My friend Ted Sarvata, a business consultant with Gazelles, Inc. shared an interesting article with me recently about the strategies used by savvy buyers to drive down the price on a business sale.
One tactic to watch for is an initial offer for way more money than the owner dreamed of, often based on a formula tied to company earnings, especially when it includes an exclusivity clause to prevent negotiations with other prospects. Most owners are delighted to get such a generous offer, and happily sign the exclusivity agreement. Then the fun begins.
Despite promises of a speedy sale, the due diligence phase drags on longer than expected. Meanwhile, the owner postpones key expenditures which will affect earnings and thus drag down the sale price. Then the buyer begins demanding “emergency” meetings, often at inconvenient times, disrupting the owner’s routine and increasing stress levels.
With the owner mentally checked out of the business and worn out from due diligence – and the business suffering from a cutback in critical expenditures to pump up earnings – the business unsurprisingly suffers a temporary slump. The buyer wants the company’s performance to suffer a little so they can use it to drive down the price. Beat up by the entire process, the owner will be more likely to give in to all kinds of last minute concessions affecting the final price of the business.
How do you avoid this unpleasant outcome? Start by enlisting a good business broker. If a serious prospect wants an exclusivity agreement, limit it to 30 days and require a big deposit that will be forfeited if the deal doesn’t close. And do your best to insulate yourself from the transaction. Have a trusted executive work with your broker as a go-between with the buyer, and push back against last-minute demands for meetings.
No matter how you structure a sale of your business, you will almost certainly get a better sale price if you take steps now to increase its value.
My friend Eric Williams, who is a business broker and consultant with Codiligent, LLC has several suggestions for businesses looking to boost value in the time leading up to sale.
1. Increase cash flow
Can you raise prices or eliminate expenses? For many small business owners, reducing their tax burden is second nature. But low taxable income creates a perception of low value for a buyer. In addition, eliminate owner personal expenses that are paid through the business, such as car allowances, club memberships, and the like.
2. Decrease risk perceptions
Implement a reporting system that gives you key information about company performance. Manage accounts receivable and implement credit and payment standards. Keep outstanding loans and financing needs to a minimum. Control growth at a rate that the company can finance internally and replace short-term credit with long-term, fixed-rate loans.
3. Highlight opportunities for growth and efficiency
Every buyer wants the chance to exploit undeveloped potential. Maximize the value of your business by highlighting untapped markets, new services, or technological advances that will take your business to the next level.
4. Use a professional
To ensure the greatest likelihood of a sale for your asking price, work with a qualified professional business broker to ensure that your company listing is presented in the best possible light to the widest possible audience of prospective buyers.
If you are starting to think about retirement or just want to spend less time on your business without giving up total control, consider hiring a temporary Chief Executive Officer. Using an interim CEO lets you see what life is like outside of your business. It also can be a great way to transition to retirement or other new ventures.
Advantages of hiring an interim CEO
Advantages of hiring an interim CEO include the ability to step back in if your inner control freak won’t let you give up the reins. It also means that customers and vendors are still dealing with the same owner. In addition, hiring a CEO is much less complicated than a full-blown exit and may boost the value of your business by demonstrating that it doesn’t need your daily involvement.
Challenges of hiring an interim CEO
A downside of hiring a CEO is that you’ll have to trust someone else to run your business. Not every hire will work out, so you may have a false start before finding the right person. If the new CEO’s leadership style or personality is different from yours (and it will be), employees may be less inclined to work as hard or as well as they did for you. Perhaps the most obvious drawback is that you will need to pay the new CEO a big chunk of the money that you used to pay yourself.
While it may not be the best choice for owners who expect to continue taking significant amounts of cash out of the business, testing the waters with an interim CEO can be a great way to literally buy more time as you refine your ultimate exit strategy.
What is an ESOP?
Another option for successful closely held companies is to create an Employee Stock Ownership Plan, or ESOP. An ESOP is a kind of employee benefit plan which allows companies to provide their employees with stock ownership, often at no up-front cost to the employees. In an ESOP, a company sets up a trust fund with new shares of company stock or cash to buy existing shares. Alternatively, the ESOP can borrow money to buy new or existing shares, with the company making cash contributions to the plan to enable it to repay the loan.
How ESOPs work
Regardless of how the plan acquires stock, company contributions to the trust are tax-deductible, within certain limits. Shares in the trust are allocated to individual employee accounts. As employees accumulate seniority with the company, they acquire an increasing right to the shares in their account. According to the National Center for Employee Ownership, over 11,000 companies have an ESOP. The ESOP shares are treated as part of the employee’s total compensation and may be sold when the employee retires or leaves the company, assuming that the employee has had the shares long enough to be fully vested.
The benefits of an ESOP
Pluses include potential tax avoidance for the owner and potential goodwill from the perception that the company has “given” shares to the employees. In addition, an ESOP can help ensure the continuity of the business because the existing employees will remain after the sale and already know how to run the business. Perhaps most important is the intangible motivation to boost employee performance by vesting each employee with an ownership incentive. If the company exceeds its goals, the employees can generate personal wealth through the increased value of their respective ownership shares of the company.
The challenges of an ESOP
Downsides of an ESOP are that they are expensive, complex and time consuming, and require significant administrative resources to administer. In addition, the share price for an ESOP may be lower than from an IPO or third-party sale, and an owner must trust the ability of the remaining employee group to be able to repay the ESOP loan.
For a detailed explanation of ESOPs you can read more here.
Going public before selling
Although impractical for most small businesses, another option for an owner of a corporation looking to sell is taking the business public through an Initial Public Offering (IPO). The IPO is the first time that a company’s shares are traded on a public market. An IPO brings profits to initial investors and employees and raises capital for the company.
How going public works
First the company must file a Form S-1 with the U.S. Securities & Exchange Commission (better known as the SEC), which includes basic business and financial information. A group of investment bankers are selected to act as underwriters, who help in raising capital from investors. A public stock exchange such as NASDAQ or NYSE is selected, and a ticker symbol is chosen. Then the company and its underwriters make presentations to investors in major cities, seeking buyers for large blocks of shares. After the SEC has approved the filing, the company and the underwriters set the opening price and numbers of shares that will be sold. The investment capital is transferred to the company and investors get their shares. The next day they begin selling those shares on the public market.
How big should a business be to go public?
Typically, IPOs are not appropriate for companies with less than $100 million in sales. Apart from the significant expense of an IPO, there are other drawbacks. A private company has full control over its shares and is not obligated to disclose key financial information to the public. Shares of publicly traded companies are available to anyone and public companies must answer to those shareholders and also must face significant regulatory oversight. But for fast-growth, innovative companies that rise above their competitors (think Square, Twitter and Dropbox, for example), going public is the next benchmark for success.