How to value your company for sale (Part 2)

In Part 1 I explained how it’s senseless for small companies to compute “one correct value” for the company, but rather that buyers and sellers must be considered separately. I covered the buyer side there; now let’s tackle the seller.

Are you willing to sell your baby? At what price? Most entrepreneurs would love to be in a position to have to decide!

Most, but not all. There are plenty of folks who wouldn’t sell their company for a billion dollars; Jason Fried and Joel Spolsky are public examples from the bootstrapped startup world. I’ve heard various reasons from these guys and others: “it’s the company I want to work at forever” or “it’s my mark on the world that will outlast my life,” or “I literally don’t know what else I would do.”

But this article is about selling, so I’ll assume that, like me, you’re like the woman in the old G. B. Shaw yarn:

“Ma’am, would you have sex with me for a million dollars?”

She thinks, then says she would.

“So,” he says, “would you have sex with me for $50?”

Indignantly, she exclaims, “What kind of a woman do you think I am?”

He replies: “We’ve already established that, ma’am. Now we’re just haggling over the price.”

So let’s haggle.

What if someone offered you a million dollars for your startup, right now, check in hand — would you take it? How about $100,000? $10,000?

Better question: How do you arrive at an answer that satisfies your emotional attachment but also makes economic sense? How do you even compute the economics at a small company with a scant track record and an uncertain future?

Navel-gazing

Remember how the buyer has his own way of valuing the deal? You need to be similarly selfish in your approach.

You’ll be tempted to say things like “How much do you think they’d pay,” but that won’t help you decide what’s right for you. You’re skipping a step — trying to decide if the deal is even plausible — but how can you decide that if all you’re doing is thinking about the other side? Let them take care of themselves.

OK, you’re ignoring them. Where to start?

Collapsing the possibilities

I just coached an entrepreneur who couldn’t decide whether to accept an offer for selling his business of nine years. The conversation went like this:

HIM: They offered me $X, but I wonder whether I could make the same money if I just kept the company.

ME: How so?

HIM: Well we’re growing pretty well now, so I think I could take out $1m/year for myself for the next few years. Then I’d personally make most of what I’d get, but now I’d have an even more valuable company.

ME: How confident are you in that growth?

HIM: I don’t know, pretty much, although just last year we were shrinking.

ME: Supposing you do grow, how do you know that in a few years there’ll still be buyers around? Or what if we have another stock market collapse or if they shoot down a plane over California?

HIM: When you put it that way seems like I should just take the money. In fact, what if a new competitor pops up in a year and starts kicking our ass?

ME: Sure, but maybe that competitor would further validate and grow the market, which could increase your sales and make you even more attractive to a buyer!

HIM: That’s true, and besides we’re talking to [big company] about a potential partnership that would really launch us.

ME: Of course getting tied up with that might distract you from other growth opportunities, and sometimes buyers don’t like that you’re dependent on another company for revenue.

HIM: Yeah, in fact one of my best employees doesn’t like [big company] and has threatened to leave if we do it, which would make it hard to continue this growth.

This vacillation continued for twenty minutes — what if things go really well, or flat, or they find a great deal, or the economy kills them, or a much better buyer appears six months from now, or a big new competitor appears, or….

Of course this is unresolvable. He can’t assign a probability to any scenario and almost none of it is under his control.

The way to wrap your head around this is to simplify — to ignore all of these hypotheticals and instead to decide what feels like an acceptable amount. This isn’t as emotional and illogical as it sounds.

My favorite tool for this is called the “box game,” already described in this article about why I sold my company Smart Bear. (The following assumes you’ve read it.) If you have a deal in front of you it’s easy to plug in the requisite numbers. If not, it’s easy to try a few until you get a good idea of what your minimum number is. If box A holds $5m, are you good?  If box A holds $3m and box B holds $100m, do you still take A? Have someone else ask you with different combinations and your true risk/reward profile will appear.

In fact I’ll go one step further than the standard game: Box B isn’t a 50/50 chance. Rather, Box B has a probability that you aren’t allowed to know! When framed that way, it’s even more difficult to gamble on the future, and even easier to figure out what your “magic number” is.

It’s a gut-check, yes. But trying to work out the risk/reward of unknowable possibilities is worse.

It’s not the number, it’s the whole term sheet

Now I have you fixated on “your number,” but actually you shouldn’t be fixated on that number. It’s important, it sets the stage, defines the ballpark, but there’s so much more to term sheets than that number.

Examples:

• Deal A requires you to work for three years at the acquiring company in a capacity that you know you’ll hate: Answering to bosses with political agendas, watching your beloved employees leave in disgust, and muzzling creativity. Deal B gets you only 80% of your number, but comes with a six-month transition period and you’re free to start working on the next fun thing. Would you take a lower “number” to get Deal B?
• Deal A gets to your number in stock options with a 4-year earn-out in a public company whose stock has been uninteresting for the past three years, plus an additional third of your number in cash — more than you wanted! Deal B gives you 70% of your number, all in cash, all up-front. Do you prefer Deal B?
• Deal A gets you your number, but your employees get a small signing bonus and no salary raises; they’ll resent you for not taking care of them. Deal B gets you 70% of your number, but your employees are well-compensated both upon signing and with their annual compensation. How much is your employees’ continued satisfaction and appreciation worth?
• Deal A hits your number; Deal B gets you 60% of your number, and up to an additional 100% if you hit performance bonuses, which could be $0 if you don’t achieve goals. Do you want to continue rolling the dice?

Of course there are no wrong answers! Only personal choices.

The point is that, although it’s important to establish your “number” as a point of reference, the structure of the deal matters too.

Except this number

What the box game really does is answer this question: What number do you need to see in your personal bank account in order to be comfortable with the choice. That’s post-tax, post earn-out. “Net net,” some people say.

One of the best ways to arm yourself going into negotiations is to know this number and be prepared to blow up the entire deal if it cannot be met. That means you have to be that sure that that’s the number, regardless of deal structure.

Here’s why: The acquirer knows that you, the founder, are looking for financial freedom. They know there’s a minimum valuation, under which you’re not interested. In fact often this is how they come up with their initial offer, and it’s why companies with three founders often get more money (all else equal) than companies with one founder. (I’ve talked with people in the M&A departments of several large businesses who confirm the previous statement.)

Finding this number is more complex than it sounds. Tony Wright (founder of RescueTime) has a great article about it here.

But still, the money truly isn’t everything. It’s more personal and emotional than that.

The personal stuff

There’s a lot of important factors outside of money. Here’s a few:

• Burn-out. Type-A workaholics like me (and most successful entrepreneurs?) cannot, in fact, maintain the energy and stress level. We laugh at people who talk about things like “stress,” but denial doesn’t work forever. As Andrew Warner said, “I used to think that only wimps took breaks, so I foolishly worked nonstop until I couldn’t keep going. Michael and I sold the business.” So yeah, “don’t do that,” but we do it, and then we’re finished. Time to sell. Or maybe just a sabbatical — what if you took 3 months off and let everyone else mind the store, even if that means “not as well as you” and other things? You might feel differently.
• What’s the job you want? Can you imagine yourself doing anything else? Does the prospect of starting fresh with a new idea sound refreshing and invigorating or depressing and laborious? Do you like the idea of “active retirement” where you keep cashing the checks and relaxing in the corner office or does that sound like a boring, pointless existence? Selling your company means you’d better be up for “the next thing” (after a well-deserved rest period).
• Lifestyle. Do you want to stop having to go into work every day? Will the amount of money you get selling the company actually alter your daily lifestyle? Does it even need to alter lifestyle for selling to make sense? Will it change how much time you have for family? Can you can decide to change these things anyway — without selling — or is selling the only way?
• Alternatives. For example, If you’re sick of being the CEO but would love to continue hacking on the code, it’s actually OK to hire a CEO and just hack on code. You could promote from within or find someone externally. Yes, whomever you pick — especially if external — you need to trust and might do a bad job and will certainly behave differently from you and even if they’re successful it might not be as successful as you would have been… but it’s OK because you’re solving for the underlying issue, which is that you don’t want to be the CEO. Selling is one way, but not the only way.

It really comes down to something sappy but true: What makes you happy? This is the hardest question to answer. Not just in this context, but in life.

I’m still figuring it out, I’m embarrassed to admit; I envy those rare birds who know the answer and know how to seek contentment. I love writing code, but I don’t want to be the guy up at 3am on a Sunday when the code breaks. I love writing this blog, but I’m not up for the book deal that was offered me. I love helping other people with their startups, but I don’t have the time to do justice to all the requests. I love the idea of funding new startups, but I’m not sure I’m up for the requirements attending profitable angel investment (see the multi-part series from Mark Suster).

If you know what makes you happy, you can make decisions that move you towards it. If you don’t, how do you know if you want to sell this company, now, or what else you would do, or why, or… ?

So where does it leave us?

Don’t believe anyone who says “it’s not personal, it’s business.” It’s your life and livelihood. It’s personal.

The money is important, and it has to fit your minimum criteria so you know you’re doing the right thing economically.

But the personal, emotional stuff is important too, maybe more so. You hear rich people saying things like “money doesn’t make you happy,” and your response is “boo hoo, yeah I just want a chance to prove that it won’t me happy either.”

But it’s still true, and when you’re facing the decision to sell your company, it’s immediately relevant.

If this sounds more like therapy than economics, it’s because it is.

If your number, your deal structure, and your happiness coincides with whatever constraints and desires the seller is under, congratulations!

And don’t forget to send me $10k after the close for helping you out.  :-)