What Entrepreneurs Need to Know When Selling a Private Company
by Alan J. Smith April 15, 2006
As published in Business Week Online
A common entrepreneurial saga involves the enormous amount of time, energy and resources spent developing a successful business but the failure to capitalize at that most critical moment: when the owner is ready to sell out. Take one of the three companies I founded, Advanced Medical Devices, a $22 million distributor of surgical products, which I sold in 1998 to Johnson & Johnson.
Johnson & Johnson's initial offers were significantly less than the final offer. I attribute that to one factor: my decision to retain an expert in mergers and acquisitions to represent my interests. The leveling of the playing field between the two parties - J&J's sophisticated financiers were now dealing with a peer who they could assume was knowledgeable and credible- made all of the difference in securing the higher price.
Lesson Learned: What Entrepreneurs Don't Know
Therein lies a lesson - in fact, the first of two lessons-for entrepreneurs aiming to sell a privately held company. No matter how adept they may be when it comes to running their enterprises or astute about financial matters, owners should begin by hiring an experienced M&A specialist, private investment banker, or intermediary to quarterback the effort.
In 2002, I founded and currently serve as president of such a firm, San Francisco-based Bay Pacific Group, Inc. In this role, I have witnessed a lot of wishful thinking: Owners cling to the notion that they can sell the company themselves with the help of their attorney, CPA, and internal financial executives. However, it doesn't work that way. For the vast majority of entrepreneurs, selling the company is a unique, one-time experience. Owners are on a continual learning curve from start to finish. They are pitted against a buyer armed with an M&A specialist who has extensive experience - and thus a significant competitive edge in the negotiations.
Full disclosure means I must mention that the year after I sold Advance Medical Devices, I sold another company which I had founded (and had been running concurrently) without the assistance of an M&A specialist. However, this company, with annual revenue of $2 million, was much smaller. In addition, I was on intimate terms with one of the two buyers, because he was working for me.
In short, it was the exception that proves the rule: that literacy regarding the sale of a company involves acknowledging what you don't know - and acting accordingly. Better to concentrate on managing your company - after all, this is no time to take your eye off the ball - and let your M&A specialist manage the sale.
Lesson Learned: What Entrepreneurs Must Know
That brings us to the second lesson. Being literate about selling your company also means acquiring enough knowledge about the process to be able to work intelligently with your representative. Teamwork is essential when marketing a private company. The M&A specialist will want to work closely with the owner's accountant and legal advisors to determine where adjunct support is needed. Another essential is that confidentiality be maintained until it is absolutely necessary to disclose information. Three distinct phases are involved in the marketing process. What follows is a look at each. PHASE I: Historical Analysis and Company Valuation
A company for sale must be presented in a way that clearly demonstrates the benefits and value it offers potential acquirers. A detailed, insightful written analysis that includes its business history, financial information and current operations is needed to understand how to emphasize strengths and shore up weaknesses.
A proper valuation - a determination of the company's worth on the market -- prepared by a valuation professional working with the firm's CPA or CFO is the mandatory next step. The valuation serves more than one purpose. It defines and supports a range of value for the company and also explains what went into the analysis and how the conclusions were made. Finally, it identifies the factors that influence and enhance what the company is worth.
The process itself, which the M&A specialist oversees, involves the accumulation and analysis of client data, external research, management interviews, normalization of historical financial statements, assessment of projected financials, and the application of suitable valuation approaches and methods.
PHASE II: Marketing and Buyer Considerations
Marketing the company is undertaken with the use of two pieces of vital information. The first is a so-called blind business profile, which provides an overview of the company but does not identify it. Included is information about the company's size, the industry and markets it serves, a financial snapshot, and an assessment of its potential. This is the document the M&A specialist provides to prospects, which are gleaned through personal contacts and from proprietary databases and research. It is conveyed to those buyers who initially fit the type of buyer most suitable for the company.
The second piece of information is called the Confidential Business Review (CBR). This document is given only to potential acquirers that have been further qualified as being able to buy and interested in buying. It is not released until the prospect signs a confidentiality agreement. The CBR, which usually ranges from 30 to 45 pages, provides the complete story on the company. Ultimately, it serves as the basis from which potential acquirers submit Letters of Intent (LOI) to buy the company. It also becomes the foundation for the acquirer's due diligence, or thorough research prior to the final signing.
An obvious concern is how to properly price a company in the marketplace. Owners can always specify an asking price, but rest assured that if they do, the price will only go down from there. Our solution at Bay Pacific Group is always to go to market without a defined price, allowing buyers to set terms and positioning the company for offers that exceed its expectations. Consider the case of a Canadian company that, internally, expected to be sold for $6 million. The company received an $8 million offer, which was eventually raised to $11 million, because the buyer believed its manufacturing process would significantly reduce the time required by its own.
PHASE III-Due Diligence, Structuring, Negotiating, and Closing
Once a Letter of Intent (LOI) is received, negotiated and agreed upon, the buyer begins due diligence, a comprehensive examination of the company's operations, finances, and legal obligations. No stone is left unturned. At this point, a Confidential Business Review that has described the company intelligently is worth its weight in gold, because it boosts the company's credibility with the buyer and thus eases the due diligence process.
Anticipating and preparing for due diligence is a major task for the M&A specialist, who should coordinate with the company's professional advisors to ensure that the seller is properly represented. Information is usually required from the company's attorneys, CPA, CFO, and financial planner, as well as the professional who determined its valuation and possible even its environmental consultant.
Another very important related point is that the seller must be advised about ways to structure the sale to maximize after-tax proceeds. The right advice and implementation from the financial planners and tax professionals can make a tremendous difference. Early in the process, this area should be carefully considered.
When due diligence is satisfactorily completed, a definitive purchase agreement is drafted, specifying all of the considerations in the offer, the mechanics of the offer, and the allocation of risk.
The process is then largely finished, a process that brings to an entrepreneur the fulfillment of perhaps a lifetime of work. It isn't a matter to be taken lightly - or without the benefit of being informed and prepared. Literacy in this milieu is twofold. It involves knowing what you don't know and must ask another to do for you. And it demands that you know enough to work knowledgeably with your representative. When the time comes to sell your company, be sure to make literacy your ally.
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