It’s one of the best-known gambling terms. The decision is simple, twist for another card or stick with what you have in the hope that another player doesn’t get closer to 21. But it’s not that simple. Are you betting or are you counting? If you’re counting, is the deck hot or cooling? Have you lost the count? Can you keep the count under pressure? There’s a lot to think about. Now imagine it was the biggest financial decision of your life, like selling a business. Obviously, you wouldn’t make that decision with a ‘stick or twist’ frame of thinking. Or would you?
When attempting to time the sale of your firm, the main question you want answered is ‘how much is it worth?’ Business brokers are always very active and they should be able to answer that question for you. Probably won’t charge you for the information either. Their pay day is when the sale closes. And to be fair, the good ones will have a feel for prices and could therefore give you a steer. The information will be based on the market. Are prices historically high? Are deal terms positive? Is it a sellers’ market?
Market sentiment is important but the other question you should be asking yourself is ‘Is now the right time for me to sell?’ This one is a little trickier and requires more work. It’s one of the first ways we add value for our clients. Diagnosis. If you’re asking us, there are two key factors to consider: you and the firm.
Let’s start with you. Here are a few questions that we often ask about your financial situation: –
- Have you defined what financial independence looks like for your family?
- Have you already achieved financially independence and if not, how close are you?
These questions should be very familiar to you. Financial planning right. Problem is that the cobblers’ children have no shoes. The owners of financial planning firms rarely have their own fully costed financial plans. Some will say that they have no secrets from their team and all their data is loaded on the system, but they’d be in the minority in my experience. You haven’t been through your own proposition and now you want to make this momentus financial decision, with incomplete information. So that’s job number one, do your own financial plan.
Now let’s turn to your firm?
- How has your firm performed in say the last three years?
- What shape is your firm?
All business valuation methods are ultimately some derivation of profit x multiple. The ultimate measure of value is the anticipated future cashflows your firm might produce for the buyer. Historical financial performance data helps us with one half of this equation – profit. The ‘shape’ of your firm is one of the factors that determines the multiple, others being macro-economic conditions, rate of growth and then there’s the size and shape of the buyer’s firm, their capital structure, strategy, appetite, competitive forces and so on. There’s a lot going on here, but let’s stick with what we can control and therefore anticipate with some degree of accuracy.
Growth rate should be obvious. If the firm isn’t growing, then a buyer is purchasing today’s profits. In that scenario, it’s hard to justify multiplying it too many times. We focus on EBITDA in valuations (let’s call it pre-tax operating profit for the sake of simplicity), so the buyer will receive this amount, less tax and any capital costs. The resulting free cashflow is what the buyer is thinking about when making you an offer. How many years until they breakeven on the acquisition, what’s the likely rate of return over n years and so on.
The ‘shape’ is a neat way of summarising the qualitative characteristics of your firm. We looked at data from hundreds of transactions, valuations and consultations and teased out similarities in the way firms are structured, managed, resourced and of course, how they perform. Using this data, we were able to settle on five stages of growth. As a firm moves through these stages, it becomes less fragile, which is important if you are trying to predict what it’s performance might be in the future. So each stage has its own multiples for valuation purposes, which reflect the strength of the firm in that stage.
An important point to note here – if you have a fragile one-man band and a buyer is paying you a huge multiple, they’re probably not buying the firm, they’re buying the clients. And they’re paying a premium for them, because they expect those clients to produce more free cashflow inside the buyer’s business, than they did inside your firm. In other words, the structure of the deal is going to result in turbulence for your clients. Be aware.
Anyway, why is shape important to timing? Well, it requires resources to move from one stage to the next. Most financial planning firms are self-funded, so guess what, the resources to change the shape of the firm are coming from the owner. And that’s going to impact your own financial plan. Worse still, the next stage in the development of your firm might require projects that could take 2 years and an investment that you might not breakeven on until the end of year 4. If you want to retire in 3 years, why are you even bothering?
Then there’s the difficulty associated with calculating a rate of return, in a firm where the key resource is time. Sure, you can price up a consultant, or the initial cost attached to a piece of kit, but how do you price the opportunity cost of your time? If you take personal production and divide by your time, you’re ignoring everything else you do for the firm. Could use profit divided by time? Either way, you’re then into comparing the value of doing one thing with your time, over doing something else. It’s tricky.
We have a financial model that does all this for us. We use it to help owners figure out the shape and value of the firm today, the likely cost to move to the next stage of growth and what the future value might be at various intervals. Having determined what financial independence looks like, we can then figure out timing. This helps provide some rigour to the decision. Stick or twist? Because in the end, the phrase you really want to be using, is ‘winner, winner, chicken dinner’.