Selling a business is a long journey. Plan your exit to maximize value. Around 82% of businesses are on the market for four to twelve months before selling, with the majority selling between seven and nine months. However, wasting time during the transaction process is often avoidable. Spending a year or more preparing can seem unnecessary and frustrating, but this work lays the groundwork for a quick, successful sale. Start early.
FIVE things you should be doing now to sell your business in one to three years:
1. BUILD A TEAM
When it’s time to sell your business, it can be tempting to go it alone. But, a team of trusted advisors with transaction experience helps business owners secure higher acquisition premiums when they sell. Before going to market, engage a M&As advisor or business broker to guide you and your company through the process. This is called a third party sale, it involves the third party advisor to the seller, in addition to the buyer and seller. In situations where management, or family are not equipped, or do not want to succeed the owner, a third party advisor can quickly expose the seller to a large network of verified, pre-qualified buyers who are already under Confidentiality Agreement, and financially qualified to make the acquisition— a huge time saver for the seller. Most sellers are not prepared to market their businesses. Without a known buyer, the search can take months or even years, treading in unknown waters, similar to FSBO of your other greatest asset, your home.
Advisors also take the 30,000 foot view for companies preparing for sale. They look for ways to increase earnings and maximize profitability now, and suggest strategic and management changes to increase their value by the time the seller wants the company to be on the market.
Advisors see and help mitigate potential challenges. Consider customer concentration, for example. Many companies inadvertently follow the 80/20 rule: 20% of customers account for 80% of revenue. Are a handful of customers responsible for most of the gross revenues of the company? This a big red flag for buyers. Bottom line revenue is too exposed if that customer goes away. Depending on how how long ’til showtime, the broker-advisor may help develop a strategic plan to market to existing customers to “rebalance”, to find additional opportunities to serve the existing customer base, help wean the company off dependency on too few customers, and explore ways to attract new customers.
Small changes needed to spruce up a business prior to sale in a predetermined time frame, usually between six months and a year may be obvious, they may not be.
Your Business broker or M&A advisor will create a Confidential Information Memorandum (CIM), sometimes called instead Confidential Business Review (CBR). This is the “deck” to be shared with the buyer (your advisor has already qualified) who responded to the generic marketing: teasers and online ads describing simply the industry and financial highlights (including Annual Gross Revenues, Cash Flow or EBITDA or both, and asking price).
What’s this worth? M&As advisors in investment banking take on engagements for a retention fee and a closing fee, which is often 10% or more of the transaction value. Business brokers vary. Some are success fee only– a great option for the seller, because the advisor earns nothing unless they produce: help the seller prepare, market the business, find the right buyer, assist in due diligence and shepherd the transaction to its successful close. Get an advisor on your team who will review the big picture from a fresh perspective.
1b) Advise your CPA of your plans to sell. Your relationship with your CPA, who knows you and your company “under the hood” will be extremely valuable for the advance tips he can offer on “tuning up”.
1c) Advise your legal counsel of your plans to sell. If your lawyer, or law firm is not aware of claims of liens, lawsuits et al, that could be out there, time to bring them into the fold. They can help clean up the “warts.” For instance, a UCC lien is a claim against your business assets under the U.S. Uniform Commercial Code. That doesn’t mean the repo man is coming to take your stuff. If you borrow money, a UCC filing simply lets the lender establish a priority claim on your assets. If your company goes belly up, the lien makes it easier for the lender to collect its due. Deals have gone south in the 11th hour, or delayed in the very least, because a UCC lien was discovered the seller was not even aware of.
Here is a perfect example why both CPA and legal counsel need to be on board. How is your business organized; what is your corporate business structure: S-Corporation C-Corporation, Partnership? LLC, Sole Proprietor? Tax liability can be wildly different for each kind of business. For instance, if your business is a C-Corp, the taxes could eat up a huge portion of the proceeds of the sale— the gain on the sale of the assets of a C-Corporation is taxed at normal corporate rates, which usually ranges from 34% to 39%, and there are more taxes to come! When the corporation sells its assets, the net proceeds after the corporate taxes belong to the corporation, not the owner. When those proceeds are paid out of the corporation to the owner, they are taxed again. If you’ve heard the term “double taxation,” this is the scenario it refers to. This very thing has scuttled deals at the point of closing, because the seller was not aware of the tax consequences! If your equity event is far enough out (more than two years), your legal counsel may even recommend changing your corporate structure, with an eye on tax liability.
We recommend these trusted advisors be on board throughout the process, even while it is being driven by your business broker or M&As advisor.
2. FINE-TUNE FINANCIALS
The single most important factor to a buyer is the health of a potential purchase’s financials (though cybersecurity is rapidly becoming a close second). A company’s financial statements should always be accurate and well-documented. Gather financials from the past three to five years to review with your accountant.
At the very least, financial reports should be free of inconsistencies and speak to the health of the company, but seasoned buyers are also looking for signs that you monitor financial performance and then make adjustments that can improve profits. If your financials tell the story of a lifestyle business focused on personal compensation and not true growth, you might have a problem. The cleanest financials have very few “add-backs“: items a seller expensed to the company, which would not really be expenses for a new owner. And, lenders for the most part, will discount these, and will lend only on the NOI* of the company, after removing from the expense column only interest, taxes (other than payroll), depreciation, and amortization (this indicates the EBITDA, or actual profit the company is producing, leaving in the owner expense: Earnings Before Interest, Taxes, Depreciation, Amortization. Private Equity, Family Office and strategic buyers** make offers based on EBITDA. Cash Flow adds what the owner is actually personally taking out of the company, salary, health or life insurance, cell phone, auto expenses, travel, etc. This is often called SDE: Seller’s Discretionary Earnings, and smaller business (under $2,000,000 gross) valuations are most often calculated as a multiple of SDE.
*Net Operating Income- the figure that appears on the tax return after all expenses, the Net Profit which the company pays income taxes on.
**Strategic buyer: A buyer looking at a company as an add-on, a complement or extension of their current portfolio or industry space: a small mom and pop printer, is acquired by a larger print company.
3. DETERMINE VALUE (RANGE)
What is your company worth, today? Your M&As advisor will develop a valuation or value opinion, by looking at your industry’s benchmarks, and reviewing recent transactions in your industry for companies your size. The advisor will then draw a conclusion based on the 1) general rules of thumb in the industry, and 2) what market is actually doing- reviewing actual transactions and opportunities for sale in the sector. Before you make any broad changes to increase your company’s valuation, you must know about what your value range will be, or at least what an educated opinion says it will be. Does it meet your expectations? Most owners are going to say, “no.“ Hence the reason to get after maximizing value today. If you will not use a broker-advisor, it will be wise to learn about the valuation models buyers use in your industry or category, and learn about valuations of comparable companies in your industry.
4. DUE DILIGENCE
Your advisor created a great deck, and you’ve got a lot of buyer interest. After a few visits, suddenly a buyer brings an offer in the form of an Indication of Interest (IOI) or a Letter of Intent (LOI). If the seller has a cash-producing company in a desirable sector, and has done a good job preparing for this day, maybe there are even multiple buyers circling or multiple LOIs on the table (we have seen this situation, seller chooses one, and the other buyers are advised that the deal is under contract, but please stand by in case it doesn’t work out).
Getting to an agreement can be a back-and-forth process just like in real estate, during which much of the pain of being put on the spot is mitigated by having a broker who is the go-between. Let’s say it’s a good offer, or you get to a successful deal in one counter, you sign and submit back to the buyer— you have a “deal.” Now the deal moves to the due diligence phase, when the seller will be expected to prove every nickel, provide tax returns, bank statements, UCC liens, insurance documents, articles of incorporation, minutes of meetings, on and on, ad infinitum… You, the seller, will need to be able to produce all of it. The historical stuff is the easy part— have the docs used to form the company at hand, and then see section 1c above.
The Letter of Intent will detail a time period after which due diligence is to be complete, and following that when a closing date should be scheduled.
5. INFORMING YOUR EMPLOYEES AND YOUR CUSTOMERS
Don’t. Unless you have family in line for succession, there are few reasons to introduce uncertainty. Make sure all advisors and confidants are advised of the need for strict confidentiality. Unfamiliar faces should be limited to a very minimum visits during business hours, and tours with buyers should be conducted after-hours, if possible— it can be difficult to stop rumblings about a sale once the ball gets rolling. At this early point in the process it might be wise to start thinking about what information you’ll share, when and how. Over- and under-informing employees can incite panic, so think carefully.
We have also seen situations like this- the private equity group has indicated due diligence is to include their introduction to all of the customers and key employees if not all of the employees. NO. The transaction is gaining strength, but it is not final, and all the potential consequences of leaks are unknown– liabilities endangering the company’s future. This is almost never in the interest of the seller, exposing the company to potential mass exodus of employees and possibly customers or both. Horror stories abound.
Pre-sale prep can seem daunting and even a little frightening, but the more work you put in before you start the sale process in earnest, the more time you save later.
Bill Oates, Integrity Broker Advisors division of Alliant Capital Advisors LLC