Selling Your Business? - 24th Jul 2017

By: Cameron Turner

Because we act for both buyers and sellers at Baird Partners, we see many transactions from both sides of the buyer-seller fence.  From whatever side, most businesses, whether big or small, can be very personal in nature.

This characteristic becomes an issue when it comes time to sell and the owner has never drawn a clear line between company business and personal business. Even companies as successful and large as Magna International fall victim to this problem. So taking several essential steps to depersonalize and otherwise prepare your business for sale can greatly facilitate a successful outcome.

Determine the Current and Future State of Your Business

First, we cannot understate the need for financial statements that fairly present the condition of the business, ideally for the past three to five years. Financial statements reviewed or audited by independent, external accountants are material to selling your company because buyers (and their bankers) will absolutely rely on those statements.

Second, have your accountant and tax advisors clean house of items that can really confuse buyers – such as non-working family members on the payroll or polo ponies and family vacation condominiums on the balance sheet. We have seen otherwise healthy businesses lose value because items like these have not been exorcised.

Third, prepare a business plan laying out the next two to three years in reasonable detail and include who will do what and when to realize these plans. Of course, the future of the business is where true value lies for buyers – and having a decent business plan prepared will put you ahead of the curve.

Buyers may want to change things once they assume control, but your negotiating position with them is always stronger if you can point to a solid, profitable future. A side benefit of a business plan is that you have a roadmap into the coming years, just in case your business does not sell immediately, and that can only help in creating value and easing the success of a future transaction.

Determine Who’s Minding the Store after the Sale

We recommend that company owners begin the process of deliberately and consciously transferring their knowledge of the company to senior managers at least two to three years before a sale process is underway.

If you are like many business owners, you have a founder’s pride in your company. You know your employees, customers, suppliers, and competitors like nobody else.  Your business is successful, and much of what makes it so is locked up in who you are and what you know.

But now you want to sell and get paid for all that value you have created and maybe leave for a world cruise as soon as the buyer’s cheque clears the bank. The problem is that buyers usually insist that owners stay around to transfer their knowledge to them, and they will often stagger their payments to ensure that the transfer of knowledge happens. In that case, the world cruise has to wait.

The business valuator’s term for all that value you have locked up in your head, hands, and heart is “personal goodwill,” and it is virtually impossible to find any buyer who will pay for it. This issue is usually a big pill for a founder to swallow, but the solution is to prepare your senior managers to mind the store after you have gone.

With a small business, this step may prove financially impractical. But if your business is big enough to have a management team, your real decision is not if but when you are going to involve them in documenting important business practices and include them in meetings with key suppliers, customers, and bankers. The sooner the better.

But there are also real risks in being this open with your managers, so you will want to be sure your managers are up to the job of becoming your proxy in the business. You may want to introduce things like management contracts and confidentiality agreements.

Creating a succession plan for your business is an emotional matter, whether you own a corner store or a $100-million enterprise. In our experience, good managers brought into the succession loop will rise to the challenge and will add significant value to your company even before a sale takes place.

Determine the Worth of Good Management

Your successful management team will have demonstrated a track record of above-average return metrics – Gross Margin, ROS, ROI, and earnings growth being a few common indicators. The benchmarks for comparison will be company history and industry norms – and there is a host of public and proprietary data sources on industry performance metrics available to business owners and buyers. So there is every reason to be benchmarking your management team -- and you won’t lose money betting that potential buyers will.

Now, valuation mathematics in its crudest form involves an earnings multiple and something to multiply it by – maybe pre-tax earnings, free cash flow, or net income. Not surprisingly, the value of good or bad management works on both sides of the equation.

We think that the valuation multiple applied to earnings is a function, in part, of management prowess. How much of a factor? Our educated estimate is that management alone might add at least 10% to the valuation multiple – driving a typical EBITDA multiple from, say, 4X to 4.5X.

Earnings multiples try to capture a whole grab-bag of valuation issues in one swoop: basic cost of capital requirements, growth expectations, taxation, and a host of risk factors being the main ones. Good management in a target company will naturally add value in all of these areas but mainly in the area of risk reduction.

We have never yet met a buyer who wants to face the risk-laden prospect of replacing the senior managers of an acquired business, and even a hint that replacement might be needed is enough to put a chill on deal value. A good management team is simply a less risky proposition for a buyer than a poor or average one, and less risk translates into a higher multiple for your business, whatever the earnings, industry sector, or size of your company.

Taken together, above-average earnings and better-than-average earnings multiples might drive a transaction price 20% to 30% higher than those for similar-sized companies in your industry.

Now you can really go on that round-the-world cruise!

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