Will 2012 Be the Year You Start a New Business?

When you're entering the fifth year of a grueling economic downturn, it's easy to get discouraged. But some would-be entrepreneurs aren't letting unemployment figures get them down -- they're seizing the chance to start their own business.

While the tough economy poses challenges, there are also some distinct advantages to starting a business now, including:

• Cheap real estate
• Affordable leases and cooperative landlords
• Weaker competition
• Vendors willing to offer generous terms
• Low-cost advertising options

Most importantly, there's the thrill of chucking a job you hate -- or maybe a floundering small business that's not working -- to try out a new idea.

The biggest hurdle to jumping into entrepreneurship usually isn't economic, anyway -- it's between your ears. On the new Halogen network reality-TV show Jump Shipp, author Josh Shipp (The Teen's Guide to World Domination) helps people who're stuck in a dead-end job (or relationship) to break free and pursue what they really want.

Many of the stories are about would-be entrepreneurs who're trying to get up the gumption to take the leap and start their own business. In a recent episode, graphic designer Debbie Lee longs to become a freelancer in her chosen field, but is stuck working in her family's jewelry business, now distressed by the bad economy.

With Shipp's help, she gets both a realistic assessment of her portfolio and how to get it in better shape to land gigs, and moral support for breaking the news to her parents that she wants to quit working in the family business.

In another episode, a talented graphic novelist gets a push from Josh to take the plunge and try to make a living from her art.

"Her kryptonite is lack of commitment," Shipp notes. Isn't that true of so many people who wish they were starting a business, but never seem to get around to it?

THE DANGER OF MARKET TIMING THE SALE OF YOUR BUSINESS

The other day I was speaking with a successful CEO in his fifties who runs a heating and air conditioning company generating eight million dollars in revenue and over one million dollars 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 impact 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, you had a business generating $100,000 in pre-tax profit in an industry that trades between three times earnings and five times earnings, depending on the point in the economic cycle.

Furthermore, let’s imagine you sat stealthy on the sideline until the economy reached the absolute peak and sold your business for $500,000 (five times your pre-tax profit) in October 2007. You took your $500,000 and bought into a Dow Jones index fund when it was trading above 14,000.  Eighteen months later  – after the Dow Jones had dropped to 6,547.05– you’d be left with less than half of your money.

Even though you cleverly waited till the economic peak, by March 9, 2009, you would have effectively sold your business for less than 2.5 times earnings.

The inverse is also true. Let’s say you waited “too long” and sold the same business in March 2009. And because you were at the lowest possible point in the economic cycle, you only got three times earnings: $300,000. Notice that’s 20% more than if you’d sold at the peak and bought an 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.

External vs. internal economic cycles

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 newfound cash and buy into the same economic market you’re selling out of.

How Do I Build A Valuable Company?

My entrepreneurial journey has seen me start and exit a number of companies. I want to share three of my best tips for building a valuable – sellable – company.

Tip No. 1: Make it all about a number of clients, not one client

It's common for a business to be dominated by one or two important customers. It happens pretty naturally. You do a good job for one customer, and they buy again. You keep satisfying them, and they stop looking for other suppliers and start to bring more and more of their orders to you in hopes you can handle the increase in business while maintaining your amazing service.

Given their importance, you're probably also servicing this giant customer personally, which makes them even more profitable because you do not need to hire sales or service staff to support the account. This, of course, makes both the account and your business very profitable—which makes it harder to walk away. It's a cash cow.

Pretty soon, you have a codependency that can undermine the value of your company—and make it virtually impossible to sell. For example, an acquaintance of mine owns a business that supplies a product to the home improvement chain Lowe's. In some months, Lowe's makes up more than half of his revenue, which is why, when the U.S. housing market crashed and Lowe's slashed the size of its orders and slowed down its payment cycle, my friend's business teetered on the brink of insolvency.

Desperate for cash, my friend tried to sell his company to both strategic and private-equity investors, all of whom offered him pennies on the dollar (when compared to the value of similar businesses) because of his reliance on just one customer.

To build a valuable company—one you can sell if you choose—you need to winnow down your reliance on any one buyer. My suggestion is to strive to ensure no one customer represents more than 15 percent of your revenue.

Tip No. 2: Increase your customer base

We survive the early years of our business by listening to our customers and responding to their requests. The problem is, when all you're doing is reacting to customers, you end up offering way too many things—customizing too much—because everyone wants a slight twist on your offering.

If you offer an ever-expanding list of things, your staff will never get really good at making or selling anything. The broader your product or service line, the more your business will be reliant on you—the person with the most knowledge in your field—rather than your employees. If the business is too reliant on you personally, it will be hard to sell.

To pull yourself out of this quagmire, you have to sell less stuff to more people. That may seem like counterintuitive advice, but some of the fastest-growing, most valuable companies in the world do it.

Take Apple for example. Apple is really good at selling a few core products (iMac, MacBook, iPhone, iPod, and iPad) that offer the same basic user interface. As a result, the company can train its Apple Store employees on one basic operating system and a few core products.

By contrast, walk into a Best Buy, with thousands of technology products running hundreds of different operating systems. If you're actually able to find someone to help you, you'll be lucky if they can read the specifications on the back of the box, let alone actually know anything about the product.

Focusing on selling less stuff to more people will allow your business to scale up beyond you, which in turn will allow you to grow through the ceiling that holds back many owner-dependent businesses. Ultimately, you'll have a company you can sell.

Tip No. 3: People want to work with you because you are the BEST at what you do.

Quick—how do you explain your business in a social situation? Do you define yourself by your industry? For example, "I own a printing company." Or do you describe what makes your business unique? For example, "We've developed a process for printing annual reports that reduces the turnaround time to three days."

The problem with describing yourself as a part of an industry is that most industries are commoditized. You're sentencing yourself to a life of low margins and groveling for work. When there is nothing unique about your business, the customer has no choice but to rely on price as the only decision-making criterion.

And before you claim "customer service" as what makes you unique, remember that people don't buy wishy-washy claims as a point of differentiation. After all, service is in the eye of the beholder, and until your prospect makes the decision to become a customer, intangible claims about how well you treat your customers ("offering great customer service since 1977," "specializing in great customer service") will not sway them.

Instead of describing your business in terms of the industry you're in, accompanied by some vague description of your service, describe in concrete terms what makes your business different. For example, under Tony Hsieh, Zappos became a successful company (Amazon acquired it in 2009) not because it's a retailer of shoes but because it offers a two-way free-shipping policy.

One-way free shipping is standard for a lot of e-tailers, but Zappos offers to ship your shoes free and then if you don't like them not only refund your money but also pay to pick them up. "Great customer service" is a wishy-washy claim. "Free returns" makes Zappos special and is a big part of what sets it apart. A shoe retailer is a boring commoditized business with low margins and very little hope of being acquired. A company that allows people to return shoes if they don't like them, all from the comfort of their own home, is unique and a big part of the formula that allowed Zappos to scale up into a sellable business.

Stop describing the industry you're in and start describing what makes you irresistible.

Mistakes to Avoid before Selling your Business

Are you planning to sell your business in the next few years? Here are eight mistakes to avoid before calling it quits:

Mistake 1: Being boring

While it is true buyers like predictability, they also like growth. Set aside a small slice of money for experimenting on new things (product ideas, etc.). The BBC, for example, has a “gambling fund,” which it uses to fund experimental programs that fail the typical new program development testing cycle. It was through the gambling fund that the blockbuster t.v. show “The Office” received funding.

Mistake 2: Selling your product, not your business

A buyer will need to see that your company has a way of winning customers without you. Hire salespeople or invest in marketing so that your business is less reliant on you as a rainmaker. Start thinking of your business as your most important “product” and invest your sales energy in meeting with people who might buy your business, not your product.

Mistake 3: Staying married

Eighty-four-year-old Hugh Hefner told The New York Times last year, “If I sold it (Playboy Enterprises), my life would be over.” If you’re too emotionally connected to your business, it will be difficult to get the price you deserve and will leave you feeling as though you’ve lost a family member after the sale. Instead, slowly start cultivating interests (e.g., travel, another business idea, charity, etc.) outside of work to ease the transition.

Mistake 4: Using retirement income as the basis of your number

Succession planners will tell you to figure out how much income you want in retirement and make that the basis for calculating how much money you need to get from selling your business. The reality is, your business is worth what someone will pay for it and has nothing to do with how much you need to retire. You’ll likely be bored after selling your company, so after taking some time to decompress, travel and play, you’ll probably find yourself starting something new anyway.

Mistake 5: Not including survivor clauses in your contracts

Acquirers like to see that you have locked customers into long-term agreements, but if your customer contracts do not have a “survivor clause” to ensure they remain enforceable after a change in ownership of your company, they may be moot. Talk to a lawyer to make sure an acquirer will get the benefit of the contracts you’ve got with customers after you’re gone.

Mistake 6: Sharing equity with key employees

It’s tempting to use equity or options to retain employees you want to keep through the negotiation and sale of your company. However, you can achieve the same result with a simple “stay bonus,” which you offer key employees who remain with your company for a period of time after the sale. A stay bonus is a lot simpler to implement, doesn’t muddy your company’s capital structure and may end up costing you less in the long run.

Mistake 7: Leaving your team rudderless

A lot of big-personality founders set the tone for their business through their personal charisma, but if you want to sell your business, you need to make sure your company has a set of values independent of you. David Ogilvy handed out Russian dolls to his managers as a reminder of the perils of hiring successive layers of smaller and smaller people. Ogilvy sold his shares in his agency and retired to a castle in France, where he ultimately passed away, but the dolls live on in the hallways of Ogilvy offices as a reminder to managers to always hire people smarter than they are. Find a way to remind employees of your values when you’re not around.

Mistake 8: Not having a BATNA

Professional negotiators suggest having a best alternative to a negotiated agreement (BATNA) — that is, a plan B in case negotiations to sell your business stall. For example, if you’re planning to sell your business to a strategic buyer, also have a financial buyer keen to make an offer or a management team with the means to buy your business over time. That way, you’ll have more leverage when negotiations get dicey.

Have you ever sold a business? If so, what you would you do differently next time?

Should You Develop a Business Exit Strategy?

Whenever you create something that's interesting and useful, you create something that's worth selling. And when you're thinking of selling something that's as vital to you as your business, it's best to have a well-developed plan firmly in place.

In business terminology, an ending for a business owner is called an "exit," while the planning of a defined ending is called an "exit strategy." Having an exit strategy tells others who have the occasion to view your business that you're in control of your business, that you're aware and goal focused, and that you have a plan for an organized and profitable ending.

Business owners who don't plan for ownership transition are often faced with the inability to receive enough money in an ownership change to fund a comfortable retirement. This doesn't happen because such owners failed to create value in their businesses; rather, it's because they failed to do the planning that would have allowed them to keep that value.

If you are just starting your business and intend to seek angel investors or venture capitalists, those investors will require that you have a viable exit strategy in place before they'll award you a dime. Business owners who are approaching retirement may want to sell their business to an outsider, a key employee, or to a co-shareholder or partner. Alternatively, they may want to transfer their interest intact to children or other family members. How can all of this be accomplished? You got it — with an exit strategy.

If you've been in business for years and are just now thinking of developing an exit strategy, don't despair. But do start your exit strategy today, keeping in mind that defining it is a process that requires careful thought. Rather than being something you'll finish in 10 minutes, this plan takes time, both now and in the future. Continue to revisit your exit strategy as your business grows.

All strategic exit plans should identify the following key topics:

• Current valuation of your business
• The factors that drive the value of your business
• Methods to increase your business value
• The potential future value of your business
• Your options for ownership change
• Likely tax implications of ownership change
• Tax-saving methods specific to your business
• Your likely proceeds from strategic ownership change

Set Up a Strategy

Let's say you accomplish the above imperatives and realize the current valuation of your business isn't what you thought it was, perhaps because you were off the mark when you originally determined the factors that drive your business's value. These two factors play into a third: your likely proceeds from an ownership change.

In cases like these, you'll need to amend your exit strategy or potential buyers won't be interested. Maybe expenses need to be reduced, better buying practices put into place, tighter controls placed on accounts receivable, improved service or focused sales and marketing initiatives need to be considered.

You get the picture. With a proper business valuation and some exit strategy planning, you can provide for a smooth transition and make the business more valuable and desirable. Alternatively, you can ensure that it will be turned over to family members on the most favorable terms to you, with the lowest tax consequences legally possible.

With your exit strategy in hand, work each day to make the decisions and moves that will position your business to reach your exit goal.

Can you use your 401k to buy a business?

As of May 1, 2008, the Small Business Administration (SBA) requires 25% down from the buyer versus 20% down. SBA lenders are also now requiring the buyer to spend $2,500 to $3,500 for a third party valuation in addition to their hefty fees. Because of these changes along with the tightening up of financial institution, many of our buyers are opting to use their 401K funds to purchase a business.

There are several IRS approved companies that will set this up without any tax consequences or penalties. Here is how it is done. Either the approved IRS company can set up a new "C" corporation for you or you can have your attorney do this. The "C" corp. then creates a new retirement plan. The funds from your existing retirement plan are rolled over into the corporation's new retirement plan. The last step is that the new retirement plan purchases stock in the newly-created C-corporation.

When your new company can afford to pay back what you have borrowed from your retirement plan, you can then change your C corp. to an S corp. which is typically more desireable when you are ready to exit your business. There are fees, of course, for doing this; however, it is a very creative and legal way to put your retirement money to work for you. Before you move forward with any loan, make sure the investment is a sound busness decision.