ONLINE EXCLUSIVE: Selling Your Company: Seven Critical Rules That Assure Your Success

November 30, 2003
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Following these seven rules can help you obtain a premium price with favorable terms when selling your company.

Selling a privately held middle market company is more of an art than a science. (Middle market deals are defined as those with transaction prices in the range from $2 million-$250 million.) Even experienced professionals realize that there are few sources of empirical data to use in pricing a middle market deal. The available information is usually sparse and superficial, and therefore of limited use in determining a transaction price. In addition, the procedures to use to sell or value a middle market company, the valuation multiple to apply, the appropriate transaction structure and the likely events that will occur after a closing are usually substantially different for middle market deals than for the more publicized major public deals. Due to the uniqueness and complexity of middle market deals and the lack of meaningful information on the subject, it is essential to follow seven critical rules to be successful in the sale of your company:

1. Obtain a principally all-cash deal.

2. Retain a competent acquisition consulting/investment banking firm (advisory firm).

3. Define your expected transaction price before going to market.

4. Demand minimal exposure to post-closing issues and liabilities arising from the definitive purchase agreement.

5. Accept that negotiations tend to be adversarial.

6. Be patient.

7. Divulge proprietary information only at the appropriate time.

Obtain A Principally All-Cash Deal

In an acquisition, as in business, you are trying to maximize both price and risk. There is no better way to accomplish the latter than by doing a principally all-cash deal. There are only two reasons why an acquirer wants a seller to accept notes:
  • There is a lack of bank or institutional financing available to the acquirer, or it is available at an interest rate much higher than they are willing to give the seller.
  • Notes can be an easy conduit for an acquirer to collect for alleged seller breaches of representations and warranties. This could necessitate a seller pursuing litigation to collect on their notes.
It is not unreasonable to demand an all-cash deal from an acquirer. Over 92% of the deals that I have closed during the past 15 years have been for all cash. No deal has been transacted where the cash component of consideration was less than 87% of total consideration.

In a similar vein, I would almost never consider a deal with a contingent price factor, unless the contingency portion is in excess of my expected transaction price. There is no way to protect the seller's ability to meet the contingency goals without unreasonably restricting the actions of the acquirer after the deal.

Retain a Competent Acquisition Consulting Firm

A seller should use an advisory firm to guide and direct them through the entire process. This includes planning the sale, the valuation, the development of an enticing offering circular, the search for a synergistic acquirer, and the conduct and control of all negotiations leading to a closing. The advisory firm should use a personalized, tailored approach that encompasses a review of all aspects of the seller's business foundation and niche. Such review far transcends a mere analysis of the financial statements, which only represents a small part of the review.

The advisory firm should be committed to closing a sale only after an aggressive premium price has been obtained. It should have a reputation that the seller's best interest is the only factor that dictates an acceptable deal. The advisor must also have a thorough understanding of the economic implications of the legal issues that are likely to arise in negotiating the definitive purchase agreement, and it should control all negotiations with the attorneys working under its guidance. In a middle market deal, it is usually preferable to use an advisory firm with entrepreneurial flair, as it often will have a similar background and psychological make-up to the selling owner. The firm will understand the feelings that the seller will be dealing with during the acquisition process. Consequently, it can provide the emotional support that most sellers find beneficial at this time. As the negotiations leading to the closing are the most critical phase of an acquisition, the seller wants an advisor that is a strong-willed, articulate and persuasive negotiator. An advisor with these skills, approach and characteristics is necessary for a seller to obtain a premium price.

Define Your Expected Transaction Price

Acquirers are trying to steal your company-that is how the capitalist system works. Unfortunately, the acquirer is usually larger, has greater resources, and is more knowledgeable about acquisitions. However, sophisticated, hard-working sellers can level the playing field.

Prior to going to market, a seller should have its advisory firm comprehensively evaluate all facets of the company's business foundation. Its major future opportunities and risks should be determined, evaluated and quantified. When this process is completed, the seller and its advisory firm should feel that their knowledge of the company's future earnings potential is greater than an acquirer's. The determinant of a company's value will be its expected future earnings/EBITDA and the risk of achieving those earnings/EBITDA. This value will be impacted by both short-term future earnings potential and long-term growth factors. The stability of the business foundation will have an impact on the multiple applied to the company's earnings/EBITDA. Depending on synergistic benefits, internal corporate needs and differing perceptions of valuation factors, most prospective acquirers will see a company's value differently but within a price range of +/-10-15% of an average market price.

Be aggressive in your pricing expectations, and demand a realistic premium price. Remember you only sell your company to one buyer. You are not trying to get five acquirers to pay a normalized price; your objective is for one acquirer to pay a premium price. Once your pricing expectations are set, be confident and firm in your position, since most acquirers will try to convince you of the exorbitance of your pricing position.

Demand Minimal Exposure to Post-Closing Issues and Liabilities

Large acquirers are used to shifting most deal risks to the seller. Although this is the norm, it could be injurious to your economic health. After a company is sold, the owner has no upside. Correspondingly, the owner should have no downside risk for occurrences that become known after the deal closes.

To ensure a more equitable sharing of deal risk between seller and buyer, a seller should want the majority of its representations and warranties to be limited to "seller's knowledge." A few representations and warranties normally require a higher standard of seller guarantee. However, in these cases, the seller usually is aware if there is a problem prior to the deal closing and should have limited risk of the unknown. An acquirer will strongly contest the "seller's knowledge" position, but a seller should not relent unless the deal price compensates them for the added risk.

Accept that Negotiations Tend to be Adversarial

Negotiations are a test of wills-a battle for control. By their very nature, negotiations are a confrontational process, and a seller should accept that. In most corporate sales, the seller is usually much smaller and less knowledgeable about acquisitions than the buyer. Correspondingly, buyers are used to deals being priced the way they want. If an acquirer is forced to pay a price in excess of their target price, it will usually require difficult and adversarial negotiations before an acquirer acquiesces. If negotiations go smoothly and amicably, the acquirer is usually obtaining their price. Rarely would this represent a premium price to the seller. Therefore, accept the confrontational nature of negotiations, as this is normally essential if a seller is to get a good deal.

Be Patient

If a seller is to be successful, patience must usually be demonstrated throughout the acquisition process. Patience should not be confused with lethargy. Instead, it represents the seasoned market response when a slow pace works to a seller's advantage. If a seller has thoroughly evaluated all factors surrounding the sale, being patient should be easy. Patience is usually a byproduct of confidence in the validity of one's position. A patient seller usually produces anxiety in an acquirer. As an acquirer should never be aware of the full dynamics of the overall sale process, a patient seller usually is interpreted as one that has many attractive alternatives. This should tend to make the acquirer more flexible in negotiations.

Divulge Proprietary Information Only at the Appropriate Time

As a general rule, it is advisable not to consider customers, competitors or suppliers as a potential acquirer. If unique or compelling circumstances mandate that such prospects be pursued, they must be approached much more cautiously than when working with a typical acquirer. When this type of prospect is solicited, it is often advisable to significantly strengthen the confidentiality agreement one or more of the following ways:
  • Limit the acquirer's right to solicit the employees and/or customers of the selling company in the future.
  • Limit the detailed information provided the acquirer at the initial stage of the process.
  • Require much more detailed financial and business information about the acquirer at the initial stage than is normally obtained.
Regardless of who the acquiring company is, it is always prudent to restrict divulging proprietary information to the latter stages of negotiations. This information usually includes the following:
  • Information pertinent to sales levels or pricing specifics for individual customers or products.
  • Purchase or production costs for specific products or customers.
  • Specific pricing strategies by product, volume or other pertinent factors.
  • Specific future operating courses of action.
This information should not be divulged until the seller has signed a letter of intent with a prospective acquirer. At that time, the parties would begin to negotiate a definitive purchase agreement, and the acquirer would commence its due diligence process. At this point, sensitive information will have to be divulged to the acquirer, especially if a seller is to obtain only minimal exposure in the representation, warranty and indemnification areas. However in certain high-risk situations, when the letter of intent is signed, a seller might expand the confidentiality agreement to prohibit the acquirer from hiring any of its key employees or soliciting key customers for a 12-18 month period if the deal does not close.

Let Your Legacy Speak for Itself

If you follow the aforementioned seven rules, you will likely obtain a premium price with favorable terms in the definitive purchase agreement. To achieve this ultimate success, there is no substitution for hard work, knowledge, determination and patience. The sale of a company is usually the culmination of an owner's career or, in many cases, the end result of the efforts of many generations of a family at the company. It usually will be the legacy of decades of effort. The seller that follows these rules is likely to put a crowning touch on a successful career. Make sure you do it right and allow your legacy to speak for itself.

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