The first installment of The Credit Junction's 4-part M&A blog series. In this piece, learn about the steps you must take to prepare your business for a sale.
So, your childhood friend just sold a family business for ten times earnings before interest, taxes, depreciation and amortization (“EBITDA”) and the gears are turning in your head – if I sold my business for ten times EBITDA it would create generational wealth for my family. Deciding to sell your business is the easy part. Preparing, planning and executing a transaction is a complicated and time-consuming process that will require intestinal fortitude and commitment.
A typical auction process lasts six to twelve months depending on the complexity of the target company and the structure of the purchase offer. As an owner, you should begin preparing your business for sale at least twelve months prior to beginning the sale process. This time would allow for the cleanup of any legal, tax or financial controls which should be reflected in a full year of financial results. The steps you take in preparing your business for sale will be your opportunity to create value by reducing perceived risk for the buyer.
For instance, financial statements that are audited or reviewed by a reputable accounting firm will increase the validity and transparency of the financial information being prepared by the company. Further, a robust financial reporting system capable of quickly, accurately and consistently fulfilling information requests will reduce questions about the financial information being provided. As a result, buyers should have less concern about the accounting practices and should rely more on the actual and projected information you present.
Here are four key focus areas when beginning to prepare for the sale of your business – finance and operations, legal and tax structure, internal considerations and external resources.
- Finance and operations
Maximize profits. Take time to review the cost structure of your company. Ensure that expenses are directly related to the company’s business objectives. Eliminate all expenses that fall outside of these parameters. In our example above, every dollar increase to EBITDA represents a ten dollar increase in valuation.
Eliminate non-business-related expenses or assets. Many privately-owned companies blur the lines between personal expenses and business-related expenses. For instance, auto leases are typically perks enjoyed by owners of a company. If these expenses are not something that will be required post-close, they should be eliminated from the cost structure or added back in any financial presentation. Remember every dollar of cost savings represents a ten dollar increase in valuation.
Ensure accurate reporting. Utilize an external accounting firm to audit or review your company’s financial statements and financial controls. They will provide an objective overview of the company’s consistent application of accounting principles and its adherence to US GAAP as well as the internal controls. Buyers will appreciate the objective third party review and it will help you eliminate any potential questions they may have about accounting treatment.
Develop realistic and defensible financial projections with assumptions and supporting documentation. Projections should be based on experience and founded in fact. If your company has never grown by 15% in any one year, it is most likely not reasonable to assume that this will occur after you sell it. If gross margins have historically been 35%, you probably shouldn’t assume that they will increase to 45% one year after the transaction, unless you have sound reasoning to support your projection. Be prepared to defend any assumption or growth projection with data.
Appropriate working capital management. Be sure to efficiently monitor cash inflows and outflows to maximize working capital. Any purchaser will require a certain reasonable amount of working capital to remain with the company. Most calculations include some form of moving historical average working capital.
2. Legal and tax planning
Ensure optimal ownership structure to minimize taxes. Consult a tax advisor with an expertise in business structuring and corporate reorganizations to obtain a comprehensive analysis of your business. Under certain circumstances there may be temporary limitations on actions shareholders can take after a corporate reorganization occurs.
Authority and decision making. Review and revise operating agreements and shareholder agreements to ensure officers have the authority to make decisions and enter into agreements. Many family-owned companies have multiple shareholders who have different opinions of the value of their ownership stake. The key is to have a limited number of people (preferably one) with the authority to make decisions and execute agreements on behalf of all the shareholders.
Ensure proper documentation of corporate duties. All too often, privately owned companies have limited documentation of corporate actions – board minutes, resolutions, amendments, etc. While recreating them at close may prove to be a minor annoyance, proper policies and procedures should be followed to document all corporate actions.
Key contracts and change of control provisions. Review customer contracts and other important contracts for transferability and change of control provisions. This will allow you to ensure that your contracts remain in place following the sale of your company, and will avoid any bad surprises after the fact. At a minimum, the mission critical contracts and key customer contracts should be reviewed.
3. Internal considerations
Create the equity story and articulate the vision. While you are selling your company, you are truly selling the future equity story. The buyer is acquiring the business for its potential, not for its history. The story should be supported by the financial projections.
Determine a likely valuation. Get some perspective on a realistic valuation for the business. If the company achieves this value, are you a willing seller? Are the other shareholders willing sellers? Does your valuation match your expectations and requirements for a post-transaction life?
Don’t be the most important person in the company. Most privately-owned companies rely on the personality and drive of the CEO. Be sure that the company is valuable even without your management participation. Most buyers have a vision for the future of the business after they acquire it. If there is a concern that you might depart after a big payday, that could affect the price a buyer is willing to pay.
Internal deal team. Determine the internal team that will know about the deal and participate actively. This is one of the most important decisions that you will make in the process. This core deal team will be responsible for representing the company and supporting the equity story that you are communicating. Make sure you can trust these employees to put the company’s best foot forward.
Identify and retain key employees. You likely did not get to this point alone. As you prepare you company for a sale, identify and communicate with key employees you want to stay with the business post-closing. Key revenue generators and management team members should be incentivized to remain with the company post transaction (employment contracts, enhanced compensation, etc.). Eliminating the risk that these employees will depart enhances the continuity of operations and supports the valuation placed on the business.
4. External resources
Work with people you trust. If you have a long-time accountant or lawyer, ask them for referrals to experienced professionals. Unless you have bought and sold several companies, you will be relying on these advisors and their experience. If you don’t trust these advisors, you won’t take their advice.
Engage an investment banker. Trying to run the process on your own will be too time consuming and too personal. Hire an investment banker who will more than pay for their fee in the increased valuation they will generate through a controlled, competitive auction. They will also allow you to maintain your relationship with the potential buyer through the negotiation process. Investment bankers will also play a critical role in conducting upfront due diligence to uncover any potential problems. Buyers will know this and rely on the investment banker’s recommendations during the due diligence process.
If you think you may sell your business at some point, begin to develop relationships with reputable advisors that you trust – an accountant, a lawyer and an investment banker. Developing these relationships now will help you professionalize your company’s operations and allow for a more open and honest dialogue when you eventually decide to sell.
Selling your business is no easy task; a significant amount of time, effort and emotion will be invested during a sale process. The key to success is being prepared. Focusing on the items outlined above will not only increase your odds of executing a successful sale, but they might even help you reduce potential risks for a buyer and increase value.
ABOUT BILL HAEMMERLE
Bill is responsible for overseeing our internal credit operations. He brings to TCJ over 18 years of experience in domestic and international corporate finance advisory, valuation advisory, private equity investing, and commercial banking. Previously, he worked for Laud Collier Capital where he was responsible for originating, negotiating, and executing private equity investments as well as investment banking advisory assignments. He also worked closely with portfolio companies on mergers, acquisitions and capital structure. Prior to Laud Collier, he worked with Revere Merchant Capital, Kildare Capital and AmperIB where he was responsible for generating investment banking advisory assignments including sell-side advisory assignments, debt and equity capital raises, and valuation advisory assignments. Bill spent seven years with the New York-based merger and acquisition advisory team of WestLB Securities, and was involved in several complex international transactions. Bill has advised clients in various industries including: technology, media and entertainment, communications, life sciences, industrial manufacturing, logistics and transportation, and business services.
Bill holds a B.S. in Finance from Providence College and an MBA from the Stern School of Business at New York University.