How business owners should prepare for a sale process

In life, "well-prepared is half-done".

And this is especially true for business owners or general managers who are considering selling the whole or a part of the business.

Here are some thoughts on the process.

1. Why is it even important to put in the effort to get a business "ready for sale"? Can't we go to market right away?

A business that is well-packaged, easy to understand, and substantiates its growth story commands two advantages:

1) Increases the valuation of the business:

It commands (in my experience) at least an additional ~1x - 2x profit multiple in valuation.

Put simply, for a business that makes ~$20M in EBITDA in an industry trading at ~7x EBITDA multiples, this can mean ~$20M - $40M more in valuation.

While this varies by industry, company, market conditions, and a host of other conditions, the work and expense involved in preparing for the exit pays off readily.

2) Decreases the risk of selling the business:

Buyers are constantly looking for hidden minefields when acquiring a business. Sometimes the risk is real, and sometimes it's not (but buyers worry anyway).

The effort involved in sell-side readiness reduces the risk, in the buyer's mind, and reduces the amount of additional work the buyer has to do to get comfortable with the business

... which increases the odds that the business successfully sells.

2. What short-term steps can business owners take to prepare?

Sometimes there simply isn't enough time because management wants to close the sale very quickly (in less than 4-5 months).

Unfortunately, this also constrains the options available.. but nevertheless, if the exit is imminent, the steps to take to get ready for the sale are generally straightforward (most common 'sell-side' process):

1. Draft a confidential investment memorandum (CIM) explaining the business and growth story
2. Build a forecast model
3. Prepare the data room
4. Identify potential Buyers and reach out to them through a structured process
5. Of the buyers who express interest, select the right Buyer(s) and move forward to structure and close the deal

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• Steps 1-3 can be done concurrently and for a relatively well-organized business (professionally prepared financials, easy-to-explain business model, few operational or management issues) can be completed in ~2 months.
• Steps 4-5 are market and situation dependent and can take 2-3 months.

3. What can businesses do to prepare over the medium to long term?

Most businesses can and should be doing much more to prepare before the sale process even starts.

The below areas (not exhaustive) can take multiple quarters (sometimes 1-2 years) but will make the sale process easier and lead to a better valuation upon exit.

1) Establish or solidify the go-forward management team:

One of the biggest fears Buyers have, especially when the Sellers are ready to retire, is the dependency on the Seller’s expertise and relationships.

Often, Buyers structure the deal to ensure that key management team members are engaged in the business after the close – via earn-outs and employment agreements.

If the Seller can demonstrate that the management team that is staying behind is strong enough to lead, this increases the Buyer’s comfort.

This kind of succession planning can take a couple of years to put in place, but is well-worth it to get a clean exit at a better valuation for the Seller.

2) Address impending liabilities (e.g. regulatory, compliance, tax, employee issues)

Unknown liabilities are usually a major cause of the Buyer’s uncertainty about the business.

And unfortunately, buyers almost always perceive this risk to be far bigger than the Sellers’ perception of it - and want protections that exceed the actual commercial risk.

To reduce risk, Buyers could ask for purchase price reductions, hold-backs, or indemnifications – all of which could reduce the Seller’s proceeds at or after the close.

3) Clean up items that require add-backs or at least document them to be defensible

Most businesses have various adjustments that the Sellers want to “add back” to show a normalized EBITDA to buyers.

Examples include non-recurring expenses, above-market compensation, or discontinued operations.

The Seller wants to have as many (and as much in $ value) of these add-backs while Buyers want the opposite.

And the Buyer makes some subjective assessments to include or exclude Seller add-backs.

However, a Seller who proactively gets a Quality of Earnings (“QoE”) from a reputable firm largely removes the debate from the question, and the add-backs can largely stand the scrutiny of buyers and their advisors.

(See?link here ?about why add-backs are so significant to valuation).

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4) Improve or steady margins

This is admittedly the hardest of the lot, since it involves some deep operational changes but it also has a strong impact on value.

This step could involve reducing fixed costs (e.g. renegotiating leases), reducing costs of sales (e.g. renegotiating supplier and supplier agreements), optimize selling and administrative expenses (e.g. automating business processes and reducing head-count).

….which sometimes take years to implement.

Buyers generally start their valuation of the stand-alone business using the margins of the past 1-2 years as a baseline.

Showing that the business has already been running at a certain EBITDA margin for at least a year or two shows the buyer that the business profitability is more predictable.

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What can sellers do to get smart about the process?

1. Reach out to peers, and business networking groups (the ACG or Association for Corporate Growth is a great one I'm involved in) to hear first-hand stories and build a network of professionals who can help.
2. Hire an advisor or consultant - ideally one who has experience with both the sell-side (i.e. helping to prepare businesses for a sale as well as selling them) and buy-side (i.e. working with corporate or PE buyers) and can provide guidance as well as hands-on execution support to move the process forward.

#mergersandacquisitions