Selling A Small Business

Introduction

All entrepreneurs who start new ventures have to plan for a harvest strategy at some point The best option is to have some kind of plan for harvesting and include it in the business plan itself. Even though this is recommended, a vast number of new entrepreneurs do not develop a business plan; however, it’s necessary to think of succession or harvesting at some stage in an entrepreneur’s life. In this case, 21 years ago, after having worked for a major retail chain for 12 years, Robert started Grimaldi Grocers.

For a detailed history of Grimaldi Grocers, read the background information in the drop down box below. This background will help you to understand the choices Robert faces as he considers the future of his business.

Background

It was a chilly winter night with temperatures reaching – 20 at 9:00pm on January 10, 2015. Robert was standing in front of his store Grimaldi Grocers. After closing the store for the day, he looked up at the glowing store sign with satisfaction and pride, just as any parent looks at their well settled children. This was a ritual Robert had followed every day for the past two decades, 21 years to be more precise. Whenever he looked at the store, a pleasant feeling passed over him as he recalled the store’s humble beginnings, its growth, and the ups and downs in the initial years. However, during the past two months he had something pressing on his mind – Grimaldi’s future. His emotional attachment with the store was so great that Robert wanted the store to be part of his family forever, but he knew that it may not be possible. Being a pragmatic person, Robert wondered about the future management of the store.

The Entrepreneur

Robert’s parents immigrated to Canada from Italy in the 1950s. Robert’s father was a farmer who chose to settle down in Kamloops. Robert was born and raised in Kamloops, a small yet beautiful community located along the banks of the majestic and beautiful twin Thompson rivers. His family consisted of his father, mother, and a brother. After graduating from North Kamloops High School in 1989, Robert enrolled himself in the BBA Program at Thompson Rivers University. Robert knew that in order to support his education he needed to take up a part-time job. After working a couple of odd jobs, Robert landed a position at the Canadian retail chain, Safeway. Working at Safeway suited him in many ways. Firstly, the hours were flexible and he could easily arrange his work based on his university routine. Secondly, it helped him to develop many skills, the most important one being people skills. Thirdly, the pay was sufficient for his current needs. Robert was making $12.65 per hour initially and by the time he left the job a few years later, he was earning $21.00 per hour. During summer vacation, he could work full time.

While at Safeway, Robert learned the intricacies of running a retail store, which Robert believes has influenced his success as a business owner. The job at Safeway not only helped Robert to pay for his tuition at university but also provided him with adequate savings for future business endeavors. Robert, being the elder son of immigrants from a humble financial background, was very frugal in his lifestyle and made saving a habit right from an early age. By 1994, Robert had not only graduated from TRU with a BBA, but also had savings upwards of $150,000.

It was during this period that Robert considered opening his own retail business and began looking for opportunities. From his research, he soon discovered that there are two types of retail stores in Kamloops: 1) large stores (e.g. the Real Canadian Super Store, Safeway, Save on Foods) and, 2) small street corner convenience stores. He was not sure if he wanted to open a conventional convenience store or an already established franchise. Around this time, Robert attended a social gathering of Europeans where he came across an interesting discussion. A group of women were discussing the difficulties in finding authentic European cheeses and olive oils in Kamloops. This was when Robert got the idea for his business: a specialty store for European grocery and food items.

The Strategy

Right from the beginning, Robert was clear about the growth strategies he wanted to pursue. The growth strategy of a firm is all about deciding the level to which the entrepreneur wants to grow his business. All firms adopt one of the following four generic strategies:

  1. Life style firms: These are normally part-time businesses with sales less than $25,000 and are started by the entrepreneur to supplement his other income. Nearly 50% of small businesses fall into this category.
  2. Traditional small businesses: These are full-time businesses that account for 22% of small businesses and have sales in the range of $25,000 to $100, 000. These kinds of businesses provide livelihood for the owners.
  3. High performing small businesses: These businesses have sales ranging from $100,000 to $1,000,000 and growth rates between 5 to 10% a year.
  4. High Growth Ventures: By far these types of firms are very few, normally around 5% of all small businesses (Katz & Green, 2012).

While Robert aimed at creating a traditional small business, it eventually developed into a high-performing small business.

The Business

Once Robert realized his business idea, he developed a business plan as the capstone project for his BBA. He tried to visualize the investment involved and make some projections about sales. Looking back now, after all these years, Robert recognizes that this effort to create a business plan certainly helped structure his approach. Another important step that helped Robert was his market research. He met owners of other specialty stores like the Indian stores on the North Shore and received valuable information from such meetings. There were many similarities between these stores and the one he planned to open, including the size of the customer population; both these communities have nearly 2,000 households in Kamloops. The Indian community is concentrated in the northern part of Kamloops; where as the European community is concentrated downtown. Robert also learned that both communities, especially immigrants and first generation Canadians, crave their respective ethnic foods. The larger stores offered a few items, but customers were not satisfied with them. The normal practice, at least for Indian families, was to buy foods in bulk from Surrey or Vancouver. Robert expected similar feedback from European Canadians too and his interviews with some Italians and other Europeans proved him to be right. From this data, he could forecast the expected sales in his business’ initial years. Robert began interacting with the European community extensively and, from these conversations, he developed a list of items that Europeans prefer.

The next piece of the puzzle was to determine the best suppliers for these foods. Robert had two options: 1) to import the items directly from Europe or, 2) buy them from suppliers in Vancouver. He could import high quality products from Europe but it would be prohibitively expensive to import the small quantities he needed. Hence, he decided to procure these items from suppliers in Vancouver and then attain those items that were not available in B.C. from Europe.

Next, Robert had to make two important decisions: 1) the location and, 2) financing for the new venture.

The Location

From his research, Robert learned that for businesses such as retail stores and restaurants the single most important factor for success is location. He recalled his new venture creation instructor who never got tired of saying “Location, Location and Location.” His market research revealed that a majority of the European population lived in and around downtown Kamloops so he decided to open a store in downtown Kamloops. The only hitch was that the downtown commercial space was very expensive. He needed a small place initially, but with a possibility to expand later, if business picked up. Also he needed sufficient parking space on the road or pay parking close by. This requirement proved to be a difficult one to meet. Many places that were available were not suitable for a store or if suitable they were very expensive. Fortunately, he came across a space available on Victoria Street. The property was owned by a group of 8 people jointly who were willing to lease the space on a long term basis. Further, the neighboring property was leased to another firm and was likely to be available in couple of years once their lease period was over. This seemed to be the closest Robert could get in terms of a desired location. Robert signed a lease agreement with the owners in January 1994.

The Financing

When it came to financing the new venture, the estimates Robert made in his informal business plan came in handy. He needed capital of $170,000 to make the store operational while keeping a reserve of 3 months working capital. Over a period of 12 years, he had saved $150,000 and thus needed only another $20,000. Family and friends promised help, as and when needed.

The Life Cycle – Introduction and Growth

That is how ‘Grimaldi Grocers” was born and opened its doors for business in 1994. Robert registered the store as a limited liability company. The store started with one employee and Robert’s father promised to help whenever needed as an additional hand. The items offered for sale were mainly of European flavor, like the olive oil, specialty cheeses, and pasta.

In the initial introductory years 1994 – 1997, the going was quite tough. Though Robert was very realistic in his projection of sales, he soon realized it was becoming difficult to reach those numbers. The first three years did not see much profit. Fortunately, Robert was able to break even and thus survive the initial growing pains. Conservatively, Robert made the decision to continue working at Safeway. This was hard work, but the strategy paid off in later years. Robert realized that in order for the store to succeed it must have a European flavor but must also cater to the needs of other communities in Kamloops. He started expanding the range of items that were offered to include products like meat and milk. Towards the end of the third year Robert started seeing the proverbial light at the end of the tunnel in the form of some decent profit.

In the initial years, Robert’s marketing and promotion campaign was mainly based on print media and radio. Though the advertising helped in creating awareness about the store and developing its branding, it did not contribute in a big way to the store’s bottom line. Robert realized that it was actually word-of-mouth that was bringing in new customers. Consequently, he started concentrating on customer relations activities aimed at retaining the existing customers and attracting new customers. Robert understood that promotional material like cotton bags with the store’s name and logo helped as well. By providing better personal service to his customers he was creating a positive image of the store in the public’s mind.

As it stands today Robert has 15 bulk suppliers from Vancouver, 15 Canadian suppliers and five suppliers of specialty items from Europe. Most of the cheese is imported directly from European suppliers; meat and milk is imported from Canadian suppliers; fruits, vegetables and other produce are from the US; and dry items like olive oil and pasta are imported from Italy.

The store entered a growth phase in 2007 and continued to grow until 2008. The growth during this period was phenomenal and the store started attracting domestic customers as well. During this period Robert concentrated on reducing waste with the eventual aim of achieving zero wastage. This is the same time that Robert introduced value added products like ready to eat European soups, meals and salads. This new addition was a success from the start and contributed 10% in the first year, growing to 25 to 30% of sales in just a few years. The location of the store, which was surrounded by many offices, also contributed positively towards the store’s growth. In the winter, soups and lasagna became very popular items and in the summer soups and salads were the meal of choice.

Robert, after having worked at Safeway for more than a decade, understood the needs and aspirations of employees well and practiced what he had learned. The store started with one employee in 1994 and by 2000 had 10 employees. The very fact that the first employee, who is 72 years old now, is still working for the store is a testimony to Robert’s human resource practices. Robert attributes the store’s success to the highly motivated employees. However, in 2000 technology started affecting small business practices and efficiency and, as a result of Robert’s adoption of automation, the number of employees fell to 6, though this number varies from year to year.

Another important development that occurred was a change in property ownership. Some of the property owners wanted to sell their shares. Robert bought the shares of 6 of the owners between 2008 and 2012. Currently, Robert owns the property along with two of the original owners.

Hungry for more knowledge, Robert enrolled in the MBA program offered at Thompson Rivers University. While attending school, Robert’s brother and father helped maintain the store. Robert performed well in the MBA program. After graduating, Robert started teaching as a sessional lecturer at the university which included instructing TRU’s program offered in Chandigarh, India. Robert shared his experiences with students and became a popular teacher at TRU. He enjoyed teaching in the classroom and appreciated the opportunity it provided to motivate young, aspiring entrepreneurs.

Last but not least, Robert believed the civic responsibilities he undertook had played a major role in developing his brand image and contributed to the success of Grimaldi Grocers. The store supported local fundraisers for charities, cancer runs, diabetes camps, Boogie the Bridge, and TRUSU clubs. His participation in Italian cultural committees and sport teams also helped to create a positive brand over the years.

In 2010, the store entered into a mature phase. The sales were still growing but at a much lower rate. The profits were still growing but less than 10% on a year to year basis. The financial performance of the store during the last 5 years is provided below:

 

GG Performance Data


 

The Future of Grimaldi Grocers

Robert realized that the time had come to either grow or to harvest the store. When he originally opened Grimaldi’s the idea had been to have a business of his own with a stable income – a healthy mix of traditional small business and lifestyle firm. A host of favorable factors over the years resulted in the business transforming into a high-performance small business. Further, apart from growing the store in terms of sales, he had been able to buy the majority of the property.

Robert had gained a lot from the community and he wanted to give something back but wondered what and how? The opportunity to teach young people at TRU had provided that answer. Robert enjoyed teaching entrepreneurship. He seriously considered teaching full-time. He also wanted to pursue other hobbies but did not have the time.

On this cold winter night these thoughts ran through Robert’s mind as he looked up at the store sign.

Read the information below for a thorough discussion of the options Robert debates when considering the future of Grimaldi Grocers. This information will be very useful as you consider Robert’s options later and will help you make decisions about selling your own business.

The Valuation of the Business

Before he could make his final decision, Robert wanted to have some clarity on a few nagging issues:

  • What legal issues existed when transferring a business?
  • What should be done about the premises?
  • What is the value of Grimaldi Grocers?

Robert contacted a lawyer for additional support. According to the lawyer, the transfer of the business was a relatively simple affair as the business had been registered as a limited liability company.

In regards to the property, Robert was the largest shareholder; therefore, he could make an offer to buy the other two parts. Fortunately, even if the owners were not willing to sell their shares, Robert believed they would not have any objection in renting the place to a new owner on a long term basis.

Now, how to establish the value of the business? From his experience teaching entrepreneurship, Robert knew that valuing a business was an art and science. Often, value is established by comparing a business to similar existing businesses for sale. While these methods are fine for curiosity’s sake, the valuation has to be more scientific in matters like selling a firm. Robert also knew that, even when using quantitative methods, one cannot rely on only technique. The most popular method is to use multiples of net annual profit. Firms are normally valued at 3 to 5 times their net profit. Going by that, Robert believed his business was worth between $330,000 and $550,000. Next, Robert worked out the Net Present Value (NPV) of the future earnings at a 10% growth rate per year for the next 5 years. The result supported his earlier estimation.

Robert also visited a number of websites that were offering information on valuing small business. He found one method called income method (www.canadone.com, 2014) particularly interesting. This method took into account the average annual gross profit (or income) before depreciation, interest, and taxes to predict future earnings. When using this method, the gross profit needed to be adjusted for earnings or expenditures which differed from proceeds from the sale of an asset. After determining the income, he had to develop an appropriate capitalization rate. This involved computing the sum of the current interest rates on borrowings from banks or lenders’ return on investment (ROI) which one should expect from their equity investment including a suitable adjustment for risk factor.

To simplify, Robert valued his business at $500,000 based on a variety of methods. Presuming that the potential investor would invest 50% of the amount and expect a return of 15% while borrowing the remaining $250,000 at 10% from a bank, adding the risk factor of 3%, Robert worked out the value of his business as follows:

Capitalization Rate

Bank Loan       50% @ 10% – 0.50 x 10 = 5%

Equity              50% @ 15% – 0.50 x 15 = 7.5%

Risk                 3%

Total (100%) = 5% + 7.5 % + 3% = 15.5%. = 0.155

Adjusted average annual Gross Profit

= (116,500 + 108,100 + 115,800 + 118,900 + 123,800) / 5

= 116,620

Capitalization = Adjusted average gross Profit / Capitalization Rate

= 116,620 / 0.155

= 752,387.09

Robert also hired a small business valuation firm for help estimating the net worth of his business. The valuation firm studied various aspects of Grimaldi’s, including past performance, future projected performance and goodwill. In the end, they also valued the business at $500,000. From all these efforts, Robert felt that at best he could reach a price range but never an exact figure.

Harvesting: The Alternatives

Robert decided to sit down and discuss the future of Grimaldi’s with his father and brother. Robert’s father was a pillar of support right from the beginning. He used to look after the store in the initial years when Robert was busy with his job at Safeway or during later years when Robert was pursuing his MBA. Even now he opens the store every day and performs the morning chores of cleaning and prepping the food counter. But, at 87 years old he was not in a position to take on a full-time role. Though his brother, who already had a full-time job, also helped Robert in the past when needed, he was not able to take on the role of full-time owner-manager either. Robert’s children were in university pursuing different careers and the store did not figure into their career goals. After the discussion with his father and brother, Robert effectively ruled out business succession within the family.

Friends and colleagues advised Robert to exploit the possibility of developing franchises in small towns within BC and Alberta. Robert gave some thought to this idea as it appeared viable. Even with as few as 5 franchisees, he could start importing the food items directly from Europe which would likely improve sales and profits. He could then expect to get better deals and quantity discounts from the local suppliers. With all his expertise and experience Robert was sure that the probability of success would be very high. However, franchising required a large amount of initial investment, frequent travel and a heavy commitment on his part. This was not the original goal when Robert first conceptualized owning his own business. Franchising would also prevent him from realizing his future plans.

Another option was to open new branches of stores in the Sahali area in Kamloops and in Kelowna. This was another viable option but would require a lot of additional investment. Again, instead of getting time for his hobbies, this would tie him up more with the store. There would also be a significant element of risk involved.

The other option available to Robert was to make an outright sale and harvest his business venture. This seemed to be the best option according to some of his family members and friends. While it appeared to be a very reasonable idea, Robert was of two minds. The idea of sale of the store was making him emotional and uncomfortable. In his heart of hearts, he was not comfortable with the idea of selling his store to a stranger. The store had been the center of his life for two decades. He considered his employees. Would one of them be interested in buying and running the store? He was not sure. His most senior employee, who had been with the store for 21 years, was already 71 years old and not interested for obvious reasons. The majority of his remaining employees were TRU students, as Robert felt it was part his civic responsibility to hire TRU students. And, unfortunately for Robert, the students had different career goals post-university and lacked the finances to take over the business.

The last available option to Robert was to take a partner. Ideally, the new partner could be an understudy for a year or two and then operate the business himself. Possibly, the new partner could help open new stores and grow the business further. Or, he may be able to help in developing the franchises. This option would also alleviate some of the emotional issues involved with outright sale of the firm.

 

Case Study Questions

Consider the following questions. This will help you in your own decision-making as you sell your own small business. Once you’ve decided upon your own responses to the questions, review the answers provided.

 

This is the question that all successful entrepreneurs face at some point in the long and arduous journey of making a new venture successful. Entrepreneurs are highly motivated individuals who spend their energy, money, time and effort to make their dream a successful reality. During this process they face many challenges and achieve many successes. Success in any new venture comes at a great cost and as a result of the many sacrifices that entrepreneurs make. Every entrepreneur who creates a successful venture would like his creation to go on and on forever, but the reality is it may not be possible. Many entrepreneurs become highly emotional at the very idea of harvesting the successful business they created. In many cases it is very difficult to break the emotional bonds the entrepreneur has developed with his business and customers.

However, entrepreneurs also have to be pragmatic. A highly successful entrepreneur must also be aware of when it is the optimal time to harvest the business. If you don’t decide to sell at the right time, the business may also lose value. In harvesting the business, there is also a window of opportunity. Entrepreneurs should be pragmatic enough not to lose sight of this window.  There are thousands of examples of successful small businesses missing the boat by not taking appropriate action at the right time.

We think Robert is making the right decision to sell the business.  While sales are still growing and the profits are still increasing, there are also some limitations on growth rates. Taking into account all these factors, selling is the right decision.

We agree with Robert’s Analysis. Robert has gone about his harvesting strategies in a logical manner. Like any other successful entrepreneur, he wanted to keep the business in the family. That is why he discussed the issue with his father and brother to get their perspectives. But the reality is that Robert’s father is aging and his brother is employed full-time so neither are in a position to take on the full-time commitment of the business. The next generation are at university and each one of them have their own personal ambitions which do not include running the family business. Robert clearly understands that succession in the family is not a possibility, however much he may want it to be. Hence, he is now looking at options outside the family.

All the harvesting options that Robert analyzed are worth pursuing. The options are to try and expand this business by offering franchises, to sell it to an employee, to take a partner by selling part of the ownership or to sell the business outright. Each one of these options has advantages and disadvantages. The final decision will depend on finding an option that satisfies economic realities and emotional needs.

No one can provide a clear cut answer for these kinds of decision as the importance of the various factors will vary from person to person. The aim of this question is to get you to consider the issues that are important while making such important decisions.

Taking an equal partner means giving up 50% control. In this case, the business owner will have the psychological satisfaction that he is still carrying on with the business.  That means he will be able to satisfy his emotional needs. However, a partner will expect his views on all important issues to be considered. This creates another problem for the business owner who was used to making all decisions himself. His experienced views and the new innovative ideas of his partner may also be in conflict. The secret of successful partnerships is a great understanding between partners and respect for each other’s views.  A large number of partnerships fail at some stage, even among people who are good friends. Taking a new partner at this stage is risky and has only about a 50% chance of success.

On the other hand, an outright sale would result in a clean break. This would also reflect mature and detached thinking on the part of the business owner. The only issue here is to convince oneself that it is only natural to harvest a business.

This choice again depends on many factors. The most important ones are the finances available and expertise in these areas. Many business persons tend to think that developing a franchise network is very simple, but the reality is otherwise. Developing a franchise requires a number of steps, such as developing legal documents for franchises clearly delineating the obligations and responsibilities of franchisor and franchisees. One of the important issues is standardizing the business processes. Then decisions have to be made about store layout and location. Many other issues like hiring employees and setting an advertising budget also play a major role. Hence, when a business owner thinks of franchising, he should be able to consider all the issues involved. Most importantly, he should consider his ability to employ people with expertise in this area and to clearly identify all the risks.

If a business owner plans to open up new stores by himself with a partner, he will have complete control over expansion and business operations, but this decision also exposes unlimited risk of failures. There will be a great need for financial resources and the success of this idea is primarily dependent on the ability of the business owner to muster the required funds or arrangements for loans.  This option also needs to be looked into from the point of view of management and control of the local stores and employees. Owners are ‘vicariously’ responsible for their employee’s actions. Being an absentee owner can involve its own risks.

However, the business owner has to consider another important issue for both options – supply chain management. The ability to maintain reliable supply chains is necessary for success.

Yes. Robert used different approaches to value his business. It is important to note that different quantitative approaches will result in different outcomes. When trying to sell a business, it is crucial to determine the most appropriate price.

No, because different approaches have different assumptions leading to the expected value. Those assumptions may be applicable to the present business or not.  In most cases, it is difficult to arrive at a definite figure. The best approach is to evaluate the value of the business from a number of quantitative approaches, as Robert did, and take an average of the outcomes. That number, in all likelihood, will be very close to the real value.

The seller expects the higher limit of the range, whereas the buyer looks at the lower limit of the range. To be able to arrive at a mutually acceptable figure, both buyer and seller must be willing to reach a more acceptable figure somewhere in the middle ground. That again depends on the negotiation skills of each party.

Usually, Robert should quote the higher figure of $ 700,000. If there is an urgency to sell the business, then Robert may want to quote the average price of $ 500,000.

However, if it is a distress sale, then Robert may be compelled to offer the lowest figure of $300,000.

If the business and its products are in great demand, Robert can quote a higher price and then negotiate. However, if that is not the case, quoting a higher price may deter potential buyers from making a proposal.

If Robert quotes a more appropriate figure, he may have a higher chance of successfully selling the business. One has to remember that the buyer is also evaluating the business, using more or less the same techniques and market values.

Ideally, you should make decisions about harvesting the business when you make your initial business plan. Having said that, this may not always be practical. A vast majority of small business owners do not have a business plan and hence may not have a clear harvesting strategy. A dynamic business can change for better or worse as time passes by.  Many issues, such as changes in family or financial circumstances, may necessitate changes to that policy.

Unfortunately, there was not much information available to entrepreneurs in the past and not many universities offering courses in entrepreneurship.  That has changed now and a lot of information is available on Internet and entrepreneurial training is available from many sources.

Robert ideally could have made decisions about harvesting when he wrote his business plan, but may have been handicapped by a lack of information. However, it is recommended that new entrepreneurs incorporate a harvesting strategy in their business plan and follow it.

 

Conclusion

Harvesting a successful business venture can be a very complex project, even at the best of times. Many issues become involved in this process. Financial and emotional issues compete with each other. Many successful business owners become emotionally attached to their businesses. While this is a perfectly natural and normal phenomenon, it hinders the objectivity that is required in selling a new business. The first step in selling a business is to overcome these emotional issues.

Once the successful entrepreneur is able to overcome the emotional issues, then it is time to make some pragmatic decisions regarding what to do with the business.  The first option is to see if there is anyone in the family who can carry on the family business. The second is to look for a loyal and capable employee with entrepreneurial ambitions. The third option is make the firm a public one by offering an IPO. The fourth option is to take a partner. The fifth option is an outright sale. Which option one takes depends on individual characteristics and external factors.

Before taking any of the above options (except the first), the owner has to establish the value of his business in a scientific manner. There are a number of ways of doing this as explained in the case.

Once a value has been established, realizing the actual potential value of the business depends on the negotiation skills of the business owner. We strongly recommend having a harvesting strategy as part of the business plan.

 

References

  1. Katz, J. & Green, R. ( 2012), Entrepreneurial Small Business, 3rd McGraw-Hill Irvin, pp 641.
  2. canadone.com, (2014), Valuation Formulas, The Income method, Retrieved on 30 March 2015 from http://www.canadaone.com/tools/buy_a_biz/section2f.html
  3. Interviews with Robert
  4. Interviews with Krishna.
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