131 - How to Sell Your Business with Jonathan Baker

A successful exit strategy is essential for business owners considering selling their firms. In today’s episode, we are thrilled to host Jonathan Baker, an experienced M&A specialist from punctuation.com, who shared his invaluable insights into the world of business acquisitions.

Whether you're contemplating selling or simply want to future-proof your firm, this episode is packed with valuable advice to guide you through the process.

Podcast Highlights:

00:00 Prologue 

01:00 Introduction of the episode and guest

03:47 What factors influence a firm's valuation in an acquisition?

05:44 Why do software firms generally command higher multiples than service businesses?

08:36 What are earnouts, and how do they typically work in professional services deals?

10:39 How are M&A deals typically structured?

12:48 When might it be more beneficial to keep a business rather than sell it?

15:52 What steps should business owners take to prepare their staff for a transition?

19:09 How do clients and employees typically react to a business being acquired?

24:18 Why might business owners consider acquiring other firms?

26:48 What are some practical tips for preparing a business for sale?

29:17 Best way to get in touch with Jonathan

Connect with Jonathan Baker:

Website: https://punctuation.com/

Sign up for their newsletter: punctuation.com/seoleverage

LinkedIn: https://www.linkedin.com/company/wearepunctuation/

Connect with Gert Mellak:

Website: https://seoleverage.com/

Email: [email protected]

How to Sell Your Business with Jonathan Baker

Are you a business owner considering selling your company but unsure where to start? Or perhaps you're just looking to prepare your business for a potential sale. Either way, tuning in to this episode featuring Mergers and Acquisitions expert Jonathan Baker is ideal!

With years of experience in Punctuation, Jonathan shares his insider knowledge on how to sell your business successfully. From preparation to negotiating the best deal, this gives tips that every entrepreneur should know.

Key Factors that Determine a Company's Price in an Acquisition

Jonathan Baker, who owned a craft brewery in the southeastern United States, developed a passion for Mergers and Acquisitions (M&A). Despite an unsuccessful deal, the emotional and qualitative aspects of the experience fascinated him.

Four years ago, he joined Punctuation to build their M&A practice. He handles 30-40 valuations and 10-20 transactions annually for small—to mid-sized independent firms.

When evaluating a company's value in an acquisition, he observed several factors:

• Firms with higher profits, particularly those reaching a million dollars or more, attract more potential buyers.
• A diversified client base rather than a single major client reduces flight risk and increases firm value.
• Firms with clear, strategic positioning tend to be valued higher.
• Businesses with recurring revenue streams are more attractive to buyers.
• Repeatable processes that don't rely heavily on the owner to enhance valuation.
• Unique intellectual property and tools add value.
• The experience and seniority of staff can be a key factor, as some firms acquire primarily for the talent pool.

Why Software Firms Outperform Service Businesses in Acquisitions

Software firms generally command higher multiples in acquisitions compared to service businesses. This is because software companies, especially those with SaaS models, are more scalable and less reliant on individual people. The inherent scalability and potential for recurring revenue make them more attractive to buyers.

Selling a professional services business requires a strategic timeline:

• In professional services, sellers often need to stay on board for 2-3 years post-sale.
• Consider your personal and professional goals, such as retirement or career changes.
• Ideally, have at least one solid year of financials, preferably three, showing growth leading up to the sale.
• Obtain a business valuation early to understand where you stand and identify areas needing improvement.

How Earnouts Impact Valuation in Professional Services Deals

An earnout is a financial arrangement in which the seller stays with the company for a set period after the sale to ensure a smooth transition. Many sellers are aware of this requirement, but some are not. Also, those who are unaware can find it disappointing.

Buyers need assurance that the company won't fail after the purchase. So, they require the seller's continued involvement to maintain stability and facilitate the transition.

However, the challenge is that sellers often imagine a clean break after the sale. But in reality, especially with service businesses, they are deeply involved in the company's operations. 

Transitioning this knowledge and responsibility to the new owner and their team takes time.

M&A Deals Structure

Each M&A deal is unique, but generally, the structure includes:

• 30 to 50% upfront in cash. The upfront percentage can vary based on the client roster. Larger clients often mean more money is at risk for future payouts.
• Remaining 50 to 70% spread over 2-3 years. This portion is paid in relatively equal chunks and is often tied to performance targets. These targets include top-line revenue, maintaining a specific percentage of EBITDA, and retaining key clients.

The earnout ensures the seller stays motivated to meet these targets, which benefits the buyer. Gert also agrees that this structure makes sense. He also notes that many agency coaches advocate for preparing an agency for sale. This suggests that a well-prepared business may end up being so well-run that the owner no longer feels the need to sell.

Moreover, a good business to sell is often a good business to keep. If a business is ready for sale, with a strong team and operational efficiency, the owner might decide to retain it. This is due to its smooth functioning and reduced personal involvement.

When Might It Be More Beneficial to Keep a Business Rather Than Sell It?

Sometimes, after evaluating a business for sale, it's determined that the owner might benefit more by keeping the business. If the business is highly profitable, the owner receives a good salary, and a strong second-in-command is in place. But, if you want to sell it, here are things you need to consider in finding a buyer:

• The process of finding a buyer is cyclical and can take 9-12 months.
• Smaller firms typically sell to larger firms, not private equity or venture capital.
• Factors such as market timing, the buyer’s current engagements, and cash reserves can affect the duration.
• Preparation includes updating valuations and creating marketing materials, followed by a period of going to market.

The goal is to build a business that offers the owner flexibility to either sell or keep running it with minimal effort. Gert suggests testing the business's independence by taking a vacation to see how it runs. This helps identify any issues that need addressing, such as permissions, access to tools, and process gaps.

Moreover, Gert's team has implemented clear guidelines and processes to handle client needs during his absence. However, such experiments always get new lessons.

Anticipating Client Reactions to a Business Acquisition

Clients' reactions can vary. Some might be sensitive to changes in control, while others may not care much. This is especially true if the current owner remains on board during the transition. Similar to clients, there is generally no large-scale departure of employees post-acquisition.

The owner's role often shifts after the sale. Responsibilities might move towards business development and sales, partly to meet earnout targets. Additionally, owners can offload admin tasks to the larger company's internal teams.

To prepare clients and employees, and develop individualized strategies for sensitive clients. Also, the business's resilience can be tested by taking long vacations to see how it functions without the owner.

Tips for Preparing a Business for Sale

Owners start considering acquisitions when they aim to move to a higher multiple band for greater valuation. Ambitious owners or those nearing the top of their current multiple band may look to acquire other profitable firms.

Here’s how to prepare a business for sale:

• Get a Valuation Done. Understand the starting point for the business’s value.
• Maintain Clean Operations and Financials. Ensure the business runs smoothly and financial records are clean. Avoid intermingling personal expenses with business expenses.
• Reduce Dependency on the Owner. Make the business less reliant on the owner to ensure a smoother transition and higher valuation.

Acquiring smaller firms can theoretically boost valuation. However, integrating smaller firms can be challenging due to cultural differences and varying processes. Effective integration is crucial to realizing the benefits of acquiring smaller firms.

For those interested in learning more about M&A or getting a business valuation, Jonathan Baker offers professional advice and services.