by Dave Driscoll
In a previous article, we differentiated the business cycle for a lifestyle business from the mergers & acquisitions (M&A) market. But what qualifies as a “lifestyle business?”
A lifestyle business is usually founded by one or more owners who believe they can financially support their families and “lifestyles” with their specific marketable skills and talents. In many cases, there are no other shareholders, giving the owners more control in the operations of the business. The focus is often on achieving and sustaining the owners’ particular lifestyles.
When people hear the phrase lifestyle business, they may think of small, part-time, or home-based businesses. However, many small lifestyle businesses have grown to be successful larger businesses due to the founders’ skill in recognizing and exploiting a niche.
Building a business in support of a specific lifestyle is certainly a valid business strategy. My own business, Metro Business Advisors, as well as my previous business (Ambassador Envelope Co.) can both be classified as lifestyle businesses. Other examples include small, market-focused brokers or distributors, manufacturers’ representatives, and consulting firms. To repeat—lifestyle businesses are a valid business structure, BUT there are implications if the owner desires to sell the business. Market value and transferability can limit a successful transfer.
Selling a lifestyle business can be dependent on the size and level of operational sophistication the business has achieved under the founders’ leadership. Where is the business on the technology/operational curve?
Whether the business is behind, on, or ahead of the curve will become apparent when analyzed by a potential acquirer. The business may be constricted by technology and an obvious lack of investment. Likewise, the company could be well ahead of the curve, reflecting the owner’s desire to keep the business competitive through continued investment. These are significant choices that must be made along the ownership journey because these factors impact whether the owner will be able to sell the business.
A buyer will not pay top dollar for a business that needs substantial capital investment to be competitive, or if future profits are at significant risk due to owner dependence or failure to adapt to industry changes.
Advantages of a Lifestyle Business
The advantages of starting a lifestyle business include being able to control most aspects of the business. Additionally, due to the necessity to “boot strap” and be conservative with cash and expenses, there is usually a positive cash flow from early in the business’s growth, enabling the owner to eventually pursue personal goals with profits from the business.
Most advantages revolve around the common theme of freedom.
- Time: freedom to choose when to work (or not!)
- Financial: generate income sufficient to support a desired lifestyle
- Fulfillment: opportunity to pursue passions, talents and interests
- Location: ability to choose where to work.
Disadvantages of a Lifestyle Business
- Funding sources are limited.
- Founder’s talent is not easily replaced, creating owner-dependence.
- Customer relationships are typically tied to the founder.
- Recruiting top talent is difficult due to limited compensation.
- Business value is difficult to transfer to a new owner.
- Potentially very few assets are available to sell beyond a client list and goodwill.
- When sold, does not provide a lump sum for retirement.
Advice for Selling a Lifestyle Business
Ultimately, the owner(s) must decide whether the goal is to have the business solely support their lifestyle and freedom, or to build an asset that has value transferable to a buyer/investor in the future.
To build a lifestyle business to sell, we recommend following this advice:
- Start building sellable value many years before you intend to sell. Pick a chronological age or end date to help in defining your plan (realizing that may change based on circumstances beyond your control). Building value takes time, so if you want to sell next year…it’s too late. The cake is already baked.
Implement value-building strategies at least five years prior to your target date.
- Reduce business dependence on you. Any business that needs the owner’s daily attention to succeed has no value and cannot successfully be sold. Establish a second-in-command and build a bench of competent leaders who can operate the business. Training and empowering your employees are mutually beneficial ways to eliminate owner dependence. In the meantime, the business will also benefit from the increased employee engagement and commitment.
- Distinguish between the business and your identity. If you and your clients can’t differentiate between you and your business, it’s unhealthy on both sides. You were naturally the face of your company when you founded it, but past the startup phase, your company needs a corporate identity separate from your personality. On the personal side, this will also help you emotionally detach when you exit the business.
- Share the relationships. If clients and vendors only communicate with you, at best, they will be nervous about new ownership. Knowing and trusting other employees offers the needed reassurance that service and quality will be consistent after the sale to a new owner. Ensure that client loyalty lies with the company, not with you personally.
- Create a competitive niche. Your business should be focused when it comes to services/products and target clients. Zeroing in on your company’s core strengths will be more productive than trying to be all things to all customers.
- Invest in technology and training. Make sure you are at least on the curve, not behind it. Transferable value requires that the business is up to date with capital and human investment.
- Document historical financials accurately. Businesses operating within a niche while sustaining a competitive advantage and demonstrating historical positive cash flow are most likely to be sold. Remember: You can’t sell value that you can’t prove.
Note, historical cash flow does not mean last year and the year before. Business value is based on performance over the past five years. To sell your lifestyle business eventually, you need to build and demonstrate value with at least five years of established, rock-solid fundamentals.
To conclude, as a rule of thumb, the basic valuation of a small business ranges from 1.7 to 2.85 times free cash flow (including owner compensation and benefits). However, that calculation is meaningless if the talent and skills that clients rely on cannot realistically be transferred to a buyer. Implement the advice above to help make your lifestyle business sellable and maximize the amount you reap to fund your life beyond business.™
Dave Driscoll is president of Metro Business Advisors, a business brokerage, valuation and exit planning firm helping owners of companies with revenue up to $20 million sell their most valuable asset. Reach Dave at DDriscoll@MetroBusinessAdvisors.com or 314-303-5600. For more information, visit www.MetroBusinessAdvisors.com.