The Pre-Sale Business Tune-Up
Owners are often asked, “do you think you will ever sell your business?” The answer varies from, “when I can get my price” to “never” to “I don’t really know” to everything in between. Most sellers may think to themselves when asked this question, “I’ll sell when the time is right.” Obviously, misfortune can force the decision to sell. Despite the questions, most business owners just go merrily along their way conducting business as usual. They seem to believe in the old expression that basically states, “it is a good idea to sell your horse before it dies.”
Four Ways to Leave Your Business
There are really only four ways to leave your business. (1) Transfer ownership to your children or other family members. Unfortunately, many children do not want to become involved in the family business, or may not have the capability to operate it successfully. (2) Sell the business to an employee or key manager. Usually, they don’t have enough cash, or interest, to purchase the business. And, like offspring, they may not be able to manage the entire business. (3) Selling the business to an outsider is always a possibility. Get the highest price and the most cash possible and go on your way. (4) Liquidate the business – this is usually the worst option and the last resort.
When to Start Working on Your Exit Plan
There is another old adage that says, “you should start planning to exit the business the day you start it or buy it.” You certainly don’t want to plan on misfortune, but it’s never to early to plan on how to leave the business. If you have no children or other relative that has any interest in going into the business, your options are now down to three. Most small and mid-size businesses don’t have the management depth that would provide a successor. Furthermore liquidating doesn’t seem attractive. That leaves attempting to find an outsider to purchase the business as the exit plan.
The time to plan for succession is indeed, the day you begin operations. You can’t predict misfortune, but you can plan for it. Unfortunately, most sellers wait until they wake up one morning, don’t want to go to their business, drive around the block several times, working up the courage to begin the day. It is often called “burn-out” and if it is an on-going problem, it probably means it’s time to exit. Other reasons for wanting to leave is that they face family pressure to start “taking it easy” or to move closer to the grandkids.
Every business owner wants as much money as possible when the decision to sell is made. If you haven’t even thought of exiting your business, or selling it, now is the time to begin a pre-exit or pre-sale strategy.
Considering Selling? Some Things to Consider
- Know what your business is worth. Don’t even think about selling until you know what your business should sell for. Are you prepared to lower your price if necessary?
- Prepare now. There is an often-quoted statement in the business world: “The time to prepare your business to sell is the day you buy it or start it.” Easy to say, but very seldom adhered to. Now really is the time to think about the day you will sell and to prepare for that day.
- Sell when business is good. The old quote: “The time to sell your business is when it is doing well” should also be adhered to. It very seldom is – most sellers wait until things are not going well.
- Know the tax implications. Ask your accountant about the tax impact of selling your business. Do this on an annual basis just in case. However, the tax impact is only one area to consider and a sale should not be predicated on this issue alone.
- Keep up the business. Continuing to manage the business is a full-time job. Retaining the best outside professionals is almost a must. Utilizing a professional business intermediary will allow you to spend most of your time running your business.
- Finally, in the words of many sage experts, “Keep it simple.” Don’t let what looks like a complicated deal go by the boards. Have your outside professionals ready at hand to see if it is really as complicated as it may look.
Can You Really Afford to Sell?
In many cases, the sale of a small company is “event” driven. That is, the reason for sale is often an event such as a health decline or illness, divorce, partnership issues, or even a decline in business.
A much more difficult reason for selling is one in which the owners simply want to retire and live happily ever after. Here is the problem:
Suppose the owners have a very prosperous distribution business. They each draw about $200,000 annually from the business plus cars and other benefits. If the company sold for $2 million, let’s say after debt, taxes and closing expenses, the net proceeds would be $1.5 million. Sounds good, until you realize that the net proceeds only represent about 3 1/2 years of income for each (and that doesn’t include the cars, health insurance, etc.). Then what?
The above scenario is not atypical, especially in small companies. These are solid companies that provide a very comfortable living for two owners. In the above example, the owners obviously decided they couldn’t sell because it didn’t make economic sense to them. The business was worth much more to the owners than to any outside buyer. Perhaps they thought that an intermediary could produce a buyer who would be willing to pay far more than the business was worth. But, the M&A market is a fairly efficient one.
So, what should they do?
The downside is that competition could enter the fray and their business would not bring in the same cash flow.
The business could also suffer because the owners are not continuing to build it. They apparently want to retire and take life easy, and this mind-set could dramatically undermine the business.
If the owners are forced to sell the business because it is declining, they, most likely, won’t even receive the $2 million they might have received earlier.
On the other hand, the owners, ready to begin their happily ever after, could bring in a professional manager. This addition would cut their earnings slightly to pay for the new manager, but it would also reduce their responsibilities and give the business a chance to grow with new energy and ideas.
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Surprises CEOs Face When Selling Their Companies
Surprise #1: Substantial Time Commitment
In the real estate business, once the owner engages the broker there is very little for the owner to do until the broker presents the various offers from the potential buyers. In the M&A business, there is a substantial time commitment required of the CEO/Owner in order to complete the sale properly, professionally and thoroughly. The following examples are worth noting:
Offering Memorandum:
This 30 + page document is the cornerstone of the selling process because most business intermediaries expect the potential acquirers to submit their initial price range based on the information presented in this memorandum. The intermediary will heavily depend on the CEO/Owner to supply him or her with all the necessary facts.
Suggestions of Potential Acquirers:
Chances are that the sales manager is the only person who knows the best companies to contact and those not to contact (competitors). Arguably, this information should be mostly supplied by the intermediary, but as a thorough team effort, the CEO/Owner should play a major role in this endeavor.
Management Presentations:
Assuming the intermediary conducts the normal process of boiling down the bidders to 4 or 5 potential acquirers, it is then customary to have management presentations before the final bids are submitted. In order to help extract the best offers, it is advisable that the CEO show the benefits of combining the acquirer and seller and/or the future upside for the selling company.
Surprise #2: The Need to Enjoin Other Employees in the Process
A number of owners selling their company are paranoid about a confidentiality leak regarding the sale of their company. In fact, some owners prefer that no other person in the organization is aware of the pending sale of the company. At a bare minimum, the CFO and Sales Manager should be informed. The CFO will be asked to pull all the financials together, to supply projections, to articulate reconstructed earnings (add-backs) and to supply monthly statements…all of which suggest that the company is being sold. The Sales Manager will be asked to supply the names of synergistic companies in or around the particular industry. And, perhaps, the CEO’s secretary will be asked to set up a “war room” where all legal and contractual information is assembled for the buyer’s due diligence team. In order to protect the company from confidentiality leaks and assure retention of key employees, the CEO/Owner should implement “stay agreements” for these key employees.
Surprise #3: The Need to Maintain, or Accelerate, Sales
The tendency for some owners is to become so distracted with the M&A process that they take their “eye off the ball” in running the business on a daily basis. Potential acquirers will be watching the monthly sales reports like a hawk to see if there is a turn-down in business. Acquirers become very apprehensive when they see a recent downward trend in the company they are about to acquire and may, as a result, want to negotiate a lower price.
Surprise #4: A Confidentiality Leak
Naturally, most CEOs expect the M&A process to go smoothly and usually it does. However, there should be a contingency plan in place for such occurrences as confidentiality leaks. The degree of damage determines what action should be implemented. On one occasion the draft of the Offering Memorandum was e-mailed to the CEO/Owner for his corrections; however, the sender from the brokerage firm used one incorrect letter in the CEO’s e-mail address. As a result of this misstep, the e-mail was rejected by the CEO’s computer and ended up in the company’s general mailbox which was administered by the employee in charge of IT. The employee was told by the quick-thinking CEO that the Offering Memorandum was being used to raise growth capital. Luckily, the incident went no further. Much more serious confidentiality leaks can occur, and it is wise to discuss ahead of time how the matter is going to be handled with those concerned.
Surprise #5: Unexpected Low Bids
Ultimately, the M&A market sets the price of the company. However, rarely does a seller go to market without having certain expectations of price. Let’s use a hypothetical case in which a company is growing at 15% annually. The CEO/Owner believes that it is worth $6 million based on $1 million of EBITDA. However, the top bid is $5 million cash or, obviously, 5 times EBITDA. Assuming the business intermediary has exhausted the universe of acquirers, the seller has two choices to reach his desired $6 million selling price. Either he can take the company off the market and return several years later when either the company’s earnings have improved or when the M&A market has heated up. Alternatively, the CEO can negotiate further with the top bidder by selling 80% of the company now and the remaining 20% in three years on a pre-arranged formula on the expectation that business will improve. Or, the CEO can sell the company now for $5 million with an earnout formula that might give him the additional $1 million.
Surprise #6: The P&S Agreement is Not What the CEO Expected
Numerous CEOs drive the M&A process to the letter of intent and then turn over the deal to their attorney to iron out the details of the purchase and sale agreement. While the CEO should not micro-manage his designated professional advisors in the transaction, he should be involved throughout the process, or otherwise the CEO will invariably object to the final wording of the document at the signing state. The area most likely to be overlooked by the CEO/Owner is the critical section of reps and warranties.
Surprise #7: Agreement of Other Stakeholders
While the CEO can negotiate the entire transaction, the sale is not authorized until certain stakeholders agree in writing, namely the Board of Directors, majority of the shareholders, financial institutions which have a lien on certain assets, etc.
Conclusion
For many CEOs, selling their company is a once in a lifetime experience. They may be very experienced, very talented executives, but they can also be blind sided by surprises when selling their company.
Read MoreCompany Weaknesses
Take two seemingly identical companies with very similar financials, but one of the companies was worth substantially more than the other company. One company will sell for $10 million “as is” or some changes can be made and the same company can be sold for $15 million. Following is a partial list of potential company weaknesses to consider in order to assess a company’s vulnerability.
Customer Concentration: First, one has to analyze the situation. The U.S. Government might be considered one customer but from ten different purchasing agents. Or, GM might have one purchasing agent but be directed to ten different plants. One office product manufacturer with $20 million in sales had 75% of its business with one customer…Staples. They had three choices: 1. Cross their fingers and remain the same; 2. Acquire another company with a different customer base; or 3. Sell out to another company. They selected the third choice and took their chips off the table. The acquirer was a $125 million competitor which was unable to sell to Staples, so after absorbing the smaller company, the customer concentration to Staples was only about 10% ($125m + $20m=$145m of which $15 million was sold to Staples or 10+%).
Single Product: Perhaps the most famous example of a single product acquisition is when General Motors overtook Ford’s single product, the Model A, with Alfred Sloan’s brilliant concept of a different model for people with different financial thresholds. Henry Ford’s stubbornness to stay with one product (Model A) almost cost the company its existence.
Regional Sales/Limited Marketing: Companies with parochial focus have limited capabilities to grow other than within their own domain. A widget company with national and international sales has substantially greater prospects to grow than one limited to its own region.
Aging Workforce/Decaying Culture: Skilled workers in certain trades, such as tool and die shops, are not being replaced by the younger generation. This is a sign that the next generation will not provide the companies with a skilled workforce in certain industries.
Declining Industry: Some companies are agile enough to completely change their industry, such as Warren Buffet’s Berkshire Hathaway and Fashion Neckwear Company which completely changed from neckties to polo shirts.
Pricing Constraints/Rising Costs: Companies who sell a commodity product often lack pricing elasticity and are unable to pass on their increased costs to their customers. For a while, the steel industry was in this predicament, but through massive industry consolidation and a booming demand from China, the situation changed.
CEO Dependency/No Succession Plan: Many middle market companies have successfully been built up by the founder/entrepreneur/owner and some critics call these individuals a “one-man-band” for good reason. These superman types tend to dominate most aspects of the company, but this is no way to build a sustainable business long term. Furthermore, these CEOs usually have not created a succession plan.
Maximizing Value
If the owners of a company, many of whom may be outsiders, want to increase the value of their investment, they should, through the Board of Directors, try to overcome the company’s weaknesses. On the other hand, the CEO may not be either capable or motivated to do so. The alternative is to implement a CEO succession plan, preferably with the cooperation of the current CEO. Kenneth Freeman’s thesis in “The CEO’s Real Legacy” (Harvard Business Review, Nov 2004) is that the CEO’s real legacy is implementing a succession plan.
Freeman advises:
“Your true legacy as a CEO is what happens to the company after you leave the corner office.
“Begin early, look first inside your company for exceptional talent, see that candidates gain experience in all aspects of the business, help them develop the skills they’ll need in the top job…
“During good times, most boards simply don’t want to talk about CEO succession…During bad times when the board is ready to fire the CEO, it’s too late to talk about a plan for smoothly passing the baton…Succession planning is one of the best ways for you to ensure the long-term health of your company.”
Both buyers and sellers should assess the company’s weaknesses. While some weaknesses are difficult to overcome, especially in the short term, one potential weakness that is very easy to overcome is to implement a succession plan…especially during the company’s good times before things go bad and it’s too late.
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