The danger of market-timing a sale

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Writing for The Globe and Mail over the past two years has been a treat for me but I've decided it's time to stop talking about running a business and get back to actually running one again. I've recently launched a new software business and will be dedicating my time to it. This is my last column. Thank you, readers, for sharing your time with me.

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Report on Business Magazine: The December issue

The other day I was speaking with a successful chief executive officer in his fifties who runs a heating and air conditioning company generating $8-million in revenue and more than $1-million in profit before tax.

Even though he was tired and nearing burnout, he was planning to wait another five to seven years before selling his business because he “wanted to sell at the peak of the next economic cycle.”

On the surface, his rationale seems to make sense.

If you speak with mergers and acquisitions professionals, they’ll tell you that an economic cycle can affect valuations by up to “two turns,” which means that a business selling for five times earnings at the peak of an economic cycle may go for as low as three times earnings at a low point in the economy.

The problem is, when you sell your business, you have to do something with the money you receive, which usually means buying into another asset class that is being affected by the same economy.

Let’s say, for example, that you had a business generating $100,000 in pre-tax profit in an industry that trades between three times and five times earnings, depending on the point in the economic cycle.

Furthermore, let’s imagine you sat on the sidelines until the economy reached an absolute peak and sold your business for $500,000 (five times your pre-tax profit) in June, 2008.

You took your $500,000 and bought into a TSX index fund when it was trading above 15,000. By Nov. 20 of the same year – after the TSX had dropped to 7,724 – you’d be left with about half of your money.

Even though you cleverly waited until the economic peak, by Nov. 20, 2008, you would have effectively sold your business for 2.5 times earnings.

The inverse is also true. Let’s say you waited “too long” and sold the same business in November, 2008.

Because you were at the lowest possible point in the economic cycle, you only got three times earnings: $300,000. Notice that’s 20 per cent more than if you’d sold at the peak and bought a TSX index fund at the top of the market.

Just like when you sell your house in a good real estate market, unless you’re downsizing, you usually buy into an equally frothy market, which is why timing the sale of your business on external economic cycles is usually a waste of energy.

Instead, I’d recommend timing the sale of your business when internal economic factors are all pointing in the right direction: employees are happy, revenue and profits are on an upward trend, and there is still lots of market share for an acquirer to capture.

When internal economic factors are pointing up, you’ll fetch a price at the top end of what the market is paying for businesses like yours right now, which means that – for good or bad – you get to use your new-found cash and buy into the same economic market you’re selling out of.

Special to The Globe and Mail

John Warrillow is a writer, speaker and angel investor in a number of start-up companies. You can download a free chapter of his new book, Built to Sell: Creating a Business That Can Thrive Without You.

Join The Globe’s Small Business LinkedIn group to network with other entrepreneurs and to discuss topical issues: http://linkd.in/jWWdzT

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