Matt Michel: 7 ways to know it is time to exit

There has been a lot of private equity activity in the service trades since the COVID-19 lockdowns. Suddenly, boring old businesses gained monetary sex appeal when they were declared essential and could continue making money while many other local businesses were effectively shuttered. This has led to a land rush for good service contracting businesses and many plumbers have grabbed the brass ring while the grabbing was seen as good. Is that right for you? Here are seven signs it might be time for you to exit.

1. You are not essential

Are you essential to your business? If your business cannot run without you, it is not a salable business. While most private equity buyers will try to lock you in for a number of years, they do not want to invest in a business that would not exist if you get hit by a truck. For this reason, if you ever want to sell, you should make yourself non-essential. Not only will this make your company more attractive, it’s a lot of fun to not have to worry about the things you hate, only the things you enjoy.

2. Your business is growing

You look at your business as customers and trucks and plumbers and inventory and tools. Private equity looks at it as a stream of future earnings. Are you growing year-over-year-over-year? If so, your business is more attractive and will command a higher price.

3. No one in the family has the plumbing gene

If Junior grew up in the trade, knows nothing else, and desires nothing else, why sell? Invest in Junior’s business knowledge so that he can take over one day and gradually execute a buy-out, paying you to hand around and self-actualize. Maybe that involves self-actualizing from a beach. Of course, if none of your progeny inherited the plumbing gene from you, selling may be the answer. The question then becomes whether you sell to employees, a competitor or private equity.

4. It is not fun

As long as plumbing is fun, why stop? This has been your life. It is very difficult to stop going to the shop every day and learning to play golf. As much as you might think of them as numbskulls, you will miss the camaraderie of your co-workers. You will miss your identity as the owner of your plumbing business. Few people talk about this, but it is harder than you imagine. Besides, golf or fishing or any other hobby may sound like a lot of fun in theory, but when confronted with it every day it starts to seem like work, except the money is flowing the other direction.

On the other hand, when going to work becomes agony for you, it might be time to look for an exit. When the risks of ownership become overbearing, it might be time to take your chips off of the table.

5. You get money-whipped

With some of the amounts private equity is slinging around (or at least, was slinging around before debt got more expensive), it can be easy to be money-whipped. Being money-whipped is not bad. In fact, it is a lot of fun. If you get money-whipped, do not fight it. Like the song says, take the money and run.

6. You can live on the proceeds of a sale

Before you succumb to a money-whipping, you might want to consult with a financial advisor or work through the numbers on your own. Netting $5 million from the sale of your business sounds like a lot, but is it? First, you have to pay capital gains and other associated taxes (e.g., Affordable Care Act surtax). For long-term capital gains, which are assets held longer than a year, this works out to 23.8%. Whoops, $5 million drops by a quarter.

Of course, that’s just the federal taxes. Many states tax capital gains with the highest being California at 13.3%. I guess someone has to pay for all of Gavin Newsom’s dinners at the French Laundry.

Assuming you are in a state without a capital gains tax, that leaves you with $3.81 million. It’s a nice sum, right? An adage of the wealthy is, “Never touch the principle!” Say you want to live off of the proceeds of your $3.81 million.

While most private equity buyers will try to lock you in for a number of years, they do not want to invest in a business that would not exist if you get hit by a truck. For this reason, if you ever want to sell, you should make yourself non-essential.

What do you do with the $3.81 million? Stocks? The S&P 500 has returned 8.27% year to date. Of course, it lost 18.07% in 2022. Maybe you want something safe and secure like tax-free government bonds. Today the rate on a 20-year bond is 3.875% with steady payments every six months. This means your $3.81 million will yield $142,875 per year.

A minute ago you were anticipating $5 million. Not you are looking at less than $150 thousand per year. This is why it is important to work through the numbers and make sure you can live the results. If you can, by all means, grab the brass ring. If not, wait until you build more investments and/or grow your business so that it commands a higher sale price.

7. You have something else you want to do

If you are too young for assisted living, it is important that you have something else lined up. What are you going to do? A lot of contractors think they will become consultants and get paid big bucks to share their wealth of knowledge and experience. Almost all who try it, flame out. It is far harder, far less glamorous and far less lucrative than you might imagine. Still, after spending a lifetime as a business leader, it is important to have goals. If all other things are equal, until you know what you want to do, wait before you sell.