From time to time, I will repost articles that I have had published previously in various periodicals. This one was originally published in The Business Ledger on March 19, 2007. Since this was used in a serious publication, the tone is a bit less snarky then my usual fare…
10 Things to Do Before Selling Your Business (to Maximize Shareholder Value)
When you think about selling your business, one of your goals is to receive the most value possible for all of your years of hard work. However, a lack of planning may cause you to leave money on the table when you ultimately exit the business. Below are ten action items that every business should undertake prior to a sale process to maximize value.
1. Prioritize Shareholder Objectives
Maximizing value in a sale is not all about getting the highest price possible. For closely-held companies, there are often a variety of non-financial priorities, ranging from protecting employees to keeping brand names intact. In order to maximize value, it is critical for the shareholders to establish and rank their priorities, both from a short- and long-term perspective. While priorities may change as the company grows and evolves, this exercise will provide a needed roadmap to make certain that the most important objectives are met in any future transactions.
2. Develop a Succession/Transition Plan
Selling a business at the time the owner-manager wants to retire is one of the largest detractors from valuation. Perception plays a key role in valuing businesses, and if a buyer perceives that a company needs to sell, the seller will be penalized through a lower valuation. Additionally, many buyers want the management to stay on for a transitional period, or in the case of financial buyers, for a three to five year period. Developing a succession or transition plan, whereby the business is sold at least one or two years before the owner-manager wants to retire, and where there is capable management in place to take over some or all of the owner-manager’s responsibilities will create the most options and the most value when the business is sold.
3. Properly Incentivize Management
For companies where the managers are not the sole shareholders, there can be a conflict of interest during a sale. Management plays a critical role during a sale, but can be at odds with the shareholders during a process. Whether the management team has concerns over losing their jobs or autonomy, or simply realizes their powerful role in the process, non-incentivized management can cost the shareholders significantly or even completely derail a transaction. Incentives put in place prior to any sale process, such as a sale bonus program or stock options for managers, will align the interests of the managers and shareholders and ensure there isn’t an eleventh-hour power play. Advance planning in this area will help the shareholders avoid ponying-up more money to compensate management during the sale process.
4. Establish Key Service Provider Relationships Early
Good service providers can add substantial value to a sale process- in fact, they should more than pay for themselves. Every company contemplating a sale should have the following: (i) an accountant that has substantial audit experience; (ii) a lawyer that is seasoned in M&A transactions, preferably with experience representing both buyers and sellers; and (iii) an investment banker that works with companies of a similar size range. These relationships should be established early on, ideally years before a transaction is contemplated. You may also need to change service providers if you have outgrown your existing service provider relationships. By putting together a strong advisory team, the company will be prepared with all of the tools and resources necessary to maximize the transaction value and structure, as well as prevent any deterioration in value during negotiations.
5. Identify and Eliminate “Small Company” Expenses
Closely-held companies are typically run for tax efficiency, which maximizes short term tax benefits for shareholders by minimizing reported cash flow and earnings. Strategies of running extra, non-core expenses through the business—such as shareholder automobiles or large entertainment accounts– accomplish that short-term goal. However, this strategy is contradictory to maximizing long-term value in a sale, as businesses are typically valued as a multiple of cash flow or earnings. For a business that is valued at 6x cash flow, for example, saving the taxes on $100,000 from extra expenses will cost you $600,000 of value in a sale! It is advisable to cut extra expenses two years prior to selling a business. If you are close to initiating a sale, and it is too late to cut such expenses, work with your investment banker on a set of pro-forma financial statements. This will identify and add-back the expenses that would not be needed by the new buyer. You should get at least partial credit for reasonable add-backs, enhancing the company’s valuation.
6. Have Your Financials Audited
Financial statements that have not been audited by an experienced and reliable accounting firm are typically not regarded as trustworthy by buyers in the market. This can penalize a company in financial terms (lowering valuation) and business and legal terms (the seller having to make stronger guarantees and warranties in the transaction documents). It is advised that companies that are contemplating a sale and have more than $5 million in revenue strongly consider getting an audit on their financials for the fiscal year prior to the year of the sale. Larger companies should have at least three years of audited financial statements. Also, if you take advantage of an audit in the years prior to selling your business, it can point out weaknesses in the company’s financial operations and controls, giving you sufficient time to correct them prior to an exit.
7. Review and Organize Your Files
Many small and middle market businesses are guilty of letting their recordkeeping slide a bit. However, getting your files in order will create value. While you won’t get a higher valuation per se for organizational skills, it will prevent “value leakage”; this is where a seller is penalized in terms of items such as part of the deal proceeds being held back or onerous legal representations during the documentation phase of a transaction. The more administrative items that you have unaccounted for or are in disarray, the more penalties you will likely incur from the buyer. Make sure that all of your files are in order—all contracts signed, technical drawings and back-up copies of source code accounted for, detailed list of tooling residing with manufacturing partners available—and review them frequently. Also, examine contracts for any special requirements, such as change of control provisions, which could have an impact on a sale. Review these with your service providers to make sure they will not adversely affect your sale process.
8. Create a Strategic Plan
Even though you may be ready to exit your business, your business still has opportunities ahead of it. It is important that you create a three to five year strategic plan for the business. This will both help you to identify opportunities and issues to address prior to selling the business, and give potential buyers a roadmap to growth prospects for the future. The more opportunities and growth you can demonstrate to a buyer, the more value they will likely place on the business.
9. Scrutinize Additional Investments
If you are contemplating a sale, resist the urge to make investments, such as acquisitions, that may not show a financial benefit in the short-tem. If you are planning an exit within a few years, it is risky to have to integrate an acquisition successfully on a short time table. Make sure that the rewards justify the risks. Also, remember that if the investment lowers your financial performance in the short run, you may be penalized in terms of a lower valuation, even if the investment pays off in the long run. Obtain objective input from your trusted service providers to give you an extra level of scrutiny to ensure that your investment doesn’t decrease the company’s value during a sale.
10. Anticipate Business Cycles
Owners of growing businesses always worry that next year will be bigger and that they will be missing out on value by selling today. However, you will severely decrease value if you wait to sell until the growth has slowed. We have seen the sale value of businesses decrease by 50% because the owners waited one year too long and sold after a non-growth year. Growth businesses are able to capture upside through getting a larger, growth-oriented valuation multiple for the business. There are additional mechanisms, such as earn-out structures, that can also help you to participate in future growth. After reviewing your numbers, if you have had growth over the past few years, and expect that to continue for at least the next year, your business cycle will be appropriate for a sale.
Just like any other facet of your business, when it comes to a sale, planning is critical. Make sure to take advantage of the ten aforementioned steps prior to embarking upon a sale so that you can get full credit for the strong business you have built.