Business Broker Blog

Retaining Key Employees During the M&A Process

You've negotiated a great deal for your company. You're happy, the buyer is happy and it's a win-win situation on its way to the finish line. Then a key employee quits and the deal comes to a screeching halt. The buyer wants to renegotiate and the deal that seemed so sweet suddenly turns sour. But that is not all. This kind of loss can turn a star employee into a formidable competitor. But bonus plans and other incentives can motivate key employees to stay and help reduce the odds that this common M&A mishap will happen to you.

Companies increasingly are using bonus plans to retain vital staff through transitions and help motivate continued productivity after a merger. Common bonuses include:

Retention. These "stay" bonuses typically are offered by the selling company to retain experienced and knowledgeable staff during the integration process. They usually are provided to executives but can also be used to retain other key employees, such as top salespeople or key product developers, who add value to an M&A deal.

Most retention bonuses are awarded as a percentage of salary or a lump sum amount. But they may also take the form of:

• Stock or stock options,
• Flexible working hours or extra vacation time,
• A change in responsibility, work flow or assignments, or

• A better severance package if the employee will be employed for only a limited time.

Retention bonuses typically are offered to between 5% and 10% of the employees of the overall company or division being acquired.

Project completion. This type of bonus is offered to employees assigned to specific projects that are usually short-term (between three to six months). The bonuses may constitute 5% to 20% of an employee's total compensation for work on the project. Companies might base the payout for this type of bonus on the importance of an individual's role in the project, its successful completion and possibly the customer's satisfaction.

Management by objectives (MBO). MBO bonuses are offered by employers to enable the successful completion of internal projects that might otherwise be neglected or overlooked as staff focuses on merger integration. Employees might receive a list of specific tasks, deliverables, due dates and dollar value for completing each assignment based on the company's priorities. These bonuses are built into employees' overall compensation plans, with dollar value buckets from which quarterly project assignments are made.
Assigned tasks should be able to be completed by the employee with minimal help from co-workers. Otherwise, it may be difficult to determine how much of the task was completed by the employee assigned - which could lead to disagreements, even a lawsuit.

Gain sharing. Companies wanting to jumpstart synergies following a merger might consider this bonus program in which individual employees or teams are rewarded for determining and implementing cost-savings plans. Gain-sharing bonuses can include profit-sharing and restricted stock plans - all of which tie compensation to the company's growth and profits.

Before you offer an employee a retention bonus, be sure to thoroughly assess the individual's performance and productivity to ensure he or she is worth the financial commitment and really is essential to the successful execution of your M&A deal. Also make sure that the employee is invested in the future of the company and willing to stay on board.

Paying bonuses in installments gives employees an incentive to remain as long as you need them. But you also may want to consider asking employees to sign agreements that bind them to your company for a specified time period. Clarifying their roles and performance expectations and ensuring that changes in compensation policies and processes, bonus arrangements, benefits and share schemes don't affect them adversely will also help you retain key staff.

Not all employees receive retention bonuses, but it's still important to reassure the rank-and-file workers that they're part of the team and crucial to the future success of the new organization. Early communication about the deal is essential, including the rationale behind your decision to award certain employees bonuses. A management representative - possibly from your human resources department - should be available to answer questions and address concerns about the merger and its implications.

There's no simple formula for establishing an effective retention bonus plan. So start thinking early in the sale process about how you'll keep your experienced and knowledgeable team members in place. The ill-timed loss of even one key employee could mean the difference between a successful deal and one that falls apart before you reach the finish line.

 

Business Sales - the Boomer Effect

We have all heard from multiple sources that, beginning now and for the next 15 years or so, the number of businesses for sale will increase substantially. We also know that the demographics support this since the majority of the businesses are owned by baby boomers, and the boomers are starting to retire. There are also numbers thrown around relating to this wealth transfer. A book has been written about the "$10 trillion dollar opportunity". Others claim the dollar amount to be much greater. Let's take a closer look at "the numbers behind the numbers".

Steve McNaughton and Dennis Roberts have written a White Paper for the Middle Market Investment Banking Association (MMIBA) titled "The Fabled Wealth Transfer: Urban Legend or Reality?". As one might suspect, the paper was written primarily for the middle market ($10 million to $500 million revenue companies) but in getting to the middle market the authors discuss the numbers associated with the universe of companies. According to the Federal Reserve Survey there were 350,000 companies sold in 2004 and the Survey projects that about 750,000 will be sold in 2009. So one can see that the number of businesses sold has increased dramatically. The US Census Bureau in 2002 estimate that there were a total of 5,697,759 businesses in the United States with one or more employees (some with many more) and that 79% of these businesses had revenues of $1 million or less. This leaves 4,501,229 businesses with at least 1 employee and revenues $1 million or less. It is also estimated that 70% of these businesses are owned by baby boomers so that leaves us with 3,150,860 businesses with 1 employee or more with revenues of $1 million or less owned by baby boomers. If you assume an average value of $350,000, that yields a market value of $1.12 trillion. Keep in mind that these are 2002 numbers and only companies with revenues of $1 million or less. If one used updated numbers and included all companies with revenues of $5 million or less, the market value of $1.12 trillion would increase substantially. Also, all these businesses will not be sold now, but will be sold gradually over the next 15 years or so. With any kind of growth over that period the total value of businesses sold will increase accordingly. The authors state that some economists place the total market value over the next several years of baby boomer middle market companies ($5 million to $500 million in revenue) to be over $50 trillion.

However you look at it the numbers are big! The authors do present a caveat: there will be an increasing number of businesses for sale going forward and a limited number of buyers. Consequently, business owners should strive to prepare their company for sale long before it is placed on the market.

Should you wait to sell your Business?

A few years ago I wrote an article titled "Selling your Business - why the time is now". The article related that period (late 2006) with the storm of 1991 in which 3 weather systems came together to produce "the Perfect Storm". This storm was so extraordinary that a movie was made about it starring George Clooney. In the article the 3 elements of the financial "Perfect Storm" were low interest rates, low capital gains, and the eagerness of banks to lend money. In the article I had asked many of my colleagues "how long will this last"? The consensus was "a couple of years". Well, in a couple of years we were in the greatest economic decline since the great depression. A pretty accurate forecast!

Supposing in the spring of 2008 you were thinking about selling your business. The business is doing well - good cash flow, competent, reliable employees, good relationships with vendors and customers, business growing, etc. You're a bit burned out, you would like to try something else, or you're close to retirement age and you would like to do some traveling.  But you've got some ideas on how to increase the value of the business and you think "If I hang on for another year I can increase the value of this business by X%" and so that is what you decide to do. In a few short months you realize that it was a bad decision.

The recent recession was an event that you had no control over. Other events that you have little control over are death and disability. Even divorce has been known to happen quickly. What else can happen? You may not have the energy and enthusiasm to accomplish your goals. Your ideas may be old and are no longer pertinent in this ever-changing world. And you may not be able to implement them even though you had the energy and enthusiasm to do so. What's the name of that law that states "whatever can go wrong will go wrong"? Oh yeah - Murphy's Law! There a lot of ways that hanging on for another year could decrease the value of your business.

Where are we now? Low interest rates and low capital gains are still hanging in there. Banks' eagerness to lend is history (for now). Capital gains are automatically scheduled to increase in 2011 and it could increase sooner. Interest rates will increase as the economy improves. The financial "perfect storm" has blown out to sea!

But there are some bright spots. One is that the economy is improving. Another is that the banks are slowly becoming less rigid in their lending policies. Also, there are many buyers who have experienced corporate downsizing or corporate burnout (tired of airports) and they are looking to settle down with their own business. And interest rates and capital gains remain attractive (for now).

So is this the right time to sell your business? Only you can answer that. But if you feel that the business needs work before you can sell (i.e. you need to increase sales) - make sure that you have the energy to get the work done. If you've lost the enthusiasm you used to have for the business, it could be worth less a year from now. If your gut tells you it is time to sell, then it probably is time to sell.

Price Negotiation - a Rocky Road to Travel

For every lower middle market M&A negotiation between buyer and seller the perceived value of the company and the ultimate price paid for the company travel a rocky road to deal consummation. In its initial stages value can be pulled out of thin air, especially by the seller. "I know someone who sold his company for $$ and his company is a lot like mine." Or, "companies in my industry are selling for X times revenue". Buyers usually have a more analytical approach although their perception of value can be quite different depending on whether they are a financial buyer or a strategic buyer.

From these initial perceptions, the rocky road may continue to an informal valuation.  This can provide an estimate of value by using some, but not all, of the techniques that a professional valuator would use. This is typically performed by an advisor or business intermediary.

Most deals move to a formal valuation of the company prepared by a credentialed business valuation professional. A professional has the intention of providing an independent, objective opinion of value using methods and procedures accepted within the valuation industry.

The seller and the intermediary continue discussions relative to the asking price. This is influenced by the market value determined by the formal and informal valuations; what the seller would like to get; the bottom-line price that the seller would accept; and finally, an asking price that they feel comfortable with.

The buyer, on the other hand, is doing his own analysis. This is usually based on free cash flow or some other earnings metric. The deal then moves further down the road:

 The buyer makes an initial offer which may or may not be accepted by the seller

 The price is negotiated subject to due diligence.

 Due diligence may unearth information that results in an adjusted price

 The final transaction price subject to contingencies and earn-outs.

 The final transaction price after all contingencies and obligations have been met.

There's usually another party involved in the process - the funding source. Prior to closing, the funding source(s) may evaluate the proposed purchase price package and compare it to their concept of value as part of their evaluation of the risk and funding terms of the financing to be provided.

Smaller transactions (under $1 million) will typically go through an abbreviated version of the process described above. Regardless of the size of the deal, the road to the consummation of the transaction is rarely smooth!

Who will buy your Company?

An important element of Exit Planning is making an educated guess as to who will buy your company. Transaction value typically determines the type of buyer. Anything over $3 million in transaction value usually eliminates the individual and first time buyer. That leaves corporations and private equity groups (PEGs). Let's take a closer look at these 3 types of potential buyers:

Individuals - these are usually corporate people who have been downsized or simply want to be in charge of their own destiny. Financing is a huge issue here as is the appropriate industry experience of the buyer. At this point in time, some seller financing is a must. Another factor is that many prospective individual buyers are "tire kickers" and will never buy. Others are reluctant to "pull the trigger".  It's important to have these buyers submit a personal financial statement and a resume before they can be considered serious buyers. A lot of time can be wasted dealing with individual buyers if they are not properly screened.

Corporations - these are usually strategic buyers, looking to expand geographically or looking to add to their product line so that they can sell more products and services to their customer base. Corporations usually have one or more people assigned to acquisitions, depending on the size of the company. Their due diligence is quite intense, but they can make decisions rather quickly. Financing is still an issue but not as much as with an individual buyer. Some seller financing may be necessary, but again, not as much as with an individual buyer.

Private Equity Groups - Whereas corporations are typically strategic or synergistic buyers, Private Equity Groups (PEGs) are financial buyers.  They are looking for a return on their investment (ROI) based on operating profits and the eventual sale of the business. PEGs are usually looking for companies with revenues of at least $5 million and EBITDA of at least $1 million. If the PEG is looking to acquire an add-on to an existing platform company, it may be interested in acquiring a smaller company.

Once you've made an educated guess as to the type of buyer that may buy your company, you need to determine what they are looking for in your company. Your ability to identify these areas early on in the exit planning process will give you the time to improve them in order to maximize the company's value in the eyes of the prospective buyer.

Value = Increased Cash Flow / Risk

If you took an Electrical Engineering course in college, you probably remember (vaguely!) the voltage formula V = IR. Well, a good basic formula when thinking about increasing value in your company is V = I/R. V is value of course. I stands for "Increased Cash Flow" and R is "Risk". Since Risk is the denominator in our formula, decreasing Risk increases Value. Let's take a quick look at each of these elements.

When thinking about increasing cash flow the first thought that comes to mind is to increase sales. But be careful you don't go after low- or no-margin work in an effort to simply increase volume. If your gross margin dips below the industry average you will hurt your company's value. Also - watch your expenditures. Clean up your P&L and eliminate any unnecessary expenses. The most likely valuation of a profitable private company involves the capitalization of cash flow; so every dollar saved on your P&L equates to two to four dollars (or more) of value in your company.

To decrease risk you'll want to put yourself in the shoes of a potential buyer of your company. What would you want to see if you were looking at your company for the first time? First, you will want to have updated information systems, including up-to- date accounting software such as Quickbooks. Second, make every effort to maintain a diversified customer base. Customer concentrations for any single customer of greater than 25% can drag down value. Finally, make sure that you the owner are as separable from the company as possible. Train managers or key employees and delegate as many duties as you feel comfortable to these employees. A business is difficult to sell if the owner is too embedded in it.

If you do a little each day to increase the cash flow and decrease the risk of your company you will be sure to increase its value over time.

Deal-Making - What does the Future Hold?

The big M&A deals get all the visibility and we're starting to see some activity at the top of the business pyramid. But there is more deal-making going on beneath the radar screen. Buyers and sellers of small and medium sized companies have begun to stir, and indications are that this activity will continue to accelerate. The consensus among experienced business brokers and M&A advisors is that 2010 will be a very good year for deal-making. Many brokers had deals go south because the buyers were unable to get financing. But the sellers are still their clients and they are hopeful of getting a deal done in the foreseeable future. The climate for deal-making is certainly improving and there are many reasons for this:

 Pent-up Demand - typically, following a recession there's a pent-up demand for goods and services. Purchases were put in a holding pattern. This is also true with business transactions. This process was amplified by the depth of this recession, the worst that most of us have experienced.

 Baby Boomers cashing out - It's been estimated that the next several years will see the largest transfer of wealth in the history of the country. Boomers retiring or just burned out will be transferring ownership of their businesses. It's estimated that the number of businesses for sale will double in the coming years.

 Technology - Rapid technology advances are driving consolidation. In distribution, for example, the profitability of individual companies depends on Inventory Management and Order Fulfillment. In the last ten years productivity has increased by 40% because of technology. Smaller companies that don't have this technology will be acquired by companies that have the technology.

 Foreign Buyers - there's been a steady increase in the number of foreigners buying American companies. British, French, and oil-rich Middle Eastern countries in particular have been aggressively buying American companies.

 Private Equity Groups - most Private Equity Groups (PEGs) have been in a holding pattern for the last couple of years and they are loaded with cash. Investors are beginning to apply pressure to these PEGs to do some deals after a long hiatus.

 Credit Availability - Credit is easier to come by now although restrictions are tougher than they were a couple of years ago. The covenants are tighter and the requirements for a business loan are stricter with commercial banks. The SBA has lifted its limit of $250,000 for goodwill and some fees have been reduced or eliminated. However, the SBA is stricter relative to the experience requirements of the buyer.

Because of the recession, many corporations have downsized and become lean and mean. Consequently, there are potential buyers with business experience and money looking for businesses to buy. That, coupled with the businesses that will be available for sale, should mean a significant increase in deal-making in 2010 and beyond.

 

Exit Planning - What to do

At some point in time every business owner will exit his/her company. Most owners do little or no planning for one of the most important events in their life. Why is this? Most owners are just too busy with day-to-day operations and they are just not aware of the vital importance of Exit Planning. Business owners need to build and shape their company in order to attract the best buyers. So Exit Planning needs to focus on these key areas:

• Maximize your company's value - There are obvious things like increasing earnings, increasing the demand for your products and/or services, and fine-tuning the company's infrastructure. Be sure to understand your business strengths, weaknesses, opportunities, and threats.
• Minimize taxes - The tax issue plays a huge role in the ownership transfer of your business. Be sure you elect the appropriate legal entity and corporate structure so you can avoid costly taxes.
• Facilitate due diligence - Due diligence is one of the important steps in the exit transaction process. It is when the business buyer has the right to inspect the business and test every representation. If it goes smoothly, it can expedite the process. If not, it could cause a buyer to re-negotiate the price and terms or, worst-case, it may un-ravel the deal completely. Proper Exit Planning ensures that the critical information is accessible, and accurately reflects the true condition of the company's sources of income, assets and liabilities.

• Ensure the survival and growth of the business - Exit Planning helps prepare the business to ensure the key assets are easily transferred, key employees are retained, and the revenues and earnings are sustainable post transaction. The higher the buyer's level of confidence that the revenues and earnings are sustainable and transferable, the more they are willing to offer for the business.

When do you start the process? Generally, the sooner the better, even if you are two or three years away from exiting your company. Exit Planning will put you on the right track to maximize the value of your business. To start the Exit Planning process, you need to assemble a team of advisors including:

• Attorney - The attorney should have experience in business transactions. An attorney will also be called upon for estate planning, tax planning, pre-transaction due diligence, etc. Consequently, it is best to work with a law firm that has expertise in all of these functions.
• Accountant - The Accountant or CPA not only generates your financial statements and prepares your tax returns, but also ensures that your accounting is done under Generally Accepted Accounting Principles (GAAP). Your CPA can suggest the appropriate level of financial reporting to attract the highest quality buyer, should your statements be Compiled, Reviewed, or Audited.
• Wealth Management Advisor - The net worth of many business owners is concentrated in the business. When ownership transfer occurs, the equity that the owner had in the company has been transferred to a more liquid form (cash, stocks, etc.) and needs to be managed according to the owner's needs and wants. A Wealth Management Advisor will help plan your financial future.

• M & A Advisor - The M & A Advisor is your link with the buyer community. He/she should be able to evaluate your company and determine how it aligns with buyer criteria, and suggest ways to increase the value of your company. When your company is ready, the M & A Advisor can advise how to properly document the company to attract the best possible buyers. The best buyers may be public or private corporations looking for strategic or synergistic acquisitions, or financial buyers such as private equity groups looking to re-capitalize the company for growth.  The M&A Advisor will package and market your company to the buyer community. During this deal-making process the Advisor will screen buyers for confidentiality, financial and business viability, evaluate offers,  negotiate letters of Intent, and help facilitate due diligence and the closing process.

It is difficult for most business owners to allocate time to think about Exit Planning. Most owners are optimistic, busily planning for the future growth of the company and dealing with day to day challenges. By selecting the right team of advisors, the business owner can properly prepare their business without wasting valuable time. In the end, with proper planning, they'll be able to complete the sale of their business with the best buyer in the market at the best value and terms.

6 Ways to Increase Business Value

When a strategic or financial buyer invests in a company, they are in essence investing in a stream of future cash flows. At the end of that stream of cash flows comes the "terminal value" - the last big cash flow from their eventual exit event. Naturally buyers will want to minimize the risk that they won't receive those future cash flows. The more you can reduce a potential buyer's risk, the greater your company will be worth. So what can you do in your company to reduce that risk? What could potentially happen that could negatively impact profitability and what can you do to mitigate that risk? Here are a few things you can do:

1) Diversify your customer base. Having more than 25% or so of revenue coming from a single customer is a big risk.

2) Separate yourself from the company as much as possible. Easier said than done especially for small companies - but the less integral the owner is to the operations of the company the lower the risk to a new owner.

3) Groom management and offer key employees "stay bonuses" so they are incentivized to stay with the new ownership.

4) Contracts with key suppliers and customers can ensure that those relationships transfer to successor ownership.

5) Manage your assets. Make those necessary ongoing "maintenance" capital expenditures so that your equipment isn't out of date and in need of replacement ahead of schedule.

6) Financial statement accuracy. Ensure that your accounting system is up to date and have financial statements prepared annually by your accountant. Reviewed statements are better than compiled - and some buyers may even require audited statements. They may cost more but the perceived reduction to risk in the eyes of the buyer will almost certainly increase the value of your business enough to more than cover the cost of the audit.

These are just a few of the many ways you can reduce risk in your business. The more you can focus on risk reduction the more your business will be worth.

Exit Strategies: How Business Owners can Prepare for a Sale

Every business sooner or later will be sold or transferred to someone else. Whether that someone else is an insider (e.g., a family member or key employee) or an outsider, certain steps can be taken to ensure that the transfer achieves the goals of the business owner. This process is known as exit planning. Unfortunately, the majority of business owners do not take the proper steps to maximize the proceeds they'd receive upon the sale of their company and/or achieve their overall objectives.

Set goals for yourself

You may have put together a business plan when you started or acquired your business, but how often have you updated it? I'd recommend that you annually sit down and reevaluate your strategic plan for yourself and your business. Project the business three to five years into the future. Will you be entering new markets or introducing new products?
Also, how do you see yourself transitioning out of the business? Will you sell to a third party or keep the business in the family? Do you plan to retire upon exit or will you be starting a new career or buying another business?

Assemble a solid team

There are numerous professionals involved in successful exit planning, many of whom are probably your current advisers. Your team should include: attorney; accountant; wealth adviser; mergers and acquisition adviser/business broker; insurance professional; and any other trusted advisers. Each of these professionals brings vital skills to the table.

Watch your expenditures

Be careful where you spend your cash. Clean up your income statement and eliminate unnecessary expenses. The most likely valuation of a profitable company involves the capitalization of a company's cash flow; so every dollar saved on your P&L equates to two to four dollars of value in your company.
Also, make sure that you earn a good return on investment on capital expenditures. Put yourself in the potential buyer's shoes - what about your company is valuable? Make sure the capital and time you invest in the company enhances that value.

Make sure your information systems are up to date

Owners and managers should have systems in place so that information received is timely and accurate. These systems need to be transferable to the buyer. While a spreadsheet of financial data may work for the owner, would a new owner be able to understand it? Bookkeeping should be performed using standard accounting software such as QuickBooks. The same goes for any other system in the business - if the industry standard is to have certain software to handle inventory or project management, then the company should have that software in place.

Management and/or trained employees in place

A business is difficult to sell if the owner is too embedded in it. A buyer will want to be able to step into the business and take over from as close to Day 1 as possible. (Often sellers stay on for a finite transition period after the sale.) Talk to members of your exit planning team regarding creative ways to create incentives for key employees to stay.

Manage the relationships with customers and suppliers

Your goal in selling to an outside party is to minimize the perceived risk of buying your company. A key component to this is customer diversification. If any one customer comprises greater than half of your revenue, you're at risk of that customer leaving and inflicting a potentially mortal blow to your business. The same risk exists if any one supplier of a key material or service has too much power.

Perform pre-transaction due diligence

Review with your advisers all of the items a potential buyer would want to review, including contracts, leases, equipment lists, etc. Additionally, you'll want to ensure that you have up-to-date financial statements from the last three to five years available, prepared by your CPA. It may make sense to pay for more in-depth financial statements such as reviews or even audits if your company is large enough. Lastly, make sure that these items, as well as any potential "skeletons in the closet" are documented and presented to the buyer. Obviously, if the skeletons can be removed then do so, but definitely make sure that a buyer isn't surprised. That could kill the deal.

These are certainly not the only things you can do to ensure a smooth exit plan. Most of all, heed the advice to hire professionals to assist you. With the right help, you greatly improve the odds of achieving your goals!