Conclusion

No one said this would be easy. After all, how many endeavors in life require expertise in sales, negotiation, accounting, finance, and lawyering – with a healthy dose of psychology to boot? You could build a rocket ship with less collective brain power than it can take to successfully pull off the sale of a $500 million business. Or a $5 million company, for that matter.

But by following the guidelines outlined in this book – advice based on personal experience and lessons learned from more than 20 years of selling mid-sized businesses – you will maximize your chances of scoring a timely transaction at top dollar.

If you’re one of those readers who jumps to the end to see how things turn out, you’re in luck. What follows is the CliffsNotes version of the measures you can take to help ensure the best possible outcome for you and your business.

First things first: Are you sure you want to do this?

Deciding to Sell

The decision to sell your company is a critical one. You’ve invested years or decades painstakingly building your business, and you’ve made countless sacrifices along the way. When contemplating such an important decision, there are four crucial factors to consider:

1. Your Goals, Including Personal, Financial, and Business: Start the process by writing down your goals – understanding what you want is the first step toward achieving your objectives. Only after you clarify your long-term goals can you examine how selling your business will move you closer to them. 
2. Internal Factors, Such as Emotions: Look at yourself and your business objectively and determine if a change would make you happier. At the same time, though, beware of trading one set of problems for another. 
3. External Factors, Including Timing and Competition: Timing the sale of your business is difficult, but you can come close to being spot on with the right intelligence. The ideal time to sell is when your business and industry are about to peak. Consult with industry veterans to obtain their opinion regarding the current market cycle of your industry. Consider both narrow industry cycles and broader macroeconomic cycles. But remember that, as with most important decisions, the timing will never be perfect. 
4. Your Business’s Value and Exit Options: Intelligent financial planning is difficult without having an accurate idea of the worth of your most valuable asset – your business. It makes sense to pay a professional to assess your business and get an idea of the steps you can take to increase its value.

Preparation vs. Execution

Most entrepreneurs have a strong bias toward action. Once they decide on a plan, they prefer to dive right in and figure things out later. But you must realize that a lack of preparation will extend the time frame of the sale, reduce the selling price of your business, put less cash in your pocket, and lower the overall chances of a successful sale. 

Proper preparation, on the other hand, will elicit the opposite outcomes – you’ll increase the chances of a successful sale, shorten the time frame, command a higher selling price, and put more cash in your pocket. As with most skilled endeavors, preparation makes execution look effortless.

No two exits are alike. Each exit must be deliberately planned. There’s no templated process you can follow to prepare your company for sale. Rather, the preparation stage involves creating a plan, prioritizing your plan, and then executing your plan. 

How Long It Takes To Sell a Business 

For all business sales since 2000, the average time on the market is 200 days or about 7.3 months. In recent years, however, the average time to sell a business increased to 10 months, from 6 months in the early 2000s. That timing, however, depends on several variables, namely:

1. Your industry
2. How attractive your business is to buyers
3. Your marketing strategy

Most of the factors that increase the value of a business will also have an impact on the amount of time it takes to sell the business. If you want to increase the value of your business or speed up the time frame, the steps you must take are often the same.

Why Some Businesses Don’t Sell

Most transactions die during one of the following stages:

• Marketing: Some transactions never get off the ground because the seller and their M&A advisor or investment banker can’t get the traction necessary to generate meaningful discussions with buyers.
• Letter of Intent: The seller has generated interest from a buyer, but they lose interest after taking a closer look at the business. 
• Due Diligence: The buyer makes an offer, but the transaction dies during due diligence for any number of reasons.
• Closing: The buyer successfully concludes due diligence, but then the deal dies sometime before the closing – again, for any number of reasons.

A variety of factors can cause a business to not sell. But you can dramatically improve your odds of success if you invest time to prepare for the sale well in advance. While some problems can’t be completely overcome, buyers often consider the totality of the circumstances. Still, the more risk the buyer perceives, the more likely they are to walk away and the less they’ll be likely to pay. 

However, even if a problem can’t be eliminated, it may still be possible to mitigate its effects to reduce the buyer’s perception of risk. The result of properly preparing your business for sale is that you dramatically tilt the odds of a successful transaction in your favor. 

Exploring Your Exit Options

All exit options can be broadly categorized into three groups:

• Involuntary: Involuntary exits can result from death, disability, divorce, or other unplanned events. Your plan should anticipate such occurrences, however unlikely they may seem, and include steps to avoid or mitigate potential adverse effects. 
• Inside: The buyer comes from within your company, such as your management team, or your family. Inside exits require a professional who has experience dealing with family businesses, as they often involve emotional elements that must be navigated and addressed discreetly, gracefully, and without bias. Inside exit options greatly benefit from tax planning because if the money used to buy the company is generated from the business, it may be taxed twice. Also, inside exits tend to realize a much lower valuation than outside exits. Due to these complexities, most business owners avoid inside exits and pursue an outside option instead. 
• Outside: The buyer comes from outside of your company or family. Outside exits tend to realize the most value. This is also the area where M&A advisors and investment bankers specialize. Outside exit options will nearly always yield you the highest price. If that’s your goal, focus on outside exit options and hire an M&A advisor or investment banker to conduct a private auction to sell your company.

Management buyouts (MBOs) are common in the middle market. Your current managers, or people in their networks, may have distinct insider knowledge that allows them to quickly make a decision. This can be one of the most efficient sales experiences any seller can hope for. Unfortunately, your management team may not have the financial resources necessary to buy your business and invest in its growth. To sell to a management team, be prepared to finance all or part of the sale or arrange for a bank to finance the transaction. Private equity firms also commonly back management teams that may be looking to acquire a business.

In addition to these three exit options, you can also sell a portion of your business. This would allow you to focus your talents on a division of your business with the most significant potential, or that you most enjoy, or that offers you the greatest opportunity for work-life balance. In deciding whether to sell your whole company or only a portion of it, first examine the overall value of your business and then determine the individual value of each division. Once you’ve performed this analysis, you may decide that it would be prudent to break your business in two to extract the most value.

Deciding to Double Down

One of the first things you should consider when deciding whether to sell your company is if suitable alternatives exist to an outright sale. Often, selling your business isn’t an all-or-nothing decision. Several potential options may exist. But before you explore those options, consider how committed you are to your business. Exploring your level of commitment requires being emotionally honest with yourself. If you decide you’re truly committed to your business and would like to double down, then do just that. But many entrepreneurs lack the capital to fuel the growth of their business. If this is you, growth equity from a private equity firm might be a suitable option. 

What Buyers Look For

When preparing your business, it’s important to understand the different buyer types and their criteria. That way, you can position your business to be as attractive as possible to the type of buyer who is most likely to acquire your company. Each type of buyer has a different set of preferences regarding the type of infrastructure, systems, and other elements they desire in a business. Many buyers will consider a profitable business that lacks infrastructure. But few buyers will consider an unprofitable business that has significant infrastructure in place. Always prioritize profitability over infrastructure until your EBITDA exceeds several million per year.

For most businesses, developing a management team is the most critical factor in building a salable business other than profitability. For other businesses, creating systems or increasing cash flow may create more value. There’s no cookie-cutter formula. Knowing the potential types of buyers for your business can help you maximize your sale price and properly market your business to the right audience when the time comes, setting it apart from others like it.

EBITDA

Before you value your business, you must ensure your financials accurately reflect its actual earning capacity. You do this by making numerous adjustments to your financial statements to calculate EBITDA. This process is called normalizing, recasting, or adjusting your financial statements. The resulting cash flow after the adjustments have been made is called earnings before interest, taxes, depreciation, and amortization (EBITDA).

Nearly all valuations in the middle market are based on EBITDA. But when it comes time to adjust your financial statements, there are several guidelines you should keep in mind. If you’re planning to sell your business soon, remember to:

• Minimize the number of adjustments several years before the sale.
• Ensure all adjustments are thoroughly documented.
• Be conservative when making adjustments.

The number one method for increasing the value of your business is to increase its EBITDA. The second method is to increase revenue. So if you want to increase the value of your business – focus first on increasing your EBITDA, then look at increasing your revenue.

Valuation Multiples

Buyers buy businesses so they can receive a return on their investment (ROI). ROI refers to the return on an investment divided by the investment amount. For example, a $100,000 return /$1,000,000 investment = 10% return on investment. 

In the real estate world, a capitalization rate is the rate of return a real estate investment generates. Typical cap rates for real estate range from 4% to 12%. This would correspond to an 8.3 to 25.0 multiple. In the business world, ROI is the inverse of a multiple. If the multiple is 4.0, then the ROI is 25%. Common multiples for most mid-sized businesses are 4 to 8 times EBITDA. This equates to a 12.5% to 25% ROI. Because returns are higher, it’s easier to calculate a multiple than a cap rate.

Multiples are the foundation of nearly every business valuation in the middle market. But while the math of calculating a multiple is simple, don’t let the apparent simplicity fool you. Just as a golf club is easy to swing, properly doing so is much more difficult. Understanding what multiples are and how they’re used is foundational to understanding how to value your business.

Valuation Theory

Valuing a business is a challenging task, even for the most seasoned advisor. The best you can hope to do is to make an educated guess about what the future will bring while trying to stay unbiased. While such an assessment of value may be tenuous, it’s nonetheless the starting point of the M&A process and a critical component of a successful exit strategy for any entrepreneur. A valuation of your business serves as a baseline from which to develop your exit strategy – the ultimate value can only be determined through a carefully executed sale. Remember these critical valuation concepts:

• Information Is Limited: The information available in transaction databases for mid-market transactions is often submitted without being verified, and only pieces of the story are provided, such as high-level financial information. 
• Predicting the Future Is Difficult: The essence of valuation is predicting how other investors will behave. Predicting the behavior of a single individual is difficult enough, let alone predicting the impact of fear, greed, and herd behavior. Changes in the macroeconomic environment can also have an enormous impact on the value of a business, and such changes have proven impossible to foresee.
• Buyers Have Different Criteria: The universe of potential buyers for a business is diverse, which greatly expands the possibility for a wide range of opinions.
• Valuation Methods Are Subjective: Be aware of the potential for biases to be built into any valuation and be cognizant of the impact such biases can have on the appraisal.
• Significant Time and Effort Is Required: Properly valuing a business takes a great deal of time and effort, especially when it comes to understanding and predicting future cash flows. The more sweat equity that’s invested in preparing the appraisal and predicting cash flows, the more accurate those predictions will likely be. 
• Fair Market Value vs. Strategic Value: Most business appraisals use fair market value (FMV) as the standard of value. This can limit the value of a business. The primary alternative is strategic value, but here’s the downside – you can’t measure strategic value until you know who the buyer is. That’s because every buyer can extract a different amount of value from your business based on the synergies they bring to the table.
• Business Valuation Is a Range Concept: Business valuation isn’t a hard science. Various buyers will value each business differently, and the same goes for appraisers. The value of a business should never be a single hard number, but rather a range of values. 
• Transaction Structure Affects Value: The terms of the sale – such as the amount of the down payment, the repayment period, and the interest rate – can all affect how much a buyer will be willing to pay. 
• Your Personal Needs Affect Value: Poor health or financial pressures may force you to sell. If for these or other understandable reasons you need to sell quickly, you’ll probably have to accept less than the optimal sale price.

Valuation Practice

Pricing a business is based primarily on its profitability. Profit is the #1 criteria buyers look for when acquiring a business, and the #1 factor that buyers use to value a business. There are other variables that buyers may consider, but the majority exclusively look for one thing – profit. Most valuation models are therefore based on some multiple of the profit a business generates.

Yes, a business’s potential can enhance its value – especially if that potential is close to being realized – but don’t expect the buyer to pay a lot for a promise that has yet to be entered into the ledger. The primary value driver of your business is historical profitability.

When considering whether you should have your business appraised, you have several options available to you. The various types of valuations don’t have standard definitions, but most reports fall into one of three main categories: 

1. Verbal Opinion of Value: These types of reports are useful if you’re in the exploratory stages of selling your business and would like a ballpark idea of what your business is worth before committing more time, money, and effort to the process. A formal report isn’t essential for most businesses.
2. Written Report for Non-Legal Purposes: These reports are useful for non-legal purposes such as a business sale, but they don’t comply with appraisal standards and can’t be used for legal purposes. These reports are most useful for business owners looking to sell a business. 
3. Self-Contained Appraisal: This type of report is also known as a “formal appraisal” and is required for any legal purpose such as a divorce, tax matters, or bankruptcy. While the price can fluctuate widely, these appraisals usually run at least $5,000 to $10,000. 

When choosing an appraiser, your options include M&A firms, CPAs, and business appraisers. M&A intermediaries with real-world experience selling companies are ideal when your objective is to sell your business or weigh your exit options. You don’t need an appraisal designed for legal purposes or one that can be used in court when you are selling your company. As a result, your advisor can produce a shorter report that’s limited to the valuation methods that buyers use in the real world, which will save you time and money.

Factors That Can Affect Value

Many of the factors that affect the value of your business can be boiled down to two simple elements – risk and return. The less risky your business, the greater its value. Likewise, the more potential your business represents, the higher the potential value. For most businesses, focusing on reducing risk is more prudent than focusing on maximizing potential. That’s because potential is usually limited by external factors, such as demographics and industry structure, which is less the case when it comes to reducing risk. 

The potential range and mix of factors that can affect the value of your business are more complex than a simple list of factors. Reality is more nuanced. When evaluating your business, buyers will initially consider a vast collection of issues, and then reduce this list down to just a few that represent the greatest risk. When selling your business, it’s wise to pay a professional to independently evaluate it to identify the factors that have the greatest impact on value and then develop a strategy to mitigate them.

Here is a summary of the factors that can affect the value of your business:

The Industry

• Barriers to entry
• Acquisition activity in your industry
• Industry trends
• Industry desirability
• Industry growth
• Scalability
• Industry stability
• Ability to replicate
• Regulations

Competition

• Degree of consolidation or fragmentation
• Degree of organic growth that’s possible
• Strength of competition
• Strength of your competitive advantage
• Threat of new entrants
• Threat of indirect competition and the effect of technology
• Brand awareness of your business vs. competition
• Reputation of your business vs. competition

Products and Services

• Ability to increase pricing
• Degree of product concentration
• New products in development
• Degree of specialization vs. commodity
• Outlook for your product category
• Overall demand for your product, such as if it is discretionary or cyclical
• Intellectual property rights
• Warranty obligations

Customers

• Mix and type of customer base
• Customer acquisition metrics
• Product fit with acquirer’s product line
• Customer database (CRM)
• Customer concentration
• Existence of close relationships with customers
• Degree of repeat or recurring customers
• Customer contracts

Operations

• Systems
• Attractiveness of location and facilities
• Ability to expand facilities and capacity utilization
• Ability to relocate the business
• Age and condition of equipment and other hard assets
• Age and condition of inventory, and turnover

Staff

• Degree of dependence on owners
• Number of active owners involved in business operations
• Compensation of owners
• Family members involved in business operations
• Strength of management team
• Dependence on key employees
• Compensation of staff compared to industry standards
• Average tenure and turnover rate of staff

Finance

• Overall financial performance vs. industry averages
• Revenue trends
• Growth prospects
• Gross margin trends
• Profitability trends
• Recurring revenue
• Cash flow cycle
• Working capital requirements
• Capital expenditures
• Quality of financial records

Legal

• Adequacy of insurance coverage
• Strength of intellectual property
• Pending litigation

Economic Factors

• Strength of national, regional, and local economies
• Inflation rates
• Unemployment rates
• Labor trends

Other Factors

• Negotiating skills and posture
• Overall marketability of your business, size of buyer pool, and financing available to acquire your business
• Factors that affect timing – price, region, financing, industry, attractiveness, marketing strategy

Improving Value

There are only two ways to directly increase the value of your business:

1. Increase EBITDA: This can be accomplished by reducing expenses or boosting revenue.
2. Increase the Multiple: Multiples are based on two factors – risk and return. Take steps to reduce risks associated with your business and improve its perceived growth potential.

At the same time, there are many areas in which you can indirectly create value, including:

• Business Model: The easier it is for a buyer to replicate your business’s offerings, the lower the price they’ll be willing to pay. By creating a business that’s difficult to replicate, you’re guaranteed to receive more for it.
• Financial Metrics: Two words: cash flow. Focus on maximizing cash flow over all other value drivers.
• Growth Plan: Develop an outline highlighting the major ways you can grow your business. Begin executing your growth plan before you put your business on the market.
• Operations: Take the time you need to ensure your operations are running as smoothly as possible. This minimizes risk for the buyer.
• Customers: Minimize customer concentration. Ensure customer contracts are assignable in the event of a sale. 
• Legal: Have your attorney identify any legal issues that need to be rectified before you begin the sales process. Legal issues generally don’t present an opportunity to create value, but they do present an opportunity to reduce perceived risk for the buyer. 
• Staff: Nearly every buyer will be concerned with the quality of your staff. Make sure there are minimal employee issues that can deter a buyer. Focus on building a strong management team with evenly distributed responsibilities. 
• Ownership: Make it easy for a successor to replace you. Don’t come across as being personally indispensable to the success of the company.

Prioritizing Your Value Drivers

Once you’ve identified your value drivers, prioritize and execute them based on their potential impact or return, and the risk, time, and investment required in achieving them. 

After you’ve educated yourself on the possible value drivers you can implement in your business, I recommend consulting with an experienced investment banker to help you prioritize them. A knowledgeable advisor can help you identify the value drivers that are most likely to generate the highest returns, that require the least amount of time and money to implement, and that represent the lowest associated risk. They can also help you identify which value drivers will appeal to all buyer types and which value drivers may only appeal to a specific buyer group. 

Team

Selling a business has become more complicated over time. Tools for financing, mitigating risk, and structuring the transaction can be complex but crucial to the sale of your business. Assembling a team of professionals who can give you the best advice specific to your business will help you navigate this complicated field. So, when considering advisors and professionals who might help you, understanding their fee structure, their specialty, and what they can bring to the table will help you assemble the most effective team to get your business sold.

• M&A Advisor: Think of your M&A advisor as your quarterback. They’ll play a key role throughout the transaction, from the opening kickoff until the final whistle blows. Your M&A advisor will initially assist in helping you package your company for sale, which will include valuing your company, identifying any issues that need to be addressed before putting your business on the market, and preparing key sales documents. Once the preparation is complete, they will put your business on the market, contact buyers, and manage your negotiations. They will also work closely with your M&A attorney in negotiating the letter of intent (LOI) and purchase agreement. Your M&A advisor will negotiate with the buyer regarding the high-level elements of the transaction and how the various components work together to form the overall deal structure, while your M&A attorney will negotiate the finer details of the agreements.
• Attorney: Your attorney will play the second-most critical role in the transaction and will negotiate the key agreements – primarily the non-disclosure agreement (NDA), the letter of intent, and the purchase agreement. In some cases, your M&A attorney may assist you in identifying legal issues that need to be resolved before you put your business on the market, so you can then delegate these matters to your commercial attorney to resolve.
• Accountant: Your accountant will assist you in preparing your company for sale from a financial perspective and make sure your financials are clean and consistent once your business is on the market. Accountants may also be involved in financial due diligence, as well as in examining the financial and tax implications of the purchase agreement. The role of an accountant is typically less involved than your M&A attorney, although the extent to which this is the case will vary based on the transaction.

Managing Employee’s Expectations

Employees are a key asset of any business. To maximize the value of your business, you must therefore protect the nature of your relationship with them. This is especially true in the event of a planned sale.

One of the most delicate decisions to make during a business sale is the timing of when to tell your employees. You need to determine the best way to approach this for your situation, and consider your relationship with your employees and personal advisors. Obviously, word will get out eventually, but if you maintain control of the timing and the process, you can use this critical stage to your advantage. Be prepared for the unexpected, consult with your advisors, and make plans to ensure the sale unfolds smoothly and successfully for everyone involved. 

If you have a trusting culture at your company, you may consider informing your employees of a pending sale early in the process. Your staff will most likely appreciate the vote of confidence you display by sharing with them news of such a monumental nature, and you’ll have time to build even more trust and prepare them for what’s to come. Furthermore, any apprehensions on the part of the buyer will likely be lessened if they know the staff is mentally and emotionally prepared for a change in ownership. If, on the other hand, you’re concerned that one or more key employees could sabotage or otherwise undermine a sale, it may be best to wait as late as possible before cluing them in – up to and including the day of the closing.

Non-competition agreements are another tool you can use with your staff to protect the value of your company. If a non-compete is illegal in your state, or if asking your employees to sign a non-compete is impractical, you have two sound alternatives – a non-solicitation agreement and a confidentiality agreement (CA). Both can be effective in helping to protect your business’s value.

Preparing the Information Memorandum

You may want to approach competitors or the market anonymously to start with. If this is the case, a two-to-three-page teaser profile can be written in a way that drums up interest in your business without divulging its identity. After the buyer signs an NDA comes the confidential information memorandum (CIM), a 20-to-40-page document that includes the name of the business along with more details about your company. The story of your business should be presented in a coherent, professional package. Your CIM should provide answers to the basic questions every buyer will ask and contain enough information for the buyer to decide if they’d like to invest time in meeting with you and learning more about your business. Questions with more nuanced answers should be reserved for a phone call or face-to-face meeting. Your CIM shouldn’t answer all the buyers’ questions, but it should provide enough information for the buyer to decide if they’d like to proceed to the next steps.

The CIM should present the key selling points of your business in a persuasive story. Remember, the purpose of the CIM is to sell. That said, readers of CIMs are sophisticated and won’t be keen to read a document filled with hyperbole, so strike a balance between presenting information and selling your company.

Maintaining Confidentiality

Understanding a few basic points about confidentiality agreements ensures they can protect you while selling your business. By examining their language and negotiating their terms, you can make sure they aren’t made obsolete by ambiguities or ignorance of the meaning of the terms used in the agreement.

Here are some ways you can help maintain confidentiality:

• Prepare for the Sale in Advance: An ounce of prevention is worth a pound of cure, and selling your business is no different. To preserve confidentiality, you should ideally prepare for the sale years in advance. 
• Draft a Non-Disclosure Agreement: While an NDA isn’t bulletproof, it does prevent leaks in most cases. Often, a leak is negligent, and the offending party isn’t intentionally trying to harm your business. The real purpose of a confidentiality agreement is leak-prevention, but it’s not the only tool you should use.
• Contact Buyers Based on Increasing Stages of Risk: When selling your business, contact buyers that represent the lowest risk to you and your company first in the process. Typically, this involves initially contacting private equity (PE) firms and indirect competitors.
• Thoroughly Screen Buyers: You should thoroughly screen all buyers before you provide them with sensitive information on your company. 
• Release Information in Phases: As the buyer demonstrates continued interest in your business, you can release more and more information. In this manner, you release more sensitive information as you come to know and trust the buyer over time. You should release highly confidential information, such as customer contracts, only at the later stages of due diligence. 
• Control How Information Is Released: Controlling how information is released is foundational to maintaining confidentiality. Here are several strategies for controlling what and when information is furnished to potential buyers:
  • Redact or aggregate information
  • Release information in phases 
  • Develop strategies for different types of information
  • Set up an electronic deal room
  • Email information to create a document trail
• Mark or Stamp Documents “Confidential”: Stamp or watermark all documents “Confidential” before releasing them to the buyer. 
• Handle Breaches Immediately: In the event of a breach, immediately call the offending party.

Maintaining confidentiality is essential when it comes to selling your business. Many critical issues are addressed in a properly drafted NDA, including non-solicitation and other “sales process” issues. It’s tempting to assume that all NDAs are boilerplate, but a mistake at the stages of negotiating and signing a non-disclosure agreement can close off critical options later in the process. In extreme cases, leaks can destroy your business. A CA is executed in nearly every M&A transaction but is only one of many tools in your toolkit to maintain confidentiality during the sales process.

Understanding and Finding Buyers

Knowing who your probable buyer is will help you figure out the steps you need to take to prepare your business for sale and determine the best marketing strategy to maximize your company’s value.

If you’re most likely to be approached by an individual buyer, for instance, you’ll want to focus on minimizing the perception of risk. If you expect to sell to a private equity firm, build a strong management team if you don’t already have one. If you’ll be looking for a corporate suitor to come knocking, build value in your company that can’t be easily replicated.

Then there’s the buyers’ list – a mini database assembled by you and your advisors of names, numbers, and background information of companies that might be interested in what you have to offer. The bigger the list, the better, as the idea here is to create a private auction. Once a potential buyer realizes they’ve got competition for something they want, they’ll likely be more willing to pay up. Keep in mind how the numbers shake out – a list of 100 to 200 buyers is necessary to produce the 30 to 40 conversations required to generate 5 to 10 letters of intent.

Screening Buyers

A major mistake entrepreneurs often make in the early phases of a transaction is wasting time on unqualified buyers. You can waste vast amounts of time weighing the merits of an offer if you don’t first obtain background information on the buyer. 

Just as buyers perform due diligence on you and your business, performing due diligence on buyers is paramount. Screening potential buyers is, in fact, one of the most critical first steps in the sale process. Its importance can’t be overstated.

Screening potential buyers will help ensure you’re dealing with serious buyers who have the means and determination to follow through on the purchase, saving you time and money in the long run. Understanding the differences between various buyer groups will help you determine how to best approach marketing your business while maintaining confidentiality. 

Meetings

Buyer meetings are far more than a forum for you to answer questions. With these meetings, you’re selling not only your business, but yourself. You want to assure your buyer that you’re prepared, honest, composed, and serious about selling. Working to foster a healthy relationship with your buyer will not only save you time and effort in the long run, it can increase the value of your business as a whole. It’s a key aspect of selling a business that’s often overlooked. Here’s how to do it right. 

When meeting with a potential buyer, remember the Golden Rule – treat others the way you want to be treated. Here’s what I mean:

• Be respectful of their time and needs when making the arrangements – send them the message that you’re professional and cooperative, but not a pushover.
• Be prepared. Be sure to have access to a computer and your confidential information memorandum (CIM) when you talk so you can easily answer their questions.
• If you talk with the buyer on the phone or via video meeting, do so in a quiet place. I’ve encountered far too many buyers that were annoyed because they talked with a seller who was on a cell phone driving in their car or in some other environment that wasn’t conducive to an important conversation.
• Schedule enough time so you can hold the meeting without any distractions.

Maximizing Negotiating Leverage

High-level negotiating skills aren’t as crucial as you might think, at least as they pertain to you as the seller. That’s because you can hire an M&A intermediary or investment banker to do the dirty work. But that doesn’t mean you’re off the hook. You’ll still need to:

• Conduct pre-sale due diligence.
• Hire a third party to perform due diligence.
• Reduce sunk costs.
• Create a strong position with many options.
• Maintain emotional objectivity.
• Focus on running your business.
• Beware of deal fatigue.
• Listen before speaking.
• Be honest and humble.

Negotiating the Letter of Intent

The LOI is the most significant document in an M&A transaction. With that in mind, here are the major terms and characteristics of an LOI and the impact they have on the negotiations:

• Preliminary Agreement: The LOI is a preliminary agreement that will be replaced by a purchase agreement and allows the parties to begin due diligence. Any terms of the transaction that aren’t defined in the LOI will be drafted to the buyer’s favor in the purchase agreement.
• Exclusivity: Most LOIs contain an exclusivity clause.
• Limited Information: The terms of the transaction and the content of the purchase agreement may change based on what the buyer discovers during due diligence. 
• Contingent: The LOI is contingent on the buyer’s successful completion of due diligence. 
• Momentum: The LOI presents an opportunity for each party because it enables them to resolve problems before becoming too deeply entrenched in a position.
• Highlights Unresolved Issues: The LOI highlights any potential undefined issues.
• Non-Binding Except for These Provisions: Most of the terms in the majority of LOIs are non-binding. However, the following provisions are typically drafted to be binding – exclusivity, confidentiality, due diligence access, earnest money deposit, and expenses.

There are many problems that can arise as a result of signing an LOI. Here’s a list of the most common ones and a solution for each:

• Terms Degrade During Due Diligence: The terms of an LOI will never improve for you after you’ve signed it.
  • Solution: Define as many terms as possible before signing the LOI, when you have the maximum amount of leverage. But remember that doing so is a balancing act because buyers have access to a limited amount of information at this stage.
• Undefined Terms: Undefined terms will always be slanted in the buyer’s favor.
  • Solution: Define terms in as much detail as possible in the LOI.
• Long Exclusivity Periods: The longer the exclusivity period, the lower your negotiating leverage. Most exclusivity periods range from one to three months, while some buyers propose an open-ended exclusivity period.
  • Solution: Keep exclusivity periods as short as possible. Include milestones in the LOI for the buyer to continue to be granted exclusivity.
• Losing Negotiating Leverage: Signing the LOI disarms you. You give up nearly all your bargaining power the moment you sign the LOI.
  • Solution: Take your time negotiating the LOI. Rush to close the transaction once you’ve signed the LOI.
• Due Diligence Problems: Problems the buyer discovers during due diligence will result in less favorable terms and price.
  • Solution: Prepare for due diligence to minimize the number of problems the buyer discovers during due diligence that can be used to renegotiate the price or terms. 

 Here are the most important tips to bear in mind when negotiating the LOI:

• Remember the Balance of Power: The balance of power changes the moment you grant the buyer exclusivity. Due to this dramatic shift in the balance of power, take your time to ensure the LOI is as specific as possible. 
• Take Your Time Before Signing: Regardless of what the buyer says and how urgent they appear to be, move slowly when negotiating the LOI.
• Move Fast After Signing: Take your time negotiating the LOI but get hopping the moment it’s signed.
• Prevent Re-trading: Do the following:
  • Take your time negotiating the LOI – it should be as specific as possible.
  • Include milestones and deadlines in the LOI.
  • Commit to the shortest possible exclusivity period. 
  • Move as fast as possible once you have accepted the LOI.
  • Prepare for due diligence. Doing so will speed up the process and reduce the possibility of re-trading.
• Focus on Running Your Business: Once you’ve signed the LOI, continue to focus on running your business as if you weren’t going to sell it. Your top priorities should be maintaining profitability and keeping your sales pipeline full.
• Read the Buyer: There’s no standard LOI. If you suspect the buyer will be particularly picky about certain issues, such as the reps and warranties or access to employees during due diligence, be sure to address those matters in the LOI. It’s much better for the deal to blow up at this point than for you to take your company off the market for three months and then spend tens of thousands of dollars conducting due diligence, only for the deal to derail later because you failed to address sensitive issues up front.
• Prepare for Due Diligence: Preparing for due diligence can dramatically speed up the process. The main documents most buyers will request should be ready and available to pass along the moment you’ve accepted the LOI. They should be highly organized and uploaded to a virtual data room or other location that can be easily accessed by third parties. 
• Maintain Confidentiality: Confidentiality agreements aren’t bulletproof. Avoid sharing some sensitive information during the due diligence process even if you have a signed CA in place, especially if the buyer is a direct competitor. If you must disclose sensitive information, wait until the end of the due diligence process to do so.
• Disclose Beforehand: Disclose all problems about your business before the buyer makes an offer. If you disclose new, negative information after you accept the LOI, the terms of your deal will change.
• Be Thorough: The LOI should ideally encapsulate all the major terms of the transaction and not leave any significant provisions to be negotiated later in the process. 
• Define Working Capital: If you want to avoid the working capital adjustment time bomb, the language in the LOI regarding how working capital is to be calculated should be as specific as possible. 

Deal Structure

Bear in mind, a $20 million all-cash offer isn’t the same as a $20 million offer with $1 million down and a $19 million earnout. When receiving an offer, you should evaluate the various financial and legal components to determine how favorable the offer is compared with others on the table.

You should first evaluate the form of consideration. How is the purchase price being paid? The purchase price can be paid as follows:

• Cash: This can be from cash the buyer has on hand or third-party financing, which will be delivered to you in cash at closing.
• Seller Financing: The terms of the seller note and the creditworthiness of the buyer should be considered, in addition to the seniority of your note relative to any other lenders.
• Stock: The health of the acquirer and liquidity of the stock should both be carefully considered.
• Earnouts: Earnouts are a complex matter and should be carefully considered before you commit to one.
• Employment or Consulting Agreements: These are normally guaranteed payments, but are taxed at ordinary income tax rates to you.
• Holdback/Escrow: Most transactions include a holdback, although the terms of the holdback should be analyzed to ensure it’s reasonable.
• Royalties and Licensing Fees: Licensing fees are less commonly used and are designed to compensate you for new product launches.

You should next evaluate the legal structure of the transactions. Most small and mid-sized transactions will be structured as asset sales. If that’s the case, how the purchase price will be allocated is critical and will have a tremendous impact on your taxes. The allocation of the purchase price should be carefully analyzed by your accountant to determine if it’s reasonable and to evaluate the extent to which your tax burden can be mitigated.

Due Diligence

After you accept an LOI on your business, the buyer will begin confirmatory due diligence, as opposed to preliminary due diligence that occurs before the LOI is signed. Due diligence normally lasts 30 to 60 days, but can be extended if both parties agree. In most circumstances, the buyer can walk away from the transaction if they’re unsatisfied for any reason during the due diligence period.

I strongly recommend that you invest the time necessary to prepare your business for due diligence. Most business owners skip this step altogether. By preparing for this process, you’ll significantly improve the chances of a successful sale. Additionally, demonstrating to the buyer that you’ve prepared for due diligence increases the buyer’s confidence in your business and reduces their perception of fear and risk. 

Due diligence can be heaven or hell. If you have your financials in order, and all is well from an operational and legal standpoint, chances are due diligence will be uneventful, and your deal will take flight, bringing you one step closer to the closing of your dreams. If you’re unprepared and the buyer finds things amiss during due diligence, you’ll find yourself on the horns of a dilemma. Being prepared can go a long way in facilitating the outcome you want.

Purchase Agreement

Negotiating any component of the purchase agreement can’t be done in isolation since there are many interconnected components that constitute the overall transaction structure. All these components should be taken into consideration on a collective basis during negotiations. 

For example, if the buyer proposes a lower purchase price, you may concede but may request more cash down at closing or that the size of the earnout be reduced. Or, if you insist on providing minimal representations to a buyer, the buyer may concede but may tighten up other elements of the deal structure, such as escrows, knowledge qualifiers, or thresholds.

The trade-offs and tensions can be summarized as follows:

Seller’s Objectives:

• Maximize the purchase price.
• Receive maximum cash down at closing.
• Pay minimum taxes.
• Reduce earnouts, escrows, and other contingent payments.
• Reduce the scope and breadth of reps and warranties.
• Reduce the strength of indemnification via baskets, caps, and survival periods.

Buyer’s Objectives:

• Minimize the purchase price.
• Put minimum cash down at closing.
• Maximize the tax-deductibility of assets acquired by increasing the tax basis in these assets.
• Increase earnouts and escrows.
• Increase the scope and breadth of reps and warranties.
• Increase the strength of indemnification via baskets, caps, and survival periods.

The purchase agreement is a tool for allocating risk. As the seller, the more assurances you’re willing to provide the buyer in the purchase agreement, the lower the risk for the buyer and the higher the purchase price they can potentially afford to pay given the amount of risk they’re assuming. Risk and return are directly related. The higher the risk, the lower the return – and vice versa. By lowering the risk for the buyer by offering a collection of protections in the purchase agreement, you can potentially realize a higher purchase price. 

The most fiercely debated elements of the transaction are as follows:

• Price and Terms:
  • Purchase price
  • Terms of the seller note
  • Post-closing purchase price adjustments, such as working capital adjustment
  • Size and length of escrow
  • Contingent payments, such as earnouts and escrows
  • Specific terms of employment and consulting agreements
• Deal Structure:
  • Allocation of the purchase price, which affects the tax implications of the transaction
• Protective Mechanisms:
  • Survival period, knowledge, and materiality qualifiers of reps and warranties
  • Caps, baskets, and survival period of indemnification
• Miscellaneous:
  • Conditions to closing, such as material adverse change (MAC) clause

Closing

On the closing date, you and the buyer may physically meet around a table, where the buyer delivers the final payment and you sign and deliver the closing documents. Alternatively, they may sign the documents electronically or via FedEx. These days, most closings are virtual closings where documents are sent electronically or via next-day delivery. 

And Finally … 

“It’s always best to start at the beginning.”

– Glinda the Good Witch in The Wizard of Oz

The conclusion to the conclusion might seem like a strange place to invoke Glinda the Good Witch’s advice about starting at the beginning. But think back to the beginning of this book – the introduction, to be precise.

That’s where I first emphasized the importance of preparation in getting your business – and you – ready to be put on the market. And I kept mentioning it – the word “prepare” or one of its derivatives appears nearly 350 times throughout these chapters.

That’s the theme that ties everything together. Whether you’re getting ready to hit the Yellow Brick Road or about to sell your business, you’re going to face challenges virtually every step of the way – challenges that can be met and mitigated or overcome with preparation – challenges that are cataloged and discussed throughout this book, based on my years of experience actually selling businesses.

Consider this – what if, well into the sales process, you suddenly discover new information about your industry or new truths about yourself? Be ready to switch gears or strategies, if necessary, at a moment’s notice. The number one deal-killer of business sales is incomplete or inaccurate financial records – are your financial statements up to date and well organized? What if the buyer discovers a material fact they can use against you? How do you answer the question, “Why are you selling?” When and what do you tell your employees?

Preparation is key, whether you’re rehearsing how you’ll announce a sale to your staff or making sure your financials are in order. Being fully prepared will not only ensure you maximize your price, it will also ensure the process unfolds as smoothly and quickly as possible.

Whether you’ve already put your pending sale in motion or are getting ready for an exit a couple of years down the road, Acquired is a useful tool to keep at the ready – every step of the way.

Thanks for reading Acquired. Best of luck with the business. You’ll find links to more resources in the next section. And stay in touch. If you’ve had any unique challenges in getting your business ready for sale or you’re in the market for a consultation, drop me a line at [email protected]. And, if you’ve enjoyed this book, please leave a review on Amazon – I’d really appreciate it.