Should Entrepreneurs Sell in Today's Economy?

You may be surprised to learn that now — even in this economy — could be a great time to sell the company you've spent years building. But entrepreneurs hoping for an exit strategy could make costly tactical errors if they don't understand what's changed in the last year. In our experience advising companies, entrepreneurs in this environment are vulnerable to making three significant mistakes if they don't understand the new rules of the game.
Mistake 1: Assuming getting 100% cash-at-closing is the optimal outcome. It used to be that we'd counsel clients to get as much cash as possible at the closing of the sale and to be cautious about earn-outs, i.e. deals where portions of the sale price are contingent on the seller meeting pre-specified objectives in the future. In these types of transactions, exceeding those objectives will often greatly enhance your payout. In addition to the obvious inherent added risk, earn-outs can be tricky to negotiate and even trickier to enforce.
However, in this economy we've reversed our stance. Most companies' earnings are depressed in 2009 so earn-outs often offer the ideal mix of value, upside and security. Consider this: You decide to sell 50% of your company at the going multiple, say 6X your EBITDA and then 25% each year for the next 2 years. As the economy recovers, your earnings accelerate and you exceed your projections, reaping the reward from the recovery by multiplying those increased earnings to reach the final 2 portions of your purchase price.
Mistake 2: Assuming you know in advance who the buyer of your business will be. Many of our clients think they know who should buy their companies (they even may secretly be wishing for a particular buyer). Making this assumption is dangerous today. That's because too many prospective buyers are in no position to acquire other companies. They may already be carrying too much debt, or their own businesses may be underperforming. Usually, when a company is faced with its own challenges it will be reluctant to buy another company, no matter how good the match. The likelihood that one of a handful of buyers who you think should buy your company will actually turn out to be the buyer is lower today than it was a year ago. Approaching a smaller universe of buyers will almost surely result in disappointment. As a result, sellers should look to broaden the pool of prospective buyers, including even those they might view as long-shots.
Mistake 3: Not realizing it may be in your best interest to sell now — even if you don't have to. A popular misconception is that no one would sell their company during a downturn if they did not have to. Exit multiples (the ratio of a company's value to its earnings) are lower now and there are fewer buyers willing to be aggressive with their bidding. But, that doesn't mean that your company will sell for more next year or two years from now. Many companies and some industries are still winning premium pricing, including technological innovators and strong cash-flow performers.
In fact, there are some really good reasons not to wait for the economy to rebound before selling your company, including these scenarios:

• You've had a strong year despite the down economy and can show consistent growth for the past few years. If this is the case, you'll appear to be the rose in a field of weeds and will still receive premium pricing.
• Buyers are overwhelmed with prospects in good times and it's a lot easier to get lost in the shuffle, whereas in down times, most companies will get a better review even when the fit may not be apparent at first.
• A number of strategic buyers are sitting on cash reserves. While they may have been outbid/out-finessed by financial buyers in the past, many are ready to jump in the market now that most financial buyers are sidelined.
• Too often, sellers who are waiting for the economy to turn around will wait too long. Selling now, even for a slightly lower multiple, is often a better outcome than waiting for the perfect moment and realizing you've missed the opportunity entirely.

Reed Phillips and Jessica Luterman Naeve are managing partner and managing director of DeSilva + Phillips, a boutique investment bank which specializes in traditional and digital media.