Let’s assume that you own and operate a company that manufactures a product in an industry that is eroding or going downhill. What are your choices or alternatives?
- Run the company as a “cash cow,” resigning yourself to the fact that your industry is slowly declining or is no longer a growth industry. Keep what you are doing profitable even if you
have to increase prices and/or cut costs.
- Increase R&D to develop new products.
- Acquire or merge with a competitor or strategic partner.
- Expand geographically.
- Diversify within the same familiar market.
- Sell the company now before there is further erosion in your industry
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A close review of the financial statements is always in order when considering the acquisition or merger of a company. However, that is only part of what a buyer is acquiring. Other important assets are:
- Repeat customers or clients
- Patented product, government approvals, profitable copyrights
- Broad customer or client base (diverse & growing)
- Long-term contracts
- Recognizable brand or product name
- Experienced management team and trained work force
- Valuable intellectual property
- Proprietary products
- Profitable alliances
- Contracts/non-competes with valuable employee
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According to a Price Waterhouse Coopers survey of more than 300 privately held U.S. businesses that have been sold or transferred, the most common steps companies take to improve their prospects for a sale, prior to taking the company to market, include:
- Improving profitability by cutting costs
- Restructuring debt
- Limiting owners’ compensation
- Fully funding the company pension plan
- Seeking the advice of a consultant or intermediary
- Improving the management team
- Upgrading computer systems/processes
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The 65-year old owner of a multi-location retail operation doing $30 million in annual sales decided to retire. He interviewed a highly recommended intermediary and was impressed. However, he had a nephew who had just received his MBA and who told his uncle that he could handle the sale and save him some money. He would do it for half of what the intermediary said his fee would be – so the uncle decided to use his nephew. Now, his nephew was a nice young man, educated at one of the top business schools, but he had never been involved in a middle market deal. He had read a lot of case studies and was confident that he could “do the deal.”
Inexperience # 1 – The owner and the nephew agreed not to bring the CFO into the picture, nor execute a “stay” agreement. The nephew felt he could handle the financial details. Neither one of them realized that a potential purchaser would expect to meet with the CFO when it came to the finances of the business, and certainly would expect the CFO to be involved in the due diligence process.
Inexperience # 2 – It never occurred to the owner or his nephew that revealing just the name of the company to prospective buyers would send competitors and only mildly interested prospects to the various locations. There was no mention of Confidentiality Agreements. Since the owner was not in a big hurry, there were no time limits set for offers or even term sheets. It would only be a matter of time before the word that the business was on the market would be out.
Inexperience # 3 – The owner wanted to spend some time with each prospective purchaser. Confidentiality didn’t seem to be an issue. There was no screening process, no interview by the nephew.
Inexperience # 4 – The nephew prepared what was supposed to be an Offering Memorandum. He threw some financials together that had not been audited, which included a missing $500,000 that the owner took and forgot to inform his nephew about. This obviously impacted the numbers. There were no projections, no ratios, etc. This lack of information would most likely result in lower offers or bids or just plain lack of buyer interest. In addition, the mention of a pending lawsuit that could influence the sale was hidden in the Memorandum.
Inexperience # 5 – The owner and nephew both decided that their company attorney could handle the details of a sale if it ever got that far. Unfortunately, although competent, the attorney had never been involved in a business sale transaction, especially one in the $15 million range.
Results — The seller was placing almost his entire net worth in the hands of his nephew and an attorney who had no experience in putting transactions together. The owner decided to call most of the shots without any advice from an experienced deal-maker. Any one of these “inexperiences” could not only “blow” a sale, but also create the possibility of a leak. The discovery that the company was for sale could be catastrophic, whether discovered by the competition, an employee, a major customer or a supplier .
The facts in the above story are true!
The moral of the story – Nephews are wonderful, but inexperience is fraught with danger. When considering the sale of a major asset, it is foolhardy not to employ experienced, knowledgeable professionals. A professional intermediary is a necessity, as is an experienced transaction attorney.
If you’ve never bought or sold a business before, then the factors that drive and influence business valuations likely seem a bit murky. In a recent Divestopedia article from Kevin Ramsier entitled, “A Closer Look at What Drives and Influences Business Valuations,” Ramsier takes a closer look at this important topic.
Business brokers and M&A advisors play a key role in helping business owners understand why their business receives the valuation that it does. No doubt, the final assessed value is based on a wide array of variables. But with some effort, clarity is possible.
In his article, Ramsier points out that “value means different things to different buyers” and that the “perceived value depends on the circumstances, interpretation and the role that is played in a transition.” It is important to remember that no two businesses are alike. For that reason, what goes into a given valuation will vary, often greatly.
Looking to EBITDA
Ramier points to several metrics including return on assets, return on equity and return on investment. Another important valuable for companies with positive cash flow is a multiple of EBITDA, which stands for “earnings before interest, taxes, depreciation and amortization.” EBITDA is widely used in determining value. On the flip side of the coin, if the company in question has a negative cash flow, then the liquidation value of the business will play a large role in determining its value.
Primary Drivers to Consider
Ramsier provides a guideline of Primary Drivers of Valuation, Secondary Drivers of Valuation and Other Potential Drivers of Valuation. In total there are 25 different variables listed, which underscores the overall potential complexity of accurately determining valuation.
In the Primary Drivers of Valuation list, Ramsier includes everything from the size of revenue and revenue stability to historical and projected EBITDA as well as potential growth and margin percentages. Other variables, ones that could easily be overlooked, such as the local talent pool and people training are also listed as variables that should be considered.
Support for the Business Owner
The bottom line is that determining valuation is not a one-dimensional affair, but is instead a dynamic and complex process. One of the single best moves any business owner can make is to reach out to an experienced business broker. Since business brokers are experts in determining valuation, owners working with brokers will know what to expect when the time comes to sell.
Quality employees are essential for the long-term success and growth of any business. Many entrepreneurs learn this simple fact far too late. Regardless of what kind of business you own, a handful of key employees can either make or break you. Sadly, businesses have been destroyed by employees that don’t care, or even worse, are actually working to undermine the business that employs them. In short, the more you evaluate your employees, the better off you and your business will be.
Forbes’ article “Identifying Key Employees When Buying a Business”, from Richard Parker does a fine job in encouraging entrepreneurs to think more about how their employees impact their businesses and the importance of factoring in employees when considering the purchase of a business.
As Parker states, “One of the most important components when evaluating a business for sale is investigating its employees.” This statement does not only apply to buyers. Of course, with this fact in mind, sellers should take every step possible to build a great team long before a business is placed on the market.
There are many variables to consider when evaluating employees. It is critical, as Parker points out, to determine exactly how much of the work burden the owner of the business is shouldering. If an owner is trying to “do it all, all the time” then buyers must determine who can help shoulder some of the responsibility, as this is key for growth.
In Parker’s view, one of the first steps in the buyer’s due diligence process is to identify key employees. Parker strongly encourages buyers to determine how the business will fair if these employees were to leave or cross over to a competitor. Assessing if an employee is valuable involves more than simply evaluating an employee’s current benefit. Their future value and potential damage they could cause upon leaving are all factors that must be weighed. Wisely, Parker recommends having a test period where you can evaluate employees and the business before entering into a formal agreement.
It is key to never forget that your employees help you build your business. The importance of specific employees to any given business varies widely. But sellers should understand what employees are key and why. Additionally, sellers should be able to articulate how key employees can be replaced and even have a plan for doing so. Since, savvy buyers will understand the importance of key employees and evaluate them, it is essential that sellers are prepared to have their employees placed under the microscope along with the rest of their business.
The first step towards successfully selling a business is finding a qualified business broker to work with. Sellers should also ask themselves an array of important questions. A recent article, “7 Questions to Answer Before Selling Your Business,” published by Good Men Project, has a great overview of questions sellers should answer before moving forward.
Author Troy Lambert believes that at the top of the list is one very simple and powerful question, “Are you ready?” For example, your financial reports should be ready to show.
The second question is, “What’s it worth?” Determining what a business is worth means you’ll need a professional business valuation. A great deal can go into evaluating your business and you need an expert to help you determine that value.
Third, Lambert believes that prospective sellers should ask themselves, “How’s the health of my industry?” He emphasizes that honesty is key here for a variety of reasons. If your industry is in a transition period, for example, then it might be better to wait until a better time to sell.
The fourth question on Lambert’s list is, “How long will it take?” In short, you need to remember that selling a business can take a long time. Successfully selling your business may even mean that you have to stay on and work with the new owner during a transition period.
The fifth key question is, “Who is my buyer?” You don’t want to waste a lot of time with potential buyers who are simply not a good fit. Finding the right buyer for your business helps to ensure that a deal will be finalized.
Sixth, Lambert wants sellers to think about how they will get paid. Are you willing to finance part of the deal? What about balloon payments over time? Understanding, before you put your business on the market how you want to be paid and how flexible you can be in terms of payment is essential.
For most sellers, selling a business will stand as the largest financial decision of their lives. With this realization comes more than a little pressure.
Considering the enormity of the decision, having good advice is simply a must. A seasoned and experienced business broker understands what it takes to buy and sell a business. Working with a business broker is an easy and efficient way to begin the process of selling your business. Brokers know what it takes to successfully sell a business and can help you answer these questions and many more.
A recent article on Businessbroker.net entitled, First Time Buyer Processes by business broker Pat Jones explores the process of buying a business in a precise step-by-step fashion. Jones notes that there are many reasons that people buy businesses including the desire to be one’s own boss. However, he is also quick to point out that buyers should refrain from buying a business that they simply don’t like. In the quest for profits, many prospective owners may opt to do this, but it could ultimately lead to failure.
Step One – Information Gathering
For Jones, there are seven steps in the business buying process. At the top of the list is to gather information on businesses so that one has an idea of what kind of businesses are appealing.
Step Two – Your Broker
The second key step is to begin working with a business broker. This point makes tremendous sense; after all, those new to the business buying process will benefit greatly from working with a guide with so much experience. Business brokers can gain access to information that prospective business owners simply cannot.
Step Three – Confidentiality and Questions
The third step in the process is to sign a confidentiality agreement so that you can learn more about a business that you find interesting. Once you have the businesses marketing package, you’ll want to have your broker schedule an appointment with the seller. It is vitally important that you prepare a list of questions on a range of topics. There is much more to buying a business than the final price tag. By asking the right questions, you’ll be able to learn more about the business and its long-term potential.
Step Four – Evaluation
In the fourth step of the business buying process, you’ll want to evaluate all the information that you have received from the seller. Once again, a business broker can be simply invaluable, thanks to years of hands-on experience, he or she will know how to evaluate a seller’s information.
Step Five – The Decision
In the fifth step, you’ll need to decide whether or not you are making an offer. If you are making an offer, you will, of course, want it to be written and include contingencies.
If your offer is accepted, then the process of due diligence begins. During due diligence, you and your business broker will look at everything from financial statements to tax returns. You will evaluate the company’s assets. Again business brokers are experts at the due diligence process.
Buying a business is an enormous commitment. Making certain that you’ve selected the right business for you is one of the most critical decisions of your life. Having as much competent and experienced help as possible is of paramount importance.
In a recent Divestopedia article entitled, “Kids Take Over the Business? 8 Things to Consider,” author Josh Patrick examines what every business owner should know about having their children take over their business. He points out that there are no modern and accurate numbers on what percentage of businesses will be taken over by the children of their owners. But clearly the number is substantial.
Patrick emphasizes as point number one that allowing a child to take over a business right after finishing his or her education could be a huge mistake. After all, how can a parent be sure that a child can handle operating the business without some proven experience under his or her belt?
Point number two is that businesses frequently create jobs for the children of owners. The flaw in this logic is pretty easy to see. This job, regardless of its responsibilities, isn’t in fact a real job. Senior decision-making roles should be earned and not handed out as a birthright. The end result of this approach could create a range of diverse problems.
The third point Patrick addresses is that pay should be competitive and fair when having children take over a business. Quite often, the pay is either far too high or far too low. This factor in and of itself is likely to lead to yet more problems.
Business growth must always be kept in mind. When having your children take over a business, it is essential that they have the ability to not just maintain the business but grow it as well. If they can’t handle the job then, as Patrick highlights, you are not doing them any favors. Perhaps it is time to sell.
Another issue Patrick covers is whether or not children should own stock. If there are several children involved, then he feels it is important that all children own stock. Otherwise, some children will feel invested in the business and others will not. In turn, this issue can become a significant problem once you, as the business owner, either retire or pass away.
In his sixth point, Patrick recommends that a business should only be sold to children and not given outright. If a child is simply given a business, then that business may not have any perceived value. Additionally, if a child or children buy the business, then estate planning becomes much more straightforward.
In point seven, Patrick astutely recommends that once a parent has sold their business to their child, the parent must “let go.” At some point, you will have to retire. Regardless of the outcome, you’ll ultimately have to step back and let your children take charge.
Finally, it is important to remember that your children will change how things are done. This fact is simply unavoidable and should be embraced.
Working with an experienced business broker is a great way to ensure that selling a business to your child or children is a successful venture. The experience that a business broker can bring to this kind of business transfer is quite invaluable.
Forbes author Keith Gregg’s, February 8, 2019 article, “Using Tech to Enhance and Sell a Business,” has a range of interesting ideas that business owners should explore and embrace. Gregg looks at three big ways that business owners can use technology to help them get the most out of the sale of the business. He explains how important it is to address these three areas before placing your business on the market.
The first tip Gregg explores is to upgrade systems. Upgrading systems can be particularly important for attracting younger buyers. It is common for businesses to be successful without proprietary technology or procedures, but that doesn’t mean that technology should be ignored.
Important information should be digitized, as this data will be vital for the new owner to grow the business over the long haul. Incorporating software that can track and analyze data across the business is likewise valuable. Using software, such as customer relationship management and financial management software, will showcase that your business has been modernized.
Determining the value of your business can be tricky and laborious. Gregg recommends opting for a business valuation, as he feels, “business valuation calculations can remove much of the guesswork from the process.”
You should expect a business valuation calculator to include everything from verified data on comparable business deals, including gross income and cash flow figures and more. There are even industry-specific calculations that can be used as well. The main point that Gregg wants to convey is that business owners should use tangible and proven data to sell their businesses. Like upgrading systems appeals to younger buyers, the same holds true for using verified data to sell.
Take Advantage of the Digital Marketplace
Gregg’s view is that perhaps the single greatest technology for business owners to leverage is that of the digital marketplace. Sites that link businesses with prospective buyers can help to streamline and expedite the sales process. Through such sites, it is possible to go deeper than a specific industry and even explore sub-sectors, thus enhancing the chances of finding the right buyer.
Technology can be used to help sell businesses in a variety of ways. An experienced and proven business broker will leverage a whole range of tools to assist business owners when selling their businesses. When you opt for a proven business broker, you can expect to receive offers from serious and vetted buyers and, in the process, save a great deal of time while maintaining confidentiality.