Billy Joe and Bobbie Sue have spent most of their working lives building their business, Miller Enterprises (an S Corporation), but weren’t necessarily ready to sell. Now it’s caught the eye of a private equity firm, which has made an unsolicited offer of $25 million—a multiple of 10x Miller Enterprises’ current EBITDA of $2.5 million.
If they move forward, the couple will receive $20.0 million in cash up front, while rolling $5.0 million tax-free into the NewCo. The private equity firm expects to resell the company in five years, at which time the rolled equity could at least double in value (selling for $10.0 million).
At first glance, Billy Joe and Bobbie Sue are wary of selling. They had planned to keep running the business for several more years. After all, Miller Enterprises is a proverbial “golden goose” that just happens to lay $1.0 million eggs (in the form of business distributions) annually. Why give up a good thing?
Should I Sell My Business Now? Establish a Baseline
While skeptical, Billy Joe and Bobbie Sue engaged their Bernstein private wealth advisor and CPA upon receiving the offer. To help them better understand what it could mean, we provided financial advice analyzing the difference between selling today versus in the future.
Note that after years of hard work and reinvesting in the business, the high-net-worth couple recently started taking distributions of $600,000 per year. Combined with their salary of $400,000 per year ($200,000 each), these distributions generate $1.0 million of income. This is more than enough to support their lifestyle spending of $300,000 per year, and as a result, have allowed the pair to accumulate $2.0 million in savings. Assuming the couple keeps taking these distributions, they can expect to add about $300,000 per year to their wealth management portfolio after paying income taxes and covering their living expenses.
Using Bernstein Private Wealth Management’s Wealth Forecasting Analysis, we projected that their existing liquid assets of $2.0 million—with the annual $300,000 top-up—would ultimately grow to $6.9 million in 10 years (Display 1) assuming a 50% global stock and 50% bond asset allocation. While this seems like a sizable amount, how does it compare to selling the company?
Here, the answer greatly depends on how their company performs after the sale. As a reminder, while the company was valued at $25.0 million, Billy Joe and Bobbie Sue would only receive $20.0 million up front, or $15.0 million after paying income taxes.1 The remaining $5.0 million would be tied up in equity in the NewCo. If we take an ultra-conservative view and assume the pair sells today—but never monetizes the rolled equity—we’d expect their portfolio to be worth $21.0 million in 10 years (Display 1) net of income taxes and annual spending.
Based on their conversations with the private equity group, Billie Joe and Bobbie Sue considered this overly pessimistic. They asked to see a more “realistic” analysis reflecting their interest doubling to $10.0 million—or at least retaining the $5 million they’d rolled in. If this came to fruition, we projected their portfolio to be worth $25.4 million (no growth) or $29.6 million (upside case) at the end of 10 years (Display 1).
In Search of Breakeven
Now that we have an idea of what their assets could be worth under various sale scenarios, we know what a future sale must look like for a small business owner like Billy Joe and Bobbie Sue to break even (Display 2).
Based on the data we analyzed, if Billy Joe and Bobbie Sue believe the company is well enough positioned to at least recoup their rolled equity, they’re in a good spot. In other words, they would essentially need the exact same valuation ($24.7 million) that they received today to break even in 10 years.
Time to Sell?
At today’s valuation, the couple could go either way. But what if Billy Joe and Bobbie Sue could command a higher valuation down the road by growing their EBITDA? If they could expand this figure from $2.5 million to $3.5 million—and the market was still willing to offer a 10x multiple in the future—they could exit at a $35.0 million valuation. This price would place them comfortably above the breakeven numbers, making the wait worth their while.
Yet, holding out for another 10 years exposes Billy Joe and Bobbie Sue to the vagaries (and risks) of managing their business over a longer period. For instance, the amount a potential buyer might be willing to pay could decline in a recessionary environment, or a new competitor or disruptive technology could cloud the company’s revenue and growth prospects. In those cases, perhaps Miller Enterprises would only command a multiple of 7.5x. Then, even if EBITDA grew to $3.0 million, the business would only be valued at $22.5 million—slightly below the breakeven point. In hindsight, they would have been better off accepting today’s offer.
To further illustrate the potential range of outcomes, we analyzed various EBITDA levels (from $2.0 million to $4.0 million) and market multiples (7x to 11x) that the pair might secure in the future (Display 3). For each combination, we noted whether the couple would be able to command a higher price (shaded in blue), or a lower one (shaded in red) relative to the current offer of $25.0 million.
It’s always challenging to find the “right” financial decision when selling your business. Because ultimately, the notion of when to sell your business is full of what-ifs. But by going through this thought exercise, business owners like Billy Joe and Bobbie Sue quantified some of the risks and rewards that might arise from continuing to run their business. In the end, solid investment advice allowed them to make an informed decision about whether it’s the right time to “take the money and run.”
- Sean Sullivan, CFA
- AVP/Senior Analyst—Wealth Strategies
- Andrew Bishop, CFA
- Director—Wealth Strategies Group
1 Income taxes were calculated assuming a federal rate of 20% and a state rate of 5%.