For many owners, the sale of their company is the largest, most complex transaction of their career. Due to its magnitude and impact on their future, it also is one of the most stressful. Sellers will often feel better if they have an experienced and determined adviser guiding them during the process.
Middle-market transactions are defined as deals valued between $2 million and $250 million, a range that encompasses many contractors. There is very little information available on these deals to enable a potential seller to know what is involved in the sale process. Prospective sellers are often under numerous misconceptions.
These seven questions are among the most common erroneous beliefs of middle-market company owners. The answers should correct these misconceptions.
1. Is an appraisal a ‘numbers-crunching' process?No. A properly conducted appraisal or "valuation" involves the complete investigation of a company's business foundation. It includes defining the company's future opportunities and major risks along with its projected impact. The following factors must be evaluated during this process:
· The strength of the company's marketing program, including the diversity and control of its customer base.
· For manufacturing companies, the ability to produce a high-quality, low-cost product, and the caliber and productivity of its research and development operations.
· For distribution or service businesses, the demographics of its trading area, the quality of its product or service line, the attractiveness of its locations and the ability to run its operation on a cost-effective basis.
· The quality of the management team and the presence of a reasonably paid, well-motivated work force.
These become a determining factor to use when deciding the multiple to apply to the company's expected future earnings.
2. Will planning and timing the sale increase the transaction price?Owners should time the sale to maximize the transaction price. A solid business foundation will increase the value of the company. In addition, the planning of the sale will enable a company to be prepared to "go to market" at the appropriate time to generate the maximum price. It also enables owners to respond intelligently to the unsolicited interest of a prospective buyer.
3. Is the deal fundamentally completed when a preliminary price is established in the letter of intent?In fact, a letter is merely the start of the negotiating process. The buyer often demands a price reduction between the letter of intent and closing. You must make sure that a buyer knows that will never be productive. The negotiation of the definitive purchase agreement is often a difficult, confrontational and time-consuming process. If it is not negotiated to provide maximum protection to the seller, it can give the buyer a post-closing opportunity to recover a considerable portion of a seller's profits.
4. Should owners sell their company only when they are at or near the end of their business careers?The answer is definitely no. Most owners don't understand many of the benefits that can arise from a sale. Usually owners of closely held corporations - those with a very small number of shareholders - have a vast majority of their personal wealth concentrated in the business.
This is generally poor financial planning, but it is a typical byproduct of ownership. By selling all or part of the company, owners can reduce their concentration of wealth in the business. In addition, it puts their estate in more liquid condition.
Many younger sellers enter a deal wanting to make sure they can enjoy the finer things for a few years while still in prime health. After their no-compete clause expires, which could occur after a five-year period, they can get back into the business. However, ideally they will commit only a small portion of their sale proceeds to the new business endeavor. This will assure that they have lifetime financial security. They will be refreshed and might be eager to pursue a new business endeavor. From a personal standpoint, this is a very attractive alternative for a number of owners.
Where sellers merely want to reduce their concentration of wealth in the business, but still want to run the company, a "re-capitalization" with a private equity firm might be the answer. In this type of situation, an owner can get approximately 90 percent of the deal value while retaining a 30 percent interest in the recapitalized company.
As most private equity firms strongly prefer management to stay, the sellers should be able to continue to run their business in an unfettered manner. The only thing likely to change is that the owner will now report to a board of directors. However, the owner will still determine the company's strategic course. For an owner that wants to pursue this alternative, it is essential that they find the right private equity firm. Only a few private equity firms are price-aggressive and pay a price comparable to a strategic buyer. Some of these firms might have companies in their portfolio that are a strategic fit with the seller. This should enable them to pay a price comparable to a strategic buyer. An experienced advisory firm will know if a recapitalization makes sense for the owner. They also should know which private equity firms historically pay a strong price.
5. Do private equity firms pay a fair price for a company?Most, but not all, private equity firms pay substandard prices for companies. These firms typically pay 15 percent to 30 percent below what a strategic buyer would pay. So an adviser should only deal with the few private equity firms that have historically paid prices comparable to a strategic buyer. In general, if an owner wants to primarily sell the company to get out of the business, the most logical buyer is the pure strategic buyer.
6. Should a selling owner accept promissory notes as part of the transaction proceeds?Many advisory firms, which are not overly concerned about maximizing their client's interests, believe that buyers will always want a seller to take back a significant portion of the purchase price in promissory notes. They think that an acquirer needs this as protection against legitimate hidden problems that might be uncovered after the business is sold and because growth-oriented companies must use all available leverage to fund future expansion. However, this is nonsense. When an individual sells his or her company, he or she has the right to receive their proceeds in cash except for the equity portion retained in a recapitalization.
7. Should a seller employ special legal counsel to handle the transaction?It all depends on the sophistication of the seller's present law firm. If it is a large firm that has specialists in environmental law, human resources, intellectual property and corporate finance, it might be appropriate to retain the current counsel for the transaction.
However, if the sellers presently use a smaller, general practice law firm, they may want to employ new counsel that has specialists to advise them in the transaction. If the seller employs a sophisticated advisory firm that will direct the deal negotiations, it is often advisable to allow the firm to bring in a large, experienced law firm with whom they are familiar.
Owners that avoid these pitfalls should be able to sell their company at an aggressive premium price with only limited, if any, exposure to post-closing issues.
(George Spilka is president of George Spilka and Associates, a Pittsburgh-based merger and acquisition-consulting firm that specializes in middle market, closely held corporations. They have a broad-based service that advises clients through the entire acquisition process. These firms include a diverse group of contractors, distributors and manufacturing companies throughout the U.S. and Canada. For more information, write Castle Town Square South, Suite 301, 4284 Route 8, Allison Park, PA 15101. Also call (412) 486-8189 or fax (412) 486-3697 or e-mail firstname.lastname@example.org; see www.georgespilka.com on the Internet.)