United States: "Take This Exit" - Critical Considerations in Preparing for and Selling Your Business – Part I

Selling a business can be the single most important decision of an entrepreneur’s life.

But it’s more than just making the decision. It’s an emotionally charged, often deeply personal matter for you, the entrepreneur.

Your business is typically the single largest element of your asset base and estate, often with both real capital tied up and huge amounts of sweat equity invested. And it’s probably been the center of your life, with relationships that have been built with partners, employees and customers that are nearly family-like. Often, it’s not just a company that has been created, but also a culture. It not only has your imprint, but the blood and sweat of partners, employees and, perhaps, your own family.

But with all this at stake, few entrepreneurs ever plan their exit. Typically, they first really begin to think about it when a prospective buyer approaches them. Or worse, when external pressures, like health, family or partner problems force the issue. And even those that actually do some planning for their exit, find it can be an overwhelmingly complicated decision with layers of questions to be answered before beginning to move ahead and still more to consider once you do.

To help you better understand and organize the process, we break it into four basic stages – The Decision, The Plan, The Approach and The Deal. We will address the initial two in this article and remainder in an article to follow.

In addressing the first stage – The Decision - some key questions are highlighted that should be answered to see if and when selling is right for you.

Why are consider selling? Have you been approached by a prospective buyer or merger partner? Are there expansion or capital issues that would be better addressed with a larger partner with deeper pockets, more infrastructure and greater reach? Does it seem time to "cash out," get your estate in order or have you simply "had enough" and want to move on? Have you taken the company as far as you believe you can, given your management capabilities? Are you intrigued by another business concept that you want to develop? Are you weary of the financial pressure or employee issues and want a "partner" to take on that burden?

In short, there should be a specific reason or reasons to sell. They could be found in answers to any one or some combination of the previous questions …or even some other consideration such as a major conflict in a family-owned business. Simple or complicated, weighing these is a crucial first step in the process. Whatever your rationale, it is the foundation of the decision.

The question then becomes how to realistically value the business? Remember, "there are no ugly children," in the eyes of a parent, and "beauty is in the eye of the beholder." Can you objectively arrive at a value? Have you researched selling prices of comparable businesses in your market sector are receiving? Do expectations far exceed those multiple of revenues or valuations?

And a word of caution about valuation. It can become not unlike the dollar figure of a contract for a professional athlete – a "scoreboard" for value, the "number" you can flaunt to other members at the club or a trade group meeting. However, while acknowledging that the maximum selling price is a prime objective, this isn’t just about getting a certain valuation. It’s truly about what you get to actually "keep" after taxes and professional fees, regardless of how and when you are paid.

Whether you plan to stay on with the company or move on after a sale, there are a myriad of options for payment that can have costly tax implications. This is where advice, both professional and practical, is well worth it. Talk to professional advisors, particularly your lawyer and accountant. Talk to owners who have sold their businesses, both those who ended up happy and not so. Ask those from the investment banking community for their opinion. Consider getting a professional valuation done to get a baseline, realizing, however, that a buyer will only pay what they think the business is worth, not what a valuation claims it is.

After establishing why you’re selling and what you expect that sale to bring, understand the changes that typically result from a sale – some good, some… maybe, just okay.

The good results are real easy to identify. No more financial or personal pressure and all that that implies – richer personal bank account; capital available for growth (if you stick around), or maybe a short consulting gig or board seat before you "ride off into the sunset" (if you don’t). There could be new availability of management depth, perhaps international business expansion and an opportunity for more personal professional growth (if you stick around), no more worries about benefits plans, supplier problems or off-shore price pressures (if you don’t).

But how about the "just okay" results – actually the tradeoffs made for all of the positives you get?

First and foremost, for an entrepreneur, selling his or her company is likely akin to putting a child up for adoption. Harsh thought, perhaps, but the analogy holds. You have raised the "child" to this point and you will always be your "child’s" parent, but now your company will have a new "parent" that will be responsible for and control its life!

Plus, you won’t be "king" anymore. And we all know "it’s good to be king!" If you stay, you WILL have a boss – someone to whom you will have to answer! Perhaps, many new bosses. Your control over company direction and how capital is allocated will be reduced. And a new, different, maybe better, maybe worse, corporate culture will be introduced and you’ll be center stage in front of a new and highly judgmental audience.

The unfortunate consequences of not realistically considering the potential scenarios of a post-sale situation and thinking through whether or not you can accept what it might bring cannot be emphasized enough. Disillusionment and unhappiness has occurred because most entrepreneurs only considered the plusses and glossed over what they could be trading for those good things. Make no mistake; while there are sales that have worked out phenomenally well, there are always tradeoffs.

If you understand why you want to sell and fully accepted the implications of a sale, the next thing to consider is timing. And timing IS everything!

Your company’s recent operating history as well as market conditions, both overall and in your specific industry, will drive both value and the timing of the sale. Have you just come off a couple of your best years …or your worst? Is your industry sector suddenly "hot" …or "stone cold"? How have valuations in your industry and for comparable businesses been over the last six to twelve months? Is there some pressing need either for the business, or for you personally to consider a sale now? An example would be a pending contract requiring serious capital infusion or more infrastructure, on the business side. On the personal side, divorce, children’s issues, either yours or a partner’s, could be driving the need to sell.

Again, answering some of these key questions will determine if the timing is right. Sometimes, there is no choice –a down market, personal pressures or health problems may force the issue. In virtually all cases, timing will adversely affect valuation. Most buyers are fairly astute and will uncover or discern your real reasons for selling, regardless of what you tell them.

If the business is coming off a bad year or two, and there is no overriding reason to sell, consider taking the steps needed to get your numbers back to where they should be before proceeding. If the overall M&A market is soft, as it had been from late 2000 through early 2003, realize that there will be buyers, just fewer of them, offering lower amounts. If valuations in your market sector are lagging behind those of other firms with which they’ve always been comparable, perhaps waiting another quarter or more will make far better sense.

In any case, timing will be a major consideration both for the available buyers who might have an interest and the selling price you might receive. Some words of advice – it is always better to sell a little too soon…than a little too late!

Now it’s decision time.

If there were questions you need to think more about or answers you didn’t like, take the time to address each. If there’s nagging doubt, or answers found that raised a whole other series of difficult questions, think about those some more and either talk to or bring in the experts. If all other issues have been addressed, but the timing is wrong, for whatever reason, wait. This is a decision that not only affects you, personally and professionally, but your family and your extended family in your company.

On the other hand, if you’re satisfied that you’ve addressed and answered all of the key questions, then the decision to proceed should be obvious. Get ready to roll up your sleeves. The real work is just beginning. Now it’s getting ready for "prime time, " with the next stage – The Plan.

Plan your exit and then execute your plan.

The process of selling a business is one that can easily get out of control. It can chew up huge amounts of your time, cause you to "take your eye off the ball," negatively affect management of day-to-day business and can often impact the very value that’s been built up over the years. A typical sale will take a minimum of six months to up to a year or more from the time you confirm your decision to sell. For these reasons, it is essential that you develop a pro-active plan and seriously consider how to best use professional advice in preparation for the sale itself.

Business owners who have been most satisfied with the outcome of their sale have used professional advisors. Your accountant and attorney will be invaluable in helping you through the process. Successful sellers have tended to use an intermediary like an investment banker or M&A advisory firm. There are boutique firms that specialize in working with smaller businesses. They will help you package your company, creating a summary "selling" document that will go to prospective buyers. They also effectively guide a seller through the complicated process of preparation, finding the right buyer and helping negotiate the deal. Professional advisors will have seen situations you are now facing multiple times each year with multiple clients. Most business owners may only get to do this once…ever! Effectively using these professionals can save time, money and unnecessary aggravation, to say nothing of the affect on quality of life during and after the transaction.

Select the one you are most comfortable with and let them lead and guide the process. The more responsibility they take on, the less impact the process will have on your day-to-day management of the business. Weigh their experience and the scope of their proposed engagement against the fees they charge. But by all means use them. This is a critical element of a successful sale, possibly the single most important financial and professional event in your life.

At its core, selling a business is no different than selling a product. It should be presented in the best possible light, promoting its positive aspects, while downplaying those that are less than stellar. Your financial reporting, in particular, should be as "buttoned up" as possible. There should be at least three years worth of financial reports reviewed and prepared by an outside accounting firm. Having audited statements is a real plus, but not absolutely necessary. If you have neither, you should, at least, have the previous fiscal year reviewed and prepared. Tax filings alone don’t present the true picture of a business, nor will they satisfy a buyer.

If there is a business plan that describes your company’s objectives and strategies for the next several years, that’s also a positive. Even a rudimentary one will do. It shows prospective buyers that you are planning for growth, not just hoping it will happen. At minimum, there should be a basic plan for the current year and a forecast for at least two beyond that. A good rule of thumb for preparation is "three years back, three years forward" for presenting your company. Prospective buyers will want to know results you’ve had and what you’re targeting, so they know what can be expected from the business.

Words of caution: don’t develop a forecast that shows growth at a rate significantly higher than what you have achieved in the past. Unless there are specific and defensible growth strategies that back it up – new products, new distribution, etc., - it will erode your credibility. Further, overly optimistic projections won’t it impact "up front" valuation, but could be used against you, by appearing to create more future value, and an earn-out scenario that you have no chance of attaining. This will be touched on in greater depth, later.

Most companies know their strengths well. Few, however, readily admit to or understand their weaknesses. Every business has "warts." Some have more than others. Some have bigger ones than others. No matter, the prospective buyer will find each one …sooner or later. Recognizing what the "warts" are and being prepared to discuss why they exist and how they can be fixed is the most prudent course. They can’t and won’t be ignored.

Sometimes there are more than simple "warts." There may be proverbial "skeletons in the closet." For instance is there some major issue that may have occurred in years past, that has since been corrected? Examples would be a major customer or employee problem, or an issue that has yet to be resolved, such as a lawsuit, an expiring patent or a defect in a product that triggered caused warranty issues.

In any event, it is better to be prepared to tell a prospective buyer about these problems early in the process rather than have them discovered later in the due diligence process as you move closer toward closing. While it may turn away some buyers, it’s better than having a buyer uncover problems somewhere down the line, then either substantially reduce the amount of their offer, or far worse, angrily walk away from the deal on the table, questioning your integrity. And after having expended a lot of time, energy and expense getting there.

There’s at least one buyer out there who will buy the business, "warts" and all. They should learn of all known problems and not have to dig them out! Be ready to show and tell them, whether they ask or not.

In the Decision Stage, we reviewed the necessity for realistic expectations. Now is time to frame out how you would like to see those expectations tied into the needs and requirements you have for any transaction to be truly acceptable. Monetary and non-monetary; both are equally important.

Clearly, how payment is made varies with virtually every deal. You may have certain financial needs and requirements that are paramount: a certain amount of cash in the bank, a retirement fund, children’s college fund, your estate, etc. Or there may be simply cash flow needs on a monthly, quarterly or yearly basis. Then there may be certain perks that you expect to continue for the foreseeable future. Each of these issues will be flavored by whether you leave the company some time shortly after the closing, or you stay on for a considerable period of time. And don’t worry about structure. Deal structure will be somewhat dictated by whom the buyer is and how they prefer to do transactions. Determine what’s acceptable, and when you expect it, since not all monetary compensation may be paid at closing.

In the non-monetary arena (even though some items may carry some form of remuneration), consider that if you intend to "ride off into the sunset," how long of a transition are you willing to provide the prospective buyer? If you intend to stay, what role do you expect to be playing in your former company and for how long? And what about non-competition agreements? The buyer will ask for them whether you go or stay. What do you feel is a reasonable time period for a non-compete, once you’ve left the company? What about your people? Out of loyalty, are there certain people that have to be taken care of either through employment contracts or special perks after the sale?

Again, advisors can be or great help here. They’ve been through this dozens of times and they can counsel as to what is reasonable and what may not be and what any tax ramifications there may be.

If you have already been approached by a buyer with whom you are comfortable, then you may very well have the "right" buyer. However, if a buyer is not on your doorstep, where and how you find the "right" buyer, the one who’ll not only give you the "right" price and present the "right" opportunity for you and your employees, is really based on what kind of company you’re looking to partner with. You need to create a profile of what that "right" buyer might look like.

This is a completely subjective judgment, dependent on your specific situation and specific requirements.

For example, getting the maximum price is always a major objective. If that is the only objective then a strategic buyer, one from your own or a closely associated industry sector, might be targeted for the best fit.

For some entrepreneurs, continuation of the business at its current location with its current employees staying in place, and an ongoing advisory role for the entrepreneur may be an overriding objective. Then the ideal buyer might be former operating manager, with access to capital, who is looking for a business to run or a private equity fund. In any event, it is paramount to understand what you want to accomplish in a sale. Revisit the Why question we talked about in Stage I.

To help profile the "right" buyer, try to establish some criteria for judging prospective buyers. For example,

Whatever criteria you establish for profiling prospective buyers, keep them simple and relevant to what’s important to you. Clearly, any buyer must have the resources to meet your price. There will be other considerations, chief among them, the corporate "culture" that your company would be entering. Those issues will be explored as you prepare to approach prospective buyers. These decisions as well as other critical questions regarding the next two stages of the selling process – The Approach and The Deal will be considered in our next article.