Posted by John Gledhill on Tue, Aug 25, 2009 @ 09:13 AM
If you're at all like me (e.g. not a lawyer nor aspiring to be one), legal sounding words like "Due Diligence" go in one ear and out the other. You will, however, become intimately familiar with those dreaded words when you sell your company. Additionally, it makes sense to become familiar with them and incorporate them into your day to day business life - just in case you do have to sell your company when you least expect to. If something were to happen that would force a sale, you will want to have all your figurative ducks in a row.
Due diligence is one of the final steps in the process of transferring company ownership to a third party. Simply stated, it is the step in which the buyer makes sure that he is buying what he thinks he is buying. At this point in the sales process, a lot of energy has been expended by both parties and a lot of confidential information has been exchanged. Despite signed non-disclosure agreements, this information can seep into the marketplace should the deal be derailed during the due diligence process. And this is where most deals are derailed.
We recommend that our clients conduct a self-assessment due diligence prior to going to market. Most buyers will be looking for similar information, so it makes sense to organize the documents providing this information in a file which you can then hand to the buyer when they ask for it. This is perhaps the best way to combat the feeling of "buyer remorse" - an efficiently prepared documentation of all aspects of the company. It also makes sense to have a file like this even if you are not planning to sell your company in the foreseeable future; just make sure that you update it at least annually.
The buyer will want to review documents in the following general areas: legal, financial, human resources, and administrative. Legal documents include all those documents executed when your company was organized or incorporated, corporate records, financing documents (both bank debt and leases), property leases, intellectual property, and any regulatory matters. All details related to lawsuits past and present should also be included. Make sure that minutes of corporate meetings are documented so you aren't scrambling at the last minute to get them done. Finally, and most importantly, make sure that you have a corporate attorney review these documents for completeness and keep them in a safe and accessible location.
Financial documents to be reviewed include detailed income statements and balance sheets describing revenues, expenses, taxes, cash, accounts receivable (and payable), prepaid expenses, work-in-process, inventory, fixed assets, intangible assets, deferred revenue, debt, and shareholder equity. Obviously you will want your CPA involved in this process. Your financial statements should be prepared by your accountant (preferably with notes attached) and she should be able to assist you in preparing projected financial statements. Projections should be realistic but aggressive enough to interest a potential buyer.
Human resources documents to be examined include: company policies, processes, and practices; group insurance; retirement plans; key employees; training policies; internal communications methods; 1099 contractors; and contracts. If you have employees you should have an employee handbook listing paid holidays, policies for sick time, personal time, vacation, etc. An HR Consultant can assist you in this increasingly complex area if you don't have the time or patience for it.
Administrative items to be reviewed include: descriptions of real estate, insurance paperwork, travel and entertainment policies, and contracts (including customer, vendor, and maintenance). This last item is of special importance because the value of the company is impacted by the transferability of the above listed contracts. Again, have your lawyer review these documents for completeness.
The majority of deals that fall apart do so because they failed due diligence. Some of these failures are due to misrepresentation of company facts. Some are due to the seller trying to hide company "skeletons". These errors are almost always discovered during due diligence. Consequently, it is always better to fix the problem before you go to market, or bring it to the attention of the buyer at the start of the sales process. Waiting for these problems to be discovered during due diligence is a tremendous waste of everyone's time, and can render a crippling blow to the future salability of the company. On the other hand, a smooth due diligence process verifying all the information presented to the buyer greatly improves the odds of a successful sale.
Posted by Tom Gledhill on Mon, Aug 10, 2009 @ 10:20 AM
Positioning your company for prospective buyers is the most critical element in maximizing your company's value. Without the knowledge of what the buyers want you can't make the appropriate strategic decisions and you may leave a lot of money on the table.
Several years ago I worked with a company that provided information technology to the health care market. In what the owner thought was a logical growth pattern, the company expanded geographically into New York and New Jersey. He opened several sales offices in the area and hired salespeople to staff them. The cumulative cost of opening offices, hiring & training salespeople, travel, etc, was nearly a Million dollars. The company also had to pay trainers a premium (in addition to a per diem) as they didn't like to train in NY & NJ. Also, he found that the market there wasn't willing to pay their standard rates, so the system prices had to be decreased.
Ownership was also being urged by some of their "early adopter" clients to develop an electronic medical record (EMR). The company proceeded to do this at a cost of approximately $750K and installed the system in three of their clients' facilities at an extremely reduced price. The extra support and maintenance required produced an additional set of costs not reflected in the above.
The ultimate buyer already had sales offices in NY & NJ. The buyer was interested in penetrating New England and was having a hard time doing it. Also, they had their own EMR. They were not interested in my client's technology; they were interested in his customer base, especially in New England.
So how does this affect value? In most cases, a company's value is a multiple of cash flow or EBITDA (Earnings Before Interest, Taxes, Depreciation, & Amortization). If my client had NOT expanded into NY & NJ and NOT developed the EMR, he would have saved $1.75 million which would have been added to EBITDA. Since value is a multiple of EBITDA, the company value would have increased substantially. An even better strategy would have been to take a fraction of the money that was spent penetrating NY & NJ and add a couple of more salespeople in New England, thus increasing the customer base in the buyer's desired territory. This most likely would have increased the multiplier effect, further increasing the company's value.
So what's the lesson learned here? Research the type of buyer that is most likely to buy your company. By knowing that, you can make the correct strategic decisions that will increase the value of your company. A good M&A Advisor (Intermediary) will help you identify the appropriate buyer type for your business.
Posted by Tom Gledhill on Fri, Aug 07, 2009 @ 04:12 PM
A surprising number of businesses just don't sell. It's been estimated that only about 1 in 4 small businesses (less that $2 million) actually sell. Why is that? Well, first of all, 1 of the 4 would probably never sell for a variety of reasons (paltry revenues, losing money, no or little demand for their product or service, etc) and will simply close the doors. What about the other 2 that don't sell? Why don't they sell?
Unrealistic Expectations - this is the number 1 reason that many small businesses don't sell. It's human nature to think that the business that you've put so much of yourself into has a premium value. However, other parties ( Banks, Prospective Buyers, Valuation experts, etc) will look at your business objectively and apply universal rules in determining its value. In a previous blog (What is Your Business Worth?), I wrote of a boating business owned by 3 brothers (1 active in the business). It was a nice little business and very saleable except for one thing - unrealistic expectations on the part of the 2 inactive owners. They were not dealing with reality. They were in fantasyland! Note - because of the internet most of the prospective buyers are knowledgeable about the buying process and business valuation.
Lack of Information - many of the small businesses that I've dealt with over the years don't have accountant-generated financial statements. The accountant prepares the tax forms, why not have him/her take the next small step and generate the financial statements? The internally generated statements don't have all the accruals, depreciation amount, amortization amount and other items that more accurately reflect the performance of the company. Also, customer and vendor contracts need to be updated and readily available for examination. What about key employees? Do they have non-compete agreements or employment contracts? What motivation will they have to stay with the business once it's sold?
Landlord agreement - an assignable lease agreement with your landlord is critical if the present location of the business is important to the buyer. If you're an at-will tenant the landlord can do whatever he/she pleases. I'm familiar with a situation where the landlord, after 12 years and a seemingly good relationship, demanded a big chunk of the transaction amount in exchange for a lease for the buyer! This may seem extremely unethical (and it is!), but according to the lawyers there's nothing illegal about it.
If you're thinking about selling your business, it makes sense to perform a pre-transaction due diligence. Using a due diligence checklist, make sure that you have all the forms and financials that a prospective buyer needs. It also makes sense to have a valuation of your business so that your expectations will be aligned with reality. If you need a due diligence check list, let us know and we will provide you with one.