Business owners devote their lives to the successful growth of their companies and what is likely the most significant asset to support their retirement. Yet, in the final stages of ownership, some owners do not take the necessary steps to plan a sale and to maximize the value of their company and life’s work.
The following discussion will cover common investments a business owner can make to realize a higher value in a sale to a third party, how the sales process progresses and the different parties that are involved, and other considerations regarding multiples of earnings before interest, taxes, depreciation and amortization (EBITDA), which is how a transaction is generally referenced.
There are several factors including size, geography, and profitability that determine whether a business can be successfully marketed, but assuming a business has reached this stage there are other investment considerations that can impact a transaction price, including the following:
Implementation of Enterprise Resource Planning (ERP) Software
A successful ERP implementation will integrate all platforms used to manage a business. This investment prepares a business for the future and creates an opportunity to streamline business data and processes from personnel across all departments to drive successful future decisions. Buyers seek this level of sophistication in acquisitions to easily manage a possible investment.
Development of an Executive Level Management Team
There is no doubt that a business owner’s passion and dedication to his or her business are critical factors to the success realized thus far, but has the owner put in place a team that shares that passion and dedication and can run the business in his or her absence? If yes, this supports certain add-backs to EBITDA that will increase the sale price, but also adds flexibility in the timing of the sale.
Preparation of Internal Financial Statements in Accordance with Generally Accepted Accounting Principles (GAAP)
GAAP MATTERS! Businesses focus on operations and often do not invest in building out a robust financial team that can produce accurate monthly or annual financials. Buyers will perform due diligence on the financial records and are likely to engage a third-party accounting firm to perform a buy-side quality of earnings (discussed below) that will identify errors in reported EBITDA. The key here is to eliminate the opportunity for significant adjustments to internally reported EBITDA.
Once the company has operated for 2-3 years with the aforementioned investments in place, the next step in the sales process will involve engaging a broker and transaction advisor. This engagement depends on the size of the company’s revenues and the company’s EBITDA (certain ranges of EBITDA are more desirable for buyers).
A business broker and transaction advisor will provide guidance that may include various timing, tax, and marketing strategies. A business broker is also going to identify and solicit potential buyers. The more potential interested buyers there are, the higher the price.
How does the broker solicit buyers? Brokers will develop a teaser that includes select information from the Confidential Information Memorandum (CIM). The CIM is a much more extensive piece of marketing literature that includes financial results, adjusted EBITDA, and customer and vendor information, in addition to other relevant insights to the business that will be provided after execution of a non-disclosure agreement.
The CIM will also be supported by a Quality of Earnings (QoE) report that is generated by a third-party certified public accountant. QoE’s will provide a detailed analysis of the company’s revenues and expenses, walk through all adjustments to the company’s EBITDA, and support the accuracy of the historical accounting records and the CIM. A potential buyer will use the QoE to determine how likely it is that a company will achieve projected financial results.
Now the sales process has reached a stage with multiple buyers and all parties are comfortable with the adjusted historical EBITDA in addition to any projected financial results.
Transaction prices are commonly referenced as a multiple of EBITDA and buyers will look at multiples of similar transactions to assist in determining a possible valuation of an acquisition candidate. As a seller, it is imperative to understand that these multiples do not represent bound ranges at which to transact. A seller should be cognizant of all synergies that are created in a possible transaction and project the performance of their business under the operating model of potential buyers. If done correctly, it is possible to transact at a price that exceeds the ranges suggested by other transactions.
The topics above are pieces of understanding the sale process and planning of an exit strategy to maximize value. A deal’s transacted price and structure to a third party will be influenced by other factors as well and it is imperative to work with experienced advisors regarding one of the largest assets you hold as an owner.
For more information regarding transition planning to a third party or other methods to transition your business, please contact your local Blue & Co. advisor.