A Seller’s Dilemma

When one sells their house, the best deal is usually the highest price.  When one decides to sell their business, there may be other factors to consider.  Many buyers are similar to the “overlooked” buyer described below, serious and qualified; and most sales of businesses are win-win transactions.  However, there are a few exceptions, and sellers should consider them carefully, balancing their prerequisites to the goals of the buyer.

Selling to a Competitor – Many company owners think this is the best way to go.  They read about the mega-mergers such as Bank of America and Fleet bank, or the pending deals such as Federated and the May Company Department Stores, and U.S. Air and American West.  Consolidation may play a major role in large public companies; this is not the case in middle market companies.

Many owners of middle market firms look at these mega-deals and think it might work for them.  However, upon further consideration, they realize that by disclosing a lot of confidential information to a competitor, their business could suffer irreparable damage if the deal would fall apart – and many do.

Selling to a Strategic Acquirer – This may bring the highest price, but there are several reasons why this may not be in the company’s best interest.  Many owners have worked with key employees for years and would not like to see them replaced. The strategic owner might not only replace members of management, but might also move the company to another part of the country.

Selling to a Financial Buyer – This buyer may not be willing to pay the seller’s price and is usually buying a company with intentions of selling it at a profit in three to five years.  This leaves the company and its employees in limbo waiting for a new owner to take over.

Other Buyers – The employees may decide to buy the company (ESOP).  However, this usually means a long-term payout for the owner. An individual buyer may come along such as a Warren Buffett, but what are the chances?  A key member or members of management might decide to purchase the company, but generally they won’t pay the price.  If a sale is not consummated, the key management member(s) will most likely leave.

The “Overlooked” Buyer – There are many individuals who want to own their own company.  They might be former executives of major companies who want to do something on their own. Some buyers have access to large amounts of investment capital. There are many qualified individual buyers in the market place. Russ Robb, the editor of a leading M& A newsletter, M&A Today, has written a book, Buying Your Own Business, for those individuals interested in buying their own company. This book has sold over 20,000 copies, which indicates the large number of people who are interested in buying a company.

There Is No Magic Answer – Selling a company comes with no guarantees.   When Badger Meter Company, a public company headquartered in Milwaukee, acquired Data Industrial Corporation based in Mattapoisett, Massachusetts, this appeared to be a marriage made in heaven.  Their respective product lines fit like a glove, their corporate cultures seemed compatible, and sales expansion by cross-selling was evident.

This strategic acquisition would have been fine except for one change.  The parent company moved Data Industrial’s operation to Kansas, and every employee’s job was terminated.  However, one should not construe that all acquisitions by strategic or competitive acquirers end up in a similar fate.  Furthermore, for price considerations, the seller can draft restrictions in the Purchase & Sale agreement to prevent the transfer of the business, at least for a specified time period.

Certainly selling to the overlooked type buyer doesn’t guarantee all of the seller’s concerns, but knowing the interests of some of the various buyer types can help insure that the goals of both buyer and seller are met.  Sellers should determine their goals prior to attempting to sell their business.  A consultation with a professional intermediary is a good start to this process.

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What’s Your Business REALLY Worth?

A recent article in INC magazine titled”Street Smarts,” by Norm Brodsky (his column is worth the price of the magazine) addressed the subject of the title above.  However, in the very first paragraph of the article, Mr. Brodsky stated, “Unfortunately, most of them [business owners] have grossly inflated notions of what their companies are worth.” Mr. Brodsky is not one to mince words.  Some of his examples were: “One company had lost money on sales of about $60 million, and yet its owners thought it was worth between $50 million and $100 million … Another company had a net profit of less than $335,000 on sales of about $6.5 million – and still the owners somehow came to believe it was worth between $100 million and $200 million.”

Mr. Brodsky feels that the reason for this is “… our egos can get us in trouble when it comes to putting a dollar value on something we’ve created.  We generally take the highest valuation we’ve heard for a company somewhat like ours – and multiply it.”

He goes on to point out that prospective acquirers are more concerned about profits, especially Free Cash Flow, than sales.  Too many company owners use some rule of thumb based on sales.  He also points out that company owners tend to use a comparison of a similar business across town that sold for some multiple of sales and then apply it to their company.  There are so many variables of how sales (and subsequently earnings) are generated that no two companies are ever alike.

Business owners tend to forget the negatives of their business; e.g., sales from just a few customers, lack of contracts with customers and suppliers, lack of product diversity, out-dated equipment, etc.  Also, as Mr. Brodsky points out, “Before you try to sell, make sure you know what buyers want.”

Turning to another expert voice, here is some good advice from Allen Hahn, Senior Vice President of Valuation Research Corporation: “The level of EBIT or EBITDA used for negotiating a purchase price is the ‘normalized’ level that will be available to the new owners from the assets acquired.  Often times this requires elimination of unusual, inappropriate or non-recurring expenses.  Buyers will typically consider a company’s last twelve months of financial performance.  However, projected results may be more relevant if a structural change has recently occurred in the business (loss of a key customer, acquisition, etc.) that renders historical results less meaningful.”

What does all of this mean?  It means that owners should disregard rules of thumb based on what the company across town sold for; it means that owners should not use a multiple based on what the business did four or five years ago, or what they think the business will do next year.

Business owners should first put their egos aside, then look long and hard at the company’s cash flow, realistically assess the negatives (and positives) of their business and “make sure you know what buyers want.”

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Is Your Company Hiding an “Orphan”?

Does your business have an orphan product or service that is doing okay, but doesn’t seem to fit into your core business?  Many companies, private equity groups and even some individual buyers are seeking product lines to augment existing ones, or even to build a business around.  Here are just a few of the reasons why a company might want to divest itself of a product line or even a particular service:

  • It may not be a good fit for the parent company, thus diffusing efforts that could be placed into the core business.
  • Because it is an orphan, it is a distraction.
  • It man be a break-even side business that with a full-time effort could be profitable, but resources are better devoted to the core business or service.
  • The money received could be used to expand the core business or fund some improvements that are not currently budgeted.

Certainly, there can be some disadvantages in allowing the adoption of an orphan – on both sides.  There is the all-important people issue.  Some valuable employees may be attached to the product line – and may go with the sale or decide to leave and move on.  This can negatively impact both sides of the transaction.  It can also have a negative impact on the selling company’s employees when the selling or purchasing company releases employees. There are cultural issues to consider.  The product may be a more important part of the selling company than management thought.  It may have played a role in selling other products or services.  The distribution channels may play a role in other product lines.  It is important for management to consider whether the orphan is really an orphan before selling it off.

On the plus-side for the acquiring company, the addition of the product line may be a perfect fit for their existing distribution chain.  The brand name acquired may provide name recognition to some existing products.  The new product line may be able to be manufactured with only a minimum increase in employees and plant capacity.

The purchasing company may have a difficult time establishing a price.  It may seem easy to look at the sales and the cost of sales, but the cost of sales may not include an allocation for rent, and for support services such as legal, accounting, corporate oversight, etc. Some part of the product may be manufactured on equipment used for other products, warehousing may be shared, and parts used in other products.  Many acquisitions are sold with a form of licensing agreement so the selling company receives a royalty or license fee representing a small portion of the sales of the acquired product line.

Company management is prone to think of only selling the entire business, a division or subsidiary of the company, when a sale of a product line may be an excellent solution.  The decision to sell a product line or service may solve a host of problems and perhaps even eliminate the need for sale of the entire business.  As Fortune magazine has written, “Companies once obsessed with cutting costs are now urgently trying to boost sales – with new products, new services and new markets.  The surest – and ultimately cheapest – way to increase your total sales is to persuade your existing customers to buy more products.”

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When Is A Company In Trouble?

Companies can be in trouble or headed for it for many reasons.  However, most of them can be linked to one or more of the following:

• Lack of proper focus
• Poor management
• Poor financial controls
• Loss of key employee(s)
• Loss of important customer(s)/client(s)
• Not keeping up with technology
• Quality control or other operating issues
• Legal or governmental issues
• Target market change or shift
• Competition

Unfortunately, by the time a business owner realizes that the business is in trouble and recognizes why, it may already be too late. The obvious solutions are to either fix it or sell it.  The decision should be made quickly, since time may be of the essence.

Unfortunately, too many owners of privately held businesses wait too long.  A decision to sell should be made when the business is doing well, not when it is in trouble.

Now may be the time to check with a professional intermediary to see what you can do to prepare your business for sale.

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How Does Your Company Rate?

Valuation of private companies is much more subjective than public companies because there is no free trading marketplace for the private companies’ stock.  Just like a champion Olympic figure skater, the performance has to be flawless.  Take a look at the following check list – see if the target company rates near perfect (on a scale of 1 to 10 – 10 being best):

• Stable Market
• Stability of Earnings Historically
• Realized Cost Savings After Purchase
• No Significant Capital Expenditures Herewith
• No Significant Competitive Threats
• No Significant Alternative Technologies
• Large Market Potential
• Reasonable Market Position
• Broad-based Distribution Channels
• Synergy Between Buyer and Seller
• Sound Management Willing To Remain
• Product Diversity
• Wide Customer Base
• Non-dependency on Few Supplier

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Mistakes Sellers Make

• They neglect to run their business during the sales process. – The owner of a business with sales under the $20 million range can get so involved in the selling process that they neglect the day-to-day operation of the business.

• They don’t understand the “real” value of their business. – A business may actually command a higher price than the value determined by an appraiser.  The business may be worth more than the sum of its parts.  A professional intermediary, along with other advisors, can answer the question of real value and help determine a “go-to-market” price.

• They aren’t flexible in structuring the transaction. – In many cases, how the deal is structured is more important than the price or terms.

• They are not looking at the business from a buyer’s perspective. – Buyers may look for different aspects of a business than those the seller looks for.  For example: growth potential, management depth, customer base, etc.

• They start with too high a price. – Sellers obviously want to maximize the price they receive for their business, but today’s marketplace is difficult to fool.  A good buyer may just elect to pass because of an overly aggressive starting point.

• They are impatient. – Sellers have to understand that it can take 6 to 18 months to find a buyer and proceed through the sales process, which includes due diligence, the legal and accounting issues that must be handled, and ultimately the closing.  However, on the flip side, the longer the deal drags, the more likely it is to fall apart.  As the saying goes: Time is of the essence!

• They have insufficient or inadequate documentation. – Sellers should have current real estate and equipment appraisals at the ready along with any documentation a buyer might want, such as projections, business forecasts and plans, and environmental studies.  Having all the documentation and financial records readily available will not only speed things along, but might also provide for a higher price or, even more important, save the deal.

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Expediting Change Post-Closing

The deal is done and you have completed the closing.  Now what do you do?  You help the new owner because chances are that you have some vested interest in the new entity, and it is in your best interest that the new owner is successful.

For example:
– there may be an escrow account due you.
– the buyer may have given you a note.
– you may be the landlord, and the buyer the tenant.
– your name remains on the company letterhead, and your personal reputation continues to be associated with the business.
– your former employees depend on you to have made the right decision in selling to the particular buyer, thus preserving their jobs.

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Surveying the Business Scene: How Many Sell?

One of the most frequently-asked questions by those looking at the independent business scene is: “How many are for sale?” Right on the heels of that question comes another: “How many actually sell?”

To determine how many of these businesses are for sale at any one time, and what percentage of these get sold, it is necessary first to define terms by business category. The industry groups that account for the majority of small to mid-sized business sales are: manufacturing, wholesale trade, retail trade, business and personal services, and household/miscellaneous services. Using these categories as components, the total number of businesses that apply to our “survey” is approximately 6.3 million.

Of this total, businesses that are for sale at any one time account for roughly 20 percent. There is naturally going to be a higher percentage of businesses for sale that employ four or less workers, but some independent business experts feel that fewer of these businesses–at least percentage-wise–sell than do the larger ones. Of those businesses with four or less employees, one expert’s estimate is that one out of six actually sells; with five to nine employees, about one out of five sells; and the trend continues.

Why is the actual-sale percentage lower for very small businesses? Many factors operate to affect this tendency. For example, the much smaller business may suffer more from unsubstantiated income or inaccurate financial information. Some owners may not be realistic in their pricing or simply aren’t serious about selling (problems that can threaten the sale of a business at any level). Still others may simply pay the bills and close the doors.

However, no matter what the percentages show, a business owner considering putting a company on the market should remember this: most businesses are salable if the seller is realistic in assessing value and is aware that the marketplace is the final arbiter of the selling price.

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Rating Buyer Seriousness

Use the following criteria to separate the serious buyers from window-shoppers. (Add up plus points, subtract minus points. The serious buyer will rate a 6 or above.)

Minus Point Factors

  • -4 needs outside financing (excluding home equity)
  • -4 been looking for 6 months or more
  • -3 no available cash
  • -3 still working in corporate world
  • -2 spouse not supportive of buying a business
  • -2 uses a legal pad or clipboard and takes too many notes
  • -2 feels leisurely about finding the “just-right” business
  • -1 now renting (although has lived in area for some time)
  • -1 under 25 or over 62

Plus Point Factors

  • +3 does not have a job or has just resigned
  • +3 understands that books and records are not the only indicators of value
  • +2 has enough money to buy a business
  • +2 no dependents
  • +2 family member or close relative has been a business owner
  • +2 willing to take the time to look without a lot of notice
  • +1 location is not a prime consideration
  • +1 age 25 to 62
  • +1 skilled worker or professional

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How’s Your Corporate Social Responsibility (CSR)?

Your first question may be, “Just what is Corporate Social Responsibility (CSR)?” We see CSR demonstrated in a variety of ways in areas such as:

o Contributing to local community programs through financial support and personal involvement

o Using packaging and containers that are environmentally-friendly
o Recycling
o Using low-emission and high mileage vehicles where possible
o Seeking more efficient manufacturing processes, etc.

o Utilizing responsible advertising, public relations and business conduct
o Exercising fair treatment of suppliers/vendors, contractors and shareholder

o Implementing fair and equitable treatment of employees
o Upholding workplace safety, equal opportunity employment and labor standards

Actions such as these not only uphold today’s business standards, but they also pave the way for future generations. In years past, many of these elements were considered almost anti-business and some had to be enforced by governmental regulation.

Successful companies such as Tom’s of Maine (producer of natural personal care products) and Newman’s Own have practically been built on CSR. More and more companies – public and private – are following the elements of CSR. Google is a desired workplace because of the way they treat their employees: great benefits, great food in the employee cafeteria, exercise equipment – you name it, Google provides it.

Recognizing CSR in today’s business climate not only increases shareholder/investor interest, but also increases value. Socially-conscious companies are considered sound investments.  They attract buyer interest and acquire higher selling prices when it comes time to sell. After all, most buyers want to find a business with the following attributes:

• Good relations with the local community
• Products and/or services that are meeting the current trends in the marketplace and are positioned to meet future trends
• Positive relations with employees and low-turn-over
• Excellent customer loyalty
• Good relationships with suppliers and vendors
• No “skeletons” in the company closet

In addition, good environmental practices reduce costs, create efficiencies and provide excellent public relations. Good employee relations make for happy workers, which translates to higher productivity and lower absenteeism. Good relationships with customers and suppliers eliminate, or greatly reduce, the possibility of legal entanglements.

All in all, Corporate Social Responsibility not only creates additional value and helps in creating a higher selling price when that time comes – it is also very good business for now and in the future.

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