I always thought that building a profitable company that could run without my input was the perfect passive income.
It was until I met two co-founders who had built a profitable social media agency, left two managers to operate the day-to-day operations, and received dividends.
When I first heard they wanted to sell the business, I thought they were crazy.
But they just wanted to be free of the responsibilities and risks of ownership.
As a business owner, you are always anxious about keeping the cash machine alive and healthy. Even if your business gives you free time to develop another company, it will still occupy your mind.
In my client's case, the managers who didn't want to become owners felt increasingly frustrated by the lack of attention and resources for scaling the agency.
My clients found themselves in a situation where the social agency business took up more mental space.
Finding new owners was the best solution because the social media agency had become too much of a risk factor for its founders.
The journey from when a founder entrusts me to when he has money in his bank account takes 5 to 11 months, and it usually goes like this.
From 1 to 2 months of preparation to build an attractive equity story, depending on the quality of the financial information and how familiar I am with the company.
From 3 to 6 months of marketing to get an acceptable offer, depending on the opportunity cost the company represents.
From 2 to 3 months of negotiation, depending on the outcome of due diligence.
Photo de krakenimages on Unsplash
The journey with my client took about one month (😁) of preparation, seven months (😕) of marketing, and four months (🤯) of negotiation.
It's been an exciting ride, but I've learned four hard lessons to help you keep a sales process close to the 6-month mark.
Market trends are not enough to demonstrate the attractiveness of a market
When buying a business, you give up the opportunity to invest your time and money in other projects. This lost potential is known as the opportunity cost.
The project perceived to have the greatest opportunity cost will receive priority time and money.
Buying a business is the riskiest kind of investment. Before moving in, potential buyers will take a severe look at alternatives:
Starting with the time needed to conduct due diligence vs. running the business, closing a big client, closing a funding round, etc.
Without an opportunity cost, I am getting, at best, a polite "Not interested." answer. No response at all after several attempts is the typical response.
Then buying a business vs. building an alternative and organic growth.
With a low opportunity cost, I am getting a "No-go" after several meetings or non-acceptable offers.
Finally, buying my client's business vs. purchasing another company.
With a low-to-medium opportunity cost, I may receive acceptable offers, but after matters perceived to have a higher opportunity cost.
In M&A, marketing a company as the category leader with defensible moats in an attractive market triggers a high opportunity cost.
Regarding market attractiveness, I've learned the hard way that trend analysis is not enough if I don't have a solid underlying: addressable, high-paying customers in large and growing numbers.
Due to the relatively low number of high-paying customers, my client's market was considered slightly attractive. So we fell into the nice-to-have opportunity with low-to-medium opportunity cost.
Nice enough to get several offers but not sufficient to generate the famous FOMO needed to get a three months marketing process.
Ideal buyer profiles based on founders' feelings are often just guesses.
When communicating value, there is a difference between bringing value to customers and extracting value from customers.
The first deal momentum killer is value miscommunication.
Founders often communicate value by describing their service's benefits to a customer. But potential buyers care more about the customer's willingness to pay compared to the direct costs to acquire and serve this customer.
In financial terms, I'm talking about the contribution margin or the margin on direct costs.
For example, suppose you say to an interested potential buyer that you're one of the most valuable suppliers of your customers thanks to your awesome service. However, he sees that you have a low contribution margin, lower than his, and you’ll have killed its initial interest.
In my client's case, his offer included three services: (1) strategic consulting to produce a brand content strategy with ready-to-produce content, (2) content production, and (3) media buying content promotion.
Considering strategic consulting as the central pillar of his value proposition, he thought the ideal buyer profile would be the one willing to integrate this expertise.
However, the best price was formed by someone interested in leveraging content production, and it makes sense from a contribution margin perspective:
Content production accounted for more than 70% of the contribution margin of the business.
It turned out that this buyer was approached later in the marketing process.
A better evaluation of best-qualified buyers based on contribution margin, not my customer feeling, would have led me to focus my marketing efforts on creating and maintaining a better deal momentum.
When the main reason for selling is to move on asap, focus on speed rather than price.
A company's valuation is usually based on future cash flow projections.
Regarding assessing valuation with potential buyers, I focus discussions about future cash flow potential based on a synergy-based Business Plan.
However, this approach does not hold with founders who want to move on after the closing, as the buyer will have to bear alone the burden of integrating the business and implementing synergies.
Valuation assessment will be based on historical data, which is often a heavy discount on value expectations.
Reducing the discount means an increased emphasis on the historical quality of earnings. I personally defined three types of earnings:
Accounting Earnings: found on the financial statement.
Earnings reported on a company's certified financial statements are not subject to negotiation, and these figures represent the highest quality earnings available.
Seller's Discretionary Earnings: Accounting Earnings + Founders' Compensation.
The Seller's Discretionary Earnings may be negotiable as a buyer may assess that the time needed to integrate and run a business requires compensation.
Normative Earnings: Seller's Discretionary Earnings + Non-related business expenses + One-time expenses + Investments in the company's growth
Normative Earnings are highly subject to negotiation and discussion based on buyers' doubts about the fundamental nature of non-related business and one-time expenses.
My client had three types of non-related business expenses. I spent considerable time and energy agreeing with a buyer to a Normative Earnings close to my client's value expectations.
So yes, my client got a better offer, but we lost several weeks in the marketing process to achieve this result.
Sometimes speed is better than price, especially if you want to move on quickly.
Make your Normative Earnings as close as possible TO your Seller's Discretionary Earnings to reduce the time regarding valuation assessment significantly. If it's not possible in the short term and you want to close fast, set lower valuation expectations.
Prepare the due diligence process from the beginning when deal team energy is at its highest.
Deal fatigue can turn a smooth transaction into an agonizing one.
Time is the number one deal killer.
Once an offer is accepted, every minute that goes by increases the odds of deal fatigue. Deal fatigue is the mental exhaustion that sets in as a long negotiation continues.
When a buyer makes an offer, my first goal is to ensure a high probability of closing this deal on time.
In closing time management, due diligence is the most common reason for timeline disruption.
During due diligence, a buyer calls upon auditors to avoid costly mistakes by ensuring he knows all the facts about a business.
Auditors are like food critics. They evaluate companies, and their reviews help buyers decide if a company is overpriced and know what they will truly buy.
Based on the quality of the information served, if:
The reviews are good: a buyer will proceed according to the timeline.
The reviews are average: a buyer will ask for additional information and may renegotiate deal terms or demand specific guarantees (timeline disruptor).
The reviews are bad: a buyer will back down (deal killer).
In due diligence, I take a stoic approach to the elements I can control and those over which I have no control.
I have no control over auditors' schedules; they manage several clients simultaneously, like me. However, I control the quality of the information (data room) served.
I used to prepare data rooms when I was in the stage of receiving offers. However, my client didn't have a management team to rely on while managing an emotional process such as offer negotiation.
By the time of due diligence, the data room was loaded with low information quality leading to multiple back and forths, timeline disruption, and a burned-out CFO and CEO.
A data room preparation since day one, when the energy of the deal team is at its maximum, allows us to control the due diligence timeline better.
Here is a list of information requests compiled from all the request lists received from auditors over the past several years.
In the end, my overall experience was positive. This article acts as an exercise of turning my learned experience into a framework that will help anyone (especially me) keep a sales process close to the 6-month mark.
Here's the recap of the four lessons learned the hard way:
Market trends are not enough to demonstrate the attractiveness of a market
Ideal buyer profiles based on founders' feelings are often just guesses.
When the main reason for selling is to move on asap, focus on speed rather than price.
Prepare the due diligence process from the beginning when deal team energy is at its highest.
Use it wisely!
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