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July 15, 2009 Article 4 min read

Sunny boardroom set up for a meeting 

Here are five best practices to consider

We're in the midst of what many consider to be the most severe recession since the Great Depression. The U.S. government has allocated trillions of dollars to various initiatives designed to restore liquidity to the financial markets, create or save jobs, reduce taxes, and jumpstart the economy from recession; the S&P 500 Index remains approximately 45 percent below its peak in October 2007; and gross domestic product shrunk at an annual rate of 6.1 percent from January through March.

Nonetheless, mergers and acquisitions in the middle market (those transactions valued at less than $250 million) continue to occur, albeit at a slower pace. Alongside this continued activity, a number of trends have emerged, including more private equity firms acquiring minority stakes in companies; more frequent use of seller financing in transactions; larger equity contributions (with less debt); and larger earn-outs, which serve to incentivize shareholders while reducing risk to buyers.

Business owners continue to sell and explore strategic alternatives for a variety of reasons, including wealth diversification, succession planning, estate and tax planning, and a desire for personal liquidity. Certain business owners also are attracted to the opportunity to form alliances with strategic or financial partners that can help them take their businesses to the next level or become a more formidable competitor in the marketplace.

There are at least five key steps any business owner should consider in order to maximize flexibility and enhance the ability to pursue specific alternatives in the future. Advanced preparation and business positioning can significantly increase company valuation and buyer interest, shorten a future sale process, and decrease the likelihood of running into serious financing constraints in the future.

Be Proactive Now

Enlist a reputable accounting firm to review or audit your financial statements; this will shorten the due diligence process. Prepare supportable financial projections with defined avenues to growth. Having a credible plan to achieve projections is just as important as the projections themselves. Develop a 12-month budget that can be tracked against actual results — did the company and management meet, exceed, or fall short of expectations? Develop a clear understanding of margins and profitability trends, while identifying key performance indicators and tracking metrics. Unfortunately, many companies focus on revenue while ignoring what actually contributes to the bottom line. Finally, agree upon a realistic valuation expectation — not what you believe the business is worth, but what buyers may be willing to pay.

Refine Your Long-term Strategic Plan

Develop a strong and deep management team that has industry expertise, a proven track record, and the ability to execute the company’s business plan. Diversify your supplier and customer base, as large concentrations are viewed by both buyers and lenders as considerable risks. Develop strong inventory controls, and improve your company’s cash conversion cycle. Are accounts receivable days, inventory days, and payables days in line with industry averages? If not, develop an improvement plan. Reinvest in the business and in personnel to achieve growth objectives — buyers want to see reinvestment in the company. Finally, optimize the utilization and throughput of production equipment; buyers may be willing to pay more for a company that’s able to operate with lower total assets.

Think Like a Buyer To Be a Better Seller

Buyers are willing to pay more for companies that are diligently pursuing carefully crafted strategic plans. That’s why it’s critical to perform reverse due diligence. Anticipate how buyers will view the company, and be prepared to confront potential issues upfront. Consider yourself as the buyer: what would you want to see in a business you’re considering acquiring? What would you view as a negative or a deal breaker? Apply these answers to your company.

Understand the Difference Between Financial and Strategic Buyers

Financial buyers include private equity firms searching for platform acquisitions or add-on acquisitions to existing portfolio companies, while strategic buyers include larger companies usually already operating in the same industry. Unlike strategic buyers, which normally purchase 100 percent of the company, most financial buyers encourage or even require current management to retain a minority stake in the company going forward. Strategic buyers, on the other hand, may be able to pay more due to potential synergies or competitive positioning, such as market share, technology, and customer lists. Tightness in the credit markets also frequently favors strategic buyers in the current market.

Enlist the Assistance of an Investment Banker Early to Assure Best Results

Regardless of whether you currently are considering a transaction, it’s never too early (or late) to meet with an investment banker to discuss strategic alternatives. Now may be the optimal time to start that dialogue.

Current conditions, although arguably improving, remain far from optimal. Many business owners are finding themselves forced into selling early for a variety of reasons, including debt repayment challenges, competitive disadvantages, impending estate and tax liabilities, and bankruptcy prevention. Following these best practices can better position you and your company to maximize value and avoid being defeated by market conditions that may not be in your favor.