Dig Deeper

I wrote recently about the wonderful experience I had this spring teaching a new graduate seminar that explored how entrepreneurship shapes our economy, society and culture. 

What all of the students came away with is an understanding of the true complexity of the issues we face today.  The standard my party is better than your party debate and the bumper sticker solutions that seems to always lead us to just doesn’t cut it in times like these.  They discovered how essential it is to dig deeper into the fundamental assumptions, the data we have on what works and what doesn’t, and the longer term trends.

The Acton Institute has put together a powerful resource page that provides deep and thoughtful analysis of the current crisis and possible solutions.  It also dives into the moral and cultural issues that are so intertwined with any set of economic policies. 

Brew a fresh pot of coffee and explore some of the writings they are collecting at this site.

Don’t Assume it is not a Good Time to Exit

I have been hearing of an increase in the number of people selling their businesses over the past few months.  Financially strong companies and cash rich investors looking for good acquisitions are starting to move in the market.

Since it is a buyers’ market right now, you need to set realistic expectations going into any discussions on selling your business.  From CNNMoney.com:

Of course, if you want to sell your company right now, expect it to fetch a lower price.

“Investment bankers say that valuations have dipped from a year ago by multiples of one-half to one point,” [John] Brown, [president of Business Enterprise Institute] says. “So if businesses were selling for six times EBITDA [earnings before interest, taxes, depreciation and amortization], today it’s five or 5½ times.”

What I am hearing is about the same drop in earnings multiples — about a one point drop.  However, most of the deals I have been seeing are running 3-4 times EBITDA, down from 4-5 times EBITDA a couple of years ago.

What does that mean?  Just like your home value, your business value has dropped 20-25% all things being equal.

But remember — the other part of the valuation equation is the profitability of the business measured by EBITDA.  Most entrepreneurs have reported a significant drop in their profit margins over the past year.  So that means that the drop in value could become much greater than 20-25% if profits are also down.

My advice:

  1. Understand what drives the value of your business.  It is most often some multiple of EBITDA.  The most common range historically has been 3-8 times.  What multiple you are likely to get is based on your projected growth, the health of your industry, the strength of your customer base into the future, and specific strategic advantages that you may be able to offer the buyer.  Currently, most multiples are 2-5 times EBITDA.
  2. Know your number.  If you need a certain amount of money from your business to retire, have that number in mind going in.  If the market is not supporting that value right now, you might want to wait until it does.  Use that time to improve your EBITDA so that when the economy picks up you will have an even greater value.
  3. Seek expert advice.  Work with your CPA and an attorney who specializes in Mergers and Acquisitions to understand the process and to help set realistic expectations.  You will have to invest some money up front, but it is money well spent.
  4. Realize that deals change.  Once the buyer gets into due diligence the price may drop.  Once they learn more about your business they may lower their projections for what your business can do in the future.  Be prepared for this, and know how much you are willing to go down ahead of time.  Be ready to walk away if the price they are willing to pay drops too much.  Don’t let your emotions lead you to take an overly discounted price — buyers can smell desperation and will use that to their advantage by trying to drive down the price during due diligence.

The odds are that about one out of fifty inquiries about buying a business will lead to an actual closing.  Keep that in mind right up until the deal is closed.  I have seen more than one deal collapse at the closing table.  Keep a level head and don’t spend the money until you actually have it in hand.  In fact, I recommend that you should not even dream about how you’ll spend it until you get it.

Small Business Owners Still in a Funk

The National Federation of Independent Business Index of Small Business Optimism fell 1.6 points in March to 81.0 (1986=100), making March the second-lowest reading in the 35-year history of the NFIB survey.  Two of the index components improved and eight declined, but nothing in the survey indicated a signal that the economy is improving.

Small business owners have yet to be impressed by some recent slightly encouraging economic news.  They remain skeptical, unwilling to commit to more spending or hiring until they see more customers in their stores.
 
The hard components of the index, those measuring owner spending and hiring plans, actually reached a survey record low.

“At this point, it is not clear that we have hit a quarterly bottom in the index, and we can only hope for a reversal and subsequent expansion led by the small business sector,” said NFIB Chief Economist William Dunkelberg.  “There are signs that the economy is bottoming in the reports of sales, housing starts and auto purchases, but they were not strong enough in March to lift the spirits of small business owners.”

Bootstrapping Should be Part of Self-financing Formula

While I was off the grid over the Easter weekend, my Sunday column about self-financing and bootstrapping ran at the Tennessean:

The thought of having to put your life savings, your home, or your retirement accounts at risk to launch a new business can send a chill down the spine of even the most committed entrepreneur.

And for the accidental entrepreneurs who have to start a business to make it through the current recession, it can create an almost paralyzing fear.

But self-funding is a part of the financing equation for almost every new business.

The base of self-funding comes from the entrepreneur’s personal savings. When my partners and I started a health-care business in the 1980s, we had to rely on our savings to help us start the venture.

As the owners, we only received paychecks about half the time during the first two years. By having savings in place, we were able to maintain the lifestyle we had experienced before we launched the new venture.

Entrepreneurs come in all sorts of packages. Some new businesses need to be developed while the owner continues to work at another job.

If your business can be worked on during any time of day, find a day job that can pay the bills. Or, be prepared to take on an evening job, such as waiting tables or bartending, to help create a bridge until the new business brings in a steady income.

Of course, at some point the business will demand too much time to allow you to maintain two jobs. Hopefully, this will occur at a time when the new venture is able to pay you a regular salary.

Learn to pinch pennies

Banks generally do not lend money directly to startup businesses. However, you may be able to get a personal loan that you can use for the business. If you have enough equity in your home, you may be able to secure a second mortgage.

Another option is to put up property such as stocks that can serve as collateral to back a personal loan. Understand that such loans put your personal property at risk, if you default on the loan.

The most effective means you have to minimize the amount of cash you will need to put into a business is to find ways to bootstrap or shave dollars off your startup costs.

Bootstrapping can help reduce the time it takes to reach break-even in the business by reducing the overhead expenses you have to pay every month. That is why so many entrepreneurs start their businesses out of their kitchens, their garages or their basements.

Bootstrapping can also reduce operating costs, giving the owners more profit from each dollar of sales. The sooner you reach break-even and cover your basic expenses, the sooner you will have enough cash flow to pay yourself a salary and stop putting more of your own money into the business.

Theme for the Day — Bootstrapping

Yesterday ended up being a “bootstrapping” kind of day.

In my class during the day, Clint Smith, co-founder of Emma, talked to my students about his company and its growth.  He told my students that bootstrapping is best described as “you don’t get it until you have to have it.”  He went on to say that with that comes a trade-off.  “It takes longer to get out ahead of your growth.”  So patience is a virtue that bootstrappers must have as they build their businesses.  Good advice!

Then last evening I met with a new group of local entrepreneurs, called Better Bootstrap,  who are getting together once a month to talk about all things bootstrapping.  This was their first meeting and about two dozen people showed up — a great initial group.

The group heard from local entrepreneur, Ernie Clevenger, who co-founded a company called Care Here.  It has grown from a highly bootstrapped start-up into a very impressive operation.  Since they had no money during their launch, they had to find creative ways to bootstrap their company, which establishes in-house medical clinics for employers.  This is not the typical kind of business one might think of to bootstrap, but they did, and it has yielded remarkable results.

The group then shared some of their own bootstrapping challenges and got some useful feedback from their fellow entrepreneurs.

The Better Bootstrap group is something that I think could and should serve as a model for other communities.  Bootstrapping entrepreneurs, just like any business owners, need help, advice, and wise counsel.  The problem is that they often cannot afford to join typical business organizations.  This group charges no dues — you just have to agree to try and buy a little food at the restaurant where they hold their meeting.

Tech’s Future in the Recovery

Tim Jackson, Canadian entrepreneur and venture capitalist, offer his thoughts on our economic future in an interview by Gordon Pitts at ReportonBusiness.com.  Here is a sample of what he had to say:

So if you are laid off from your job and have a business idea, what do you do?

You beg, borrow, steal and you get it going – and you find a customer.

I know that sounds overly simplistic and there are certain companies where you need a venture-backed business because it will take three or four years to develop the technology. But traditionally, businesses have been started by designing something or creating a service or a product.

Then you went and sold it, and you used the revenue from the first customer to get your second customer and improve the product slightly. The revenue from the second customer was used to improve it again and you get the third customer.

We saw 300 companies last year [and funded two] and the vast majority should never have been looking for venture capital. Our advice is just go and start the company. Go and sell this. If you have something people will buy, they will partner with you and you can build a business.

Great advice not only for the accidental entrepreneur, but anyone starting a business.  Your goal is never to raise money — it is to build a business.  If you are successful at that and eventually need funding, it will follow.