Most founders and CEOs leave preparing their businesses for sale far too late to do any serious changes. Generally they decide that they wish to sell out and it becomes an imperative that they do it as quick as possible. If you think about this a little, you can readily understand why selling quickly is foremost in their minds. For many years they’ve been working diligently in the business and their efforts has been focused on the future of the business, now, all of a sudden, their focus is on life after the business and their willingness to put the same energy into the business reduces – thus the quicker the sale the better.

Suddenly faced with the prospect of selling, they quickly realize that they really should have spent some time increasing the profits so that the valuation on sale would be higher. This is almost certainly based on their expectation that their business will be sold for some multiple of earnings and that the earnings number will be, most likely, the most recent full year result or some variation on it. With this in mind, they quickly try to find ways of reducing costs as increasing revenues rapidly is generally not possible. As they search around for costs to reduce they imagine that they can take some infrastructure costs out of the business which won’t have an immediate effect on revenue generation. This often leads to cutting back on advertising, marketing expenses, research and development, delaying equipment replacement, deferring maintenance of plant and so on. This window dressing takes costs out of the business and immediately improves the bottom line. They now feel ready to put the business on the market and feel confident that the increased profits will gain them an extra kick up in the valuation.

This could not be further from the truth. In fact, what they are doing is rolling the dice on whether a smart or a dumb buyer comes through the door. If they are really unlucky, only the smart ones will be interested. However, smart buyers know these tricks as well and they will diligently go about looking for such adjustments. Smart buyers are looking for sustainable profits. As soon as they see window dressing cost cutting they will simply add back the expenses to get a better view of the long term profitability. However, they will also probably increase their assessment of the risk in the business predicting that they may not have found everything and that the business may need additional investment or time to bring it up to the estimated profits. The increase in risk reduces the earnings multiple thus further reducing the value of the business. The window dressing which the seller had undertaken to improve valuation has now reduced the valuation below that which the seller could have achieved before the cost cutting occurred.

If you want to protect the value of your business at the time of sale, make sure the buyer only sees changes in the business which improve the long term profit potential.

In last week’s post I talked about how to evaluate an angel group with my Letterman Top 10 list. Today’s headline covers #2 of that list (Do they actually have capital and a track record of investing their own personal funds) and is from a story I’ve told at several entrepreneurial events. Although most people would assume it’s a reference to the Bible story, it’s actually from working overseas in a previous life.

Years ago while working in a country that had heavy-handed currency laws, I always had to go to a bank or other government-sanctioned business to exchange money at a ridiculously unfavorable exchange rate. As is always the case in these locales, you could find some enterprising entrepreneur that would exchange your US dollars at a more favorable rate. For many that ventured to do this, the common ploy was to receive an envelope of what looked like a big wad of local currency. In reality there were some actual bills on the outside of the stack and newspaper that had been meticulously cut and placed in the middle to make it look like you were receiving actual money.

With angel investing now in vogue in the US there is a similar con game for startup companies raising money, with many organizations masquerading as angel groups or individual investors. Although it could as easily be described as the angel equivalent of the email scam from my good friend the Nigerian Prince.

Several years ago one of our portfolio companies was invited to present to one of these purported ‘angel’ groups. At the presentation, the founder was approached by several members of the group who claimed to be angel investors. In reality—and after getting their legal hooks into the company and extracting exorbitant fees—were nothing more than consultants that offered to help the company raise money.  At the time the Pasadena Angels invested-and many billable hours of legal time later—we were able to extricate these individuals from the company—although not until considerable damage and expense had been incurred. Unfortunately this is not an isolated instance and occurs frequently.

Aside from making entrepreneurs aware that this goes on, the best advice I can share is twofold. Before proceeding with someone or an organization that claims to be an angel (or any other type of) investor, do some due diligence on that investor. Through websites such as SoCalTech it’s easy to access the old press releases announcing that an angel group has invested in a particular company. Call these companies and ask the tough questions—including how much of the investors’ personal funds were contributed.  If you can’t find any companies, ask the investor for specific ones that you can speak with.

Lastly, the only agreements you should be signing with an investor are the typical investment documents that are prepared just prior to closing on your investment and the money going into the bank. If you’re asked to sign an agreement early in the process or long before an investor has done sufficient diligence, be wary and always seek the advice of a good lawyer. In all of the situations where we’ve had to undo the damage to a portfolio company caused by these unsavory individuals, it was because an unsuspecting company founder had signed one of these consultant’s agreements.

I’m often asked ‘When should I sell my business?”.  Usually they want me to give them some highly professional, probably, theoretically reason based on the state of the share market and their industry. Almost as if I could predict what the Federal Reserve Bank is likely to do in two years time. While I’m sure there are advisors out there who would be willing to speculate on such an alignment of stars and planets, I have come to the conclusion that selling a business has more to do with the interests and motivations of the entrepreneur than the state of the business.

Assuming that the business is making a profit and growing and has reasonable potential, when should you sell? One would hope that the value in the business is growing with increased profits, however, value in a business need not be based on profits. For example, when you sell based on strategic value, the value is determined by what a large corporation can extract from your underlying assets and capabilities rather than on your current or potential profits. Thus your current revenue, profits, staff numbers and customer base may be irrelevant in terms of extracting the premium price. In fact, value may be lost by getting bigger or delaying the sale.

On the other hand, a conventional business does generate value through increased profits, but the right buyer who can exploit the business much better than the current owners may be willing to pay well beyond conventional revenue or EBIT multiple to have that opportunity. It might be better to sell now to someone who can better exploit it than you.

Also clearly the future cannot always be predicted with any accuracy. Look at the likes of Enron, Arthur Anderson and so on. Who would have predicted their demise?

Instead focus on your own motivations and potential. Is this the right business for you or should you put your effort into a different business?  Could someone else take your business to a new level thus providing a better workplace for your employees?  Do you have passion for a different type of business? Are you physically and mentally able to continue with the business or would you be better off getting out of this one and reshaping your life?

Ask the personal questions first. What do you want to do with your life and is the business giving you what you want? Would you enjoy life better if you took the money and did something else?  Where is your passion and your interest and are you following that in your business?

Business for entrepreneurs is their life. Find a business which you have a passion for and then spend your time there – don’t waste your life and your passion where you don’t have fun.