ROCHESTER, NY – Mid-market business owners consider sales, divestitures and spinoffs for a variety of reasons, both positive and negative. Fortunate triggers for a sale include opportunities to capitalize on strong acquisition markets or an owner’s planned retirement. Unhappier reasons include financial stresses (declining revenues, capital constraints or bankruptcy) or the sudden departure or demise of key leaders.
Regardless of the reasons for a sale, business owners must clearly understand why they are selling and craft a strategy that maximizes the sales price given those specific conditions. Why? Because while the value of M&A deals in the United States has increased to $893.1 billion, up 3.8 percent from 2012 to 2013, many owners walked away from years of hard work without getting the best returns on those investments.
The difference between those satisfied with a sale and those who wonder why their deals went wrong depends in large part on how sellers prepared themselves, and their organization, for a transaction.
Preliminary benchmarking will determine the viability of a sale; a more sophisticated review will determine if it’s the right time to sell (will conditions improve in six months to a year?) and whether the transaction is likely to generate the desired sales price. A thorough pricing analysis will assess the organization’s “fair market value,” which accounts for every asset, including capital equipment, real property and current assets such as inventory.
And while accounting can differ by type of sale (e.g., assets or stock), gains or losses included in fair market value will generally be recorded based on treatment of the individual assets (e.g., capital assets result in a capital gain or loss, inventory results in ordinary income or loss).
This doesn’t mean, of course, that a seller can’t negotiate for a premium above fair market value. An eager acquirer can allocate a premium purchase price against the fair market value of the company, with the excess purchase price recorded as goodwill. But preparing a fair-market-value analysis offers a realistic starting point for a seller before negotiations begin.
Sound accounting analysis should be accompanied by well-documented business practices and workflows as the company’s management team continues to operate and invest in the business as it always has. Meanwhile, the firm’s owners, along with professional advisors including brokers, accountants and lawyers, will guide the sale process.
It’s important, too, that leaders be upfront with top employees if a sale is rumored or confirmed. Prospective buyers may lose interest if top talent leaves due to uncertainty. Clear internal communication of any tentative sale can help facilitate successful post-acquisition integration.
A study conducted by the International Association of Business Communicators and Mercer Human Resource Consulting asked CEOs post-merger what they would change if they had it to do over again. Their top response was the way they communicated with employees.
Apart from applicable “quiet period” restrictions during which a company and related parties cannot disclose information publicly, external communications can actually improve the deal-making process. A strong PR strategy will get the word out about a sale to analysts and others who can influence corporate acquisition decisions, priming the pump for potential buyers.
Pricing and positioning the business for sale
Sell-side due diligence, or valuing the company’s assets and examining and documenting the health of the organization, is a fundamental component of the sale process. This procedure, even for small businesses, will help drive a selling price that satisfies ownership while reassuring a buyer of sufficient return on investment.
Estimate value: There are many methods for valuing an organization, although the eventual selling price is always based on the value perceived by the buyer. Two common methods are:
Asset valuation: This approach is common when a manufacturer is being sold for liquidation, as the assessment identifies the potential selling prices for used equipment, facilities, inventory and real estate. This approach also applies to businesses being transferred to new owners for operation, in which case intangible assets can greatly impact overall corporate value. For example, a manufacturer with few physical assets might hold intellectual property that hasn’t yet been commercialized, or it may have long-standing customer agreements that can be reinvigorated with new products and new sales practices.
Market-based valuation: This approach looks at the value of the business from the next owner’s perspective— it identifies how much value the company will continue to generate. Market valuations examine the value of similar companies and their assets, and then establish a multiplier driven common for the market or industry, such as a multiple of sales or earnings before interest and taxes. For smaller businesses, this may be a multiplier of the seller’s discretionary earnings, which consists of the business’ profit plus benefits to the owner (e.g., salary or nonrecurring expenses)
Sell-side due diligence: With valuations as their basis, companies seek to convince potential buyers of the business’ worth. Sell-side due diligence looks for both issues that negatively impact sales price, allowing the seller to counteract them to support the desired valuation, and hidden positive features that may boost sales price. Thorough sell-side due diligence provides an opportunity for a seller to identify and correct problems before getting in front of buyers.
Sell-side due diligence should address:
• Business basics
Document the company’s financial history, including earnings, cash flows, debts and obligations.
• Working capital requirements
Identify requirements to maintain current and future business performance (to drive ongoing operations) or to close down the business (to assist the liquidation).
• Sales forecasts
Quantify future business demand, relying on contracts, market forecasts and realistic sales-staff expectations. This analysis should differentiate by products, markets, distribution channels and customers (e.g., a high sales forecast for a large, growing customer can offset tepid forecasts elsewhere).
• Business relationships
Affirm that business is not driven by personal relationships that will end when the current owner exits. The seller will also need to reassure the buyer that favored pricing and performance levels with suppliers will survive the transaction.
• Accounting practices
Detail procedures and assumptions in a manner consistent with industry standards.
Smart sellers quantify risks in anticipation of buyer concerns, e.g., “What if a competitor releases a superior product? What if the senior leadership team retires? What if a new law/ regulation/tax is passed?”
Megan Broomfield, CPA, is a partner with Mengel, Metzger, Barr & Co. LLP and may be reached at Mbroomfield@mmb-co.com.