For most business owners, the sale of their company will be the single largest liquidity event that they will experience. The thought of the sale and related process can ignite numerous emotions including excitement, anticipation, fear, confusion, and angst. Based on this range of emotions, these are the questions that typically follow:
When is the right time to sell the company? How do I know when I’m ready to sell? How do I get the highest value for my business? What does a buyer focus on when contemplating buying my company?
All of these questions are legitimate and all are interrelated. The following will provide some insight into answering these questions and address sale readiness and the preparation for the transaction process. Let’s start with a few base items.
The typical liquidity options for shareholders of privately held companies include the recapitalization of debt and/or equity or the sale of all or part of the company. In the sale scenario, there are typically two types of buyers: strategic companies and financial buyers/investors (private equity groups, family offices, etc.). The two buyer groups can have very different approaches and investment theses, which can result in differences in purchase price, transaction structure, and transaction processes, all three of which can be impacted through thoughtful transaction planning.
While each buyer will perceive value from different characteristics of the business, there are several general areas that most buyers will consider value drivers.
Fortunately, a thoughtful planning process for a transaction can help unlock the value of the business and streamline a transaction process. However, not planning appropriately for a sale transaction can threaten value maximization. Threats to unlocking the value of a business include:
- Picking the wrong time to sell
- Mismatched perceptions
- Underestimating the process
- Not “selling” the business
- Managing emotions
There are several types of benefits to planning for a transaction. The potential benefits focus on several areas including the selling shareholders, the management team, and the overall organization. A summary of select potential benefits of transaction planning is as follows:
|Provides a framework of value as seen by a buyer or investor||Shareholders|
|Aligns seller expectations with viable outcomes||Shareholders|
|Helps shareholders identify value attributes and constraints||Shareholders|
|Helps align corporate strategy with personal, tax, and wealth planning of the shareholders||Shareholders|
|Prepares management team/seller for sale process||Management Team|
|Affords opportunity for company to remedy shortfalls in advance of a deal||Organization|
|Resolves potential deal obstacles to ensure smooth due diligence process||All|
|Reduces risk of "running fixes" during diligence and increases likelihood of deal success||All|
Unlocking the value in a business: Three key steps
There are three important steps to unlocking the value within a business:
Step one: Plan before you think you need to plan
Properly planning for a sale transaction takes time and commitment of the shareholders and the dedication of a management team. The overarching message to shareholders is to plan before you think you need to plan.
The planning items are different in every situation; however, planning and action items as viable options are directly correlated to the runway to the sale process. A longer runway allows for greater value driving processes and action items. For example, if a company’s shareholders were considering the sale of the business in two to three years, more impactful value drivers could be optimized. Some of these items include customer and end-market mix/concentration, geographic presence, overall management team and succession plan, and accounting processes, systems, and internal controls.
A longer runway allows for greater value driving processes and action items.
However, if the shareholders are contemplating a more imminent exit (less than two years), there would most likely be a different set of value drivers to be optimized. In this instance, the sale readiness action plan may focus more on near-term solutions including existing management team gaps, data clean-up and preparation, and overall preparation of the management team for a sale process. Regardless of the available runways, the advantages of the sale readiness process far outweigh the risks of the unknowns in the transaction process, while maintaining focus on the overall goals of maximizing value, minimizing risks for the buyer, and streamlining the sale process.
Step two: Take a holistic approach to planning for a sale
There are two major segments on which shareholders can focus when planning for a sale: 1) financial considerations and 2) nonfinancial considerations.
- Financial considerations
- Growth opportunities
- Margin levels
- Key performance indicators
- Employee compensation & incentives
- Nonfinancial considerations
- Customer stickiness
- Risk management
- Environmental issues
- Management gaps & succession
The financial and nonfinancial considerations span a variety of factors that can influence the outcome of a transaction. When considering a holistic approach to planning for a sale, it is important to understand the predominant dynamics that can influence a transaction. In general, the overall success of a sale transaction depends on the readiness of four key areas, which can be interconnected or unrelated to each other, yet should all be considered in conjunction with the overall plan. The four key areas that can impact the outcome of a transaction include: economic, market, ownership, and the business itself. These four key areas are described in more detail below.
The readiness of the economic environment and company’s core markets are generally out of a shareholder’s control, while the readiness of the ownership and overall business are certainly impacted by the shareholders’ decisions and actions, which is why these two key areas are where the sale readiness planning is focused.
Step three: Create an effective action plan
Once the strategy and potential areas of focus have been identified, it is important to implement an efficient and effective plan to execute the sale readiness and value optimization strategy. Often the use of third-party consultants and advisors can be valuable in executing the effective action plan.
The benefits of performing a sale readiness review
To optimize a transaction outcome for clients, PMCF, the investment banking affiliate of Plante Moran, recommends performing a sale readiness review. While closely aligned with seller due diligence, sale-readiness planning is a more holistic assessment to ensure that overall shareholder objectives are met. PMCF suggests paying close attention to these key attributes of sale readiness.
Current market dynamics
- Capital markets
- M&A markets
- Macro economy
- Transaction objectives, such as legacy, value and management team opportunity
- Timing to exit
- What is the shareholders’ “number” required to ultimately transact?
- Financial performance: growth, margin and capital investment trends
- Positioning and differentiators of the company
- Supportability of projections
- Identification and mitigation of potential issues, which PMCF calls “value eroders.” Examples include customer concentration, product or technology obsolescence risk, lack of forecast visibility, management gaps or departure risk of key people, and environmental issues at facilities.
Sell-side due diligence and its value proposition
While the sale readiness assessment and optimization process is effective as part of a longer term strategy, sell-side due diligence can serve as an effective near-term tool in preparation for a sale transaction. There is an increased amount of capital chasing a limited number of quality assets, which has resulted in the middle market becoming an attractive investment space for buyers. However, companies that operate within the middle market (especially the lower middle market) tend to focus less in the finance and accounting operations and invest less in IT systems, which results in a weak financial reporting infrastructure and minimal quality data to be analyzed by a buyer. Companies that operate in the middle market also often have lean management teams, which can place significant stress on the business during a sale process. This environment can become challenging to potential buyers, lead to a stressful transaction process, and result in non-optimal outcomes. Transaction preparation, specifically sell-side due diligence, can offer a potential solution to these problems. Sell-side due diligence is gaining traction in the middle market. The increased number of transactions that fail mid-process, or result in purchase price reductions, has motivated companies to conduct sell-side diligence proactively in order to mitigate some of the transaction risk and potential surprises that could pop up during the sale process and derail a transaction. It’s worth noting that sell-side due diligence is also gaining momentum with private equity firms as they get ready to market their investments and seek to maximize returns for their limited partners.
What value is derived from sell-side due diligence?
It’s fairly common to see sellers leave value on the table as a result of failing to see the company from a buyer’s perspective and not preparing properly for the rigors of the buyer’s due diligence process.
By not being properly prepared, the seller and management do not anticipate the buyer’s concerns, and are not prepared when confronted with difficult questions and topics related to operations, budgets and projections, and customer and product/service concentration.
A sell-side diligence process will most likely flag some of the potential issues that may be detrimental to value and to the likelihood of a successful transaction outcome. By recognizing these items and proactively analyzing the issues, the company will be better positioned for the transaction process.
For example, it is not uncommon for owners of middle-market companies to use tax efficient practices in relation to valuing inventory. These strategies can result in a shifting of inventory and related cost of sales expense between periods. In transactions where the valuation of the business is predicated upon a certain period’s earnings, the shifting of the cost of sales can have a sizable impact on a buyer’s valuation. If these strategies were properly assessed ahead of the transaction process, the seller would have a better valuation expectation and would have been better prepared to discuss the item with potential buyers. Instead, having this issue arise late in the diligence process may result in leverage for the buyer in negotiating a potential purchase price adjustment.
In addition, a sell-side due diligence report allows the seller to provide qualified buyers with credible financial and operational information from which an informed offer could be submitted. This process enables the seller to maintain credibility, eliminate surprises, minimize disruptions, and increase the likelihood of a successful transaction. The sell-side diligence report provides the buyers with a consistent set of analysis, which can reduce the burden on management to respond to multiple information requests and allow management to remain focused on running the business. Private equity groups are also experiencing the many benefits of sell-side diligence. Some private equity groups are requiring their portfolio companies to conduct internal/sell-side due diligence as a way to prepare management teams for the transaction process, which inherently streamlines a transaction process and maximizes value.
The true cost-benefit of sell-side diligence
Conducting a proper sell-side diligence process does come at a real cost. However, it’s worth noting that the sell-side diligence can more than pay for itself by assisting the company in maximizing value and allowing management to focus on running the business. Middle-market businesses, which often have less than ideal financial information infrastructure and lean management teams, could see significant value in partnering with a third-party diligence provider that has the skill set and time to take a deeper dive into the appropriate analysis and be sure that no value is left on the table.
Summary and conclusion
For most business owners, the sale of their company will be the single largest liquidity event that they will experience. With that in mind, it is very important to plan for the sale process in order to increase the likelihood of a successful outcome. Not planning can threaten a transaction process and result in a not maximized value outcome. Steps can be taken in order to mitigate risks and maximize value. However, risk mitigation and value optimization are not accomplished overnight. Shareholders must realize that it is never too early to start the transaction planning process. The direction of an action plan and the amount of actionable items as a result of the planning process will most likely be dictated by the runway to the potential sale process. However, regardless of the runway, the benefits of planning and executing a viable and effective action plan will far outweigh both the hard and soft costs associated with the overall sale readiness process.