United States: The Anatomy of Selling a Business

As the economy gains momentum, industries are becoming more confident in the future and are looking to execute the growth strategies they put aside during the recession. Part of these growth strategies inevitably will be acquisition strategies, and some business owners are realizing that the time may be fast approaching to exit the businesses they have developed. The process of buying or selling a business can be quite an exciting time for an owner. Buyers are hungry, and sellers are finally getting to reap the value of the companies they have work so hard to create. The process can also be quite frustrating if the buyer or seller has unrealistic expectations or is not familiar with the process. Often it is the seller who gets the most frustrated, because it is usually his or her first experience with the sale of a business. It is crucial for both buyers and sellers to know the anatomy of selling a business.

Historically, trends in mergers and acquisitions have been cyclical in nature, much like economic cycles. The start of the merger and acquisition (M&A) cycle will usually lag behind the beginning of positive economic growth, and the end of the M&A cycle will pre-indicate a slow down in the economy. The reason for this is that as the economy grows, companies start to generate cash and balance sheets start to improve, leaving companies in a better financial position for acquisitions. On the other hand, as market conditions decline, companies will start to feel a cash crunch, and therefore will slow the rate of mergers and acquisitions. There are certainly identifiable stages of the M&A cycles that an entrepreneur should know if they are considering buying or selling a business. Those stages of the cycle are:

Stage 1—This stage generally starts at the being of an economic or industry upswing. The stock market will be at a cyclical low, lenders will be taking very few risks, and economic indicators will flatten after recent declines. Job growth will stagnate, and there will be no announcements for initial public offerings. Mid to large companies that have weathered recent down-turns will begin to dust of their growth strategies and start looking for smaller, troubled companies that they believe they can get for a bargain, known as bottom-feeding. Most of the time the smaller companies will sell for a lower price in order to get out from under suffocating debt or a dying business. However, there is usually no M&A activity in this stage.

Stage 2— Stock market and economic indicator gains will fluctuate greatly, but will trend slightly upward. Lenders will be more open to looking at lending proposals but still will be cautious. Companies and capital markets will begin to talk up potential initial public offerings. Temporary staffing firms will see increased activity, and unemployment will see a slight decline. As economic realities begin to take hold, growth increases slightly and optimism grows, mid- to large- sized companies will be willing to pay a "reasonable" price for smaller companies. They are generally less selective about the companies they are willing to buy and will usually pay slightly higher prices without over paying. Healthy companies will bring the highest multiples in acquisitions.

Stage 3— Stage 3 is the peak of the merger and acquisition cycle. The economic engines will be pumping, the stock market will be seeing consistent gains, job growth will be optimistic, capital markets will be actively investing in growth companies and industry stock prices will be trading at 52- week and historical highs. Buyers will be extremely optimistic about their own businesses, so they will tend to be optimistic about the industry’s long-term future. Cash flows will be positive, so buyers will have plenty of cash to make major purchases. Headline-grabbing deals usually will be announced during this stage. Small companies will be able to raise money with ease and begin making purchases for themselves. Mid- and large-sized companies generally will be more selective about the companies they are willing to buy, but will pay large multiples. There are usually plenty of buyers and sellers in the market.

Stage 4—Many companies that have been heavily active in the merger and acquisition will have their hands full with absorbing their new purchases. The stock market and economic indicators will have peaked and will trend slightly lower. Companies will announce an increase in layoffs, and lenders will start to tighten lending requirements. The market for companies will stabilize because of sellers seeking excessively high multiples and because of a slight slow down in industry conditions. There will generally be more sellers than buyers in the market. Most sellers will be trying to participate in what they have seen happen to others in the industry in Stage 3.

Stage 5—Economic conditions will start to decline, capital markets will contract, and the bottomfeeding will start again. Those companies that still have cash to make a purchase will do so only at deflated values and favorable buying terms. There will be plenty of sellers in the market, but very few will find a buyer.

Most business owners are not aware of what stage their industry is in until it is towards the end of a stage and opportunities have passed them by. While sellers will want to be in Stage 3, they quickly find that they were slow to react and have ended up in Stage 4 or 5. Experts say that to take full advantage of any cycle, participants have to plan at least one stage ahead of when they want to act. At the time of press, merger and acquisition specialists believe the staffing industry is in late Stage 1 or perhaps the beginning of Stage 2.

Sellers or those considering selling their companies usually are unfamiliar with the process of selling a company or how long it will take. Expectations are often such that a sale could take place within 30 days. Buyers and brokers are often the source of the 30 day closing expectation, because they use this tactic to get the seller interested in moving toward a sale. Unfortunately, this is unreasonable and usually leads to frustrated buyers and sellers. It is extremely important that a seller understand the process and time involved in selling his or her company. Sellers also under estimate how much of their time could be involved in selling a company. They haphazardly will ignore the running of their businesses and preoccupy themselves with the activities of their acquisitions. This is quite unfortunate because what they will find is that the buyer may be unwilling to close the deal or offer a devalued price because of recent poor business results. More than a few deals have been terminated because owners were concerned with closing their deals and did not manage the businesses successfully during the acquisition proceedings.

The following process is what can be expected during a typical acquisition of a business:

Without knowing the value of a selling business, maximum returns are rarely realized. Part of the selling process for the shareholders or owners is determining the dollar amount they are willing to sell for and how they wish to structure the deal. The business valuation will determine the sale price. The question for the owner is, "Is this enough?" "Enough" is a very personal decision and one a financial planner may have to help make. If a seller decides "enough" is not enough, the question becomes, "How do I get to where I want to be?"¹ Resources to help with this situation include investment bankers and consultants.

The valuation will serve as ammunition when negotiations start with a potential buyer. Companies considering selling must prove to the buyer that they are worth the asking price. If sellers cannot document the asking prices and provide back-up for the answers to the following questions, they may need to reassess their acquisition strategies.

• What is the maximum capacity of the business’ infrastructure?
• What are the revenue, gross profit and net profit per staff member? (In-house and field)
• Do the current business lines correlate with active buyers in the market?
• How do the financial ratios compare with others in the industry?
• How critical are the owners to the ongoing success of the business?
• This business is worth $X because of reasons A, B, and C.

To avoid being discounted, it is important to have evidence to back up the assessment of the company’s value. Not having a professional valuation performed for your company could come at a considerable cost for several reasons.

• Revenues, gross profits, and EBIDTA are not the value of your company and are poor tools to guide your growth strategies. Ask experts what staffing and home healthcare agencies are currently selling for and most will say 3 to 5 times earnings. That’s a fairly broad range. What they are saying is: A company with an EBITDA of $500,000 will sale for $1,500,000 to $2,500,000, which is quite a range. Ask a buyer of staffing agencies what they are paying and you can guarantee he/she will say a figure at the lowest end of that range. Without a comprehensive valuation, negotiations will start at the low end of multiple ranges rather than the high end.
• The value of the company should be the basis for growth strategy development. Reasonable sellers will have valuations completed before putting their companies on the market. Occasionally, the prices they had in mind for their companies are lower than appraised values. At that point they have to decide to sell at or just above the appraised value or wait to try to grow the company to the level that would bring them the return they desire. If a seller decides not to sell at that time, a credible valuation would identify the areas that would increase the value of the firm. If the decision is to go ahead and sell, a savvy seller will use the valuation to show the potential buyer what needs to be done to grow the company and perhaps get a higher price for the business through an earn-out provision.
• Knowing the value allows owners to know how their companies compare with other companies in the industry and geographical market. If a seller can prove the value of his or her company by comparing with other like companies, a buyer will have a hard time ignoring the real value of the business.

NOTE: A mistake that is often made by owners is sitting back and waiting for an offer. They may even call around to investment bankers or brokers and make it known they would consider selling if the price were right. Industry and business growth may have been good, and the owner is confident that the business will continue to grow, so the business owner assumes he doesn’t have to sell unless he gets the price that he wants. While this could be true there are three things wrong with his assumptions.

1. The "right price" in this case may or may not be reasonable for the business or market conditions. The owner will have to negotiate based on any offer that comes in, and be reactive rather than proactive.
2. The "right price" may be reasonable, but the owner may be able to get more for the company based on favorable current market conditions and higher multiples that may be available. The owner is just looking for the "right price" and may not be aware of all that he or she could earn. Getting the most for a business that you have built is not greed but smart business.
3. Usually, when an owner waits on the "right price", and a potential buyer comes along who is willing to pay something close, the owner usually will perceive only two options, to sell or not to sell to that buyer. The owner may be missing out on competing offers that may be better than the original. The owner should always be aware of his or her options. Committing to one buyer too early could come at a considerable loss.

Determining the exit strategy is obviously an important decision that will affect the deal structure that a seller is willing to accept. If the seller is satisfied with the valuation and strategy to get the most for the company, the following will help determine an exit strategy.

• Formulating the deal structure that will be acceptable to the owner is a major step in determining the exit strategy. While the deal structure may be amended as negotiations begin, it is critical for the buyer and the seller to know what the owner is willing to accept. The deal structure is defined by how the owners and/or shareholders will be paid. Determining the structure depends several factors including:
• Market conditions and what other sellers are being paid for their businesses.
• The selling company’s current financial condition.
• Whether or not the owners and/or key employees will be involved in the business post acquisition.

Determining the deal structure is often when transactions fall apart. As part of the negotiations it is important for both sides to be open to structuring a deal that meets the needs of other side.

Three common types of deal structures are:

• All cash deals: obviously, this means a buyer will pay 100% of the cash up front. This type of structure is usually reserved for companies with multiple buyers pursuing it and where the owners will probably not remain with the company.
• Cash plus note: Buyers will pay a portion of the sales price up front and pay the rest over a period of time with a reasonable amount of interest applied to the note, also called owner financing. With this type of deal structure, it is important for the seller to be certain that the buying company is on a good financial foundation, because the owner would become a creditor.
• Earn outs: This type of structure is typically designed for selling companies that have not reached their full potential and will continue to grow a fast pace. The structure will usually consist of some cash up front with the other portion to be paid to the owners/shareholders based on meeting or exceeding certain performance factors. This allows the owners, who usually remain with the business post-transaction, to reap the further benefits from future profits of the business.

Deal structures are often very creative to meet the demands of both buyers and sellers. Ultimately, a successful deal structure is one that is rewarding to both sides.

• Another aspect of the exit strategy is determining the role the owner is/willing to play after the deal is closed. The owners should be specific about the roles they are willing to play after the company is sold. If they do not make their desires clear, the buyers may put them in undesirable roles in the merged companies. The position will need to be one for which the owner is qualified, excited and rewarded in some way. If the position offered during negotiations is not what the owner is willing to accept, he or she can choose to
• Work with the buyer to find a position that is appropriate and acceptable for both sides,
• Work for the buyer on a consulting basis only and be compensated accordingly,
• Not sell to that particular buyer and either find another buyer or postpone the sale, or
• Exit the business after the transition and find another challenge.
• Owners should determine the exit strategy for the key employees as well. If the owner is committed to protecting certain employees, it is important to determine their specific roles prior to the completion of the transaction. Most buyers are willing to secure key employees with employment contracts and other benefits that will encourage them to be productive employees post-acquisition. Having a written strategy that can be offered to the buyer that will identify a transition period and staff additions, if necessary, will show the selling company in the most professional light.

Having a valuation completed and determining the exit strategy are major steps towards preparing for the sale of a company. The next step is just as crucial. The due diligence part of the acquisition process involves fully disclosing all of the financials to the buyer and vice versa. This disclosure is very in-depth and time-consuming. What the buyer will ask for as part of their due diligence process varies greatly in detail, but they will require some core disclosures. A savvy seller will have at least the core prepared and organized before the buyer asks. Again, preparation speeds the closing processes and reduces acquisition costs on both sides. A complete list of due diligence items would be too lengthy to list, but a few items have been listed below:

• Financial Records
• Historical financial statements for the last three years
• Federal tax returns
• Interim financials for the most recent reporting period
• Employee-Related Documents
• Organizational chart
• Copies of employee benefit plans
• Copies of employment contracts
• Legal Documents
• Copies of all insurance policies
• Articles of Incorporations, stockholder or partnership agreements
• Loan and lease agreements

• Miscellaneous
• Brochures and pricelists
• Data on customers
• Appraisal of business, property and equipment

Selling a company can be quite demanding of an owner’s time and emotions. It is important for an owner to surround him/herself with competent advisors.

• Internal Staff Members: Depending on the size of the company, an owner may choose to include one or two members of the staff to assist in gathering and preparing various documents. Involving a member of the staff in the acquisition process often can be a sensitive issue for many owners and should be consider carefully.
• Attorney: Obviously, an owner needs to choose an attorney to direct the legal proceedings involved in a transaction. Although many owners have an attorney relationship for general corporate and employee matters, it is extremely critical that the seller choose an attorney who has had experience with mergers and acquisitions that are larger than the one proposed. References should be checked and at least one face-to-face meeting should be conducted with the prospective attorney so the owners and the attorney can get comfortable with the process and each other’s personalities.

The attorney’s role in the acquisition process will be constructing and reviewing legal documents and issues, which will protect the seller against future legal claims. Some owners will choose to have an attorney handle all negotiations; however, this can be costly. Many owners choose to handle negotiations involving transaction value, employment agreements and deal structure themselves or use an intermediary who will be discussed later in this paper. The attorney will then be left to negotiate the critical issues involved in the purchase agreement and employment contracts.

• Certified Public Account: A CPA’s role in the usual acquisition process will be to advise the owner about corporate and personal/shareholder tax issues. The CPA may also assist in the preparation of financials during the due diligence procedures. It is recommended that an owner use the same CPA who has been responsible for the company’s corporate financials and tax filings. This will assist in answering questions pertaining to financial entries quickly.

An intermediary’s primary role is to find qualified buyers for a seller. An experienced intermediary will know the most effective way to approach a potential buyer and determining if he or she could be a match for the seller. Sellers may choose to use an intermediary if they are not sure of a fair market price for their business, do not have the time to devote to a sales process or need guidance on how to approach a buyer. Intermediaries are generally able to generate more interest from buyers, which usually leads to a higher price.

Typically, all intermediaries offer the following services:

• Identify a list of buyers
• Qualify whether the buyer has the capacity to acquire the selling business
• Advise the seller on a selling price
• Create an auction process if appropriate
• Advise the seller on the process of selling a business
• Refer other professionals such as attorneys or CPAs, to assist the seller
• Assist in maintaining the relationship between the buyer and seller. During the due diligence process and in negotiations, tensions can rise between a buyer and seller that can lead to one side walking away.

Not all intermediaries offer the same services. It is important to choose an intermediary whose sole occupation is the management of buying and selling businesses. In today’s competitive environment, there are many part-time brokers who divide their time between selling real estate and selling businesses. The complexity of mergers and acquisitions take a staff of experts to guide a seller through the maze of legal, financial, emotional and strategic hurdles to complete a successful transaction. It is in the seller’s and the buyer’s best interest to find an intermediary who is experienced in and devoted to the particular field of the selling company.

Intermediaries can be divided into two groups, investment bankers and brokers. The characteristics of each can be confusing and misleading.

• Investment bankers:

• Usually, investment bankers will either specialize in a certain industry or have individuals within the firm who are specialized. It is important for a seller to find a firm that has indepth experience in his or her industry. Because of this specialization, investment bankers have a clear understanding of what businesses are worth, what the market conditions are and an idea of what the stage the M& A cycle is in for that industry. This also allows the transaction to move more quickly because the intermediary will not have a steep learning curve in regards to the industry.

• Investment bankers will usually take the selling company directly to potential buyers rather than broadcasting or advertising for the sale of the company. Broadcasting will usually make the seller’s competitors and/or clients aware the business is for sale, which is usually detrimental to the company.
• Investment bankers will manage the entire acquisition process from assisting with developing an exit strategy to managing the due diligence to negotiating the final terms of the deal. They will also assist the owner and key employees in negotiating employment agreements.
• Investment bankers usually charge a higher fee for M&A management services, but in the current competitive investment banking market, these fees have decrease significantly.
• Investment banks are regulated and have to adhere to certain standards of practice.
• Brokers:
• Brokers are not usually industry-specific and will have to broadcast or advertise for buyers for the selling company.
• Brokers usually will have experience selling smaller businesses only.
• A broker’s fees will generally be the same to slightly less than an investment banker’s fees.
• Brokers will usually not participate in the negotiation process, leaving that aspect up to the attorneys, which could drive up the cost for the seller.
• Brokers are unregulated, so they have latitude in how they conduct their businesses.

The anatomy of selling a business can be quite complex. It is emotional for the seller who has worked so hard to build the business into a thriving entity. Owners are challenged to be diligent and thoughtful throughout the process, yet still manage their business as if there is no option of selling. Too often, sellers become frustrated and settle for the potential buyer’s offer, leaving money on the table or missing the peak of the M&A cycle. It is often helpful for an owner to talk to others who have sold their business and learn where the pitfalls were. Most importantly it is crucial to have a thorough understanding of the factors are involved in selling a business. If a seller understands the process, prepares for it and is proactive, the experience can be one of the most rewarding of a business career.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.