Archive for Things to Avoid

Why Owners Fail To Maximize The Value Of Their Companies

Here are five reasons why business owners fail to maximize the sale value of their companies:

  1. They do not have a solid understanding of the current value of their business in the market;
  2. They do not clearly articulate the acquisition rationale, have inadequate documentation, and are not prepared to undergo the intensive due diligence process that forms a crucial step in the acquisition process;
  3. They failed to identify and engage with buyers who will pay a premium for the company;
  4. They fail to structure a transaction that minimizes risk and maximizes their total cash consideration; and
  5. They sell their company at the wrong time.

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Common Errors Business Owners Make When Selling Their Business

Two popular sayings come to mind when I think about the common (recurring, repeated) mistakes that I see entrepreneurs make when they are think about selling their business.  These are “Time is Money” and “Great businesses are bought, not sold”.  I agree with the first saying and disagree with the second.  Let me explain.

With few exceptions, time is your enemy when you are selling your business.  Stretching out a process opens you to unexpected negative economic events that at the very least can have a negative impact on valuation or even put a halt to the process; causes concern and uncertainty among your employees; gives key employees an opportunity to find alternate employment; gives competitors an opportunity to spread rumours or go after your customers; causes uncertainty with customers who become concerned with continuity of supply or services; and provides the prospective buyer with more time than is desirable to look under the covers of your business.

In terms of the second saying, I am a firm believer that great companies are sold and not bought. While I agree that the best time to sell your business is when someone wants to buy it, a business owner has to be prepared to maximize the value of any transaction by “selling the business”.  A very simplistic comparison would be that of selling your house.  You would never consider putting the “For Sale” sign on the lawn without first cleaning, organizing, and prepping the house and property. Or, when you go to buy a new car you often find yourself paying for all of those additional options or add-ons that unexpectedly cause the price to go up by 25%.  You went to buy but you got sold!  Selling your business is comparable, albeit on a much larger, complex and important process.

So let’s take a look at some of the common errors entrepreneurs make when they go to sell their business.

  1. Lack of preparation – why you have to control the process/timing of your sale

Despite the fact that selling one’s business is an extremely important event and something that entrepreneurs think about often, it continues to amaze me that these same extremely successful businessmen or women fail to prepare for what is likely the most important event in their business careers. Selling a business takes preparation, time, and considerable resources.  In order to maximize the value of the sale, the company should be prepped, prepared, and polished.

Failure to prepare NEVER has a positive impact on the value an entrepreneur receives for their business.  Whether they are approached with an unsolicited offer for the business or they decide to proactively seek out acquirers, a lack of preparation leads to time delays or questions about the quality of management reporting systems or unexpected and inopportune demands on staff resources.  Failure to be prepared can result in the company not being in a position to respond quickly to an offer and the potential buyers lose interest or the length of time it takes to complete due diligence is extended, thereby adding event risk or that management will simply get deal fatigue as the process drags out.

  1. Not being fully engaged or ready to sell

Entrepreneurs, founders, and CEOs work so hard to build successful businesses that often they come to view the business and themselves as being one and the same.  While it can be quite easy to see the sale of their company as a business transaction, many important post-sale life issues have not been fully thought through.  Sometimes, these issues have a way of rearing their ugly head as the probability of selling the business and becoming the ex-owner or ex-CEO increases.  Status, industry membership, peer opinion, a lack of outside interests, and many other personal and business issues have a way of playing a role in the decision process.

It is important to understand that once the process of selling one’s business begins, it is very difficult to simply call off the process without impacting the business.  The last thing you want for your company is to be seen starting a sale process and not completing a transaction.  Rightly or wrongly, the company appears to have been “shopped” and questions arise as to why it could not attract a buyer.  Competitors may attempt to use news of the sale or lack thereof to their advantage, customers may become concerned about continuity of services or supply, suppliers may wonder if your firm is in financial distress, and employees become concerned about future employment.  These and other concerns are usually easily addressed with forethought and preparation and, if handled properly, should have no impact on the value of your exit.

So before you make the final decision to move forward with the sale of your company you should take the time to answer a number of serious questions including:  How much of your self-worth is wrapped up in the business and what are my plans following the sale?   While these may sound like trivial issues with simple answers like “I’m just going to golf,” in most cases it’s just not that simple.  I’ve seen a founder walk away from a lucrative offer because he was concerned about what his peers might say, only to realize three years later that he left millions of dollars on the table.  Yes, that’s right, and within months of walking away from a very rich offer the company’s largest supplier decided not to renew their exclusive distribution contract and began to sell direct.  Revenues declined, management scrambled to find a new supplier, margins contracted, the company went into a downward spiral and was eventually sold for a fraction of the original offer.

  1. Not understanding the amount of time and resources it takes to go through the process

Selling a business can be a long and demanding process, taking anywhere from six to 18 months.  Sellers need to understand the amount of effort that it takes to prepare and market a company in order to maximize sale value. During that time the owner will be required to spend time and money and allocate important management and employee resources to the process, particularly when the potential acquirer moves into the due diligence phase. A good banker will manage the process in a manner that minimizes requirements on the business owner’s time during the early phases of the process but eventually the owner will be required to take an active role in due diligence and discussions   The key is to understand the process, resource requirements, and, most importantly, operate the business as aggressively as possible throughout the process to ensure that revenues and profitability continue to grow.

  1. Not having all agreement among all stakeholders

Prior to commencing a sale process, it is of utmost importance that all stakeholders are in agreement on key items related to timing, valuation, desired terms and conditions, and ultimate deal structure.  Failure to come to a common agreement can be disastrous for the sellers as multiple agendas, internal negotiation and shareholder’s acting in their own self-interest looking to extract more value for themselves delay or even scuttle the process.  In particular, addressing these issues and coming to agreement is particularly important in partnerships and companies that have institutional shareholders such as venture capital or private equity investors.

An additional topic of discussion and agreement relates to a situation where the sale transaction includes an earn-out component and not all of the active partners in the business will be remaining with the company post-acquisition.  The partners who remain with the Company and are responsible for achieving the earn-out milestones from which all partners will benefit in receiving the contingent payout sometimes look to the departing partners to compensate them for their ongoing tenure and performance.  While this issue does not arise in all cases, it is important to address it early as leaving this discussion to the later stages of the sale process can be disruptive.

  1. Trying to time the market

Of course, every business owner wants to time their sale transaction to ensure that they have maximized the value of their business.  For the seller this usually means selling the business when every last dollar of revenue has been maximized in order to ensure that they get paid for all of their hard work.  In reality, this probably means that the sale process should be initiated about 18 months before the owner wants to exit the business.

Like many investors in the stock market, attempting to time the top of the market or a company’s growth curve is difficult – often impossible – and can often lead to disaster.  Unlike the stock market, where a shareholder can sell their shares quickly, selling a private business is not so easy.  If the market turns down or regional or global economic events negatively impact the business, buyers could move to the sidelines, waiting to see what happens to market or sector valuations.  The sellers may find themselves in a position where they will have to wait through an economic downturn and recovery before buyers come back to the table and this could take two or three years.  The best time to sell your business is when revenues and profits are growing, backlog is strong, the pipeline is growing, and the timing coincides with your personal agenda or plans.  Let’s face it, buyers don’t pay premiums for companies that have peaked or are on the downward slope.

  1. Not engaging the right team

Prior to beginning a sale process, founders must decide whether or not they are going to use the services of a financial intermediary, agent, or banker to work on their behalf to manage and run the process.  The entrepreneur must also make sure that they have a lawyer who is capable and experienced in sale transactions and that their accountant is brought into the team to ensure that company and personal issues related to their area of expertise are addressed.

Since most founders have reasonably long-term relationships with their accountants and lawyers, it’s really the selection of the banker that presents the wild card.  Once you accept the fact that the sale process is going to be measured in months, you have to feel comfortable that your banker is going to maximize the value of your sale.  This may also mean that you are going to hear things that your employees will not tell you.  It’s important to remember that you’re not hiring a “yes man” but an experienced banker who has a proven track record for successfully executing on sale mandates.  While I’m not saying that you shouldn’t question and discuss their recommendations, failing to follow advice leads to problems more often than not.  If you feel you must run every decision by your father-in-law or your cousin who happens to be a real estate lawyer, it may be best for you just to handle the sale process yourself.

  1. Failing to disclose problems up front

Honesty and full disclosure is the only way to deal with the prospective acquirer of your business.  Believing that problems can be concealed from the buyer threatens the transaction, the price, and trust going forward.  Sophisticated buyers conduct extensive due diligence that will in most cases uncover these problems.  Representations and warranties agreed to in the final purchase agreement will protect the buyer from post-transaction discovery of problems and financial loss.  And the period of time that it takes to complete a transaction often leads to the problem raising its ugly head before closing.   Full and plain disclosure up front builds trust while thinking that problems can be overlooked or drip fed to the prospective buyer is a sure way to blow the sale or, at the very least, to receive a much lower price than originally offered.

  1. Putting forth aggressive forecasts as part of the sales presentation

Often, sellers believe that by presenting aggressive sales forecast to a potential buyer the value paid for their business will be increased.  We see this tendency every day when companies that have had two or three years of flat or marginal growth forecast hockey stick shaped growth over the next two years with most of that revenue growth coming three or four quarters after a sale process is initiated.  Buyers do not pay for these forecasts and often the purchase process is delayed as buyers takes a “wait and see” approach to confirm the growth.  Over-promising and under-performing in the expectation that having aggressive growth numbers will result in a higher valuation simply doesn’t fly and more often than not raises serious questions about the quality of the management team.

  1. Not having a list of “wants” and “must-haves”

Both buyers and sellers should have a pretty good idea of their “wants,” “must haves,” and their “nice to haves.”  Going into an engagement thinking that the longer the discussions drag on, the more engaged the buyer will be and the more likely they will be to make major concessions at the 11th hour seldom works.  Sellers should be able to articulate to their banker what they must have in order to successfully close the transaction.  Examples include a minimum transaction value, a minimum cash amount, earn-out conditions that are or are not acceptable, compensation, and length of employment contracts.

  1. Not being flexible around terms, conditions and structure

Having unrealistic expectations about valuation is probably the most common reason transactions don’t take place.  I like to ask the seller to put themselves across the table in the buyers seat and tell me what they would be willing to pay for the company.  In many cases, the number that the seller tells me is well below what they are asking for and if the numbers are similar the rationale does not stand up to scrutiny.  At the end of the day there is only one valuation that matters and that is the amount a buyer is willing to pay you for your business.  All of the other values derived through discounted cash flow calculations, public market comparables, recently completed transactions, replacement value, or value per subscriber are used to support valuation expectations.  The final offer that is put on the table is either acceptable to the seller or it is not.  If not, then both parties simply agree to move on.

Have you done your homework to understand the range of values for your business?

How did you arrive at these numbers?

How much of the value that you are ascribing to the business depends on what the buyer brings to the business and do you have good reasons for why that buyer should pay for these results?

These are all good questions to answer as you think about the value of your business.

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Don’t Be The Last One Standing

The number of businesses and the value of assets set to hit the market during the next ten years are mind-boggling.

With many business owners having 70% or more of their personal assets tied up in their businesses, the Baby Boom generation cannot afford to delay preparation for the sale of their businesses.  There’s simply too much at stake.

In late 2012, CIBC World Markets published a report estimating that between 2012 and 2017 $1.9 trillion in business assets were poised to change hands and that by 2022 that number would explode to at least $3.7 trillion as 550,000 owners plan to exit their businesses. (1)

While it appears that the expected deluge of business sales has not taken place between 2012 and 2015, neither the companies nor the exit expectations have not gone away.

We are beginning to see more business owners in the 65+ age range ask the right questions about selling their businesses and some are moving forward.  Others are not ready to move forward for a number of reasons including:

  • Having still not recovered sufficiently from the last recession whereby their revenues and earnings can support their valuation expectations;
  • Finding the weak Canadian dollar to be negatively impacting their business,
  • Many are struggling with conflicting advice from multiple advisors;
  • Many are not ready to fully face the challenges and put forth the necessary time and resources to implement a sale process;
  • Some don’t view the current low interest rate environment as providing attractive investment returns on monies received from the sale of their businesses so they decide to just stay the course; and
  • Some simply have valuation expectations that far exceed what rational buyers are willing to pay and will never sell their businesses.

I find the game of Musical Chairs to be an interesting analogy for understanding what will probably happen when many of the Baby Boomers finally decide to sell their businesses between now and 2029.  As we all know, the first to sit in chairs win, all others lose and I’m guessing that it’s fair to surmise that there will be very few winners and a whole lot of losers.

Think of the “chair” as being the number one or two dominant industry players in any traditional business sector that have an appetite to consolidate the industry.  The first to market or the most attractive find a seat (are acquired) at reasonable prices and everyone else is left standing.  Power shifts to the buyers, acquisition prices decline, those left behind disappear.  I know it sounds dramatic and apocalyptic, but that’s just how industry consolidation takes place.

What are the options available to a seller of a business?

  • Private Equity firms will not be a viable exit for most of the companies: In 2014, there were a total of 296 deals completed by Private Equity firms for a total of $41.2 billion dollars with the top 10 transactions accounting for $26.8 billion or 65% of value.
  • Going public by way of an initial public offering, RTO, or CPC is not viable for many of the companies for many reasons including: size of business, sector, lack of liquidity, lack of sizzle…
  • Many traditional business owners are finding that their children do not have an interest in assuming or acquiring the family business.
  • Purchase by employees is a rare exit option.

So we arrive at two viable options for most of the owners: sell their business to an arms-length third party or continue to operate the business and extract value through salaries, dividends, and asset sales as they run the business to the end of their life.

For many, the latter will be the only option as valuation expectations simply are not in line with the market and there will be no offers for the business or the offers that come will be rejected.

In terms of selling to an arms-length third party, maximum value will be realized by those individuals who are well prepared, have attractive businesses with predictable revenues and earnings, are willing to consider terms and conditions on a sale that may include a vendor take-back or earn-out, have realistic valuation expectations, and are not coming to market at the same time as many similar companies in their sector.

We are currently in a sellers’ market.  Acquirers are looking to augment slow growth through acquisitions; interest rates are low, making debt financing attractive; and the weak Canadian dollar makes acquisitions attractive to US buyers.

If you’re thinking of selling your business over the next five years, now is a good time to start planning.  If you would like to understand the process for preparing your business for sale and the options that are available to you, we’re always happy to have that discussion.

(1) CIBC World Markets Inc., In Focus, November 13, 2012, “Inadequate Business Succession Planning – A Growing Macroeconomic Risk”

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