FOR SALE SIGNS: When to consider an exit strategy? That's a Dickens of a dilemma.
Leader's Edge Magazine - October 2005
Author: Robert J. Lieblein
- Timing for the exit is everything.
- You’ll get the best deal if you are proactive and consider all the options.
- Preparation and professional help can yield a more successful sale.
Things to do:
- Clean the wheels on the classic Mustang before taking its picture for the Auto Trader.
- Replace the dangerous railing on the deck before letting your real estate broker hold an open house.
- Spiff up the bona fides of your brokerage before implementing an exit strategy.
Does that last one sound a bit vague? Well, dumping an old car or even selling the family home is a cakewalk compared to executing an exit strategy for your brokerage. There are so many variables to factor in, such a great number of details to attend to, that if you’re even thinking—or even thinking about thinking—of selling your brokerage or agency or creating an exit strategy, you’d better get started now.
Charles Dickens began his 12th novel with the oft-quoted words: “It was the best of times, it was the worst of times…” (You remember the rest of the sentence, right? Think about it, there’s extra credit if you get it right.)
The agency owner considering an exit strategy for his business today is faced with a Dickensian mix of good and not-so-good indicators, and how you value them will determine whether this is the right time for you to implement an exit strategy.
Timing Is Everything
During the recent hard market, many brokerage owners did not want to consider an exit strategy because they were doing quite well, thank you. However, in many cases their gains were due more to market conditions than management savvy.
“Kurt” was majority owner of southeastern based retail operation that had sustained major losses due to hurricanes, which resulted in lost markets and forgone contingent income that he had enjoyed for years. Revenue dropped 40% in a year and he was ready to retire on his 40-foot boat on the Florida Keys.
Suddenly, Kurt had to face the prospect of what to do now. He had not planned on catastrophic events to erode his firm, which he had worked to build for 28 years. He had been approached numerous times during the previous five years with significant offers from major companies—offers that would line his golden parachute and that exceeded market parameters. But Kurt, emboldened by 30% growth for three consecutive years, had not wanted to sell.
Finally, at age 67 and his wife’s health becoming a concern, he was forced to make a decision. Internal perpetuation wasn’t viable and the only option was to seek out a third party transaction partner. Offers and interest was now scarce. He ultimately sold the firm for 60% of his previous offers. To compound matters, the deal was contingent based, which created further risk to the ultimate financial outcome.
Now he and his wife live in a condominium a quarter of the size of their former home and Kurt has sold his boat. He spends his days on the patio playing revisionist’s history over his decision.
Now that the market has gone a bit soft, many firms find themselves facing declining organic growth rates and a decrease in profitability. In today’s circumstances, the best choice may simply be to ride out the soft market.
But even if that describes your dilemma, that doesn’t mean you shouldn’t be getting ready for a sale. The most damaging thing owners can do is to fail to look ahead and consider their exit strategy, even if they are forced to wait. The lesson to be learned: timing is everything. So when is the right time to consider an exit strategy? Here are a few clues:
- When product rates are hardening
- When your firm is on the upswing but not quite at the top
- When demand is high due to many qualified and eager buyers
- When you think your firm is near maturity
- When the insurance M&A market is strong.
The next major mistake made by many would-be sellers is playing the wallflower. Being passive won’t get you a good deal any more than it will get you a turn around the dance floor with that enchanting stranger you see across the room. A brokerage owner who’s ready to sell must take a proactive approach, increasing the chances of finding the right deal, versus just finding any deal. But remember: waiting for the perfect deal is like expecting to win the lottery. Determine your goals and objectives—financial and non-financial—then go about finding the buyer that is most closely aligned with those goals and objectives.
Consider All Options
Once you’ve decided that an exit strategy is the right choice and you have begun to define your goals, make certain that you’re not overlooking any options.
“Stan” was the majority shareholder of a very prosperous commercial retail operation. The brokerage was one of the top firms in the region and Stan enjoyed continuous growth. He also faced some moderate medical issues and at 58, reviewed options to execute upon a succession planning strategy. Leverage created by an internal selling agreement immediately ruled out that as a viable alternative. Stan sought out market opportunities that had courted him for several years. Ultimately, Stan consummated a transaction with a major institution at consideration about 15% above the top level that the market set at the time. Today, Stan enjoys his health and his rewards along with his blessings. His firm, under the successor entity has remained flat given the current market conditions while having to make significant investments in its sales and technical infrastructure.
The lesson is that Stan carefully evaluated all options and opportunities and with hindsight being 20/20, has no regrets. Today, Stan’s business would be valued at 20% to 25% less than it was at the time of his decision.
Set a Realistic Value
How much is your agency worth? Unfortunately, just like that old Mustang—whose sentimental value and classic lines are much more attractive than its oxidizing paint and tired upholstery—your business may be worth less than you think. Many owners do not initially have a realistic value of their agency’s worth. Considering a sale or exit strategy without fully understanding the value of your agency can result in major disappointment. Understanding value is one of the first steps that must be taken when considering an exit strategy.
Realistic value is, of course, in the eyes of the beholder, and it is a number that will be unique for each agency based on historic growth rates. Too many people simply try to ballpark the value of an insurance agency based on “rule of thumb” multiples, such as seven times or eight times EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization), but that is not a reliable standard. Such a calculation will be especially out of sync with reality for a business that isn’t showing significant growth.
A firm that shows organic growth regardless of the rate cycle will certainly be more attractive to a buyer and will probably command a premium price. But the only brokerages that really gain premium prices are ones that have strong strategic plans in place, continue to grow regardless of market conditions and are proactive rather than reactive to conditions that affect their growth. In other words, if you’ve been polishing up that Mustang once a week since it was new, you’re more likely to get above-book price than if you just dust it off and shine it up when placing the ad.
Think About the Afterlife
So, when should you sell, and what do you expect will happen with your life after the sale? If you’re planning to retire after the sale, your options to sell or implement other exit strategies become very limited. If you are willing to continue to work in the business post-sale, your value and the going concern value of your business will be enhanced, and the universe of potential buyers will be broadened. Whether you come with the business is the difference of having a tour guide in a foreign city or going it alone: a first-time visitor will have a much tougher time than someone who’s been down those roads before.
Again, it’s a matter of trying to keep your choices as wide open as possible. One way to do that is to look at the purchase of your company from a buyer’s point of view. What would they expect after the sale? What would they get? Realizing the importance of post-sale expectations of the buyer is a critical step in both creating options and maximizing shareholder value.
Bring in the Pros
Want do this all on your own? Of course you do because you think that you’ve been a salesperson all your life and you know how to handle it. You will have no problems managing an exit process without involving professionals, right? Well, no. You are an expert in running your business, but you are not an expert in exit strategies. It’s one thing to identify a buyer, but quite another thing to also hold expertise in the law, accounting, valuation, taxation and deal structures. There are guaranteed to be elements of the deal that you do not even know you don’t know.
There can be quite a difference between creating a done deal and creating a successful deal. Yet many sellers would never even know the difference. Hiring professionals up-front, soon after you’ve made the decision to take the plunge, will result in the best investment you’ll ever make.
So, one morning you wake up and make that decision to exit the business. The key to any successful sale is good preparation; this is no different.
First, we have “Jeff,” who successfully transferred his majority interest through adopting a leveraged ESOP. This allowed his firm to enjoy its unique culture and to preserve its reputation and integrity.
Then there is “John,” who very effectively transferred his ownership to his children through “put/call” options in a sales agreement. In hindsight, John would not have changed a thing with his internal transfer while enjoying a gentle segue out of the business he spent 40 years building.
Preparation can involve six months to several years of work. The lesson: to prepare ahead is to maximize value.
Perhaps that snap decision made as you tumble out of bed one morning is not sitting well by lunchtime. You wouldn’t be the first, or even the thousandth, brokerage owner to have those pangs of pre-sale remorse. Many times I hear firm owners verbalize their desire to sell, but when it comes down to the nitty-gritty, psychologically they are not ready to go through with it.
You must be mentally prepared to make the sale and understand the emotional aspects of the process and what to expect after the transaction. I have seen deals fall apart because, at the end of the day, the owners could not cope with the mental aspect of not running their business anymore or of not being in charge.
One way to commit your mind to the game is to take a thorough look at the financial arguments for and against selling. It’s not just a simple equation, like now I’m taking home X amount and if I sell I’ll have X amount in the bank.
To realistically compare the value of selling versus continuing operations, many factors are involved. For instance, what are the real dollars in your pocket from selling and reinvesting proceeds at capital gains rate (15%) versus income derived and taxed at ordinary income tax rates (35%)? How about how much of your profits do you really need to reinvest to sustain and grow your agency? Using after-tax dollars and taking the present values of future cash flows is the only way to compare apples to apples.
Such a detailed analysis will provide a clear understanding of the financial impact of ordinary income vs. capital gains and what growth rate the business will need to sustain going forward to reach a break-even point versus the value of after-tax investments from proceeds of a sale. Just like a valuation, this is essential data that you need to objectively decide whether an exit strategy is right for you.
So now, what’s the to-do list of an owner who is considering an exit strategy? Consider the timing; don’t wait for Prince Charming; weigh all potential sale options, even to non-traditional buyers; admit that it’s outside your expertise to do it yourself and engage professionals; and make sure you set a realistic schedule for getting your business into shape before putting it on the market.
Oh yes, and possibly the most important thing, one that will earn that extra credit in your bank account, is to not succumb to the conundrum faced by the characters in Dickens’ A Tale of Two Cities. While it was simultaneously the best and worst of times, also “it was the age of foolishness, it was the age of wisdom.” Your company’s value may vary greatly from the best to the worst of times, but with realistic, proper planning, you will enjoy a successful exit strategy because it will be done at the right time. You have spent a lifetime building your brokerage, so do not make the critical mistakes that many others have made and fail to maximize shareholder value.
Lieblein is a contributing writer and managing principal of WFG Capital Advisors. firstname.lastname@example.org