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).

Company Weaknesses

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Take two seemingly identical companies with very similar financials, but one of the companies was worth substantially more than the other company.  One company will sell for $10 million “as is†or some changes can be made and the same company can be sold for $15 million. Following is a partial list of potential company weaknesses to consider in order to assess a company’s vulnerability.

Customer Concentration:  First, one has to analyze the situation.  The U.S. Government might be considered one customer but from ten different purchasing agents.  Or, GM might have one purchasing agent but be directed to ten different plants.  One office product manufacturer with $20 million in sales had 75% of its business with one customer…Staples.  They had three choices: 1. Cross their fingers and remain the same; 2. Acquire another company with a different customer base; or 3. Sell out to another company.  They selected the third choice and took their chips off the table.  The acquirer was a $125 million competitor which was unable to sell to Staples, so after absorbing the smaller company, the customer concentration to Staples was only about 10% ($125m + $20m=$145m of which $15 million was sold to Staples or 10+%).

Single Product: Perhaps the most famous example of a single product acquisition is when General Motors overtook Ford’s single product, the Model A, with Alfred Sloan’s brilliant concept of a different model for people with different financial thresholds.  Henry Ford’s stubbornness to stay with one product (Model A) almost cost the company its existence.

Regional Sales/Limited Marketing:  Companies with parochial focus have limited capabilities to grow other than within their own domain.  A widget company with national and international sales has substantially greater prospects to grow than one limited to its own region.

Aging Workforce/Decaying Culture:  Skilled workers in certain trades, such as tool and die shops, are not being replaced by the younger generation.  This is a sign that the next generation will not provide the companies with a skilled workforce in certain industries.

Declining Industry:  Some companies are agile enough to completely change their industry, such as Warren Buffet’s Berkshire Hathaway and Fashion Neckwear Company which completely changed from neckties to polo shirts.

Pricing Constraints/Rising Costs: Companies who sell a commodity product often lack pricing elasticity and are unable to pass on their increased costs to their customers.  For a while, the steel industry was in this predicament, but through massive industry consolidation and a booming demand from China, the situation changed.

CEO Dependency/No Succession Plan: Many middle market companies have successfully been built up by the founder/entrepreneur/owner and some critics call these individuals a “one-man-band†for good reason.  These superman types tend to dominate most aspects of the company, but this is no way to build a sustainable business long term.  Furthermore, these CEOs usually have not created a succession plan.

Maximizing Value

If the owners of a company, many of whom may be outsiders, want to increase the value of their investment, they should, through the Board of Directors, try to overcome the company’s weaknesses.  On the other hand, the CEO may not be either capable or motivated to do so.  The alternative is to implement a CEO succession plan, preferably with the cooperation of the current CEO.  Kenneth Freeman’s thesis in “The CEO’s Real Legacy†(Harvard Business Review, Nov 2004) is that the CEO’s real legacy is implementing a succession plan.

Freeman advises:

“Your true legacy as a CEO is what happens to the company after you leave the corner office.

“Begin early, look first inside your company for exceptional talent, see that candidates gain experience in all aspects of the business, help them develop the skills they’ll need in the top job…

“During good times, most boards simply don’t want to talk about CEO succession…During bad times when the board is ready to fire the CEO, it’s too late to talk about a plan for smoothly passing the baton…Succession planning is one of the best ways for you to ensure the long-term health of your company.â€

Both buyers and sellers should assess the company’s weaknesses.  While some weaknesses are difficult to overcome, especially in the short term, one potential weakness that is very easy to overcome is to implement a succession plan…especially during the company’s good times before things go bad and it’s too late.

First Half Results are In

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In an effort to keep you up to date on the state of the market for buying and selling a business in Orange County or the rest of the county , I am sharing information from a couple of reports which give us an interesting insight to the market.   Bizbuysell, a prominent website for listing businesses for sale, reports a significant spike in small business sales for the second straight quarter.  Forbes reports Private Companies forecast strong revenue growth.  Axial (which tracks larger enterprise value transactions)  forecasts for the balance 2013  are very optimistic.  In my opinion, this tells us the climate for selling or buying a business has improved and is moving in the right direction.

Buying or Selling a Business: The External View

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There is the oft-told story about Ray Kroc, the founder of McDonalds. Before he approached the McDonald brothers at their California hamburger restaurant, he spent quite a few days sitting in his car watching the business. Only when he was convinced that the business and the concept worked, did he make an offer that the brothers could not refuse. The rest, as they say, is history.

The point, however, for both buyer and seller, is that it is important for both to sit across the proverbial street and watch the business. Buyers will get a lot of important information. For example, the buyer will learn about the customer base. How many customers does the business serve? How often? When are customers served? What is the make-up of the customer base? What are the busy days and times?

The owner, as well, can sometimes gain new insights on his or her business by taking a look at the business from the perspective of a potential seller, by taking an “across the street look.â€

Both owners and potential buyers can learn about the customer service, etc., by having a family member or close friend patronize the business.

Interestingly, these methods are now being used by business owners, franchisors and others. When used by these people, they are called mystery shoppers. They are increasingly being used by franchisors to check their franchisees on customer service and other operations of the business. Potential sellers might also want to have this service performed prior to putting their business up for sale.

 

What Would Your Business Sell For?

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There is the old anecdote about the immigrant who opened his own business in the United States. Like many small business owners, he had his own bookkeeping system. He kept his accounts payable in a cigar box on the left side of his cash register, his daily receipts – cash and credit card receipts – in the cash register, and his invoices and paid bills in a cigar box on the right side of his cash register.

When his youngest son graduated as a CPA, he was appalled by his father’s primitive bookkeeping system. “I don’t know how you can run a business that way,†his son said. “How do you know what your profits are?â€

“Well, son,†the father replied, “when I came to this country, I had nothing but the clothes I was wearing. Today, your brother is a doctor, your sister is a lawyer, and you are an accountant. Your mother and I have a nice car, a city house and a place at the beach. We have a good business and everything is paid for. Add that all together, subtract the clothes, and there’s your profit.â€

A commonly accepted method to price a small business is to use Seller’s Discretionary Earnings (SDE). The International Business Brokers Association (IBBA) defines SDE as follows:

Discretionary Earnings – The earnings of a business enterprise prior to the following items:

  • income taxes

  • nonrecurring income and expenses

  • non-operating income and expenses

  • depreciation and amortization

  • interest expense or income

  • owner’s total compensation for one owner/operator, after adjusting the total compensation of all other owners to market value

Here are some terms as defined by the IBBA:

  • Owner’s salary – The salary or wages paid to the owner, including related payroll tax burden.

  • Owner’s total compensation – Total of owner’s salary and perquisites.

  • Perquisites – Expenses incurred at the discretion of the owner which are unnecessary to the continued operation of the business.

Developing a Multiplier

Once the SDE has been calculated, a multiplier has to be developed. The following (just as a guideline) should be rated from 0 to 5 with 5 being the highest. For example, if the business is a highly desirable business in the current market, “desirability†would be rated a 4 or 5. If the business is in an industry that is quickly declining or nearly obsolete, “industry†would be given a 0 or 1 rating.

Age: Number of years the seller has owned and operated the business.

  • Terms: Is the seller willing to offer terms?  For example, will the seller accept 40 percent as a down payment with the seller carrying back 60 percent at terms the business can afford while still providing a living for the buyer?
  • Competition: Consider the local market.
  • Risk: Is the business itself risky?
  • Growth trend of the business: Is it up or down?
  • Location/Facilities
  • Desirability: How popular is the business in the current market?
  • Industry: Is the industry itself declining or growing?
  • Type of business: Is the business type easily duplicated?

The average business sells for about 1.8 to 2.5. Obviously, if the SDE is solid and the multiple is above average, the price will be higher. Keep in mind that the price outlined includes all of the assets including fixtures and equipment, goodwill, etc. It does not include real estate or saleable inventory. The price determined above assumes that the business will be delivered to the buyer free and clear of any debt.

Veteran Wisdom

When all else fails, the words of a veteran business broker will work.

Asking Price is what the seller wants.

Selling Price is what the seller gets.

Fair Market Value is the highest price the buyer is willing to pay and the lowest price the seller is willing to accept.

Sellers should keep in mind that the actual price of a small business is about 80 percent of the seller’s asking price.

 

Burnout: One of the Top Reasons for Selling a Business

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Burnout is one of the main reasons mentioned by owners selling his or her business. Potential buyers may have trouble accepting this as a valid reason for sale. However, burnout is a valid reason for selling one’s business.

A business owner can experience burnout even with a business that’s successful and growing. Many independent business owners feel they’ve worked hard, made their money, and now is a good time to cash out and move on, before burnout endangers the health of the business.

The following warning signs should remind a business owner that cashing out beats burning out:

You are overwhelmed on a daily basis.

When a business owner is a one-man show, even small tasks and minor decisions can seem bigger than Mount Everest. These owners have been shouldering the burden alone for too long, and the isolation has taken its toll.

You sense a failure of imagination.

Burnt-out owners are so close to their work that they lose perspective. Prioritizing becomes a major daily challenge, and problem solving sometimes goes no further than the application of business Band-Aids that cost money in the long run rather than increasing profits.

The fun is gone.

Although owning a business is hard work, it should also provide a good measure of enjoyment. When the work day begins with dread or boredom, the owner probably needs a change of scenery and a new challenge.

You are simply worn out.

Being “just too tired†is a complaint heard just as often from the owner of the successful business as from the business that’s struggling to survive. In fact, a business that is growing will create increased demands of time and energy.

No matter what the status of the operation, the sheer work of keeping a business going day after day, year after year, is enough to encourage a business owner to make a change. This kind of schedule is not for everyone; in fact, statistics show that it’s hardly for anyone on a long-term basis.

How Long Does It Take to Sell a Business?

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Recent studies indicate that it now takes, on average, about eight to ten months to sell a small business. This figure seems to increase yearly. Why does it take so long to sell a business?

Price and terms are the biggest reasons!  It is very important not to overprice the business at the beginning of the sales process. A business will also sell more quickly if there is a reasonable down payment with the seller carrying the balance.  Having all of the necessary information right from the beginning can also greatly reduce the time period.  Finally, being prepared for the information a buyer may want to review or having the answers available for the questions a buyer may want answered is another key.

Here is the basic information a prospective acquirer will want to review and a seller should have prepared to help facilitate a quicker sale:

Copies of the financials for the past three years.

A copy of the lease and any assignments of the lease from previous sales.

A list of the fixtures and equipment that will be included in the sale. Note: If something is not included in the sale, it is best to remove it from the premises prior to the sale or at least have a list that specifies which items are not included.

A copy of the franchise agreement, if applicable, or any agreements with suppliers or vendors.

Copies of any other documentation pertaining to the business.

Supporting documents for patents, copyrights, trademarks, etc.

Sales brochures, press releases, advertisements, menus or other sales materials.

In addition, here are some key questions that buyers may likely ask.  A prepared seller should have ready answers and information to support those answers.

Is the seller willing to train a new owner at no charge?

Are there any zoning or local restrictions that would impact the business?

Is there any pending litigation?

Are any license issues involved?

Are there any federal or state requirements, or environmental OSHA issues that could affect the business?

What about the employee situation? Are there key employees?

Are there any copyrights, secret recipes, mailing lists, etc?

What about major suppliers or vendors?

A prepared seller is a willing seller, and having the answers to the above items can significantly reduce the time it takes to sell a business.

Using the services of a professional business broker can also greatly reduce the time period.  Business brokers are knowledgeable about the current market, they know how to market a business, and they can advise a seller on price and terms.  They can also recommend professional advisors if a seller doesn’t have them already.  Using advisors who are transaction experienced can also shorten the time it takes to close the sale.