“I remember the first time I closed a big deal – was for about 50,000 bucks. That evening, I went out and got myself a fancy watch – that probably cost me half as much,” my friend Murali recounted. He’d been invited to talk to a group of young entrepreneurs, who were looking for mentors. “I was so ignorant, that I didn’t know that revenue is not profit,” Murali continued. “And of course, I knew nothing about revenue versus cash flow even. So here I was spending money that I didn’t have and in hindsight couldn’t have afforded to spend, even if I had it.”
Murali is by no means the first entrepreneur to fall into this particular hole. He’s the one that I’d seen recall it with the most relish and absolute candor. His point was that doing business requires a good understanding of financial basics. Not an MBA but just plain nuts and bolts of understanding, what revenues are, net and gross margins, cash flow versus revenues. In other words everything your mother, or for those of you lucky enough, your spouse, felt you should learn about budgeting and handling money. And of course if he could do it, so could you – was his unstated message.
This is never more evident or critical than when you set out to sell your company.
As entrepreneurs when we engage in sales conversations, we tend to focus on the “selling price” a great deal. And all too often, they mistake their selling price with the cash that may flow into their accounts. This is made a lot worse, especially when the negotiation is around selling their business.
“How much money do you want to have in your bank, after this whole thing is done?”
You’d think this is a simple enough question to answer. And it is. This is usually the first question I pose to entrepreneurs when they talk about selling their business. Most of them, after some initial hemming and hawing, are able to give reasonably specific answers – “A million dollars. five crores.” It’s almost always a round number. I don’t ask why that number, whatever it is. But have a slew of other questions? The first one I ask them, is this before or after taxes? And what if it is not in cash but in stock? What if it is deferred or staggered in time? Against deliverables or future performance? And how would you partners answer these same questions? By this time, the entrepreneur’s turned quiet and introspective. Given how often this conversation takes place, I reckoned it makes sense to capture these starter questions.
How much money do you want to have once everything is done? The answer to this obviously is a very personal thing. One woman’s 250K maybe another woman’s billion dollars. But this is the amount you want – never mind if you will get it – in your bank account with NO strings attached – no further taxes to pay and no assumptions about what more you may get. In other words, you would be perfectly willing to walk away from you business, for this much money in the bank NOW.
What taxes are you liable for? Knowing this is critical. Keeping the usual disclaimer, that I’m no tax expert and this should not be deemed as any sort of competent tax advice, consult your own tax advisor, recognise that you are liable for capital gains tax – which may vary from taxed as straight income (up to 33% in some cases) to varying degrees (long-term vs short-term, privately held vs publicly held) and liable to state or local taxes in some jurisdictions. In other words, if you wanted to still have that X million dollars, you may have to clear (x/(1-tax rate) (1.5M to have 1M left over after 33% tax for instance)
Will the cash all come in tomorrow or will some of it be deferred? Does this matter? It may if you need or want all the money now. It may also matter whether the amounts are deferred simply over time, to retain you for instance or they are tied to performance or other deliverables. In both cases, will you be ready to walk away if you got nothing beyond the first payment or tranche? If so would you revisit your answer to the first question?
Will it all be in cash? While our answer may always be yes, reality may not be. And getting some of it in stock may not be all bad – but as my mentor Chandrashekar would put it, balancing your need and greed is important. And how would this change your answers to the questions we’ve already asked?
Finally, how would your partners answer the above questions? Whilst what you need or want should, in an ideal world, be not influenced by what your partners want, reality is that a good deal can be consummated only if all parties are at least semi-clear on what they want. While this is NOT critical, as with salaries or many things in life, we might be happy with the answers we come up with, till we find out what the other guy is making. So thinking about it and factoring it in, helps our mental wellbeing if not our bank accounts.
In an earlier article, I spoke about Valuation 101 – how you can value your company. The reality is that your answer to the first question “How much money do you want to have once everything is done?” is really what sets the valuation of your company – or the walk-away price. So stop reading and get out a piece of paper or a spreadsheet if you prefer and begin answering these questions as the second step to selling your company. For those still looking for the first step – you can find it here.
As many companies that I’ve been involved with grow past their fifth or even seventh anniversary, they are facing new questions around exits – be the outright sales or mergers or in some case existential questions. I’m hoping to write about these questions in what I’d like to think of as “Selling your startup” series