The purpose of this post is to discuss the ten key factors that a business owner should consider in their once in a lifetime opportunity to maximize the rewards from their life's work with the sale of their business.
You started your company 20 years ago "in your garage", worked many 80 hour weeks, bootstrapped your growth, view your company with the pride of an entrepreneur, and are now considering your exit. The decision to sell is all too often a reactive one rather than a proactive one -- the primary reasons are a serious health issue, owner burnout, the death of a principal, general industry decline or the loss of a major customer. Often times very capable business people approach the sale of their business with less formality than in the sale of a home. Advance planning can ensure that you exit your business from a position of strength, not from weakness due to necessity.
1. Do not wait too long. Have you ever heard, "I sold my business to early?" Compare that with the number of times you've heard somebody say, "I should have sold my business two years ago." Unfortunately, waiting too long is probably the single biggest factor in reducing the proceeds from the sale of a privately held business. The erosion in business value typically is most pronounced in that last year before exiting. The decision to sell is often times a reactive decision rather than a proactive decision. An individual who spends 20 years running their business and controlling their outcomes often behaves differently in the exit from his business. The primary reasons for selling are events such as a serious health issue, owner burnout, the death of a principal, general industry decline, or the loss of a major customer.
Exit your business from a position of strength, not from the necessity of weakness. Don't let that next big deal delay your sale. You can reward yourself for that transaction you project to close with an intelligently written sale agreement containing contingent payments in the future if that event occurs.
2. Prepare yourself for life after business. We all create business plans both formally and informally. We all plan for vacations. We plan our parties. We need to plan for the most important financial event of our lives, the sale of our business. Typically a privately held business represents greater than 80% of the owner's net worth. Start out with your plans of how you want to enjoy the rewards of your labor. Where do you want to travel? What hobbies have you been meaning to start? What volunteer work have you meant to do? Where do you want to live? What job would you do if money were not in issue? You need to mentally establish an identity for yourself outside of your business.
3. Spruce up your business to create the maximum value in a sale. Now that you are all excited about the fun things you'll do once you exit your business, it's now time to focus on the things that you can do to maximize the value of your business upon sale. This topic is enough content for an entire article, however, we will briefly touch upon a couple of important points. First, engage a professional CPA firm to do your books. Buyers fear risk. Audited or reviewed financial statements from a reputable accounting firm reduced the perception of risk. Do not expect the buyer to give you credit for something that does not appear in your books. If you find that a large percentage of your business comes from a very few customers, embark on a program immediately to reduced customer concentration. Buyers fear that when the owner exits the major customers are at risk of leaving as well. Start to delegate management activities immediately and identify successors internally.
If you have no one that fits that description and you have enough time, seek out, hire and train that individual that would stay on for the transition and beyond. Buyers want to keep key people that can continue the momentum of the business. Analyze and identify the growth opportunities that are available to your business. What new products could I introduced to our existing customer base? What new markets could utilize our products? What strategic alliances would help grow my business? Capture that in a document and identify the resources required to pursue this plan. Buyers will have their own plans, but you'll increase their perception of the value of your business through your grasp of the growth opportunities.
4. Keep your eye on the ball. A major mistake business owners make in exiting their business is to focus their time and attention on selling the business as opposed to running the business. This occurs in large publicly traded companies with deep management teams as well as in private companies where management is largely in the hands of a single individual. Many large companies that are in the throws of being acquired are guilty of losing focus on the day-to-day operations. In case after case these businesses suffer a significant competitive downturn. If the acquisition does not materialize, their business has suffered significant erosion in value. There simply is not enough time for the owner to wear the many hats of operating his business while embarking on a full-time job of selling his business.
The owner wants the impending sale to be totally confidential until the very last minute. If the owner attempts to sell the business himself, by default he has identified that his business is for sale. Competitors would love to have this information. Bankers get nervous. Employees get nervous. Customers get nervous. Suppliers get nervous. The owner has inadvertently created risk, a potential drop in business and a corresponding drop in the sale price of his business.
5. Be sure to get multiple buyers involved in your business sale. The "typical" business sale transaction for a privately held business begins with either an unsolicited approach by a competitor or with a decision on the part of the owner to exit. If a competitor initiates the process, he typically isn't interested in over paying for your business. In fact, just the opposite is true. He is trying to buy your business at a discount. Outside of yourself there is no one in a better position to understand the value of your business more than a major competitor. He will try to keep the sales process limited to a negotiation of one. In our mergers and acquisitions practice the owner often approaches us after an unsolicited offer.
What we have found is generally that unsolicited buyer is not the ultimate purchaser, or if he is, the final purchase price is, on average 20% higher than the original offer. If the owner decides to exit and initiates the process, it usually begins with a communication with a trusted advisor - accountant, lawyer, banker, or financial advisor. Let's say that the owner is considering selling his business and he tells his banker. The well- meaning banker says, "One of my other customers is also in your industry. Why don't I provide you an introduction?" If the introduction results in a negotiation of one, it is unlikely that you will get the highest and best the market has to offer.
6. Hire a Mergers and Acquisitions firm to sell my business. You improve your odds of maximizing your proceeds while reducing the risk of business erosion by hiring a firm that specializes in selling businesses. A large public company would not even consider an M&A transaction without representation from a Merrill Lynch, Goldman Sachs, Solomon Brothers or other high profile investment banking firm. Why? With so much at stake, they know they will do better by paying the experts. Companies in the $3 Million to $50 Million range fall below their radar, but there are mid market M&A firms that can provide similar services and process. Generally when you sell your business, it is the one time in your life that you go through that experience. The buyer of the last company we represented for sale had previously purchased 25 companies.
The sellers were good business people, knew their stuff, but this was their first and probably last business sale. Who had the advantage in this transaction? By engaging a professional M&A firm they helped balance the M&A experience scales.
7. Engage other professionals that have experience in business sale transactions. You may have a great outside accountant that has done your books for years. If he has not been involved in multiple business sales transactions, you should consider engaging a CPA firm that has the experience to advise you on important tax and accounting issues that can literally result in swings of hundreds of thousands of dollars. What are the tax implications of a stock purchase versus an asset purchase? A lower offer on a stock purchase may be far superior to a higher offer on an asset purchase after the impact of taxes on your realized proceeds. Is the accountant that does your books qualified to advise you on that issue?
Would your accountant know the best way to allocate the purchase price on an asset sale between hard assets, good will, employment agreements and non-compete agreements? A deal attorney is very different from the attorney you engage for every day business law issues. Remember, each element of deal structure that is favorable to the seller for tax or risk purposes is generally correspondingly unfavorable to the buyer, and vice versa. Therefore the experienced team for the buyer is under instructions to make an offer with the most favorable tax and reps and warranties consequences for their client. You need a professional team that can match the buyer's team's level of experience with deal structure, legal, and tax issues.
8. Be reasonable in your expectations on sales price and terms. The days of irrational exuberance are over. Strategic buyers, private equity groups, corporate buyers, and other buyers are either very smart or do not last very long as buyers. I hate rules of thumb, but generally there is a range of sales prices for similar businesses with similar growth profiles and similar financial performance. That being said, however, there is still a range of selling prices. So, for example, let's say that the sales price for a business in the XYZ industry is a multiple of between 4 and 5.5 times EBITDA. Your objective and the objective of a good M&A advisor is to sell your business at the top end of the range under favorable terms.
In order for you to sell your business outside of that range you must have a very compelling competitive advantage, collection of intellectual property, unusual growth prospects, or significant barriers to entry that would justify a premium purchase price. If you think about the process of detailing your car before you offer it for sale, a good M&A advisor will assist you in that process for your business. Let's say, for example, that 4 to 5.5 multiple from above was the metric in your industry and you had an EBITDA for the last fiscal year of $2.5 million. Your gross transaction proceeds could range from $10 million to $13.75 million. A skilled M&A firm with a proven process can move you to the top of your industry's range. The impact of hitting the top of the sales price range vs. the bottom more than justifies the success fee you pay to your M&A professionals.
9. In the business selling process, disclose, disclose, disclose, and do it early. A seemingly insignificant minor negative revealed early in the process is an inconvenience, a hurdle, or a point to negotiate around. That same negative revealed during negotiations, or worse yet, during due diligence, becomes, at best, a catalyst for reexamining the validity of every piece of data to, at worse, a deal breaker. No contract in the world can cover every eventuality if there is not a fundamental meeting of the minds and a trust between the two parties. Unless you are lucky enough to get an all cash offer without any reps and warranties, you are going to be partnered with your buyer for some period in the future.
Buyers try to keep you on the hook with reps and warranties that last for a few years, employment contracts, or non-competes that last, escrow funds, seller notes, etc. These all serve a dual role to reduce the risk of future surprises. If future material surprises occur, buyers tend to be punitive in their resolution with the seller. Volunteer to reveal your company's warts early in the process. That will build trust and credibility and will ensure you get to keep all of the proceeds from your sale.
10. Be flexible and open to creative deal structure. Everything is a negotiation. You may have in mind that you want a gross purchase price of $13 million and all cash at close. Maybe the market does not support both targets. You may be able to get creative in order to reach that purchase price target by agreeing to carry a seller note. If the sale process produces multiple bids and the best one is $11.3 million cash at close. You may counter with a 7-year seller balloon note at 8% for $3 million with $10 million cash at close. If the buyer is a solid company, that may be a superior outcome than your original target because the best interest return you can currently get on your investments is 4%. Be flexible, be creative, and use your team to negotiate the hard parts and preserve your relationship with the buyer.
You may have spent your life's work building your business to provide you the income, wealth creation, and legacy that you had planned and hoped for. You prepared and were competitive and tireless in your approach. You have one final act in your business. Make that your final business success. Exit on purpose and do it from a position of strength and receive the highest and best deal the market has to offer.
Dave Kauppi is a Merger and Acquisition Advisor and President of MidMarket Capital, providing business broker and investment banking services to owners in the sale of lower middle market companies. For more information about exit planning and selling a business, click to subscribe to our free newsletter The Exit Strategist
Tuesday, December 16, 2008
Sunday, December 07, 2008
A Little Coverage in Crain's Chicago Business 12-08-08
Follow this link to see the article where we were interviewed about selling your privately held business now or waiting until the recession ends.
http://www.chicagobusiness.com/cgi-bin/mag/article.pl?articleId=31083
http://www.chicagobusiness.com/cgi-bin/mag/article.pl?articleId=31083
Thursday, December 04, 2008
Clean Up Your Financials Well in Advance of Your Business Sale
When you sell your business, many factors are important in maximizing your selling price. Rock solid financials are job one before you sell. This post discusses why you should remove all personal expenses from your business financials well in advance and how you will be rewarded in your business selling price.
Buying a business is a risky proposition. The buyer is attempting to examine and access all of the risk factors to determine how much to pay, what deal structure to propose, and even whether or not to even make an offer. What if I lose a key customer, employee, or supplier? What if our technology is surpassed by a new, lower-cost solution? What happens if a big company decides to enter our niche? These are just a few of the concerns that make buyers less generous in their offer price and terms. If your financials are questionable, that may be the deciding factor that diminishes your selling price or even blows up the deal.
Audited financials are the best to put a buyer's mind at ease. For smaller companies, the cost of this is not warranted. The next best are reviewed financials. They show that a CPA has put your accounting process through some review and scrutiny. Compiled statements are OK, but are closer to a book keeper's role than a CPA's approach. Just remember, the buyer's accountant is going to perform due diligence on your financials at a level closer to an audited statements process. If he finds mistakes and inconsistencies, a lack of trust on all other data can develop.
Your business tax returns will be gospel to the buyer because the IRS frowns on companies not reporting a portion of their income and that is what the buyer's bank reviews to determine the financing available for the acquisition.
In the Mergers and Acquisitions business we all rely on "recast" financials to basically remove all of the expenses the owner runs through his business and make the company look more profitable to drive up the selling price. Sophisticated buyers (i.e. acquisition oriented corporations) may not directly confront you on the recasting, but they are not likely to give you full credit in their analysis. They may even develop some reservations about your character and ethics if the amounts are excessive. They may question your ability to fit in as a good corporate citizen as you transition your business to their institutional corporate structure.
If you are planning on selling your company in three years, why not start eliminating the expenses you run through the business that push the boundaries of business versus personal expenses? In the first year eliminate 33% of the country club, entertainment, business trips, conferences and non-contributing relatives on the payroll. The second year, eliminate another 33% of those and in the year preceding the sale, eliminate them completely.
Imagine the style points you would get from a sophisticated buyer when they discovered that your financials are really your financials with no recasting. Not only that, but you will likely receive a high end purchase price multiple and a greater percentage of cash at close. So, for example, if companies in your industry sell for a range of between 5 and 6.25 X EBITDA, then your company would likely sell at a multiple closer to the 6.25 high end than the 5 low end multiple.
If you had run $200,000 of owner expenses through the business and eliminated that practice you would pay approximately $80,000 in additional taxes. Your recast EBITDA would be higher than your reported EBITDA, but the sophisticated investor might only give you $100,000 credit and would adjust your multiple to the low end. Your recast EBITDA, for example, of $3.2 million would be credited by the buyer at $3.1 million with a valuation multiple of 5 X, resulting in a proposed purchase value of $15.5 million.
Compare this to using your real EBITDA of $3 million, but because it is not recast, your buyer pays a risk reduction premium in valuation multiple and moves you up to 6 X, resulting in a proposed purchase value of $18 million. This is a pretty impressive improvement in selling price for increasing your company's taxable income phased in over the three years prior to your business sale.
You may be asking yourself skeptically, how can this be? Remember, buying a business is all about minimizing the buyer's perception of risk. Now your financials are rock solid and do not require a long explanation on why they are really better than reported to the IRS. This is the most powerful risk reduction strategy available to business sellers. You will differentiate your company from every other acquisition target the buyer has reviewed. You increase your credibility on every other piece of information that you have provided during the courting and due diligence process. Their opinion on your business acumen, management ability, judgment, and ethics has been elevated. The buyer feels more confident that this will be a successful acquisition. For that they will pay a premium.
Buying a business is a risky proposition. The buyer is attempting to examine and access all of the risk factors to determine how much to pay, what deal structure to propose, and even whether or not to even make an offer. What if I lose a key customer, employee, or supplier? What if our technology is surpassed by a new, lower-cost solution? What happens if a big company decides to enter our niche? These are just a few of the concerns that make buyers less generous in their offer price and terms. If your financials are questionable, that may be the deciding factor that diminishes your selling price or even blows up the deal.
Audited financials are the best to put a buyer's mind at ease. For smaller companies, the cost of this is not warranted. The next best are reviewed financials. They show that a CPA has put your accounting process through some review and scrutiny. Compiled statements are OK, but are closer to a book keeper's role than a CPA's approach. Just remember, the buyer's accountant is going to perform due diligence on your financials at a level closer to an audited statements process. If he finds mistakes and inconsistencies, a lack of trust on all other data can develop.
Your business tax returns will be gospel to the buyer because the IRS frowns on companies not reporting a portion of their income and that is what the buyer's bank reviews to determine the financing available for the acquisition.
In the Mergers and Acquisitions business we all rely on "recast" financials to basically remove all of the expenses the owner runs through his business and make the company look more profitable to drive up the selling price. Sophisticated buyers (i.e. acquisition oriented corporations) may not directly confront you on the recasting, but they are not likely to give you full credit in their analysis. They may even develop some reservations about your character and ethics if the amounts are excessive. They may question your ability to fit in as a good corporate citizen as you transition your business to their institutional corporate structure.
If you are planning on selling your company in three years, why not start eliminating the expenses you run through the business that push the boundaries of business versus personal expenses? In the first year eliminate 33% of the country club, entertainment, business trips, conferences and non-contributing relatives on the payroll. The second year, eliminate another 33% of those and in the year preceding the sale, eliminate them completely.
Imagine the style points you would get from a sophisticated buyer when they discovered that your financials are really your financials with no recasting. Not only that, but you will likely receive a high end purchase price multiple and a greater percentage of cash at close. So, for example, if companies in your industry sell for a range of between 5 and 6.25 X EBITDA, then your company would likely sell at a multiple closer to the 6.25 high end than the 5 low end multiple.
If you had run $200,000 of owner expenses through the business and eliminated that practice you would pay approximately $80,000 in additional taxes. Your recast EBITDA would be higher than your reported EBITDA, but the sophisticated investor might only give you $100,000 credit and would adjust your multiple to the low end. Your recast EBITDA, for example, of $3.2 million would be credited by the buyer at $3.1 million with a valuation multiple of 5 X, resulting in a proposed purchase value of $15.5 million.
Compare this to using your real EBITDA of $3 million, but because it is not recast, your buyer pays a risk reduction premium in valuation multiple and moves you up to 6 X, resulting in a proposed purchase value of $18 million. This is a pretty impressive improvement in selling price for increasing your company's taxable income phased in over the three years prior to your business sale.
You may be asking yourself skeptically, how can this be? Remember, buying a business is all about minimizing the buyer's perception of risk. Now your financials are rock solid and do not require a long explanation on why they are really better than reported to the IRS. This is the most powerful risk reduction strategy available to business sellers. You will differentiate your company from every other acquisition target the buyer has reviewed. You increase your credibility on every other piece of information that you have provided during the courting and due diligence process. Their opinion on your business acumen, management ability, judgment, and ethics has been elevated. The buyer feels more confident that this will be a successful acquisition. For that they will pay a premium.
Wednesday, December 03, 2008
The Management Buyout Business Sale
Many owners think that selling their privately held company to their management team is a great way to reward loyal employees for years of service. This post discusses why that seldom works and puts forth another approach that is a better alternative for owners, employees, and the buyers.
Many business owners want to thank their loyal employees that have helped them build their businesses when they exit. It is a noble desire that often leads to the exploration of a management buyout. Who better to buy the business than the management team that is familiar with the procedures, the customers, the suppliers, the industry and the intellectual property?
From a practical standpoint, however, unless the potential management buyout team already owns a meaningful percentage of the company, it is unlikely they have the financial resources to complete the acquisition.
These managers may be great employees, but they generally do not have the risk tolerance to put their personal assets at stake in order to finance the acquisition.
They may originally think that they will be able to secure financing to make the acquisition. When they begin to peel back the layers they find that their enthusiasm begins to crack. Banks are not going to finance an acquisition based on a competitive market price for the business. They will make loans based on a percentage of the asset value of the equipment, receivables and inventory that exceed the company's debt level. This will likely result in the buyout group getting financing at 40-50% of the true value of the company.
Where does the rest come from? When the management buyout team explores the effective rate of mezzanine financing - 12% interest rate with warrants that drive the cost to 25%, they usually eliminate that option. The next option is the personal assets of the team. When the banks start asking for personal guarantees, individuals drop out pretty quickly.
This process sometimes evolves to the owner being asked to settle for a purchase price closer to the secured financing level available rather than the market value of the company. On a company with a $10 million fair market value, this could result in a discount of $5 million or more. I am sure the business owner is grateful to his loyal employees, but this is just not practical.
The problem occurs after this process unfolds and the once very excited management team realizes that their dream of ownership has been knocked off the track. If some of the key players blame the owner, they can turn from loyal to disgruntled and may even leave the company. This can result in erosion in company value in the eyes of the eventual buyer. The original noble plan has blown up in the owner's face.
Another approach would be for the owner to engage an investment banker to seek competitive bids from both strategic buyers and private equity groups. This process will establish the true market value that will be far superior to the financing value of the assets minus liabilities. The owner could grant key employees a cash award based on years of service, salary, or other criteria of his choice.
If the buyer is a Private Equity Group, the owner has another option that may be even more attractive to key employees and the Owner. PEGs encourage sellers to invest some of their equity back into the business. They get to invest leveraged equity along with the PEG.
So let's say that the selling price of the business was $10 million. The PEG would borrow $7 million and need $3 million in equity. If the seller invests $1 million of his proceeds back into the business, he would own 33% of the new entity. If the owner was planning on distributing $500,000 to employees, he could reinvest that $500,000 along with his $500,000 back into the business and he would then own 16 ½% and the employees would own 16 ½% of the new entity.
This works out for everybody because the employees will be highly motivated to stay and to perform at a high level for their eventual exit and cash out. The PEG gets to keep a performing management team in place that is highly motivated. The owner gets the maximum selling price for his business because of the soft auction business selling process. Finally, the owner gets to reward his loyal employees with a powerful investment in their future.
The second payoff for the owner and the powerful payoff for the employees comes five years later when the PEG sells the company now valued at $50 million to a strategic industry buyer. This second bite of the apple values the owner's retained 16 ½% stake at $8,250,000. The loyal employees cash out at that same level from an original $500,000 bonus. Now that's a bonus!
Many business owners want to thank their loyal employees that have helped them build their businesses when they exit. It is a noble desire that often leads to the exploration of a management buyout. Who better to buy the business than the management team that is familiar with the procedures, the customers, the suppliers, the industry and the intellectual property?
From a practical standpoint, however, unless the potential management buyout team already owns a meaningful percentage of the company, it is unlikely they have the financial resources to complete the acquisition.
These managers may be great employees, but they generally do not have the risk tolerance to put their personal assets at stake in order to finance the acquisition.
They may originally think that they will be able to secure financing to make the acquisition. When they begin to peel back the layers they find that their enthusiasm begins to crack. Banks are not going to finance an acquisition based on a competitive market price for the business. They will make loans based on a percentage of the asset value of the equipment, receivables and inventory that exceed the company's debt level. This will likely result in the buyout group getting financing at 40-50% of the true value of the company.
Where does the rest come from? When the management buyout team explores the effective rate of mezzanine financing - 12% interest rate with warrants that drive the cost to 25%, they usually eliminate that option. The next option is the personal assets of the team. When the banks start asking for personal guarantees, individuals drop out pretty quickly.
This process sometimes evolves to the owner being asked to settle for a purchase price closer to the secured financing level available rather than the market value of the company. On a company with a $10 million fair market value, this could result in a discount of $5 million or more. I am sure the business owner is grateful to his loyal employees, but this is just not practical.
The problem occurs after this process unfolds and the once very excited management team realizes that their dream of ownership has been knocked off the track. If some of the key players blame the owner, they can turn from loyal to disgruntled and may even leave the company. This can result in erosion in company value in the eyes of the eventual buyer. The original noble plan has blown up in the owner's face.
Another approach would be for the owner to engage an investment banker to seek competitive bids from both strategic buyers and private equity groups. This process will establish the true market value that will be far superior to the financing value of the assets minus liabilities. The owner could grant key employees a cash award based on years of service, salary, or other criteria of his choice.
If the buyer is a Private Equity Group, the owner has another option that may be even more attractive to key employees and the Owner. PEGs encourage sellers to invest some of their equity back into the business. They get to invest leveraged equity along with the PEG.
So let's say that the selling price of the business was $10 million. The PEG would borrow $7 million and need $3 million in equity. If the seller invests $1 million of his proceeds back into the business, he would own 33% of the new entity. If the owner was planning on distributing $500,000 to employees, he could reinvest that $500,000 along with his $500,000 back into the business and he would then own 16 ½% and the employees would own 16 ½% of the new entity.
This works out for everybody because the employees will be highly motivated to stay and to perform at a high level for their eventual exit and cash out. The PEG gets to keep a performing management team in place that is highly motivated. The owner gets the maximum selling price for his business because of the soft auction business selling process. Finally, the owner gets to reward his loyal employees with a powerful investment in their future.
The second payoff for the owner and the powerful payoff for the employees comes five years later when the PEG sells the company now valued at $50 million to a strategic industry buyer. This second bite of the apple values the owner's retained 16 ½% stake at $8,250,000. The loyal employees cash out at that same level from an original $500,000 bonus. Now that's a bonus!
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