How to Build a Business to Sell

How to Build a Business to Sell

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Research shows that business owners generally take home less money each month than their corporate executive counterparts, yet business owners are, on average, more wealthy than corporate executives. The reason for this is that much of the business owners’ wealth is tied up in their businesses. To realise this wealth they need to sell their business at some point in time.

A small minority of people may wish to never sell their business because they are building it as a family enterprise that they will pass on to their children, but for others, the sale of their businesses is critical to realising the fruits of their entrepreneurial and management efforts. The earlier business owners consider the realities of selling a business, the more likely they are to build a business that is actually saleable.

John Warrillow, the author of the book Built to Sell, reports that just one out of every one hundred business owners is successful in selling their business each year. The primary reasons that so many businesses are unsaleable is that (a) the business is too dependent on the current owner (b) the business offers nothing unique or distinguishable (c) the demand for the business offering is no longer growing or (d) the business is too messy because of poor records or potential liabilities.

How do you build a business that others will want to buy? In this article I will examine three phases of business value creation and what can be done within each phase to maximise the likelihood of a sale and the value that will be created through that sale. Phase one focuses on decisions and actions when launching the business, phase two focuses on decisions and actions when building a business, and phase three is orientated toward selling the business.

When building a business, it is important to begin with the end in mind. Therefore, if you wish to build a business you can sell one day, think about what will happen at the time of the sale. In discussing the key decisions and actions that are applicable at each phase of the business lifecycle, I will begin with the third phase and work my way back to the first phase.

Phase 3

Selling the Business

The most common buyer of a business is another business, but you may also sell your business to another individual or to public investors by listing it on the stock exchange. Because only a tiny minority — less than 0,1% — of entrepreneurs will ever list their firm on a stock exchange, I will focus on sales to other businesses or to individuals.

There are three major factors to be aware of when thinking about the sale of a business: (1) the reason for acquisition (2) the number of interested buyers and (3) the timing to sell.

Reasons for Acquisition

One of the keys to being effective in selling a business is to clearly understand why the buyer wants the business. There are four primary reasons why another company or individual will purchase a business: access to the cash flow and profits, access to the customer base, ownership of the technology in the business or utilisation of its people.

As a business owner, it is important to recognise what kind of value you are creating. Is your value embedded in the operating cash flow of the business, in its customer base, in the technology that is being developed or in the talented mix of employees.

Often a combination of these factors will be discussed in the sale negotiation, but in the end one of these factors will be the primary reason someone wants to buy your company. If you wish to sell your business one day, you need to create significant value in at least one of these areas.

One Buyer = No Buyer

A few years back I discussed the concept of exiting a business with Steve McCraken, a Seattle based serial entrepreneur who had

successfully sold three companies he founded. He told me that the number one piece of advice that he has learned through selling his businesses is that “one buyer is no buyer — unless you can create a bidding process between two or more interested acquirers you will very seldom be paid the true value of your business.”

Since hearing this I have observed it time and time again. Business owners who engineer more than one interested buyer get a much better deal when selling their business. Therefore, as you work toward selling your business make sure that you are keeping multiple potential acquirers interested in what you are doing.

Don’t Max Out: Sell on the Up

The third piece of advice related to selling a business is perhaps a little counterintuitive. Most people wish to sell their business when it is at the height of its popularity so they can show the best possible cash flows and profits; however, most people buy a business for its future prospects.

Therefore, it is generally better to sell a business while it is still growing; no one can forecast exactly how long business growth will last but the prospect of growth is much more attractive for a buyer than a company with stagnant or declining revenues.

The managers at Yahoo! have learned this the hard way. Over the years they have been offered less and less for the firm as revenues and profits have stagnated. Had they sold five years back, they would have made a much better return for shareholders than what they have by holding out.

If you plan to realise the value from your business by selling it, plan to sell before you reach the top of the growth cycle. Even if you leave some money on the table, you will be better off selling too early than selling too late.

Related: How To Expand Your Business To 5 Times Its Size In 5 Years

Phase 2

Building the Business

The value you create in selling a business will depend largely on the actions you take to build it. Therefore, if you wish to extract value by selling a business at some point in the future there are four key things you can do to build the business and make it more saleable and attractive to potential acquirers.

These include (1) systematising all processes and practices (2) reducing risk by eliminating dependency (3) keeping the records and liabilities clean and (4) incentivising people for the outcomes you desire.

Systematise Everything

The number one reason why business owners are unable to extract reasonable value from a business they have created is because the business is too dependent on them. If you are the business then the business is worthless without you. So how do you create a business that is not so dependent on you? The answer is through ‘systems and processes’.

Through the development of systems and processes you are able to create a machine that can operate when you are not there, a machine that can be replicated multiple times over, and that can be passed on to someone else who can continue to extract value.

In the insightful book entitled The E-Myth Revisited, Michael Gerber points out that it is no longer the hamburger that creates value for McDonalds, it is McDonalds’ systems. The more every element of the business is built into a documented, repeatable process that any person in the firm can carry out, the greater the opportunity to create ongoing value in the business, to expand it and to sell it when the time is right.

Reduce Risk

Many people refer to entrepreneurs as addictive risk takers. While good entrepreneurs invariably take risks to start and grow their businesses, they also aggressively manage risk to prevent avoidable failures. Bill Murphy Jr studied three Harvard graduates who, between them, started ten businesses.

In his book, The Intelligent Entrepreneur he reports that “successful entrepreneurs focus on managing their risks to the point where launching a new company is not much more risky than most of the other professional choices they could make.”

Risk while growing a business is related to dependency — the more you are dependent on someone or something the more risk there is in the business. People acquiring a business dislike risk and dependence. If they look at a potential acquisition and see a high dependence on one customer, one supplier or one employee they will immediately discount the value of the business.

Therefore if you wish to maximise the value of your business you need to spread your dependence across multiple stakeholders. Source your inputs from more than one supplier, diversify your customer base and spread responsibilities across a number of employees.

Keep it Clean

The sales of many businesses have fallen through because the buyers could not make head or tail of the financial records or because the sellers discovered an unexpected liability. In preparing to write this article I interviewed a number of business brokers and one of them said to me, “a clean financial history will inspire confidence and reduce the invitation for closer scrutiny… managers who use the right software, people and processes to keep up to date financial records make it much easier to build trust and negotiate with buyers.”

It is often essential to incur debt to grow a business, but outsiders hate buying debt. If you attempt to sell a business with significant or unexpected debt on the balance sheet, buyers will see it as a forced sale and believe they have the upper hand in the negotiation. Therefore if you envisage selling your business at a future date, work to clean up your balance sheet by reducing debt over time so that your finances paint an unambiguous picture for those interested in buying the business.

Incentivise Outcomes

One of the best items of practical management advice I was given by a professor while doing an MBA was: ‘What you measure is what you get.’ This can be expanded to: ‘What you measure and reward is what will drive people’s behaviour and the outcomes they achieve.’

This is a very important truth in building a business you can sell. If you reflect on why another business or person may buy your business — for cash flow, customers, technology or people, you can incentivise people to deliver based on the criteria that are going to drive the attractiveness and price of your business.

That means that if you are creating a social networking website that is dependent on a high number of users to make it attractive, the better you can incentivise employees to grow the user base, the more valuable your business becomes.

Related: How To Identify and Rescue Declining Products

Phase 1

Launching the Business

Research shows that a great deal of value is created or destroyed in a business based on the early decisions and choices that an entrepreneur makes. If you are launching a business as something more than just a hobby, clarity on (1) the competitive advantage (2) the scaleability and (3) the timeframes for building a business will help you make it more valuable over the long term.

Be Clear on Competitive Advantage

If your business is going to be worth anything to an acquirer one day, it should be able to do at least one thing better than anyone else. When starting a business many people are tempted into ‘me too’ businesses. Because they read that Mark Zuckerberg is worth $12 billion they think it must be a great idea to start a social networking website, something like Facebook.

Wrong! Facebook is valuable now because six years back the founders created a unique way for university students to connect. From the focused product targeted at a specific niche a global business evolved. Initially, Zuckerberg focused on doing a few things really well and that provided the firm with a competitive advantage in a specific area.

What you need to ask is, ‘What is my business going to do better than anyone else and for whom are we going to do it?’ If you launch your business with clear and compelling answers to those two questions then you are more likely to create a business that is worth something when you attempt to sell it.

Make is Scaleable

Scaleability is a term that comes from engineering but has become a very important concept in entrepreneurship. In engineering, scaleability is the ability of a system, network, or process, to handle growing amounts of work in a graceful manner or its ability to be enlarged to accommodate that growth. In business it refers to the ability of a firm to deliver more and more of its offering without placing significant or unreasonable demands on resources.

Scaleability enables growth. If it is difficult or expensive to sell more and more of your product or service to an expanding market, the lack of scaleability will limit growth which will ultimately limit the value of the business when you wish to sell it.

Factor in Timeframes

The final thing to be aware of when establishing a business is how long it takes to create one that is truly saleable. Although there are exceptions, the general rule of thumb is that most businesses take approximately seven years to reach a point of being sufficiently established to interest buyers. Therefore, if you are getting into business to make a quick buck, you may be fooling yourself. Building a saleable business is at least a seven year project.

Qualities of a Scaleable Product or Service

John Warrillow, the author of Built to Sell suggests that scaleable products and services exhibit three qualities:

  1. Repeatable. They are repeatable in that they don’t require a high level of expertise and customisation every time you make a sale and they are something customers need often
  2. Teachable. They are teachable in that you can teach employees to deliver so that you’re not the only person who can operate the business
  3. Valuable. They are broadly valuable so that more people will want them

Reasons a business gets acquired

  1. Cash flow: The most obvious reason for acquiring a business is to get access to the cash flow that the business is generating. The focus of the sale negotiation will be on the financial models underlying the company, the financial history, the forecasts and the risk attached to future cash flow.
  2. Customer: A second reason why a company is acquired is to give the acquirer access to the current and future customer base of the acquired business. Many web-based companies get good valuations when they are sold, even before they are profitable, because of their strong customer or user base. For example, AOL recently acquired the Huffington Post (a news website) and TechCrunch (a blog about technology start-up firms) for $330 million and $100 million respectively. Both of these firms have marginal profits but huge readerships which make them very attractive to larger corporations that believe they can monetise that reader base in the future.
  3. Technology: A third reason that a firm might be interested in acquiring another firm is to get access to the technology owned by the acquired firm. This is the reason why many pharmaceutical firms acquire biotechnology start-ups before their drugs have even been approved and the reason Google acquired YouTube for $1,5 billion just 30 months after the company was founded and before it was generating any revenue — they wanted the YouTube technology. Technology is most valuable when it is protected by patents and the value of such companies is often linked to the perceived value of the patents they have filed.
  4. People: A final reason why an acquiring firm may be interested in buying another company is to get access to the people in that company. Creative enterprises (eg advertising firms or design houses) tend to be acquired primarily to gain the talent of the individuals in the business. The challenge is that it is difficult to put a price on talent and people can walk out the door at any time. This is therefore the least valuable and most subjective reason for acquiring a firm.

Advice from Michael Gerber in The E-Myth Revisited

To truly systematise your business imagine making it the prototype for 5 000 more exactly like it. In so doing, you should strive to build a model that will:

  • Be operated by people with the lowest reasonable level of skill
  • Stand out as a place of impeccable order; it will operate in an orderly and repeatable fashion
  • Be rigorously documented in an operations manual
  • Provide a uniformly predictable service to the consumer
  • Keep operating when you or any other key individual is absent

Recommended Reading

Built to Sell: Creating a Business That Can Thrive Without You

  • Author: John Warrillow
  • Publisher: Portfolio Hardcover to be released on 28 April 2011

The E-Myth Revisited: Why Most Small Businesses Don’t Work and What to Do About It

  • Author: Michael Gerber
  • Publisher: HarperCollins; Third Edition (1995)

How to Build a Business and Sell It for Millions

  • Author: Jack Garson
  • Publisher: St Martin’s Press (2010)

High-growth, successful businesses are a result of a number of factors, none more so

than planning and beginning with the end in mind. This requires a thorough analysis and understanding of what your profit goal is, over what period of time you will grow your business and which reasons will motivate an individual or company to purchase your business: access to the cash flow and profits, access to the customer base, ownership of the technology in the business, or utilisation of its people. Consider this three phase approach to potentially and dramatically raise the sales value of your business.

Greg Fisher
Greg Fisher, PhD, is an Assistant Professor in the Management & Entrepreneurship Department at the Kelley School of Business, Indiana University. He teaches courses on Strategy, Entrepreneurship, and Turnaround Management. He has a PhD in Strategy and Entrepreneurship from the Foster School of Business at the University of Washington in Seattle and an MBA from the Gordon Institute of Business Science (GIBS). He is also a visiting lecturer at GIBS.