Reducing the Impact of Illiquidity in Selling your Small Business

Over the past 20 years or so, I’ve done a lot of business valuations…either for estates, or transactions, or planning, etc.  One key element of a valuation for a privately held business is the “Discount for Lack of Marketability”.  This is a discount from the theoretical value if it was a publicly traded company.  For a small privately held business this discount can be enormous.   Basically, you are assigning risk in the value of a purchase/sale that the buyer takes on for getting into an illiquid investment.

For owners, it’s a fact of life, that when you want to sell your small business, the market can be down, the economy can be down, banks can be tight, there may be a lack of interest in your company, or those who are interested may not be able to finance the purchase.

This can be a real sticking point if you have no heirs, and your plan for retirement was to sell the business and live off of the assets.

Wouldn’t it be great if you could plan ahead, and if there were a “mechanism” to diminish the negative impacts of this lack of liquidity?

Here are a few principles we are building into our mechanism:

  • a transaction doesn’t work if one of the parties feels like they are getting beat up in the deal.
  • most owners of SMBs know when they are about five years out from wanting to retire, or dramatically reduce their operational activity.
  • the real value of the business is its ability to produce future income.
  • adding new capital and/or expertise can increase the operational performance and/or size of the SMB.
  • timing of a sale should not have such a large impact on pricing.
  • availability of financing should not have such a large impact on pricing.
  • the SMB owner selling either a minority interest, or the entire venture to us should be able to reverse that decision if things change in his/her life.
  • services companies that have real businesses and real free cash flow will retain their value in a transaction better with a planned long-term transition…producing a better price for the seller.

So here’s a little imaginary case study:

Imagine –

  • you’re the owner of a mid-sized manufacturing or services company.
  • you don’t have any children or key employees to take over. (or your key employees aren’t quite ready in terms of capital, experience, etc.)
  • a significant portion of your personal and family net worth is tied up in your private business.
  • you would like to pull some or all of the value out of that business in the next 2 – 5 years.
  • if you’re going to carry part of the sale price, you don’t want to do that with someone you’ve just met.

Here’s something along the lines of what we would propose:

  • set up a transitional ownership plan which would involved some capital investment, some contribution of expertise, some stability in operations currently and post-transaction.
  • set up a plan for a transaction that while put in place now, would still allow the seller/owner to reverse that decision if things change…plans change, a key employee shows interest and capacity, whatever.
  • give the owner the benefit now of capital and experience, and maybe the ability to grow the business beyond what he/she would be able to do on their own…resulting in a higher value at the liquidity event.
  • be able to participate in the future growth of your business post transaction, just in case you sold too early, or you live longer than you planned.

That’s our goal.

We think this proposition is unique in the world, and we think owners of SMBs are going to clamor to be a part of it.

If it holds some interest for you, we’d love to talk with you about it.