Selling a business is an emotional and tedious process for most people. You poured your heart and soul into your business for so many years and yet no one seems to view the value as you do. Be sure about selling because backing out in the middle of the sale process can damage your relationships with employees, customers or suppliers.
Getting all stakeholders (including your co-founders/partners/shareholders) totally committed to selling is also a difficult process. Deciding who should be on the negotiating team and how the decisions will be made can also be difficult. Our experience tells us that it is quite difficult to achieve consensus.
Finding a Market
Unlike publicly companies or real estate, private companies do not have a ready market to sell in a short period of time. Owner and his advisor must create a market through strategic thinking, research, promotion, and persuasion. It takes lot of expertise, time and effort to sell a private business.
Timing is critical. It is quite tough to sell when the economy is down or when you are under time pressure. It helps to be prepared because the window to sell at the peak period is narrow. You can also get better price and terms by making some changes in advance. It takes time to prepare for a sale and the best time to prepare is when the economy is down, and you are not under pressure. It is easier said than done. Selling a business is not like selling real estate – it is much more complicated, and deals fall apart much more than the real estate transactions. Some businesses stay on the market for more than 2-3 years and go through 2-3 different intermediaries. Thoughtfully planned, prepared, and priced business should take about 6-18 months to sell.
Can a cardio surgeon successfully perform a heart surgery without a thorough diagnosis?
Getting a professional valuation done before deciding to sell may save you lots of time, money and grief because the market may not be willing to pay what you expected. Privately held companies are valued much lower than publicly traded companies, mainly due to higher risk and lower liquidity.
There are advantages and disadvantages of using different valuation methods. Asset approach, capitalization (multiples) of historical revenue/EBITDA/EBIT/earnings/cash flow approach, and discounting future cash flow approach are most common. Selecting an appropriate multiple or discount rate is not simple and requires market insight and experience. A combination of the qualities of revenues, cash flow, customer relationships, tangible assets, brand equity, intellectual properties, employee base, channel relationships and other variables will have a significant impact on the multiples or discount rates applied in valuation.
The valuation may uncover hidden values and provide useful negotiating tools. The valuator can identify weaknesses to be improved and identify the value drivers that will maximize the sale value. The better-prepared party with more comprehensive information will have an edge over the less-prepared party in negotiation.
How much do you get to keep after tax? It helps to know what your tax position is so that you don’t sign an agreement that is disadvantageous to your net proceeds. Should you sell shares or assets? It makes a big difference. Do you qualify for the enhanced capital gains deduction? Could you “purify” your company to be eligible as a qualified small business corporation? Would it matter whether the buyer is a publicly traded company? What about the GST, Land Transfer Tax and Sales Tax, etc.? Private company transactions are heavily tax driven and a help of tax specialist is a must.
There are many legal issues that may reduce your effective sale price or net proceeds. Are there any restrictions on selling, such as shareholders’ approval or first right of refusal? Do you need to address the issues of employee benefits, employee share options and severance arrangements? Do you have any contracts that require third party consent on sale or change of control (e.g. landlord or bank)? Will there be any regulatory requirements under the Securities Act, Investment Canada Act or Competition Act? What representations and warranties are you prepared to give? All these and other legal issues will have impact on your effective sale price.
What will happen to employees after the sale? When should you tell them? What if key employees leave before the sale? Will the leak damage employee morale and customer loyalty? What are your options when a buyer requests certain employee be terminated before the closing? What are the implications?
Are there any issues that may kill the deal at the last minute? Have you reviewed your environmental, litigation, tax and product warranty obligations, etc.?
What must be done to maintain the business and what can be deferred? Will any of the capital expenditures pay off in time?
Keeping It Up
Keeping up the business while spending time on the sale process is critical. Declining sales will put a damper on selling your business and losing a major customer will kill a deal.
Would you ask your family doctor to perform a heart surgery? Choosing the right professionals to perform right tasks are critical in a successful sale. Asking a real estate broker to sell a business is like asking a pediatrician to perform a heart surgery. Asking a lawyer or accountant to sell your business is like asking neurosurgeon to perform a heart surgery. Anyone can sell a business, but the results will be vastly different. Just like a heart surgeon can’t perform a surgery alone, a professional M&A intermediary will bring in the right experts at the right time to work as a team.
How much will fine-tuning and upgrading your business increase the value? Do you have a management information system (MIS) that generates timely, accurate and useful information? Do you have an accurate costing system that tracks profitability by product line and by customer? Do you have capable managers that will stay and work with new ownership? Do you have any redundant assets that do not contribute to value? Do you need to remove shareholder payables, personal properties and non-operating payables?
Is your corporate house in order? Is your business in tip-top shape – physical appearance, information, documentation and regulatory compliance? Does your business give the impression of a well-run business? Do you have deficiencies that a buyer might use to negotiate? Could you dispose excess or obsolete inventories? Could you collect accounts receivables and keep them current? Could you lower the working capital requirement?
Recasting Financial Statements
Do your statements really reflect the true picture of the business? Statements presented according to accounting principles and tax reporting standards may not be so attractive to prospective buyers. Do you have excessive salaries, bonuses, perks and one-time expenditures etc. that should be adjusted for? Can you justify all adjustment items in your normalized statements?
Expectation & Pricing
The final price will vary depending on the number of buyers, buyer motivation, buyer type, vendor financing, earn-out, management contract, representations and warranties. Is your expectation in line with the market? What would you do if no one submits an offer that is anywhere close to your expectation?
Should you quote an asking price or not? How do you avoid over pricing or underpricing? Can you get someone to submit an offer without an asking price? What would you do if the market conditions and company circumstances change (e.g. substantial increase/decrease in sales)?
Will the auction approach be better? How do you get multiple offers to have buyers compete against each other? What if no one bids?
How much information is enough and how much is too much? What should be included in the information package – History, Industry, Market, Economy, Products, Customers, Management, Facilities, Financials and Future Outlook? The sensitive and competitive (customer names or intellectual property) information should be not be released too early where the buyer is not quite fully committed in the transaction.
You need to be careful about what you say about the business and verify accuracy before making statements. You want to put forward positive image of the business, but you want to avoid misrepresentation.
Proper disclaimers should be inserted in all appropriate documents and marketing materials.
Buyer’s Motivation Analysis
Who would be the logical buyers and why? What are the differences between the strategic buyer, synergistic buyer, financial buyer and job buyer? How should you approach them? Is there some strategic fit, synergy or growth opportunity? Do you know the buyer’s position and motivation? Can you quantify the synergy effect to estimate the buyer’s price? Can the buyer take advantage of weaknesses in your business?
Market Share – Increase market share faster & with less risk to be the leader.
Management – Top quality people with creativity, experience & know-how.
New Market – Penetrate new markets faster & ahead of the competition.
New Product – It may be faster, cheaper and less risky to acquire than develop.
Channel – Immediate access to established distribution channels.
Competition – Eliminate your competition before they eliminate you.
Synergy – Overhead, Capacity Utilization, Marketing, R&D & Purchasing.
Investment – Maximize return on excess capital by making sound acquisitions.
Customer Base – Expand to increase revenue and diversify risk.
Diversification – Increase competitiveness (one stop service) and reduce risk.
New Technology – Faster, cheaper and less risky in capturing new technology.
Capacity – Reduce seasonal impact and maximize capacity utilization
Qualifying Suspects, Prospects & Buyers
How do you screen out the tire-kickers? Did you know that 90% of inquiries are from unqualified prospects? Do they have sufficient cash or have financing in place? Do they have a focused acquisition plan? Do they have the background or capability to operate the business? Have they bought a business in the past? Why do they want to buy your business?
How do you let the right buyer know you are selling while protecting confidentiality? Have you got everyone to sign a Confidentiality Agreement before releasing information? Does the agreement contain all provisions that prevent prospects from damaging your business? Have you creatively sanitized or camouflaged your marketing material? Are you keeping track of all the packages given out and details of all people that received information? Are you ensuring the return of all information if they abort? When should you release sensitive/competitive information?
- Have the Confidentiality Agreement signed by all prospective buyers?
- Use the qualifying questionnaire to ask relevant questions to determine the basic qualification
- Have the prospective fill out the registration form and sign for verification authorization – the questions should include ready cash amount, management background, education, acquisition history, decision making process & authority, objectives, acquisition criteria, urgency,
- Call and verify the references
- Have them come into the office to discuss and pick up information
- Do a search: web, D&B, bankruptcy, litigation/courts
- Anonymous advertising
- Full information is not released until fully qualified and perhaps until the site visit
Are you being clear and straightforward about the business and reasons for selling? Is the buyer being same? Credibility can be lost quickly after a couple of surprises. Have you developed mutual respect and trust with the buyer that will be fundamental in completing the deal?
Do you know what’s going on in your industry and can you present your business in a positive light? Can you defend the negatives that the buyer will try to use for negotiation?
Q & A Practice
Have you prepared for buyers’ questions – past performance in sales, gross margins, wages, expenses, capital expenditures, sales breakdowns, obsolete inventory and monthly operating variances, etc.?
LOI – Letter of Intent
Should you consult your lawyer and tax specialist before signing back on the LOI? Do you think you can reopen the discussion on terms already agreed in your LOI if you find out later that you made a mistake? Do you know if it is truly non-binding? Should you ask for a deposit? How much? Should you ask for a break fee? Should you address the price allocation if it is an asset sale? How much detail should you address at this stage?
Letter of Intent sets forth certain basic terms and conditions of a subject transaction. It is not usually intended to be binding. It generally only imposes a moral or good faith obligation on the parties. However, actions of the parties may create certain obligations and legal advice should be sought prior to signing the letter.
Would you sell to a buyer with highest offer even if you don’t like that buyer? How long are you willing to stay after the sale? How important is your stay, after the closing, to the business? What if you can’t get along with new owners?
Buyers seldom pay all cash in private company transactions. Are you prepared for offers with vendor financing, earn-out, consulting fee, employment contracts, common shares, preferred shares and other combinations? What should be your remuneration if you decide to stay on? What are the tax implications?
Earn-out is a form of consideration that is based on future performance of the business. Should you agree to an earn-out? Should it be based on the sale, gross margin or something else? Should it be 3 years or longer? What are the tax implications? The earn-out provision usually takes time to be negotiated, can be subject to disputes after the closing and thus needs to be carefully crafted.
Earn-out from Seller’s Perspective
It is a payment over a period based on certain performance of the business. It can be based on sales, gross margin, EBITDA or other combination of benchmarks. It is usually used to bridge the price gap.
It makes easier for buyer to finance the acquisition and thus more saleable.
The seller will be more committed to ensure future performance since its payment is tied to the future performance.
It’s treated as capital gain that lowers the tax rate.
The seller may no longer have sufficient control to influence the direction and performance of the company.
It should not be more than 5 years since the tax treatment is different after 5 years.
Clarifying the benchmark is not an easy task. How do one-time costs, unexpected costs, new management costs get treated?
What happens if the seller and buyer can’t get along?
Will anyone buy without vendor financing? How much are you willing to finance and at what terms? What kind of security or collateral should you ask for?
Most small-medium businesses involve VTB or note. Buyers will usually seek VTB as a performance assurance and is seen as vendor’s confidence and commitment in the business. However, the vendor that provides VTB should and will act like a banker – asking for security on the loan and personal guarantee.
Some businesses ($1-3 million) are too big for individual buyers to come up with all cash and it is usually tough to get bank financing.
The amount ranges from 1/3 to 2/3. The interest rate is around prime plus/minus 1
- Personal guarantees by the buyer and spouse
- 3-5 years at prime plus 1-3%
- Security position after the banks on fixtures, equipment and inventory
- Shares held in escrow (held by seller’s lawyer until note is paid off) and in default, the shares and voting control revert to seller to allow recoup investment
- Remuneration to buyer and related parties of buyer is capped at certain threshold until the note is paid off
- Major capital purchases, commitments, guarantees, change of suppliers and other relevant seller perceived risks must be approved by seller until the note is paid off
Should you give any prospective buyer an exclusive period that restricts you from marketing the business or accepting another offer?
In a letter of intent, buyers may ask for an exclusive period to conduct due diligence and negotiate a definitive agreement. Unless a significant price premium or very short time is offered, a deposit or break fee commitment should be obtained; otherwise it is a free option and the opportunity to accept a better offer may be lost.
Try to obtain non-refundable deposit or substantial break fee.
In some cases, the difference from a higher bid is shared between the two parties.
Are you clear on what’s being sold? What are the excluded assets and liabilities? What should you concede on and what should you be firm on? Should you read and understood every detail of the agreement, especially the representations and warranties? Should you calculate the risks and potential consequences of representations and warranties?
What happens if the buyer dies or becomes disabled before paying off your note? How do you protect yourself from these possible events?
A Data Room should be set up at a neural location (intermediary’s or lawyer’s office) to centralize the information, control the access and minimize interference with operations of the company. It contains the company’s material financial and accounting, tax, legal and material contractual information but does not include competitive, secretive or privileged information.
Competitive information such as customer and pricing information should not be provided until a firm commitment is received.
Intellectual Property and Trade Secret information should not be provided until a binding commitment is received. Sometimes, seller’s lawyers or consultants, who already have the information under obligations of confidence, will provide a report to provide sufficient comfort to a prospective buyer to enter a binding commitment.
Privileged communications regarding tax assessments, patent filings and litigations should not be provided.
Generally, transactions of moderate size will require audited financial statements. Management statements will also be required but the company should disclaim any representation or warranty regarding the statements. It is important for respective accountants to agree early on a common accounting treatment of the company. The payment for the audit is usually shared.
Legal due diligence will include review of minute books, legal audit letters, publicly filed litigation documents, material contracts, banking and credit agreements, security and title reviews and intellectual property reviews.
Sometimes, a minor glitch can kill a deal. Some of the issues to be addressed are collection of receivables, undisclosed liabilities, minimum level of equity and working capital at closing, audited statements, costs, covenants, representations, warranties, and indemnities.
- Conduct Ordinary course of business
- No capital expenditures without consent
- No material obligations without consent
- No hires without consent
- Maintain rights and property
- Maintain Insurance
- Satisfy conditions
- Further Assurance to complete the transfer of business
- Tax – cooperation on filings and elections
- Third party claims – procedures, assumption, and responsibilities in the event of third-party claims
- Employees – responsibilities on retention, benefits plan and incentive plans
Regulatory approvals, third party consents, no material adverse change, performance of covenants and the bring-down of representations and warranties at closing are standard conditions. Buyer’s request for conditions on financing and board approval should be resisted.
Representations & Warranties
“Reps & Warranties” is about disclosing information and risk allocation. Without certain representations and warranties, buyers will not buy your business. But many representations and warranties are up for negotiation and qualification. What’s the difference between “to my knowledge” and “to the best of my knowledge”? What should be the time limit (e.g. 3 years after closing)?
The representations and warranties serve to confirm factual matters and to allocate risk between the company, the seller and buyer. The normal representations include corporate structure, corporate approvals, no third-party consents, no conflicting laws, bylaws or agreements, no prohibiting litigation, all proceedings disclosed and the agreement creating binding and legally enforceable obligations. Some of the representations addressed are:
- Financial Statements – Standards, Accuracy and Completeness
- No Undisclosed Liabilities
- No Infringement of third-party technology
- No undisclosed material facts
Buyers will ask for a non-compete agreement from you. How many years and how wide of a radius restriction? You may not sell the real estate and lease out the facilities. What should be the rent? Who will fix the roof leak? You will most likely be asked to stay around for the transition period or even longer to ensure the business reaches targets set in the earn-out provisions. How much should you be paid? What restrictions should you accept in the employment/consulting contract? What if you want to get out before the expiry?