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.
Finding the money to start your own small business can be a challenge. Over the decades, countless people have turned to the Small Business Administration (SBA) for help. A recent Inc. Magazine article, “Kickstart Your Business Dreams with SBA Lending,” by BizBuySell President, Bob House, explored how SBA lending can be used to the buyer’s advantage.
The article covers the basics of an SBA loan and who should try to get one. House notes that the SBA doesn’t provide loans itself, but instead facilitates lending and even micro-lending with a range of partners. The loans are backed by the government, which means that lenders are more willing to offer a loan to an entrepreneur who might not typically qualify for one. The fact is that the SBA will cover 75% of a lender’s loss if the loan goes into default.
Entrepreneurs can benefit tremendously from this program. In some cases, an SBA loan even means skipping the need for collateral. SBA loans can be used for those looking to open a business, expand their existing business or open a franchise.
House points out that getting an SBA loan has much in common with receiving other types of loans. For example, it is necessary to be “bank ready.” By “bank ready,” House means that all of your financial documentation should be organized, clear to understand and ready to go.
Next, a buyer would need to check that he or she qualifies, find a lender and fill out the necessary SBA forms. In order to be eligible for an SBA loan, it is necessary that the business is a for-profit venture and that it will do business in the United States. Once the necessary forms have been submitted, it can take between 2 to 3 months for an application to be processed and potentially approved.
The simple fact is that the SBA helps thousands of people every year. If you are looking to buy a business or expand your current business, then working with the SBA could be exactly what you need. Of course, business brokers are experts on what it takes to buy. Working with a broker stands as one of the single best ways to turn the dream of owning a business into a reality.
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.
Where your money is concerned, myths can do damage. A recent Divestopedia article from Tammie Miller entitled, Crazy M&A Myths You Need to Stop Believing Now, Miller explores 5 big M&A myths that can get you in trouble. Miller points out that many of these myths are believed by CEOs, but that they have zero basis in reality.
The first major myth Miller explores is the idea that the “negotiating is over once you sign the LOI.” The letter of intention is, of course, important. However, this is by no means the end of the negotiations and it is potentially dangerous to think otherwise. The negotiations are not concluded until there is a purchasing agreement in place. As Miller points out, there is a great deal that can go wrong during the due diligence process. For this reason, it is important to not see the LOI as the “end of the road.”
Another myth that Miller wants you to be aware of is that you don’t have to take a company’s debt as part of the purchase price. Many business brokers, such as Miller, recommend that buyers don’t take seller paper.
A third myth that Miller explorers is a particularly dangerous one. The idea that everyone who makes an offer has the money to follow through is, unfortunately, simply not true. Oftentimes, people will make offers without securing the money to actually buy the business. No doubt, this wastes everyone’s time. As the business owner, it can derail your progress. If you are not careful, it could actually prevent you from finding a qualified buyer.
Another myth is built around the notion that sellers don’t need a deal team in order to sell their business. Again, this is another myth that has no real foundation in reality. While it may be possible to sell your business without the assistance of an experienced M&A attorney or business broker, the odds are excellent that doing so will come at a price. According to Miller, those working with an investment banker or business broker can expect, on average, 20% more transaction value!
Additionally, there are other dangers in not having a deal team in place. A business broker can handle many of the time-consuming aspects of selling a business, so that you can keep running your business. It is not uncommon for business owners to get stretched too thin while trying to both run and sell a business and this can ultimately harm its value.
Miller’s final myth to consider is that you must sell your entire business. It is true that most buyers will want to buy 100% of a business, but a minority ownership position is still an option. There are many reasons to consider selling a minority stake, so don’t assume that selling your business is an “all or nothing” affair.
Ultimately, Miller lays out an exceptional case for the importance of working with business brokers when selling or buying a business. Business brokers can help you avoid myths. In the end, they know the lay of the land.
Before buying any business, a seller must ask questions, lots of questions. If there is ever a time where one should not be shy, it is when buying a business. In a recent article from Entrepreneur magazine entitled, “10 Questions You Must Ask Before Buying a Business”, author Jan Porter explores 10 of the single most important questions prospective buyers should be asking before signing on the dotted line. She points out to remember that “there are no stupid questions.”
The first question highlighted in this article is “What are your biggest challenges right now?” The fact is this is one of the single most prudent questions one could ask. If you want to reduce potential surprises, then ask this question.
“What would you have done differently?” is another question that can lead to great insights. Every business owner should be an expert regarding his or her own business. It only makes sense to tap into that expertise when one has the opportunity. The answers to this question may also illuminate areas of potential growth.
How a seller arrives at his or her asking price can reveal a great deal. Having to defend and outline why a business is worth a given price is a great way to determine whether or not the asking price is fair. In other words, a seller should be able to clearly defend the financials.
Porter’s fourth question is, “If you can’t sell, what will you do instead?” The answer to this question can give you insight into just how much bargaining power you may have.
A business’ financials couldn’t be any more important and will play a key role during due diligence. The question, “How will you document the financials of the business?” is key and should be asked and answered very early in the process. A clear paper trail is essential.
Buying a business isn’t all about the business or its owner. At first glance, this may sound like a strange statement, but the simple fact is that a business has to be a good fit for its buyer. That is why, Porter’s recommended question, “What skills or qualities do I need to run this business effectively?” couldn’t be any more important. A prospective buyer must be a good fit for a business or otherwise failure could result.
Now, here is a big question: “Do you have any past, pending or potential lawsuits?” Knowing whether or not you could be buying future headaches is clearly of enormous importance.
Porter believes that other key questions include: “How well documented are the procedures of the business?” and “How much does your business depend on a key customer or vendor?” as well as “What will employees do after the sale?”
When it comes to buying a business, questions are your friend. The more questions you ask, the more information you’ll have. The author quotes an experienced business owner who noted, “The more questions you ask, the less risk there will be.”
Business brokers are experts at knowing what kinds of questions to ask and when to ask them. This will help you obtain the right information so that you can ultimately make the best possible decision.