Business Broker Blog

Stay and Grow or Sell and Go?

There is a saying among business purists that you should run your company "as if you're going to sell it tomorrow". In other words, have all your customer, vendor, & employee contracts in place, train your employees so that you're irrelevant, streamline your systems and workflow and, most importantly, maximize your cash flow.

But what if you're in the early stages of a high growth period and you want to invest in the resources to achieve that high growth.  How do you pay for it?  Debt is expensive assuming you can find it and it ends up as a liability on your balance sheet. Equity funding is very hard to find for a small company. The legal fees, compliance, and investor presentations can be costly and time consuming and you also have to give up a percentage of your company ownership.

So what other option is there? What about cash flow, assuming that it's sufficient to cover the needed resources? But doesn't that decrease the value of your company in the short term? Yes, in most cases (In some special situations, using the discounted future cash flow method of valuation, it may not. However you need the right buyer to accept your assumptions).

So using cash flow to fund growth in the early stage of a company may be the best option. But what if you've grown your company to the point where reaching the next plateau requires a huge cash infusion to obtain the necessary resources?  What if you realize that you don't have the necessary management skills to make it happen?  What if you're reaching retirement age and you don't have the energy required? Or you're just getting burned out and you want to do something else?

This is where Exit Planning comes into play. I'm not talking about the type of Exit Planning that takes place about 5 years before you exit and requires a cadre of advisors. The Exit planning that I'm referencing should take place 1-2 years (preferably 2) before you exit the company and its sole purpose is maximizing the value of the business. The cardinal rule here is "don't invest any money in the business that a prospective buyer wouldn't". At this point your goal is to have cash flow as high as possible. Assuming that the other parameters mentioned above are in place, this should maximize the value of the business.

For another slant on this subject, refer to my blog titled "Strategic Planning - a Business Owner's Story".

Clean up Your Books if You Want to Sell Your Business!

This should be obvious but I come across this time and time again. I guess if the small business owner is not financially savvy - and usually they are not - they focus on what has made them successful and skimp on the accounting. But this is a mistake. Take the time to set up your accounting and spend some time with your CPA so you know what you are looking at. Do this early in your business lifecycle. Like any small business owner, I'm sure you'll want to expense as much as you can so you minimize your taxes - just make sure you can identify those items that are discretionary (e.g. Not absolutely necessary to the operation of the business) so they can be segregated later.

It is amazing how some business owners are able to bury their profitability so deep in their financial statements that no one can find it. This doesn't just apply to those "cash" businesses with revenues of $200K a year either. I recently analyzed (I suppose "analyze" is what I was doing as I tried to make sense of them) a company's financial statements - it was a nice niche distributor with over $3 million in annual sales. I looked at every expense line item in Quickbooks and I couldn't find more than $80K in cash flow (discretionary earnings including the owner's salary).  Granted there are plenty of companies with marginal profitability - but I know this isn't one of them. (And not just because of the vehicles the owner and his wife are driving.) I'm just having a hard time with finding the earnings. I'll take it to a deeper level and I'm sure I'll find them, but then we have to convince potential buyers that the company is worth what we say it is, which is that much harder because of the poor quality financials. SO:

1. Clean up your financial statements. Set up a logical Chart of Accounts and keep it consistent year after year. Segregate discretionary expenses.
2. If you are big enough, have your CPA prepare compiled, reviewed, or even audited statements. These are progressively more expensive but can be worth it during the 2-3 years leading to your planned exit.
3. Contact us or another qualified Business Brokerage or M&A Advisory Firm if you have any questions.
   

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.

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.