Maximizing the result of your exit strategy

Avoiding the pitfalls of the mergers and acquisitions process and maximizing the business value at the time of exit is a combination of partnering, planning, packaging, and process.

A. Assemble the Professional Team and Develop a Divestiture Strategy

I don’t know which management guru said it, but he was right when he said, “If you fail to plan, you plan to fail.” Business owners should start planning for their exit strategy the day they open their doors. It takes time, often as much as six to eighteen months, to sell a business when the goal is to search for a buyer that will pay the maximum price. Accordingly, once a business owner begins thinking about the possibility of a sale, they should begin taking preliminary steps in furtherance of their goal.

The first step in the process is assembling a team of professionals who have the expertise to address the myriad issues that will arise. This is, indeed, the most crucial single step. The wrong team can cost sellers millions of dollars and months or years of wasted effort. Just as most people should not represent themselves in a legal matter, most owners should not represent themselves in a mergers and acquisitions (M&A) transaction. They should retain a combination of experienced M&A, legal, and accounting professionals, to guide them through the process. The M&A professional’s knowledge and skills will be important in developing the divestiture plan, preparing for presentations to prospects, soliciting and marketing the business to these prospects, and conducting the negotiations. A well-chosen M&A firm will expand the range of prospects, ease the burden of screening them, manage the time-consuming chore of soliciting them and prevent negotiations from breaking down.

The business owner should be careful to establish team members’ expertise within their assigned roles. Business divestiture is not the time for amateur hour. Whether or not a professional is new to you, or your best friend, inquire about the number and type of transactions they have handled in the past few years and their role in those transactions. Just because an advisor is excellent in the real estate field, does not mean they are the best choice to represent a business owner in a divestiture. Also, especially if a professional advisor is new to the business owner, they should request references, relevant coursework, and credentials. The team is only effective if it works as one cohesive unit. One key to this is to have a high level of communication between team members and to provide each with clearly defined responsibilities.

Typical team members include an experienced transaction lawyer, an M&A professional, and an accountant with experience in tax planning and purchase price allocation. Potential focus areas for team members include:

1. Valuing the Business – Determining the potential market value range of the business is a function that is typically performed by the M&A Firm and reviewed with the client and his/her accountant. It is essential to get an objective perception of the potential market valuation range for the business from someone who is familiar with actual business transaction prices, not merely with abstract valuation methodology. By taking this initial step, the owners will save themselves time and money by verifying that their price expectation is reasonable and limiting the disclosure of the business’ “Confidential Information” to a select group of highly qualified prospects. Central to the valuation process is the recasting of the business’ historical financial statements to highlight the business’ true profitability for a potential buyer. Getting a third party assessment of value will also enable the professional team to better anticipate the valuation issues and analyses that are likely to be surfaced by the buyer’s team.
2. Preparing Marketing Documentation – It is essential that the documentation presents the business in a favorable light, highlighting the strategic and synergistic opportunities it presents to a buyer, while simultaneously providing full disclosure of all material facts and be prepared in a fashion that is easily understood by buyers. Due to the fact that they spend so much time working with buyers and sellers, M&A firms are the best suited to handle this phase of the process and will often have established templates for the various levels of documentation. When prepared correctly, these marketing materials will “pre-sell” a buyer on the opportunity and value of the business before the seller and his advisors waste a lot of time on them. To preserve confidentiality, the marketing materials should be drafted to provide increasing levels of detail as merited by the buyer’s decision making stage in the process. Prior to release to potential buyers, the seller and their other professional advisors should review the documents for accuracy.
3. Locating and Qualifying Multiple High Quality Buyers While Maintaining Confidentiality – Qualifying buyers before providing them with any information, other than the most generic descriptive information, will help avoid wasting time on “low ball” offers from poorly capitalized buyers. It is essential to make sure one is negotiating with the ultimate decision maker in the buyer’s organization, or at least the individual(s) who is/are in a position to act as the acquisition’s champion within the buyer’s organization. Understanding a buyer’s motivation to buy and the value drivers they are seeking will assist the seller and their advisors to extract the maximum value from the buyer during the negotiation phase of the process. Several of the key questions to ask about the buyer include: (1) Does the buyer have the financial and operational ability to buy the business? (2) What strategic or operational benefit will the buyer receive from buying the business? (3) Have they ever bought a business before, and, if so, what was the deal like?; and (4) What is the buyer’s approach to valuation? There are a multitude of other key questions to ask, but these few will at least help to understand the buyer’s value equation. The importance of confidentiality cannot be overstated. Any knowledge of the fact a seller is considering the possibility of a sale can erode the value of even the strongest business at light speed. An M&A firm will typically be experienced in exposing the business to a broad array of potential buyers, without endangering its value due to premature disclosure of the sale. Also, they will have techniques and processes in place to minimize the danger of information that is disclosed to even the most qualified buyers.
4. Handling the Dissemination of Information to the Buyers, Scheduling Meetings and Responding to Information Requests – This is the most time consuming part of the entire process and, as such, has caused many a seller to take their eyes off the importance of running their business. The end result of that type of distraction is typically either a sales decline or a decrease in profitability, or both, none of which bodes well for achieving the maximum price for the business. Often, the business’ outside advisors can be excellent conduits for such information to avoid alerting the business’ employees. It is important to note that, just because a buyer asks for certain information, does not mean it is appropriate for them to receive it at that particular stage in the process. It is important for someone to play the role of traffic cop and make sure the buyer is not receiving information which is injurious to the business at an inappropriate time. Advisors who are experienced in the process will often have alternative ways of helping the buyer achieve the comfort level they need to proceed to the next stage, without exposing the business to an unacceptable level of risk from the disclosure.
5. Soliciting Offers, Analyzing Offers and Negotiating the Economics of the Transaction – Obviously, this is one of the most critical stages of the process. The economics of any proposed offer need to be subjected to a thorough analysis. A skilled, experienced and professional negotiator will always outperform someone who does not negotiate these types of deals on a regular basis. Many business owners, as a result of having successfully negotiated many contracts, view themselves as superb negotiators. However, because they generally have so much at stake, they tend to get emotionally involved in the process and take hard line postures on issues that can otherwise be resolved in their favor. A negotiating team headed by an experienced M&A professional, leaving ultimate decision-making authority with the seller is ideal. The M&A professional is experienced in structuring and closing deals and, assuming the seller remains outside of the fray, she/he can smooth things over, if necessary. Further, all of the steps in the process should be designed to support and reinforce the negotiating strategy. The skilled M&A professional is always conscious of the impact that even the most innocuous seeming comment made during a two minute phone call can have on the buyer’s responses during negotiation and on the ultimate value achieved. Another one of the keys to achieving the highest value for the business in the negotiating process is to have multiple, highly qualified buyers interested in the business at the same time so they will put their best offers forward for the business. Often, the mere involvement of a competent M&A firm will cause buyers to realize that they are competing with others and make them “sharpen their pencils”.
6. Tax Implications and Deal Structuring – The process of examining the tax implications and structuring the deal to be most beneficial to the Seller, of all of the phases of the process, is the one wherein collaboration between all of the team members is most essential. Apparently small differences in deal structures can save, or create, millions of dollars in unnecessary taxes. The synthesis of the combined experiences of the M&A professional, the accountant and the lawyer consistently result in a superior after tax result for the seller. The M&A Professional’s focus should be on structuring the economics of the transaction, but, throughout that process, he/she should be working closely with the tax professionals to structure the transaction to maximize the after tax results. While the ultimate responsibility for the tax implications part of this phase should rest with the accountant and/or tax attorney, but a collaborative effort of the team members typically produces the best results.
7. Document Preparation and Review – The preparation and review of all of the legal documents is a critical role in the process. Regardless of the experience possessed by a seller, accountant or M&A professional, a seller who executes any document without the advice of an experienced M&A lawyer is taking an incredible risk. Tens of thousands of dollars of fees spent on an experienced lawyer while the transaction is in process can save hundreds of thousands, or millions, spent on lawsuits after the transaction takes place. This is not an area for amateurs. Make sure your lawyer is truly an expert in M&A. Using an experienced professional typically reduces the portion of the billable hours spent on document creation and allows the lawyer to focus their valuable time on issue spotting, client protection and problem solving.
8. Due Diligence – Regardless of the type and size of the business, a buyer is likely to insist on the right to verify that what they have been told by the seller and his/her advisors is accurate. This process is typically known as “due diligence”. The business’ outside accountant, legal counsel and owners are typically the ones with the primary responsibility for this phase of the process. In certain instances, it may become necessary to involve non-owner senior management team members of the buyer in this process. If such a need arises, each of those managers should be made a party to a confidentiality agreement that protects the business. Other consultants and/or employees who may participate in the process may include: (1) environmental; (2) intellectual property; (3) integration management; (4) human resources; or (5) information technology.

B. Preparing the Business for Sale

In addition to hiring the right advisors, there are a variety of steps a business owner can begin taking before they begin the sale process to maximize their end result. The following are a few of the more common ones, but, be advised, each business has its own unique risk factors and opportunities, each of which can affect how a buyer values that business.

1. Clean up the business’s finances – Since buyers focus primarily on the profitability a business will generate when they determine its value to them and their shareholders, it is essential to make sure the business is positioned well financially for a sale. The following are just a few of the steps a business owner can take to get the business’s finances in order for a divestiture:

Choose the right time to divest – The best time to sell a business is when it is in a mature/multi-year growth trend, hopefully with steady or improving profitability, not when it is in a downturn. Also, it is best to divest a business when its owner is vital and healthy enough to facilitate an orderly and efficient transition to the buyer’s operating team.

Unwind tax-advantaged strategies – Unlike public companies, closely-held businesses, in order to minimize the tax liabilities and maximize the after-tax financial benefits of its principals, will choose accounting methods and/or business practices that actually serve to understate profitability. Whereas, when one tries to sell a business, the goal is to maximize the profitability of the business due to the business owner’s desire to maximize the value they receive for their business. Examples of typical adjustments include:

• A. Normalizing salaries, compensation and executive perks for shareholders and their family members to fair market value levels that are reflective of the economic value of the individual’s services to the business, regardless of his/her ownership interest. In other words, the amount you would have to pay a similarly skilled and experienced non-shareholder to perform the individual’s duties.
• B. Adjusting for non-core/discretionary expenses that occur more as a result of the business owner’s lifestyle than because they are essential business expenses that almost any owner of the business would incur.
• C. Reexamine the business’ capitalization policies to make sure that capital asset purchases are being capitalized on the balance sheet, with only the useful life depreciation being expensed on the income statements, rather than expensing the entire purchase through the balance sheet in the year the asset is acquired.
• D. Adjusting for non-recurring expenses that are not expected to be incurred by the business on an ongoing basis. One time inventory write offs, professional fees due to drafting of an employee handbook, etc.

Tighten accounting controls – Improving the collection policies for Accounts Receivable and devoting a concerted effort to improving collection history can be a major plus for financial performance. Also, improved tracking of inventory turns by SKU and writing off obsolete inventory well in advance of a sale can help to: (1) Allay buyer’s suspicions; and (2) help to highlight the business’ true profitability in the periods that are closest in time to the marketing phase.

Documenting Internal Transfer Payments – Formalize intra-company payment mechanisms and accounting systems for transactions between related entities and ensure that such payments are at fair market rates.

Remove Excluded Assets – Some business owners carry assets on the books of their businesses that are not necessary for the ongoing operations, which the owners intend to retain following a sale. Typical examples include personal vehicles, computers, and office equipment in a home office, real estate, marketable securities, family heirlooms, etc.

2. Diversifying the Business’ Client Base – One of a buyer’s key concerns when buying a business, especially one in which the clients loyalty and/or interface relies heavily on the seller(s), is the retention of its core business. Where there is a large concentration of sales dollars with a few key accounts, buyers will either: (1) discount the price they will be willing to pay for the business, or (2) have a substantial portion of the purchase price paid only if the business continues to achieve certain financial benchmarks under the new management team. In some cases, a buyer will take both approaches to minimize the risk they perceive from the client concentration. This transfers much of the risk back to the seller. To avoid these issues, the seller’s goal should be to have less than 40% of Sales with the business’ top five customers and less than 20%-25% of Sales with any one account. Despite the foregoing, it is perfectly acceptable to have a little higher percentage of Sales with one account for a limited period of time, if it is higher margin business and the incremental profits from those sales are reinvested into developing additional new clients. Other situations in which higher concentration levels with certain accounts may be justified are when it occurs pursuant to a multi-year supplier agreement, or if the business is the sole source to the client for a proprietary product/technology.
3. Develop Additional Management Depth – One of the key issues a buyer takes into account when buying a business is the management talent of the employees that will be remaining active in the business following the sale. Most buyers realize that providing a business owner with a meaningful financial incentive to maximize the business’s profits can be difficult once they have received a multi-million dollar purchase price. Often a buyer will try and structure part of the purchase price into a contingency based formula to account for the potential risk they perceive from the owner(s) losing their strong financial ties to the business. To minimize this risk to the buyer, sellers should begin focusing on the development and professional growth of a second and third tier management team by delegating more responsibility to non-owner employees. Conversely, to avoid any one employee being in a position to hold the divestiture hostage, or capture some of the value a buyer would otherwise pay to the owner(s), it is typically a good idea to try and limit the percentage of the business’s primary sales relationships that are concentrated with any one employee. Wherever possible, it is desirable to maintain multiple points of client contact within the firm.
4. Formalize Contractual Relationships – Another area of concern for buyers is informal business arrangements for critical business functions/operating assets that could possibly come to an end when the owner(s) leave the business. Often closely-held businesses fail to develop some of the formal contractual relationships into which a larger company would typically enter, relying on the owner(s) personal ties/relationships to provide the key resources the business requires. Sellers can formalize, and provide for the right to assign, favorable and/or critical agreements and relationships, including: (a) Facility leases – These should be benchmarked to reasonable fair market value commercial rates; (b) Vendor and customer contracts and relationships; (c) Various Personnel Matters. Some of the key personnel matters to consider include entering into Employment, Non Competition and Confidentiality Agreements with key employees, where necessary and formalizing job descriptions and reporting authority. This is especially important in closely held family businesses. Also, to the extent a business has such relationships, it is vital to formalize Marketing Representative and Distribution Agreements with non-employees who represent the business in dealing with customers and providing for the seller’s right to assign those agreements.
5. Organize and Disseminate Confidential and Proprietary Business Know How and Intellectual Property – Often, businesses develop a substantial amount of knowledge/techniques in their workforces that never becomes part of a formal process or operations manual. The business’s owner(s) should work to institutionalize/formalize informal business technological know-how and disseminate the knowledge more broadly throughout the business by cross-training and in-house seminars. Also, where it can be patented or registered, but well in advance of entering into a divestiture process, the business owner(s) should file to protect the business’s proprietary technological expertise and intellectual property.
6. Spruce Up the Premises – Cleaning up the basic physical appearance of the facility and its equipment/machinery, including lighting, floors, windows and general business appearance can help leave a positive impression with the buyer. Also, remove broken or idle machinery and excess inventory from the shop floor or yard also helps to provide a buyer with a more favorable first impression of the business.