Selling your business is one of the most important decisions that you, as a business owner, will ever make. A recent survey by M&A Today discovered that 85% of business owners have no exit strategy, yet 75% have their net worth tied up in their business. For many business owners, a business sale is uncharted territory, however, if you are interested in a business sale at some point in the future, it is critical that you keep this intention conscious, and begin to integrate it within your business goals. 

For example, if your planning a sale and decide to research potential purchasers as a business goal, your research may indicate that in order to make yourself attractive to a large player in your industry, you should look at buying companies - competitors, suppliers or customers – to increase revenue and take advantage of economies of scale in your cost structure to increase earnings. This conclusion may in turn set up an important new business strategy and a multi-year plan leading to a more fruitful exit.

Other specialized exit strategies that require some forward thinking in order to execute are selling your business to existing management, an initial public offering, recapitalizations, ownership transition plans and succession plans. However, since selling a company is the most common exit strategy, I've simplified the process into five basic steps outlined below.

Retaining a Financial Advisor

Once the decision is made to sell your business, the first step is to retain a financial advisor. There are three types of financial M&A advisors:

• Low end: specializing in private company transactions with values in $1 to $2 million range typically serviced by business brokers.
• High end: specializing in public and private company transactions with values starting at $50 million, dominated by investment banks, particularly for public company transactions.
• Middle market: specializing in mostly private company transactions with values falling in the range of $2 million up to $50 million serviced by a variety of intermediaries with varying expertise and specialization.

Following the execution of a retainer letter with your financial advisor, the advisor should help “dress up” the company, confirm a value range for the business, and write an information memorandum to be used in marketing the business to potential buyers.

Dressing Up Your Company For Sale

Large companies that pay premium prices for smaller businesses prefer companies that are “clean” with demonstrable operating histories and minimum extraneous issues. It is important to begin to look at your business holistically from the eyes of a purchaser, and groom your company prior to the sale process to ensure when a sale is made, it's made for the most attractive price, under the most attractive terms. I recommend a detailed financial and operational review as a starting point.

An operational review should include a detailed assessment of the important operational aspects that purchasers will be concerned with. Key areas to focus on will be:

• Equipment and machinery needing repair or replacement
• Information systems – ensuring the capability for timely and useful management information such as accounting and budgeting
• Management structure – ensuring a capable management team interested in continuing with the company after the sale
• Corporate housekeeping – focusing on such things as contingent liabilities, ensuring corporate records are well organized, insurance policies in place, IP properly documented.

After a detailed review of your business, your financial advisor should suggest remedial action in any number of areas, some of which I've previously discussed. It's important to interrogate reality voraciously, and deal with any weaknesses up front. Be sure that purchasers will uncover issues during their due diligence, and attempt to use them to negotiate the purchase price. It is important to note that weaknesses can be turned into strengths if you as the vendor can prove that the deficiency offers up front opportunity.

Establishing a Pricing Strategy

Advisors need a clear understanding of the exit objectives of the vendor in order to navigate effectively through the negotiation process. It is important to establish a minimum acceptable price, and it is equally important to keep the price objectives within an overall context of other important objectives such as representations and warrantees you're prepared to offer, the form of consideration your are prepared to accept (all cash, all stock, partial cash and stock, vendor take-back, earn-out), and your time commitment subsequent to the transfer of ownership.

With respect to negotiations, depending on the specific circumstances of the vendor, the price may or may not be disclosed. If demand for the company is high, your advisor should be working toward an auction, and the asking price should not be disclosed. Conversely, if there are limited bidders or internal problems, you may have no choice but to disclose your offered price. In more likely scenarios, where a purchaser approaches the vendor, or if there are two bidders for the business, I recommend letting the purchaser first table an offering price (or range of value) and negotiate from this point or range.

Valuation Process

When business owners begin thinking about selling companies, the first question is usually: how much is my company worth? With respect to the valuation of the selling company, buyers use different techniques to establish a range within which to negotiate. It is important to understand that valuation is theoretical and often subjective, so it is of the upmost importance to create a negotiating strategy that maximizes value based on logic and is supported by the best possible facts. There are many ways to approach valuation, however the two most common are 1) applying a multiple to the normalized earnings of your company; and 2) capitalizing your future cash flows.

Earnings Multiple Valuations

With respect to the earnings multiple approach, the first step is to define your historic and projected profits adjusted for abnormal or non-recurring items. Then you must consider which multiple is most appropriate to arrive at an overall value for your business. The multiples commonly used are:

• Price earnings multiple (p/e) ratio – provides an approximate value picture, and a great rule of thumb for considering the number of years required to reach pay-back on the purchase price (the p/e multiple equals the number of years), however, its primary drawbacks are that it doesn't take into consideration a company's cost of debt, it's particular tax situation, or any non-cash charges such as depreciation and amortization.
• Earnings Before Interest and Tax (EBIT) – provides a measure of the operating profit of your business before considering cost of debt and income tax. It provides a clearer earnings picture than the p/e ratio and defines intrinsic value more accurately.
• Earnings Before Interest, Tax, Depreciation and Amortization (EBITDA) - provides the cleanest earning picture, since in addition to extracting the effects of taxes and debt servicing on earnings, it neutralizes the effects of other non-cash charges - depreciation and amortization. There is an assumption that depreciation typically nets out capital expenditures over time, but our experience is that it may not be the case depending on the capital expenditure profile of business. Important to consider, investment industry sage Warren Buffett uses EBITDA for his valuation analysis, then makes his own adjustments for capital expenditures to get a clear picture of cash flow.

The actual multiple chosen to arrive at a value is typically determined by some combination of comparable transactions in the industry, and multiples applied to public companies in the same or similar sector with an appropriate discount for liquidity (public company multiples would obviously be higher since the ability for an investor to sell her position in company at any time is an attractive reduction of risk). The extent to which the public market multiple is discounted will vary between 20% and 50% and depend on the particular strengths of your business such as your growth rate, market share, degree to which your profit margins exceed industry averages, your management team and your strategic importance to the buyer.

Discounted Cash Flow Valuations

This valuation method takes future cash flows from your business, discounts them into today's dollars, and calculates a present value for your business. The cash flows are discounted using a discount rate , which is typically determined by the required rate of return of the prospective buyer employing capital in your business. And it stands to reason that when the owners perceive less risk, a lower discount rate is applied, yielding a higher valuation – which is why it is so important to take necessary steps to reduce the risk in the grooming process.

Buyer Identification

As the financial advisor is preparing an Information Memorandum to market your company, the next step is to identify potential buyers. A universe of potential buyers is then prepared by you and your advisor with 50 to 100 potential purchasers – eventually to be shaved down eliminating companies that aren't suitable. The list is then prioritized based on motivation and interest and can include strategic buyers, competitors, suppliers, vendors, known industry acquirers, and financial buyers who focus on industry. I believe in many cases, the best values are to be obtained from large industry consolidators where there is strategic alignment and financial synergy. The financial synergy is expressed by the purchaser eradicating duplication in cost structure (a significant percentage of the vendor's selling general and administrative costs). When this is the case, the purchaser will be buying cash flow and a higher multiple can be negotiated.

Approach Tactics

There are various tactics for creating a market for your business, and each has a nickname:

Rifle Shot: Your advisor contacts 3 to 5 very likely candidates that have expressed interest previously. These are typically buyers that want to increase market share or extend product lines. This method is best for preserving secrecy.

Shotgun: Your advisor contacts 100 plus names encompassing any business that might have a remote interest in your company. This approach is more difficult to manage, and is usually reserved for larger $50 million plus and public companies.

Full Blown Auction: This is the Shotgun approach with a strict deadline for responding. These work the best with highly attractive companies that are sure to attract multiple bidders.

Modified Auction: I believe this is the best overall approach and can work in most scenarios. Here your advisor groups the potential buyers according to their level of interest – and each group has 20 to 30 names. Your advisor then contacts each group according to it's level of priority starting with a compiled forecast of the most motivated buyers, and work down until they procure three or four real bidders. Then your advisor sets a deadline for negotiating final deal terms. This process doesn't turn off buyers, optimizes confidentiality, and keeps the process manageable.

Summary of Sale Process

A summary of the typical sales process is as follows:

Assess and Groom

After your financial advisor is retained, your company undergoes a financial and operating review by the advisor with a specific focus on strengths to be highlighted and weaknesses to be corrected and fortified in order to present your company in the best possible light.

Prepare Information Memorandum

This is the principal selling document that will outline the benefits of your company. Its purpose is to articulate the key selling points of the business, present the company in best possible light (often without your company name). Commercially sensitive information is withheld.

Identify Buyers

Create a detailed list of potential buyers including strategic, vertical (competitors), horizontal (suppliers or vendors), and financial if appropriate. Your advisor will typically send an anonymous executive summary as a first step toward creating interest to generate a competitive bidding environment.

Make confidential approach

Once interest is determined, prospective buyers are qualified by phone, and sign a confidentiality agreement before receiving a detailed information memorandum.

Seek indicative and revised offers Your advisor guides the interested parties to your preferred structure, creates a short list of prospective buyers,and with you, attends necessary meetings with the aim of moving the process along to generate multiple offers.

Exclusivity and contracts

The best offer is chosen, and exclusivity often granted for a finite time period to begin financial and legal due diligence. Either during the due diligence process, or after it is substantively complete, the formal legal documents are drafted – including the purchase and sale agreement, ancillary documents relative to service contracts, financing etc. and the transaction is finanalized.

Through my experience in merchant banking and entrepreneurial ventures, I have significant expertise in the middle market defined as private companies with values ranging between $2 million and $100 million. If you're planning to sell your business within the next five years, I recommend you seek advice now.

I can help plan the process early, discover any issues that might impact your valuation, recommend ways to further your price objective, and ensure that you begin to groom your company for presentation in the best light possible. My goal is typically to create an auction of multiple bidders which is your best opportunity for the highest return. As a skilled M&A tactician, I inject the right amount of cajoling, tension and spirited competition to create the most fertile ground in order that you achieve the best possible price, on the best possible terms.

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