June 2012

When one sells their house, the best deal is usually the highest price.  When one decides to sell their business, there may be other factors to consider.  Many buyers are similar to the “overlooked” buyer described below, serious and qualified; and most sales of businesses are win-win transactions.  However, there are a few exceptions, and sellers should consider them carefully, balancing their prerequisites to the goals of the buyer.

Selling to a Competitor – Many company owners think this is the best way to go.  They read about the mega-mergers such as Bank of America and Fleet bank, or the pending deals such as Federated and the May Company Department Stores, and U.S. Air and American West.  Consolidation may play a major role in large public companies; this is not the case in middle market companies.

Many owners of middle market firms look at these mega-deals and think it might work for them.  However, upon further consideration, they realize that by disclosing a lot of confidential information to a competitor, their business could suffer irreparable damage if the deal would fall apart – and many do.

Selling to a Strategic Acquirer – This may bring the highest price, but there are several reasons why this may not be in the company’s best interest.  Many owners have worked with key employees for years and would not like to see them replaced. The strategic owner might not only replace members of management, but might also move the company to another part of the country.

Selling to a Financial Buyer – This buyer may not be willing to pay the seller’s price and is usually buying a company with intentions of selling it at a profit in three to five years.  This leaves the company and its employees in limbo waiting for a new owner to take over.

Other Buyers – The employees may decide to buy the company (ESOP).  However, this usually means a long-term payout for the owner. An individual buyer may come along such as a Warren Buffett, but what are the chances?  A key member or members of management might decide to purchase the company, but generally they won’t pay the price.  If a sale is not consummated, the key management member(s) will most likely leave.

The “Overlooked” Buyer – There are many individuals who want to own their own company.  They might be former executives of major companies who want to do something on their own. Some buyers have access to large amounts of investment capital. There are many qualified individual buyers in the market place. Russ Robb, the editor of a leading M& A newsletter, M&A Today, has written a book, Buying Your Own Business, for those individuals interested in buying their own company. This book has sold over 20,000 copies, which indicates the large number of people who are interested in buying a company.

There Is No Magic Answer – Selling a company comes with no guarantees.   When Badger Meter Company, a public company headquartered in Milwaukee, acquired Data Industrial Corporation based in Mattapoisett, Massachusetts, this appeared to be a marriage made in heaven.  Their respective product lines fit like a glove, their corporate cultures seemed compatible, and sales expansion by cross-selling was evident.

This strategic acquisition would have been fine except for one change.  The parent company moved Data Industrial’s operation to Kansas, and every employee’s job was terminated.  However, one should not construe that all acquisitions by strategic or competitive acquirers end up in a similar fate.  Furthermore, for price considerations, the seller can draft restrictions in the Purchase & Sale agreement to prevent the transfer of the business, at least for a specified time period.

Certainly selling to the overlooked type buyer doesn’t guarantee all of the seller’s concerns, but knowing the interests of some of the various buyer types can help insure that the goals of both buyer and seller are met.  Sellers should determine their goals prior to attempting to sell their business.  A consultation with a professional intermediary is a good start to this process.

A recent article in INC magazine titled”Street Smarts,” by Norm Brodsky (his column is worth the price of the magazine) addressed the subject of the title above.  However, in the very first paragraph of the article, Mr. Brodsky stated, “Unfortunately, most of them [business owners] have grossly inflated notions of what their companies are worth.” Mr. Brodsky is not one to mince words.  Some of his examples were: “One company had lost money on sales of about $60 million, and yet its owners thought it was worth between $50 million and $100 million … Another company had a net profit of less than $335,000 on sales of about $6.5 million – and still the owners somehow came to believe it was worth between $100 million and $200 million.”

Mr. Brodsky feels that the reason for this is “… our egos can get us in trouble when it comes to putting a dollar value on something we’ve created.  We generally take the highest valuation we’ve heard for a company somewhat like ours – and multiply it.”

He goes on to point out that prospective acquirers are more concerned about profits, especially Free Cash Flow, than sales.  Too many company owners use some rule of thumb based on sales.  He also points out that company owners tend to use a comparison of a similar business across town that sold for some multiple of sales and then apply it to their company.  There are so many variables of how sales (and subsequently earnings) are generated that no two companies are ever alike.

Business owners tend to forget the negatives of their business; e.g., sales from just a few customers, lack of contracts with customers and suppliers, lack of product diversity, out-dated equipment, etc.  Also, as Mr. Brodsky points out, “Before you try to sell, make sure you know what buyers want.”

Turning to another expert voice, here is some good advice from Allen Hahn, Senior Vice President of Valuation Research Corporation: “The level of EBIT or EBITDA used for negotiating a purchase price is the ‘normalized’ level that will be available to the new owners from the assets acquired.  Often times this requires elimination of unusual, inappropriate or non-recurring expenses.  Buyers will typically consider a company’s last twelve months of financial performance.  However, projected results may be more relevant if a structural change has recently occurred in the business (loss of a key customer, acquisition, etc.) that renders historical results less meaningful.”

What does all of this mean?  It means that owners should disregard rules of thumb based on what the company across town sold for; it means that owners should not use a multiple based on what the business did four or five years ago, or what they think the business will do next year.

Business owners should first put their egos aside, then look long and hard at the company’s cash flow, realistically assess the negatives (and positives) of their business and “make sure you know what buyers want.”

Does your business have an orphan product or service that is doing okay, but doesn’t seem to fit into your core business?  Many companies, private equity groups and even some individual buyers are seeking product lines to augment existing ones, or even to build a business around.  Here are just a few of the reasons why a company might want to divest itself of a product line or even a particular service:

• It may not be a good fit for the parent company, thus diffusing efforts that could be placed into the core business.
• Because it is an orphan, it is a distraction.
• It man be a break-even side business that with a full-time effort could be profitable, but resources are better devoted to the core business or service.
• The money received could be used to expand the core business or fund some improvements that are not currently budgeted.

Certainly, there can be some disadvantages in allowing the adoption of an orphan – on both sides.  There is the all-important people issue.  Some valuable employees may be attached to the product line – and may go with the sale or decide to leave and move on.  This can negatively impact both sides of the transaction.  It can also have a negative impact on the selling company’s employees when the selling or purchasing company releases employees. There are cultural issues to consider.  The product may be a more important part of the selling company than management thought.  It may have played a role in selling other products or services.  The distribution channels may play a role in other product lines.  It is important for management to consider whether the orphan is really an orphan before selling it off.

On the plus-side for the acquiring company, the addition of the product line may be a perfect fit for their existing distribution chain.  The brand name acquired may provide name recognition to some existing products.  The new product line may be able to be manufactured with only a minimum increase in employees and plant capacity.

The purchasing company may have a difficult time establishing a price.  It may seem easy to look at the sales and the cost of sales, but the cost of sales may not include an allocation for rent, and for support services such as legal, accounting, corporate oversight, etc. Some part of the product may be manufactured on equipment used for other products, warehousing may be shared, and parts used in other products.  Many acquisitions are sold with a form of licensing agreement so the selling company receives a royalty or license fee representing a small portion of the sales of the acquired product line.

Company management is prone to think of only selling the entire business, a division or subsidiary of the company, when a sale of a product line may be an excellent solution.  The decision to sell a product line or service may solve a host of problems and perhaps even eliminate the need for sale of the entire business.  As Fortune magazine has written, “Companies once obsessed with cutting costs are now urgently trying to boost sales – with new products, new services and new markets.  The surest – and ultimately cheapest – way to increase your total sales is to persuade your existing customers to buy more products.”

The first key is to have your accountant take a look at your accounting procedures and make recommendations on how to improve them.  He or she may also help in preparing financial projections for the coming year(s).  Getting your company’s financial house in order is very important in establishing the value of your firm.

The second key is to review the reputation, image, and marketing materials of your company.  Certainly, the quality of your product or service is paramount, but how your firm presents itself to customers, clients, suppliers, etc. – and the outside world – is also very important.  The appearance of your facilities and customer services – beginning with how people are treated on the telephone or in the waiting/reception area – are the kind of first impressions that are critical in dealing with your customers or clients.  Don’t forget about the company’s Web site; in many cases, it is the initial introduction to your company.  Now may also be the time to update your marketing materials.  The image of a company can help create a happy workforce, improve customer service, and impress those that you deal with – all of which can increase the value.

A third key is to get rid of outdated inventory – sell off any extra assets such as unused or outmoded equipment. The proceeds can be used in the business. If there are any assets that should not be included in the value of the company, such as personal vehicles or real estate, you might want to separate them from the assets of the company.  This is especially important if you are considering placing the company on the market.  A prospective purchaser expects everything they see to be included in the sale.   If a portrait of your grandfather is your personal property, delete it from any list of company furniture, fixtures, and equipment; and if the business is for sale, remove it entirely.

Another important key is to resolve any pending items.  For example, if the company has a trademark on any of the important products, and the paperwork for registering is sitting on someone’s desk, now is the time to complete the filing. Trademarks, patents, copyrights, etc., can be very valuable, but only if they have been properly recorded and/or filed.

Contracts, agreements, leases, franchise agreements, and the like should be reviewed.  If they need to be extended, take the appropriate action.  A contract with a customer has value and if it is scheduled to expire soon, why not get it renewed now?  The same is true for leases.  Favorable leases for a long period of time can be a valuable asset.  Do your key employees have employee agreements?

The key factors outlined above not only build value, but they also increase the bottom line.  If you are considering selling your company at some point, these key issues will come back many-fold in the selling price.  A professional business intermediary can help with other factors that can influence the value of the business.

One other hidden benefit of building the value of your company is that you never know when the Fortune 500 Company will come “knocking at your door” with an offer that you can’t refuse.  At that point, it’s probably too late to work on some of the issues mentioned above.

Every company has weaknesses; the trick is to fix them.  There is a saying that the test of a good company president or CEO is what happens to the company when he or she leaves.  Some companies–on paper–may look the same, but one company may be much more valuable due to weaknesses in the other company.  Not all problems or weaknesses can be resolved or fixed, but most can be mitigated.  Fixing or lessening company weaknesses can not only significantly improve the value, but also increase the chances of finding the right buyer.  Here are some common weaknesses that concern some buyers, causing them to look elsewhere for an acquisition.

“The One Man Band”

Many small companies were founded by the current president, and he has made all of the major decisions.  Since he has not developed a succession plan, there is no one in place to take over if he gets hit by the proverbial truck.  He is the typical one man band; and, as a result, the company is not an attractive target for acquisition.

Declining Industry

Companies that are in a declining market have to be smart enough to recognize the situation and make changes accordingly.  A real-life example of a “smart” company is one that made ties, and, realizing the decline in this apparel item, switched over to making personalized polo shirts.  A company can still make ties but has to have the foresight – and ability – to move into new product areas.

Customer Concentration

This is a major concern of most buyers.  It is not unusual for the one man band to focus on what made the company successful – one or two major customers.  He has built the relationships over the years.  These relationships are seldom transferable.  Finding new customers may take time and money, but the effort is absolutely necessary should the owner eventually decide to sell.

The One Product

Many one man band run companies were based, and still are, on either the manufacture and sale of one product or the creation and development of a single service.  Henry Ford made a wonderful car – the Model A – but that’s all he made.  General Motors decided that many people would like something different and were willing to pay for it.  Fortunately, for Ford, he caught on quickly, but almost went out of business with the thinking that one model fits everyone.

Aging Workforce/Decaying Culture

Young people are not entering the trades, leaving many jobs such as tool and die positions filled with “old hands” who will soon be retiring.  Technology may be able to replace them, but that decision has to made and implemented.  No one wants a business that will have idle machines with no one trained to operate them.

There are many other areas that could be considered company weaknesses.  If there is a Board of Directors or an Advisory Board, perhaps they can help the one man band create a succession plan and just as importantly – a successor.  Certainly the time to act on all of this is before the decision to sell is made.    Whether current ownership plans on staying the course or eventually selling the company, the good news is that resolving company weaknesses is a win-win situation.

If you are considering selling your company in the next year or so, the time to start is now.  Planning ahead can significantly add to the eventual selling price.  A visit with a professional business intermediary is the first step.