Selling Your Company
Andrew J. Sherman, Partner, Dickstein Shapiro Morin and Oshinsky LLP
Regardless of your specific motivation for selling your business, the key to the selling process is preparation. That means anticipating the questions and concerns of a prospective buyer and preparing your own financial and retirement plan so as to determine your pricing parameters.
The process begins with a strategy meeting of all members of the seller's team. The purpose of this meeting is to identify your financial and structural objective, develop an action plan and timetable, start writing an outline of the "Offering Memorandum" and identify potential legal and financial hurdles that a successful transaction would have to clear. Any problems that might "turn off" a prospective buyer should be considered, such as unregistered trademarks, questionable accounting practices, wasteful overhead, illegal securities sales or difficulties in obtaining a third party's consent.
The strategy meeting should develop a definitive "to do" list of corporate housekeeping matters, such as preparation of board and shareholder minutes and the maintenance of regulatory filings. The team should also identify how and when prospective buyers will be recruited, proposed terms evaluated and final candidates selected.
Selecting the Seller's Team
One of the first and most important steps in the preparation process is the selection of a team of advisors. These professionals not only provide assistance for the sale itself, they also help the seller develop an Offering Memorandum that summarizes the key aspects of the company's operations, products and services, personnel and financial performance. In many ways, this Offering Memorandum is akin to a traditional business plan, and serves as both a road map for the entrepreneur and an informational tool for the company buying your business.
When selecting members for the team, choose people who:
- know the company, its history and founders
- understand your motivation, goals and post-closing objectives
- are familiar with trends in your industry
- have access to a network of potential buyers
- have a track record and experience in mergers and acquisitions with emerging growth and middle-market companies
- have expertise with the financing issues facing prospective buyers
- know tax and estate-planning issues that may affect you and your company, both at closing and beyond.
At a minimum, the team should include the following members:
Financial Advisor or Investment Banker. Counsels the seller on issues affecting valuation, pricing and structure, and helps to identify and evaluate prospective buyers. Multiple offers may have both different structures and different consequences for the seller, so a financial advisor can suggest how to evaluate each proposed transaction.
Certified Public Accountant (CPA). Assists in preparing the financial statements and related reports that buyers request, and explains the tax implications of the proposed transaction. The CPA can also assist in estate planning and structuring a compensation package for the seller, in order to maximize the benefits associated with the proposed merger or acquisition.
Legal Counsel. Lawyers representing a business being sold take on a wide variety of duties. The attorney is responsible for assisting the seller in pre-sale corporate "housekeeping," which involves the "clean-up" of corporate records, developing strategies for dealing with dissident shareholders and shoring-up third party contracts. The attorney also works with the financial advisor, advising the seller how to evaluate competing offers; assists in the negotiation and preparation of the letter of intent and confidentiality agreements; negotiates definitive purchase agreements with buyer's counsel; and works with you and your CPA in connection with certain post-closing, tax and estate-planning matters.
Conducting the Legal Audit
To get the company ready for the buyer's analysis and due diligence investigation. a pre-sale legal audit should be conducted. This review assesses the "state of the union," identifying and predicting the problems that the buyer and its counsel are likely to raise. The legal audit should include corporate housekeeping and administrative matters, the status of your company's intellectual property and key contracts (including issues regarding their assignability), regulatory issues and any pending or possible litigation. The goal is to find the "bugs" before the buyer's counsel discovers them for you (which would be embarrassing as well as costly from a negotiating perspective) and exterminate as many as possible before starting negotiations.
For example, now may be the time to resolve any disputes with minority shareholders, complete the registration of copyrights and trademarks, deal with open issues in your stock option plan or renew or extend your favorable commercial leases. It may also be a good time to get a prompt response from third parties whose consent may be necessary to close the transaction, such as landlords, bankers, key customers, suppliers, or venture capitalists—because there are may be provisions in a company's contracts that prevent an attempted "change in control" without third-party consent.
As part of the legal audit, it also may be necessary to change certain sloppy or self-interested business practices before you sell your company. This strategic re-engineering will help build value and remove unnecessary "clutter" from your financial statements and operations. The legal audit should include an examination of certain key financial ratios such as debt-to-equity, turnover and profitability. The audit should also look carefully at the company's cost controls, overhead management and profit centers to ensure the most productive performance.
Don't try to hide anything under the carpet. Explain the status of any remaining problems to the prospective buyer, and negotiate and structure the deal accordingly. Even if you don't have the time, the inclination, or the resources to make improvements, it will still be helpful to identify these areas and address how the company could be made more profitable to the buyer. The potential for better long-term performance could earn you a higher selling price, as well as help the buyer company raise capital it may need to implement the transaction.
Preparing the Offering Memorandum
Your marketing strategy to attract prospective buyers for your company should include developing a set of criteria that constitute a profile of the "ideal" buyer. Then, determine how and when your company will go about identifying and meeting with potential buyers. Finally, draw up the initial set of materials that will be given to potential buyers and their advisors. These initial materials are often referred to as the Offering Memorandum.
The Offering Memorandum should include the following information:
- Overview of the company for sale
- Description of its key products and services
- Description of its management team and organizational structure
- Summary of your company's financial performance to date
- Schedule of key customer relationships and intangible assets
- Key hurdles (if any) to accomplishing the sale
- Supplemental materials.
As you know, when offering anything for sale—from single products to an entire company—you must present the information truthfully and attractively. In drafting the Offering Memorandum, you must resist the temptation to paint an overly attractive picture or fail to disclose key problems or challenges looming in the company's future.
Rectifying Your Mistakes
Take a look at some of the common mistakes entrepreneurs often make when getting ready to sell their company. The most frequent ones are impatience and indecision. Timing is everything. If you seem too anxious to sell, buyers will take advantage of your impatience. If you sit on the sidelines too long, the window or market cycle to obtain a top selling price may pass you by.
If you tell key employees, vendors or customers too early in the process that you are considering a sale, they may abandon the relationship with your company, in anticipation of losing their jobs or contracts or out of fear of the unknown. Key employees may not want to risk relying on an unknown buyer to honor their salary or benefits. Yet these key employees and strategic relationships may be items of value that the buyer is counting on to be there after closing. If you wait too long and disclose at the last minute, employees may resent being kept out of the loop. Key customers or vendors may not have time to evaluate the impact of the transaction on their businesses or, where applicable, provide their approvals.
Eliminate third-party transactions with relatives, when those relationships would not carry over to the new owner. Shed ghost employees and family members on the payroll who will follow you out the door. Also, buy up minority shareholder interests so the new owner won't have to contend with their demands after the sale.
Enhancing Your Chances
When a publicly-held company that files reports with the SEC is sold, recasting the company's financial statements is usually not necessary, except possibly for strategic reasons. However, since privately owned companies often tend to keep reported profits, and thus taxes, as low as possible, financial recasting is a crucial element in understanding the real earnings history and future profit potential of your business. Buyers are interested in real earnings, and recasting shows how your business would look if its philosophy matched that of a public corporation in which earnings and profits are maximized.
In presenting the complete earnings history of your company, recast your financial statements for the preceding three years. For example, adjust salaries and benefits to prevailing market levels (not overinflated). Eliminate expenses that are avoidable, unusual or non-recurring, such as personal expenses, country club dues and expensive car leases. Recasting presents the financial history of your business in a way that buyers understand. This gives sophisticated buyers the means and opportunity for meaningful comparisons with other investment consideration. It is key for translating your company's past into a valuable, saleable future.
The price a buyer may be willing to pay for your company also depends on the quality and reasonableness of profit projections that you can demonstrate and substantiate. To establish your proforma, the profit and loss statement, balance sheet, cash flow and working capital requirements must be developed and projected for each year over a five-year planning period. Using these documents, plus the enhanced value of your business at the end of five years, calculate the discounted value of future cash flow. This establishes the primary economic return to the buyer on the acquisition investment.
Pre-qualify the Acquiring Company
Before selling your company, it is critical to pre-qualify your buyers, especially if the deal provides for a continuing business relationship after closing. The buyer must demonstrate its ability to meet one or more of a series of pre-closing conditions, such as availability of financing. Take the time to understand the acquiring company's post-closing business plan, especially in a roll-up or consolidation where your "upside" will depend on the buyer's ability to meet its business plans and growth projections.