Considering Selling? Some Important Questions

Some years ago, when Ted Kennedy was running for president of the United States, a commentator asked him why he wanted to be president. Senator Kennedy stumbled through his answer, almost ending his presidential run. Business owners, when asked questions by potential buyers, need to be prepared to provide forthright answers without stumbling.

Here are three questions that potential buyers will ask:

  1. Why do you want to sell the business?
  2. What should a new owner do to grow the business?
  3. What makes this company different from its competitors?

Then, there are two questions that sellers must ask themselves:

  1. What is your bottom-line price after taxes and closing costs?
  2. What are the best terms you are willing to offer and then accept?

You need to be able to answer the questions a prospective buyer will ask without any “puffing” or coming across as overly anxious. In answering the questions you must ask yourself, remember that complete honesty is the only policy.

The best way to prepare your business to sell, and to prepare yourself, is to talk to a professional intermediary.

© Copyright 2015 Business Brokerage Press, Inc.

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Is Your “Normalized” P&L Statement Normal?

Normalized Financial StatementsStatements that have been adjusted for items not representative of the current status of the business. Normalizing statements could include such adjustments as a non-recurring event, such as attorney fees expended in litigation. Another non-recurring event might be a plant closing or adjustments of abnormal depreciation. Sometimes, owner’s compensation and benefits need to be restated to reflect a competitive market value.

Privately held companies, when tax time comes around, want to show as little profit as possible. However, when it comes time to borrow money or sell the business, they want to show just the opposite. Lenders and prospective acquirers want to see a strong bottom line. The best way to do this is to normalize, or recast, the profit and loss statement. The figures added back to the profit and loss statement are usually termed “add backs.” They are adjustments added back to the statement to increase the profit of the company.

For example, legal fees used for litigation purposes would be considered a one-time expense. Or, consider a new roof, tooling or equipment for a new product, or any expensed item considered to be a one-time charge. Obviously, adding back the money spent on one or more of these items to the profit of the company increases the profits, thus increasing the value.

Using a reasonable EBITDA, for example an EBITDA of five, an add back of $200,000 could increase the value of a company by one million dollars. Most buyers will take a hard look at the add backs. They realize that there really is no such thing as a one-time expense, as every year will produce other “one-time” expenses. It’s also not wise to add back the owner’s bonuses and perks unless they are really excessive. The new owners may hire a CEO who will require essentially the same compensation package.

The moral of all this is that reconstructed earnings are certainly a legitimate way of showing the real earnings of a privately held company unless they are puffed up to impress a lender or potential buyer. Excess or unreasonable add backs will not be acceptable to buyers, lenders or business appraisers. Nothing can squelch a potential deal quicker than a break-even P&L statement padded with add backs.

© Copyright 2015 Business Brokerage Press, Inc.

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Do You Have an Exit Plan?

“Exit strategies may allow you to get out before the bottom falls out of your industry. Well-planned exits allow you to get a better price for your business.”

From: Selling Your Business by Russ Robb, published by Adams Media Corporation

Whether you plan to sell out in one year, five years, or never, you need an exit strategy. As the term suggests, an exit strategy is a plan for leaving your business, and every business should have one, if not two. The first is useful as a guide to a smooth exit from your business. The second is for emergencies that could come about due to poor health or partnership problems. You may never plan to sell, but you never know!

The first step in creating an exit plan is to develop what is basically an exit policy and procedure manual. It may end up being only on a few sheets of paper, but it should outline your thoughts on how to exit the business when the time comes. There are some important questions to wrestle with in creating a basic plan and procedures.

The plan should start with outlining the circumstances under which a sale or merger might occur, other than the obvious financial difficulties or other economic pressures. The reason for selling or merging might then be the obvious one – retirement – or another non-emergency situation. Competition issues might be a reason – or perhaps there is a merger under consideration to grow the company. No matter what the circumstance, an exit plan or procedure is something that should be developed even if a reason is not immediately on the horizon.

Next, any existing agreements with other partners or shareholders that could influence any exit plans should be reviewed. If there are partners or shareholders, there should be buy-sell agreements in place. If not, these should be prepared. Any subsequent acquisition of the company will most likely be for the entire business. Everyone involved in the decision to sell, legally or otherwise, should be involved in the exit procedures. This group can then determine under what circumstances the company might be offered for sale.

The next step to consider is which, if any, of the partners, shareholders or key managers will play an actual part in any exit strategy and who will handle what. A legal advisor can be called upon to answer any of the legal issues, and the company’s financial officer or outside accounting firm can develop and resolve any financial issues. Obviously, no one can predict the future, but basic legal and accounting “what-ifs” can be anticipated and answered in advance.

A similar issue to consider is who will be responsible for representing the company in negotiations. It is generally best if one key manager or owner represents the company in the sale process and is accountable for the execution of the procedures in place in the exit plan. This might also be a good time to talk to an M&A intermediary firm for advice about the process itself. Your M&A advisor can provide samples of the documents that will most likely be executed as part of the sale process; e.g., confidentiality agreements, term sheets, letters of intent, and typical closing documents. The M&A advisor can also answer questions relating to fees and charges.

One of the most important tasks is determining how to value the company. Certainly, an appraisal done today will not reflect the value of the company in the future. However, a plan of how the company will be valued for sale purposes should be outlined. For example, tax implications can be considered: Who should do the valuation? Are any synergistic benefits outlined that might impact the value? How would a potential buyer look at the value of the company?

An integral part of the plan is to address the due diligence issues that will be a critical part of any sale. The time to address the due diligence process and possible contentious issues is before a sale plan is formalized. The best way to address the potential “skeletons in the closet” is to shake them at this point and resolve the problems. What are the key problems or issues that could cause concern to a potential acquirer? Are agreements with large customers and suppliers in writing? Are there contracts with key employees? Are the leases, if any, on equipment and real estate current and long enough to meet an acquirer’s requirements?

The time to address selling the company is now. Creating the basic procedures that will be followed makes good business sense and, although they may not be put into action for a long time, they should be in place and updated periodically.

© Copyright 2015 Business Brokerage Press, Inc.

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What a Buyer May Really Be Looking At

Buyers, as part of their due diligence, usually employ accountants to check the numbers and attorneys to both look at legal issues and draft or review documents. Buyers may also bring in other professionals to look at the business’ operations. The prudent buyer is also looking behind the scenes to make sure there are not any “skeletons in the closet.” It makes sense for a seller to be just as prudent. Knowing what the prudent buyer may be checking can be a big help. A business intermediary professional is a good person to help a seller look at these issues. They are very familiar with what buyers are looking for when considering a company to purchase.

Here are some examples of things that a prudent buyer will be checking:

Finance

Is the business taking all of the trade discounts available or is it late in paying its bills? This could indicate poor cash management policies.
Checking the gross margins for the past several years might indicate a lack of control, price erosion or several other deficiencies.
Has the business used all of its bank credit lines? Does the bank or any creditor have the company on any kind of credit watch?
Does the company have monthly financial statements? Are the annual financials prepared on a timely basis?
Management

Is the owner constantly interrupted by telephone calls or demands that require immediate attention? This may indicate a business in crisis.
Has the business experienced a lot of management turnover over the past few years?
If there are any employees working in the business, do they take pride in what they do and in the business itself?
Manufacturing

What is the inventory turnover? Does the company have too many suppliers?
Is the business in a stagnant or dying market, and can it shift gears rapidly to make changes or enter new markets?
Marketing

Is the business introducing new products or services?
Is the business experiencing loss of market share, especially compared to the competition? Price increases may increase dollar sales, but the real measure is unit sales.
When business owners consider selling, it will pay big dividends for them to consider the areas listed above and make whatever changes are appropriate to deal with them. It makes good business sense to not only review them, but also to resolve as many of the issues outlined above as possible.

A “Pig in a Poke"

Once a buyer has negotiated a deal and secured the necessary financing, he or she is ready for the due diligence phase of the sale. The serious buyer will have retained an accounting firm to verify inventory, accounts receivable and payables; and retained a law firm to deal with the legalities of the sale. What’s left for the buyer to do is to make sure that there are no “skeletons in the closet,” so he or she is not buying the proverbial “pig in a poke.”

The four main areas of concern are: business’ finances, management, buyer’s finances, and marketing. Buyers are usually at a disadvantage as they may not know the real reason the business is for sale. This is especially true for buyers purchasing a business in an industry they are not familiar with. The seller, because of his or her experience in a specific industry, has probably developed a “sixth sense” of when the business has peaked or is “heading south.” The buyer has to perform the due diligence necessary to smoke out the real reasons for sale.

Business’ Finances: The following areas should be investigated thoroughly. Does the firm have good cash management? Do they have solid banking relations? Are the financial statements current? Are they audited? Is the company profitable? How do the expenses compare to industry benchmarks?

Management: For a good quick read on management, the buyer should observe if management is constantly interrupted by emergency telephone calls or requests for immediate decisions by subordinates? Is there a lot of change or turn-over in key positions? On the other hand, no change in senior management may indicate stagnation. Are the employees upbeat and positive?

Buyer’s Finances: Buyers should make sure that the “money is there.” Too many sellers take for granted that the buyer has the necessary backing. Sellers have a perfect right to ask the buyer to “show me the money.”

Marketing: Price increases may increase dollar sales, but the real key is unit sales. How does the business stack up against the competition? Market share is important. Does the firm have new products being introduced on a regular basis.

By doing one’s homework and asking for the right information – and then verifying it, buying a “pig in the poke” can be avoided.

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.
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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.

 

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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.

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Company 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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