The Confidentiality Agreement

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When considering selling their companies, many owners become paranoid regarding the issue of confidentiality. They don’t want anyone to know the company is for sale, but at the same time, they want the highest price possible in the shortest period of time. This means, of course, that the company must be presented to quite a few prospects to accomplish this. A business cannot be sold in a vacuum.

The following are some of the questions that a seller should expect a confidentiality agreement to cover:

  • What type of information can and can not be disclosed?
  • Are the negotiations open or secret?
  • What is the time frame for which the agreement is binding? The seller should seek a permanently binding agreement.
  • What is the patent right protection in the event the buyer, for example, learns about inventions when checking out the operation?
  • Which state’s laws will apply to the agreement if the other party is based in a different state? Where will disputes be heard?
  • What recourse do you have if the agreement is breached?

Obviously, executing an agreement does not mean a violation can’t occur, but it does mean that all the parties understand the severity of a breach and the importance, in this case, of confidentiality.

While no one can guarantee confidentiality, professional intermediaries are experienced in dealing with this issue. They are in a position to understand the extreme importance of confidentiality in business transactions as well as the devastating results of a breach in confidentiality. A professional intermediary will require all legitimate prospects to execute a confidentiality agreement.

A confidentiality agreement is a legally binding contract, enforceable in a court of law. It establishes “common ground” between the seller, who wants the agreement to be extensive, and the buyer, who wants as few restrictions as possible. It allows the seller to share confidential information with a prospective buyer or a business broker for evaluative purposes only. This means that the buyer or broker promises not to share the information with third parties. If a confidentiality agreement is broken, the injured party can claim a breach of contract and seek damages.

© Copyright 2015 Business Brokerage Press, Inc.

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Common Reasons for Selling

It has been said that the sale of a business is usually event driven. Very few owners of businesses, whether small or large, wake up one morning and think, “Today I am going to sell my company.” It is usually a decision made after considerable thought and usually also prompted by some event. Here are a few common “events” that may prompt the decision to sell:

Boredom or “Burn-out” – Many business owners, especially those who started their companies and have spent years building and running them, find that the “batteries are starting to run low.”

Divorce or Illness – Both divorce and illness can cause a rapid change in one’s life. Either of these events, or a similar personal tragedy, can prompt a business owner to decide that selling is the best course of action.

Outside Investors – Outside investors may include family, friends, or just plain outside investors. These outside investors may be putting pressure on the owner/majority owner in order to recoup their investment.

No Heir Apparent – In this scenario, no family member has any interest in the business; and the owner has not groomed his or her successor. Unfortunately, in this event the owner often continues to run the business until he is almost forced to sell.

Competition is Around the Corner – In this scenario, the owner would have been better off selling prior to competition becoming an issue.

A “Surprise” Offer is Received – This may be about the only reason not truly event driven; an unsolicited offer is presented that is too good to pass up.

Everything is Tied Up in the Company – The owner/ founder sometimes becomes aware that everything he or she has is tied up in the business. In other words, all the eggs are in one basket.

Should Have Sold Sooner – Owning a small to midsize company (or even a large one) is not without its risks. A large customer goes under, suppliers decide to increase their prices, trends change, business conditions change, etc.

Surveys indicate that many small company owners do not have an exit strategy; so, when an event does strike, they are not prepared. Developing an exit strategy doesn’t mean the owner has to use it. What it does mean is that a strategy is ready when the owner needs it.

A professional intermediary can supply a business owner the real world information necessary not only to develop a plan, but also to know how to implement the plan when it becomes necessary.

© Copyright 2015 Business Brokerage Press, Inc.

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Valuing the Business: Some Difficult Issues

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Business valuations are almost always difficult and often complex. A valuation is also frequently subject to the judgment of the person conducting it. In addition, the person conducting the valuation must assume that the information furnished to him or her is accurate.

Here are some issues that must be considered when arriving at a value for the business:

Product Diversity – Firms with just a single product or service are subject to a much greater risk than multiproduct firms.

Customer Concentration – Many small companies have just one or two major customers or clients; losing one would be a major issue.

Intangible Assets – Patents, trademarks and copyrights can be important assets, but are very difficult to value.

Critical Supply Sources – If a firm uses just a single supplier to obtain a low-cost competitive edge, that competitive edge is more subject to change; or if the supplier is in a foreign country, the supply is more at risk for delivery interruption.

ESOP Ownership – A company owned by employees, either completely or partially, requires a vote by the employees. This can restrict marketability and, therefore, the value.

Company/Industry Life Cycle – A retail/repair typewriter business is an obvious example, but many consumer product firms fall into this category.

Other issues that can impact the value of a company would include inventory that is dated or not saleable, reliance on short contracts, work-in-progress, and any third-party or franchise approvals necessary to sell the company.

© Copyright 2015 Business Brokerage Press, Inc.

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Considering Selling? Some Important Questions

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Some years ago, when Ted Kennedy was running for president of the United States, a commentator asked him why he wanted to be president. Senator Kennedy stumbled through his answer, almost ending his presidential run. Business owners, when asked questions by potential buyers, need to be prepared to provide forthright answers without stumbling.

Here are three questions that potential buyers will ask:

  1. Why do you want to sell the business?
  2. What should a new owner do to grow the business?
  3. What makes this company different from its competitors?

Then, there are two questions that sellers must ask themselves:

  1. What is your bottom-line price after taxes and closing costs?
  2. What are the best terms you are willing to offer and then accept?

You need to be able to answer the questions a prospective buyer will ask without any “puffing” or coming across as overly anxious. In answering the questions you must ask yourself, remember that complete honesty is the only policy.

The best way to prepare your business to sell, and to prepare yourself, is to talk to a professional intermediary.

© Copyright 2015 Business Brokerage Press, Inc.

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Is Your “Normalized” P&L Statement Normal?

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Normalized Financial Statements – Statements that have been adjusted for items not representative of the current status of the business. Normalizing statements could include such adjustments as a non-recurring event, such as attorney fees expended in litigation. Another non-recurring event might be a plant closing or adjustments of abnormal depreciation. Sometimes, owner’s compensation and benefits need to be restated to reflect a competitive market value.

Privately held companies, when tax time comes around, want to show as little profit as possible. However, when it comes time to borrow money or sell the business, they want to show just the opposite. Lenders and prospective acquirers want to see a strong bottom line. The best way to do this is to normalize, or recast, the profit and loss statement. The figures added back to the profit and loss statement are usually termed “add backs.” They are adjustments added back to the statement to increase the profit of the company.

For example, legal fees used for litigation purposes would be considered a one-time expense. Or, consider a new roof, tooling or equipment for a new product, or any expensed item considered to be a one-time charge. Obviously, adding back the money spent on one or more of these items to the profit of the company increases the profits, thus increasing the value.

Using a reasonable EBITDA, for example an EBITDA of five, an add back of $200,000 could increase the value of a company by one million dollars. Most buyers will take a hard look at the add backs. They realize that there really is no such thing as a one-time expense, as every year will produce other “one-time” expenses. It’s also not wise to add back the owner’s bonuses and perks unless they are really excessive. The new owners may hire a CEO who will require essentially the same compensation package.

The moral of all this is that reconstructed earnings are certainly a legitimate way of showing the real earnings of a privately held company unless they are puffed up to impress a lender or potential buyer. Excess or unreasonable add backs will not be acceptable to buyers, lenders or business appraisers. Nothing can squelch a potential deal quicker than a break-even P&L statement padded with add backs.

© Copyright 2015 Business Brokerage Press, Inc.

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Do You Have an Exit Plan?

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“Exit strategies may allow you to get out before the bottom falls out of your industry. Well-planned exits allow you to get a better price for your business.”

From: Selling Your Business by Russ Robb, published by Adams Media Corporation

Whether you plan to sell out in one year, five years, or never, you need an exit strategy. As the term suggests, an exit strategy is a plan for leaving your business, and every business should have one, if not two. The first is useful as a guide to a smooth exit from your business. The second is for emergencies that could come about due to poor health or partnership problems. You may never plan to sell, but you never know!

The first step in creating an exit plan is to develop what is basically an exit policy and procedure manual. It may end up being only on a few sheets of paper, but it should outline your thoughts on how to exit the business when the time comes. There are some important questions to wrestle with in creating a basic plan and procedures.

The plan should start with outlining the circumstances under which a sale or merger might occur, other than the obvious financial difficulties or other economic pressures. The reason for selling or merging might then be the obvious one – retirement – or another non-emergency situation. Competition issues might be a reason – or perhaps there is a merger under consideration to grow the company. No matter what the circumstance, an exit plan or procedure is something that should be developed even if a reason is not immediately on the horizon.

Next, any existing agreements with other partners or shareholders that could influence any exit plans should be reviewed. If there are partners or shareholders, there should be buy-sell agreements in place. If not, these should be prepared. Any subsequent acquisition of the company will most likely be for the entire business. Everyone involved in the decision to sell, legally or otherwise, should be involved in the exit procedures. This group can then determine under what circumstances the company might be offered for sale.

The next step to consider is which, if any, of the partners, shareholders or key managers will play an actual part in any exit strategy and who will handle what. A legal advisor can be called upon to answer any of the legal issues, and the company’s financial officer or outside accounting firm can develop and resolve any financial issues. Obviously, no one can predict the future, but basic legal and accounting “what-ifs” can be anticipated and answered in advance.

A similar issue to consider is who will be responsible for representing the company in negotiations. It is generally best if one key manager or owner represents the company in the sale process and is accountable for the execution of the procedures in place in the exit plan. This might also be a good time to talk to an M&A intermediary firm for advice about the process itself. Your M&A advisor can provide samples of the documents that will most likely be executed as part of the sale process; e.g., confidentiality agreements, term sheets, letters of intent, and typical closing documents. The M&A advisor can also answer questions relating to fees and charges.

One of the most important tasks is determining how to value the company. Certainly, an appraisal done today will not reflect the value of the company in the future. However, a plan of how the company will be valued for sale purposes should be outlined. For example, tax implications can be considered: Who should do the valuation? Are any synergistic benefits outlined that might impact the value? How would a potential buyer look at the value of the company?

An integral part of the plan is to address the due diligence issues that will be a critical part of any sale. The time to address the due diligence process and possible contentious issues is before a sale plan is formalized. The best way to address the potential “skeletons in the closet” is to shake them at this point and resolve the problems. What are the key problems or issues that could cause concern to a potential acquirer? Are agreements with large customers and suppliers in writing? Are there contracts with key employees? Are the leases, if any, on equipment and real estate current and long enough to meet an acquirer’s requirements?

The time to address selling the company is now. Creating the basic procedures that will be followed makes good business sense and, although they may not be put into action for a long time, they should be in place and updated periodically.

© Copyright 2015 Business Brokerage Press, Inc.

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The Devil May Be in the Details

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When the sale of a business falls apart, everyone involved in the transaction is disappointed – usually. Sometimes the reasons are insurmountable, and other times they are minuscule – even personal. Some intermediaries report a closure rate of 80 percent; others say it is even lower. Still other intermediaries claim to close 80 percent or higher. When asked how, this last group responded that they require a three-year exclusive engagement period to sell the company. The theory is that the longer an intermediary has to work on selling the company, the better the chance they will sell it. No one can argue with this theory. However, most sellers would find this unacceptable.

In many cases, prior to placing anything in a written document, the parties have to agree on price and some basic terms. However, once these important issues are agreed upon, the devil may be in the details. For example, the Reps and Warranties may kill the deal. Other areas such as employment contracts, non-compete agreements and the ensuing penalties for breach of any of these can quash the deal. Personality conflicts between the outside advisers, especially during the
due diligence process, can also prevent the deal from closing.

One expert in the deal-making (and closing) process has suggested that some of the following items can kill the deal even before it gets to the Letter of Intent stage:

  • Buyers who lose patience and give up the acquisition search prematurely, maybe under a year’s time period.
  • Buyers who are not highly focused on their target companies and who have not thought through the real reasons for doing a deal.
  • Buyers who are not willing to “pay up” for a near perfect fit, failing to realize that such circumstances justify a premium price.
  • Buyers who are not well financed or capable of accessing the necessary equity and debt to do the deal.
  • Inexperienced buyers who are unwilling to lean heavily on their experienced advisers for proper advice.
  • Sellers who have unrealistic expectations for the sale price.
  • Sellers who have second thoughts about selling, commonly known as seller’s remorse and most frequently found in family businesses.
  • Sellers who insist on all cash at closing and/or who are inflexible with other terms of the deal including stringent reps and warranties.
  • Sellers who fail to give their professional intermediaries their undivided attention and cooperation.
  • Sellers who allow their company’s performance in sales and earnings to deteriorate during the selling process.

Deals obviously fall apart for many other reasons. The reasons above cover just a few of the concerns that can often be prevented or dealt with prior to any documents being signed.
If the deal doesn’t look like it is going to work – it probably isn’t. It may be time to move on.

© Copyright 2015 Business Brokerage Press, Inc.

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Family Businesses

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A recent study revealed that only about 28 percent of family businesses have developed a succession plan. Here are a few tips for family-owned businesses to ponder when considering
selling the business:

  • You may have to consider a lower price if maintaining jobs for family members is important.
  • Make sure that your legal and accounting representatives have “deal” experience. Too many times, the outside advisers have been with the business since the beginning and just are not “deal” savvy.
  • Keep in mind that family members who stay with the buyer(s) will most likely have to answer to new management, an outside board of directors and/or outside investors.
  • All family members involved either as employees and/or investors in the business must be in agreement regarding the sale of the company. They must also be in agreement about price and terms of the sale.
  • Confidentiality in the sale of a family business is a must.
  • Meetings should be held off-site and selling documentation kept off-site, if possible.
  • Family owners should appoint one member who can speak for everyone. If family members have to be involved in all decision-making, delays are often created, causing many deals to fall apart.

Many experts in family-owned businesses suggest that a professional intermediary be engaged by the family to handle the sale. Intermediaries are aware of the critical time element and can help sellers locate experienced outside advisers. They can also move the sales process along as quickly as possible and assist in negotiations.

Keeping it in the Family

It’s hard to transfer a family business to a younger kin. Below are some statistics regarding family businesses.

  • 30% of family businesses pass to a second generation.
  • 10% of family businesses reach a third generation.
  • 40% to 60% of owners want to keep firms in their family.
  • 28% of family businesses have developed a succession plan.
  • 80% to 95% of all businesses are family owned.
Source: Ted Clark, Northeastern University Center for Family Business

© Copyright 2015 Business Brokerage Press, Inc.

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Two Similar Companies ~ Big Difference in Value

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Consider two different companies in virtually the same industry. Both companies have an EBITDA of $6 million – but, they have very different valuations. One is valued at five times EBITDA, pricing it at $30 million. The other is valued at seven times EBITDA, making it $42 million. What’s the difference?

One can look at the usual checklist for the answer, such as:

  • The Market
  • Management/Employees
  • Uniqueness/Proprietary
  • Systems/Controls
  • Revenue Size
  • Profitability
  • Regional/Global Distribution
  • Capital Equipment Requirements
  • Intangibles (brand/patents/etc.)
  • Growth Rate

There is the key, at the very end of the checklist – the growth rate. This value driver is a major consideration when buyers are considering value. For example, the seven times EBITDA company has a growth rate of 50 percent, while the five times EBITDA company has a growth rate of only 12 percent. In order to arrive at the real growth story, some important questions need to be answered. For example:

  • Are the company’s projections believable?
  • Where is the growth coming from?
  • What services/products are creating the growth?
  • Where are the customers coming from to support the projected growth – and why?
  • Are there long-term contracts in place?
  • How reliable are the contracts/orders?

The difference in value usually lies somewhere in the company’s growth rate!

© Copyright 2015 Business Brokerage Press, Inc.

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What Are Buyers Looking for in a Company?

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It has often been said that valuing companies is an art, not a science. When a buyer considers the purchase of a company, three main things are almost always considered when arriving at an offering price.

Quality of the Earnings

Some accountants and intermediaries are very aggressive when adding back, for example, what might be considered one-time or non-recurring expenses. A non-recurring expense could be:

  • meeting some new governmental guidelines,
  • paying for a major lawsuit, or
  • adding a new roof on the factory.

The argument is made that a non-recurring expense is a one-time drain on the “real” earnings of the company. Unfortunately, a non-recurring expense is almost an oxymoron. Almost every business has a non-recurring expense every year. By adding back these one-time expenses, the accountant or business appraiser is not allowing for the extraordinary expense (or expenses) that come up almost every year. These add-backs can inflate the earnings, resulting in a failure to reflect the real earning power of the business.

Sustainability of Earnings

The new owner is concerned that the business will sustain the earnings after the acquisition. In other words, the acquirer doesn’t want to buy the business if it is at the height of its earning power; or if the last few years of earnings have reflected a one-time contract, etc. Will the business continue to grow at the same rate it has in the past?

Verification of Information

Is the information provided by the selling company accurate, timely, and is all of it being made available? A buyer wants to make sure that there are no skeletons in the closet. How about potential litigation, environmental issues, product returns or uncollectible receivables? The above areas, if handled professionally and communicated accurately, can greatly assist in creating a favorable impression. In addition, they may also lead to a higher price and a quicker closing.

© Copyright 2015 Business Brokerage Press, Inc.

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