Selling a privately held middle-market company is an art, not a science. Pricing information is usually sparse.

Selling a privately held middle-market company is an art, not a science. Middle-market deals are defined as those with transaction prices in the range of $2 million to $250 million.

The available pricing information is usually sparse and superficial, and therefore of limited use in determining a transaction price. In addition, the procedures to sell or value a middle-market company, the valuation multiple to apply, to appropriate transaction structure, and the likely events that will occur after a closing are usually substantially different for middle-market deals than for the more publicized major public deals.

Due to the unique nature and complexity of middle-market deals and the lack of meaningful information on the subject, it is essential for sellers to know these seven critical rules if they are to be successful in the sale of their company.

The rules are:

1. Obtain a principally all-cash deal.

2. Retain a competent acquisition consulting/investment-banking firm (advisory firm).

3. Define your expected transaction price before going to market.

4. Demand minimal exposure to post-closing issues and liabilities arising from the definitive purchase agreement.

5. Negotiations tend to be adversarial; accept that fact.

6. Be patient.

7. Divulge proprietary information only at the appropriate time.

We will now examine each rule in detail.

Obtain a principally all-cash deal

In an acquisition, as in business, you are trying to maximize price and minimize risk. There is no better way to accomplish the latter than with an all-cash deal. There are only two reasons why a buyer wants a seller to accept promissory notes. One is there is either a lack of bank or institutional financing available to the buyer, or it is available at an interest rate much higher than the buyer is willing to give the seller.

The other reason is that notes can be an easy way for a buyer to collect for alleged breaches of representations and warranties. This could necessitate a seller pursuing litigation to collect on his or her notes.

It is my firm's philosophy to only do principally all-cash deals. More than 92 percent of the deals that I have closed during the past 15 years have been all cash. No deal has occurred where cash was less than 87 percent of total consideration. It is not unreasonable to demand an all-cash deal from a buyer.

Also, I would almost never consider a deal with a contingent price factor, unless the contingency portion is in excess of the expected transaction price. There is no way to protect the seller's ability to meet contingency goals without unreasonably restricting the actions of the buyer after the deal.

Retain a competent acquisition consulting/investment-banking firm

Sellers require an advisory firm to guide and direct them through the entire process. This includes planning the sale, the valuation, the development of an enticing offering circular, the search for a synergic buyer and the conduct and control of all negotiations leading to closing. The advisory firm should use a personalized, tailored approach that encompasses a review of all aspects of the seller's business foundation and niche.

Such review far transcends a mere analysis of the financial statements, which only represents a small part of the review. The advisory firm should be committed to closing a sale only after an aggressive premium price has been obtained. They should have a reputation that the seller's best interest is the only factor that dictates an acceptable deal. The advisor must have a thorough understanding of the economic implications of the legal issues that are likely to arise in negotiating the definitive purchase agreement, as they should control all negotiations with the attorneys working under their guidance.

In a middle-market deal, it is usually preferable to use an advisory firm with entrepreneurial flair, as they will often have a similar background and psychological makeup to the selling owner. They will understand the feelings that the seller will be dealing with during the acquisition process. Consequently, they can provide the emotional support most sellers find beneficial at the time. As the negotiations leading to the closing are the most critical phase of an acquisition, the seller wants an advisor who is a strong-willed, articulate and persuasive negotiator. An advisor with these skills, approach and characteristics is necessary for the seller to obtain a premium price.

Define your expected transaction price before going to market

Buyers are trying to steal your company - that is how the capitalist system works. Unfortunately, the buyer is usually larger, has greater resources and is more knowledgeable about acquisitions than you. However sophisticated, hard-working sellers can level the playing field.

Prior to going to market, a seller should have his or her advisory firm evaluate all facets of company's business foundation. The company's major future opportunities and risks should be determined and evaluated. When this process is completed, the seller and advisory firm should feel that their knowledge of the company's future earnings potential is greater than any buyer's.

The determination of a company's value will come from its expected future earnings or earnings before interest, taxes, depreciation and amortization, commonly called EBITDA, and the risk of achieving those numbers. This value will be impacted by both short-tem earnings potential and long-term growth factors. The stability of the business foundation will have an impact on the multiple applied to the company's earnings and EBITDA.

Depending on synergic benefits, internal corporate needs and differing perceptions of valuation factors, most prospective buyers will see a company's value differently but within a price range plus or minus 10 percent to 15 percent of an average market price.

Be aggressive in your pricing expectations. Demand a realistic premium price. Remember you only sell your company to one buyer. You are not trying to get five buyers to a pay a normalized price; your objective is for one buyer to pay a premium price.

Demand minimal exposure to post-closing issues and liabilities arising from the definitive purchase agreement

Large buyers are used to shifting most deal risks to the seller. This is the norm, and it could harm your economic health. After a company is sold, the owner has no upside. Correspondingly, they should have no downside risk for occurrences that become known after the deal closes. To ensure a more equitable sharing of deal risks between both parties, sellers should want the majority of their representations and warranties to be limited to "seller's knowledge."

A few reps and warranties normally require a higher standard of seller guarantee. However, for these representations and warranties, sellers are usually aware if there is a problem prior to the deal closing, therefore, they should have limited risk of the unknown. But the general rule is that the last majority of representations and warranties should be limited to "seller's knowledge."

A buyer will most likely strongly contest this position; however, sellers should not relent, unless the deal compensates them for the added risk.

Negotiations tend to be adversarial - accept that fact

Negotiations are a test of wills, a battle for control. By its own very nature, negotiations are a confrontational process. A seller should accept that. In most corporate sales, the seller is usually much smaller and less knowledgeable about acquisitions than the buyer. And buyers are used to deals being priced the way they want. If buyers are forced to pay prices in excess of their targets, it will usually result in difficult and adversarial negotiations before a buyer agrees.

If negotiations go smoothly and amicably, then buyers are usually obtaining their price. Rarely would this represent a premium price to the seller. Therefore, accept the confrontational nature of negotiations, as this is normally essential for sellers to get a good deal.

Be patient

If a seller is to be successful, usually patience must be demonstrated throughout the acquisition process. However, patience should not be confused with lethargy. Instead, patience represents the seasoned market response when a slow pace works to a seller's advantage. If a seller has thoroughly evaluated all factors surrounding the sale, being patient should be easy.

In have found that patience is a byproduct of the confidence in the validity of one's position. A patient seller usually produces anxiety in a buyer. As a buyer should never be aware of the full dynamics of the overall sale process, a patient seller usually is interpreted as one that has many attractive alternatives. This should tend to make the buyer more flexible in negotiations.

Divulge proprietary information only at the appropriate time

As a general rule, it is advisable not to consider customers, competitors or suppliers as a potential buyer. If there are unique or compelling circumstances that mandate such prospects be pursued, they must be approached much more cautiously than would a typical buyer. When this type of prospect is solicited, it is often advisable to significantly strengthen the confidentiality agreement in the following ways:

A. Limit the buyer's right to solicit the employees and/or customers of the selling company in the future.

B. Limit the detailed information provided to the buyer at the initial stage of the process.

C. Require much more detailed financial and business information about the buyer at the initial stage than is normally obtained. Regardless of the buyer, it is always prudent to restrict the divulging of proprietary information to the latter stages of negotiations. This information usually includes the following:

  • Information pertinent to sales levels or pricing specifics for individual customers or products.

  • Purchase or production costs for specific products or customers.

  • Specific pricing strategies by product, volume or other pertinent factor.

  • Specific future operating courses of action.

    This information should not be divulged until the seller has signed a letter of intent with a prospective buyer. At that time, the parties would begin to negotiate a definitive purchase agreement and the buyer would begin his or her due diligence process.

    At this point, sensitive information will have to be divulged to the buyer, especially if a seller is to obtain only minimal exposure in the rep, warranty and indemnification areas. However, in certain high-risk situations, when the letter of intent is signed, a seller might expand the confidentially agreement to prohibit the buyer hiring any of its key employees or soliciting key customers for a 12 to 18 month period, if the deal does not close.

    If these seven rules are followed, it is likely that a seller will obtain a premium price with favorable terms in the definitive purchase agreement. To achieve this ultimate success, there is no substitute for hard work, knowledge, determination and patience. The sale of a company is usually the culmination of an owner's career, or in many cases, the end results of the efforts of many family generations at the company. It usually will be the legacy of decades of effort.

    The seller who follows these rules is likely to put a crowning touch on a successful career. Make sure you do it right and allow the legacy to speak for itself.

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