Your Exit Strategy

Tom Johansmeyer
Private companies do not sell easily. As the size of a business increases — by top line, bottom line or head count — the mechanics become more difficult and the field of likely buyers shrinks.

What results is a serious succession- planning problem, especially in the adult content industry. In the coming years adult entrepreneurs eager to retire or simply cash in early may be trapped by their businesses.

The two traditional disposition vehicles in adult entertainment have been family dynasty creation and vanilla private sale. Both are ideal only in limited situations.

The "family dynasty," i.e. passing the business to your children, can be an effective way to exit the business — if a number of conditions are satisfied. First, your kids must be interested in running the company and want to be involved. Otherwise, this is a nonstarter.

The more complex issue involved in passing the business along to the children is the actual sale. Giving the business to your children is fine if you have saved sufficiently for retirement. But if you need the income from your business or the proceeds of a sale to finance retirement, buy another business or simply not work for a while, making a gift of the business to your children is not viable.

Structure of Sale
To extract some value from the business and leave it before you die, you have a few different approaches at your disposal. One is to structure a sale of the business over time, financed by annual earnings. You are paid for your stake in the business without forcing your kids to reach into their pockets. Alternatively, you could retain ownership of the business and grant your children operational control. They run the day-to-day operations but you retain veto power. More importantly, you can receive dividends (or partnership distributions, depending on the company structure) based on company earnings throughout your golden years. When you die, you can leave the business to your children without having to structure a sale.

If you are unwilling to accept the business risk of a multiyear sale financed by earnings or passive ownership to fund retirement, you could sell your private business outright — to your kids or to a complete outsider.

While there are plenty of formulas for valuing private companies; the tricky part is deciding the numbers to plug in. The prevailing approach is to use a multiple of earnings before interest, taxes, depreciation and amortization (EBITDA). Determining the multiple is the hard part. Most private businesses are valued at two to three times EBITDA, but this "room temperature" estimate is not universally applicable.

The multiple of EBITDA that you use will depend on a number of quantitative and qualitative factors — the primary factor will be your company's margins. Wider margins indicate healthy operations, making your business more attractive to buyers. The other quantitative factor is your annual growth rates (for both top-line revenues and profits). Consistent growth, preferably at a high rate (at least double-digit) is vital. Smaller businesses should show annual growth rates that significantly outpace those of the market (showing the potential to capture market share) and those of the top companies in the industry.

Qualitatively, brand recognition, operational efficiency and industry relationships can result in a value at a higher multiple of EBITDA — as long as you can substantiate your claims. The ability to distribute product widely and efficiently to consumers who exhibit consistent interest (or even loyalty) can justify a higher multiple of EBITDA.

Makings of A Deal
Finding a number on which you and a buyer can agree on leads to another thorny discussion — deal structure. Larger payments up-front only accompany lower sale prices, and a one-time, 100 percent up-front payment may cost you dearly. Structured deals, though, require the assumption of business risk.

The most popular structure among buyers is to structure a buyout over three to five years that is financed by company earnings. The buyer will offer to pay a certain percentage of the profits to the current owner, usually on a declining basis. For example, the offer may consist of 50 percent of profits the first year, followed by 25 percent for the second and third years. The result is a three-year process that gives you only one year's EBITDA (less, if you consider the time value of money). As a result of this approach, your sale price declines, and you still are left with business risk.

If the company fails to perform sufficiently to cover your anticipated sale price, you are stuck with the terms of the sale. A talented manager could make an earnings-based deal more lucrative to you, but the flip-side is a three-year sale that nets you less than you could have earned by operating the business for one more year and literally giving it away.

The ideal situations of willing family members or deep-pocketed buyers are scarce. Instead, the disposition of your business could become a long-term project that leaves you happy only because it is finished. It is never too early to start planning the sale of your business, even if you have no plans to dispose of it now. Simply keeping track of the market from year to year can give you an idea of what your company could be worth.

The eventual sale price will hinge on profit margins and company growth. These two factors also matter if you have no plans to sell your business. As an owner-operator, you still want your company to grow and continually generate greater profits. Focusing on the profitability of your company and revenue growth in the present will position you for a higher future selling-price while generating more money for you in the interim. Effective financial management now leads to a better sale price at any time.

Preparation is more important than patience when selling a private adult entertainment company. With a smaller group of potential buyers, it is imperative that you get it right the first time. There are only a few buyers and a mistake can cost you at least one of them. Look at your business from the buyer's perspective; find holes in your plan. Then prepare even more: Plug the gaps and justify your claims, and bring facts to the table.

While negotiations are always fluid, information will help you get the best price. Even if you decide to sell to your children, pricing and deal structure are important, especially if you plan to rely on the proceeds of the sale to finance your retirement — or the purchase of another business.

Regardless of your price and prospective buyer, watch the terms of the deal carefully. A private sale is a form of art, but doing your homework can help turn it into a science — at least in part.