BEGIN WITH THE END IN MIND

Perhaps you have heard the phrase, “begin with the end in mind.” I first heard these words at a Small Business Development Center (SBDC) Conference in 2003. I was new to my job as a consultant at Washburn University, excited about the prospect of helping local entrepreneurs. At the time, the phrase resonated as a call for thorough business planning.

Now some twenty years later, I have clients that I helped start in my early SBDC days now selling their business, and my perspective has evolved. Beginning with the end in mind requires not just sound business planning but also consideration that the ideal outcome for any entrepreneur is selling (or transferring) the business to someone else.

Easier said than done, most startup entrepreneurs are focused on the now — securing funding, which requires competent financial projections and a business plan. For some, the buildout is paramount, must finish on time and under budget, with equipment in place and licenses secured. Finding and hiring employees is never easy. Between taxes, legal and accounting, not to mention the hundreds of other startup questions, navigating the startup is challenging.

No surprise then that few “begin with the end in mind.” But some do. The smartest small business entrepreneurs I have met over the years are planning to sell their business on day one and are effective in building a business to sell it, often on repeat. Best tip today — seek coffee with these savants.

For the rest of us, how does one do this? Where should one reflect at startup? What considerations are in the middle? And where is the opportunity at exit?

A fundamental truth, all small businesses will either end or transfer in some form. If so, where are the sellers and where are the buyers? I have an idea to share with you — know your multiple.

1: KNOW YOUR MULTIPLE

Entrepreneurs should have some understanding at startup of how their business will be valued at exit. It’s the valuation that drives the purchase price, the reward for the years of hard work building a business.

Some perspective is important, for valuing a business is not an exact science. Two businesses in the same industry with the same cash flow could be worth significantly different amounts due to trends, opportunities, geography, etc. No two businesses are identical.

With that said, however, it is possible to arrive at a general sense of a possible range of value for a business using one of the generally accepted valuation methods. The best way to do this for the entrepreneur is the market approach, which is similar to how one values and buys real estate.

Market Approach

The market approach is based on the tenet that the value of a company is whatever can be obtained upon sale. Therefore, it is extremely helpful to know the past transaction sales price of similar businesses and price accordingly.

There are several reputable companies that provide comparable data on past small business transactions, but perhaps none better than DealStats (formerly Pratt’s Stats), which contains the largest database of complete, auditable private company transactions in the world. DealStats includes over 43,000 transactions, organized by industry and type of business.

The listings do not contain any identifying information, but you can see a myriad of information including a full financial footprint and transactional data for the business. Helpful information includes a brief business description, the age of the business, the number of employees, and the state in which it is located. Financial information includes, but is not limited to, total sales, gross profit, total operating expenses, and net income. Rent expense and owner’s compensation is broken out. Additionally, the asset values are provided: inventory, fixed assets, and intangible assets.

Transactional information is highlighted. Data includes the sale date, the asking price for the business, and what the business actually sold for. Further, you can see the deal terms, including whether any seller financing was offered and whether the purchase included an assigned lease (or not).

By knowing the financial footprint and the final sales price, one can calculate valuation multiples that can be extrapolated for market comparison purposes. For example, based on data provided by DealStats, pizza shops typically sell for between 22% (25th percentile) to 42% (75th percentile) of annual sales, with the average being 33%.

This is helpful information. The pizzeria owner would know that to exit with a cool $1 million (not a bad goal), on average they would need to grow the business to somewhere around $3 million in annual sales. We know this because the market tells us that pizza shops typically sell for 33% of sales. Beginning with the end in mind, this means that the entrepreneur would need to scale the business with multiple locations.

Seller’s DiscretionaryEarnings (SDE)

Another term one should become familiar with is seller’s discretionary earnings (SDE), which is a cash-flow based measure used to value a small business. It includes the operational earnings of the business (before depreciation, interest, and taxes) plus the owner’s compensation, plus all other owner benefits (health care, cell phone, automobile to name a few). The number represents the total financial benefit to the owner of a small business.

Knowing your SDE is important as it is most commonly used to determine a small business’s value. The good news is that SDE multiples are available from DealStats as well. Based on 118 transactions reflected in the database, the average SDE multiple for pizza shops is 3.3x. In our example, this means that to exit with a cool $1 million, the pizza entrepreneur would need to be able to support approximately $300k in seller’s discretionary benefits upon sale.

Knowing your multiple from the beginning can provide some clarification in an otherwise murky and uncertain endeavor. It provides an idea of what the business your building is worth. It can, upon reflection, provide goals for growth and an on-going incentive to monitor financial performance.

3: BUILD A BUSINESS THAT WORKS WITHOUT YOU

About the same time I first heard “begin with the end in mind,” it was recommended to me to read the E-Myth Revisited by Michael Gerber. An older book, first published in 1986, the author makes the case in the first half of the book for why most small businesses fail (most businesses are started by technicians) and provides the anecdote in the second half.

I recall being thunder struck by his advice to build a business that works without you. What?

That is certainly not what I had done in business with my dad. We had built (and struggled with) a business that relied too much on us. Personally, I was involved in everything. I thought it was what small business owners did. It never dawned on me that the secret of success was exactly the opposite.

E-Myth Revisited urges entrepreneurs to focus on working on the business (not just in it) by developing processes, systems, and people. It made sense then, and it makes sense now. Building a business that works without the owner not only provides some sanity, but also produces far more value at exit.

Vice versa, a business in which the owner is the business is hard to exit. That business owner finds a trap of their own making. Recently, a friend confessed to me that his business failing was a blessing in disguise because he was never going to be able to keep up, much less retire.

The significance of this should not be understated, yet it is counterintuitive to the startup entrepreneur. Build a business with systems, processes, and people. Build a business that works without you, not because of you.

3: AN OPPORTUNITY

Perhaps you have heard, we are undergoing the single greatest wealth transfer in the history of our nation. According to a New York Times article (May 2023), $84 trillion is projected to be passed down from older Americans to Millennials and Generation X through 2045. More notably, $16 trillion will be transferred in the next decade.

Not all this wealth is in small business ownership, but some of it is. Because of this, I tell my entrepreneurship students that their big opportunity is not to start a business but to buy a business. I teach students how to find a business and perform due diligence, with the thought that they should pursue an acquisition at some point in their career.

In my opinion, Washburn entrepreneurship students (approximately 250 since 2013) present a unique opportunity for local business owners who do not already have a transition plan in place. Unless junior is already in line or the buyer of your business is already on staff, why not consider a Washburn graduate?

My experience tells me that the best business opportunities are not listed. If your are considering selling your business, reach out to me at rick. lejuerrne@washburn.edu. Who knows? Maybe a connection is made in which a student interns or a graduate gets hired on, learns the ropes, and is ready to buy your business when that day comes.

For the business and Washburn graduate, it’s a win-win, as both begin with the end in mind.

The Washburn SBDC provides free and confidential services to local entrepreneurs, including the DealStats information referenced in this article. The Washburn SBDC can be reached at (785) 215-8375. For more information visit www.washburnsmallbusiness.com.