Why Your Business Might Not Sell

If you have the time, you should focus on building a salable business to maximize its value. In order to do that, it’s critical to know what buyers of businesses want – and then give that to them. Most buyers desire a company with infrastructure and a management team as opposed to a one-person show. 

Starting a business requires a different set of skills than growing a business. And different sets of skills are required at different stages of growth. 

The skills required to grow your business from zero to $1 million in revenue are not the same skills needed to grow your business to $10 million or $100 million in revenue. Institutionalizing your company is key not only to growing your business but also to improving its value.

You can accomplish several objectives when you institutionalize your company through installing systems and building a management team. 

• It prepares your company for the next stage of growth. 
• It increases the value of your company.
• It increases the salability of your company.

If you want to sell your business for the most money possible, you should institutionalize your business to maximize its value.

Institutionalizing Your Business

Institutionalizing your business is accomplished through two primary tools – building systems and building a management team. 

Building Systems

Developing systems involves streamlining, automating, and documenting your processes. By documenting your key processes, you increase the chances of selling your business and increase its value. 

Some benefits of building systems include: 

• Easily attracting valuable employees with clear job descriptions.
• Managing your business more efficiently using well-documented processes.
• Increasing the value of your company.
• Maximizing the opportunities to sell your business.

Building a Management Team

Most businesses under $10 million in revenue lack a formal management team. Businesses that lack a professional management team would likely die without the owner’s presence. How long can your business survive without you? A year? A month? A week? 

Building a professional management team requires a new set of skills for most entrepreneurs. When you first started your business, you likely performed most of the key tasks yourself. Once you reach a certain point in your business, however, you must build a team. 

Building a team requires both recruiting and management skills. You have to learn how to find and hire good people, and then how to get results from those employees. 

What position or positions would add the most value to your company? What does your company need most? A CFO, COO, VP of Marketing, VP of Sales, VP of Human Resources? Should you bring in an external president? Take the time to develop a formal management team. Not only will your business be easier to sell, but it will also sell faster, and your revenues and profits will likely increase.

Building the Right Business for Your Buyer Type

There are three broad types of buyers. Each has a different set of preferences regarding the type of infrastructure and systems they desire in a business. When preparing to sell your business, it’s important to understand the different buyer types, their criteria, and how you can best position your business to be as attractive as possible to these different types of buyers.

Understand the different types of buyers and the degree to which they require systems and a management team before you invest in building systems and a management team.

Buyer Type 1: Individual Buyers

If your company is valued at less than $2 million, chances are high it will be sold to an individual buyer. 

Infrastructure isn’t as important to individual buyers because most individual buyers will be involved in the day-to-day operations of the business. If your business is small enough to appeal to an individual, it may not be necessary to invest a significant amount of money in building infrastructure before selling your business. But don’t think you’re off the hook – your business must still have enough infrastructure to ensure a smooth transition, but these types of buyers may require less infrastructure than corporate or financial buyers.

These buyers are highly numbers-driven. You should prioritize profitability over building infrastructure until your profitability exceeds $1 million to $2 million per year. If your business is valued at less than $5 million, it’s usually more beneficial to invest in sales and marketing to increase the revenue or profitability of your business than to invest in building infrastructure. To be sure, adding infrastructure helps, but most individual buyers prefer a more profitable business than one with more infrastructure.

Buyer Type 2: Corporate Buyers

The degree to which corporate buyers require infrastructure in your business depends on if they will be integrating your business with theirs or if they will run your business as a stand-alone entity after the closing.

• Integrated: Corporate buyers who will be integrating your company with theirs require less infrastructure than if it will run as a stand-alone business after the closing. In these cases, the buyer already has existing infrastructure and usually doesn’t require much – if any – more.
• Stand-alone: Corporate buyers who will keep your business as a stand-alone entity will require significant infrastructure. They may not be interested in acquiring your business unless your company has adequate infrastructure in place and it can continue to operate on a stand-alone basis without you. In some cases, this type of buyer has a manager at their corporate office who will be promoted to run your company as president. Still, your business should have a management team and systems in place to ensure that operations continue to run smoothly during the transition process.

Buyer Type 3: Financial Buyers

Financial buyers primarily consist of private equity groups. Private equity is a relatively new asset class, and this group’s criteria are not as homogenous as those of corporate buyers. Some private equity groups specialize in lower middle-market businesses, which tend to have less infrastructure. Others seek stand-alone entities where the owner and management team stay on for several years and where there is already significant infrastructure in place. 

Most private equity firms require significant infrastructure, though the need for infrastructure will vary depending on the buyer. If you plan on selling to a private equity firm or other financial buyer, you should plan on building a significant amount of infrastructure in your business.

Financial buyers expect to double or triple their investment in five to ten years before selling the business again to another buyer. This is often possible only with systems and infrastructure in place, and installing these systems and infrastructure costs time, money, and risks for the financial buyer. If your business lacks these systems, the buyer must make a large investment to build them. A multiple of two to three times the amount of this infrastructure investment is usually deducted from the purchase price the financial buyers are willing to pay. 

Most private equity firms require that the management team and owner remain to run the business after the closing, in addition to requiring significant infrastructure. Partners in private equity firms focus their time on purchasing companies and don’t become actively involved in the management of their investments. So, either existing management must remain to operate the business, or the private equity firm must hire a management team to run the business after the closing. The only exception to this rule is when the private equity firm owns a portfolio company that competes directly with yours, and they plan to integrate your business with that company. 

Three Additional Factors That Buyers Consider

What follows are three additional factors that buyers will look for when considering your company as an acquisition candidate. These factors must sometimes be prioritized before building systems and a management team. An understanding of these critical factors is also important when deciding which systems to implement before you put your business on the market.

Factor 1: Profitability

The most important factor buyers look for is profitability. Few buyers will be interested in your company if it isn’t taking in more money than it’s shelling out. If your business isn’t producing a profit, don’t waste your time or money building systems. Invest in sales and marketing activities instead. Only when your business is profitable should you invest in building infrastructure. 

Many buyers will consider a profitable business that lacks infrastructure. But few buyers will consider an unprofitable business that has significant infrastructure in place. Always prioritize profitability over infrastructure until your profitability reaches $1 million to $2 million per year.

The most important factor buyers look for is profitability.

Factor 2: Scalability

Sophisticated buyers look for a business that is scalable, or that has the potential to quickly grow. Financial and corporate buyers love a scalable business in which the owner hasn’t tapped its full potential. This usually involves an owner who is burned out or one who has not built effective sales and marketing systems – but the business has operational systems in place that allows it to quickly scale once sales and marketing are ramped up. If you want to sell your business for the maximum amount possible, focus on building a business that is scalable from day one.

Factor 3: Competitive Edge

Corporate and financial buyers are usually in the market for a business with a competitive advantage that is sustainable and not easily replicated, while individual buyers regularly purchase lifestyle businesses with little or no competitive edge. 

An unsophisticated buyer may purchase your company if you don’t have a competitive edge, but many sophisticated buyers will not. Superior customer service is not a competitive advantage. Personal relationships are not a competitive advantage. Proprietary technology can constitute a competitive advantage, as can economies of scale and brand image recognition, to name a few.

If your business has low barriers to entry and is a “me too” product or service, then the lack of a competitive advantage may turn many buyers off if they feel they can easily replicate your business. A competitive advantage should be summarized in an objective statement and should be difficult for competitors to copy. 

Your business must have a competitive differentiation that a buyer can’t easily reproduce. Otherwise, it will be difficult to sell your business to anyone other than an unsophisticated buyer. Remember, almost every company over $5 million in selling price is purchased by a sophisticated buyer, so any business valued at more than $5 million should have some form of competitive advantage, or the price will be discounted.

Key Points

• For most small businesses, developing a management team is the critical factor in building a salable business. For other businesses, building systems may create more value. There is no cookie-cutter formula. 
• Your business is one of your most valuable assets. Consider how you will sell your company from day one. Focus on building a profitable, scalable business with a competitive advantage that can’t be easily replicated. 
• Concentrate on hiring the right people and building the right systems. By doing so, you will not only increase the value of your company, but you will likely end up making more money and increasing the quality of your life in the process.