Navigating the Sale of Your Company

October 2014       Download PDF      Print

  • In late 2012, Ivan Martin, the founder of a solar tracking system manufacturer, sold his business to retire and spend more time with his family. Martin's company developed highly efficient systems that automate the movement of solar panels to maximize sunlight exposure. He drew interest from dozens of players within the renewable energy sector, including two interested buyers who submitted offers. One was a manufacturer of modular housing units made from recycled materials that was incorporating solar power into its units, and the other was a private equity firm with portfolio investments in solar cell manufacturing and solar technology companies. As a result, Martin was able to choose the buyer who offered the best combination of value, chemistry, and strategic fit.

This kind of success doesn't happen by accident. Rather, it requires advanced planning and the guidance of a team of professionals. Throughout this article we'll return to the example of Ivan Martin to illustrate the steps he took to achieve a successful transaction.

The Importance of Exit Planning

Privately held companies play a vital role in the economy, employing almost half of the U.S. working population and producing roughly 46% of our gross domestic product. The founders and owners of these businesses contribute to economic growth by creating jobs, giving back to their communities, and inspiring innovation. Yet more than half of business owners are now over the age of 50. Eventually, these owners will need to transfer ownership of their companies in order to produce the liquidity needed to fund their retirement goals.

By some estimates, business owners typically have 50%-75% of their personal net worth tied up in their companies. With retirement looming, and so much of their personal net worth tied up in their companies, it's concerning that half of all owners haven't done any succession planning. In fact, two thirds of business owners aren't even familiar with all the available exit planning options. Most of them get so caught up in the daily grind of operating their companies that they don't have time to plan for the future. Others put planning off because they are personally and emotionally attached to their companies and aren't ready to relinquish control.

Unfortunately, avoiding exit planning can leave owners vulnerable to unplanned events, such as death, disability, or a declining market. These events often trigger a business sale or transfer of ownership where, without a plan, the company could lose a significant portion of its value. For example, if an owner delays planning until he is forced to sell, he likely hasn't developed realistic price expectations, considered the tax implications of a sale, or articulated his post-exit goals. In these cases, owners often find themselves unable to sell their companies or achieve their retirement goals. Given the importance of exit planning, owners should fully understand their goals and the options available when it's time to sell. They should also understand the process of selling a company, which can be divided into five steps:

1) Business Valuation
2) Strategic Planning
3) Confidential Marketing
4) Deal Making
5) Due Diligence & Closing

Early Preparation Maximizes Value

Business owners share many concerns about selling a company. Will their company be undervalued by the acquiring company? Will employees become upset with the change? Will the company lose a primary customer? To overcome these concerns, owners should start preparing their companies for sale several years in advance. They should begin by setting long-term goals, considering their motivation for selling, and making their business more self-sufficient by delegating some of their daily responsibilities to key personnel. Preparing early will allow owners to organize company records, develop a plan to minimize taxes, and focus on improvements that make the company more appealing to buyers. Preparation will also allow owners to learn more about the M&A process and develop realistic price expectations.

Before embarking on the sale process, owners should assemble a team of professional advisors, sometimes referred to as their “deal team.” These advisors, including an M&A advisor, attorney, accountant, and wealth advisor, can provide guidance on a multitude of issues and offer support during discussions with prospective buyers. In particular, an experienced M&A advisor can cultivate a competitive bidding environment between multiple buyers, while keeping the sale process strictly confidential. Ultimately, an investment banker will help the owner evaluate offers from various buyers, negotiate a purchase price, and structure deal terms that will allow the owner to meet his or her financial objectives.

  • For example, Ivan Martin began thinking about selling his company in early 2010, more than two years before the sale was completed. By working with his wealth advisor over the years, he had determined the dollar amount needed to achieve his retirement goals. Martin planned to generate these funds by selling his business and met with his M&A advisor to learn more about the sale process.

    While Martin didn't have a particular exit date in mind, the M&A advisor made him aware of the expected increase in the capital gains tax rate that was expected to take effect on January 1, 2013. Knowing that the capital gains rate was likely to increase from 15% to 20% at the end of 2012, Martin recognized that he could potentially save over $1 million dollars in taxes by selling his company before 2013. Consequently, Martin timed the sale for the end of 2012 and was able to save an additional 5% of its total sale price, which ultimately helped him reach his financial objectives.

Step 1: Business Valuation

The first step in preparing for the eventual sale of a company is to understand how much it's currently worth and which factors determine its value. A business valuation will provide the business owner with such information. To perform an accurate valuation, business appraisers typically review the company's historical financial statements, tax returns, and management forecasts. Appraisers also often request documents that describe the company's services or products, asset and inventory lists, details of liabilities, and reports completed by other professionals. This information-gathering process allows the owner to organize key documents that will become useful later in the sale process and review information that will help them gain a better understanding of their company's strengths and weaknesses.

The value of a company is influenced by many different forces, both internal and external. Business appraisers typically use one or more generally accepted valuation methodologies, the most common of which evaluate a company's financials in terms of potential future earnings or assess value based on the sale price of similar businesses that were recently bought or sold in the marketplace. Appraisers then consider a number of external factors, including the economic and political environment (i.e., interest, tax, and unemployment rates); industry lifecycle (i.e., growing, maturing, declining); market position and competitive landscape; goodwill and other intangible assets; strength of customer relationships; and diversity of customer base, suppliers, products, and services.

Drawing on the insights provided by the business valuation, owners can develop plans for maximizing the value of their companies. Owners should explore a number of options, including focusing on the bottom line, grooming a successor, focusing on quality of earnings, reducing owner perks, creating a niche, and diversifying both customer base and product/service offering.

  • Like many privately held business owners, Martin expensed a number of personal items (or "perks") through his company, such as a vehicle, personal travel, and other personal items, as a way to reduce his taxable income. As part of the business valuation process, the appraiser made normalizing adjustments to the company's financial statements, which typically involves adding back discretionary expenses to the subject company's earnings to show its true financial performance and future income-generating ability.

    Martin's M&A advisor explained that it is difficult for buyers to see the company's true earning potential if they have to navigate through various adjustments, and that ultimately, it could result in a lower sale price. Therefore, Martin immediately began reducing some of the discretionary expenses that he had been running through his company.

Step 2: Strategic Planning

Although adequately funding their retirement goals is a top priority for most business owners, for many, value is about more than just the price they receive at closing. Some owners place significant value on the preservation of their legacy and the company's culture, and many hope to find a buyer who will retain their existing employees.

During the strategic planning stage, M&A advisors walk owners through all available exit planning options and develop plans that will help them achieve their objectives. This may involve developing a marketing strategy to sell the company, outlining the timing of key events in the M&A process, and determining how to present the unique characteristics of the company. Sellers must first understand the types of deals available and the intentions of the various types of prospective buyers. This will ultimately allow owners to identify those offers that may provide the best overall value.

Selling Outright vs. Recapitalization

Some owners reach retirement and decide to leave their companies behind in the hands of trusted managers or pass full responsibility and ownership along to their children. But for many owners, the best option is often to sell their company outright to an outside party. Experienced M&A advisers have techniques and the right contacts to manage a controlled process where multiple buyers compete for the company, which helps maximize the sale price. However, an owner many not be quite ready to exit his business altogether, but would still like to reduce the amount of wealth he has tied up in his company. In this case, a recapitalization is often an ideal alternative.

In a typical recapitalization, an owner maintains a financial stake in their company but sells a portion of the business to an investor who can provide resources to help it grow. The investor will often provide financial support and management expertise that will allow the company to pursue new growth initiatives. Ideally, the owner will be able to sell their remaining financial stake in the company after it has increased in value. Often, this allows them to receive a higher overall price than if they had originally sold 100% of their company.

If a strategic sale or recapitalization doesn't address the business owner's needs, the sale of a business can be conducted in a number of other ways, including selling to a co-owner, or through an employee stock ownership plan or voluntary liquidation.

Types of Buyers

Prospective buyers in M&A transactions generally fall into two categories: strategic and private equity. A strategic buyer is typically a private or public company that is seeking to grow by acquiring another company. Strategic buyers usually pursue investments that will allow them to diversify their product offering or customer base, extend their geographic reach, or create operational efficiency. These buyers hope to realize synergies in the form of cost savings and/or increased incremental revenue. As such, strategic buyers are often willing to pay a premium for the right company. On the other hand, private equity groups, typically invest in a company with the goal of building its value and eventually reselling it to realize a return. Often, private equity buyers will pursue companies that complement their existing portfolio investments.

  • Martin had spent the previous year and a half reducing the amount of time he spent at the office and had slowly passed the bulk of his primary duties off to key members of his management team. Knowing the company would be in good hands, he was prepared to sell 100% of the company.

    After performing extensive industry research, the M&A advisor was confident that the company would attract interest from a large number of strategic buyers due to the high amount of deal-making occurring within the renewable energy sector. The advisor was also well-connected within the private equity industry and knew of several firms actively searching for similar investments. Therefore, the M&A advisor compiled a list of industry-specific strategic buyers through market research and personal contacts within the industry. The advisor's robust private equity database was also utilized as a source for potential buyers.

Step 3: Confidential Marketing

During the confidential marketing stage, the business owners' advisor should generate interest from numerous prospective buyers and maximize the company's exposure through a number of channels, including email, telephone, direct mail, and web marketing resources. M&A advisors should also produce and distribute high-quality print marketing materials to present the company being sold in the best light. Relevant materials include a brief, confidential profile highlighting the company's products, services, and financial history, and a lengthier confidential information memorandum providing an in-depth look at the company's operations, management team, past performance, and future opportunities.

Maintaining strict confidentiality is critical throughout this process. If word of the upcoming sale gets out, competitors might raise concerns among customers, vendors might rethink their contracts, or key employees might get nervous and decide to leave. An experienced M&A advisor should gather information about prospective buyers, carefully assess their suitability to complete the acquisition, and require a signed confidentiality agreement before providing them with the name of the company being sold.

  • The M&A advisor's support staff organized a direct mailing and completed phone calls to contacts at each firm on the strategic buyer list on behalf of Martin. They sent emails to thousands of private equity firm contacts across the country, providing electronic copies of a confidential profile and confidentiality agreement. Additionally, they posted the company's profile to several popular M&A deal-sourcing websites.

    Within two weeks, the M&A advisor was receiving several phone calls and emails per day in response to the messages and letters they had received regarding the Martin's company. In total, the marketing efforts generated preliminary interest from nearly two dozen private equity firms and almost 20 potential strategic buyers.

Step 4: Deal Making

Creating a competitive bidding environment is critical to selling a company for maximum value. By coordinating a confidential process that is designed to generate offers from multiple investors, a skilled M&A advisor can provide business owners with negotiating leverage. The business owner can then meet with several prospective buyers in order to evaluate each of their unique strengths and assess his level of chemistry with each firm. An M&A advisor can help the owner determine which buyer would be the best fit for the company being sold.

Throughout this process, a vast amount of correspondence occurs between the business owner's M&A advisor and prospective buyers. Efficiently managing this correspondence is key to completing a successful transaction. The advisor can field initial inquiries, manage information requests, track all correspondence, and solicit multiple bids—all while maintaining strict confidentiality for the company being sold.

Many business owners make the mistake of focusing too much on purchase price and not enough on negotiable terms, deal structure, and net proceeds after taxes. Owners can maximize the total value of their transaction by remaining flexible and understanding their options. Ultimately, they will need to evaluate offers from prospective buyers by weighing the risk/reward factors of any contingent payments and by carefully considering how the structure of a proposed deal will impact their tax liability. By planning early, owners can implement a strategy that will allow them to minimize or defer their tax liability and take advantage of significant savings. With proper tax planning, owners have a better chance of meeting their financial objectives through a sale.

  • Martin's M&A advisor fielded dozens of phone calls from interested parties and ultimately scheduled several meetings with a handful of prospective buyers who had significant interest in the company. Eventually, two of the interested buyers—one private equity firm and one strategic buyer—submitted letters of intent (LOIs) that met and exceeded Martin's price expectations.

    Both parties offered promising synergies and the individuals with both management teams seemed to possess great chemistry with Martin's key managers. However, the strategic buyer's initial offer was significantly higher than that of the private equity firm and the terms of the agreement were more favorable for Martin. The M&A advisor and Martin's attorney submitted a counter-offer, which the company ultimately signed.

Step 5: Due Diligence & Closing

After the business owner and his M&A advisor have negotiated a signed letter of intent (LOI) with a prospective buyer, due diligence begins. The buyer will request large amounts of information—including financial statements, tax returns, customer and employment contracts, and debt agreements—to verify the accuracy of every representation that has been made about the company. This process can be stressful and time consuming, lasting from two to three months, or even longer if the required documentation isn't readily available or disagreements arise.

Thorough pre-sale preparation pays off at this time. Owners who maintain organized financial statements and other company records will find it easier to fulfill document requests during due diligence. Moreover, if the business valuation uncovered any red flags, the owner and his advisor will have had time to determine the best strategy for dealing with them. Owners can help keep due diligence moving forward by continuing to work openly and honestly with their advisors. Advisors can help streamline the process by overseeing the data collection and managing the owner's M&A deal team. They can also anticipate and address potential pitfalls that sometimes arise along the way, such as the loss of a major customer or key manager.

  • Because Martin began exit planning several years before his target sale date, by the time he arrived at due diligence, all of his financial documents were in order and he and his advisor were prepared to address any unexpected challenges that might come up. As a result, due diligence and closing went smoothly, and Martin was able to hand ownership of his company over to a buyer that offered both a good cultural fit and a strategic opportunity for continued growth. The transition also went smoothly because Martin had gradually passed on most of his daily responsibilities to his management team. In the end, Martin was able to retire knowing not only that he had achieved his financial goals, but also that his legacy was in good hands.

Timing is Critical

Although timing the sale of a company can be challenging, choosing the right time to sell can help owners achieve a higher value for their companies. Variables such as the company's financial performance, the current lending environment, economic conditions, and industry outlook will affect how much a buyer is willing to pay for the company being sold. It is best to sell when the economy is on an uptick and the company has demonstrated strong financial performance. In a strong economic environment, buyers will find it easier to obtain credit. Consequently, they will be able to leverage more debt and pay more for the company being sold.

Owners operating in a growing industry will encounter higher demand for their companies, while those operating in industries undergoing consolidation may find that larger competitors are willing to acquire their companies at a premium. Selling during such periods will allow owners to solicit more interest from prospective buyers. Occasionally, a prospective buyer will make an unsolicited offer to purchase a company from its owner. If the offer is reasonable, the opportunity may be worth exploring with the assistance of an experienced M&A advisor. Owners who have prepared well in advance of their eventual exit are better able to take advantage of timely M&A market conditions or unexpected offers and still achieve maximum value. Finally, owners should consider how to reinvest their wealth post-exit, as that will have a tremendous impact on whether they can achieve and sustain their retirement goals.