Is it possible for a $5 million business to be more valuable than a $15 million business? Let’s look at a fictional but representative story to show how a larger valuation doesn’t always mean that the company is in the right position for you to exit successfully.
Business Exit Paper Tigers
Harriet and Jake were long time friends who each opened their own businesses at nearly the same time. As their careers progressed, they began hosting yearly entrepreneurial get togethers to help older and younger business owners enhance their strategies for business success. One of the most popular sessions each year was a symposium on business value.
This year, the business value symposium focused on the idea of business exit paper tigers: businesses that looked extremely strong but whose value was more of a mirage than a foundation upon which to base an Exit Plan.
With permission, Harriet and Jake agreed to share the value of their companies during the symposium to show business owners how the top line numbers don’t always translate to business exit success.
At the start of the symposium, Jake shared that his company was worth $15 million. Harriet shared that her company was worth $5 million. Each company worked in similar industries and had similar headcounts.
Jake asked the crowd a simple question. “Which one of these companies is better positioned for their owner to exit?”
Everyone in the crowd chose Jake’s company, which was worth $10 million more than Harriet’s.
“As much as I’d like to agree,” Jack said, “Harriet’s is actually in a better position for her exit.”
Why Less Could Be More
After a short murmur among the attendees, Harriet announced, “My business is better positioned for my exit because it doesn’t need me.”
Jake and Harriet then ran through all of the elements that made Harriet’s $5 million business better positioned for her exit then Jake’s $15 million business.
First and foremost, Harriet’s business thrived because it did not rely on her to make the biggest decisions. Her next-level management team did almost all of the important work, allowing Harriet to pick and choose the responsibilities she wanted to take on.
Jake, on the other hand, was still intimately involved in all business decisions. This meant that if Jake were unavailable, the business’value would plummet. It also meant that the only way he could make $15 million from selling his business is if he were to stay and work for someone else. The crowd erupted in laughter at the prospect of Jake ever working for someone else.
Second, Harriet’s business had practically no debt but was well positioned to borrow if an unexpected event ever forced her to do so. Jack’s business, on the other hand, was more heavily leveraged with investments from outsiders. Borrowing money would be more challenging for Jack if he needed to do so.
Finally, because Harriet’s business ran well without her, there were fewer obstacles that she would have to overcome to receive a $5 million payout for the sale of her business.
Jake’s business, though it ran well with him, included many more strings attached to receive his $15 million payout. Some of these strings included either staying with the company or finding someone else to run it in his stead and ensuring that his investors received their cut from the sale.
Valuation as a Starting, Not Ending, Point
The good news was that Jake had no intention of leaving his business anytime soon, whereas Harriet did. But the point they were making was clear to all business owners in attendance: Business valuation should be a starting point, not necessarily an ending point, for planning a business exit.
Having a business that is worth a lot of money to a buyer often means running a business that simply does not need you to run it. This can be extremely challenging for business owners to accept, especially if they’ve spent their entire lives running the business.
But as Jake and Harriet showed, it’s possible to have a business with a higher business valuation that isn’t actually worth the money to the business owner.
Jake could have sold his business as it was for $15 million, but it would require him to work for someone else, which, as a lifelong business owner, was not something Jake was ever willing to do. He would also have less of a say in who to sell it to for that amount, because there were so many more strings attached to his business’value.
On the other hand, though Harriet’s $5 million business may have seemed modest compared to Jake’s, it did all of the most important things for her to consider her exit successful:
- It allowed her to achieve financial security.
- It allowed her to find a buyer who wouldn’t upend her company culture in exchange for the money.
- It gave her the freedom to sell the business when she wanted on her terms.
Harriet didn’t found her business with the goal of reaching a certain dollar amount in value. Though she always knew that she would eventually need to sell it, she focused instead on how to build a business that delivered on its promises, provided a service unlike any other, and had strong internal management that could run it without her.
Doing so gave her an edge when determining how valuable she needed her business to be to consider herself successful. In the end, that number was $5 million.
Harriet admitted that it would have been possible for her to build the company’s value even higher. But she decided that she didn’t want to do that. Five million dollars was more than enough to ensure financial security. It also allowed her to avoid staying in the business longer than she wanted to or selling to someone who may have harmed the company’s culture, which she had spent decades building.
What’s Your Measure of Success?
For many business owners, a successful exit goes well beyond how much they managed to sell their business for. But many of those same business owners aim at an arbitrary dollar amount and believe that they must hit that dollar amount to be considered successful.
As you consider the terms of your business exit, it’s important to consider three things about business valuation:
- Rules of thumb are often misleading.
- The amount of money you need for financial security is likely unique to you.
- The highest bidder may not be the right buyer for your goals.
Ask yourself: Why do I think I need this amount of money to consider my business exit successful?
Among financial security goals, aspirational goals, and your post-exit lifestyle goals lies the amount of money that you need to consider your business exit a success.
But the way, to determine that dollar amount is not by guessing,arbitrarily selecting, or comparing your business to others. It’sdetermining which goals are most important to you and then figuring out how to leverage those goals into building a business that you can sell for the amount of money that you need.
We strive to help business owners identify and prioritize their objectives with respect to their businesses, their employees, and their families. If you have questions on this topic, we can help with more information or a referral to another experienced professional.