think I wanna sell my business. What are really some of the steps when somebody comes to you maybe and says that, what are some of the steps you have to say, well, hang on a second, we need to do X, Y, and Z to get your business ready.

(01:38): Yeah, sure. So basically it's a giant exercise in empathy and understanding the position of the buyer . Yeah. Just like every business thinks about their customers and what their customer wants, when you wanna sell your business, you are basically entering the same kind of world, but instead of your product or service, it's your business. Now that is the item of objective inventory, if you will, that you're trying to, you know, promote and sell to the buyer. And so what that feature is that makes somebody wanna buy the business is the cash flow that the business produces. And so people are gonna look at that cash flow and they're going to, they're gonna use all kinds of different methods and there's many different ways to do this, but they're gonna figure out what that cash flow is worth to them. That's the very first thing. So the business produces, you know, $200,000 of earnings for its owner every year.

(02:28): That's the cash flow, and they'll pay some multiple upon that. And it's all based on the perception of risk in the industry. So the multiple paid for the septic pumping company is gonna be a much higher multiple than the multiple paid for a restaurant. Mm-hmm. , just because the two industries have a different risk profile, you know, but restaurants, you know, more a discretionary type of service, you know, fewer barriers to entry, lots of competition, you know, new entrance into the market, that septic pumping company, you know, you've gotta invest a lot in equipment to get into that trade. You have licensing issues, there's very little competition. People call you infrequently, but whether they need you and no one can remember quite what they paid three years ago, the last time they called you. So if you, the price is 10% higher, they may not even know.

(03:17): Right. And so a lot of those different features make the cash flow from the septic pumping business worth more to a buyer than the one from the restaurant. And that's just a quick example that I think people can appreciate easily. The value is one thing, the next thing that the buyer's gonna think about is, will this cash flow continue under my stewardship? And that's when you open the Pandora's box of getting into process, procedure, methodology is the, you know, everything in the business running through that owner is the owner, got his hands on, you know, every deal, every sale. That's when you get into all that other, you know, e-myth stuff, you know, system. Yeah. So we could go, we could spend the rest of our time talking about valuation. Right. , but, uh, couple things I'm, I'm sure that a lot of people wanna know.

(04:04): So if I'm that solo owner and I've been paying myself a nice salary and there's maybe 10% profit at the end of it, I mean, is that what I've been paying myself? I mean, is that considered cash flow or is that considered an expense of the business? So, that's a great question. So small businesses, and I use, I don't like the term small business because different groups have different ways of defining it. The government, for example, often defines small business by the number of employees. Banks are gonna have different sets of definitions. So I like the term main Street. Mm-hmm. , because a main street business creates the connotation in our head of that small mom and pop kind of business, maybe with a few employees. And so these businesses tend to sell for a function of seller's discretionary earnings, which is the profit of the business and the owner's salary.

(04:51): And the reason why they sell for this type of function is because most of the time the buyers of these businesses are going to similarly be looking for both an investment and a job at the same time. Mm-hmm. , because they'll come into the business and take over the owner's position and role, and they'll start to manage the business. So they're asking themselves, if I invest my money to buy this business, how much do I get? And they're kind of mixing the value of their labor and the return on investment in the business together. When you get up to bigger businesses, people are more, uh, you know, they look at it in sort of a more formalized kind of business format. They're gonna separate out that leader's role, the salary, and they're gonna say, you know, that's a separate kind of expense for the leadership position, and they're gonna look at EBITDA cash flow.

(05:37): But for that small business that you described, we're looking at discretionary earnings. And there will be some people that will criticize this and say, you know, why would somebody buy a job? But the reality is that there are a lot of people out there that would like to buy a job because the job they have, they don't like, or they don't have a job, or there's some barrier to entering the labor market that makes them unable to get a job that they might like to have. And so willing to make an investment to, to secure that income. That's interesting you say that because there are some, you know, let's say some small business owner's been paying themselves a quarter million dollars. Well, somebody might look at that and say, well, I can find somebody just as talented as you to do that for a hundred thousand dollars.

(06:15): And so it's like, I'm gonna actually discount, you know, that, you know, piece of it or you know, as part of the, the cashflow puzzle. So I'm sure you deal with a lot of bi, I'm certain of this because I own a business and I know I'm emotionally attached. You know, a lot of business owners certainly wanna sell their business. But also, would you say that it is very common for them to overvalue what, you know, the market is going to, you know, probably come to the table with when I find deals in the wild, and I describe in the wild being someone who's not working with a business broker or anyone with a lot of experience of business valuations, it's typical to find businesses overpriced by two to 300%. Yeah. So that's two to three times what they're really worth. And there's all kinds of ways that people rationalize how they get to the number.

(07:02): They'll hear things or they'll read articles and they'll misapply what they read. They might read that a small business might sell for 2.2 times discretionary earnings, and they'll do that and then they'll add on the value of their equipment and inventory and all this other kind of stuff. And, but that's not how that methodology works, right? Yeah. And so again, it gets back to empathy because if you think about the buyer, you know, if you look at your business, look at the cash flow, look at the money you want, and then say, well, who is the buyer likely to be? Is it likely to be an individual person? And what kind of money would they have available? So maybe they would have some home equity they could pull out or some savings. They're probably gonna put, you know, some kind of down payment, maybe let's say 20%.

(07:47): Well, where are they gonna get the rest of the money and what's that gonna cost them? What's the debt service gonna be like? You can very quickly find out if there's enough cash flow in your business to be able to satisfy that scenario. And you can't put, you can't have the buyer putting the last nickel of cash flow into debt service because we all know that there's ups and downs to cash flow. And the only reason that the buyer wants to pay you for the business, what, why they'll be willing to pay you an amount of money greater than the value of the business's assets. Now, that's what goodwill is. The reason people pay for goodwill is to avoid the danger and risk of a startup. Mm-hmm. that that initial period where you don't make money. And so for somebody to get into business in the first place, there needs to be some kind of return for them.

(08:34): There needs to be a benefit, which means you've gotta leave some meat on the bone. There has to be some detectable amount of profit that this person is gonna enjoy beyond the value of the time they put in after they've made all the payments to the bank. They need to have some extra bit of profit there that's going to make this whole endeavor worthwhile to them. Let's talk about some of the deal structures you've seen. So, you know, it's really common for somebody to, you know, you talked about will this business, can I operate this business without that owner? Well, it's very common, isn't it, for there to be a transition period or an earnout even of parts of, so talk about a little bit about some of the common ways that you've seen people structure deals that, you know, maybe get the B, maybe get the seller a little more money, but they have to, you know, put a little more effort in.

(09:23): Sure. So we're gonna assume we're talking about a good, successful, profitable business here because right, the rules change when you, when those conditions aren't there. So in general, buyers are terrified that there's something wrong with the books or the business or something's not being disclosed to them, et cetera, et cetera. Right? So if you pay cash for a small business, and there are limits to the ability that a buyer has to do due diligence because certain information just isn't available in a lot of small businesses. So they're fearful. And if they're fearful, what they will do is they will discount every possible negative outcome into their offer. So the way that a seller gets a reasonable price for their business is by putting a warranty on it. Mm-hmm. . And the way that you do this is by being willing to accept part of your money over time.

(10:12): So we, this is called a seller note or a vendor takeback, there's different terms for it. If we want to take an example, you know, you're gonna buy, sell your business for a hundred thousand dollars and you're willing to accept, you know, a third of it or 25% of it over time and that seller note. So on closing day, you might get 75,000 in cash. And then there's a note, just like a car note when you borrow to buy a car and it says you're gonna pay this amount per month over this many years. But that note often has an offset clause. It'll say something like this note subject to offset in the case of a material misrepresentation or an undiscovered or undeclared lien or liability. And so what that means is that if something should arise in the business after the handover that costs the buyer money because you didn't fully disclose, or your books were incorrect, or you know, yeah, I've seen all kinds of things.

(11:05): Like a big customer told you they were gonna move their business someplace else, but you didn't tell the buyer that would be a material misrepresentation. Right? Because most of these buyers are gonna use a disclosure document that's gonna have a big open question saying, is there anything important you haven't yet told me about this business . Right? So, so that would be something you would need to put in there. I know that customer X, Y, Z is going to leave, right? Mm-hmm. , it's gonna materially affect the business. So what would then happen is the buyer can then offset their loss against that note and the seller won't get the full amount. And so what it does though is it gives the buyer confidence that what the seller is showing them is accurate. And here's the other big thing, John, is it aligns the interest of the buyer and the seller because now in order for the seller to collect all the money for the business, they need the buyer to be successful.

(11:52): Mm-hmm. , which means they need to choose a buyer who's got the right capacity, capability, aptitude, et cetera, to be successful. So they're going to be more choosy about who they do this with. And so they're gonna pick someone who's better and they're gonna be more willing to advise coach and help that buyer to make sure they get off to a good start. Because that's how they're going to get paid, is through the buyer's success. Hey, marketing agency owners, you know, I can teach you the keys to doubling your business in just 90 days, or your money back sound interesting. All you have to do is license our three step process that's going to allow you to make your competitors irrelevant, charge a premium for your services and scale perhaps without adding overhead. And here's the best part. You can license this entire system for your agency by simply participating in an upcoming agency certification intensive look, why create the wheel?

(12:49): Use a set of tools that took us over 20 years to create, and you can have 'em today, check it out at dtm.world/certification. That's DTM world slash certification. How about, and I've seen deals that, that are structured this way where they said, here's, you know, here's the totaled package. You know, here's how much you get at closing. You have to agree to stay here for two, three years, whatever it is. Mm-hmm. and that, and by the way, if we hit this target and this target you get, you know, even you get a hundred percent of the deal or you get, you know, less if we don't hit targets. Yeah. So, so what you're describing is you're describing a scenario where maybe the business is very dependent on the owner. Yeah. So the buyer, they can't buy the business without, you know, sort of inden the seller to be part of the whole thing.

(13:39): Right. That, that you have to sign a term of service kind of mm-hmm. , you know, and, and so we see that a lot in businesses that are very driven by an individual professional service firms, you know, accounting practice. Yeah. Uh, architecture firm, marketing agency. When, when I sold my business brokerage, that was the kind of deal that we had where basically I was getting a percentage of all the files I had opened while I was the owner of the business from the buyer. And so they were buying this catalog of inventory of businesses I had for sale, but they knew j all of the different things that could happen to cause a business not to close. Right. And so my payment was contingent upon the deals actually closing. So, alright. Let's say that, let's say we've got that, you know, we've got the deal done, you know, we've signed all the things.

(14:34): I mean, are there some dos and don'ts when it comes to transition, you know, to make it very smooth? Or is it just kind of every deal's different based on the relationship of the buyer seller? Yeah, I, it depends on the experience of the buyer, because if they are someone who comes from the industry, they're gonna have a pretty good idea of what is going on in the business already. I always suggest that the seller is the one that should be creating the transition plan because they know the things that need to be transferred as far as knowledge from the buyer's point of view. I always point out that, you know, that transition period is a great time to be bringing in some process and procedure and documentation into the business if it's not there the way you like to see it. I've had examples before where buyers have, and this is easy now, the day of cell day and age of cell phones, making videos of the seller doing different things, explaining different things.

(15:28): And those videos can be referred to help the buyer, but then they also become part of the training catalog available for when the buyer wants to then hand that thing off to an employee to delegate. Right. You know, you've got that person who knows it really well, who sort of gave the training script and now it's been recorded. Right. Stand on transition, you know, so we've got 10, 15 employees, they love David, David's like, been a dad to that new person comes in and they're like, I'm outta here. You know, that kind of materially changes the deal possibly. Do people write clauses in for that or is that just a Hey, you know, if it happens? Well it, it's interesting you should say that because the call just before this one, I was talking about that with one of my clients who's a buyer and he's worried about that.

(16:13): And so there's a few different ways to do to handle this. I mean, obviously we don't own people, right? I mean, anyone can get sick, you know, fall in love with someone in the next city over or decide to quit. In my experience, most employees need their job. And so even though they may not be happy to hear the news that there's been a changeover, most employees can't afford to just up and quit. And so they're going to give the new person a chance. They're going to, they're gonna see how it goes. Right? One of the, you know, the client that I was talking with earlier, he's buying a business that is a very technically oriented business and there's estimators and foreman and people that run a shop floor and things like this. And he identified four key people and he is like, if one of these four leaves, this is gonna be really bad.

(16:57): So here are some of the suggestions is that in the transition agreement with the seller, if one of those four people quits within the first year, the buyer has the ability to get the seller to come back and help hire and train someone new. So that's something the seller can agree to and the seller is qualified to do the, and if sellers don't want to do that, the only other thing you can come up with is, well then if one of these four people quits in the first year, I want some kind of offset against the note. Yeah. Because I could face some kind of financial hardship trying to replace them or trying to run the shop without them while I fiddle around trying to figure out how to do their job. And that's gonna cost me money. So, you know, if I get to, if I knock 50 grand off what I owe you, then I should be just about square.

(17:47): And of course sellers don't want that. Want to collect all their money. Sure. And so it's, you know, that's one of the best ways that, that I've come up with of how to do that. The understanding, the depth and the breadth of the labor market can be important. There was, uh, this time I was, had a business for sale. They were in the forestry products industry. They had a very high end computerized molding router. They could run miles of wood through that and make all these different kind of, you know, quarter round and window trims and all this kind of thing. And so the buyer asked the question, you know, who's qualified to run this thing? And the owner said, you know what, this is the most sophisticated piece of machinery around here. There's a community college that has a class every year of people that are in the millwright trade, and they come here on a co-op stint for a couple weeks to play with our machine.

(18:37): And so any of those people potentially could become a new operator. And of course the manufacturer has a whole training thing set up for that. And so that buyer then became satisfied that if the person left, it wouldn't be the end of the world. There would be some way to, to keep operations going. So let's talk about, we're doing this out of order maybe a little bit, but you know, we've got their business ready and you think, yeah, we've got the price nailed and we think we know, you know, who we're going after. You know, what's marketing look like for, you know, a business to get? I mean, cuz theoretically you want the most buyers potentially, or most people that have a, maybe even a strategic reason to buy the business. So you've gotta get that word out. Is it, is it really any different than a traditional marketing campaign?

(19:20): Oh, it's very different because you have to keep it secret. Ah. So the last thing you want is for people to find out the businesses for sale. Because if people find out your business is for sale, the business can be destroyed. Ah. And there's all different stakeholders that are gonna worry and freak out potentially from employees to suppliers to customers, you know, the whole gamut. Your banker, you know, I've seen lots of bad things happen when word got out that a business was for sale. So we want to keep it secret. So this is why if you go onto one of the big marketplace websites where they advertise businesses for sale, you're gonna find things like family friendly restaurant franchise in southwest Wisconsin. You know, it's gonna be very broad, but what you should see is you should see the annual revenue number and the cash flow.

(20:06): Remember that the valuations based on the cash flow. So anyone who's looking for a restaurant in Wisconsin is gonna see that ad and they'll say, Hey, that might suit me. They reach out to the broker or the seller and then they're probably gonna be asked to sign a non-disclosure agreement. Right. And it's critical for buyers to understand that this sellers want to keep this confidential and so should you. Yeah. Right. Here's why you're gonna be valuable thing you're trying to buy. Right, . Yeah. If you really hate your job or if you're trying to grow your business by buying other businesses, this business could be the solution to your problem. The last thing you want to do is upset it in any way. Yeah. Because it won't serve your needs ultimately. So. So David, as we wrap up, I appreciate you coming by the Duct Tape Marketing Podcast.

(20:52): Tell, I'd invite you to tell people where they can learn more about what you're up to and connect with you. Yeah, sure. So the easiest place to find me is at my blog site, David c barnett.com. And there's links there to all the stuff I do about a YouTube channel and podcast. And I've written books and I have some online courses and stuff, all kinds of information on there. There's over 500 videos that I've done. So if you wanna learn about buying or selling small and medium sized businesses, there's all kinds of content there for you to learn. And I'd love for everyone to come and be my guest. Awesome. Well, again, I appreciate you taking a little time out of your day and hopefully we'll run into you one of these days out there on the road. Thanks John.

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