A Decision Tree Exit: Helping business owners decide when to sell


Decision Tree image

Some of the oldest and most respected things alive on this planet are trees, very old trees. The oldest is called Methuselah, a Bristlecone Pine tree, which sits ten thousand feet up in California’s White Mountains 100 miles north of Mt Whitney and is said to be 5,000 years old. Methuselah is nature’s most resilient form of wisdom indeed. But there is another kind of tree just as wise if you know how to navigate its branches. It’s called a Decision Tree, and as an investment banker helping CEOs sell their businesses, I thought I would create a Decision Tree to help business owners decide when to exit and sell their business.

Like thousands of years ago, many of today’s business owners are family-owned and operated, and for them exiting the business usually means handing over the reins to family. But for a vast number of non-family-run businesses, the decision when to exit and sell the business is not so obvious. Non-family-run business owners today need more advice to answer the growing number of questions and issues that come with exit planning, and I thought a Decision Tree as a tool might be just the thing needed to help. See Decision Tree Graphic – v4

Decision Trees are not new. They are a well utilized decision-making tool used in dozens of ways. The concept of a Decision Tree is to lay out a series of branches on paper that quantify the expected value of each possible event that could happen. Each branch from tree trunk (decision) to branch tip (value) is essentially measuring a series of choices a CEO could make. Decision Trees are used in many industries including oil & gas exploration. There, for example, each tree branch helps quantify the risks and rewards (chances) of finding large oil or gas deposits underground. But Decision Trees can be used for nearly any problem.  The key is to know what to ask, and how to guesstimate the probability of each outcome.

To test my own mechanical Methuselah, I created a Decision Tree based upon a few basic assumptions for sales and EBITDA, and a few typical options or paths a business owner might include in his/her decision to sell or not. For example, assume a manufacturing company with $50M in annual sales has $10M adjusted EBITDA (earnings before interest tax & depreciation). The key decision I was seeking to determine in this tree was whether to Sell Now, or Wait 1yr (see graphic).

Selling now or waiting is one of the oldest most common questions I get from clients. While no business owner wants to sell at the wrong time, many naturally feel anxious about waiting too long and selling into a down market. So, in turn, I added a 50-50 chance tree branch that the business could improve 10% or decline 10% over the next year, and a 50-50 chance tree branch of a good market or a bad market. And these are but a few of the many common issues owners face before exit (see the list below for more.) In this simple way, these few potential outcomes are all you need to get started.

From this point building out my tree is a matter of assigning probabilities and calculating the value of each branch. The more accurate the probabilities the more accurate the resulting value of the decision. In my example (attached) the probabilities I assigned to each potential outcome stems from my personal experiences and those of other investment bankers and colleagues. Finally I calculated the values of each tree branch and tallied up the value of whether to sell now or wait.  But to my surprise the result threw me for a loop, and here’s why.

In my Decision Tree the values of the choices to proceed and Sell Now or Wait 1yr were nearly equal. In other words, absent of any key insights particular to an industry or business, a business owner should not fear waiting 1 year vs selling now in order to maximize price. The reason for the near equal value of the outcome in my example I discovered later was the 50-50 chance I gave my business to grow 10% next year. If that happened, and the market remained constant, my business value could be higher next year. On the other hand, if I instead anticipated a flat or declining sales forecast next year, the choice of Selling Now may produce a higher value decision. And this makes sense.

The power behind using a Decision Tree is that you can grow or shrink the number of branches based on the choices and decisions specific to your life and your business. For instance, many of the most common downside issues I hear from owners looking to sell at some point but for now remain on the fence include some or all of the following:

  • What if I get sick before I retire?
  • What if my business needs a large capital equipment investment to stay competitive?
  • What if I lose access to my lending resources?
  • What if I lose a key account or manager to a competitor?
  • What if I see my competitors consolidating?
  • What if I received an offer to sell now from a Private Equity group?

The idea here is to rank these in importance and put a value under each as a branch with probabilities. From there a Decision Tree that includes the likelihood of each possibility begins to grow and take shape. This may help the many thousands of business owners who come to market only when things go wrong, or worse, when they get sick, and need to find a buyer. These sellers don’t have a Decision Tree to make, but rather face the market when the time comes. A situation no business owner should have to face prematurely.

So remember this. When the time comes to consider the right time to exit your business, try creating a Decision Tree that specifically measures your business and life events. It’s not hard. And because  getting the maximum value for your business is the goal of every business owner, if you’re lucky, you’ll find a simple Decision Tree created today won’t need to hang around as long as a Methuselah to help you make a wise move. [if you would like a copy of the Decision Tree spreadsheet, please send me a note. Rick]


About the author: Rick Andrade is an investment banker at Janas Associates in Pasadena, Ca and finance writer in Los Angeles helping CEOs buy, sell and finance middle market companies. Rick has earned his BA and MBA from UCLA along with his Series 7, 63 & 79 FINRA securities licenses. He is also a Real Estate Broker, a volunteer SBA/SCORE instructor, and blogs at www.RickAndrade.com on issues important to middle market business owners. He can be reached at RJA@JanasCorp.com. This article is for informational purposes only and should not be considered in any way an offer to buy or sell a security. Securities are offered through JCC Advisors, Member FINRA/SIPC.