Why Does the Sale of a Business Take So Long?
Updated: Jun 15
PART 4: Why Does the Sale of a Business Take So Long? Exploring Due Diligence and Transaction Factors.
Lamar Rutherford continues her interview with Exit Story . . .
It’s important for a business owner to understand the closing phase, and due diligence is a big part of that. Many owners will ask, “why does a sale take so long?”
Sometimes it's due diligence, sometimes it's negotiating the purchase agreement. And a lot of times it's the seller that actually slows it down. It usually takes at least six to nine months to sell most businesses. And that's if they're reasonably priced. If they're not reasonably priced, it can take a lot longer.
In terms of phases, we do a preliminary due diligence before we have a buyer, so that we don't run into surprises that can derail a deal when we go through actual due diligence.
I tell sellers it's a little like someone going through your underwear drawer and asking why you bought every pair.
A buyer will go back five years and question a transaction you made. To you, it seemed like it made sense at the time. You have to try and remove your personal emotions as you go through this phase.
Remember that the buyers are really nervous that they're going to miss something and make a mistake. So, maintaining trust is the biggest part of the process.
They say in selling real estate that you don't want to surprise a buyer, because it can derail a deal. It’s ten times worse in business transactions because there are so many elements involved. Buyers can't look at absolutely every aspect of a business. So, they rely on due diligence. That’s why being prepared for it is very important. The faster and more smoothly it goes, the more likely the deal is to close.
We always say time kills deals. To the seller, that may not make any sense. You may wonder why extra time could kill a deal if someone really wants the business. But there's a real wear-out factor. If there are a lot of hassles and challenges as the deal progresses, buyers are more likely to give up with the “it wasn’t meant to be attitude”. I warn sellers about this up front – getting too nitpicky early on can mean buyers will lose patience.
Later, when you really need to sit down and negotiate those things that are important, the buyers’ tolerance is already worn out and you can either end up with worse terms or they'll walk away.
What’s a good valuation? How do you value your business? The simple answer is it's not that simple.
There are a lot of multiples in industries that people throw around. The multiples might be accurate -- but what you multiply it by-- might not be.
For medium to larger businesses, multiples can be as high as 10-12 times (or more) adjusted EBITDA (earnings before interest, taxes, depreciation and amortization).
But for a small business like a hair salon, they can be as low as one and a half or two times what is called sellers discretionary earnings (SDE). SDE is slightly different than adjusted EBITDA. The difference is really only the seller's salary.
Why use SDE instead of adjusted EBITDA for smaller businesses? The argument comes from banks. They see that some sellers pay themselves a lot and others pay themselves very little. So, they add back whatever owners pay themselves, because they want to take the differences in pay out of the equation and look at the cash flow regardless of the owner’s salary.
When a business gets to be a little larger, they include seller’s salary because banks assume the seller gets paid a market rate. And so adjusted EBITDA includes the owner’s salary.
“Add backs” are another term you'll hear, and that's what can make a lot of difference. As an example, let’s say a seller wanted to sell his business and was making maybe $500,000. For $500,000, you might get a three times multiple, but that's the other thing about increasing the size of your business -- the bigger the business, the bigger the multiple.
This makes sense because the bigger the business, the lower the risk. You have more employees, more management, more customers, more of a buffer if things go right or wrong.
You can get multiples much higher if it's a business on the public market. Even with the companies we work with from $2 to $50 million in revenue, we have seen businesses at a multiple of six or even higher -- if it's a really strong business and maybe has $3 to $5 million in adjusted EBITDA.
Every industry can be a little different. It’ll depend on certain characteristics specific to the industry, and then other things like add backs can make a difference.
Here’s an example of where an add back made a difference. This seller was sure his business was worth three or four times his $500,000. But he owned the property and the building, and he neglected to notice that he wasn’t paying himself rent. Once he calculated the rent, which was over a $100,000 a year, his adjusted figure went down quite a bit, three to four times that $100,000.
The multiple is mostly calculated on the earnings before interest and taxes. That's the number we're looking at to then apply that two or three or five multiple.
It depends again on the type of business. If it's like an accounting or legal firm, it's a multiple on revenue -- and recurring revenue might get an even higher multiple.
I worked with the owner of an alarm business. They had a multiple of what's called recurring monthly revenue, and it was like 35 times that. So sometimes there are industry characteristics that we have to pay attention to.
As a business owner that has sold three businesses, and now an M&A broker, I’ve seen the process from both sides of the table. And as a broker, I’ve helped hundreds of people through it. It’s best to start preparing for your exit from one to five years ahead. That should give you time to make changes that can help boost that multiple.