How to Know the Right Time to Recap or Sell Your Business: An Investor’s Perspective

Imagine you’re in a game where your character has a treasure of immense value, attained through years of sacrifice, risk taking and toil.  The objective of the game is simple – find a buyer for the item and transact at a mutually acceptable price.  Easy, right?  Well, there’s a twist[1]:

• • The buyer’s identity and location are a mystery
  • You can only transact once (i.e. no do-overs)
  • The item’s value fluctuates, and
  • A poorly-timed trade may sentence you to a lifetime of regret and self-loathing

Yikes.  Who would want to play that game?  Well, this mirrors the journey that founders embark upon when contemplating either a recapitalization of their business with a private equity firm partner (a ‘recap’) or the full sale of their business  (an ‘exit’).  Not to worry, there are people and insights that can help across all of the anxiety-laden dimensions of planning a recap or exit.  While the ultimate decision is yours, you are not alone.

Indicators That It’s Time

This piece will focus on timing and is informed by my nearly 20 years of experience as an investor in and seller of businesses.  Interestingly, across the matrix of decisions that a business owner has to make, timing of a recap / exit is one of the more straightforward exercises.  The trick is knowing what indicators to look for.  So, without further ado, here are some signs that the timing might be right:

1. 1. A comparable business in your industry achieved an appealing valuation. If you see another founder deciding to engage in a recap or exit transaction, it may merit introspection on your own transaction timing.  What’s good about another founder “going first” is that the multiple they sold for will eventually become known in the circles that care about these things[2].  We suggest reaching out to the investment banker(s) that worked on the transaction to learn about what attributes of the other business buyers focused on the most (i.e. the “value drivers”).  If you would like an introduction to one or more investment bankers who have strong qualifications and successful transaction experience working with owners of B2B professional services firms, please email me, and I’ll connect you. 

1. 2. Proceeds from a transaction will allow you to “hit your number”.  Admit it, you have a magic number in mind (after tax) that you would like to achieve from all of your efforts to develop your business.  This number is typically informed by various objectives for life in retirement such as estate planning goals,  philanthropy, or simply enjoying the well-earned fruits of your labors.  The reason for defining this number before you consider a transaction is to prevent clouded judgment during negotiations.  Therefore, if a transaction is likely to meet or exceed your target, then the timing could be right.  Remember the adage, “Pigs get fat, hogs get slaughtered.”   As importantly, when considering a recap vs. an exit transaction, keep in mind that the recap will provide you with two opportunities to monetize the value created by your team’s efforts while the exit transaction is a one-shot payout.  So the total proceeds and likelihood of reaching your target amount may be substantially greater in the recap scenario.  I’ll share more on this very important topic of recap vs. exit transaction in an upcoming blog post.  

1. 3. You’ve experienced multi-year growth in revenue and profits. In the words of Bruce Lee, “Long-term consistency trumps short-term intensity.”  This certainly applies to how investors will assess the quality, sustainability, and growth potential of your revenues and profitability.  For instance, if you have an abnormally great year with outsized profitability, you might conclude that you should exit to capitalize on your inflated earnings.  However, if your surge in EBITDA is attributed to one-time revenue wins or other unsustainable factors, a buyer is not likely to give you anywhere near full credit for it. Further, if your financials have been volatile such that there are a lot of ups and downs one year to the next, you’re not going to garner the same multiple as a business that elicits more confidence in the predictability of future financial metrics.  Consistent growth creates a reassuring storyline that will attract more interest.

1. 4. Value remains for a new investor. Sometimes looming headwinds can drive an owner’s decision to exit.  Conceptually, getting out before these challenges arrive makes sense, but it’s likely that investors are already, or will be, attuned to those same issues, and it may then be too late to drive an optimal outcome from a sale.  Would you purchase an orange with all of the juice squeezed out of it?  Clearly not.  At a minimum, investors are going to need to know that the prospects for growth will remain strong for the next 5-10 years.  Otherwise, they may encounter challenges when they ultimately seek an exit.  Think of it this way, reflect on whether you would want to invest in your business today.

1. 5. Bringing on a partner could help address the strategic needs of the business. For first-time founders of growing businesses, it’s a truism that their company is the largest entity they’ve ever managed.  For a time, managing growth can be fun and present an array of “high class problems” whose solutions can be fulfilling to solve.  However, growth can transform manageable hills into formidable mountains whose successful summit requires the support of someone that has climbed them before.  A good partner, like a sherpa on Everest, will see the opportunity that these mountains present and be able to help you develop a path forward.  Common strategic challenges that get a founder thinking about bringing on a financial partner include (i) their industry’s transformational change, (ii) investing in and building a formal and scalable sales and marketing system / organization, (iii) a sizable add-on acquisition, or (iv) professionalizing / incentivizing a management team.  

While these signs can guide your decision, the ultimate choice is personal and nuanced, and I wish you well in making it with the full support of your trusted advisors.  Get in touch any time if you ever want to talk through where you are in your journey.

About RLH Equity Partners

RLH is a private equity firm with over 40 years of experience investing in rapidly growing, founder-owned, knowledge-based B2B services firms.  Our value creation strategy is defined by a heightened focus on culture, continuity of founder leadership, an emphasis on organic growth, and a conservative approach to the use of debt.  In our long history, we’ve invested in and divested dozens of businesses and made many decisions about the optimal time to sell the companies in which we are investors.

[1] There are certainly exceptions to all of these items, so simply accept them here for the sake of example.

[2] Two other advantages of allowing a peer company to go first are (i) the number of viable targets for the interested investor/buyer universe has been reduced by one which improves the scarcity value of the remaining peers and (ii) the prospective investors/buyers who finished second, third, and fourth in the process to acquire the peer company probably still want to acquire a business similar to yours and are logical targets for your transaction process.