What should I know before I sell my business?
That question, more than any other, is asked by clients and prospects. Having advised on the sale of more than 300 small- and medium-sized, often family-owned, businesses during my 30-plus years as a middle-market investment banker, here’s an insider’s perspective on the three key elements sellers need to know.
One, allow time for due diligence. Resist a banker’s entreaties to give your blessing to a sale if a comprehensive appraisal of your business hasn’t been completed. Bankers generally are anxious to complete a deal without delay, especially before the end of a year. They get compensated only if they complete a transaction and, as the banking adage goes, “time creates risk.” So, they seek to create momentum and a desire for a client to complete a deal, which may not be in the client’s best interest.
Be willing to walk away from a deal if the price is insufficient or doesn’t meet your requirements. Also, set up a calendar with your banker and monitor it to ensure it’s being followed. One industrial company that got lower offers than it sought but was being prodded by its banker (who used the familiar “a bird in the hand is worth two in the bush” adage) opted to walk away on our recommendation. The company had encouraging developments underway, and it is benefiting from its decision.
Two, spend sufficient time on pre-transaction housekeeping and wealth planning. Both are essential. Consider housekeeping, which comprises those items critical to your business’ revenue and expenses, ownership and financial statement integrity. For instance, know where your stock certificates are and possess verifiable business records that document your business’ normalized income-generating power. Ideally, you no longer should be flowing major personal expenses such as cars and boats through your financial statements, and you have reduced large, discretionary bonus payments from your compensation structure that a potential buyer may not be willing to assume. Also, prepare at least two years’ audited annual statements before beginning the sale process.
Without pre-transaction wealth planning, you potentially will leave a lot of money on the table. Bankers aren’t incented to slow you down to develop an orderly and deliberate process that considers family members’ wishes and concerns. But letting family members be heard before the transaction can help ensure personal financial considerations do not spill into the sale negotiations. Also, effective tax-planning to support family members’ needs and philanthropic plans can add substantial value. If giving to a family foundation or donor-advised fund is important, consider as part of the transaction the tax opportunities from an ESOP. And if wealth transfer to children and the mitigation of taxes is important, work with a strong wealth planner to create family partnerships and trusts.
One client prospect wanted to complete a sale by year-end, but many key decisions had not been worked-out, including the desires of family members and wealth planning for selling shareholders. By delaying the sale to take time to plan effectively, the family successfully channeled wealth from the estate and realized roughly two times the value from the transaction they otherwise would have achieved.
Three, tap the right legal counsel. I can’t stress this enough. In this market, your buyer most likely will be a private equity firm or strategic advisor that will ask you to represent and warrant your life away in the stock purchase agreement, and your banker will be anxious to close the deal. So, your legal counsel is chiefly looking out for you. Your investment banker will prove to be a good source for recommending a seasoned deal attorney. A banker you liked and trusted but didn’t hire and your trade association also are good sources for input.
Get the names of two to three attorneys, do your due diligence and call their previous clients. You are assessing their competence and whether you will like working with them. An attorney with whom you see eye to eye on business decisions is valuable because at the end of the day, the sale is a business decision. Conversely, hiring an attorney who argues every comma to impress you will cost more in legal fees than you will gain in the sale price.
In a recent transaction, our client’s brother, also a selling shareholder, wanted his own attorney and opted for a top-name M&A firm and its top fee. Unfortunately, his counsel lacked the ability to work collaboratively with the other shareholders and their respective counsels. The attorney insisted on lengthy conference calls and belabored small issues, which doubled the legal fees for the entire transaction. That’s money out of the seller’s pockets. In contrast, in a different transaction an attorney with an equally prestigious Wall Street firm was consistently calm and insightful, generating good ideas and making everyone felt heard, enabling smooth negotiations. That’s more money in the seller’s pockets.
Clients ask, “Is it possible to limit legal costs in advance?” Not in most cases, because law firms detest capping fees since they “don’t know what’s under the hood” of a company until the transaction begins. That said, do have a “minding the clock” conversation upfront to communicate your budget-consciousness.
Another point: If a family business wants to use its traditional attorney or firm to handle the sale, it likely will be understaffed for the negotiations ahead. Retain this individual or firm as the family’s consigliere and trusted advisor, but hire a dedicated deal counsel to negotiate and construct the sale transaction.
Here is why these three key pointers are important. Increasingly, the middle market is dominated by private equity buyers that, to limit risk and meet guidelines their limited partners prefer, intensify negotiations and raise the ante on due diligence and getting assurances from the selling shareholder. Plus, as noted, bankers often will push you to complete the transaction. It’s like a house sale where both the realtor and banker don’t get paid if there is no deal. That’s why broadcasting a credible threat to walk away makes your wishes clear.
Generally, you sell the business you’ve built only once. By keeping these dynamics that underlie any deal in mind, you will be better prepared to achieve the outcome that best serves you, your family and other shareholders.