August 27th, 2007
Selling your company: seven common pitfalls that can produce failure
For many owners, the sale of their company is the largest, most complex transaction of their career. Owing to its magnitude and impact on their future, it also is one of the most stressful. A seller will often find security with an experienced, determined, compassionate acquisition advisor who can provide guidance during this process. It can be especially helpful for a seller if a self-made person heads the advisory firm. Usually this advisor will fully understand the intensity and depth of emotions an owner is facing.
Middle-market transactions are defined as deals valued between $2 and $250 million. There is little information available on these deals to enable a potential seller to know what is involved in the sale process. Correspondingly, prospective sellers are often under numerous harmful misconceptions. During my many years in acquisitions, I have talked to thousands of owners/entrepreneurs. From these conversations I have found the following seven pitfalls to be the most common erroneous beliefs of middle market owners.
The answers to the following questions correct these misconceptions.
1. Is a valuation basically a “numbers crunching” process? Nothing could be further from the truth. A properly conducted valuation involves the complete investigation of a company’s business foundation. It includes defining the company’s future opportunities and major risks, along with their projected impact. The following factors must be evaluated during this process:
A. The strength of the company’s marketing program, including the diversity and control of its customer base.
B. For manufacturing companies, the ability to produce a high-quality, low-cost product, and the caliber and productivity of their research and development function.
C. For distribution or service businesses, the demographics of their trading area, the quality of their product and/or service line, the attractiveness of their locations and the ability to run their operation on a cost-effective basis.
D. The quality of the management team and the presence of a reasonably paid, well-motivated work force.
These factors become a prime determinant of the multiple to apply to the company’s expected future earnings.
2. Will planning and timing the sale of a company increase the transaction price?
Prudence dictates that a seller plans and times the sale to maximize the transaction price. As part of the planning process, all factors defined in Question one are evaluated and suggestions are made to strengthen the business foundation. The solidifying of the business foundation will increase the transaction price. In addition, the planning of the sale will enable a company to be prepared to “go to market” at the appropriate time to generate the maximum price. It also enables an owner to be capable of responding intelligently to the unsolicited interest of a prospective acquirer.
3. Is the deal fundamentally completed when a preliminary price is established at the letter of intent (LOI)?
The execution of an LOI is merely the start of the negotiating process. Unless you have a sophisticated, experienced advisory firm that has a strong personality and the ability to control the deal, it is not unusual for an acquirer to demand a price reduction between the LOI and the closing. A good acquirer knows that will never be productive. The negotiation of the Definitive Purchase Agreement (DPA) is a difficult, confrontational and time-consuming process. The DPA includes all the critical representations, warranties and indemnifications that are of potentially equal financial importance to the deal price itself. If not negotiated to provide the seller maximum protection, it can give the acquirer a post-closing opportunity to recover a considerable portion of a seller’s deal proceeds.
4. Should owners only sell their company when they are at or near the end of their business career?
The answer is definitely no. Most owners do not understand many of the benefits that can arise from a sale. Usually owners of closely held corporations have a vast majority of their personal wealth concentrated in the business. This is poor financial planning, but it is a typical byproduct of owning a closely held corporation. By selling all or part of the company, owners can reduce their concentration of wealth in the business. In addition, it puts their estate in more liquid condition. I have advised many younger owners recently in the sale of their business who have wanted to put their financial condition in that shape. They also wanted to enjoy the finer points of life for a few years, while still in prime health. After their covenant not to compete expires, which could occur after a five year period, they can get back in business. However, they will commit only a small portion of their sale proceeds to the new business endeavor. This will assure they have lifetime financial security. They will be refreshed and might be eager to pursue a new business endeavor. From a personal standpoint, this is an attractive alternative for a number of owners.