What a Buyer May Really Be Looking At

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Buyers, as part of their due diligence, usually employ accountants to check the numbers and attorneys to both look at legal issues and draft or review documents. Buyers may also bring in other professionals to look at the business’ operations. The prudent buyer is also looking behind the scenes to make sure there are not any “skeletons in the closet.” It makes sense for a seller to be just as prudent. Knowing what the prudent buyer may be checking can be a big help. A business intermediary professional is a good person to help a seller look at these issues. They are very familiar with what buyers are looking for when considering a company to purchase.

Here are some examples of things that a prudent buyer will be checking:

Finance

Is the business taking all of the trade discounts available or is it late in paying its bills? This could indicate poor cash management policies.
Checking the gross margins for the past several years might indicate a lack of control, price erosion or several other deficiencies.
Has the business used all of its bank credit lines? Does the bank or any creditor have the company on any kind of credit watch?
Does the company have monthly financial statements? Are the annual financials prepared on a timely basis?
Management

Is the owner constantly interrupted by telephone calls or demands that require immediate attention? This may indicate a business in crisis.
Has the business experienced a lot of management turnover over the past few years?
If there are any employees working in the business, do they take pride in what they do and in the business itself?
Manufacturing

What is the inventory turnover? Does the company have too many suppliers?
Is the business in a stagnant or dying market, and can it shift gears rapidly to make changes or enter new markets?
Marketing

Is the business introducing new products or services?
Is the business experiencing loss of market share, especially compared to the competition? Price increases may increase dollar sales, but the real measure is unit sales.
When business owners consider selling, it will pay big dividends for them to consider the areas listed above and make whatever changes are appropriate to deal with them. It makes good business sense to not only review them, but also to resolve as many of the issues outlined above as possible.

Business Valuations

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When the owners of private businesses in Orange County finally make the decision to sell their business, the first question on their mind is “what is the value of the business” when it goes to market.  Reality is that the market place will determine the actual value of the business.   It is not a perfect market and five different buyers will bring five different offers as  each buyer will assess the risk associated with future earnings differently.  The predictability of earnings going forward is critical to the valuation of the business but the certainty of the forward looking earnings is subject to risk.  The buyer will consider each of the following aspects of the business to determine the risk;

1.  Business Model

2.  Uniqueness in the market

3.  Products/Costs

4.  Competition in market and reputation of business

5.  Management in place and their strengths

6.  Gross Profit Margins

7.  Operation Strengths and Weaknesses

8.  Location

9.  Asset Strengths

10.  Customer Concentation

11.  Barriers to entry

12.  Intangible Assets

13.  Size of business.  Size does matter

14.  Financial Performance (past and projected)

 

These issues contribute to a company’s risk profile  which will impact the multiplier of pre-tax earnings  used to determine value.

Ultimately a buyer looks at valuing a business based upon “return on investment”  (ROI).  A buyer looks at the value of a business by determining a reasonable rate of return based upon the risk.  Buyers looking for a low risk  might be happy with a 5%-10% ROI.  Buyers with a higher risk tolerance might go for 30%-50% ROI because of the risk involved.  Privately held companies would generally be considered in the middle to high risk part of the scale. Expected annual returns for these acquisitions would be in the 15%-30% range.  Valuation if determined by dividing the expected rate of return by 100%.  For example, if a buyer wants a 20% return, then the multiple will be 5. (100% /20%=5).  The multiplier times the recast profits equal enterprise value for the business.   Why so some businesses have a value based on a multiple of 2 or 3 while other businesses have much higher multiples (5-6 ).  Low multiples may apply when a buyer is buying a job.  Much higher multiples apply to larger companies with much lower risk, proprietary products or processes, intangible assets no reflected on the  Balance Sheet or increasing earnings.

Empire Business Solutions offers a free Broker Opinion of  Value for owners who want to look at selling their business in Orange County.

 

A “Pig in a Poke"

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Once a buyer has negotiated a deal and secured the necessary financing, he or she is ready for the due diligence phase of the sale. The serious buyer will have retained an accounting firm to verify inventory, accounts receivable and payables; and retained a law firm to deal with the legalities of the sale. What’s left for the buyer to do is to make sure that there are no “skeletons in the closet,” so he or she is not buying the proverbial “pig in a poke.”

The four main areas of concern are: business’ finances, management, buyer’s finances, and marketing. Buyers are usually at a disadvantage as they may not know the real reason the business is for sale. This is especially true for buyers purchasing a business in an industry they are not familiar with. The seller, because of his or her experience in a specific industry, has probably developed a “sixth sense” of when the business has peaked or is “heading south.” The buyer has to perform the due diligence necessary to smoke out the real reasons for sale.

Business’ Finances: The following areas should be investigated thoroughly. Does the firm have good cash management? Do they have solid banking relations? Are the financial statements current? Are they audited? Is the company profitable? How do the expenses compare to industry benchmarks?

Management: For a good quick read on management, the buyer should observe if management is constantly interrupted by emergency telephone calls or requests for immediate decisions by subordinates? Is there a lot of change or turn-over in key positions? On the other hand, no change in senior management may indicate stagnation. Are the employees upbeat and positive?

Buyer’s Finances: Buyers should make sure that the “money is there.” Too many sellers take for granted that the buyer has the necessary backing. Sellers have a perfect right to ask the buyer to “show me the money.”

Marketing: Price increases may increase dollar sales, but the real key is unit sales. How does the business stack up against the competition? Market share is important. Does the firm have new products being introduced on a regular basis.

By doing one’s homework and asking for the right information – and then verifying it, buying a “pig in the poke” can be avoided.

The Pre-Sale Business Tune-Up For Selling Your Business in Orange County

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Owners are often asked, “do you think you will ever sell your business?” The answer varies from, “when I can get my price” to “never” to “I don’t really know” to everything in between. Most sellers may think to themselves when asked this question, “I’ll sell when the time is right.” Obviously, misfortune can force the decision to sell. Despite the questions, most business owners just go merrily along their way conducting business as usual. They seem to believe in the old expression that basically states, “it is a good idea to sell your horse before it dies.”

Four Ways to Leave Your Business

There are really only four ways to leave your business. (1) Transfer ownership to your children or other family members. Unfortunately, many children do not want to become involved in the family business, or may not have the capability to operate it successfully. (2) Sell the business to an employee or key manager. Usually, they don’t have enough cash, or interest, to purchase the business. And, like offspring, they may not be able to manage the entire business. (3) Selling the business to an outsider is always a possibility. Get the highest price and the most cash possible and go on your way. (4) Liquidate the business – this is usually the worst option and the last resort.

When to Start Working on Your Exit Plan

There is another old adage that says, “you should start planning to exit the business the day you start it or buy it.” You certainly don’t want to plan on misfortune, but it’s never to early to plan on how to leave the business. If you have no children or other relative that has any interest in going into the business, your options are now down to three. Most small and mid-size businesses don’t have the management depth that would provide a successor. Furthermore liquidating doesn’t seem attractive. That leaves attempting to find an outsider to purchase the business as the exit plan.

The time to plan for succession is indeed, the day you begin operations. You can’t predict misfortune, but you can plan for it. Unfortunately, most sellers wait until they wake up one morning, don’t want to go to their business, drive around the block several times, working up the courage to begin the day. It is often called “burn-out” and if it is an on-going problem, it probably means it’s time to exit. Other reasons for wanting to leave is that they face family pressure to start “taking it easy” or to move closer to the grandkids.

Every business owner wants as much money as possible when the decision to sell is made. If you haven’t even thought of exiting your business, or selling it, now is the time to begin a pre-exit or pre-sale strategy.

Top Businesses for Sale

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Here is a list compiled by a leading businesses for sale website.

Top Ten Businesses for December 2013:

  1.  E-Commerce
  2. Convenience Stores
  3. Restaurants
  4. Fast Food – Non Franchises
  5. Websites
  6.  Bars
  7.  Auto Repair, Service & Parts
  8. Services
  9. Liquor Stores/Off Licences/Wine Merchants
  10. Gas/Petrol Service Stations

Top Ten M&A Businesses for December 2013:

  1. Distribution Businesses
  2. Wholesale Businesses
  3. Mining Businesses
  4. Auto Repair, Service & Parts
  5. Manufacturing Businesses
  6. Car Wash & Valet                         
  7. Food & Drink Distributors
  8. Food & Drink Wholesalers
  9. Transport Services
  10. Road Haulage & Freight Services

Considering Selling Your Business? Some Things to Consider

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  • Know the value of your business.   Don’t even think about selling until you know what your business should sell for.  Get a formal Valuation or, at minimum, a Broker Opinion of Value.  Call us to explain.
  • Get prepare to sell.  Have your financials properly prepared.  There is an often-quoted statement in the business world: “The time to prepare your business to sell is the day you buy it or start it.” Easy to say, but very seldom adhered to. Now really is the time to think about the day you will sell and to prepare for that day.
  • Sell your business when it is growing and it is doing well. The old quote: “The time to sell your business is when it is doing well” should also be adhered to. It very seldom is – most sellers wait until things are not going well.
  • Consult with your Tax guy.   Ask your accountant about the tax impact of selling your business. Do this on an annual basis just in case. However, the tax impact is only one area to consider and a sale should not be predicated on this issue alone.
  • Maintain or continue growing the business.   Continuing to manage the business is a full-time job. Retaining the best outside professionals is almost a must. Utilizing a professional business intermediary will allow you to spend most of your time running your business.
  • Finally, in the words of many sage experts, “Keep it simple.” Don’t let what looks like a complicated deal go by the boards. Have your outside professionals ready at hand to see if it is really as complicated as it may look.

Can You Really Afford to Sell?

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In many cases, the sale of a small company is “event” driven. That is, the reason for sale is often an event such as a health decline or illness, divorce, partnership issues, or even a decline in business.

A much more difficult reason for selling is one in which the owners simply want to retire and live happily ever after. Here is the problem:

Suppose the owners have a very prosperous distribution business. They each draw about $200,000 annually from the business plus cars and other benefits. If the company sold for $2 million, let’s say after debt, taxes and closing expenses, the net proceeds would be $1.5 million. Sounds good, until you realize that the net proceeds only represent about 3 1/2 years of income for each (and that doesn’t include the cars, health insurance, etc.). Then what?

The above scenario is not atypical, especially in small companies. These are solid companies that provide a very comfortable living for two owners. In the above example, the owners obviously decided they couldn’t sell because it didn’t make economic sense to them. The business was worth much more to the owners than to any outside buyer. Perhaps they thought that an intermediary could produce a buyer who would be willing to pay far more than the business was worth. But, the M&A market is a fairly efficient one.

So, what should they do?

The downside is that competition could enter the fray and their business would not bring in the same cash flow.

The business could also suffer because the owners are not continuing to build it. They apparently want to retire and take life easy, and this mind-set could dramatically undermine the business.

If the owners are forced to sell the business because it is declining, they, most likely, won’t even receive the $2 million they might have received earlier.

On the other hand, the owners, ready to begin their happily ever after, could bring in a professional manager. This addition would cut their earnings slightly to pay for the new manager, but it would also reduce their responsibilities and give the business a chance to grow with new energy and ideas.

 

More Information Suggesting It Is Time to Sell Business Orange County

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Several surveys indicated that Private Equity activity is slow but the lower middle market and main street is picking up steam, particularly to sell business in  Orange County.

Overall small-business performance has continued to improve.  According to a recent study, median revenue jumped to $420,000 in the third quarter of 2013 from $385,327 in the same period in 2012, showing an 8.9 percent increase. Cash flow increased to $98,034 from $93,000 in the second quarter of 2012–a solid 5.4 percent quarter-over-quarter and a 3.4 percent year-over-year from $94,880 in the third quarter of 2012.

Expectations of sellers are growing also.  Asking prices from business on the market has increased: The median asking price for businesses sold in the third quarter bumped up 2.1 percent to $199,000 and the median sale price rose 2.9 percent from Q2 to $180,000.

From our perspective, we are seeing sellers warm to the idea of putting their business on the market due to the performance increases they are experiencing.  Clients  who wanted to retire but felt like they missed the boat are absolutely seeing their businesses come back to the point where feel comfortable in selling.

Surprises CEOs Face When Selling Their Companies

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Surprise #1: Substantial Time Commitment

In the real estate business, once the owner engages the broker there is very little for the owner to do until the broker presents the various offers from the potential buyers.  In the M&A business, there is a substantial time commitment required of the CEO/Owner in order to complete the sale properly, professionally and thoroughly. The following examples are worth noting:

Offering Memorandum:

This 30 + page document is the cornerstone of the selling process because most business intermediaries expect the potential acquirers to submit their initial price range based on the information presented in this memorandum.  The intermediary will heavily depend on the CEO/Owner to supply him or her with all the necessary facts.

Suggestions of Potential Acquirers:

Chances are that the sales manager is the only person who knows the best companies to contact and those not to contact (competitors).  Arguably, this information should be mostly supplied by the intermediary, but as a thorough team effort, the CEO/Owner should play a major role in this endeavor.

Management Presentations:

Assuming the intermediary conducts the normal process of boiling down the bidders to 4 or 5 potential acquirers, it is then customary to have management presentations before the final bids are submitted.  In order to help extract the best offers, it is advisable that the CEO show the benefits of combining the acquirer and seller and/or the future upside for the selling company.

Surprise #2: The Need to Enjoin Other Employees in the Process

A number of owners selling their company are paranoid about a confidentiality leak regarding the sale of their company.  In fact, some owners prefer that no other person in the organization is aware of the pending sale of the company.  At a bare minimum, the CFO and Sales Manager should be informed.  The CFO will be asked to pull all the financials together, to supply projections, to articulate reconstructed earnings (add-backs) and to supply monthly statements…all of which suggest that the company is being sold.  The Sales Manager will be asked to supply the names of synergistic companies in or around the particular industry.  And, perhaps, the CEO’s secretary will be asked to set up a “war room” where all legal and contractual information is assembled for the buyer’s due diligence team.  In order to protect the company from confidentiality leaks and assure retention of key employees, the CEO/Owner should implement “stay agreements” for these key employees.

Surprise #3: The Need to Maintain, or Accelerate, Sales

The tendency for some owners is to become so distracted with the M&A process that they take their “eye off the ball” in running the business on a daily basis.  Potential acquirers will be watching the monthly sales reports like a hawk to see if there is a turn-down in business.  Acquirers become very apprehensive when they see a recent downward trend in the company they are about to acquire and may, as a result, want to negotiate a lower price.

Surprise #4: A Confidentiality Leak

Naturally, most CEOs expect the M&A process to go smoothly and usually it does.  However, there should be a contingency plan in place for such occurrences as confidentiality leaks.  The degree of damage determines what action should be implemented.  On one occasion the draft of the Offering Memorandum was e-mailed to the CEO/Owner for his corrections; however, the sender from the brokerage firm used one incorrect letter in the CEO’s e-mail address.  As a result of this misstep, the e-mail was rejected by the CEO’s computer and ended up in the company’s general mailbox which was administered by the employee in charge of IT.  The employee was told by the quick-thinking CEO that the Offering Memorandum was being used to raise growth capital.  Luckily, the incident went no further.  Much more serious confidentiality leaks can occur, and it is wise to discuss ahead of time how the matter is going to be handled with those concerned.

Surprise #5: Unexpected Low Bids

Ultimately, the M&A market sets the price of the company. However, rarely does a seller go to market without having certain expectations of price.  Let’s use a hypothetical case in which a company is growing at 15% annually.  The CEO/Owner believes that it is worth $6 million based on $1 million of EBITDA.  However, the top bid is $5 million cash or, obviously, 5 times EBITDA.  Assuming the business intermediary has exhausted the universe of acquirers, the seller has two choices to reach his desired $6 million selling price.  Either he can take the company off the market and return several years later when either the company’s earnings have improved or when the M&A market has heated up.  Alternatively, the CEO can negotiate further with the top bidder by selling 80% of the company now and the remaining 20% in three years on a pre-arranged formula on the expectation that business will improve.  Or, the CEO can sell the company now for $5 million with an earnout formula that might give him the additional $1 million.

Surprise #6: The P&S Agreement is Not What the CEO Expected

Numerous CEOs drive the M&A process to the letter of intent and then turn over the deal to their attorney to iron out the details of the purchase and sale agreement.  While the CEO should not micro-manage his designated professional advisors in the transaction, he should be involved throughout the process, or otherwise the CEO will invariably object to the final wording of the document at the signing state.  The area most likely to be overlooked by the CEO/Owner is the critical section of reps and warranties.

Surprise #7: Agreement of Other Stakeholders

While the CEO can negotiate the entire transaction, the sale is not authorized until certain stakeholders agree in writing, namely the Board of Directors, majority of the shareholders, financial institutions which have a lien on certain assets, etc.

Conclusion

For many CEOs, selling their company is a once in a lifetime experience.  They may be very experienced, very talented executives, but they can also be blind sided by surprises when selling their company.

Business Sales Activities

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Recent reports from the leading business-for-sale websites indicate significant increases in sales transactions.  These seem to be primarily in Main Street businesses as other reports from M&A portals are telling us the deals are very slow.  Two very different scenarios seem to indicate the lower market is moving but Private Equity is stalled.  My personal experience in closing deals validates the activity at the Main Street level.  Also another indication of this activity is the number of sellers now considering selling whereas previously they were sitting on the sidelines waiting for their business to return to normal valuations.  If you are interested in selling your business, please contact me for a free Broker Opinion of Value (BOV).