Peter Graves Growth & Investment

The Entrepreneur Hero Myth

(And why you can’t sell your business)

The Hero Myth

I heard yet again, last week one of the common versions of the Entrepreneur Hero Myth. In this often-repeated tale, the entrepreneur builds the business and eventually sells it to an investor. Two years later they buy it back for a fraction of what they sold it for, get back in and do what they used to do, and build it up a second time.

Entrepreneur beats chest and shows off new Ferrari. (yawn)

There are many versions of this hero myth, this one I’ve heard so many times. In others of course the Entrepreneur has long retired or is otherwise occupied with new projects, so the company folds and the employees lose their jobs.

Can’t sell the business

At the same time we hear that at least 80% of SMEs going to market are never sold, and have to find another retirement solution. Often this is the gentle fade away towards retirement and closure. Maybe an Asset sale if they have any.

So how do these two stories help you understand why you can’t sell your business – and how you could if you approached it differently?

The buyer got it wrong

Part of the issue icould be with the buyer. According to the Hero Myth the buyer wasn’t as good at running the business as they were, changed everything that didn’t need to be changed, lost the trust of the employees, lost the clients and their demise was self-created.

Or perhaps they just bought badly, and set themselves up to fail when they made the deal?

The Deal

A large part of the problem is wrapped up in the way the business was sold and bought, and we’ll have to dig into that a little.

Traditionally the most common way of buying a business is the “LBO” or leveraged buy-out. Here some funding is put together by the purchaser, perhaps by financing the property or the stock, or an existing shareholding in another business. There may be 3rd party investors. What’s important here is that getting money costs money, perhaps a business loan might average out at 15% a year. If this is being paid back over 3-6 years, then we’ll find that 50% or more of the entire transaction value will go to a financial institution. Either the seller will have that 50% reduced from their sale price, or the business will have to pay back that too.

What is key is that all the costs of the sale always have to be paid by the business. There is no Santa Claus or sugar-mummy to just drop a million, for no return, in a typical business transaction.

The debt incurred in the transaction is usually fixed in that the repayments are set each year, while the actual fortunes of a business naturally ebb and flow.

It is very easy for a smaller business to end up with a crushing debt burden where all their profitability is absorbed in paying for the business and the interest on it.

Bag of Swag

Note that the seller rode off into the sunset with a bag of cash and not a care in the world. They are now free to set up down the road. Non-compete clauses are famously hard to enforce, or only last a period.

In another version of the hero myth you hear “I’m waiting for my non-compete to expire and my plans are in place to start again”. The entrepreneur may use their long-standing relationships with the staff and clients to snaffle them all away.

A typical earn-out deal can also be counter-productive. The old owner is imprisoned in the business for a few years to “hand over”. With the need to maximize profitability to justify their final payment, they are incentivized to avoid all investment for the future, and eventually step out of a business at the peak of its profitability, and on the verge of collapse.

The new owners’ fate can be sealed before the ink on the S&P agreement is dry.

Can buy, won’t buy

Experienced buyers understand these risks, and have a number of coping strategies.

One is just to buy larger businesses, where there’s a working management team to come across a more mature approach to financing, more systems and processes that don’t depend on the owner, and a business that can actually function with the owner away.

And there’s the reason why larger businesses typically have many, even thousands of potential buyers, while 80% of SME’s never sell. Buyers simply walk away from the SME knowing the risks of taking on your baby are too high, the potential returns too low.

How to maximize your prospects

So while planning to sell your SME business, how do you learn from this to maximize your prospects of a great exit?

Two key areas to focus on are:

  1. Setting up the business to sell
  2. A deal which aligns the long-term interests of the seller and the buyer

To set it up so it works without you is all operational. You need managers who can cope in your absence, make decisions and grow the business. You need to have nurtured and developed them sufficiently that they’ve grow into the role. You need systems that are clearly understood and documented, not just “I know how to do everything”. You need a steady pipeline of new work which again isn’t dependent on you’re the owner. And the business needs to be run so that it returns a steady profit, without anyone having to remortgage their house periodically to prop it up.

More about preparing your business to sell here.

If these tasks have not been achieved, the buyer should know they have a lot of work to do, and risk to run. They will either look for another business, or you need to work together to understand each risk and put in place effective mitigation.

Being a Successful Seller

Then there’s the deal itself. Let’s look at how that can work better.

If the seller just disappears with cash, we know that the amount you can pay them will be halved, and the risks to the business much higher.

We need to engineer the deal so that everyone wins together, and so the business can afford the cost of the transaction.

Effective tactics are:

  1. Seller acts as the bank and is paid for the business over time. Not only can this be extremely tax efficient, but the full sale value of the business comes to them, not the bank.
  2. Now the seller is invested in the future of the business, even while they increase their eventual earnings, they need to ensure the business survives and thrives.
  3. This can be enhanced by leaving the seller with a minority stake in the business. Now they have leverage to ensure that the buyer stays “on track” and can keep making their payments.
  4. You can work with share structures and guarantees so that the seller has some come back if their payments are not met.
  5. Structuring the payments to the seller so they are a proportion of profit, until the full sale value is reached, means that paying the seller won’t kill the business.
  6. The seller keeping a minority stake means that if the business grows, as it should with new skills and energy behind it, they benefit from that and increase their total exit value.
  7. If the business is added to a group, the seller also benefits from that in terms of additional exit value.

The selling of a business, if it is to be a success for all parties, rarely does well if its considered a short-term transaction. To be a good seller and a good buyer and ensure success is a more drawn-out affair. You will have to work together so ensuring the right personal chemistry, values, business relationship and aims is essential for the transfer to succeed. All of this is based on the alignment of incentives so you all win together.

I just want the Cash

You may reject this longer-term approach, we’ll often hear something like “I don’t trust them to run the business as well as me (the hero), I just want all the cash now”. There’s an obvious attraction here, but if you chose this route there’s every chance that you will:

  1. Watch your life’s work be closed down in a couple of years, your loyal team laid off.
  2. Receive 50% or less of the true value of the business.
  3. Have limited future earnings (or nothing more than the 5% or 6% that will come from your cash with a financial advisor) when compared with receiving the full value of the business, plus equity growth.
  4. Be among the 80% that never sell, and keep working, working, working.

Your final Success

Selling a business is the last act in the play. You’ve founded it, grown it, lived it, sweated and worried it. You’ve founded a community, helped to feed families, allowed them to educate their kids and buy their house, and your people have helped you to prosper. A few people may have bitten the hand that fed them, but you learned and you carried on.

The final act is where you take the value and set yourself and your family up for the future, so be good at it. The final act of patience and professionalism should be the icing on the cake of the whole business venture.

Talk to us if you’d like to make a successful business exit a reality, either now or a few years in the future.