Family-Owned Businesses Do Have Choices

Family-owned businesses do have some options when it comes time to sell. Selling the entire business may not be the best choice when there are no other family members involved. Here are some choices to be considered:

Internal Transactions

  • Hire a CEO – This approach is a management exit strategy in which the owner retires, lives off the company’s dividends and possibly sells the company many years later.
  • Transition ownership within the family – Keeping the business in the family is a noble endeavor, but the parent seldom liquefies his investment in the short-term, and the son or daughter may run the company into the ground.
  • Recapitalization – By recapitalizing the company by increasing the debt to as much as 70 percent of the capitalization, the owner(s) is/are able to liquefy most of their investment now with the intent to pay down the debt and sell the company later on.
  • Employee Stock Ownership Plan (ESOP) – Many types of companies such as construction, engineering, and architectural are difficult to sell to a third party, because the employees are the major asset. ESOPs are a useful vehicle in this regard, but are usually sold in stages over a time period as long as ten years.

External Transactions

  • Third party sale – The process could take six months to a year to complete. This method should produce a high valuation, sometimes all cash at closing and often the ability of the owner to walk away right after the closing.
  • Complete sale over time – The owner can sell a minority interest now with the balance sold after maybe five years. Such an approach allows the owner to liquefy some of his investment now, continue to run the company, and hopefully receive a higher valuation for the company years later.
  • Management buy-outs (MBOs) – Selling to the owners’ key employee(s) is an easy transaction and a way to reward them for years of hard work. Often the owner does not maximize the selling price, and usually the owner participates in the financing.
  • Initial public offering (IPO) – In today’s marketplace, a company should have revenues of $100+ million to become a viable candidate. IPOs receive the highest valuation, but management must remain to run the company.

Source: “Buying & Selling Companies,” a presentation by Russ Robb, Editor, M&A Today

Copyright: Business Brokerage Press, Inc.

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Who Is Today’s Buyer?

It has always been the American Dream to be independent and in control of one’s own destiny. Owning your own business is the best way to meet that goal. Many people dream about owning their own business, but when it gets right down to it, they just can’t make that leap of faith that is necessary to actually own one’s own business. Business brokers know from their experience that out of fifteen or so people who inquire about buying a business, only one will become an owner of a business.

Today’s buyer is most likely from the corporate world and well-educated, but not experienced in the business-buying process. These buyers are very number-conscious and detail-oriented. They require supporting documents for almost everything and will either use outside advisors or will do the verification themselves, but verify they will. A person who is realistic and understands that he or she can’t buy a business with a profit of millions for $10 down is probably serious. They must be able to make decisions and not depend on outside parties to do it for them. They must also have the financial resources available, have an open mind, and understand that owning one’s own business means being the proverbial chief cook and bottle washer.

Today’s buyers are usually what might be termed “event” driven. This means that the desire to own their own business is coupled with a need or reason. Maybe they have been downsized out of a job, they don’t want to be transferred, they travel too much, they see no future in their current position, etc. Many people have the desire, but not the reason. Most people don’t have the courage to quit a job and the paycheck to venture out on their own.

There are the perennial lookers. Those people who dream about owning their own business, are constantly looking, but will never leave the job to fulfill the dream. In fact, perspective business buyers who have been looking for over six months would probably fit into this category.

Business brokers spend a lot of time interviewing buyers. Here are just a few of the questions they will ask. The answers they receive will determine whether or not the prospective buyer is serious and qualified.

  • Why is the person considering buying a business?
  • Has the person ever owned their own business?
  • How long has the person been looking?
  • Is the person currently employed?
  • What kind of business is the person looking for?
  • Is he or she flexible in the kind of business?
  • What are the most important considerations?
  • How much money is available?
  • What is the person’s timeframe?
  • Does the person’s experience match the type of business under consideration?
  • Who else is involved in the purchase decision?
  • Is the person’s spouse positive about owning a business?

There are other questions and considerations, but those cited above reveal the depth of a buyer interview. Business brokers want to work only with buyers who are serious about purchasing a business. They don’t want to show a business to anyone who is not qualified, which is simply a waste of their time and the seller’s time.

Copyright: Business Brokerage Press, Inc.

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Why Deals Fall Apart — Loss of Momentum

Deals fall apart for many reasons – some reasonable, others unreasonable.

For example:

• The seller doesn’t have all his financials up to date.
• The seller doesn’t have his legal/environmental/administrative affairs up to date.
• The buyer can’t come up with the necessary financing.
• The well known “surprise” surfaces causing the deal to fall apart.

The list could go on and on and this subject has been covered many times. However, there are more hidden reasons that threaten to end a deal usually half to three-quarters of the way to closing. These hidden reasons silently lead to a lack of or loss of momentum.

This essentially means a lack of forward progress. No one notices at first. Even the advisors who are busy doing the necessary due diligence and paperwork don’t notice the waning or missing momentum. Even though a slow-down in momentum may not be noticeable at first, an experienced business intermediary will catch it.

Let’s say a buyer can’t get through to the seller. The buyer leaves repeated messages, but the calls are not returned. (The reverse can also happen, but for our example we’ll assume the seller is unresponsive.) The buyer then calls the intermediary. The intermediary assures the buyer that he or she will call the seller and have him or her get in touch. The intermediary calls the seller and receives the same response. Calls are not returned. Even if calls are returned the seller may fail to provide documents, financial information, etc.

To the experienced intermediary the “red flag” goes up. Something is wrong. If not resolved immediately, the deal will lose its momentum and things can fall apart quite rapidly. What is this hidden element that causes a loss of momentum? It is generally not price or anything concrete.

It often boils down to an emotional issue. The buyer or seller gets what we call “cold feet.” Often it is the seller who has decided that he really doesn’t want to sell and doesn’t know what to do. It may also be that the buyer has discovered something that is quite concerning and doesn’t know how to handle it. Maybe the chemistry between buyer and seller is just not there for one or the other of them. Whatever the reason, the reluctant party just tries to ignore the proceedings and lack of momentum occurs.

The sooner this loss of momentum is addressed, the better the chance for the deal to continue to closing. Because the root of the problem is often an emotional issue, it has to be faced directly. An advisor, the intermediary or someone close to the person should immediately make a personal visit. Another suggestion is to get the buyer and seller together for lunch or dinner, preferably the latter. Regardless of how it happens, the loss of momentum should be addressed if the sale has any chance of closing.

Copyright: Business Brokerage Press, Inc.

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Personal Goodwill: Who Owns It?

Personal Goodwill has always been a fascinating subject, impacting the sale of many small to medium-sized businesses – and possibly even larger companies. How is personal goodwill developed? An individual starts a business and, during the process, builds one or more of the following:

• A positive personal reputation
• A personal relationship with many of the largest customers and/or suppliers
• Company products, publications, etc., as the sole author, designer, or inventor

The creation of personal goodwill occurs far beyond just customers and suppliers. Over the years, personal goodwill has been established through relationships with tax advisors, doctors, dentists, attorneys, and other personal service providers. While these relationships are wonderful benefits, they are, unfortunately, non-transferable. There is an old saying: In businesses built around personal goodwill, the goodwill goes home at night.

It can be difficult to sell a business, regardless of size, where personal goodwill plays an integral role in the business’ success. The larger the business, the less likely that one person holds the key to its profitability. In small to medium-sized businesses, personal goodwill can be a crucial ingredient. A buyer certainly has to consider it when considering whether to buy such a business.

In the case of the sale of a medical, accounting, or legal practice, existing clients/patients may visit a new owner of the same practice; they are used to coming to that location, they have an immediate problem, or they have some other practical reason for staying with the same practice. However, if existing clients or patients don’t like the new owner, or they don’t feel that their needs were handled the way the old owner cared for them, they may look for a new provider. The new owner might be as competent as, or more competent than, his predecessor, but chemistry, or the lack of it, can supersede competency in the eyes of a customer.

Businesses centered on the goodwill of the owner can certainly be sold, but usually the buyer will want some protection in case business is lost with the departure of the seller. One simple method requires the seller to stay for a sufficient period after the sale to allow him or her to work with the new owner and slowly transfer the goodwill. No doubt, some goodwill will be lost, but that expectation should be built into the price.

Another approach uses some form of “earnout.” At the end of the year, the lost business that can be attributed to the goodwill of the seller is tallied. A percentage is then subtracted from monies owed to the seller, or funds from the down payment are placed in escrow, and adjustments are made from that source.

In some cases, the sale of goodwill may offer some favorable tax benefits for the seller. If the seller of the business is also the owner of the personal goodwill, the sale can essentially be two taxable events. The tax courts have ruled that the business doesn’t own the goodwill, the owner of the business does. The seller thus sells the business and then also sells his or her personal goodwill. The seller’s tax professional will be able to give further advice on this matter.

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The Three Ways to Negotiate

Basically, there are three major negotiation methods.

1. Take it or leave it. A buyer makes an offer or a seller makes a counter-offer – both sides can let the “chips fall where they may.”

2. Split the difference. The buyer and seller, one or the other, or both, decide to split the difference between what the buyer is willing to offer and what the seller is willing to accept. A real oversimplification, but often used.

3. This for that. Both buyer and seller have to find out what is important to each. So many of these important areas are non-monetary and involve personal things such as allowing the owner’s son to continue employment with the firm. The buyer may want to move the business.

There is an old adage that advises, “Never negotiate your own deal!”

The first thing both sides have to decide on is who will represent them. Will they have their attorney, their intermediary or will they go it alone? Intermediaries are a good choice for a seller. They have done it before, are good advocates for their side and they understand the company and the seller.

How do the parties get together in a win-win negotiation? The first step is for both sides to work with their advisors to settle on the price and deal structure positions. Both sides should be able to present their side of these issues. Which is more important – price or terms, or non-monetary items?

Information is vital to a buyer. Buyers should keep in mind that the seller knows more about the business than he or she does. Both buyer and seller need to anticipate what is important to the other and keep that in mind when discussing the deal. Buyer and seller should do due diligence on each other. Both buyer and seller must be able to walk away from a deal that is just not going to work.

Bob Woolf, the famous sports agent said in his book, Friendly Persuasion: My Life as a Negotiator, “I never think of negotiating against anyone. I work with people to come to an agreement. Deals are put together.”

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Copyright: Business Brokerage Press, Inc.

Due Diligence — Do It Now!

Due diligence is generally considered an activity that takes place as part of the selling process. It might be wise to take a look at the business from a buyer’s perspective in performing due diligence as part of an annual review of the business. Performing due diligence does two things: (1) It provides a valuable assessment of the business by company management, and (2) It offers the company an accurate profile of itself, just in case the decision is made to sell, or an acquirer suddenly appears at the door.

This process, when performed by a serious acquirer, is generally broken down into five basic areas:

• Marketing due diligence
• Financial due diligence
• Legal due diligence
• Environmental due diligence
• Management/Employee due diligence

Marketing Issues
It has been said that many company officers/CEOs have never taken a look at the broad picture of their industry; in other words, they know their customers, but not their industry. For example, here are just a few questions concerning the market that due diligence will help answer:

• What is the size of the market?
• Who are the industry leaders?
• Does the product or service have a life cycle?
• Who are the customers/clients, and what is the relationship?
• What’s the downside and the upside of the product/service? What is the risk and potential?

Financial Issues
Two important questions have to be answered before getting down to the basics of the financials: (1) Do the numbers really work? and (2) Are the seller’s claims supported by the figures? If the answer to both is yes, the following should be carefully reviewed:

• The accounts receivables
• The accounts payable
• The inventory

Legal Issues
Are contracts and agreements current? Are products patented, if necessary? How about copyrights and trademarks? What is the current status of any litigation? Are there any possible law suits on the horizon? What would an astute attorney representing a buyer want to see and would it be acceptable?

Environmental Issues
Not too long ago this area would have been a non-issue. Not any more! Current governmental guidelines can levy responsibility regarding environmental issues that existed prior to the current occupancy or ownership of the real estate. Possible acquirers – and lenders – are really “gun-shy” about these types of problems.

Management/Employee Issues
What employment agreements are in force? What family members are on the payroll? Who are the key people? In other words, who does what, why, and how much are they paid?

Operational Issues
The company should have a clear program covering how their products are handled from raw material to “out the door.” Service companies should also have a program covering how services are delivered from initial customer contact through delivery of the services.

The question is, do you give your company a “physical” now, or do you wait until someone else does it for you – with a lot riding on the line?

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Copyright: Business Brokerage Press, Inc.

Considerations When Selling…Or Buying

Important questions to ask when looking at a business…or preparing to have your business looked at by prospective buyers.

• What’s for sale? What’s not for sale? Does it include real estate? Are some of the machines leased instead of owned?

• What assets are not earning money? Perhaps these assets should be sold off.

• What is proprietary? Formulations, patents, software, etc.?

• What is their competitive advantage? A certain niche, superior marketing or better manufacturing.

• What is the barrier of entry? Capital, low labor, tight relationships.

• What about employment agreements/non-competes? Has the seller failed to secure these agreements from key employees?

• How does one grow the business? Maybe it can’t be grown.

• How much working capital does one need to run the business?

• What is the depth of management and how dependent is the business on the owner/manager?

• How is the financial reporting undertaken and recorded and how does management adjust the business accordingly?

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A Buyer’s Quandary

Statistics reveal that out of about 15 would-be business buyers, only one will actually buy a business. It is important that potential sellers be knowledgeable on what buyers go through to actually become business owners. This is especially true for those who have started their own business or have forgotten what they went thorough prior to buying their business.

If a prospective business buyer is employed, he or she has to make the decision to leave that job and go into business for and by himself. There is also the financial commitment necessary to actually invest in a business and any subsequent loans that are a result of the purchase. The new owner will likely need to execute a lease or assume an existing one, which is another financial commitment. These financial obligations are almost always guaranteed personally by the new owner.

The prospective business owner must also be willing to make that “leap of faith” that is so necessary to becoming a business owner. There is also the matter of family and personal responsibilities. Business ownership, aside from being a large financial consideration, is very time consuming, especially for the new business owner.

All of these factors have to be weighed very carefully by anyone that is considering business ownership. Buyers should think carefully about the risks – and the rewards. Sellers should also put themselves in a buyer’s position. The services of a professional business broker or intermediary can help determine the relative pros and cons of the transaction.

The Confidentiality Agreement

When considering selling their companies, many owners become paranoid regarding the issue of confidentiality. They don’t want anyone to know the company is for sale, but at the same time, they want the highest price possible in the shortest period of time. This means, of course, that the company must be presented to quite a few prospects to accomplish this. A business cannot be sold in a vacuum.

The following are some of the questions that a seller should expect a confidentiality agreement to cover:

  • What type of information can and can not be disclosed?
  • Are the negotiations open or secret?
  • What is the time frame for which the agreement is binding? The seller should seek a permanently binding agreement.
  • What is the patent right protection in the event the buyer, for example, learns about inventions when checking out the operation?
  • Which state’s laws will apply to the agreement if the other party is based in a different state? Where will disputes be heard?
  • What recourse do you have if the agreement is breached?

Obviously, executing an agreement does not mean a violation can’t occur, but it does mean that all the parties understand the severity of a breach and the importance, in this case, of confidentiality.

While no one can guarantee confidentiality, professional intermediaries are experienced in dealing with this issue. They are in a position to understand the extreme importance of confidentiality in business transactions as well as the devastating results of a breach in confidentiality. A professional intermediary will require all legitimate prospects to execute a confidentiality agreement.

A confidentiality agreement is a legally binding contract, enforceable in a court of law. It establishes “common ground” between the seller, who wants the agreement to be extensive, and the buyer, who wants as few restrictions as possible. It allows the seller to share confidential information with a prospective buyer or a business broker for evaluative purposes only. This means that the buyer or broker promises not to share the information with third parties. If a confidentiality agreement is broken, the injured party can claim a breach of contract and seek damages.

© Copyright 2015 Business Brokerage Press, Inc.

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The Devil May Be in the Details

When the sale of a business falls apart, everyone involved in the transaction is disappointed – usually. Sometimes the reasons are insurmountable, and other times they are minuscule – even personal. Some intermediaries report a closure rate of 80 percent; others say it is even lower. Still other intermediaries claim to close 80 percent or higher. When asked how, this last group responded that they require a three-year exclusive engagement period to sell the company. The theory is that the longer an intermediary has to work on selling the company, the better the chance they will sell it. No one can argue with this theory. However, most sellers would find this unacceptable.

In many cases, prior to placing anything in a written document, the parties have to agree on price and some basic terms. However, once these important issues are agreed upon, the devil may be in the details. For example, the Reps and Warranties may kill the deal. Other areas such as employment contracts, non-compete agreements and the ensuing penalties for breach of any of these can quash the deal. Personality conflicts between the outside advisers, especially during the
due diligence process, can also prevent the deal from closing.

One expert in the deal-making (and closing) process has suggested that some of the following items can kill the deal even before it gets to the Letter of Intent stage:

  • Buyers who lose patience and give up the acquisition search prematurely, maybe under a year’s time period.
  • Buyers who are not highly focused on their target companies and who have not thought through the real reasons for doing a deal.
  • Buyers who are not willing to “pay up” for a near perfect fit, failing to realize that such circumstances justify a premium price.
  • Buyers who are not well financed or capable of accessing the necessary equity and debt to do the deal.
  • Inexperienced buyers who are unwilling to lean heavily on their experienced advisers for proper advice.
  • Sellers who have unrealistic expectations for the sale price.
  • Sellers who have second thoughts about selling, commonly known as seller’s remorse and most frequently found in family businesses.
  • Sellers who insist on all cash at closing and/or who are inflexible with other terms of the deal including stringent reps and warranties.
  • Sellers who fail to give their professional intermediaries their undivided attention and cooperation.
  • Sellers who allow their company’s performance in sales and earnings to deteriorate during the selling process.

Deals obviously fall apart for many other reasons. The reasons above cover just a few of the concerns that can often be prevented or dealt with prior to any documents being signed.
If the deal doesn’t look like it is going to work – it probably isn’t. It may be time to move on.

© Copyright 2015 Business Brokerage Press, Inc.

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