Sunday, September 22, 2019

Getting The Most Value When Selling Your Business


I was recently asked to speak about how business owners can maximize the value of their business as they prepare for an exit.  More and more business owners are starting to think about the next chapter in their lives and the demographics support this.  Note the following:

·         One quarter of business owners today are over age 60 (Source: Kiplinger Letter May '19)

·         Many of those intend to sell relatively soon, half of them within 5 years (Source: same)

·         Few of them have a solid exit strategy in place (Source: same)

Generally, it is best to have a 3 to 5 year runway of planning to execute a proper exit strategy.  The more time one gives to the process, the more options will be available.  The following are some bullet points I covered in my talk:

·         Valuation is key, depends on your sector, past performance, future outlook, composition/quality of customer base, management team, etc.

·         Re: management team, buyers just don’t buy businesses, of course they are also buying talent.  The more talent you have in management beyond the owner, the more valuable a business is.  If the business relies heavily on its owner, it’s more of an alter ego and lesser so a business.

·         During a potential sale, when going to market, stay focused.  Stay focused on business execution to maintain strong results (i.e. business value).  It’s easy to get distracted by the prospect of the exit, whether sale, ESOP, etc.  If business results start lagging, often so too will the value of the transaction.  Further, not all transactions are completed and if your business weakens as you lose focus, it's all your problem to solve when a deal falls through.

·         Have a strong accounting/reporting function.  The owner may know what is transpiring in the business, but outside parties such as prospective buyers and their due diligence teams, valuation firms (including for ESOP), etc. do not.  They rely on strong financial reporting to understand the intrinsic value of the business.  Incidentally, strong reporting is also useful in running the business regardless of potential exit.

·         Have a written strategic plan.  While the reporting function tends to tell the story of the past, a strategic plan provides insight into the future.  At the end of the day, valuation of a business is a discounting mechanism of the future cash flows of the business.  The strategic direction outlining opportunities/threats and how to address them is a useful document for prospective buyers as well as management.

·         Get year end CPA audited or reviewed financial statements.  Having this outside attestation regarding the quality of the financial statements is another useful resource for outside interested parties.  This will lend credibility to the financial data used by prospective buyers and valuation firms.

·         Curtail discretionary spending and ensure normalization of earnings during due diligence.  There are certain types of expenditures that a strategic buyer would not incur and those should be added back to earnings for a proper measure of enterprise value.

·         Run lean.  Ensure efficiency with your labor force.  This is one of the most difficult areas to manage in a business and not having unnecessary slack capacity is helpful to force efficiency into your business and improve earnings results, a key driver in valuation methodologies.

·         To the extent possible, avoid customer concentrations.  This is often times the norm, however mitigating these concentrations when all other things are equal is good to avoid questions with the associated risks and a potential downward adjustment to value or worse, a deal not happening because of them.

·         Build quality backlog (as you would ordinarily do).  Backlog is a clear indication of future earnings and will be built into the measure of enterprise value.

·         Sell at a good time in the cycle.  This seems obvious, but is sometimes hard for business owners to do.  Similar to walking away from the blackjack table when you are ahead, selling at a time of strong earnings and future prospects will lead to a higher valuation.  Waiting until the next downturn when things are not looking quite as good and when others are also looking to get out will have downward pressure on value.

·         Understand your enterprise value.  If you don’t, there is a risk you will not get a fair price for what you’ve built.  Be sure to have professionals on your team that can help in this regard.  You need to know the right price to make an educated decision regarding offers.

·         Understand the tax implications of the proposed transaction.  Entity structure, transaction type (e.g. stock vs. asset deal), and a myriad of other factors can significantly affect the net amount of the transaction.  It’s not what you sell for, it’s what you keep after taxes that counts.  Again, be sure to have professionals on your team that can help.  Work with these professionals on deal structure to maximize the benefit for all involved, both seller and buyer.  It’s generally best for all parties to “win” in any transaction.

·         Do not be distracted by purchase price.  There are other considerations such as non-compete, cash vs. credit (or some combination), the deal vs. the “after-deal” for you and your employees.  What will professional life look like for you and/or your team after the deal consummates?  Will your key people be happy in the new environment?  Will your customers be happy?  Is this the right fit?

As you can see, there are many considerations when thinking about your off ramp from business ownership.  The longer that off ramp is, the more likely it is to be smoother.

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