Earn Your Way to a Better Exit

When Mayor Johnson (not his real name or title) asked me to meet, I assumed he wanted me to sponsor a table at his next fundraiser. He ushered me into his office, and after looking at pictures on the wall of him with nationally prominent politicians, he got to the point. “I’m not here to talk politics, Jim, I want to talk about selling my business. I know you can help me.

Mayor Johnson has lived in his community his whole life. His extended family has generational roots there, and they are highly regarded for their civic leadership and business successes. The mayor’s business is located on one of the town’s main roads, and it seems to stay busy all the time. To say his business is a local institution would not be an overstatement.

“I’m 69 years old, and my kids and grandkids want me to slow down. They’re right, I’m at that point where I don’t have to work anymore. What can I say? The people of this community have been very good to me.”

I didn’t say it during our first meeting, but I was concerned about his valuation expectation, even before I knew what the mayor was hoping to get for his business. I have been in enough conversations with retiring business owners to know there are commonalities in their perspective, over-valuation being the most prominent.

After I reviewed the financial history, I met again with Mayor Johnson. I told him his business could be sold for three times his most recent profit. But I also had to tell him he’d probably have to take 35-40% of the price in the form of an earn out where the proceeds are paid over time based on the future results of the business. “But here’s what you don’t understand, Jim,” he said to me in his polite southern drawl, “I’ve been pulling down 10 to 12% profit margins for 20 years now, this business is a sure thing for whoever buys it.”

The mayor’s business was a sure thing, for him. But that was the problem. The business was so closely identified with him, a potential buyer would see risk in the business. That risk being the loss of customers if/when Mayor Johnson was no longer running the business. If a business, even a good business, is too closely identified with one person, there is a reasonable expectation the business will decline when that person is no longer in the business. If the business declines, it obviously has less value. The way a buyer can protect himself is to pay based on the future performance of the business, and that’s the essence of an earn out. If the business stays strong after Mayor Johnson has sold it, the business value stays strong and he will get his full valuation, over time. Both parties are protected.

 

JIM CUMBEE is President of Tennessee Valley Group, Inc. a retainer-based business brokerage and transition mediation firm in Franklin, TN. Cumbee is an attorney and has an MBA from Harvard Business School. He has a wide range of corporate and entrepreneurial experiences that make him one of the most sought-after business transition advisors in the state of Tennessee.

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Tennessee Valley Group

Jim Cumbee established Tennessee Valley Group to help business owners fulfill their dreams for life after business ownership. It’s a mission that his 30+ year career history had prepared him well for—in addition to being an attorney, transition mediator and business broker, Jim has been a buyer, seller, and entrepreneur. His broad range of experience gives him unique insight into how business buyers and sellers can achieve their goals.