Pearls of Wisdom

When Selling

The following “Pearls of Wisdom” were assimilated from multiple middle-market intermediaries by Mr. Russ Robb, Editor-in-Chief of M&A Today. The ideas below were published in M&A Today, Volume 10, Number 2.

1. Partner with real professionals. Improper advice could cost you tenfold later on. In retaining an attorney, be sure he or she is a “transaction” attorney, not a trust attorney. Make sure the intermediary properly screens and qualifies potential buyers.
2. M&A involves three sometime inconsistent objectives: speed, confidentiality, and value. Sellers should identify the two that are most important to them.
3. Openly recognize certain “on and off” balance sheet items such as customer pre payments, work in process billing, contract obligations, lease obligations, legal threats, etc.
4. If company owners are totally inflexible, the potential buyer may abandon or postpone the acquisition project.
5. Negotiate “stay agreements” with top management so they will not jump ship before the business is sold. Depending on the situation and the importance and number of people involved, a stay agreement could be equivalent to anywhere from two to six months salary.
6. Set up a complete file in one place of all relevant information the buyer and/or his due diligence team will ultimately request, e.g., contracts, distribution and purchase agreements, leases, licenses, intellectual property documents, etc.
7. As a seller, be prepared to accept lower valuation multiples for lack of management depth, reliance on a few customers, and regional versus national distribution.
8. If a buyer indicates he or she will be submitting a Letter of Intent, tell them right up front what items you want to be included in the document:

• Price and Terms
• If asset purchase, what assets and liabilities are to be assumed
• What contracts and warranties are to be assumed
• Lease or purchase of real estate
• Responsible for what employee contracts or severance agreements
• Time schedule of due diligence and closing.

9. The principal reason why numerous transactions come apart at the letter of intent stage is that so many new parties get involved in the deal that agreement by consensus becomes more and more difficult. The best hope for successfully completing the deal after LOI is to have very experienced transaction attorneys and advisors.
10. Audited Financial Statements: While an accounting firm’s “review” is a bare minimum for a company in the process of selling, it would be well worth the effort and expense to have audited financial statements for several years before the company is presented for sale. The validation of inventory, receivables, notes, etc., is most assuring for a buyer and only audited statements will really satisfy a buyer’s complete scrutiny.
11. An owner needs to sell his business from a position of strength. The extra dollars incurred in preparing an audit and obtaining very strong financial documentation comes back several times over in the purchase price.
12. Unadjusted Financial Data: If an owner is serious about selling his business, he should show “real” earnings without a lot of adjustments and add backs. Buyers do not get excited about companies operating at a breakeven basis with a list of add backs. By nature, buyers become suspicious.
13. High Quality Management: Usually if the selling company’s CEO will remain on the job for several years after the company is sold, it will add value to the purchase price.

If the selling company has numerous family members on the payroll, it is considered a negative. Therefore, the selling company might be wise to have those family members under contract with a specific buy out clause.

With appropriate discretion, it is effective if the owner can “show off” the top management to a prospective buyer. Especially effective is a top management well versed in the company’s strategy, its goals and its position in the market. Conversely, what is most damaging for a seller is when he comes across as a “one man band” as opposed to a team oriented organization.

14. Settle all litigation and environmental matters before discussing a sale of the business. These items can be deal breakers, so present these problems ahead of time.
15. Prepare the business for sale two to five years in advance by preparing a business plan, by providing timely, accurate and pertinent financial reports and implementing a culture of continuous improvement.
16. Hire a great transaction lawyer, because the buyer will probably have the best available attorney.
17. Be flexible with the real estate component of the business. Most buyers would rather rent the plant and invest their money in growing the business. Real estate usually does not make money for the operating company and many times it is difficult to recover its full value within a “multiple of EBIT”.
18. Do not be afraid of buyer’s notes to the seller. It is unusual where a founder, temporarily remaining in place, is not desirable. Additionally, the best deal for buyers is one in which seller paper can be used as subordinated debt. Consequently, as long as former owners are owed money, they have a right to view themselves as quasi-partners, and I would suggest that the insightful buyer will consider structuring a share of future earnings improvement to the former owner’s benefit – as long as he’s in place.

Of course, it is desirable for the seller to have some sort of security on the notes and there should be a reasonable risk rate on the coupon. The fact that the seller continues for a short time as a quasi partner, albeit as a debt holder, certainly creates value in the deal.

19. Understand the Buyer’s Concerns: The buyer is usually aware that the founder, owner, and CEO is principally responsible for running the business. If the company has no depth of management or is perceived to be a “one-man band,” the price for the business will be discounted. It is not wise for the CEO to overly brag about himself or let the seller know he has not taken a vacation in three years and works twelve-hour days.
20. Don’t negotiate directly, but through an intermediary who can mediate, act as a buffer, and carry on “sidebar” conversations. Don’t let too much time elapse between meetings with an interested buyer. Once the process starts, keep it moving, or you may lose momentum and affect your business and the morale of your employees.
21. Don’t delegate important aspects of the deal to underlings – and don’t let the buyer do so either. It is important for key players to stay in touch and to develop confidence in each other, and engage an investment banker who understands your business and has knowledge of your industry.
22. Complexity is a killer in dealmaking. It sucks time and saps strength. The more complicated the deal structure, the less likely it is to work.
23. The buyer must work hard to put himself in the shoes of the seller in order to determine the real reason why the seller is talking about a sale. The real reason is seldom obvious and sellers usually sugarcoat the problems.
24. You should be sure that the CEO has the legal authority to sell the business. This may rest with the board of directors, a majority stockholder, and a bank with a lien on the business, etc.
25. Valuation is an important exercise, but usually the value thus determined is not the purchase price. The business will be bought for whatever the seller will take for it.
26. In approaching a negotiation, the first problem is determining who is the decision maker on the other side. Lots of jawbones have been worn out in psuedo-negotiations with the wrong person.
27. Once the decision maker has been identified, it is important to establish a rapport with him or her. Unless the seller and the decision maker on the buyer’s side are able to work together, the consummation of a deal is highly unlikely. At some point, a social dinner including the buyer’s spouse may be an ideal way of furthering the negotiation.
28. Try to control the drafting of the Purchase & Sale Agreement and other documents. While it is customary for buyers to do the drafting, if the seller can seize that function, the seller will have an advantage.
29. Keep the momentum going. Deals that drag don’t close. Energy and zeal are critically important.
30. From a legal viewpoint, the essential features of any acquisition agreement are representations and warranties, covenants, conditions precedent to the closing and the indemnifications. Based on the above, sellers should be prepared to “hold-out” for a full price on the business knowing that the buyer will be seeking a near perfect business condition, or there will be adjustments post closing. On the other hand, if there is to be an adjustment on the price, then the post-closing conditions should be more lenient.
31. As a seller, beware that many buyers will view the value of a Sub Chapter S company to be worth less than if the same company was a C Corporation. In a Sub Chapter S company, most of the earnings flow out to the shareholders, in which case the company’s book value probably will not increase proportionately to the level of earnings. This book value earnings disparity will adversely affect the value of the business and reduce the leveragability of assets for the buyer.
32. In the process of selling a company, there are three questions to expect from the buyer: What differentiates your company? How would you grow the company? What would you do if the company received a sizable windfall of cash?
33. When an underperforming company is being positioned to sell, it is important to dress it up – to put a “tuxedo on the patient,” according to Ray Sozzi, turnaround specialist from Raymond Group of Chappaqua, New York. Sozzi continues: “One has to look for perceived value within the company. This is the time to form strategic alliances, product licenses, distribution arrangements, endorsements…, all of which cost very little or nothing to accomplish. If arranged with a Fortune 500 company, it creates value. Continue displaying at trade shows for industry awareness and for possible contacts with potential buyers. Outsource all non-essential activities and concentrate on only the core attributes. Identify component values of the company which will entice the potential buyer to pay more for the business than just its intrinsic value. It may be the perceived value of the company’s patents or it may be the perceived value of merging with a public company.”
34. In negotiations, start with the less confrontational issues first. Win/win negotiating makes use of the principle that handling easier topics at the beginning encourages yes answers with the habit of saying yes.
35. Don’t negotiate with people who are not motivated to buy.
36. Businesses get stale after sitting on the shelf for awhile.
37. There is just no plausible reason for sellers to enter into contracts with marginally qualified buyers and lose inordinate amounts of precious marketing time in the process.
38. With an earnout agreement the seller should secure a note, albeit contingent, collateralized and cross-defaulted with a non-compete agreement.
39. There are a number of ways to incentivize employees when selling the company in order to assure the employees that remain on board will provide them with some job security after a sale such as: Employment contracts coupled with a one-year non-compete agreement to provide additional value to acquirers, and to assure these employees that remaining on board now will provide them with some job security after a sale.

Owners provide employees with a direct interest in an acquirer’s purchase price by awarding them advance equity, phantom stock, bonuses, and/or other financial incentives.

40. Successful “sales” do not just happen. If you do not have a good dealmaker on your team, employ one, rent one, but get one. A dealmaker can expertly help package the important wants and needs of both sides of the transaction.
41. As stated by Richard Nixon: “Always be prepared to negotiate, but never negotiate without being prepared.”
42. Selling out doesn’t mean saying good-bye. To fetch top dollar for a business, more entrepreneurs find they must stick around and keep working after the sale.
43. Once a seller signs a letter of intent, even though it is largely non-binding, the seller’s leverage drops dramatically. Therefore, before signing a letter of intent, the seller should make sure it covers as many critical deal points as possible and that the “no shop” provision is as short as practical.
44. You should avoid the introduction of a lawyer into discussions with principals before the elements of a business deal have been completed. As soon as the buyer introduces such an expert into discussions, the seller does likewise. Since such individuals must protect the technical aspects of their client’s positions, more transactions have failed by the premature introduction of such specialists than have been made.
45. In order for your attorney to be a deal maker instead of a deal breaker, don’t expect your lawyer to win every point in contention.
46. From a seller’s perspective, if the deal falls through, a great deal of confidential information has been given to the wrong people.
47. Act with absolute clarity in all of your negotiations so that the potential deal breakers surface as early as possible and can be dealt with for as long a period of time as possible rather than at the eleventh hour.
48. Non-negotiable items should be pointed out early in the negotiation, such as an asset versus a stock sale or that the buyer’s note will be subordinated to obligations to the bank.
49. The older the business, the better established it is and the stronger its customer and supplier relationships.
50. Communicate with your banker about what you are doing. Bankers not only hate surprises, but also if they are surprised, may not be cooperative when you need them most.
51. The more industries into which the company sells its product, the more protection it has from cyclically and/or an industry downturn.
52. Sellers are often selling their legacy, and so the dynamics of the sale are often more important than the top bid. The preferred buyer, in the eyes of the seller, is not necessarily the high bidder, but rather the one who has the best intentions, the best chemistry, and/or the best credentials.