Is Your Business M&A Ready?

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by Michael Iverson

Merger and acquisition (M&A) activity can be a key part your business strategy. Whether you seek business growth through acquisition or your business is the target of a buyout offer (solicited or unsolicited, you are a party to the M&A process. From that standpoint, it makes sense to understand what the process entails and how it might affect your business.

For the sake of simplicity, and because my clients are more often sellers rather than buyers, I will address the process from the seller’s side of the transaction. However, the same principles apply whether your role is that of buyer or seller.

Organization and Documentation

In a previous article, I discussed how to build transferable value into your business. If you desire to sell your business, you have to make sure its value is readily apparent and transferable to a prospective owner. Let’s review a couple of the tenets of transferability:

  1. Your business needs to have an organizational structure that will survive your departure from the business. Many business owners don’t have that kind of structure in place. When a business owner is an irreplaceable force in their organization, the business can lack transferability.
  2. Documenting your processes and training employees to follow them consistently adds transferable value to your business. It gives a prospective buyer a high degree of confidence that he or she can purchase the business and make a successful transition to ownership. To use a sports analogy, you are turning over your playbook to a new coach.

To bring together the two tenets above, let me point out most entrepreneurs are focused on the delivery and growth of their company and not on organizational structure and documentation – at least, not initially. Most emerging growth business owners are correctly focused on meeting customer needs and providing the products and services customers want. As a business matures, it’s important for the owner to recognize that organizational process and documentation are absolutely necessary. Without them, it is very difficult for an owner to extricate himself from the business.

Well-organized processes and documentation conveys to a potential buyer that:

  • the owner knows what he/she is doing,
  • the buyer can easily understand the business model, and
  • the transfer of knowledge to run the business can happen quickly, which makes a seller attractive.

If an owner is knowledgeable about business contracts, for example, it gives a buyer confidence. When employee files are complete and updated, it reflects the owner’s commitment to matters of compliance.

Letter of Intent

When buyer and seller reach agreement about general parameters of a sale – price, terms, a timetable for completion of the deal and the consequences if the deadline is not met – the particulars are set forth in a letter of intent. The document indicates that initial negotiations have been completed and both parties are committed to additional negotiations with the intention of completing a transaction. The letter of intent (“LOI”) typically includes language stating that information learned about the other party must be held in strict confidence in the event a transaction does not occur.

An LOI is followed by a phase called due diligence. During the due diligence period, the potential acquiring party takes a closer look at the target company. This is a time when organizational structure, process, and documentation can help seal the deal. On the other hand, if any of these is found lacking, the buyer might find reason to re-negotiate the deal. Tax returns reviewed may indicate possible obligations not earlier known to the buyer. Contracts reviewed might show significant uncertainties about vendor or customer relationships that might not be transferrable in the event of a transaction. The result can be a downward revision of the sales price.

Closing the Deal

Assuming nothing significant is uncovered during the due diligence phase, attorneys from each side will then compile a list of documents needed to close the deal. Typically all the documents must be signed by each shareholder of each company, either in person, electronically or by proxy.

When all parties to the deal have signed, the process of integrating the two operations begins. In my experience, that’s the hardest part. It includes a series of meetings, deadlines and assigned responsibilities designed to make the two become one. We will address the integration aspect of M&A in a future article.

If you have questions about M&A, or your company’s readiness, contact us. We are happy to assess your situation and make recommendations.

Identifying a Likely Buyer of Your Business

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by Michael Iverson

One of the most overlooked aspects of selling a business is identifying the right buyer. Some owners never give it much thought, but they should. Finding the right buyer is absolutely fundamental to an exit strategy.

No matter what your objectives are in selling (getting the best price, ensuring a smooth transition for employees, making sure your customers are well-served, etc.), they are most likely to be met when you identify a buyer early.

When you think about selling your business, try to imagine to whom you will sell. Allow me to suggest a few ways to sell a business to your most likely prospective buyers:

  1. Sell to one or more managers of the business.
    An inside sale can be one of the most satisfying ways to sell a business. The business owner knows the character and business strengths of his or her buyer. The buyer has a good understanding of the seller, knows the strengths of the existing operation and the collective work ethic of the employees.
  2. Sell to your employees.
    When a business has many long-time employees who believe in the business and its prospects, selling to employees as a group is a good option. An Employee Stock Option Plan (ESOP) can be established as a vehicle to transfer ownership of the business to the employees. This option may take a little longer to put into motion, but it’s achievable for many businesses.
  3. Transfer ownership to a family member.
    Some entrepreneurs hope that a child or other family member has an interest in taking over the business. Of course, having an interest is just the first step. Any family member that might take over the business also needs talent, a strong work ethic, sound judgment, and an understanding of the business and its employees. If a family member has been involved in the business for a number of years, this option is a strong possibility. The family needs to determine a financing vehicle that lets the owner “cash out” without disrupting normal business operations.
  4. Sell to a competitor, business partner or vendor.
    A competitor, business partner or vendor usually has a strong knowledge of your business and its market. A competitor that is very familiar with your business may understand the immediate, positive impact a purchase would have on his or her existing business, and therefore might be an eager buyer. A competitor buying your business gains new revenue, has an opportunity to consolidate staff, and, could be in a position to raise prices.

    5. When a business partner or vendor is made aware of your desire to sell, don’t be surprised if the initial response is cautious. If the purchase has a synergistic effect with the vendor’s existing business, you might have a potential buyer. However, the benefits aren’t as immediately recognizable as they are to a direct competitor, so a longer lead time may be required.

  5. Sell to an unidentified buyer through a business broker/investment banker.
    It’s also possible to sell a business to a private equity buyer. This can be accomplished by hiring a business broker or investment banker who advertises your business for sale and contacts appropriate buyers. Unlike the potential buyers mentioned earlier, this buyer may have less knowledge about your business or industry. A private equity fund is usually interested in the business as a new stream of cash flow and sees opportunity to enhance the value of the business down the road with the intent to sell it.

    6. Entrepreneurs who haven’t planned their exit strategies could find themselves on this path. A private equity buyer generally has the financing lined up so a quick transaction is possible. The business broker / investment banker can help guide the seller through the transaction process, which at times can be very emotional.

In an upcoming article, I’ll discuss the differences between strategic buyers and financial buyers, and the price each is willing to pay for your business.

To discuss the future sale of your business, how to time your exit and maximize your sales price, let us know and we can get the right resources in place for you.

Will You Sell to a Strategic Buyer or a Financial Buyer?

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by Michael Iverson

 

In the recent article Identifying a Likely Buyer of Your Business, I suggested a number of parties that might be interested in purchasing your business. To review, possible buyers include:

  1. Your management team
  2. Employees of your business
  3. A Family Member
  4. A Competitor, Business Partner or Vendor
  5. An Unknown Investor or Investment Group

These potential buyers can be classified as either Strategic or Financial.

A strategic buyer has knowledge of both your industry and your company. This kind of buyer has a compelling business interest in a possible acquisition of your company. The business interest might be as simple as buying out a prime competitor to achieve dominance of a local market. Or, perhaps a buyout is pursued with the intention of significantly expanding the business.

Typically, strategic buyers are willing to pay more for your business than financial buyers. A strategic buyer is familiar with your business or industry and optimistic about the prospects of your business enhancing his or her existing business. A strategic buyer isn’t afraid to pay full value for your business, because he or she expects to experience significant benefits when the two businesses are combined.

In contrast, financial buyers often have little or no knowledge of your industry or your company. This type of buyer is interested in acquiring your business’ cash flow, and motivated to buy at a discount – as a sort of hedge against his or her lack of familiarity with your business. Some financial buyers aspire to cut expenses of your business to boost profitability and flip the business in a short period of time for a profit.

Given a choice between selling to a strategic or a financial buyer, most business owners would rather sell to a strategic buyer. The price is usually closer to what the owner perceives as full value. In addition, the impact on employees is usually less.
If you have an exit plan in place, you increase your likelihood of selling to a strategic buyer, including identification of likely buyers. If you don’t plan your exit, you might end up selling to a financial buyer for lack of better options.

How Price Is Determined

Businesses for sale are usually valued at some multiple of operating earnings. Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA) is a variation of operating earnings that many investors use to compare profitability between companies and across industries. It strips away the effects of financing and accounting choices to focus on true operating profits.

Depending on the buyer, an offer for your business may be based on current year’s EBITDA or average EBITDA for the past three years. Typically, some multiple of EBITDA is offered; the multiple varies by industry. For example, 1.5 times EBITDA could be the offer for a business in a steady but low-growth industry, while 6 times EBITDA might be offered for a business in a high-growth industry. Any offer’s value also depends on whether you’re selling to a strategic or a financial buyer.

To learn more about the type of multiple your business might command, or to talk about developing a plan for its sale, contact me at Trillium Financial.

Selling Your Business: What Can You Expect From a Due Diligence Review?

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by Michael Iverson

Selling a business can be an exhilarating experience. Meeting with potential buyers, presenting the business in the best light possible, fielding inquiries, receiving preliminary bids and conducting early-stage negotiations is all part of the process. It’s pretty exciting compared to a typical day at the office.

At a certain point in the process, however, the excitement of an impending sale gives way to something much more serious. The would-be buyer’s offer is usually contingent upon completion of a due diligence review. The buyer gets a chance to conduct a very thorough examination of the business. If the review uncovers unpleasant surprises, it may be possible for the buyer to walk away from the deal.

No Stone Unturned

The buyer may well be making the biggest financial commitment of his or her life, so he or she wants to be sure about the purchase. Confirmation usually comes from outside professionals who advise the buyer through the due diligence period. At the very least, expect visits to your business by an accountant and an attorney representing the buyer. These experts will advise the buyer about whether he or she is making a wise purchase decision. Make sure everyone handling your data has signed a Non-Disclosure Agreement, then provide them the information they request.

Information requests from the buyer’s accountant are likely to include, but not limited to:

  • Financial statements for recent years and related audit reports
  • Tax filings for recent years
  • Financial projections, capital budgets and strategic plans
  • The business’ general ledger and schedules of Accounts Payable and Accounts Receivable
  • Schedule of inventory
  • A schedule of capital equipment, its location(s) and copies of purchase contracts or leases
  • A schedule of depreciation/amortization calculations related to equipment
  • A list of real estate owned or leased, plus copies of mortgages, deeds or leases
  • Analysis of fixed and variable expenses
  • Details of debt covenants and credit lines

The buyer’s attorney will likely want to review the following documents:

  • The company’s Articles of Incorporation, Bylaws and Minutes of the Executive Board
  • The company’s organizational chart
  • The company’s list of shareholders
  • Certificate of Incorporation
  • A schedule of any intellectual property of the company, including trademarks, trade secrets, patents, licenses, agreements with personnel and consultants providing technical know-how.
  • A list of litigation settled or pending; regulatory proceedings against the company; environmental actions pending.
  • Insurance coverages protecting the company and Executive Board from general liability, personal liability, product liability, errors and omissions, workers’ compensation, etc.

In addition, the buyer will want to see information about your product or service lines, customers, key suppliers, major competitors, and marketing programs of the company.

As you can see, the process will test your record-keeping and organizational skills. I often stress the importance of developing a business infrastructure. This is the occasion when all of the time and effort pays off for having a well organized and documented financial, operational, sales, and administrative processes.

Managing the Process

The buyer and his or her advisers have every right to gather the information they need to evaluate the business. You have every right to make sure their work doesn’t become disruptive to your business, your employees’ work and your clients.
Manage the process by setting a few guidelines for retrieval of information. The buyer’s requests should be made directly to you, or your designee. If the provision of information cannot be immediate; encourage the buyer to request things in advance.

The due diligence process can be very intense and emotional. Have key advisors to surround yourself so that you can keep your eye on moving the business forward. Understanding what to expect can save you a lot of time and emotional energy.