Selling a company can be a long and detailed process. Preparing a company for sale may take up to twelve months, and then, once a buyer is found, the sale process can take from three to six months. Throughout this process, have an advisory team in place including an attorney and accountant who are experienced in mergers and acquisitions (M&A). Your advisory team can help you through the 10 steps necessary to sell your company. The steps are discussed in detail below.
Step 1: Define the Owner’s Goals and Potential Exit Strategies
When considering the sale of a business, a business owner has a wide variety of transaction options to sell the business. These options should be understood by the owners and board of directors, which could affect the price paid by the buyer. However, in the lower middle market, the owner’s goals often drive the type of buyer that the company desires. Types of buyers generally break down to employee buyers, financial buyers and strategic buyers. Each is discussed below:
Employee Buy-Out. An owner may sell to an insider or the company’s management team or through and Employee Stock Ownership Plan (ESOP). An ESOP allows full-time employees to participate in ownership of the company. An owner may find these options attractive if the company’s internal team is the best option for the company’s future growth and success.
Financial Buyer. Financial buyers make up a large part of the buyer pool in low and middle market transactions. Financial buyers look for businesses they can buy using debt financing for 50% to 75% of the price. These buyers are also looking for sufficient cash flow to service that debt.
Strategic Buyers. Strategic buyers expect synergies with their other businesses. They buy companies that work within their future business plans. Sometimes strategic buyers pay a premium to get clients or the expertise of a company. On the other hand, buyers may not want to engage with strategic buyers who are competitors.
All of the options have pros and cons. Sellers often have a preference for the type of buyer they prefer and sellers target their business to the particular buyer. A good M&A advisor will work with the business owner to understand the selling requirements, the range of valuation expectations, and strategic goals. This also includes the following: defining exit strategy alternatives; recognizing the most appropriate types of acquirers; determining timing of sale; identifying tax consequences; and balancing the owner's desire for future involvement with the company.
Step 2: Determine a Range of Value
Determining a reasonable valuation range is a critical step in the sale process. Owners should have a realistic valuation so the buyer and seller have similar expectations about business value. Deals can crash when sellers and buyers have completely different expectations about business value, and the parties cannot get to a mutually agreed purchase price. While the M&A advisor helps the parties come to terms, the most experienced advisor may not be able to bridge a large gap.
Several methodologies can determine a company’s value. Sellers may engage valuation experts to help them value the business prior to listing the company for sale. While the valuation provides the seller a basis for understanding company value, a strong buyer pool also helps a seller understand how the market values the company. Finally, a seller can apply standard multiples of earnings to get an indication of how the market values the business. In the end, the price is determined in the market by potential buyers, the quality of the business presentation, and negotiations with buyers.
Step 3: Enhancing Value Prior to the Sale
Often, M&A advisors will review a company's strategic plan, growth opportunities, and financial status to provide suggestions to the shareholders and board of directors on ways to improve the company’s performance over a 6-12 month period. The advisor may suggest reducing customer concentration, focusing on core competencies, streamlining processes, and reducing expenses. Working with a knowledgeable M&A advisor that has relevant transaction experience and understands the business is very valuable in the sale process.
Step 4: Gather Financial Information
Spending the time to properly evaluate and present a company's financial and business history and future projections is a crucial element of the sale process. Because business owners typically prepare their financial statements for tax purposes and not for business sale purposes, the M&A advisor often works with sellers to recast financials so that prospective buyers have a good view of the company’s earning capabilities. Taking the time to properly present a company's earning power can have a big impact on how the buyers view the business and evaluate the company.
Step 5: Compile Due Diligence Information
When potential acquirers evaluate a company, they expect the records and facts to be properly organized and documented. Owners should review their incorporation papers, corporate governance documents, permits, licensing agreements, employee agreements, and leases. These records are shared in a “data room.” A data room can be an actual room with bankers boxes of data, but today, a data room is often cloud-based. Accordingly, the seller’s M&A advisor should collect and organize the data room for buyers to quickly and easily find information about the company. Unorganized data room reflects poorly on the seller and may delay the due diligence process. Both hurt the seller.
The M&A advisor will use the company’s financial information and due diligence to prepare a high-quality business summary. The business summary allows the company to tells its story, share financial information, describe its market niche and share its growth opportunities. The business summary, often called a confidential information memorandum or CIM, is a great way to educate buyers in a quick and easy to read format.
Step 6: Target Buyers
Lower market and middle market companies often have a large number of potential buyers. Usually, companies don’t identify potential buyers on their own. This means the company’s advisors and the business owner must have tools and resources to research and access the largest and most qualified buyers. Your M&A advisor should review competitors, customers, strategic buyers, private equity firms with relevant expertise, and other sources of highly suitable capital and partnership. This is one of the most time-intensive elements of the process, but it is required for a successful deal. If you don't approach the best buyers, how can you get the best price and terms for your business?
Step 7: Qualify Potential Buyers
Many potential buyers that express interest in a business will not be qualified to purchase the company. A good M&A advisor will ask potential buyers the appropriate questions to screen buyers. Allowing the M&A advisor to prescreen buyers permits the owners and company’s management team to continue focusing on growing the business instead of wasting time talking with unqualified buyers.
Step 8: Negotiate the Deal
The sale of a business has many financial and professional considerations for the management team and owner. The purchase price is only one component of the overall result. Other terms that buyers and sellers negotiate include the following: stock sale versus asset sale, earnout, terms, seller financing and security to support that financing, liabilities assumed by the acquirer, employment contracts, non-compete agreements, current assets retained by the seller. and equity ownership.
Step 9: Indications of Interest, Letter of Intent, and Transaction Documents
Typically, buyers express interest in a company at three stages through three documents: the Indication of Interest (IOI), Letter of Intent (LOI), and Purchase Agreement. The IOI is non-binding and provides the proposed terms, valuation, and structure for a transaction. The owner decides whether or not to move forward with a buyer based on the IOI. Letters of intent are more serious show of interest by the buyer. The LOI includes deal terms and typically gives the buyer an exclusivity period to evaluate the company. During the exclusivity period, the buyer must move quickly to determine if they want to move forward with the deal. At the same time, the purchase agreement and other transaction documents (employment agreements, noncompete agreements, etc.) must be drafted to define all the details of the transaction: legal, financial, representations, warranties, etc. The purchase agreement is the definitive document outlining the terms of the sale.
Step 10: Transition the Business
The transition period is a time period of cooperation during which the seller will assist the buyer in transitioning the business. This typically includes introductions to key clients, transitioning the financing and accounting functions, better understanding the operations and transitioning, and other proprietary information and trade secrets needed to operate the business optimally.