Have you formulated an exit strategy for when the time comes to sell your business? It can be difficult to find the time to do so when you're engaged in the daily struggles of operating an HVAC business, but delaying your planning can cost you significantly. The best way to maximize the eventual sale day payoff is to build an exit strategy now.
An exit strategy is a plan to successfully relieve yourself from the ownership of your business. There are several key steps to executing a successful exit strategy. These include:
- Define the reason for exiting
- Establish a time frame
- Understand the market and potential buyers
- Gain an understanding of the value of your business
- Set realistic expectations
- Prepare the business to maximize the sale price
- Build an advisory team.
Let's take a look at each of these elements.
Define Your Reason for Exiting
Your ultimate goal should be to one day sell your business and cash in on the asset that you've worked so hard to build. Your reason is just that: yours. Typical reasons include retirement, failing health, burnout, or new opportunities, but the reason can be any reason you determine.
The important thing is that knowing why you want to sell your business helps you to set a goal and establish a time frame. Setting a goal now will be beneficial later when transactional stresses might tempt you to second-guess your decision.
Establish a Time Frame
Time frames can vary, but, generally speaking, the longer you have to execute your exit strategy, the better the final outcome. Establishing a time frame is imperative, but keep in mind the time frame should be considered an estimate, as certain events may force you to adjust your target. For example, businesses that have suffered recent setbacks may need several years to implement changes required to make themselves attractive to potential buyers. Other factors, such as an owner's failing health, may dictate an abbreviated plan from the start.
The point is that rolling out of bed one morning and deciding it's time to sell today, regardless of the reason, is the worst time to establish an exit strategy.
Understand the Market and Potential Buyers
Give some serious consideration as to who you want to target as a buyer. Necessary preparations will be different if you intend to sell to a group of employees or family members versus a third party.
A common mistake is that owners often think their best competitor will swoop down and buy the business when the time comes to sell. While your competitor may be interested in buying your business, he is likely to value your company's goodwill differently than someone who isn't already operating in your market. And the value he puts on it will probably be substantially less.
Another fairly common blunder is to believe that the "second wave" of consolidators will be your salvation. While building your business to sell to a strategic buyer is a good move, expecting the second coming of publicly traded consolidators is akin to hoping for an onslaught of qualified service technicians to appear at your door.
Look beyond consolidators to your local utility, a buying group, or a larger HVAC business not currently operating in your market. Expect these strategic buyers to proceed with caution, so be prepared to offer them a well-operated business.
Understand the Value of Your Business
Do you know what your business is really worth? Understanding this will not only communicate where you are today, but also help set realistic expectations for your exit strategy plan.
The best source of a realistic valuation is a valuation professional. Avoid "rule of thumb" guesstimates — they may be free or cheap, and that's because that's what they're worth.
To accurately calculate the fair market value of your business, a valuator must consider several attributes of your business and analyze several years of historical financial information.
A valuation professional will usually communicate the value of your business in the terms of "fair market value." This is defined by the Internal Revenue Service's Revenue Ruling 59/60 as the price at which property would change hands between a willing buyer and a willing seller, when the buyer is not acting under a compulsion to buy and the seller is not acting under a compulsion to sell, and both parties have a reasonable knowledge of the facts.
Keep in mind that a buyer may offer you more or less than fair market value for your business, depending on his compulsion. Obviously, having an understanding of your company's fair market value is an excellent tool to use as a measuring stick to judge any offer.
Set Realistic Expectations
Contractors often base expectations on wants and/or needs, and not on sound business valuation principles. Building expectations upon "pie in the sky" hopes and dreams can cause a seller to falsely overvalue his business.
Without realistic expectations, you run the chance of passing on an excellent offer, just because it doesn't meet your expectations. Worse yet, you may let your business go for less than it's actually worth.
Prepare the Business to Maximize the Sale Price
Once you have a clear understanding of your company's current fair market value, the next step in executing your exit strategy is to build value into your business.
Some ways you can do this are to:
Produce and demonstrate several profitable financial periods. The surest way to predict future results is to analyze past performance. This rings especially true in the world of business valuation. Therefore, buyers will focus on a target company's historical earnings. Commonly, a buyer will analyze the three most recent years, but there are no hard and fast rules. Buyers may want to research as far back as five years.
The business must produce financial statements that demonstrate the company's ability to generate profits. Without those, the company's fair market value (and the purchase price offered by any buyer) will suffer.
Typically, a buyer will analyze the target company's adjusted historical earnings. Adjustments to the financial statements enable the buyer to predict what the true earnings of the target company will be going forward (post purchase).
Adjustments to the historical financial statements can include excessive owner's salaries as well as certain discretionary, non-recurring, and extraordinary expenses. While a buyer may consider certain adjustments (or addbacks as they are sometimes called), an owner preparing his business for sale should eliminate any expenditures that would be difficult to prove as adjustments and might be viewed as ongoing expenses.
Demonstrate several periods of revenue and earnings growth. Along with the ability to show positive historical earnings, your company should be able to demonstrate that it's flourishing via an increase in annual gross revenues and net income dollars.
Businesses that fail to show growth, or — worse — show a decline, will attract less buyers. And those buyers that they do attract will be less likely to act in any type of compulsion to purchase the business.
Maintain clean and consistent financial statements. It's not enough to just eliminate extraordinary expenses; your financial statements must also be clean and consistent. Avoid adding and eliminating to your chart of accounts, and stick with a set group of expenses that together make up your total direct costs. A buyer will want to understand your gross profit margin, and without a consistent set of direct costs, that's difficult or impossible.
Consider having a consultant or CPA analyze your financial statements on a monthly or quarterly basis. Be sure that whoever you engage conducts his analysis with understanding of your intentions. While you may already be working with a CPA who completes your annual tax return, this may not be the best person to assist you with strategizing your exit.
Organize and maintain company records. Failure to organize and maintain proper company records can be fatal to a successful exit strategy. Whether you're selling the stock or assets of your business, a buyer will want to fully study all business records. This includes corporate minutes, employee files, vendor files, vehicle titles, and customer databases. The longer you have to plan your exit, the more likely these documents will be in the order for when a discriminating buyer requests to see them.
The Pay Off
Sooner or later, you will relieve yourself from ownership of your company. In order to guarantee that the high risks of ownership (and all your years of hard work) pay off, maximize your company's value on the sale day by formulating an exit strategy today.
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HVAC Comfortech 2006
This article is based on the presentation, Building Value to Power Your Exit Strategy, which Brandon Jacob gave at HVAC Comfortech 2006, held in Baltimore, MD, Sept. 13-16, 2006.
For more information about HVAC Comfortech 2007, which will be held September 26-29 2007 in St. Louis, MO, call 216/931-9550 or watch for updates on the show website: www.hvaccomfortech.com.
Don't Go It Alone
The Value of Building an Advisory Team
For many business owners, selling a business will be a once-in-a-lifetime event. The strength of your team will determine how successful this process will be for you. Failure to seek professional help and deciding to "go it alone" is a recipe for disaster.
As you execute your exit strategy plan, you may find it necessary to use certain professionals for very specific pieces of the transaction. Waiting until a difficult tax issue arises three days before close is a poor time to be searching for a qualified tax professional. Start seeking these professionals now, although you may not need them until later (or maybe not at all). Key team members include:
This group represents the essential deal team members. Other professionals that you may include on your team are peers, a financial planner, a real estate agent (if the sale of real estate will be part of the transactions), and industry consultants.
Brandon Jacob operates Contractors Financial Opportunity (www.Contractorscfo.com), a financial consulting firm that specializes in business valuations, transactional support and exit strategies. He has 16 years experience as a CPA, as well as industry insight gained as a valuation analyst and acquisition specialist in the HVAC, plumbing and electrical trades. He can be reached at 713/426-4041, e-mail [email protected]