IMAP Advice Increases Value
by Charles V. Lemmon

Markets are like parachutes. They work best when they are open.

IMAP's annual survey of closings proves that markets for business sales have been both open and growing over the past five years. Equity is plentiful, cash for debt is readily available, strategic buyers are acquiring market share, financial buyers are active, and individuals are buying their share of the American dream.

Within this market, we are amazed that many owners fail to take advance action to properly groom a company for its sale. Specific actions must be taken by owners to enhance the sales value of a business. Maximum value in any economy can be obtained provided owners have groomed a company with actions including:

1. Audited or reviewed financial statements, which will withstand the pressures of due-diligence. Buyers want verification of key matters not limited to gross revenues, gross margins, asset values, capitalization, bad debt, and excess owner's salary.

Comprehensive audited financial statements cost extra time and money, but they increase a buyer's confidence and accelerate negotiations. The relative low cost of an audit is offset by the potential of greater value as businesses are sold on multiples of verifiable cash flow.

2. A detailed business plan tied to an operating budget clarifies the company's priorities. A well-organized plan further demonstrates that management knows their business and recognizes its strengths and weaknesses.

It is appropriate for a seller to share internal visions with the buyer as to how the business may grow. A clear understanding of numerous revenue sources reduces perceived risk and enhances a buyer's expected return on investment.

3. The business plan should include decisive steps to improve business income and minimize expenses. The psychology of the current sales and profit trend is vitally important during the selling process. While maximizing operating profits a seller should also:

• Analyze and document all products and services individually for their demand, competition, gross margins, and incremental contributions.
• Evaluate and upgrade all production-related equipment for efficiency. Remember; however, that if capital expenditures are financed with debt, each dollar of debt reduction represents a dollar of equity in the seller's pocket at closing. Institutional debt at the time of a sale should be avoided unless the seller can clearly justify that increased cash flows will directly result from the capital improvement. Even then, the seller may have to wait to receive the consideration relating to these improvements until the company achieves the increased cash flows.
• Evaluate all office equipment and computer software for efficiency and increased profitability. Proceed with experimental evaluations of new equipment and software. Be prepared to roll out improvements if tests are successful.
• Justify and document employee costs within a specific industry.
• Make the overall appearance of the business' physical plant "clean." To score additional points, have factory layout/maintenance schedules available for inspection to verify that maintenance is up-to-date.
• Evaluate, justify, and document all ongoing service agreements and supply contracts.
• Evaluate all owner-specific "Perks" and benefits. If possible, a good idea is to combine them all into one account for simplicity so that all the earnings can be easily understood.

Make the traditional definition of cash flow easy to calculate and prove. Among sophisticated buyers the traditional definition of adjusted cash flow is Earnings before Interest, Taxes, Depreciation and Amortization ("EBITDA") plus excess owner's compensation. IMAP members can assist with the calculation and financial presentation of EBITDA plus discretionary add-backs.

4. While many companies regularly expense small equipment purchases and capital improvements, such policies prior to a sale depress earnings and are difficult to recast from "normalized earnings." Sellers who want maximum value must maximize their earnings. Yes, the tax effect will be greater, but cash flow calculations for business value begin with "Earnings Before Taxes."

5. Attention to details. Properly organize a company's records:

• Bring all corporate minutes up to date,
• Verify and update stock ownership records,
• Obtain "Good Standing" and "No Tax Due" Certificates from each state in which the company pays taxes,
• Update warrant, option, and other agreements relating to securities of the company, and related cancellation agreements,
• Prepare a detailed organizational chart,
• Renew important contracts,
• Document proprietary procedures, methods, formulas and trade secrets,
• Update written policies and procedure manuals including employee handbooks,
• Verify and document compliance with regulatory and environmental laws,
• Settle all pending or threatened litigation and claims including governmental administrative proceedings or inquiries (e.g. EEOC or OSHA),
• Bring all fees and taxes current, and
• Discuss union compliance with competent counsel.

6. Create a competent "Depth of Management Team." All buyers, both strategic and financial, want competent management to remain. Document competency with resumes, awards, and accomplishments achieved by management.

List and document all business intangibles including:

• Patents, copyrights, service marks, trade names and trademarks.
• Name recognition and reputation in the form of awards, articles, trade association commendations and etc.
• A listing of the top 10-50-100 customers to show the dynamics of sales.
• A company's leadership within an industry.
• Barriers to entry.
• Competitive advantages.
• Market conditions.

7. Anticipate buyer concerns. Smart sellers try to anticipate a buyer's concerns and are prepared to overcome potential objections. IMAP members can help sellers through an advisory process by relating the concerns of other buyers in similar circumstances – and how those concerns were overcome.

8. Give a buyer good reasons to buy. Stress the benefits of a company. Simultaneously with benefits, smart sellers say to a buyer, "I want to sell" and "I will cooperate in a sale". Active sellers create positive results.

Once a company has been groomed for its sale, the owner must plan for and fully consider personal financial needs because they directly impact the probability of success. For your information, it is unrealistic to expect all cash at closing. All buyers reasonably request that the seller provide some financing in the form of a note, non-compete agreement, and/or management consulting agreement. If for no other reason, such deferred compensation serves as a protective indemnification relating to issues such as non-collectable accounts receivable, a future lawsuit resulting from events prior to the sale, unknown environmental problems resulting from events prior to the sale, and other normal and customary representations and warranties.

IMAP intermediaries are trained and experienced to advise clients on proven steps to maximize value prior to a sale. Smart sellers begin seeking an IMAP member's consultation three years in advance of a sale so they may be properly groomed for that important transaction.

The markets are always open for well-managed, profitable, and properly groomed companies. A seller's best parachute is to follow the advice of an IMAP counselor while anticipating what may be the largest financial transaction in a seller's lifetime.

Charles Lemmon is President of C.V. Lemmon & Co., Inc., a private investment banking firm and an IMAP member in Dallas, Texas.

Charles Lemmon can be contacted by telephone at (214) 692-7248 or by E-mail at CVLemmon@CVLemmon.com.

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