Founder-Owned Businesses In Demand

A founder-owned business is owned and managed by the individual or team of individuals who originally formed the company. Many business buyers – particularly private equity groups – desire to purchase founder-owned businesses because they are often stable and successful enterprises with a long-term track record of success. Founders of businesses have an entrenched financial and emotional commitment to the health of the business, and often create strong relationships with customers and staff. Prior to selling, founders should reduce the level of owner-dependency by strengthening the management team and quality control over day to day operations. When valuing a founder-owned business, the founder’s salary, personal expenses of the founder, and non-recurring expenses which benefit the founder (and the founder’s family) should be added back to the adjusted owner benefit or true economic profits derived by a working owner.

Timing the Sale of Founder-Owned Businesses

Founders of successful businesses often desire to sell their business in order to create a legacy of financial security for their family, and to ensure the buyer is culturally-aligned with impacting the community in a positive way. Financial security is best met when the timing of the sale occurs when sales and profits are strong and on an upward trajectory (especially in cyclical industries such as construction). Since business sales typically take 6-12 months on average, it is best for founders to examine their options and begin the selling process well before their targeted exit date. Finding culturally-aligned buyers may also mean that the sale of a founder-owned business may take longer than average. Often, competitors in the same industry make excellent buyers of founder-led businesses since they are likely to be already aware of the unique competitive advantages built up over many years by the founder.

Valuing Founder-Owned Business

When valuing a founder-owned business, it is essential to understand the precise role the founder currently has in the company. The more absentee and removed the founder is from day to day operational roles – especially regarding relationships with customers and staff – then the more comfortable the buyer is that the goodwill of the business will be fully retained after the sale. This will serve to enhance the valuation of the business as the buyer will be more certain that the future cash flow of the business will not be impaired when the founder is no longer the owner. A strong and transferable management team along with a low level of owner-dependency are critical factors when valuing founder-owned businesses. Otherwise, buyers will be afraid that customers or staff may not stay after the sale and will thus not pay a premium valuation.

Adjust Financials of Founder-Owned Businesses

The financial statement such as a tax return or profit and loss report of a founder-owned business must be carefully adjusted in order to showcase the annual adjusted owner benefit or true economic profits derived by a working owner (also known as Seller’s Discretionary Earnings).
The valuation of most founder-owned business is a multiple of the annual adjusted owner benefit, so it is incumbent upon the business broker to maximize the annual adjusted owner benefit and clearly explain to buyers how it is derived.
The reported net income on the financial statement often does not reflect the adjusted owner benefit since personal expenses, non-recurring expenses, or expenses that would not be paid by a buyer still flow through the financial statement.
These expenses are referred to as add-backs because they are added back to owner benefit as expenses that will be borne by the buyer after the sale.
Founder-led businesses also frequently pay salaries to the founder and the founder’s family members.
It is appropriate to add-back the founder’s salary unless the founder’s role in the business is so specialized and skilled that a buyer may not be reasonably expected to replace them.
Fully adding-back the salaries paid to family members of the founder is always appropriate when the family members are absentee.
If the family member works in the business, then their replacement costs should be deducted from their full salary expenses when determining the add-back to owner benefit.
Further, any legal, occupancy, or real estate expenses on behalf of the founder should be added back to owner benefit so long as they are not recurring or not legitimate business expenses.

Founder May Retain Minority Stake

Since founder-owned businesses are often dependent upon the vision, leadership, and specialized knowledge of the founder, buyers often to wish to incentivize and align the founder’s interests after the sale with the long-term success of the business. This is often accomplished by allowing the founder to retain a minority stake in the business through owning shares or membership interests in the buyer’s newly formed corporate entity. Assuming the founder believes the buyer is capable of growing the business, this makes sense for many founders who still wish to enjoy benefits from the business long after the sale. Another way in which a buyer may align the founder’s interests with their own is from seller-financing part of the purchase price or by offering an earnout. Unlike seller-financing, an earnout is tied to the future performance of the business and offers a founder no security in case the buyer does not make good on future payments.

Founder-led business owners should always confidentially consult an experienced business prior to the sale in order to properly value their business. The valuation must be based on the annual adjusted owner benefit with the valuation multiple incorporating the founder’s role in the business, the transferable goodwill, and the unique competitive advantages of the business which sets it apart in the marketplace.

Give Martin at Five Star Business Brokers of Palm Beach County a call today at 561-827-1181 for a FREE evaluation of your business.