hile every entrepreneur knows how to properly package a product or service to achieve a profitable sale, few would claim that they have the same competence when it comes to selling a business. The fact of the matter is that selling a business is a specialist activity with its own set of legal and accounting issues and this is one area where experience does count. That being said, the entrepreneur knows his business and should understand better than anyone where it has growth potential, the basis for a higher sale price.
The same may be said of the inexperienced Investor. VC firms and experienced Investors who have participated in a number of investments should have some experience working with professional advisors and probably have some existing relationships which they can use. However, selling a business to a large global corporation based on strategic value is not something many investors have experience with and, to be frank, few advisors have either.
In my experience, there are few professional advisors who understand how to positiona sale on strategic value. Most often they tend to push the deal back into a conventional framework based in an EBIT multiple and in doing so miss the whole point of the exercise. They are not only a waste of time but tend to get in the way of the deal being done properly. The choice of advisors is critical.
Apart from the support you will need from professional legal and accounting firms, should you use a business broker or investment banker to help sell your business? The answer really depends on how well you understand the process of selling a business, whether you already have willing buyers in your sights and whether you have prepared the business for sale. If you are unsure about how you should prepare your business in order to achieve the best offer, or if you are uncertain how to attract the right buyers, then getting help from professionals who undertake those tasks on a regular basis makes sense. Even an experienced entrepreneur who has sold several businesses may like to have an advisor in the team to assist in the negotiations. There is considerable benefit in having an objective, knowledgeable person on your team to provide feedback, suggestions and to keep the negotiation process moving forward.
The key to the use of such professionals is, however, to use them to assist the Investor and internal management team in the process, not to take control. Too often business owners have allowed professionals to control the process and the negotiations not recognizing that their primary motivation is the commission on a quick sale. The entrepreneur who understands his or her business well and spends time identifying and connecting to the best potential buyers, will generally achieve a much better price for the business. The best buyers will be those corporations who can best exploit the potential in the business. Positioning the business with these potential buyers and preparing the business so that it can support such potential is best undertaken by the entrepreneur. It also takes time and cannotbe undertaken properly if the business is rushed into a sale.
At the same time that the entrepreneur is preparing the business for sale and positioning it with potential buyers, professional legal and accounting firms need to be appointed to assist with both preparation and sale transaction support. Better sale prices are achieved where business risk for the buyer is minimized. This process often requires the business to undergo a vendor due diligence as part of the preparation process. By proactively undertaking their own due diligence review, the entrepreneur can discover risks in their business which can be addressed long before a potential buyer emerges. Not only does such an activity improve the current business but it significantly reduces buyer due diligence costs and time during contract negotiations. A business which is well prepared for buyer handover will attract better buyers and a better sale price.
The smart entrepreneur needs good advice and smart people to support the sale process. The result usually is a much better price.If the firm has already prepared a valuation of the current business and projected valuation of the business opportunities to potential acquirers, this will contribute considerably to the discussion with the potential buyer. The advisor can review the financial projections, provide conventional valuations and brief the entrepreneur on how best to present their case. Understanding how an acquirer undertakes a valuation will ensure that the firm has prepared the proper information, presents it properly and is able to validate the underlying assumptions and values.
Preparing an Information MemorandumThe Information Memorandum (IM) is the document that most firms use to solicit interest in their business. It describes the business, sets out the historical and projected financials and provides background information on the industry, the competitors and the acquisition opportunity to allow a potential buyer to decide if they wish to proceed to a more detailed examination of the business. It is the foundation document that will be used by the potential buyer to evaluate the acquisition. It is important that the IM be prepared thoroughly, be properly explained and contain the information needed by the potential buyer to undertake their initial due diligence on the opportunity. The advisor can prepare the IM to ensure it is readable and persuasive and provides an appropriate level and type of information.
Reviewing financial InformationCurrent financial information needs to be prepared according to generally accepted accounting principles and presented in a conventional format that allows easy analysis. Your advisor can ensure that the statements are prepared correctly and that the accompanying data fully supports a detailed investigation. This information is normally reviewed by your advisor to ensure that financial information is presented on a consistent basis from year to year and that any extraordinary or abnormal items are fully explored.
Helping with introductions and referralsWell established accounting firms and investment banks participate regularly in transactions involving buyers. They are, therefore, in a good position to know most local large corporations on a personal basis and certainly by reputation. If they consider that you have a good business proposition they can help short list potential buyers you should approach and then can help with introductions or referrals. They may also be able to assist with the search for prior acquisitions and with uncovering news items that related to them. They may have connections to assist you to contact prior sellers so that you can gain an independent view of the potential buyer.
Since many professional firms have national and international offices and affiliate networks, this can be used to uncover other possible buyers and generate introductions. Having the right potential buyers in the final bid process can make a huge difference to the ultimate sale price.
Reviewing purchase terms and conditionsWhile purchase agreements are often set out in a conventional format, the vendor is not normally in a position to know what terms would be reasonable for their business. The advisor should be able to recommend where terms should be renegotiated, however, always obtain proper legal advice on contract terms.
Assisting in negotiationsThe firm that is represented by a well established and respected advisor is likely to be better prepared for the negotiation. At the same time, the buyer knows that the terms are going to reviewed by a knowledgeable party. This should result in more productive discussions and the result is likely to be better for the firm. The buyer may prefer to deal with a business represented by a professional advisor as they know that the entrepreneur will not need to be educated about conventional terms and conditions or the warranties and representations required under a normal deal.
Advice on preparationPreparation for an acquisition is much more than preparing a business plan. The advisor reviews the likely buyer’s investment criteria and investment process in advance with the management team to ensure that the vendor has prepared itself for both the negotiation and the due diligence processes.
Due diligenceDue diligence will be carried out by the buyer as part of their initial evaluation of the acquisition opportunity. This is mostly a product/market evaluation to see if the merged business can support the opportunity claims of the firm. After the business terms of the acquisition are agreed, the buyer will then carry out an extensive review to further ensure that it has a thorough understanding of the business and the management and has uncovered any data discrepancies and investment risks. Your advisor can undertake a trial due diligence process to ensure the firm is fully prepared and help to correct any deficiencies.
Advice on pensions, option schemes and remunerationOnce the buyer is involved, the firm will have little opportunity to change the remuneration and benefits of its staff. A professional accounting firm can review these before an approach is made to a buyer to ensure that the current remuneration and benefits are fair and reasonable and provide the most positive basis for the planned sale.
Tax adviceFew firms are structured from the outset to be optimal for a sale. Overtime the tax regime will most likely have changed, especially with regard to retirement strategies, trusts, capital gains and options. The corporate structure of the business may not be suitable for an outright sale or be optimal if there is an earnout portion. A professional accounting firm can also review the current business processes for compliance, tax collection and reporting. At the same time, personal tax planningfor the major shareholders should be undertaken to establish the right basis for the planned sale. This will include the best format for the sale (ie- sale of shares or sale of assets).
Exit strategy assistanceFrom their knowledge of prior acquisitions, your advisor can help define strategic value, identify integration issues and/or show how the firm can best position itself for a sale.
The purchase agreement would often be prepared by the vendor’s lawyers, however, this protocol varies in different countries. In addition, some buyers insist on having their lawyers prepare the contract. This is a complex legal document that few entrepreneurs will have ever seen and certainly few would understand in any depth. The professional legal firm can either draft the documents for you or construct the terms and conditions and identify any harsh or unusual conditions that the buyer has requested and assist in the renegotiation of those where the buyer prepares the document.
Review warranties and indemnitiesThe vendor would normally be expected to provide warranties and representations and indemnities to the buyer. These can often be renegotiated to be less harsh. The professional legal firm will know what is reasonable and what is not. This is one area where proper preparation, good reporting and compliance systems and good governance can significantly reduce the exposure of the vendor.
Review employment or non-compete agreementsThe buyer will expect the key executives and major shareholders to enter into employment agreements and/or non-compete or restraint of trade agreements. The professional legal firm can ensure that the terms and conditions associated with these agreements are reasonable.
Preparation of disclosure letterThe vendor should be prepared to disclose any issues which may effect the decision of the buyer to purchase. They should also identify any potential liabilities of the business. The professional legal firm can advise on the types of disclosures and how the letter should be worded to best protect the sellers and to ensure there is no avenue for redress on the part of the buyer if events do not go to plan.
Review corporate documentsAs part of the preparation for the sale, the professional legal firm will review the corporate documents which authorize the firm to undertake business to ensure it meets the requirements of the buyer. This review would normally extend to board minutes, shareholder agreements, option schemes and any material contracts the firm has entered into.
Depending upon the size of the transaction, the vendor should plan for approximately 5 - 10% of the sale price to be spent on their professional services fees noting that smaller transactions are likely to have a higher percentage associated with advisors fees.
Not all professional services firms have the necessary experience to undertake this type of work effectively. The Investor should not assume that their current professional services provider has the expertise to properly advise them in this area. They should seek independent advice as to which professional services firms are best equipped to handle the transaction they wish to enter into. Before they start to incur costs for this service, they should undertake some due diligence and investigate the extent to which the referred firm has a track record of success in working with clients on sales and acquisitions of similar sized businesses or to similar sized acquirers.
Asking for references would not be unreasonable and they also should ask for a list of transactions that the professional services firms has participated in and some details of the work performed for the clients involved. People move between professional firms and so the firm should ensure that the expertise is still with the professional services firms. They should ask to be allocated an advisor with personal experience in these types of transactions.
Some advisors, whether they be accounting, legal or corporate finance executives, are so locked into a traditional model of firm value that they simply ‘don’t get it’. They will want you to undertake a conventional valuation based on historical earnings, a conventional information memorandum and won’t grasp the impact of the opportunity that the buyer can extract from the strategic value in your business. Certainly you and they will have difficulty trying to put a value on the business if it is based on the buyer’s potential rather than your net worth or profitability and your advisors may be uncomfortable going forward on that basis. However, if you have clearly identified potential buyers that have expressed interest in an acquisition this should provide a good base from which they can assist you to prepare the business for sale.
If your initial discussions with a professional advisor show you that they want to take you down the conventional path, you should move on and find one that you feel can best represent the potential in your business. Ask them to provide you with references to similar strategic sale transactions that they have advised on.
Entrepreneurs and Investors who have not participated in large transactions are often concerned about entering into relationships with Investment banks, larger accounting and legal firms and often hesitate because they feel that the larger firms carry considerable overhead and that gets passed back down to the client in higher fees. It is certainly true that the larger firms typically have higher charge out rates but they also need to compete for services of the smaller clients and so it is not unreasonable to ask for a smaller charge out fee given the size of the firm.
The larger firms do have an advantage of being national and international organizations and having specialists in most areas and this can be to the benefit of the smaller firm involved in complex trading transactions. When it comes to contracts and agreements which can materially effect value dilution, a little more up front may better protect the value of the firm on ultimate sale. This would certainly apply to IP agreements, option schemes, shareholder agreements and any acquisitions that the firm entered into.
The larger professional advisors have a decided advantage in M&A transactions. They see them often, they regularly advise on both acquisitions and on sales. Larger accounting and legal firms are often asked to undertake due diligence work on behalf of larger corporations and thus are very familiar with the entire process. Larger firms are taken seriously when it comes to negotiations and thus can better protect the entrepreneur who has never experienced these types of deals.
In the end it may come down to spending a little more over a longer period to be better prepared rather than spending a lot near the end closer to the transaction.
The business is likely to be better managed and be less risky as a result of that preparation. At the same time, the impact of a large professional firm in the deal process can enhance the reputation of the seller and may result in a better price being negotiated. Certainly it should speed up the due diligence process which in itself can have a significant positive effect on deal price. It should also speed up negotiations as the buyer knows it does nothave to educate the seller about normal terms and conditions of a sale.
I have often been asked why I used a big four auditing firm with my last venture given that the business when it started only had a dozen staff and, when sold, had only grown to 30 employees. My answer has always been to show the impact on the final due diligence and deal discussions and to ask whether the person asking the question thought I got value for money.
my last business went into free fall after several large software corporations decided to enter my market with similar products. all my prospects were their customers as our supply chain optimization software sat alongside a large erp system such as those sold by sap, oracle or peoplesoft. When these corporations announced that they were going to develop their own supply chain optimization solutions, their customers decided to wait for the integrated solution from their main software vendor. Thus i found myself in a situation where i had 30 staff and no prospects. naturally we decided to sell the business before we were forced to close the doors.
This was my fourth software business and i had the experience of working through the sales process for the earlier ones. i also had been through the due diligence process for raising venture capital twice and taking on a large corporate loan. i knew from those experiences that being prepared for due diligence was a critical part of getting a quick decision. i also knew that the quickest way to get through the due diligence process was to ensure that the professional advisors i used had high credibility. Basically, i wanted to have all my source documents accepted without question. The only effective way to achieve this is to have the biggest and the best.
When you are selling out to a large, perhaps, global corporation they are going to undertake a very extensive and sophisticated due diligence. They will almost certainly use a large auditing firm and a highly respected legal firm. In order to uncover the risks and problems in your business, these advisors are going to review everything. The only way you can speed up this process is to demonstrate to them that they don’t need to audit most of the historical information because they will be able to rely on the documents produced by your own advisors. My approach here was to push back hard and state that any additional audit was wasting my time and the buyer’s money but that I was willing to provide warranties for the quality of the information presented. In any case, if there was a subsequent problem, they could always go back and litigate against my advisors who would normally have much deeper pockets than me.
This last business of mine was sold for six times revenue to Peoplesoft in a period of just over two weeks. Given that it was losing over $1 million at the time, whatever additional fees I paid to my advisors was well and truly worth it. When you are dealing with large corporate buyers, it is best to have good quality advisors in order to be very well prepared for the due diligence and the negotiations.