Selling a business is a process, not an event or a single transaction. The reality is only about 25 percent of listed businesses for sale are actually sold. This process is a proven methodology to ensure you will achieve a successful business transition at maximum possible value.
The four-stage process is as follows:
Stage 1: Opinion of value and current state of business
Stage 2: Strategy to maximize value
Stage 3: Go to market
Stage 4: Complete the transaction
Realistically the entire process can take as little as six months or as long as a couple of years, depending on the current state of the business and the owner’s overall objectives.
- Opinion of Value and Current State of Business
This is an objective look at the current state of the business. Your M&A Advisor can give you an opinion of value, a range of potential prices expected to be realized for your business at its current state. Frequently business owners are disappointed with the initial look at valuations. Their price expectations are usually higher. We will recommend actions that the business owner can take to increase value. The business owner will then have a choice: Go to market now at a lower value, or delay going to market and develop a strategy and plan to maximize value.
- Strategy to Maximize Value
This stage in the process identifies those factors that are depressing valuation, prioritizes them, and develops an action plan to mitigate them. For example, the financials of the business may not be well documented with anything other than tax returns. The corrective action would be hiring a temporary Chief Financial Officer (CFO) to recast three years of financial results to document the performance of the business. Once this is completed, the business may be ready to go to market. Typically, this can be corrected in a month or so and won’t delay the marketing of the business that much.
Another area could be management succession. The business is too dependent on the owner, and the owner wants to eventually leave post-transaction. We will work with the owner and do an objective assessment of the current management team to identify a potential successor internally. If this person does not exist, then a recruiting effort can be initiated to identify external candidates. Ideally, we want someone on the payroll before we go to market. Realistically it may take a year before a successor is identified, recruited, and onboarded into the company. Buyers, however, will reward the seller with higher value if the owner has a quality manager fully onboarded and ready to lead the business post-transaction.
A third area is customer concentration. One or a few customers make up a majority of the business. This will not only depress value but negatively impact the amount of cash the seller will receive at closing. Frankly, this takes longer to fix, and the seller will face a critical decision. If they are willing to wait a couple of years, then we recommend growing your way out of the concentration by focusing on business with new customers. This may require hiring a sales executive to lead this effort.
In any case, the objectives of the seller will drive the strategy. If the seller is in a position to wait and fix the problem, then they should wait. If on the other hand, a seller needs to sell now (health, divorce, etc.), then one must be realistic about the lower valuation they will receive.
- Go to Market
Once the strategy phase is completed, you and your adviser will be ready to begin to develop and execute the marketing plan for your business. Specifically:
- What is your industry?
- Who is your customer?
- What is the value proposition that you deliver to that customer?
- Who are your competitors?
- What is your unique advantage in the marketplace?
- What proprietary processes or intellectual property does your business own?
- How strong is your management team?
- What is the strategy for future growth?
Business sellers frequently acknowledge that by going through this selling process and by having focused, disciplined conversations about their business they learned more about their company than they ever did before! Please keep in mind all this data is confidential at this point in the process. Nothing is released to potential buyers until they have been fully vetted and they have signed the required legal agreement that all information is to be treated as highly confidential and not disclosed to anyone.
The marketing plan identifies potential buyers, the marketing messaging, and positioning of the business. Once the business owner approves the marketing plan, the M&A Advisor begins to take the business to market. It is worth repeating as the marketing stage of your business begins, do not disclose that your business is for sale to anyone unless they have signed a legal document known as a confidentiality nondisclosure agreement. You have too much to lose if word gets out! Employees and customers will be upset unless you have a solid communications plan developed for when the timing is right, and you are ready to disclose the new owner. It is too soon in the process at this point.
Your advisor will begin to market your business by creating a one-page executive summary that is called a “teaser.” Your business will not be identified in the teaser. The information provided will be vague enough so that buyers cannot identify you. The teaser includes a general overview, a couple of highlights of the business, and a summary of general financials (usually three years prior and three years forward). Annual sales, gross profit, operating expenses, and net income are usually provided. The price for your business may or may not be included. There are two schools of thought on this one. By including the price, you may help screen out unqualified and uninterested potential buyers who are just kicking tires. However, if your company is extremely profitable and has double-digit cash flow growth each year, then you are probably better off not indicating the price. You don’t want to set artificial limits on what is offered for your business. Buyers, even financial ones, will pay a premium for high-growth, profitable businesses! The key to the teaser is to give buyers just enough about a business to pique their interest without giving your business name and location (general location information is often included, such as southeastern United States).
Your advisor will review a list of potential buyers with you to receive the teaser. Make sure you sign off on this list, and the teaser only goes out to potential buyers you have approved. Anyone interested in getting more information on your business from the teaser will contact the adviser. This is when the adviser will insist that the potential buyer signs the confidentiality agreement before your name is disclosed. You and your advisor should review the list of all responders. Your advisor should provide as much information about each potential buyer as possible. If the potential buyer is a strategic buyer in your industry, how acquisitive have they been in the past? Beware of competitors in your industry who have never acquired another company. They may be on a fishing expedition to learn more about your business, so they can compete more effectively against you. Detailed information should never be shared with a competitor unless there is a high probability that they will get a deal done. Namely, they have been acquisitive, they have the financial capacity to do the deal, and the strategic value of owning your business is a no-brainer.
Financial buyers such as private equity firms and family offices should also be vetted. What is their deal velocity? Do they still have funds available? Does your company fit with their investment strategy (size, industry, financials, etc.)? Don’t assume just because a private equity fund has significant capital that they are a serious buyer for your business.
You may have some individuals interested. This group needs the most vetting. Have they ever owned or run a business? If no, then they are a long shot and you should not waste much time with them. Do they come from your industry? Again, if they don’t know your industry, then they are a long shot. Do they have the financial capacity to get the deal done? If they have to borrow more than 50 percent of the purchase price, then I would consider them a long shot to close the deal (unless they qualify for small business administration [SBA] financing). You have a business to run until you sell it. You don’t want to waste time with unqualified buyers. Your adviser should be able to provide valuable guidance to you in vetting and screening interested parties.
Once you have the potential buyer list narrowed down (hopefully at least four or five), your adviser will create a confidential memorandum on your business and will send it to them once the confidentiality agreement has been signed.
The Confidential Memorandum should at a minimum contain the following sections:
- Executive summary
This gives a synopsis of your industry, your company, the type of customer, a brief description of products and services, and a summary of financial data.
- Industry overview
This includes data and facts about your industry, usually from third-party sources to add credibility. Your major competitors may also be outlined in this section, and how you differentiate and compete with each one in the marketplace. Industry projections for the future should be included. Remember your buyer is buying the future, not the past.
This section gives information on the type of customers that buy your products or services. You do not have to give specific customer names. You can identify them as Customer A, Customer B, etc. A buyer wants to see two things in this section: how diversified your customer base is by showing percentage of business from each customer, and how strong your customer retention is by showing length of time each customer has purchased your products or services.
- Products and services
This section describes in some detail the products and services you are providing to the market. If you provide multiple services, then it may be worthwhile to indicate the percentage of your business derived from each service. Any proprietary process, computer source code, or intellectual property can be discussed in this section.
- Management and key personnel
The potential buyer is going to want to know who, besides you, runs the business. Giving summaries of management and key employees is appropriate. You may want to give headcount by function, or even an organization chart. Ideally, buyers will see an organization that can run well without you, especially if you do not intend to stay with the business.
This includes data about your location, facility (owned or rented), and hours of operation. If you own the facility, then I would strongly recommend that you sell the facility in a separate transaction from selling the business. Most business buyers are not interested in owning buildings. If they are interested in staying in your location, then as part of the deal, move the building to a separate LLC and work out a long-term rental agreement with the buyer. This gives you flexibility in the future. You can keep the building with passive rental income, or you can sell the building with an attractive long-term lease as part of the package.
This should include income statements, cash flow statements for three years, and a current balance sheet. Graphs can help make the presentation more effective. A commentary should be included, especially if there are any spikes in the data, positive or negative, over the three-year period. This section should also include future projections if you desire to do so. I feel if you have a profitable, growing business, then you have earned the right to provide the buyer with a three-year financial forecast for sales, expenses, and cash flow. Remember, the buyer is buying the future. Just be sure projections are fact-based and you can support them with facts. Overly optimistic projections (the infamous hockey stick that shows 25 percent growth in the future when you have 10 percent historical growth) may cause the buyer to reduce their price in due diligence because you lost credibility with them.
- Investment summary
This section is very important. Make sure your adviser includes it. It summarizes all the benefits of buying your business and why you should command a premium price.
An example would be the following:
- Industry is projected to grow 20 percent annually for the next five years.
- Ninety percent of revenue is recurring with long-term contracts.
- No customer represents more than 10 percent of total business.
- Management team has over fifty years of industry experience combined.
- Business owns two patents.
- Business model has operating leverage once fixed-cost is covered, so cash flow can grow 20 percent annually with only 10 percent revenue growth.
Remember this is a sales document. Tell your story and highlight the positives! Just be sure you can support every claim with facts. If your company is large (annual EBITDA is greater than $5 million), then your adviser may also create a management presentation that summarizes key points from the confidential memorandum. If your annual EBITDA is less than $5 million, then a management presentation may not be necessary.
- Complete the transaction
Your advisor will contact each potential buyer after they have reviewed the Confidential Memorandum to gauge their level of interest. No doubt they will have questions. Your advisor will be able to answer some questions without you. Others will require you to answer either by telephone or in-person. I would recommend not communicating directly with potential buyers without your adviser present. Interested buyers should submit a Non-Binding Letter of Intent to indicate the purchase price and structure of the deal.
For example, we are prepared to pay $5 million for 100 percent of the assets of company ABC, $4 million delivered at closing, and $1 million in seller notes for five years at 8 percent annual interest. The length of time they need for due diligence should be stated in the letter. Potential buyers may want to meet your management team, especially if your business is large (annual EBITDA is greater than $5 million) or you do not plan to stay with the business. This is a reasonable request. I would not, however, let any buyer meet your team unless you have a letter of intent with a price and terms you are comfortable with. Once your team knows the business is for sale, no matter how loyal they are and no matter how well they have been treated by you in the past, they become a flight risk. You don’t want to assume this risk unless you have a high probability of getting a deal done. Be prepared to pay retention bonuses (two to three months of pay) for key managers to help to mitigate this risk.
Ideally, you will come out of this stage with two to three serious offers. By serious, the purchase price is within 10 percent of your desired valuation. The deal structure also must be attractive to you. Keep in mind all-cash deals are rare. Studies have shown that all-cash deals tend to be 20 percent to 30 percent lower than those with some deferred payment (seller notes or earn-outs). Consult with your tax adviser to fully understand the tax implications of each potential deal structure.
Some buyers will ask for an exclusive due diligence period. I would avoid this if possible. You want several buyers to go through due diligence to increase your odds of getting a deal done. The only way I would accept exclusivity is if the offer is at least 20 percent higher than competing offers, and the buyer has a strong track record of completing deals quickly without haircutting the price during due diligence. Your adviser should know this. That’s what you are paying them for!
Whether there is one buyer or multiple ones, you are now entering a period of due diligence. This is so important. Three points should be made here. One, the completer and more accurate your data is the faster due diligence should go. Two, if all your claims made can be supported by facts and data, then you should not receive a haircut from the original offer from the buyer. Three, be sure to give the buyer(s) a deadline to complete due diligence. Thirty days is ideal. You should not agree to any more than sixty days.
Once due diligence is over, hopefully, you will have several highly motivated buyers that your adviser can use to get them to actively bid for your business. Worst case is the original offers stand. There were no surprises in due diligence. No excuses for haircuts! Best case is one of the buyers increases their offer because they know other buyers are in the process, and they really want to own your business!
You made it to the finish line with your sanity in check. Purchase agreement has been signed, all other legal documents are signed, assets are transferred, and the money has been wired to your account. Have a great life. You earned it!
Selling a business is a major commitment of time over an extended period. The process can be as short as six months or as long as a couple of years. Planning is the key to successful execution. There are four critical steps that need to be followed in order to increase the probability of a successful outcome. Trust the process.