Selling Your Business: The Seven-Year Itch
For a lot of reasons, successful companies between four and eight years post-startup end up selling. Call it the seven-year itch: by that point, in a study of 342 privately held acquisitions, half the companies had sold. Keep up to date with all the mergers and acquisitions news here.
You know the reasons:
1. Buyers come calling – both strategic and financial – once you’ve demonstrated business success.
2. Financial backers desire a liquidity event.
3. Some founder/entrepreneurs, possessed of self-knowledge, recognize their strength is in the earlier stages of building a company, and prefer to move on and start something new.
4. Even successful young companies encounter significant business difficulties a few years out. Growth can become harder to come by. Competition stiffer. Whipping the troops into a frenzy of 60-hour weeks more daunting.
Whatever the reasons, in my work advising founder/entrepreneur/CEOs, I’ve always felt that thinking about M&A – as a seller and a buyer – needs to be part of the strategic process as a business matures. The study cited above, by the smart people at Shareholder Representative Services (they handle escrows and other crucial closing and post-closing matters) shows the median time to sale at seven years. So, certainly by year three or four, depending on the rate of progress of your company, M&A should be a regular topic of discussion.
(Deal-making studies, by the way, typically look at strategic buyers and financial buyers and omit the capitalization structure I specialize in, employee stock ownership plans, or ESOPs. More on that below.)
As every middle market business owner knows, valuations tend to rise with scale. Organic growth is and should be the basis for most successful businesses. But M&A can and sometimes should play a part, as well. The trick is to not contribute to the record of failed mergers and acquisitions out there: overpaid; failed to realize cost synergies; cross selling opportunities proved fictional; cultures were oil and water.
The consulting firm Bain & Co. regularly surveys the M&A world, and in a study of 1,600 publicly-traded companies – and the more than 18,000 acquisitions they were involved in between 2000 and 2010 – also came to the conclusion that embedding M&A thinking into the strategic process is crucial.
Briefly, Bain found that companies that did no acquiring at all had the lowest shareholder returns during that period; to be fair, a company already in financial trouble isn’t going to be able to make acquisitions. Companies in financial trouble ought to consider accounting and consulting services from the likes of Porte Brown to help get finances back on track.
But among those that did make acquisitions, Bain recognized four distinct categories of buyers and significantly varying shareholder returns:
– At the top, with average annual total returns of 6.4% over the study period, were companies that regularly made acquisitions and whose cumulative deals were significant, adding up to more than 75% of the buyer’s market cap. For these companies, M&A is part of the business, Bain found. They become good at it, sidestep problems, and master the integration process.
– At the bottom were companies that do few deals but swing for the fences when they do acquire. Their average annual return was 4%. The supposition here is that by doing few deals, these companies don’t develop M&A chops. And leaping at a huge acquisition, they stumble.
– Slightly better than the swing-for-the-fences companies were two other groups — those that did bolt-ons and fill-ins. The former group did more than one bolt-on acquisition a year, and had average annual returns of 4.5%. The latter did fewer than one a year and had a 4.6% return. Neither group’s deals, on average, cumulatively reached 75% of market cap.
As you incorporate M&A thinking into your long-range planning, you’d be doing yourself and your business a disservice if you didn’t make an ESOP part of the discussion. They’re flexible: ESOPs can and do sell to private equity buyers; private equity owners can and do sell to ESOPs; and ESOPs can and do make acquisitions. Tax advantages are substantial: using an S corporation structure, founders can sell and, if they reinvest proceeds correctly, can defer capital gains taxes; the buyer-ESOP can skip federal income taxes going forward.
You can sell a minority stake to an ESOP, realize a partial cash-out, and keep running your business. Many owners who’ve done this report that their employees, as owners, make for hard-working and thoughtful partners, which is a boon to the business. And if it’s time to sell your business in its entirety, an ESOP structure is more likely to preserve your legacy and the jobs of the workers who helped build it.
In coming weeks in this space, I will be writing more about exit strategies for owner-entrepreneurs. And I welcome your comments both here and to me directly at CEO@verit.com