Bob Fagan is IIB Accredited & a Member of International Business Consultants Inc. – A Founding Partner of M&A International as well as the Western Region Executive Vice-President of The Callahan Group, a boutique management consulting and M&A firm specializing in middle-market companies. He features a background of more than thirty years as a C-Level Executive, Entrepreneur, and Consultant/Coach in both turnaround, hyper-growth, change, and start-ups.
(Start-ups may want to consider the following points because an exit plan and forward-thinking make building and maintain an operation so much more efficient.)
Like selling a house, there are some things that can be done to increase the value of a business before it is put up for sale. In fact, they are essential if a business owner hopes to sell his or her enterprise, let alone realize maximum value for it. Whether you are a small “Mom and Pop” concern or a substantial middle market enterprise, the rules are pretty much the same.
What can a seller do to realize top value? If the business was a house, you could fix the screen door, spruce up the yard, renovate the bathroom, and apply a fresh coat of paint. In a somewhat similar way, it is possible to prepare a business for sale, whether the seller is a corporation choosing to divest itself of the business or an individual deciding to realize a lifetime dream, an exit strategy, investment, estate plan or rather pursue a career shift or. For many, the sale of a business is a critical once-in-a-lifetime transaction and demands expert professional assistance.
An Orderly Approach Will Help to Increase Value
No matter how good a business is nor how confident the owner, advance planning and an orderly, disciplined approach to preparing the business for sale, as opposed to a casual, leave-it-to-the-last-minute crisis mode, makes it possible to avoid the traps and realize maximum value. Here are some steps to ensure maximum value is received for your client’s business when sold.
1. Optimize Cash Flow – Most knowledgeable buyers and their advisors favor a discounted cash flow approach to valuation, based on a documented and detailed knowledge of historical events and the future cash likely to be generated by the business. Once the sale decision is made, the owner should evaluate every decision on how it affects cash flow. Obviously, discretionary capital expenditures should be scrutinized according to their impact upon margin and payback. Similarly, investments in new products may not be fully valued by the prospective purchaser if there is a current negative cash impact.
Reduced overheads can cause a significant positive cash flow; if overhead reductions are required, make them. One-time implementation costs get normalized in the financial statements, as the buyer usually puts the greatest emphasis upon the ongoing performance of the business.
If the company is holding excess or obsolete inventories, get rid of them. It is false economy to preserve them on the balance sheet, as the prudent purchaser will certainly uncover the true asset value, leaving the current owner with all the pain and no gain. Similarly, make every effort to collect accounts receivable and keep them as current as possible. The lower the working capital requirements, the more the buyer can afford to pay for shares or other assets of the business.
Example: In a recent divestiture, the seller, a medium size food processor, had started the phase-out of non-core, unprofitable businesses. The overheads related to these businesses were not eliminated prior to offering the business for sale. Even though the seller presented a detailed plan,
supported with strong rationale, the buyer refused to fully value the projected savings because they were not “real” yet. Completing the disposition of the unprofitable businesses and related overheads, prior to the divestiture, could have yielded a higher selling price.
2. Complete the Normalization Process – The normalization process requires adding back extraordinary one-time costs such as for labor strikes, severance pay, discontinued product lines and restructuring costs, to reflect the performance of the business under normal circumstances. Any steps that can be taken, should be pursued to avoid a debate with the prospective purchaser about their legitimacy, and the perception that you are trying to artificially improve the portrayal of the business’ performance. Also, to convince the prospective purchaser of the legitimacy of the add-backs, document the trail from the audited figures to the adjusted, normalized figures.
Example: The seller, a light manufacturer, completed a detailed normalization of its financial statements, but its historical records were not well kept. Therefore, while adjustments were probably accurate, they were based on the judgment of the seller’s management team, some of who were no longer with the company. A big leap of faith was required to reconcile the audited financials with the normalized figures, as a clearly defined trail of documentation did not exist. Eventually, the prospective purchaser lost confidence in the validity of the normalized figures, and referred to the absence of documentation as his reason for offering a lower bid. The seller was forced to accept a value significantly below his expectations.
3. Purge Redundant Assets – Many owners have unrelated businesses owned by the divestiture candidate. It is important to show a purchaser only that part of the business for sale, net of anything that is to be left with the owner. The most obvious redundant asset is cash. Since the purchaser is responsible for his or her own financing, it does not make any sense to sell cash.
Although less obvious, the business may contain excess assets in the form of land or buildings, the values of which are too high to justify their continued employment in the business, or at minimum too high to be fully valued by a purchaser. The owner may be wise to relocate the business to other premises, or to keep and lease the land and buildings to the new owner for a reasonable transition period, thus preserving the opportunity to sell them for fair market value at some point in the future.
Example: In another might-have-been transaction, a buyer evaluated a California manufacturing business being offered for sale by an owner wishing to retire. The seller’s financial statements included accounts of unrelated businesses that were not for sale. It appeared, however, that a substantial portion of the debt on the balance sheet – which the seller wanted the buyer to assume – was incurred for the benefit of those businesses remaining with the present owner. This caused major disagreements and ultimately killed the deal.
4. Plan for Management Continuity – Most buyers value a solid experienced management team. While it is true that some buyers may want to replace one or more key people, the seller should not count on that. The seller is advised to continue to build the future capability of the firm and replace weakness promptly. Severance costs are one-time charges and will be taken out in the normalization process. Furthermore, future severance pay is usually an issue at the time of sale if marginal employees are still on board.
5. Do Not Launch Gold-Plated Incentive or Benefit Plans – If a buyer perceives that the seller is rewarding employees at a level beyond market realities, the excess cost of those compensation programs will most likely be offset by an appropriate reduction in the purchaser’s offer for the
business. The prudent buyer will allow ample time to bring the programs into line or replace the people.
Example: A few months prior to closing, a seller approved a 6½% wage increase for its hourly workforce when the norm for these types of companies had recently been around 3%. Unable to roll back the wage increase, the purchaser was prompted to reduce the purchase price by a compensatory amount.
6. Treasure and Maintain Information Systems Excellence – The seller should do whatever is necessary to ensure that the business can produce information to make prospective buyers comfortable with what is being offered on paper, and counter the fear that there are skeletons in the closet. All too often, sellers have key information in their heads and not in writing.
Being able to produce timely, accurate and relevant information often creates a halo effect, improving the prospective buyer’s perception of the overall business. The need to produce this information increases as the transaction process progresses, particularly during the due diligence
There are many cases are on record where the prospective buyer reduced the offering price by a significant amount simply because he or she could not attest to the historical numbers during the due diligence process.
7. Consider Leases and Contracts Very Carefully– Once a decision is made to sell a business, avoid making commitments that bind the future owner unless you are absolutely certain that such obligations will be deemed to be an absolute benefit, not a drawback.
Example: The owner anticipating she would soon offer her business for sale, was faced with the expiration of a major facility lease. She negotiated a short-term lease with a renewal option. Shortly thereafter, she indeed did hire an M&A firm to discreetly market her business. Her strategy to retain short-term flexibility in the lease worked wonderfully. The terms of the lease were not viewed negatively by any of the prospective buyers, as those who did not need the facility would require the better part of the 18 months remaining on the lease to relocate the business, and prospective buyers who did want to remain in the same location could exercise the renewal option.
8. Minimize Legal Contingencies – Anxieties Will Cost The Seller Money. Be prepared to settle up all outstanding matters that impinge upon the business unless they can be severed from the business and left with the seller. In most cases, this is not readily achievable and, therefore, an
owner is well advised to resolve pending or threatened lawsuits where possible. It is equally important that matters of title, trademarks and licenses be
buttoned down well in advance of the due diligence process.
Example: A multi-division New York company received numerous attractive offers for one of its businesses. After the preferred prospective purchaser was selected and the due diligence process initiated, a lawsuit was served by another company claiming it had rights to the formulations and trademarks included as a key part of the divestiture. The suing company was able to obtain an injunction, involving the seller in lengthy and costly legal proceedings, taking over two years to settle. Of course, all proceedings stalled.
9. Clean Everything – A clean bill of environmental health is becoming as important as market share and customer relations. Horror stories abound about contingent environmental liabilities coming back to bite the new owner. For that reason, purchasers are reviewing any environmental
questions with a fine tooth comb and trying to leave all contingencies with the seller or seek indemnification.
Although less complex, the concept of clean also applies literally to the plant and all workplaces. Unfortunately, when something appears to be down at the heels physically, a prospective purchaser will be concerned even if the income statement and balance sheet tell a different story.
Example: A New Jersey plating finisher who was selling his business, that had changed ownership three times in the preceding 18 years, encountered significant difficulty over the level of environmental warranty that would be provided to the prospective purchaser. Few environmental records from the previous owners were available, and the current owner had not completed an environmental audit. As a result, to save the deal the seller was forced to provide an onerous
10. Dispose of the “Junk” separately, keep it, or give it away. What you do not sell may be as important as what is sold. Contingent liabilities involving environmental matters, claims relating to products or services, employees, contracts and, of course, taxes will be the subject of intense negotiations. Which, if any, are to be left with the seller and which are to be assumed by the buyer? Any one of these decisions can be a showstopper since, in certain circumstances, the amount of money involved can exceed the purchase price. As a seller, do not underestimate the importance of eliminating risk, even if it means foregoing a portion of immediate proceeds.
11. Gain Tax Advantage, But in a Win-Win Way – Get expert tax advice. Making decisions that will affect sale proceeds due to tax implications is not a job for laymen. Often, even the subtlest difference can result in totally different treatment -either positive or negative.
A first taxation question concerns the choice of selling assets or shares. It is impossible to generalize on this subject, but the seller is well advised to understand the differences to their own account, which can be substantial. There is usually a way to compromise to create a win-win for
both buyer and seller.
Implement only those things that are clearly to the seller’s advantage and would not negatively preempt negotiations with a prospective buyer. The question of whether or not to strip net worth and its underlying asset value is even more critical in a buyer’s market environment. For all tax
matters, have a plan, including your first preferences, and present it to prospective buyers as part of the deal.
12. Do Not Neglect The Minute Book and Other Administration – Neglecting the little matters can cause a last minute panic at closing, but more importantly, can provide a purchaser a technical excuse not to close the deal if he or she is looking for an out.
13. Be “Finicky” About Buyer Fit, Capability and Reputation – Early in the process, the vendor needs to decide if the maximum value is likely to be obtained from one buyer purchasing the whole business, or whether the business is divisible into separate parts or product lines that would be
attractive to separate purchasers and, if sold separately, would fetch a higher total price.
Once having made the decision to sell, most sellers demand top dollar, which is most likely to come from the purchaser for whom the acquisition can create the most synergy. When faced with evaluating multiple offers, the seller will find that the price offered is obviously important, but
there are many other factors that must be considered. Perhaps the most critical is the buyer’s financial capability to consummate the transaction.
Although it is an extremely delicate matter, verifying the buyer’s financial strength is absolutely essential. Some buyers make high initial offers, only to negotiate the price down severely as the negotiations proceed. Other buyers are known for making unreasonable demands for
representations and warranties.
Example: A multinational company divesting a misfit division was faced with comparable excellent non-binding bids from four quality buyers. The company selected the bidder whose strategic need appeared greatest. Assurances were received from the bidder’s representative that they had
ample funds to close the deal. Months later, after numerous stalls, it became all too apparent that the bidder’s assurances were misleading and that they were unable to raise the necessary funds. More rigid scrutiny at the outset, even at the risk of offending the –prospective buyer, would have
avoided a great deal of frustration and wasted time for all concerned. The business was sold to another buyer, but only after costly delay.
14. Contemplate Earn Outs – As a Last Resort – It is not surprising that a prospective buyer may well be less optimistic than the current owner about future prospects for the business. In such circumstances, the only way to bridge the gap between what the vendor wants to receive and what the purchaser wants to pay is to make part of the purchase price conditional upon the business achieving certain performance targets. While it sounds superb in theory and can be made to work, there are perils. When there is a performance shortfall, the previous owner – the vendor – may well believe that the new owner – the purchaser has mismanaged the situation due to ineptitude, or even consciously to avoid making further payments under the earn out provisions. In either instance, a legal harangue becomes probable. If the seller is forced to accept an earn-out to realize what you consider to be acceptable value, try to specify and simplify the performance target. Usually the way to do this is to focus on the sales or the gross margin line, staying out of the mire of bottom line profitability, which is so subject to discretion and manipulation.
15. Identify Special Requests or Requirements Up Front – If the seller intends to impose certain conditions upon a purchaser, be clear about them up front. For example, if there are some employees that just have to be protected, make their protection a condition of the offer. Similarly, if
you need to be able to leave immediately upon the sale, or if you want to remain as chairman or on a consulting basis, make that known. Finally, be prepared to negotiate certain perquisites that contribute toward realizing a satisfactory value for the business.
16. Beware “Seller-itis” and False Hope – The sale of any business, but particularly an owner-operated business, can be an emotionally-charged experience. The seller must come to grips with this matter before the divestiture process begins. Are the seller’s motivations based on sound
logic or on emotions? Are price expectations realistic given the performance record, the conditions of the assets, revenue and profit prospects, and equally important, the mergers and acquisitions market at the time? Is the seller aware of the implications of the sale of the business on his or her personal lifestyle, family members and employees? If the sale process is started and the vendor changes his or her mind prior to the consummation of the transaction, or if the market values the business dramatically below the vendor’s expectations, the organization will have been subjected to an unnecessary upheaval, with ongoing organizational anxiety costs if employees believe that the future for the company and, therefore, their futures, are uncertain.
Stakes for Both Buyer and Seller Usually High
There are practical steps that can be taken to prepare a business for sale and to manage the process of sale to ensure the vendor receives full value.
Because the stakes are usually extremely high for both buyer and seller, the undertaking is bound to be fraught with risk – an I win – you lose mentality – and emotion. Having a plan, a checklist and a ruthlessly honest appraisal of what does exist in your business through the eyes of a potential buyer will allow you as owner or responsible executive to prepare the business for sale, make necessary changes and corrections and thereby avoid squandering business value.
GETTING MAXIMUM VALUE FOR YOUR BUSINESS
1. Optimize cash flow
2. Add back extraordinary one-time costs
3. Purge redundant assets
4. Plan for management continuity
5. Avoid gold-plated incentive or benefit plans
6. Maintain or create information systems excellence
7. Be careful with long-term commitments such as leases
8. Minimize legal contingencies
9. Clean everything
10. Get rid of nuisance items
11. Get expert tax advice
12. Look after details
13. Check buyer out carefully
14. Keep earn outs simple
15. Identify special requirements up front
16. If you have decided to sell, sell!