Are you looking to sell your business, but not quite sure about the best way to do it? Do you need assistance in assessing the value of your business or the real estate with which it is associated? Radius Group’s expert in California and Santa Barbara business brokerage / mergers & acquisitions advisory, Robert Rauchhaus, shares his insights and experience regarding the most frequently asked questions when selling a business. His expertise is focused on business sales, especially those that involve commercial real estate.
Radius Group’s Business Brokerage Expert
Robert got involved in the business brokerage because he saw that there was a lack of professional help for the purchase or sale of larger businesses in Santa Barbara, Ventura, and San Luis Obispo counties. Radius Group approached him while he was directly managing a small M&A advisory boutique, to allow Radius Group to offer this complementary service in-house. See Robert’s Full Biography to see the journey of how he got here.
While over half of Robert’s brokerage activity cuts across all business sectors, he in increasingly focused on assisted living, hotels, and other industries, such as income-producing agriculture and wineries where the business and real estate assets are inextricably co-mingled. Most of the companies that Robert assists are in the $2 – $25 million revenue range.
We recently interviewed Robert and asked some key questions about business brokerage / appraising businesses.
1) What are the primary reasons that owners want to sell a business? Why would someone sell a profitable business?
There are three primary reasons for selling a business: 1) retirement, 2) profit-taking to pursue new or diversified interests, 3) recognizing that a business needs new ownership or more capital to grow.
Of the three reasons, the most frequently applied is retirement, which accounts for 50% of the business that I sell. The average age of these retirees in the Tri-County / South Coast region is about 65 years old. These are people who have worked hard to build their respective companies, often over decades, and they care about their customers and employees.
Profit-sharing accounts for the next greatest reason to sell. Often these non-retiring business owners are looking to cash out on their ventures as a means of diversifying their holdings, purchasing real estate, or starting new business ventures.
2) What are the advantages / opportunities in selling a business?
Since this is a liquidity event, there are several positive outcomes and advantages for selling a business; however, the outcomes depend quite a bit on the age and desire of the seller.
As I mentioned earlier, many people sell for retirement, so this creates a cushion or safety net that allows the retiree to rest easy and have more financial breathing room. Owners are often very worried about passive management and business risk as they grow older. A business owner is never off work.
In other situations, if a business owner is looking to cash out prior to retirement, they usually like to put the assets in other investments or business ventures. I often hear that there is a concern that I describe as “too many eggs in one basket” or an urge to try something new.
Some of my clients would actually financially benefit more from closing their business and selling off their inventory and equipment, rather than selling the ongoing concern. But this is frequently overcome by a deep concern for the perpetuation of the brand. In this situation, the employees keep their jobs while the customers and community keep a prized business.
3) What are the major challenges that arise when selling a business?
First, coming up with a value for the business. It is not like determining the value of real estate property or other tangible assets. Business appraisals are tougher because of the messiness of valuing cash flows and other intangibles. The IRS may not want to hear this, but a company’s Sellers Discretionary Cash Flow (SDCF) and taxable net income are frequently far apart. We are also selling a pro forma and not just historical profitability. The other challenge of intangible assets is that they are difficult to price in a simple manner, because they include intellectual property and goodwill.
Second, you don’t want to make too much noise about the fact that you are looking to sell your business. It can disrupt normal business operations, upset your customer-base, tipping off competitors, or cause employees to find new jobs. All of these possible disruptions can not only harm the current flow of business, but also the perceived value of the business in the long run, which will be factored into the business appraisal.
Confidentially is critical. You need to have a broker that knows how to sell a business without advertising its name or address.
4) How is a business valued? What is the appraisal process?
There are several steps to the business appraisal, some of which is covered on our business brokerage page.
In order to get a better idea, I go through a detailed financial review to recast bookkeeping and tax figures into SDCF (Sellers Discretionary Cash Flow). I have created this metric thanks to the time I spent at McKinsey Consulting. Most brokers simply use net income (which is often ugly) or Sellers Discretionary Earnings (SDE). In contrast, SDCF is based on Free Cash Flow (FCF) which looks for balance sheet manipulations, such as deferred Capital Expenditure (CapEx) or shenanigans with inventory. This helps me see the true profit generating potential of a business in the future.
I provide these analyses on a confidential and complementary basis, and they take some time to compile, because I usually have to coordinate with the owner’s bookkeeper or controller, external CPA, etc, in order to get the complete picture of the business’ finances.
5) Are there any major differences with selling a business and the real estate assets in California compared to other states?
For starters, California is an over-regulated state with high tax rates, and generally it is not business-friendly. In fact California is #48 in Tax Foundation’s State Business Tax Climate Index. There are more compliance issues overall, regulatory bodies, and red tape than in many other places around the country.
To further expand upon these factors, generally people’s businesses end up changing hands within the state. Most buyers are reluctant to buy from out of California due to these regulations and tax burdens. I have been able to locate E2 or EB5 visa buyers, that are trying to escape countries in Europe with worse tax and regulatory laws, or countries in Asia or Latin America where they face economic as well as political challenges.
6) What can business owners do to prepare themselves for an eventual sale?
The most important thing to do is to seek advice early on. It is important to talk to your attorney and CPA to work on property tax planning ahead of time. The sale price of a business does not matter. All that matters is the risk adjusted Net Proceeds to Seller (NPS). Of course, getting profitability up as high as possible is critical. But many other variables matter too. Having clean books, well trained employees, good management, annuity like income streams, and many other factors matter.
I am always happy to provide some confidential and complementary advice. My best clients and most successful business sales are from relationships that took years to develop, often prior to any contract or fee. A wise owner will plan their exit three to five years in advance.
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