Time to Sell Your Business?
Peter Woog and Paul Parent
Most popular business literature is focused on helping entrepreneurs and managers launch and successfully operate ventures. Upon reaching developmental milestones and achieving success, many business owners realize they have created value, but have not yet had the opportunity to monetize their ownership interest and enjoy the financial reward for their hard work and willingness to take risks. There are many and varied paths to creating a sustainable enterprise and creating value, but there are only a handful of ways for an owner to extract the financial value that has been created.
The most visible and often exciting means to liquidity is still the Initial Public Offering (IPO) of a company’s stock on one of the world’s stock exchanges. Though these transactions frequently grab headlines, they are still relatively uncommon events, and are unavailable to many business owners for a variety of reasons. Even when an IPO is a viable option, annual reporting requirements, public scrutiny, increased regulatory oversight and escalating personal liability for executives often make this option unattractive.
A less glamorous, but fundamentally rewarding option is to draw dividends from the business over time. Established firms can pay owners dividends based on their ownership interest as income is generated through operations. Oftentimes lenders will extend leverage, allowing owners to draw larger dividends and finance the needs of the business through additional debt. This approach to realizing value typically requires a business with strong, positive cash flows or significant assets, and more patience on behalf of the owner, who must draw value from the business over longer periods of time.
The remaining common alternative for owners to consider is a sale. A sale offers a multitude of opportunities for liquidity, and is available to a wide variety of businesses at many different stages of development. There are buyers of businesses focused on cash flows, others interested in intellectual property or physical assets, still others looking for growth opportunities, and even some seeking turnaround opportunities. Owners can sell to strategic buyers who operate businesses in their own industry, financial buyers who typically purchase ownership interests for investment purposes, and even to managers currently within the company, seeking to succeed the owners. An owner can choose to sell all of his ownership interest and make a clean exit, or can sell a portion of his ownership and continue to participate in the success of the business. A sale frequently offers owners more flexibility, privacy and control than public market monetization and is available to a wide variety of businesses of value that would otherwise have trouble realizing that value through dividends or recapitalization.
As owners begin to explore the possibility of a sale, it becomes apparent that the flexibility that a sale affords and the differences in types of sales leads to a lot of choices and questions. And though it’s hard to build direct experience with the sale process before going through it, research and preparation can go a long way.
Business owners often know if they have interest from a strategic buyer or from their own companies’ management teams – but where can business owners find a financial buyer? Some businesses may attract interest from hedge funds or merchant banks, but owners increasingly look to private equity firms. Private equity firms typically seek companies that have matured beyond startup and venture stages, and require additional capital for growth or restructuring. In addition to providing capital, private equity firms typically bring capital markets expertise, acquisition and divestiture experience, and relationships with experienced operators, which can be helpful to companies in transition.
How Should Owners Select a Buyer?
Finding the right buyer is important and will impact the value of the business, the structure of the transaction, and the relationship going forward. The interests of the buyer must align with what is best for the seller and the future of the business. To achieve this result, the owner must first define the best scenario for the business; then he can test and score the objectives, strengths, weaknesses, capabilities and past performances of the buyer against these parameters. Not all private equity firms are equal. Prior to entering into a binding arrangement, owners should do their homework by researching the following:
Determine the Buyer’s Objective
A key question to address is “what are the objectives of the private equity firm?” Most, but not all, private equity firms have a fund with stated objectives and clear rules. Talk to fund principals about the types of investments they make and the commitments to the participants in their fund. For example, do they disclose to their investors that they are projecting a specified rate of return over a defined number of years? If so, in order to deliver on this commitment, they will have to sell the fund assets over this specific timeframe. An owner considering a sale should consider whether this fulfills his objective. Some private equity firms do not have a fund because they are investing the principals’ money. This often changes their objectives and can free the firm from specific rules and commitments outside the firm, and can more closely align investor interests with the needs of the business.
Another way to determine a buyer’s objectives is to ask them to define what constitutes “success” for the business that they are hoping to acquire. Owners should also ask potential buyers to identify the person who will be responsible for the business following a sale and then spend time learning about that person’s business background.
Do We Fit?
Next, take the time to talk with the principals or partners of the interested private equity firms. Owners should compare their management perspectives, philosophies of life and business, and tangible business experiences to their own to determine whether the result will bring synergy or potential conflict. This is a bit like dating, since each side should be certain that the potential for a solid marriage exists, and that the relationship will grow and benefit from the marriage.
Check References
It is also important to take the time to conduct thorough due diligence. And, no surprise, the Internet is a good place to start, but don’t stop there. Owners must be sure to ask the professionals assisting with the sale on their behalf – bankers, attorneys, accountants and their colleagues – to provide information about the buyer and its prior acquisitions. For strategic buyers, ask to speak to competitors, suppliers and customers. You will find that it really is a small world and that much relevant information can be obtained. In the case of a financial buyer, ask the private equity principals for permission to talk to the senior management of current and former portfolio companies. Speak to them about what succeeded, what issues they had, and why they thought it was a good or not-so-good fit. Ask tough questions to ascertain if the senior management teams feel that their relationships with their private equity owners have improved their professional lives and added value to the companies they manage. If these managers had the opportunity to do things again, what would they do differently? What are the lessons they learned? You can also request permission to check references with accountants and attorneys. However, ask the private equity firm to make advance introductions for you, otherwise their non-disclosure agreements will prevent the parties from speaking candidly with you. If possible, ask to tour a portfolio company. This will offer an opportunity to ask employees how the company has changed after the acquisition.
Preparing for the
Hire Professionals — Once a business owner has decided to pursue a sale, it is important to engage skilled and experienced professionals to assist in negotiating a fair and financially equitable arrangement. Accountants, consultants and investment bankers can often be helpful, but be sure to hire an attorney who specializes in mergers and acquisitions. The sale of a business is a specialized activity and owners should be properly represented.
The Company — Plan to have audited financial reports for three years before the sale. If you are unable to do that, have at least one year of audited financials available.
Define parameters such as desired price and strategic direction of the company post-closing, to decide if failure to meet these goals will affect the decision to sell.
Gather information about the business in one place (i.e., a data room) for review by prospective buyers. Information in the data room should include important financial, accounting, legal and operating documents relevant to the transaction. Examples include contracts with employees, customers, and suppliers; all loan and lease documentation; details on ownership and company governance; information about formal legal proceedings; and any other documents that create an obligation or commitment for or by the business.
Develop a communication plan for the employees, customers, and suppliers, and give careful thought regarding the timing of the announcement of the sale of the business. Also give thought to contingency communication plans if rumors of the sale occur prior to the formal announcement.
The Owner — Owners should prepare for “seller’s remorse”. Owners should ask themselves if they are ready to accept that post closing, they will no longer be in charge of the business and that the business now belongs to the buyer. Owners also must prepare for other scenarios. After making the critical decision to give up control, spending months supporting the buyer’s due diligence, and engaging competent professionals, there is the possibility that things may not work out as planned. And owners seeking to monetize their investments and remain involved with the business should be prepared for scenarios that allow for monetization, but eliminate involvement. Broadly speaking, owners must consider what the ramifications might be if, post-closing, the parties are not ultimately aligned.
Creating a Successful Outcome
Be prepared — Be prepared and plan before commencing the formal sale process. Don’t “wing it.” Cutting preparation and planning short will not benefit owners, and may turn off potential buyers.
Provide adequate information — Err on the side of over-disclosure. Surprises and negative information that surface from a buyer’s due diligence can break up a deal or information discovered after closing can end up costing the seller significant sums months and even years after the sale.
Stay engaged — This is a time-consuming process and owners need to stay engaged. Owners need to be aware of all that is said to potential buyers and should be careful what is delegated to others. While it’s often advantageous to expose buyers to the strengths of the people in the organization, the owner needs to prepare subordinates for the process and be aware of what subordinates are saying to prospective buyers.
Meet expectations — Promising what you cannot deliver will destroy your credibility. Be sure you can meet a prospective buyer’s expectations.
Allow the professionals to do their jobs — If a seller has hired a banker or other professionals, it is important to let them do their jobs. Owners should hire skilled and experienced professionals they trust. This is particularly important in negotiating certain phases of the deal.
Selling a business is a process which, if properly planned and carefully executed, can have a very positive professional and financial outcome. As in all major business endeavors, defining expectations and working diligently will lead to better results. And never forget that this all hinges on relationships. Remember, picking the right partner is important and taking the time to properly document the transaction will enhance the outcome.
Peter Woog is a partner at Najafi Companies, the largest private equity firm in
Paul Parent is an associate at Najafi Companies, and helps research and evaluate acquisition opportunities.
To contact them or for more information, please visit www.najafi.com.
AZ CPA – March/April 2007
