As we discussed earlier, sellers should be prepared to deal with either a financial buyer, who views the acquisition purely for its potential return on investment, or a strategic buyer, who views the acquisition as having potential to enhance an existing business.
MARKETING TO A STRATEGIC BUYER
If the seller has the opportunity, he or she is often better served by marketing to a strategic buyer. A strategic buyer may view the business as an opportunity to eliminate a competitor, expand market share, or roll out a new product or service line. If your business is an important piece in the buyer’s strategy, the buyer will recognize that value and pay a premium. In addition, strategic acquisitions often have intrinsic value such as increased sales, cost savings, and financial efficiencies.
MAXIMIZING THE SALE PRICE
Anticipating and selling the potential synergies for a strategic buyer should be part of the seller’s due diligence process when entering into negotiations. Naturally, sellers want to maximize the sale price by factoring potential synergies into the valuation process, while buyers would prefer to price the business as a stand-alone acquisition. Accordingly, the seller should consider the value of the company from both perspectives. As the saying goes, knowledge is power. Engaging in proactive thinking to identify potential value to a strategic buyer will empower the seller in negotiations with the buyer and will likely improve the seller’s bottom line when determining the final sale price.
Continuing from our previous post last week, here are some additional areas of due diligence preparation that sellers should anticipate in their pre-sale planning.
CUSTOMER BASE PROFILE
The buyer will likely want to know about your customer or client base. To protect customer privacy, sellers should consider creating a list indicating the total number of accounts, and the number of accounts that account for more than five percent of total sales.
PERCENTAGE OF SALES FROM KEY INDUSTRIES
Buyers may also want to know what industries use the products or services offered by your business. Sellers should prepare a breakdown showing the percentage of sales for each industry.
SALES AND MARKETING
Sellers should summarize current marketing literature, sales training, advertising, lead generation, and other marketing activities:
Help your buyer with a chronology of significant company events starting with the creation of the company and continuing to the current day.
Legal and liability issues are one of the biggest risks that buyers need to assess when considering an acquisition. To help allay concerns, sellers should consider making a list of all licenses, certifications, and permits required by public or industry authorities and verifying that they are current. In addition, sellers should be prepared to disclose prior, pending, or threatened legal or administrative proceedings that affect the business.
Prepare an organizational chart that shows how the company is run, and provide a list of employees for the past few years, as well as payroll information.
Potential buyers also will want to know about employee turnover, current (and promised) benefits, health and safety compliance, and workers compensation claim history for the company.
Getting ready for due diligence requires the seller to plan ahead, but the investment of time can pay off in several ways. First, anticipating the types of information that a buyer may want will help minimize delays that can lead to a loss of momentum in negotiations. In addition, having an advance preparation strategy bolsters the impression that the seller’s business is run professionally. That may increase the prospective buyer’s confidence in the value of the company and could lead to a higher sale price.
Here are some of the major areas that sellers should anticipate when preparing to run the due diligence gauntlet.
Any buyer will (or should) want to undertake a comprehensive financial review of the business. For larger (over $2 million) transactions, the seller also should prepare audited financial statements (balance sheets, earning statements, and cash flow statements) for the current year-to-date and the three prior years. Buyers also will want to inspect the business property and equipment.
Sellers should have a list of expenses that will not be considerations for a buyer, including what the current owner takes out of the business and any related expenses such as “fringe benefit” expenses like golf club memberships, company paid vehicles, and the like.
Itemize the company’s intellectual property (IP), such as patents, inventions, designs, copyrights, trademarks, service marks, trade secrets, computer programs, confidential information, and know-how. This should include a list of company IP as well as the documents, including any licensing or royalty agreements, relating to use of the IP.
Help the buyer understand how your business works by summarizing current processes and procedures, listing key supplier and vendor relationships, explaining inventory management, management systems, and customer relations.
SELLERS VS. BUYERS
Sellers often feel that buyers or appraisers undervalue the business because the buyer doesn’t understand the business model, or because the valuation methods fail to take into account unique qualities of the business.
THE IMPORTANCE OF ACCURATE FINANCIAL RECORDS
While it is true that different valuation methods may result in different values for the same business, one thing that can’t be overstated is the need to have accurate financial records. Most company financial statements contain errors, so it pays to go through them well before any potential sale to ensure that your numbers will hold up to the rigors of an audit or other intense scrutiny during due diligence.
DIFFERING VIEWS OF THE BUSINESS
In addition to potentially inaccurate financial statements, another reason for differing perceptions of value is how the buyer and seller view the business. Sellers would do well to consider valuing the company from two perspectives: that of a financial buyer, who is evaluating the business as a stand-alone investment with no anticipated synergies, and that of a strategic buyer who may see additional value due to synergies such as acquiring a competitor’s customer base.
DETERMINING A REALISTIC VALUATION
In each case, a realistic valuation of a company should be determined early on. The seller should have made decisions about the asking price and terms, the expected price and terms, and the walk away price and terms. These decisions should be made before getting caught-up in “deal fever.”
PICTURE THIS SCENARIO:
An investor approaches a business owner with an attractive offer to buy the business. There is an initial meeting and general deal points are discussed. A rough outline of the terms is sketched out on the proverbial napkin and the parties shake hands leaving the owner thinking they have a deal subject only to a few details to be worked out.
Then the investor starts with due diligence. It begins with a few questions trickling in. Then the first round of answers leads to new questions, and the trickle turns into a stream, and then a torrent. Spending so much time responding to questions diverts the company management away from its primary responsibilities. The investor becomes frustrated with the delayed responses and with the incomplete or contradictory information. The owner is frustrated by the amount of time and effort that is being used and may perceive the questions as signaling lack of trust or commitment from the buyer.
If the buyer is serious and likes the responses to the initial questions, then a team of advisors, including lawyers, CPAs and auditors, may come in for an even more comprehensive set of demands for information. The company undergoes even greater stress, and tensions increase. Under these circumstances, it is not unusual for negotiations to break down, and what could have been a good deal turns into no deal at all.
AFTER THE PROVISIONAL OFFER
Most due diligence is done after a potential buyer makes a provisional offer. The due diligence process then begins, often with a very short timeframe for the seller to respond.
A COMPLEX TRANSACTION
Selling a business involves a potentially complex transaction or series of related transactions. Unlike the sale of say, commercial real estate, selling a business involves significantly greater advance planning and hard work ahead of time for the seller. In the next series of posts, we’ll discuss some steps that sellers can take beforehand to make the due diligence process a little easier to navigate.