A business broker I know says that a big part of his job is being gentle when he tells small business owners that “they have an ugly baby.”
As owners, we tend to have a parental view of our business. Our child is good-looking, strong and has unlimited potential. Anyone who doubts our baby, its possibility, or its value just doesn’t understand how hard we’ve worked to grow the business.
But when we explore selling our business, it becomes painfully obvious: our baby is ugly.
You’re the One Who Took the Picture
With rare exception, financial results are what cause a business to be considered ugly. Low Seller’s Discretionary Earnings (SDE) (see definition here if you don’t recognize the term) create a huge blemish for any business for sale.
But it’s important to understand that bad financial results alone don’t create the ugly. Most businesses, even those with little profit, can be priced to be attractive to a potential buyer.
Ugly in a small business sale scenario is driven by the gap between the value you want for the business and the value justified by the SDE the business generates.
Take two different pictures of the same business:
- Picture #1. SDE = $50,000 Asking Price: $250,000
- Picture #2. SDE = $50,000 Asking Price: $50,000
Which picture is uglier? Same business, but a dramatically different buyer perception of beauty. As business owner’s we forget that we control how attractive our business will be to a prospective buyer. Many reasonable financial results have been made ugly by owners who stretched the gap between cash flow and desired value too far.
Lesson: Understand that the gap between cash flow and price is what determines how ugly your business is to a potential buyer – and you are the one that sets the price!
How Ugly Should You Make Your Baby?
Assuming you know your SDE, “how ugly” will be determined by the price you set for your business. So what’s your business worth?
It’s easy to complicate it. It’s tempting to get caught up in industry multiples, price trends, and many other techniques that jack up the potential price of a business.
This article said one times annual revenue, but this other says 1.25 times . . .
Or better yet, how about setting the price based on how much money you need to buy the retirement home you want?
Set those temptations aside and consider the pragmatic perspective that a buyer, and their bank, will likely use. Your buyer will ask some simple questions as they evaluate your business to determine if it represents a realistic opportunity. They will ask if the cash-flow your business generates will allow them to:
Can I earn a living?
Can I payments on the debt I incur to buy the business.
We call this the simple approach.
The cash flow of your business must allow a buyer to do those two things – if the value you place on your business doesn’t make that possible, your desire for a higher price is just painting on the ugly.
Lesson: How ugly is your business? Put yourself in the buyer’s shoes and take a look.
So, your Baby is Ugly, Now What?
Since it’s the relationship between price and SDE that creates “ugly”, what do you do if your cash flow is bad, and your desired price for your business is too high?
It’s not about hiring more staff or laying off a few people. It’s not about getting more capital or paying off debt. Or maybe it’s about all those things and 100 more. At least that’s the way it was for me.
In 2005 we had 50 employees, 5 million in revenue, and an ugly business. In 2010 we had 50 employees, 5 million in revenue, and a business that was sellable (and sold). We did 100 things differently during that period, but it all started from the recognition that how I was running the business was creating ugly results – and that I needed to change if I wanted different results.
The answer to the “now what?” question is very simple, but simple doesn’t mean easy. If your business is ugly, you need to change the way you run it – and the most important word in that answer is “YOU”. I know it seems like I’m not providing an answer here, but recognizing that you need to fundamentally change your mind-set about how you run your business is the answer.
Lesson: Your baby is ugly, but you can change it. In fact, only you can change it.