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When it comes time to sell, entrepreneurs are often shocked when quoted the marketplace valuation for their online business. To them, that valuation seems exceedingly low and possibly unfair.
When they have that mindset, the owner’s logic is often to keep the business, even if he believes it will decline. The thought is that the company would make more money over five years than what they would receive if they sold the business at what they feel to be lower-than-fair market rates.
But is this the right mentality? Is it more profitable to hold onto your business for five years rather than sell it today?
Obviously, nobody has a crystal ball. Mark Zuckerberg of Facebook received some very lucrative offers in the early days of Facebook, including a $10 million offer. Passing on that offer was a pretty good decision.
But the chances are your business is not the next Facebook. Even so, if your business keeps a relatively even pace, you are likely to make more money keeping the business, rather than selling it.
But the flipside of that coin is that you might want to begin a new business, or perhaps you are tired of the industry? Or perhaps you can see the warning signs and have realized a decline is coming sooner rather than later?
In that scenario, is it better to sell? Or would you make more money letting the business slowly decline over a period of years?
A Case Study
This dilemma cropped up in a review of a business I conducted not too long ago.
The business in question generated affiliate income in the travel industry. In the early 2000’s it was an absolute cash cow generating six and seven figures annually for its owners.
But as the Internet matured and major travel players entered into the space, earnings for this company declined year over year. The owners had several other businesses and spent most of their time on those, content to let this hands-off business slowly decline. With virtually no work needed to maintain the site, it still generated significant annual earnings.
Since hindsight is 20/20, it may seem obvious that they should have sold ofter 2009.
But it’s not that simple.
How Much Could They Get After 2009?
With $250,000 in earnings, 2009 was a great year for the business. Keep in mind the owners literally did little to no work. All traffic came from search and all revenues were generated through affiliate relationships.
Their job was only to cash checks, record the books, and tune up the SEO and content from time to time.
2010 was an interesting time to sell an online business. The Great Recession was still fresh on people’s minds, and multiples for online businesses certainly hadn’t rebounded quickly, although there was some recovery.
Multiples were creeping up for exceptional businesses, but there was still concern among investors.
So how much would a fully automated, easy to run business that had great search rankings be worth? Probably around $700,000.
Would You Have Sold?
Now it’s time to put yourself in those owners shoes for a minute. Would you have sold the business?
If you owned a business that just made $250,000 worth of earnings with very little maintenance work, would you have sold it for $700,000? What if that business declined slightly to $225,000? Would it make sense to sell that off?
No, neither would I.
Should They Have Sold?
Hindsight is a wonderful thing, but yes, they should have sold.
In the years after 2009, the website earned a total of $680,000 – painfully close to the amount of money they would have received in 2010. In fact, it almost appears to be a wash – especially if 2016 earns anything more than $20,000.
But there are two considerations which lead us to believe they should have sold in 2010.
Selling Changes Taxable Income Into Taxable Capital Gains
One of the main benefits of selling a website is that you effectively combine several years of earnings into one lump sum payment that is taxed at more friendly rates.
The $680,000 earned over 5 years would have been earned at regular income tax rates. Obviously, there are several things that impact your effective tax rate, but, for the sake of having a number, let’s place this tax rate at 30% (especially considering the sellers had several other businesses and were high-income individuals).
This amounts to $204,000 paid in federal taxes. So instead of earning $680,000 of actual take-home money, they would have only earned $406,000.
However, if they had sold their business in 2010 they would have instead been taxed at capital gains taxes (which was 15% at the time – it is now roughly 20%-22%).
This would have put their tax burden at a measly $105,000. So by selling their business for $700,000, they would have taken home $595,000.
That’s a huge jump from the $406,000.
Again, the numbers may change based on individual tax situations. But the principle stays the same: selling your business converts multiple years of income into a more tax friendly windfall.
The Time Value of Money
By waiting and not selling their business when they could have received $700,000 for it, these owners also missed out on the time value of money.
Any financial advisor will tell you that money now is worth more than money paid out in the future. The “time value” of money gives you the ability to earn more from what you have today rather than waiting to receive it.
The time value of money, or TVM, assumes a dollar in the present is worth more than a dollar in the future because of variables such as inflation and interest rates. Inflation is the general increase in prices. The value of money depreciates as time goes by as a result of a change in the general level of prices.
In other words, by waiting to earn your money over 5 years you actually devalue your earnings.
How You Know It’s Time To Sell
In the example above, most entrepreneurs would not have had the foresight to sell the business in 2010, despite the fact that it would have added over $100,000 into their pockets.
We assume our businesses will continue on as they always have. And if there is a decline in our business, we assume it will be a slow and gradual one.
In most businesses, as long as you stay focused on your website, as long as your industry remains viable, it makes sense to hold onto your business for the long-term.
The problem comes when we grow stubborn in our ownership or when we develop a ‘shiny penny syndrome’ and run to the next opportunity while leaving our existing businesses to slowly decline through our neglect.
Internet businesses are extremely susceptible to rapid declines in earnings, yet we place a lot of our faith in their continuance and automation.
So how can you know that it’s time to sell your business? By paying close attention to the warning signs – both industry-related and also in your personal life.
It’s possible that your business will chug along as it always has – but these tend to be the exceptions to the rule.
Selling a Business Is Always a Personal Decision
At Quiet Light Brokerage, we never tell a potential client they should sell their business. Deciding to sell what you built and own is a highly personal decision.
I remember a conversation I had with a very well known Internet personality at a Pubcon Convention a few years ago. He had just shut down his highly popular news site for Internet entrepreneurs. I asked him why he didn’t sell it rather than shut it down.
His response: “Because I didn’t want anyone to go in there and screw it up. I liked it too much.”
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