We frequently receive requests from sole proprietors seeking to sell their businesses or CPAs inquiring about valuations for sole proprietors. When approached with such requests, we often take a more creative approach to benefit the prospective seller.
Firstly, it's crucial for the seller to understand that they are essentially selling a job to someone. Customers often buy the business based on the owner's proven trustworthiness in delivering products or services. The acquirer is essentially purchasing the time and effort invested in maintaining a full calendar of work.
Understanding the pool of buyers for a third-party sale is equally important. Typically, these buyers have limited cash and may require significant financing from the seller to close the deal. They are essentially buying 1.5 to 3 years' worth of profits, expecting the seller to stay on for training, and often resulting in dissatisfaction due to differences in values or work ethic.
However, what if the script were flipped? For small "Main Street" service businesses, a different strategy can be employed. Instead of the seller financing a large portion of the deal, staying on for training, and receiving a lower valuation, they could potentially receive nearly all cash at a higher valuation.
We recently implemented this strategy for a sole proprietor with a service business netting $190k per year. Instead of selling outright, we found an individual with the desire to own a business, similar values, and a strong work ethic. We hired this person at a salary of $40,000 per year and established a non-qualified deferred compensation plan based on excess cash flows. The goal was to achieve double the output of the current owner.
If the business cash flows at $250,000, the employee receives a bonus of $25,000, which goes into the plan with a 5-year vesting period. After two years, the employee has accumulated approximately $50k-$60k in the plan. With a higher cash flow, we can negotiate a higher multiple for the business, making it eligible for SBA financing.
In conclusion, this alternative approach allows the seller to walk away with at least $500,000 more in cash than selling to a third party. They retain a larger portion of cash at closing, and there is no expectation for additional time commitment.
We are full of great strategies on helping business owners achieve their goals. Reach out if this would benefit you.