Entrepreneurial Payday: Being Acquired

Sam Norwood

The Moment has come

You started something, and you grew it. You worked nights and week-ends, neglecting family and friends and hobbies. You often worried about how you would make payroll. Challenges and set-backs happened, but you worked through them, and you and your business survived. Through courage and persistence, your little business began to take on a life of its own. Now, you are meeting the needs of a growing list of clients and customers, and your employees have become part of your extended family.

There has come the time when you are thinking it is time to marry your business to another enterprise. Stimulants for these thoughts:

You are tired and want to spend more time with your family and friends and hobbies.

Your management style, while effective in the early-stage development of your company seems to be not as effective for the next stage of your company’s growth.

You are facing the need for a strategic commitment for your business, to invest in new technology or expand geographically or launch new product or service lines to remain competitive, and you are not sure you want to take the risks or whether you can raise the financial resources to pull it off.

Your vision for growth includes the need for more financial capital than you think you can generate internally.

All of your net worth is tied up in your business, and it has come time to diversify your estate to assure a comfortable retirement with less risk.

You discover that your kids either have no interest in, or are not capable of, taking over the leadership of your business.

Decades ago there seemed to be a stigma attached to “selling out” as though it was a defeat. That is rarely the case now. Selling out is a victory. The day of closing will be the biggest payday of your life.

What makes your business attractive and valuable?
Objectively, while to you your business is a living organism with systems and suppliers, employees, and customers interacting in a mutually inter-dependent way, to an investor or buyer your business is an asset that, with continued good leadership, is capable of earning future profits. It is the stream of future profits and cash flows that matter most to an investor/buyer. If the buyer is already in a similar business (a competitor) your business may also bring customers, technology, ket locations, production facilities, and key management to the buyer. These “synergies” are what may make your business especially valuable to certain buyers, aside from your business’ own stand-alone profit-making potential.

Preparing the business
You need to start preparing for a sale of your business four or five years ahead of when you want to step aside and “retire” from it. It will take two years to prepare and market your business, and you need to be prepared to remain in a leadership position for two or three years after the sale for the period of transition.

You need to have financial accounting and cost accounting and control systems that enable you to management the business on an informed basis, to know when something is not going well or is doing extraordinarily well, and to serve as the quantitative expression of plans and expectations. You need to have an annual plan, by month, that has a financial budget of expected sales, costs, income, and balance sheet in sufficient detail for it to have credibility as a basis for comparing to actual data. You need to close the books monthly and have a financial report from your accountants within a week or 10 days that shows your key financial and operating data compared to your forecast of budget. You need for this information to be on a system appropriate for the size and complexity of your business. Without such a system a potential buyer would have low confidence in the validity of the numbers that you present to him.

If you have not previously had a certified audit, get one done as of your next year-end closing. This brings credibility to your numbers.

Environmental Issues
If you are aware of environmental issues in your business you will need to deal with them Environmental issues are early deal killers. There is just no sense in trying to sell a business that has environmental issues. They need to be fixed.

Risk is a huge factor in the valuation of any business from a financial point of view. Risk is actually measured in terms of volatility and predictability of revenues and earnings. The less volatile period to period, and the more predictable, the lower the calculation of risk in placing a value on a business.

Expect the question, “What keeps you up at night with worry?” Is it

Competitive technology?

Dependence on one or two major customers?

Retaining key managers?

Defense of your patents,?

A particularly aggressive marketing campaign by a competitor?

Forward visibility?

Adequate financing for seasonality and growth?

Studies show that a small customer base or dependence on a few major customers is the biggest risk factor that most companies face. No single customer should account for more than 20% of your revenues, and the broader the customer base, the less risky this factor becomes. A broad customer base is less risky because it is less volatile and more predictable.

Think of the ways you can reduce volatility and improve predictability. Even practicing forecasting and measuring actual results against the forecast can improve the perception of risk by refining your capacity to realistically visualize the future.

Profits and Growth
It is tempting to try to minimize costs of operations in preparation for a sale, especially in area that might not have an immediate impact on revenues and gross profit margins. Areas like research, product development, advertising and facilities maintenance come to mind. Do not yield to this temptation. Run the business just like you plan to own it forever. When you sell your business your are selling not only its history and current bottom line but also its potential for future growth in sales and earnings. You are selling both the “steak” (current condition) and the “sizzle” (vision of the future). The price you get will depend not only on the current earnings but also a “multiple” applied to those earnings that will reflect future potential as well as perceptions of risk.

Trust and Integrity
Nothing scares away away a buyer like a break-down in the sense of the  integrity of the seller. If you make exaggerated statements or unrealistic assessments of opportunities and challenges, the buyer will quickly learn to discount virtually anything you say about your business. When the buyer asks about issues and challenges, be realistic about acknowledging their existence followed immediately what you are, or are planning to, do about them. You can expect a buyer to review both your accounting system and your accounts. If the buyer finds that the system has flaws that misstate the accounts, or the accounts have been altered in any way to exaggerate earnings, your prospective deal is likely to end right then and there.

Selling is business is far more complicated than you can imagine. Selling a house is simple. In selling your business, a lot of the value is based on future expectations, and that value could be in a very broad range of realistic possibilities. The legal issues (see below) are very complex as are the tax issues. The financial value is probably larger, maybe much larger, than your house, and the buyer is likely to surround himself with advisors who know what they are doing. This may be your first and only transaction of this kind. You need to hire the best help that you can find. Use specialists. Find individual advisors that eat, live, and breathe strategic transactions. You will need

     Legal: a  transactions specialist for legal representation,

     Tax: a tax advisor that is experienced in transactions tax, and

     Strategic Transactions Specialist: a strategic financial advisor who will be your advisor on the valuations, the process, structure, and the negotiations process. This person may also be your person to contact and cultivate potential buyers in your behalf.

Representations and Warranties: In selling a business you will be expected to make legally binding representations and warranties about your business. Examples include, but are not limited to, the following:

You know of no legal issues or threats that have not been disclosed

No environmental issues that have not been disclosed

You have, to the best of your knowledge, complied with every law and regulation

You have paid all taxes due

Your accounts receivable will all be collected

Your inventories are properly valued at the lower of cost or market

All liabilities have been disclosed, and on and on

You will not go into competition with your former company after the sale (“npon-compete”)

You will not recruit your former employees after the sale

Effectively, when you say something that would influence the value of the company you will probably be held to warrant that you have communicated truthfully to the best of your knowledge. Alternatively, the buyer might put a financial penalty in the contract if your statement turns out to have been misleading. For example, if you provide a forecast of aggressive future sales growth, the buyer will likely hold back part of the transactions price pending the actual realization of that forecast.

Holdbacks and Escrows
Unlike selling a house, which is typically complete on the date of closing, the sale of a business will likely involve holdbacks of a portion of the selling price pending possible accounting adjustments based on an audit, or the collections of accounts receivable, or resolution of legal issues. Further, for some period of time during the life of the representations and warranties following the closing, a portion of the price may be held back by the buyer or put into escrow to cover potential breaches of representations and warranties. For example, if you, as the seller, represent that you will not go into competition following the sale, or you will not recruit employees from your former company, if you breach these representations the buyer can withhold a portion or all of the final payment.

The Process

The decision to try to sell

There are several steps to selling your business, starting with the decision of whether or not to start the process. Here are your questions:

What is my business probably worth?

Is this the “right” time in terms of my personal needs and the stage in the development of the business and overall business conditions in my industry?

Who are the most likely buyers? Who would I really like to be the buyer?

What do I need to do to prepare the business for sale?

Am I willing to stay on in a leadership role after the transaction?

Who should I hire as my advisors?

Contacting potential buyers

Your competitors: You are likely to get the highest price from one of your competitors. This is because you and your company can bring something strategic to the competitor, such as technology, customers, locations, a distribution channel, suppliers, and/or management. But, with your competitors you run the risk of disclosing otherwise confidential and strategically important information. So, the process is delicate. First, you need to determine which competitor would best benefit from owning your company and make an assessment as to their probable interest and capability to finance the transaction. You might want to make the initial contact yourself if you know the principal owner(s). Otherwise, your representative could make the contact on a “blind” basis.

Private Equity Groups
In recent years Private Equity Groups (PEGs) have been formed and are active and efficient buyers mainly of small and mid-sized businesses. PEGs have wealthy investor who form an acquisition entity and hire professional managers. The managers seek particular kinds of businesses and sizes, usually identified on the PEG’s web site. They typically are looking for companies that are big enough to be operationally self-sufficient but likely in need of something strategic like financing the growth or injecting technology from another enterprise that they own. They have minimal staffs. They often have a strategy of “rolling up” a number of competitors in the same industry to create a dominant enterprise that ultimately will be taken public or sold to an even larger acquirer. They are more likely to want you to continue leading the business, and they will reward you accordingly.

Brokers and Finders
Brokers and finders make a living getting buyers and sellers together for a fee. They typically have wide contacts, and can actively market your business, or, for a lower fee, they can simply put you on a list of businesses for sale. They can also be helpful in finding creative ways to reach compromises that bring a potential deal to fruition, as they typically only get paid when  transaction occurs. If you think this might be a route for you to take, be careful in your selection, relying on references and track records and reputations in your considerations as well as your personal chemistry and sense of trust. A typical fee structure is referred to as “Lehman Formula” based on price of the deal: 5% of the 1st $ million, 4% of the 2nd $ million, 3% of the 3rd $ million, 2% of the 4th $ million, and 1% for the remainder of the price, all to be paid as the money changes hands. The fees are negotiable.

Non-disclosure agreement
To lower the risk of a potential buyer using your selling process against you, you need to have an executed Non-Disclosure Agreement (NDA). Your attorney should provide you with this document, and you should require potentially interested parties to sign it before  disclosing anything confidential, often before even identifying your company as the one that is available. A typical NDA will have at least the following elements:

The party cannot disclose to anyone other than its owners, directors and necessary officers and agents that there is any discussion of a transaction. If word gets around the industry that your business is for sale it could affect the attitudes of your customers and your employees and even your suppliers.

The party cannot solicit your employees for employment

The party cannot use the confidential information it receives in any competitive way against your business. In the course of the buyers’ due diligence they will learn who your customers are, what you charge, al about your technology, patents, and processes, who your suppliers are and what you pay for materials and services, how profitable your various products and services are, what you pay for labor, how you compensate yourself and your key people, any legal issue you may have in your business, and your plans for the future. You cannot expect to sell your business without these disclosures, so your NDA is of high importance.

Early Due Diligence
After an NDA is signed, you need to be ready to turn over certain level of documents and to allow a tour of facilities to the potential buyer(s). The early materials will include 5 years of financial history, sales by product line, overall current employment, a list of customers, a separate list of the customers not by name but by volume of sales, a list of real property, and a description of significant advantages or strengths and opportunities, challenges and threats, and basic strategic plans.  The objective of this phase is to provide enough information, combined with interviews and facilities tours, for the buyer to make a fundamental decision regarding attractiveness, value, and ability to finance.


Letter of Intent
A Letter of Intent (LOI) is a relatively simple document that outlines the primary intent of the buyer to buy, and the seller to sell, at a certain price with certain terms, all subject to further due diligence and often to financing, with a closing not later than a certain date. The purpose of this is to prevent you, the seller, from showing the business to any other potential buyer until the time expires or the parties agree to abandon, and to justify the buyer’s cost of final detailed due diligence and the lining up of lender financing.

Final Due Diligence and Contract
The LOI is not an enforceable contract for sale. However, it is intended to provide enough assurance of seriousness so that each party can devote the focused resources necessary and appropriate to execute the closing transaction. In the final due diligence, more detailed financial data are provided, technology may be studied, mid-level managers interviewed, a Phase 1 Environmental study will be performed, and the details of the Purchase and Sale Contract will be negotiated. The rubber meets the road here. If the final due diligence reveals problems that were not previously disclosed, the buyer will generally use this as an excuse (with typical legitimacy) to deduct from the price and terms in the LOI. This is like a house inspection in the sale of a home. As the seller, you can either agree to a concession or not, and the buyer can either take a walk or stay with the earlier price.

The Contract becomes the binding instrument for both parties. The Contract, full of exhibits and schedules and representations and warranties may run 50 to 100 or more pages in length. I have seen some that are hundreds of pages long. The contract conveys the specific property elements (if an asset sale) or shares (if a sale of the equity) from the seller(s) to the buyer(s).

The Closing
The actual closing of the transaction, surprisingly to most people who have not done this before, is typically anti-climactic. Unlike a home sale where the parties all sit around a table signing and passing papers, in a business transaction, the final Contract will have been circulated to the parties who typically sign in the comfort of their own offices and fax or scan their signatures to the losing attorneys. The attorneys handle the wiring of funds from the buyer to the seller. The deal is done among attorneys who then communicate to the parties that it is done. It is sort of like when the doctor tells you that your wife has just delivered a bouncing baby boy or girl. You were an essential participant, but you are not necessarily present at the crucial moment of the delivery. You have just experienced the largest payday of your life, likely in your office or at home.







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