Frequently Asked Questions from Business Owners
In this report, we have compiled a list of answers to frequently asked questions that we think all business owners should read.
- I am not ready to sell now, but might be in a couple of years. How do I prepare?
- How much is my business worth?
- A buyer has called and offered me a price that I would be happy with. Why do I need an investment banker?
- How are investment bankers typically compensated?
- Does it matter which investment banker I hire?
- I am worried about confidentiality. Will my competitors know that I am for sale?
- I am not ready to retire but would like some security for my family. Do I have options other than an outright sale?
- What are the advantages and disadvantages of selling to a strategic buyer instead of a financial buyer?
- What are the stages of a typical sale process? How long does it take?
Preparation
I am not ready to sell now, but might be in a couple of years. How do I prepare?
Not ready to sell your company? Here are ten things (plus one for extra credit) you can do to ensure that your business is ready to sell when you are. We begin with initiatives that are best started two to three years before you sell your business and work our way down to later term items.
Plan for taxes
It is probably never too early to plan for the tax impacts of selling your business. If you are operating as a sole proprietorship or partnership, there may be advantages to converting to an LLC or S corporation. If you plan to bequeath some or all of the proceeds to family members, it may make sense to set up a trust or bring those family members on as partners in the business. Your business and the underlying real estate may receive more favorable tax treatment if they are separated into two different entities. The answers to these and other tax-related questions can vary by jurisdiction and are subject to frequent tax law changes. It is best to start having these conversations with your accountant or tax lawyer now, while you have time to make any necessary adjustments.
Build a strong management team
Do you envision selling to a competitor, or will your business more likely be acquired by a financial buyer? Financial buyers cannot run your company, so they will be looking for a strong management team. A strategic buyer may be able to leverage its own management team, but only if it is in the same business, in the same geographic regions and has internal management capacity.
If you are interested in exiting the business, it must be able to run without you. Take time to train your subordinates to manage all aspects of your company. If your current team is not capable, begin to hire people who can grow into those roles. At a minimum, your business should pass the "two week" rule. If you cannot take a two week vacation without your business falling apart in your abscence, then your company will likely not receive a premium valuation.
Build a sales staff that doesn't need you
Are you generating all the leads for your business? Does your sales staff track down leads and set up meetings, only to call you in to actually close the sale? If can be gratifying and quite natural for a business owner to be the principal rainmaker within a company. However, prospective buyers will often see this as a weakness. Unless the buyer has its own sales force with spare capacity, the buyer will assume that it will have to hire and train a sales team to replace you. That will also lead to assumptions of higher sales compensation expense and possibly lower revenues as the buyer projects the likely financial results for the acquisition.
If you build a sales team that can find and close its own deals, you win in several ways. First, you (hopefully) enjoy higher revenues and profits while you run the business. Second, when it is time to sell the business, it will be valued off those higher numbers. Third, buyers will likely place a higher valuation multiple on a self-sustaining business, versus one that has relied on the current owner to drive revenue.
Broaden your customer base
Have you spent years building up that top customer, who now accounts for 20%, 30% or more of your total revenue? This kind of customer can be a great asset when you are running your company, but it can raise red flags for potential buyers. You may not be worried about the customer leaving, because you know how integrated your products or services are into its operations, or you may play golf with the CEO every Sunday. However, buyers will rarely share your confidence, and instead will focus on the financial impact of that large customer going away.
Of course, this does not mean you should think about turning away business from your largest customers. However, you may want to revisit your sales compensation plan and increase incentives for new business, versus expanding existing accounts. While you wait for the new business to build, you can also examine the structure of that top customer relationship. Is it a single program or contract with a single entity, or are you actually performing services for a wide range of locations and subsidiaries? It may make sense to rework your account ledger to reflect the sub-accounts within this large customer. Prospective buyers will ultimately see that the accounts all point to the same umbrella customer, but a distributed account structure can highlight how unlikely it would be for all that business to disappear at once.
Define and refine your core competency
Buyers want to know what they are acquiring. If you do "a little bit of this, and a little bit of that," the buyer will have trouble understanding the business and its competitive position. Conversely, buyers will place a premium valuation on companies that are the best at what they do, however narrowly that might be defined. For example, it is generally better to be the best chemical transport company in the Southeast, versus a company with a hundred trucks and no definable competency. So if you have a core business, but you also do some custom work for a few legacy customers, you might want to consider gradually easing out of that extraneous business.
Start that new growth initiative
Is there a new product, service or end market that you have considered pursuing? Now may be the time to get new initiatives started. Your business will be valued primarily based on the cash flow characteristics of your core business. However, if you want to get multiple buyers excited about your business, and potentially garner a premium valuation, it helps to provide a vision of how the business might grow to be several times larger after they buy it. New, burgeoning revenue streams can help demonstrate that vision. It is okay if the new initiative accounts for only a small percentage of your business. If prospective buyers can see that it has doubled every year, or is growing much faster that your base business, they may start favorable calculations in their heads. Conversely, if you let three years go by and it is still just an opportunity, buyers will not place much value on it. While it may sound contradictory to advise both focusing on a core competency and starting new initiatives, they can be achieved together by moving resources from stagnant or declining businesses to newer, more promising projects.
Get on the same page with your partners, investors and management team
If you are considering a future sale, it is important that your key "constituencies" (partners, minority investors and senior management team) understand your exit strategy and that they buy in to the primary objectives of this plan. To the extent practicable, giving your investors and management team an opportunity now to help strategize and plan for an eventual sale of the business will very likely make the sale process more efficient and productive and less emotional.
Maximize cash flow
Some of the recommendations above, like enhancing your sales staff or starting a new growth initiative, require you in invest in the business. If at all possible, these initiatives should be undertaken a few years before you sell your company. As you get closer to the actual sale, you must adopt a laser focus on cash flow. In the last full fiscal year before you sell your business, and in any intervening quarters, you will want to demonstrate the full cash generating capacity of the company. Artificially starving the business of cash is not recommended, but you should ensure that any staff increases or other extra expenses will result in a commensurate near-term increase in revenue. Companies are typically valued based on cash flow, therefore, every extra dollar of profit in your last year can raise your sale price.
Tie up any other loose ends now
Is there a large customer contract nearing expiration? Renew it now before you go to market. Do you have an unresolved issues regarding ownership structure, legal disputes, expiring property leases, etc.? Take care of these as well. Take time to organize your records and clearly delineate between true company expenses versus owner perks and benefits. Loose ends that are minor, nagging issues for you can be magnified into potential red flags for buyers. They can also slow the closing process, providing more time for the transaction to be derailed. It is best to resolve these issues prior to putting your business up for sale.
Have your financials audited
Among businesses that sell for over $20 million, an overwhelming majority have their financial statements audited prior to sale. It pays to take care of this early. If you wait until a deal is in progress, you risk having the audit uncover something that surprises the buyer and ruins the deal. Conversely, if the audit is complete before starting the sale process, all parties will be confident that the business is being valued off of solid numbers.
Extra credit: Talk to an investment banker today, it's free and confidential
Unlike accountants or attorneys, investment bankers are not paid on an hourly basis. Because of this, you should feel free to reach out to a banker to hold an introductory meeting sooner rather than later. There is no cost to you for advice on when it might make sense to launch a sale process and what steps you may want to take now to prepare. We enjoy meeting with companies well in advance of a potential sale and all discussions ALWAYS remain strictly confidential.
Valuation
How much is my business worth?
Private businesses are typically valued as a multiple of EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization). Companies with higher levels of growth and/or higher free cash flow (lower cap ex and working capital requirements) will sometimes earn a higher multiple of EBITDA.
Multiples also often increase with the size of the business - for example a company with $10 million of EBITDA will often sell for a higher multiple than a company with $5 million of EBITDA. In other words, doubling EBITDA can more than double value. VRA Partners can give you a preliminary valuation range for your business in an initial meeting, but in the end, your business is worth whatever a buyer is willing to pay. In order to maximize that number, we recommend selling your business in a structured competitive process.
Your Banker
A buyer has called and offered me a price that I would be happy with. Why do I need an investment banker?
It is very rare that the first offer you receive is the best offer for your company. Furthermore, without the threat of a competitive process, buyers may behave poorly between the time of the initial offer and the closing of the transaction - a period that lasts several months. Do you always offer your customers the lowest pricing when there is no threat of losing the business to competitor? Buyers will always act in their best interest and it can cost you millions of dollars. When multiple buyers are brought into the process, the negotiating power shifts significantly towards the seller.
How are investment bankers typically compensated?
In a typical sale process, the investment banker will require a retainer up front in order to affirm the seriousness of the seller and allow the investment bank to assign its personnel to the project. Much of the work in a sale process is done on the front end, so it is important to form a strong partnership between the company and the investment banker early on.
The banker's interest are then aligned with the seller through a success fee that is typically structured as a percentage of the total transaction value, often with breakpoints that offer a higher percentage fee to the banker at premium levels of valuation - truly a win/win situation for the seller and the banker. If a transaction fails to close, and the seller does not get paid - the investment banker receives no additional compensation, other than reimbursement of direct, deal related out-of-pocket expenses (typically travel in the largest expense).
Does it matter which investment bank I hire?
Absolutely. As a family business owner, the sale of your business is likely the most important financial transaction of your life. You need to be comfortable with your advisor since you will work closely through a long process with many highs and lows.
You should thoroughly investigate your investment banker by calling references from past transactions. Some questions to ask:
- Were the senior personnel at the initial meeting the same people who executed the transaction?
- Did the actual sale price meet or exceed the initial valuation range?
- Did the banker effectively manage the process in order to allow you management team to continue to run the business with as limited distraction as possible?
- Finally, do you feel that the fee you paid the investment banker was worth it?
Transaction Types
I am not ready to retire but would like some security for my family. Do I have options other than an outright sale?
Yes. If you are interested in some liquidity, but still want to spend a few more years growing the business, you may be a good candidate for a majority recapitalization in partnership with a private equity firm (also known as a financial buyer).
In this type of transaction, the private equity firm will invest equity capital typically in combination with debt financing in order to fund the purchase of a majority stake in your business. The capital allows you to achieve a significant liquidity event, while maintaining a meaningful ownership stake in the business. A partnership with this sophisticated investor also often offers access to additional capital for acquisitions or other growth investments. It also provides an opportunity for other key executive to receive equity participation in the company. Private equity firms are not designed to be long term owners of a particular business. They will look to sell the business within 3 to 7 years, either to a strategic buyer or another private equity firm. When the 2nd transaction occurs, you receive a "2nd bite at the apple" that can be as large as the first payment in cases where the business has performed well.
What are the advantages and disadvantages of selling to a strategic buyer instead of a financial buyer?
An aggressive strategic buyer is often capable of paying the highest price in a clean transaction that allows you to achieve a 100% sale of the business. There is often the opportunity for your key managers to continue to operate the company on behalf of the new parent, but usually without any direct equity participation. The buyer may significantly alter the culture, business strategy and management structure moving forward. Once again it is important to work with a good advisor who can help you gain comfort with potential buyers early in the process. Some owners may choose to go with a buyer that offers a slightly lower price but outlines a better plan for the business and the people.
The Sale Process
I am worried about confidentiality. Will my competitors know that I am for sale?
A properly run sale process takes confidentiality seriously. You may decide to not approach certain competitors or may restrict sensitive information from being shared with some buyers. All potential buyers are required to sign confidentiality agreements that restrict them for using the confidential information in any manner other than in their evaluation of the acquisition.
What are the stages of a typical sale process? How long does it take?
Once it is officially launched, the typical sale process typically takes 5 to 6 months until closing. The process is designed to position your business to receive maximum value, while minimizing the potential disruption to your business.
Preparation: (4 to 6 weeks) - During the preparation phase, your investment banker will undertake due diligence, determine the marketing strategy, develop the positioning (investment highlights), prepare a list of potential financial and strategic buyers and finally prepare a confidential memorandum that will be sent to potential buyers. During this stage, your management team will spend a good deal of time in meetings and calls with your investment banker reviewing the book and list of prospective buyers.
Execution: (6 to 9 weeks) - During the execution phase, the investment banker will begin contacting buyers - after first executing strict confidentiality agreements with each. During most of the execution phase, the banker is responsible for doing most of the work while you focus on continuing to run the business. The banker will communicate with buyers a structured process that requires initials bids by a certain date. After the initial bids (indications of interest) are received, you will meet with your banker to decide which of the bidders to invite to a formal management presentation. After the management presentations and some additional sharing of information, the banker will ask for final bids and you will execute a letter of intent (LOI) with the best buyer.
Closing: (6 to 10 weeks) - Even though the LOI has been signed, the deal is far from complete. The final stage included final "confirmatory" due diligence and the negotiation and execution of a purchase agreement. The competitive process that has been run up to this point helps to keep the buyer honest in these final negotiations. The buyer knows that you have other options and is therefore less likely to try to "re-trade" on the agreed upon price and transaction terms during the final phase. Finally, the transaction closes, you are wired the funds and the next phase of your life begins.
VRA Partners, LLC
VRA Partners is an independent investment banking firm that focuses on providing merger and acquisition advisory services to leading middle-market companies and private equity groups located throughout the U.S. VRA Partners also assists companies with raising capital for growth, acquisitions, recapitalizations, going-private and management buy-out transactions, as well as provides fairness opinions, valuations and strategic advisory services. The professionals of VRA Partners have completed more than 500 transactions with aggregate transaction value in excess of $35 billion across a broad range of industries.
The founders of VRA Partners have over 100 years of collective investment banking experience and come from a variety of backgrounds, bringing to the firm a diverse set of industry experience and observations that benefit our clients. Not withstanding our past experience, every transaction and company is different, and VRA Partners approaches each assignment as such, allocating the time and resources to ensure that we are informed about the dynamics of each client's business and industry. Our transaction experience and our commitment to fully understand the opportunities facing each client allow us to effectively articulate to the marketplace how and why that client in unique. Importantly, we maintain the philosophy of treating our client's objectives and interests as if they were our own.