By Joshua D. Freeman
The Cheshire Cat
In Lewis Carroll’s story of Alice in Wonderland, Alice encounters the Cheshire Cat at a forked road. Alice asks the Cheshire Cat which road she should take. The Cheshire Cat responds by asking Alice where she wants to go, but Alice doesn’t know. Then it doesn’t matter which road you take, answers the Cheshire Cat. The same goes for business planning. If you don’t know where you want to go, then how you plan and structure your business really doesn’t matter.
Start with the End in Mind
Josh Coates, a Utah entrepreneur now with Instructure, spoke in a panel discussion about his experience planning his first business. Coates explained that before starting his business, he meticulously planned his exit strategy down to the specifics of how much he would sell the company for, to whom he would sell it, and when the sale would happen. Before launching the business and during his initial pitch meeting to who would be his lead VC investor, Coates told this VC investor that he would sell the business for a very specific amount to a very specific company at a very specific time. As it would turn out, around the time Coates planned to sell the company he received an offer from the company he had planned to buy his business for more than Coates had originally said he would sell for. If I recall correctly, he ended up passing on the offer and ultimately sold the business later on for a significantly higher amount.
When I heard Josh Coates tell his story, I was intrigued. The specificity requited to plan when, to whom, and for how much he would sell the business created a business plan and exit strategy with clarity and purpose. That purpose reflected the structure and design of the business. These three aspects of an exit plan are like three lenses that, as they overlap with each other, amplify the vision, purpose and strategic design of your business you need to be successful.
Let’s take a look at these three lenses in more detail. First, how much do you want to sell your business for?
How Much Do You Want to Sell Your Business For
Knowing how much you want to sell your business for informs a number of important understandings about the business that you are building. First, it informs you on how much revenue to target to reach that sales valuation. This revenue figure will tell you how much product or how many services you are going to need to sell to reach that target. Knowing your sales requirements from the outset will help you understand what size of a team you will need to reach your goal.
For example, some founders want to grow a billion dollar company. Depending on valuation multiples in effect at the time, to make this happen they may need to be creating at least $100,000,000 in annual revenue. If they can make $1,000 per customer per year, then they would need to have 100,000 customers to reach the $100,000,000 in revenue. You can go through this exercise yourself by calculating: Annual Revenue = $ Amount per Customer multiplied by Number of Customers. The numbers you get can help you understand and research the market size feasibility.
On the other hand some founders may say: “I’m not planning on selling this business ever.” These founders want a lifestyle business where the focus is on how to optimize the business for the founder’s lifestyle. They may think that selling the business later down the road would be great, but the purpose of the business is to be a vehicle for providing a lifestyle not a vehicle to get a big pay day.
Determining the revenue, you’ll need to sell the business for the amount you want also provides an interesting motivation check on the business. There is nothing wrong with starting a business to grow it and make money. There is nothing wrong with starting a business to make you happy. There is nothing wrong with starting a business to make a change in the world or to a certain population. The only thing wrong is to not understand or be aware of your motivation. When you’re not sure of why you are starting or running your business, ask yourself: “How much do I want to sell this business for?”
When you know how much you want to sell your business for (regardless of whether that is $10.00 or $10,000,000,000) it is time for you to ask yourself the next question. When do you want to sell the business?
When Do You Want to Sell Your Business
There is no universal answer to the question of when you want to sell your business. It could be three years, or ten, or perhaps never. The important aspect of asking yourself when you want to sell your business is to understand how you need to run it.
Let’s return to my lens analogy. When you overlay the lens of knowing how much you want to sell your business for with the lens of when you want to sell, your vision becomes clearer as to how quickly you need to get your product or service to market. Along with getting your product to market, you’ll better understand the sales strategy and growth dynamics needed. Seeing this clearly will inform you as to the type and shape of funding and financing that you will need to reach your target exit date and exit size.
The clarity you’ll have by answering these first two questions will help you know the key team members you will need to execute your vision and the legal structuring of your entity. Your team size and makeup will be determined by your vision. Once your vision for the company is clear, than you can determine who you want to buy your business.
Who’s Going to Buy Your Business
The third lens to bring everything into focus and intense magnification is to understand who is going to buy your business and design the business accordingly. Like I mentioned earlier, Josh Coates before starting his business named the company that would buy his business.
To determine who you would like to buy your business requires you to first understand what your business is and then to understand the business that you are going to sell to and why that business would like to buy yours. Here is a list of useful questions to examine this and tighten your focus on these issues. Are you a tech business? Are you a physical product business? Are you a service business? Does my proposed acquirer want to be a tech business, a product business, or a service business? How does my business compliment and integrate into that business? How does my team and culture fit within what I know about the culture of the business that I want to buy my business?
I consult with a lot of business owners about this issue, and sometimes they answer that they are not a single type of business, but rather a combination. Sometimes a combination works in a way that it aligns with a particular buyer model, but much of time the more complex you are, the fewer and fewer potential buyers exist. Instead of broadening your pool of potential buyers a combination of business types actually acts as an eliminator of suitors because the more complicated the business the harder an acquisition will be.
A common situation I encounter is a service company that has developed and uses some proprietary technology that makes their service offering more efficient and profitable. The number of potential buyers in the market for the service business is much smaller than that of a technology company. Thinking of such a business as two separate businesses, a service business and a technology company can allow you to maximize the value of the two offerings, especially if the technology can be licensed to other service providers and become an enterprise level software.
You can maximize value by growing the technology business alone as will licensing the enabling technology. That maximized value can enable narrowly focused businesses that can be acquired with much higher levels of confidence.
By carefully understanding the business or businesses you start, you can align them in a way to specifically target the companies that you want to sell to; whether that be a private equity group, a publicly traded company, a large client, a competitor, or an industry behemoth like Google or Facebook.
When you identify the specific buyer type that you want to target, you can start to design your business culture, monetization, and structure from the start that will appeal to that specific type of buyer.
If you want to create a lifestyle business that you can pass down to your family, knowing that will also inform how you design your business and your family’s role. This planning can help you avoid the relationship trappings that can come with a family business.
Understanding who will be buying your business from you either by a third-party while you are alive or by your family when you die will allow you to design a business model and structure that can reach your goals.
How Your Business Can Be Purchased
There are four primary ways your business can be purchased from you. The first way is through a stock purchase, the second way is through an asset purchase, the third is a merger, and the fourth way - a rare way - is through an IPO (due to its rarity, I’m going to ignore it in my thoughts in this section).
Understanding the differences in taxation, ongoing risk, and liabilities associated with each of these types of transactions is important. Stock purchases and mergers in most cases are going to have the best tax ramifications and ongoing liability protection. To get a buyer interested in doing a stock purchase or merger has a lot to do with how you structure your business and own its assets and how clean the business issues associated with potential liabilities. Understanding these different purchase types and how you can maximize your ability to get to that better purchase structure can make differences in millions of dollars.
The Wrap Up
Returning to the story of the Cheshire Cat, if you don’t know or care where you end up then which path you choose ultimately doesn’t matter. However, if you take the time to figure out precisely where you want to end up and invest in the outset to do those things with legal structure, contracts, and planning, choosing and navigating the path that will lead to the desired exit will be so much more possible. Many startups and entrepreneurial endeavors fail for a variety reasons, but if you want to give your business the greatest chance to beat the odds, asking the four questions outlined above in the beginning will maximize your probability of being crazy successful.