A CIM is a professionally prepared summary of your business that’s presented to pre-screened buyers. The CIM is longer than the teaser profile and reveals the identity of your business and other confidential information.

The CIM addresses buyers’ common questions quickly and efficiently, saving you time from relaying this information orally to each buyer, and thereby helps ensure a consistent and professional presentation. It includes information on your business regarding your company’s history, products, services, licensing, and competition. It also customarily includes a short financial summary, information about your operations, a synopsis of your lease terms, an organizational chart, terms of the sale, and other key information that a buyer might request before submitting a letter of intent. 

The purpose of the CIM is to help the buyer decide if they’d like to take the next steps and learn more about your company – which is usually a conference call or a tour of your facilities. By design, the CIM doesn’t address every question the buyer may have, but rather, it gives the buyer enough information to determine if they’d like to learn more about your business.

Here are the major topics typically covered in a CIM:

• Assets
• Competition
• Customers
• Equipment
• Facilities
• Financials
• History
• Improvement potential
• Intellectual property
• Inventory
• Operations
• Product or service pricing
• Product or service description
• Proposed deal structure 
• Staff

The CIM addresses buyers’ common questions quickly and efficiently, saving you time from relaying this information orally to each buyer, and thereby helps ensure a consistent and professional presentation.

Benefits of Preparing a CIM

Saves Time

When selling a business, you’ll quickly learn that all buyers ask the same set of questions. Without a CIM, you’ll constantly answer the same 50 questions from every potential buyer, which will quickly become tiring and time-consuming. A CIM replaces what might be a one-to-two-hour discussion with each buyer by efficiently answering common questions about your business, allowing you to focus on running your company instead of fielding questions from buyers about your business.

An efficient process saves you time and keeps you fresh when a serious buyer enters the fray. This is important because many buyers are tire-kickers who may not be serious or may be looking to pick up your business at a bargain price. You can fill calendars with wasted time talking with these types of buyers. And not only will they waste your time, but you may lose your patience or become dismissive when you finally have a real buyer on the hook. Making the effort to prepare a CIM saves time and ensures you’re at your best when you do ultimately meet with a buyer.

Helps You Prepare

When an M&A advisor assists you in preparing your CIM, you will have the opportunity to discuss your business in depth with an expert who is familiar with what buyers are looking for. This not only forces you to objectively examine your own business, but it also gets you ready to field the dozens of questions any buyer may ask. For example, many buyers will want to know who your key employees are and whether they’re likely to stick around after the transition. Being familiar with these questions – and answers – by including them in your CIM will prepare you for the eventual one-on-one conversations you’ll ultimately have with serious buyers.

An experienced M&A intermediary will have crafted hundreds of CIMs and will be adept at presenting your business in the best light possible. You’ll also have the chance to rehearse your answers to such common questions as:

• Why are you selling your business?
• If your business has untapped potential, then why don’t you keep it?
• Who are your competitors, and how do you stack up against them?
• What’s your competitive advantage?
• How much working capital is required to operate your business?
• How experienced is your management team?
• What is your role in the business, and how instrumental are you to the ongoing operations?
• How can you grow your business?
• What methods are you using to market your business?

Communicates the Value of Your Business

Often, a buyer may talk to others who assist in making their decision, such as accountants, attorneys, investors, or other C-level executives. In the absence of a CIM, the buyer must sell the idea of investing in your business to third parties on their own. A CIM allows you to convey your business more directly to the buyer’s team and thus maintain a consistent line of messaging. With a professionally prepared CIM, the buyer can simply present this document to the other stakeholders and then have an intelligent discussion based on the contents of the document. 

Provides You With Perspective

Reviewing your CIM gives you a unique opportunity to view your company from a fresh, realistic perspective, as if you were a buyer. A CIM is a great way to align your perceptions of your business with how they can be best presented to buyers. You’ll be better prepared for negotiations and will be able to position your business in the best light possible as a result.

Communicates That You’re Serious

Preparing a CIM also communicates to the buyer that you’re serious about selling your business. Buyers receiving a CIM rather than a rote series of answers to the most common questions are more likely to take you seriously and treat you with respect. Every experienced buyer has dealt with a less-than-committed seller, and buyers are quick to dismiss a seller who isn’t perceived as serious.

Reviewing your CIM gives you a unique opportunity to view your company from a fresh, realistic perspective, as if you were a buyer.

Tips for Preparing a CIM

Include the Right Amount of Information

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 of the buyer’s questions but should provide enough information for the buyer to decide if they’d like to proceed to the next steps.

Present the Highlights of Your Business

Your CIM should present the key selling points of your business in a persuasive story. Remember, the purpose of the CIM is to sell. But, readers of CIMs are sophisticated and won’t be keen to read a document filled with hyperbole. Strike a balance between presenting information and selling your company. Point out the benefits of your business in a straightforward, no-nonsense manner. 

In presenting your business, you should clearly identify its weaknesses, which gives you the earliest opportunity to position them in the best possible light. Weaknesses can often be positioned as potential opportunities for a buyer. For example, if you haven’t invested heavily in marketing your business in recent years, this presents a tremendous opportunity to the buyer to increase revenues. You’ll be in a much stronger negotiating position if you point out your business’s weaknesses first and spin them in a positive light as opposed to a buyer uncovering them later in the process.

It’s helpful to ascertain whether a buyer is seriously interested before allowing them access to more sensitive information on your business. A well-written teaser profile provides enough information so the buyer can determine if your company is a potential fit before they sign an NDA and you disclose your company’s identity and other confidential information.

The teaser profile is an abstracted version of your CIM and is usually only several pages in length. It contains the highlights of your business and is sent to prospective buyers on a confidential basis – that is, without divulging the identity of your business. If a buyer is interested in your business after reviewing your teaser profile, the buyer will sign a non-disclosure agreement and be given access to your CIM.

“You never get a second chance to make a first impression.”

– Will Rogers, American Actor

In an M&A transaction, there are two primary documents that need to be created that will be shared with buyers in the initial stages of the purchase:

1. Teaser Profile: A short one-to-three-page executive summary of your business that doesn’t disclose the identity of your company. This document is presented to prospective buyers before they sign a non-disclosure agreement (NDA).
2. Confidential Information Memorandum (CIM): A detailed 20-to-40-page overview of your business that’s presented to buyers after they sign an NDA.

In this chapter, we’ll take a look at these two documents, their formats, and the information that should be included in each. 

Your employees are a key asset to your business. To maximize the value of your business, you must protect the nature of these relationships. 

To do this, consider asking your key employees to sign a non-compete agreement, if they’re legal in your state. Sometimes employees threaten to leave when they hear you’re selling your business, and some may threaten to open a competing business and steal your customers, or desert to a competing business. A non-compete can greatly reduce the risk of this happening. In certain states, non-competition agreements in an employment context are illegal, though they are legal in all 50 states in the context of buying a business. If your business is located in a state where this is the case – California being the most notable example – there are two primary alternatives for protecting your interests.

1. Non-Solicitation Agreement: A non-solicitation agreement prohibits an employee from soliciting your employees or customers, but it doesn’t prevent them from competing with you as long as they don’t solicit your employees or customers. Non-solicitation agreements are most common in service businesses that have strong customer relationships. The major advantage of non-solicitation agreements is that they may be legal in states in which a non-compete is illegal. 
2. Non-Disclosure Agreement: At a minimum, all employees should sign a non-disclosure agreement. An NDA prevents employees from disclosing trade or other secrets to your competitors. They can also make it so difficult for the employee to comply with the NDA that the employee, or the employer, may pass on certain opportunities to avoid violating the terms of the agreement. The major advantage of confidentiality agreements is that they can be designed to protect your business’s confidential information throughout the sales process, and they are much easier to enforce than non-compeition agreements.

Collectively, a non-solicitation agreement and NDA serve as highly effective psychological deterrents. Deterrents are often more effective than other means – just ask anyone who owns a Doberman or has an ADT Security sign in their front yard. Next, I’ll cover these deterrents in more detail.

Non-Solicitation Agreement

A non-solicitation agreement can be a stand-alone measure, or it can be included as a component of another agreement, such as an employment, non-compete, or non-disclosure agreement. 

This is often an effective enough means to prevent your employees from competing with you, as it may prevent a band of employees from grouping together and poaching your customers. Additional measures can be created to strengthen the non-solicitation agreement. Past or future bonuses can be retracted or withheld if they violate the terms of the agreement. For example, if five of your employees band together to start a competing business, you could withhold any bonuses or other payments if they violate the terms of the non-solicitation agreement. 

Non-solicitation agreements can also serve as a form of protection if the employee leaves to work for a competitor. But your agreements need to be properly drafted for these mechanisms to be enforceable, so be sure to hire an attorney with significant experience in this area. 

Non-Disclosure Agreement

If you employ someone who has access to trade secrets related to creating your product and a competitor hires this individual, a signed NDA will prohibit that person from disclosing your trade secrets to their new employer. If the potential new employer learns your employee has a signed NDA with you, they may pass on hiring this individual due to the risk associated with doing so.

An NDA can also protect other information as well, such as:

• Customer names
• Prospective client information
• Pricing information, if private
• Financial information
• Employee information, such as names, salaries, and benefits
• Intellectual property, such as software code, designs, and technical processes

It’s important to note that in order to protect the information mentioned above, your NDA should contain a clear definition of “Confidential Information.” If you wish to protect specific elements of your business, clearly spell those out in the agreement. You should also check to make sure they’re transferable or assignable to the buyer when you sell your company.

Conclusion

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

As you can see, 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 help the sale unfold 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. Both can be effective in helping to protect your business’s value.

Once you’ve decided to inform your employees, you must formulate a plan to help ensure the buyer can retain them. Here are several strategies for doing just that.

Retention Bonuses

If you decide to tell your employees, I suggest offering your key staff a bonus for staying through the transition. The bonus should be substantial enough to motivate them to stay for a significant period following the transition, especially if you’re financing a portion of the sale. You can also consider offering employees the retention bonus as compensation for signing a non-compete or non-solicitation agreement, which should improve the enforceability of those agreements. 

Amount and Timing

You can also consider releasing the bonus in several stages for six to 12 months following the closing. A typical bonus is 5% to 20% of their annual salary. You shouldn’t give the employees so much money that they can band together and start a competing business, but it should be enough to motivate them to stick around after the closing. Releasing this bonus in stages helps prevent this problem.

Explaining the Bonus

I recommend positioning the bonus as a share of your success. If you position it as a “retention bonus,” your employees may realize the leverage they have over you and may use that perceived clout to their advantage, which may threaten the sale. Instead, let your employees know you’ll share a piece of the pie with them because the company wouldn’t be in a position to be sold without their loyalty and hard work.

The decision starts with whether to tell your employees about your plans before the sale actually happens. Obviously, they will find out eventually, but the timing can have a significant impact. Sharing this information has advantages and disadvantages, which we’ll cover here. Once you’ve decided to tell them, you must determine precisely when and how you’re going to share the news. I’ll offer you advice along these lines as well. Let’s start with deciding whether you should let the cat out of the bag.

Deciding Whether to Tell Your Employees

There are no hard-and-fast rules regarding if you should tell your employees about your plans to sell your business. If your company’s culture is positive and you trust your employees, and they trust you, you may consider telling some of them about the sale in advance. 

If your business is larger, with an in-house controller or CFO, you’ll benefit from informing them because they’ll play a pivotal role in the sale process. It would be almost impossible to keep the sale a secret from your in-house controller or CFO during your preparations, and especially during due diligence. The process of selling your business will involve numerous financial requests, and your controller or CFO will quickly become suspicious if you don’t inform them. But, you may want to disclose the sale only to them. If so, I recommend asking them to sign a non-disclosure agreement (NDA) to ensure they keep the planned sale confidential.

If you have a large number of people on staff, I recommend informing your key managers on a selective basis. Your other staff may feel betrayed that you didn’t tell them, so be prepared if the word leaks. You can simply explain that it would have been impossible for everyone to keep the sale a secret, so you had no choice but to keep it under wraps until it became official. And while you’re at it, this would be an excellent time to announce a bonus for all employees. 

If you decide to tell your employees in advance, you can use this to your advantage. You can mention to buyers that you’ve told your employees, and you can selectively let buyers meet with some of your top people. This helps the buyer feel more comfortable with your business and lowers their perception of risk. This also helps your key employees feel empowered since they’ll have the opportunity to meet with prospective buyers before one is selected.

When To Tell Your Employees

Tell your employees as early as possible or as late as possible. Why? 

If you tell your employees early, you have ample opportunities to repair any damage that may occur as a result of your conversation with them. Some employees may jump ship. If this happens, you’ll have plenty of time to replace them. 

By telling them as late as possible, the amount of damage that can occur between your conversation and the closing is minimal. In most cases, telling your employees as late as possible involves telling them the day of closing.

Deciding when to tell your employees also depends on the circumstances and the culture of your company. If you have a small team and your culture is trusting, you may consider telling them in advance. The longer the employees know, the more opportunity you have to build trust and prepare them for the process. If you decide to tell them, stress that you’ll only sell to a buyer who pledges to retain them if that is, in fact, the case. Frankly, this shouldn’t be a problem since nearly every buyer will want to retain your current staff in any event. Buyers are just as nervous about losing employees as employees are about losing their jobs. In the unlikely event that duplicate staff are laid off, you can choose to offer those staff a generous severance package and assist them in finding a new job.

Tell your employees as early as possible or as late as possible. If you tell your employees early, you have ample opportunities to repair any damage that may occur as a result of your conversation with them. By telling them as late as possible, the amount of damage that can occur between your conversation and the closing is minimal. 

How To Tell Your Employees

Once you’ve decided to tell your employees, it’s time to create a game plan to do just that. Here’s how. 

Tell the Team as a Group

I recommend first informing your management team as a group. It’s difficult for one manager on your team to keep their lips sealed, so it’s wisest to tell them all as a team. But when you do, be aware of the power of herd behavior. When confiding in your team, position the news as a positive change for them. 

This is also a perfect time to offer your team a retention bonus for their hard work. It’s crucial that pack behavior doesn’t take hold of the group and send it in the wrong direction. Your team’s support will go a long way toward a smooth transition. Remind them that you’ll only sell to a buyer who plans on retaining them – but again, you shouldn’t worry about this since nearly all buyers will desire to keep your key people in any event. But, if they don’t, you can offer your key employees an attractive severance package. 

You should also position your plans as a positive move for your employees. Let them know that a new buyer may invest heavily in the company, increase salaries, and make other improvements to the business, which spells opportunity for them. Reinforce the value of a stronger owner taking the helm of the ship. A more well-capitalized buyer can bring additional opportunities to your team, including higher compensation and more benefits. If you position the transition correctly, employees will view the change as an opportunity rather than a threat.

Your employees’ primary fears are the loss of their jobs or major changes to their roles. If you can assure them that neither will happen and that they may benefit from a change in ownership, your employees will be comforted and can assist more readily with the transition. Informing your employees will also help minimize stress on the part of the buyer. You can wrap up the meeting by presenting your team with the bonus plan. 

Ask Employees to Sign a Confidentiality Agreement

If you decide to tell your staff, you should ask your employees to sign a confidentiality agreement to ensure word of your plans doesn’t leak. This agreement can be paired with a retention bonus agreement and a non-solicitation agreement. If you do, ensure that any such agreements are assignable to the buyer. The non-solicitation agreement prevents your employees from actively recruiting other employees or customers in the event they choose to start a competing company or work for a competitor. 

Meet With the Buyer if You’ve Reached That Stage

Most employees will be terrified of losing their jobs or having to deal with major changes in the business. If you’ve already selected a buyer, it may be helpful to have the new owner at a second meeting to reinforce that they’d like to retain everyone and not make any major changes. It’s best, however, to handle the first meeting yourself so you can address any apprehension your team may have before you introduce the buyer. A savvy buyer won’t rock the boat until they’ve established a strong relationship with your team. Once this relationship has been established, they’ll also help ensure buy-in to any changes.

Prepare for the Unexpected

Be Prepared for the Question

What if one of your employees approaches you off-guard and asks, “I heard you’re selling your business. Is that true?” If this happens, you have two options:

1. Play It Off: “Yes, haha, of course. My kids are for sale, too. Buy one, get one free. Everything’s for sale for the right price. Did you bring your checkbook?” In other words, you need a pre-planned response. If you choose this route, ask a confidant to catch you off-guard and ask you several times randomly during the day as to whether your business is for sale so you can rehearse your response. This will give you the chance to practice and hone your response so you sound as believable as possible.
2. Confess: Your second option is to fess up. Again, there are no hard-and-fast rules. If you’re unsure, use the first option and play it off, and you can always confide in them later.

Have a Backup Plan in Case Things Go Wrong

I’ve been involved in transactions that hit hurdles when an employee left in the middle of due diligence because they found out about the sale and felt betrayed by the seller. This is uncommon, but you should be prepared in case this does happen. Have a contingency plan in place to mitigate potential damage and to keep your deal on course. Telling employees as early as possible gives you plenty of time to repair any damage before a deal is underway. Telling employees as late as possible minimizes the amount of time in which damage can occur.

Employees are a key asset of any business. To maximize the value of your business, you must protect the nature of your relationship with them.

“Trust starts and ends with the truth.”

– Santosh Kalwar, Nepalese Author

It’s lonely at the top. As a business owner, you know that better than anyone.

How often have you had to make confidential decisions that directly affected not only your business but also your employees’ lives? Regardless of the frequency, if you’re reading this book, I’m assuming you’re about to make or have already made at least one more key decision – the decision to sell your company.

You’ve perhaps already talked it over with your spouse, a few family members, and a couple of close friends. But what about your other “family” – your employees? When should you tell them? Or should you tell them at all before the transaction is closed?

If you spill the beans too soon, some key employees may jump ship, causing a potential disruption at precisely the time you need your business to look its best. If you wait too long, they may feel betrayed and make things difficult for the new owner when a smooth transition is essential.

In this chapter, I discuss the implications of telling your employees – and when and how to have those conversations. 

The goal here is for you to feel a little less lonely and a lot more informed.

Here are several other factors you should consider when assembling your deal team:

Flat Fees

Most professional advisors charge by the hour, while a minority charge a flat fee. Most of those who charge a flat fee are experienced in the process, which is precisely why they charge one – they understand the process enough to be comfortable quoting a flat fee. 

Experience

When building your deal team, experience is the number one thing you should look for. Ask the advisor how many clients they’ve advised in the process of selling or buying a business. Negotiating the sale of a business is a complex undertaking, and by no means should you risk your hard-earned money to pay an advisor to learn on the job. So, when hiring an accountant or attorney, look for experience. Don’t be shy when inquiring about qualifications. Ask how many M&A transactions they’ve worked on in the last three years and their role in each deal. 

The purchase agreement can have significant implications for several years following the closing. In some instances, the liability you may incur can be perpetual, such as in the case of reps and warranties related to environmental issues, the payment of taxes, or for employment-related matters. Just one word in the agreement (e.g., knowledge qualifiers) can make the difference between a million-dollar judgment and no recovery at all. 

Experienced accountants and attorneys will know what’s customary or reasonable and what isn’t. The American Bar Association (ABA) compiles surveys from attorneys in the trenches based on what’s currently considered standard practice, and therefore acceptable, in an industry. For example, the ABA might indicate that 34% of M&A transactions under $10 million in purchase price include an earnout or that the average escrow is for 12% of the purchase price. The ABA’s studies are detailed and contain specifics on every critical element of a purchase agreement. An experienced advisor can spot when the opposing party is making an unreasonable request and will be able to couple your objectives with current standards of reasonableness. A good advisor will tell you when to fight and when to acquiesce. When it comes to M&A, there’s no substitute for experience. 

Role

Ask what role they envision themselves playing in your situation – some advisors prefer to be in the background while others prefer to be on the front line.

Understand the role of your accountant or attorney based on your experience level. If you’ve never sold a business before, be prepared for your advisor to play an instrumental role in the process. On the other hand, seasoned business owners often require less guidance from their professional advisors. 

Your advisors will play significant but different roles in the sale of your business. Your attorney will be instrumental in negotiating the purchase agreement. But it’s your accountant who will take the lead in financial due diligence and examining the financial and tax implications of the purchase agreement, and determining how to allocate the purchase price. 

Risk Profile

It’s important that your team understand the importance of balancing risks vs. rewards. Attorneys and accountants are conservative by nature. Find an advisor whose appetite for risk matches your own. Some advisors are excessively risk averse. Likewise, some business owners are also risk averse. You want an advisor whose risk profile matches your own.

Knowledge of Your Business

Help your advisors understand your business from both an operational and a financial standpoint. Tell your accountant or attorney what your primary concerns are and work with your advisor to meet your needs before burying yourself in legal or financial jargon. Don’t lose sight of your objectives. Once your advisor understands your business and aspirations, you can work together to create package proposals that meet the buyer’s needs while also addressing your business needs.

The number one thing you should look for when hiring a professional advisor is real-world M&A experience.

Pre-Sale Due Diligence

Finally, ask your advisors to conduct pre-sale due diligence before you go to market. Doing so will allow you to identify and resolve potential problems before you begin the sales process. 

Additional Specialists

You may also want to consider hiring a specialist in the following areas:

• Environmental: If your business handles hazardous materials or is subject to environmental regulations, you should consider hiring an environmental consultant.
• Employee Benefits: Retain an expert in employee benefits if you have an employee benefits plan. Consult with experts in this area well in advance of the sale to ensure assets exceed liabilities and that a smooth transition of benefits can occur in the case of other benefits. In most cases, the plans will be terminated. This will mean that, as the seller, you’re obligated to fulfill the termination requirements, and the employees then continue under the buyer’s plan.
• Code Audit: When purchasing a software company, most buyers retain a third party to perform a code audit to ensure the software code is clean and well documented. If you own a software company, or if technology plays a major role in your business, it would be wise to retain a third party to conduct a code audit before you begin the sales process, which will allow you to correct any deficiencies in the code (i.e., spaghetti code) before going to market.
• Commercial Real Estate Agent or Attorney: I recommend hiring a commercial real estate agent if you own the real estate and plan to sell it. The agent can assist with marketing the property for sale or determining an appropriate rental rate.

The Annual Audit

Assemble your professional advisors for an annual meeting to perform an audit of your business. The goal of this audit is to discover problems early on and resolve them before you begin the sales process. As the saying goes, “An ounce of prevention is worth a pound of cure.”

Your advisors are a valuable source of information. This annual meeting is an opportunity to ensure they’re all on the same page and that there are no conflicts among your legal, financial, operational, and other plans. An in-person or virtual group meeting enables you to accomplish this quickly and efficiently. 

A sample agenda might include a review of the following:

• Your operating documents
• New forms of liability your business has assumed
• Any increase in value in your business that prompts the necessary changes, such as increases in insurance or tax planning
• Your capital needs
• Insurance requirements and audit, and a review of existing coverages to ensure these are adequate
• Personal and corporate tax planning
• Estate planning – including an assessment of your net worth and business value and any needed adjustments
• Personal financial planning

Conclusion

Selling a business has become more complicated in recent years. 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 evaluating 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 deal team to help ensure the sale unfolds as uneventfully as possible. 

Remember that the purpose of your advisors is to make you – and your entire management team look as credible as possible by anticipating issues and preparing disclosure in a professional manner. And the best way to do this is by ensuring that your financial statements are as clear and accurate as possible before you go to market.

Your accountant will play a critical role in assisting you and making sure your financials are clean and consistent before your business goes on the market. Your accountant may also be involved in financial due diligence, as well as in examining the financial and tax implications of the transaction. 

Your accountant will typically be less involved in your transaction than your M&A attorney, although the extent to which this is the case varies based on the transaction. If you’re selling a smaller business with a simpler set of legal agreements and less-involved negotiations, it’s possible your accountant will play a more involved role than your attorney, especially if issues related to the financials are discovered during due diligence.

Your Accountant’s Role in the M&A Process

Here are the standard roles your accountant will play in the sale of your business: 

• Review Financials: Ask your accountant or CPA to review your financial statements, tax returns, and bank statements, and correct any inaccuracies before providing your records to a buyer. This can take the form of a review, audit, or quality of earnings report. They should also reconcile your financial statements, tax returns, and bank statements to ensure they match.
• Tax Advice: Your accountant can also advise you on the tax implications of the sale. When it comes to tax advice, I recommend involving your accountant as soon as possible because you’ll have much more flexibility in tax planning and maximizing after-tax transaction revenues if you consult with your tax advisor during the exit-planning process. Your accountant can also estimate the federal and state tax consequences of selling your business under varying scenarios. These may include whether you’re selling your assets only or your entire entity, whether you’ll be paid in one lump sum versus installments over time, and whether your estate plan should also be a consideration. Additionally, they can prepare tax returns associated with the sale, such as the income tax return of a corporation that sells its assets or the tax return of an individual who sells their shares or corporate stock. 
• Allocation of Purchase Price: Your accountant can also assist in allocating the sale price among the various assets being sold by completing IRS Form 8594, the Asset Acquisition Statement under Section 1060.
• Transaction Structure: Your accountant can help review the financial aspects of the deal, including structuring earnouts, seller financing, or other contingent payments.
• Working Capital Calculations: Most acquisitions include working capital as a component of the purchase price. As a result, working capital and balance worksheets must be prepared for the closing and then re-examined after the closing to measure any differences in working capital between the two periods. Your accountant can assist with these calculations. 

Tips for Hiring an Accountant

When hiring an accountant, you should look for the following:

• Experience: Probe to see whether the CPA has M&A experience. Ideally, your accountant should have experience on both the buy side and the sell side in a range of mid-sized transactions. 
• Accessibility: You need an accountant who’s highly responsive and quickly responds to phone calls and emails. Many stages of the process are time sensitive, and you can easily lose a buyer if you or your team are slow to respond.
• Expertise: A CPA is ideal. A word of caution – not all CPAs are sufficiently qualified to provide all the services suggested above. That’s because many CPAs specialize in preparing individual tax returns but don’t routinely assist in business sales. 

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. All sellers should retain an M&A attorney before the process begins. In some cases, your M&A attorney may assist you in identifying legal issues that need to be resolved before you go to market, and you can then delegate these matters to your commercial attorney to resolve. In most cases, your M&A attorney will become involved during the stages of negotiating the LOI and will play a crucial role in the transaction until the closing transpires. 

It’s critical that you hire an attorney who has significant experience buying and selling businesses. The biggest mistake business owners make is hiring an attorney with limited M&A experience, which in many cases can cost you the sale due to their inexperience. It pays to heed the wise proverb and avoid being penny wise and pound foolish when it comes to hiring an M&A attorney.

For middle-market transactions, the buyer often brings a team of dozens of staff and advisors to conduct due diligence. As a result of the imbalance, you should aim to at least achieve negotiating parity by hiring the best advisors you can afford. Having an experienced attorney helps level the playing field. 

Your Attorney’s Role in the M&A Process

Here are the common roles your attorney will play in the sale of your company:

• Non-Disclosure Agreement: While your investment banker’s standard NDA will be suitable in most cases, I recommend having your attorney draft a custom NDA if the sale is particularly sensitive and you’re approaching or negotiating with any direct competitors.
• Letter of Intent: The buyer’s legal team customarily prepares the LOI, but your attorney should be on standby and available to respond quickly when you receive a letter of intent.
• Due Diligence: The extent to which your attorney is involved in due diligence depends on how thoroughly the buyer conducts their due diligence. I can often anticipate how thoroughly a buyer will perform due diligence based on my preliminary conversations with them. Often, your investment banker can let you know in advance if they feel your attorney will need to be more involved in the negotiations.
• Purchase Agreement: The buyer’s legal team also customarily draws up the purchase agreement. The purchase agreement is often prepared while due diligence is being conducted, which usually gives the parties plenty of time to negotiate it, and the negotiations typically tend to be less time-sensitive unless you’re facing any deadlines. On the other hand, the negotiations surrounding the LOI tend to be more time-sensitive, especially if you’re negotiating with multiple buyers. As a result, it’s critical that your M&A attorney is on standby and able to quickly become involved in negotiating the LOI.
• Negotiations: I also recommend involving your attorney to a much greater degree if negotiations become contentious or if the buyer proposes excessively restrictive reps and warranties or other clauses in the purchase agreement. In many cases, the buyer may reserve the right to claw back all or a significant portion of the purchase price if there are any material errors or omissions. Your attorney can also be instrumental in negotiating these agreements to reduce your level of risk exposure.
• Closing Process: Your attorney can facilitate the closing process and wiring of funds if the buyer’s attorney or escrow is unavailable to do so.
• Real Estate: If you’re selling a building or land, your lawyer can prepare or review the necessary transfer documents. 

Tips for Hiring and Using an Attorney

When hiring an M&A attorney, you should look for the following:

• Experience, Experience, Experience: Your attorney should spend the majority of their time negotiating M&A transactions. Don’t hire a general corporate attorney who dabbles in mergers and acquisitions. Your M&A attorney, who may charge $750 per hour, will surely be cheaper than your general corporate counsel, who only charges $350 per hour. You’re far better off hiring an attorney who specializes in M&A. 
• Availability: You’ll want to have your attorney on standby. All sellers should hire an attorney and have them prepared to become involved in the transaction at a moment’s notice. 
• Negotiating Skills: Your legal advisor should also be an excellent negotiator. While most attorneys are excellent negotiators, their skill levels can vary tremendously. Often the negotiation on reps and warranties is tougher and more challenging than negotiating the price. 
• Soft Skills: Find a lawyer who doesn’t feel compelled to participate in or influence the commercial aspects of the deal unless you specifically request otherwise. Obtain references and talk with the attorney to ensure the chemistry is a match.
• Creativity: Your attorney should be capable of offering solutions in risk management, such as creative deal structuring. 

The term “M&A advisor” covers a broad category of professionals who specialize in M&A transactions of various sizes. Throughout this book, when I refer to M&A advisors, I’m referring to this broad spectrum of M&A specialists, including both M&A intermediaries and investment bankers. I use the terms M&A advisor, investment banker, and banker interchangeably. Here’s a general breakdown of these categories: 

• M&A Intermediary: Sells businesses from $5 million t0 $100 million in annual revenue
• Investment Banker: Sells businesses with more than $100 million in annual revenue and also offers other services, such as raising capital

To borrow another sports analogy, think of your M&A advisor as your quarterback. They’ll play a major role throughout the transaction, from the opening kickoff through to the final seconds. Your M&A advisor will initially help you package your company for sale, which will include valuing your company, identifying any issues that need to be addressed before you put your business on the market, and preparing the essential sales documents. 

Once the preparation is complete, your M&A advisor 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. In contrast, your M&A attorney will negotiate the finer details of the agreements.

Types of M&A Advisors

Following is a deeper examination of the two primary categories of M&A advisors:

M&A Intermediaries

• M&A intermediaries specialize in selling middle-market businesses, or those with annual revenue from $5 million to $100 million, although there’s no universally agreed-upon range of what constitutes the middle market. The middle market can be further segmented into the lower-middle market, the middle-middle market, and the upper-middle market. This book is geared at businesses operating across this range of sizes that constitutes the middle market.
• There are approximately 3,000 to 5,000 M&A intermediaries in the United States. Most M&A intermediaries represent sellers, although a minority specialize in buyer representation. 
• Most M&A intermediaries work solo or as part of a boutique firm. A few larger firms specialize in the lower-middle market, although they are in the minority. Some M&A firms focus on specific industries, but the majority are generalists. Many firms offer additional services, such as financing, recapitalizations, and management buyouts, but these are ancillary services for most firms.
• The majority of M&A intermediaries charge upfront fees, sometimes called a retainer, in addition to a success fee. Some may also charge a monthly retainer. Typical success fees range between 2% and 8%. Standard fee arrangements include the Lehman and Double Lehman formulas, which charge a higher percentage on the first few million, such as 8% on the first million, and a lower percentage on successive amounts, such as 6% on the second million and 4% on the third million. I’ll go into more detail about these fee structures later in the chapter. 

Investment Bankers

• Investment bankers specialize in selling larger businesses, typically those generating more than $100 million per year in revenue. Be aware that the term “investment banker” is regularly and loosely used by M&A advisors to identify themselves due to the lack of a catchy moniker for those specializing in the middle market – “M&A advisor” sounds clunky. 
• Many of their clients include publicly traded companies. Investment banking firms also offer many other services, such as asset management, trading, equity research, raising debt financing, IPOs, and banking.
• There are fewer investment banking offices than M&A firms. Most investment banking firms are larger and have more support staff. However, there are some boutique firms specializing in the lower end of the market with companies between $100 million and $250 million in revenue.

Other Industry Professionals

There’s a diverse array of other professionals in the M&A world. The following section gives you an overview of some of the other professionals you may encounter. 

Exit Planners

• There’s little crossover between those who sell businesses and the fragmented collection of other professionals who help business owners prepare for the sale. In other words, the advisors who help entrepreneurs prepare their business for sale don’t normally help them sell the business and vice versa. As a result, there’s often a disconnect between exit planning and the actual exit for most entrepreneurs. How can an exit planner help you prepare your business for sale if they’re not actively engaged in the marketplace and are unfamiliar with the buyer’s preferences in the current marketplace?
• My hypothesis why most M&A advisors don’t assist in preparing a business for sale is that doing so requires a different mindset, a different set of skills, and a different process than selling a business. Processes and tools need to be created to advise owners and they are too busy doing deals to create these processes. I’ll go into detail later in this chapter about how most advisors simply don’t have the manpower to create the processes because of how most offices are structured. 

Commercial Real Estate Agents

• Many commercial real estate agents sell businesses that include a real estate component or specialize in commercial property, such as hotels, motels, or storage units. Some commercial real estate offices are active in the business marketplace, though the majority consider this a minor segment of their business. Most commercial real estate agents charge a 4% to 6% commission, with declining amounts as the purchase price increases. Most work on straight commission, but there are a few who charge upfront fees.
• It’s best to hire a specialist if you have a business with a substantial real estate component. For example, if you own a hotel, hire a hotel broker. But it may be difficult if you’re located in a smaller state, as every state requires a real estate license to sell real estate. If this is your situation, you may need to hire an out-of-state broker who can cooperate with a local broker. Most states’ real estate departments allow an out-of-state broker to cooperate with a local broker if they aren’t licensed in the state. 

Business Appraisers

• Most business appraisers only value businesses for tax or other legal purposes. They rarely sell businesses, but most will appraise a business for any owner, for any purpose, including for exit planning purposes. In my opinion, you’re better served by someone active in the marketplace as they’ll be able to best advise you on how to increase the value of your company, and their knowledge will be rooted in the real world.
• Appraisals can cost $1,000 at the low end for a verbal opinion of value, up to $5,000 to $10,000 for a company with sales of $5 million per year, and up to $20,000 or more for larger companies.

Office Structures

Knowing how an office is structured is vital because it tells you how that business operates and the level of skill, knowledge, and professionalism you can expect. Incentives are also necessary to consider. While the reputation of the firm is helpful to know, what matters most is the individual you hire, not the office.

Here’s a breakdown of how most M&A offices are structured:

Solo Offices

• Operated by one advisor, sometimes with an assistant. However, most solo advisors don’t have any support staff or assistants.
• A solo advisor must be a jack-of-all-trades – from answering the phones and fielding basic email inquiries to negotiating the purchase agreement.
• Many industry specialists happen to be solo operators.

Small Offices

• Smaller offices usually have fewer than 10 dealmakers. 
• The owner is typically an active dealmaker and manages the staff part-time, therefore:
  • If you hire an advisor who is also an office owner, you should realize their time is split between managing the office and selling businesses. 

Large Offices

• Larger offices typically have more than 10 dealmakers.
• Most large offices have an owner and an office manager, or full-time person who manages the staff. 
• The least experienced professionals in the industry tend to be dealmakers at larger offices. This is where most people gain initial experience in the industry before branching out on their own.

Fees

Most M&A advisors charge upfront fees, in addition to a success fee. Usually called a retainer, the fee varies from as low as a few thousand dollars to more than $50,000. Most also have a minimum success fee in the range of $50,000 to $250,000 if the business is sold. 

The most common fee structures are the Lehman and Double Lehman formulas, a compensation structure developed decades ago by former investment banker Lehman Brothers. There are other variations on the Lehman and Double Lehman models. For example, some M&A advisors may begin at 8% on the first million and level out at 4%.

Lehman Formula:

• 5% on the first million, plus
• 4% on the second million, plus
• 3% on the third million, plus
• 2% on the fourth million, plus
• 1% after that.

Double Lehman Formula:

• 10% on the first million, plus
• 8% on the second million, plus
• 6% on the third million, plus
• 4% on the fourth million, plus
• 2% after that.

Under the Double Lehman formula, if a business sells for $5 million, the fee would be: $100k (10% on the first million) + $80k (8% on the second million) + $60k (6% on the third million) + $40k (4% on the fourth million) + $20k (2% thereafter) = $300k. 

The Agreement

Here are a few other significant considerations to keep in mind when determining whether to work with a firm:

• Length of Agreement: Most firms require a one-year exclusive agreement, but this is sometimes negotiable. On average, the process of selling a business takes 6 to 12 months, though it can sometimes take much longer. 
• The Tail: Regardless of how long your agreement is, at the end of the contract, the firm you hire should provide you with a list of potential buyers they generated throughout the contract if your business doesn’t sell. You’ll then be obligated to pay a fee if you sell your business to one of those buyers following a specified amount of time after the expiration date of the agreement, called a “tail.” Most tails are 24 to 36 months in length.
• Cancellation of the Agreement: Discuss contract cancellation rights with the firm you hire. Some agreements allow you to cancel at any time, while others don’t. Most agreements require paying the full fee if you remove your business from the market, such as if you change your mind, so be 100% sure you want to sell if such a clause exists. 

Deciding on a Local vs. National Firm

Changes in the way the world operates need to be considered when you’re looking to hire an advisor. The world economy is evolving in ways no one could have predicted, even a decade ago. Auto manufacturers, grocery chains, and most other companies that started as brick-and-mortar businesses are changing the way they operate to online models, especially when it comes to marketing and sales.

Former Speaker of the U.S. House of Representatives Tip O’Neill famously declared, “All politics is local.” Is this true of selling a business, as well? The internet has changed the way this industry works, but has it affected how businesses are sold? 

No advisor will ever know your business as well as you do. Selling your business is a team effort, and you’re a critical element of the team. 

As a general rule, most local firms are less likely to embrace technological changes in the industry and, as a result, use fewer technological resources that are now necessary to find and arrange the best transactions for their clients. Today, most businesses are bought and sold virtually, documents are signed digitally, and transactions that once took weeks to close are now completed in a matter of minutes, so being local is rarely necessary. 

In most cases, your advisor doesn’t necessarily need to know the local market. To maximize the price, an advisor needs to know how to effectively package and confidentially market your business for sale and get it in front of as many potential buyers as possible – in other words, they need to be experts at the private auction process. The most effective auctions include buyers at a national or even international level.

Hundreds of thousands of small businesses now sell their products to a worldwide clientele because customers can find them anywhere there’s internet connectivity. Why limit your buyer pool to those within a narrow physical radius? Local connections are valuable when looking for a mechanic, plumber, or roofer. The same doesn’t apply to finding prospective buyers for a middle-market company whose audience includes international suitors. 

While staying local is appealing for many services, there are some downsides to keep in mind when considering a local firm to sell your business. These potential disadvantages include: 

• Less Innovation and Technology: Working on a national scale requires advanced technology, and not all local firms have made this investment.
• Limited Scope of Experience: Unlike local firms, intermediaries who operate on a national or international basis are exposed to a wider variety of situations, deal types, and circumstances. This increases their knowledge base, resourcefulness, and pattern-recognition capabilities.
• Limited Selection: In many cities, you will find only a small pool of local M&A advisors from which to choose, many of whom are industry generalists.

The following are a few situations in which hiring a local professional is necessary:

• In-Person Appraisals: For certain types of business appraisals, a site visit may be required.
• Knowledge of State Tax Code: Hiring an in-state certified public accountant (CPA) is recommended if your state has personal or corporate income taxes.
• State Bulk Sale Statute: If your state is one of the few states where the bulk sale statutes have not been redacted, such as California, I recommend hiring an in-state escrow agent or attorney, although it’s not necessary to hire a local M&A advisor. 

I speak from experience. I started out as a traditional local advisor in Ohio, Nevada, and California for more than eight years before making the transition to a firm with a global client base. During that time, one example stands out:

While working in Southern California, I was contacted by the owner of a manufacturing firm in Northern California who wanted to sell his business. I told the owner that I was in Southern California, so it wouldn’t be feasible for me to handle the transaction. He stopped for a second, sounding puzzled, and asked why I needed to meet with him. I had no idea what to say. I always assumed the only way to do business was to meet with clients in person. That moment was a revelation. I stuttered, paused, then jumped at the opportunity. Within 18 months, I turned our business model upside down. Since 2009, I’ve operated 100% virtually.

I’m not alone. Many industries have moved past a brick-and-mortar philosophy and are embracing new opportunities in the digital marketplace, including mine. This evolution in our industry forced me to question the utility and effectiveness of conventional industry standards and has led to many of the insights and advice that I outline in this book. 

Questions To Ask When Hiring an M&A Advisor

When hiring an advisor, background knowledge of their office and fee structure only goes so far. Here are some questions you should consider asking when hiring an M&A Advisor:

Does the firm specialize in your industry?

Industry specialists have a big leg up on generalists. From knowledge of current multiples to who the best buyer may be for your business, industry experts bring specialized knowledge and contacts to the table that can’t be offered by someone who doesn’t have in-depth knowledge of your industry.

Does the firm work solely on commission? 

Firms that work solely on commission are disincentivized from spending time working on your sale. A straight commission model incentivizes a firm to sell your business as quickly as possible with the least amount of effort expended. If you don’t want to be rushed, it may be preferable to work with a firm that charges upfront fees in addition to a success fee.

Firms that work on straight commission must also pad their fees to account for the businesses they take on but don’t sell. For example, if the firm has an 80% success rate, they must find a way to receive compensation for the work they put in on the 20% of the businesses they fail to sell.

A straight commission structure can also cause bias and misalignment between the owner and the firm. The more time the firm invests in selling your business, the more they’ll feel the need to recoup their investment. A firm that charges an upfront fee for services will feel this pressure to a much lesser extent, and your interests are more likely to be closely aligned with the firm’s interests.

Does the firm charge upfront fees? 

Some assert that upfront fees should be avoided at all costs. Their premise is that “only salespeople who work on straight commission should be trusted,” which I shouldn’t have to tell you is a weak assertion, at best. Based on this premise, accountants and attorneys shouldn’t be trusted because they don’t work on straight commission, and car salespeople should be trusted only if they work on commission. 

Most professionals are fee-based, but due to the nature of an M&A transaction, few business owners would be willing to pay tens or hundreds of thousands of dollars in fees only to have a transaction fail at the last minute. As a result, most M&A advisors charge fees for services, along with a success fee on the back end. 

But the truth is, the more experienced the firm, the higher the likelihood they’ll charge upfront fees, especially if they invest a significant amount of time preparing and packaging a business for sale. As a result, most M&A advisors will be reluctant to put in the work without being paid upfront for their expertise. 

Does the advisor have support staff, or do they do everything on their own? 

Selling a business is a difficult multi-disciplinary task that requires a wide range of skills in disparate areas. Most investment bankers have a team of specialized support and rely on both internal and external experts. The most efficiently operated offices have developed scalable systems for the repeatable elements in the sales process, such as financial analysis, valuation, marketing, packaging, screening buyers, and closing, with each process handled by an expert in that field. The best operations I’ve seen run like a surgeon’s office, where the most experienced advisors handle the most complex tasks while a variety of other staff members deftly execute well-documented and defined processes within a flexible framework. This is precisely how my firm, Morgan & Westfield, operates.

The size of the support staff has an impact on the level of professionalism the firm demonstrates and on the quality and efficiency of your transaction. Generally speaking, the more support staff the office has, the higher the skill level of everyone involved. After all, it’s easier to specialize in one specific area than to try to be an expert in all areas. If you find that your brain surgeon is also in charge of the clean-up crew, perhaps it’s best to look elsewhere – the same goes for the team of experts you plan on hiring to handle the most important business transaction of your life.

Selling a business is a difficult multi-disciplinary task that requires an enormous amount of skills in disparate areas.

“If you think professional advice is expensive – try ignorance.”

– Jacob Orosz, President of Morgan & Westfield

Remember the original Dream Team? The occasion was the 1992 summer Olympics in Barcelona. It was the first time active professional players from the National Basketball Association (NBA) were allowed to ply their trade on the American Olympic team. And what a team it was! The likes of Michael Jordan, Magic Johnson, and Larry Bird defeated their opponents by an average of 44 points before taking home the gold medal. Their collective notoriety “… was like Elvis and the Beatles put together,” said head coach Chuck Daly at the time. Despite their disparate playing styles and personalities, the superstars gelled. They played like a team, a dream team.

One of the first tasks when selling your company is building your own dream team. Let’s call it the deal team. You won’t necessarily need Michael Jordan or Magic Johnson, but it would behoove you to pick proven role players who can effectively contribute to the task at hand.

Your deal team will consist of several key people, potentially including an M&A advisor, an M&A lawyer, an accountant, and several other people in roles with varied titles. In this chapter, I’ll walk you through how to build your deal team, offer tips for finding and hiring an M&A advisor or investment banker, and detail what roles your accountant and attorney play in the process.

Following are several suggestions for strategically using the RVD Model:

• Prioritize the Value Drivers: Even though the rating for each value driver is subjective, there’s a clear distinction between the highest and lowest priority value drivers. Despite this ranking, priorities aren’t absolute but should be considered relative to one another. It’s also worth noting that individual ratings are less important than the overall ranking or priority of the value drivers relative to one another. For example, it’s clear from reviewing Acme’s RVD Model that increasing pricing should be prioritized over improving documentation because it requires less time and money to implement. Because completing the RVD Model is simple and requires little time, Acme could perform this analysis in a few hours with the assistance of an M&A advisor and could begin executing the top value driver almost immediately. There’s no need for extensive planning – the RVD Model encourages lean planning and action, emphasizing results.
• Understand the Importance of Perspective: Don’t restrict yourself to a linear, black-and-white approach. The purpose of the RVD Model is to offer you a high-level perspective of your available options and the associated criteria in deciding your course of action. Once you perform the rational analysis, let your subconscious take over to see if more strategic options evolve over time. Review your potential value drivers several times and re-rate them from scratch several times to uncover inconsistencies or areas where you may need more information to make a more intelligent decision.
• Obtain Multiple Opinions: For a more democratic approach, consider giving a copy of a blank RVD Model to your C-level executives and M&A advisor to complete independently. By asking them to complete it independently, you counteract the bandwagon effect and unveil critical assumptions your advisors may have regarding some of your value drivers. For example, a CEO may have a different perspective than the CFO, CMO, or CTO. Therefore, it’s paramount that you don’t show a copy of your completed model to those working on it for the first time. Instead, ask them to complete the model independently of your input before you collaborate. Finally, consider asking your professional advisors, such as your accountant and attorney, for their input on your RVD Model.
• Reconcile Different Opinions: Once you’ve obtained multiple opinions, summarize the results into one document, and discuss the reasons for any differences with your team and advisors. By carefully weighing everyone’s opinion, you flush out differing views, which helps prioritize the actions everyone believes could have the greatest impact and that could be executed for the least cost, time, and risk. In other words, openly debating the model results in a wiser course of action based on multiple people’s input.
• Assemble a Deal Team: It’s helpful to assemble a deal team to initially discuss the value drivers and formulate and execute your strategy. The more help you have from experienced professionals to execute the value drivers, the more progress you’ll make. This may also be a wise time to consider implementing a retention bonus plan for your key executives. A retention bonus aligns incentives and motivates your key staff to improve the value drivers, especially if their retention bonus is tied to the purchase price.
• Break Value Drivers Into Actionable Items: Consider breaking the value drivers down into specific actions, such as creating a retention bonus for key employees, as opposed to themes or categories, such as “staff.” Ratings, and therefore priorities, may be significantly different for specific actions as opposed to types of actions, and it may make sense to rank the model by specific actions as opposed to action categories.
• Adjust Value Drivers According to Reasons for Acquisitions: In addition to ranking the value drivers, it’s helpful to know why a company may desire to acquire you. Such knowledge also helps you fine-tune the ranking of your value drivers.
• Know How Value Drivers Can Overlap: Realize that value drivers can overlap. One value driver can positively affect multiple attributes of your business. For example, increasing recurring revenue can have an impact on multiple value drivers. Or, increasing the lifetime value of your customers can dramatically change the dynamics of the assumptions in your business plan, which can also affect multiple value drivers simultaneously. 

Identifying your value drivers is a crucial element in increasing the value of your business and preparing it for sale. While working to maximize your value drivers isn’t an absolute requirement for selling your business, it can significantly increase the value of your business while helping to ensure the sale process transpires as smoothly as possible.

Conclusion

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 to achieve them. 

When it comes to deciding which value drivers to prioritize, the advice of an experienced M&A advisor or investment banker is priceless. The host of factors outlined in this book will give you a head start on decisions that can increase the value of your business.

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 your list of value drivers. A knowledgeable advisor can assist you with identifying 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 determine which value drivers are most likely to appeal to all buyer types and which value drivers may only appeal to a specific buyer. Regardless, the guidance in this book is a useful starting point and will assist you in understanding the potential factors that can impact the value of your company before you choose to consult with a professional.

The following are the ratings on Acme Software’s RVD Model, which are prioritized based on the chart above:

• Increase Pricing (Rating 9.25): The potential returns from increasing pricing were high for Acme. 100% of any price increase would fall straight to the bottom line, less any sales commissions. If Acme increased prices by 20%, EBITDA could potentially double. Revenue was $10 million, and a 20% price hike would raise EBITDA by $2 million, or double EBITDA to $4 million from $2 million. The company considered such an action to be low risk because it required little time and money to implement and it was reversible. As a result, Acme focused on this value driver first due to its potential for high returns and the low amount of time and investment required to implement it.
• Document Comparable Transactions (Rating 9.25): Acme was aware of several companies within their industry that received multiples of 10.0 to 12.0, but they had no documentation to back up these transactions. Acme believed they could obtain more information regarding the transactions through several well-connected individuals in their industry, as well as through their investment bankers and professional advisors. While the potential return from this value driver was less than that of increasing pricing, little in the way of time and money was required to obtain this information. As a result, they began executing this value driver immediately after they increased pricing.
• Reduce Staff-Related Risk (Rating 7.75): Acme had several key employees who lacked employment, confidentiality, and non-solicitation agreements. The lack of agreements represented a significant risk to a potential acquirer but could be cleared up with minimal cost in a matter of several weeks. Acme asked their attorney to prepare employment agreements for key staff that included non-solicitation agreements with retention bonuses to ensure the employees would be retained in the event of a sale. The retention bonuses served as a form of consideration, which is required for contracts, and improved the enforceability of the non-solicitation agreements.
• Reduce Concentrations of Risk (Rating 6.75): Acme also had key employee, customer concentration, and product concentration risks. While these risks couldn’t be immediately mitigated, plans could be put in place to ease these risks over time. For example, the risk of key employee concentration was reduced by more evenly spreading duties across the management team. Customer concentration risk was mitigated by asking key customers to sign long-term contracts. And finally, product concentration risk was tempered by developing strategies to invest more in marketing their entire product line, as opposed to just a few products.
• Increase Revenue and EBITDA (Rating 6.25): While the potential impact of increasing revenue and EBITDA was significant, doing so involved a considerable amount of time and investment. Acme realized that the primary method for increasing revenue, and therefore EBITDA, was to hire a more experienced sales manager and invest in building the sales infrastructure, so the sales team could scale up their impact on the business. This required a significant investment in time and money, as well as a reasonable level of risk. But the risk was contained by hiring a third-party expert to help interview and screen potential sales managers.
• Conduct a Code Audit (Rating 6.25): Acme’s owners had some background in development, but they weren’t 100% sure the software was clean and well documented. They realized a buyer was likely to retain a third party to conduct a code audit during due diligence, and they reasoned it would be wise to hire an independent firm to review the code before beginning the sale process. The audit was expected to cost approximately $15,000, but they felt the investment was justified given the potential impact on improving the certainty of closing once a buyer was located.
• Strengthen IP (Rating 6.25): Acme’s name was well respected and known in the industry, but they lacked trademark and invention assignment agreements for their developers. The owners felt they could obtain a trademark, so they hired an intellectual property attorney at a cost of $25,000 to perform a trademark search, file for a trademark, and prepare invention assignment agreements for key staff. The process was expected to take approximately four to six months. While doing this wasn’t expected to significantly impact their valuation, it mitigated risk for the buyer, therefore reducing the due diligence risk for Acme and improving the certainty of closing.
• Enhance Sales and Marketing (Rating 6.00): Acme lacked sales and marketing documentation and infrastructure. They realized this might take a significant amount of time and money to build. Since the potential impact wasn’t as substantial as value drivers higher on the list, such as increasing pricing and reducing staff-related risk, they assigned this value driver a lower priority given the amount of time and money required to execute it. Acme assembled a team to document the sales and marketing processes, expecting this process to take approximately three months.
• Increase Cost To Replicate (Rating 5.75): Acme’s owners felt that a few competitors could easily replicate the functionality of their software, but they felt they could implement several defensive strategic actions to increase the difficulty of replicating the software. Acme enacted these strategies over a period of three months.
• Maximize Recurring Revenue (Rating 5.75): Acme’s enterprise customer agreements were renewable annually, and many customers stalled during the renewal process. Acme felt they could create an incentive to motivate customers to agree to an automatically renewable contract. Still, this transition process would take at least one year as they thought it would be best for customers to sign the new contract upon the expiration of each annual contract. Acme began implementing this process simultaneously while documenting their sales and marketing processes since they realized that transitioning to automatically renewable contracts would take considerable time.
• Strengthen Customer Base (Rating 5.25): Acme lacked agreements with the majority of its customers and knew this represented a significant risk to potential buyers. To counter this risk, the company created several pricing models with various contract terms and tested those models over a period of 10 to 12 weeks with the goal of creating a pricing model that incentivized customers to sign long-term agreements.
• Improve Documentation, Infrastructure, and Scalability (Rating 5.50): Acme lacked the documentation and infrastructure that could help it quickly scale, but the owners realized that improving the documentation and infrastructure would require an enormous investment of time and money – perhaps up to nine months or longer. They also recognized this work would distract their employees from other projects. As a result, they decided this was their lowest priority value driver and planned on executing it as their last priority.

A value driver is any action you can take that can potentially affect the value of your business. The goal of the RVD Model is to help you increase the value of your business with the least amount of effort.

Below is a sample chart of potential value drivers for the hypothetical middle-market technology company, “Acme Software.” My analysis includes commentary about why and how I rated each value driver, and a rating based on the four key criteria – return, risk, time, and investment. 

Note: I rated the criteria from 1 to 10, with 10 being the most favorable and 1 being the least favorable. For example, a 10 rating for risk means the action is considered low risk, and a 2.0 rating for risk represents a greater risk. A 9.0 rating for investment indicates that a low investment is required, and a 2.0 rating denotes that a significant investment may be necessary. The weighting below will vary significantly from company to company. For example, in a business with underperforming metrics, the potential return on improving a particular value driver may be as high as a 9 or 10, but in a company with favorable metrics, this represents a possible return as low as 2 or 3.

1. Rate each value driver on the four criteria – return, risk, time, and investment. The rating shouldn’t be considered definitive. Instead, the purpose of the rating is to allow you to loosely prioritize the potential actions you can take. This can help you focus first on the highest impact actions that present the lowest risk and that require the least time and energy to implement.
2. Prioritize the value drivers based on their overall rating. Improving the value of your business shouldn’t be done haphazardly. Rather, it’s best to prioritize the potential actions you can take and then execute a few value drivers at a time in a systematic fashion. Most business owners take a hodge-podge approach to value maximization as opposed to a strategic, intelligent, and rigorous one. The objective of the RVD Model is to provide you with a structured framework you can use to increase the value of your business. In addition, the RVD Model helps prioritize possible actions you can take based on potential returns, the risk involved in achieving those returns, and the associated cost in terms of time and money. 

“Before anything else, preparation is the key to success.”

– Alexander Graham Bell, Scottish-born Inventor and Engineer

How can you prioritize all the possible steps you can take to increase the value of your business?

The Return on Value Driver’s Model, also known as the RVD Model, is a proprietary tool I developed that helps you identify which aspects of your business to focus on improving that are likely to have the greatest impact on the value of your company. The goal of the RVD Model is to help you increase the value of your business with the least amount of effort.

What is a value driver? A value driver is any action you can take that can potentially affect the value of your business. For example, the most sought-after top value driver for technology, software, and online businesses is recurring revenue. If you know this is the top driver of value for your business, you can prioritize this value driver over others that will have a less meaningful impact.

The RVD Model helps you prioritize which value drivers to focus on based on the following criteria:

• Return: What’s the potential impact, or return, of implementing the value driver on the value of your business?
• Risk: What’s the risk associated with implementing the potential value driver?
• Time: How much time will the value driver take to implement?
• Investment: What financial investment is required to implement the value driver?

The RVD Model helps you determine which action steps will have the largest impact on the value of your business in the shortest time that represent the least amount of risk to implement. In this section, I walk you through a step-by-step process for deciding which aspects of your company to focus on improving first. I also provide a sample RVD Model based on a real company. 

Unfortunately, indispensable owners can lead to difficult-to-sell businesses. However, there are ways that owners can make the transition as smooth as possible when it comes to partners and other shareholders. 

Roles and Dependencies

If you own a business, your best bet is to make it easy for a successor to replace you. The more valuable you are to your business, the less valuable your business will be to buyers. The ideal situation is one in which you’re 100% replaceable. Unfortunately, many business owners end up making themselves irreplaceable. And in doing so, they not only decrease the value of their business, but also make it much harder to find a buyer when it comes time to sell.

Absentee-owned businesses are worth much more than owner-operated businesses because there’s no need to replace the captain of the ship. Most absentee-owned businesses are successfully run by a team of core employees or a management team. If it’s reasonable to assume the employees will stay after the sale, nearly anyone is qualified to purchase the business from an operational or investment standpoint.

As you streamline your business and make yourself replaceable, you’ll build a business that’s much easier to sell. To streamline your business, you must:

• Assemble a strong team of core employees and an independent management team.
• Build systems into your business and document your operations.
• Automate processes in your business using technology or other systems.

These methods of streamlining your business involve using either human talent or technology. But don’t make the mistake of trying to rely solely on either people or technology. Most businesses must use both.

Don’t make it difficult for a successor to replace you. The more valuable you are to the business, the less valuable your business will be to potential buyers.

Compensation

If your business has more than one owner, compensation must be normalized to market rates for all owners. When normalizing your financials, you should only add back one full-time owner’s compensation. You should pay all other active owners a market-rate salary based on their level of involvement in the business. This simplifies the process of calculating a replacement cost for any owners.

Emotions

If you have owned your business for a long time, you’re likely to have a high emotional investment in your company, especially if you built it from scratch. If this is the case, I recommend you address the emotional elements of the sale well before you begin the sales process. It’s also helpful if you have a compelling hobby or passion to engage in after the sale. Selling a business can be a demanding and emotionally draining process, so it’s best to be as emotionally prepared as possible.

Partners

Seek the approval of all shareholders, partners, and decision-makers involved in your business well before you begin the sales process. Consider whether everyone agrees with the time frame, the price, and other key terms.

Don’t underestimate the rights, power, and potential wrath of minority shareholders, whether voting or non-voting. Minority owners treated with disrespect can exercise their rights and powers and make things difficult for everyone involved. They can hire a lawyer and sue the company, causing considerable harm, even if they don’t win in court. The more-powerful shareholders are best advised to treat the less-powerful ones as they wish to be treated themselves. Ensure you have agreement from minority shareholders before moving forward. Consult with an attorney if you don’t.

You should also seek the approval of your spouse. Under community property laws, a spouse may contest the sale, even if they aren’t an owner of the business, as they may be able to claim that your ownership in the business is community property.

Action Steps

• Roles: Reduce your business’s dependence on you by:
  • Assembling a strong team of core employees and an independent management team.
  • Building systems into your business and documenting your operations.
  • Automating processes in your business using technology or other systems.
• Compensation: If your business has more than one owner, normalize compensation to market rates for all owners. 
• Emotions: If you have owned your business for a long time, address the emotional elements of the sale well before you begin the process.
• Partners: Seek the approval of all shareholders, partners, and decision-makers involved in your business. Consider whether everyone agrees with the time frame, the price, and other key terms.

Conclusion

As mentioned in the introduction, 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.

There are many areas in which you can indirectly create value, including:

• Business Model: The easier it is for a buyer to replicate what your business has to offer, 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 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: Reduce 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.

To download an editable spreadsheet version of this checklist or to learn more about buying, selling, valuing a business, or dozens of other topics related to mergers and acquisitions, visit the Resources section of the Morgan & Westfield website at morganandwestfield.com/resources .

Your employees are one of the two most important assets of your business – the other being your customers. Nearly every buyer will be concerned with the quality and sufficiency of your staff, so it’s wise to spend a significant amount of time ensuring there are minimal issues related to your employees that can deter a buyer. Here are several suggestions for making sure your people add considerable value to your business.

Management Team

If your business can’t be run without you and if you plan to sell your business to a financial buyer, you must usually continue running your business after the closing. To prevent this requirement, build a strong management team that can operate your business without you, or identify a successor who can take the helm when you depart.

A capable management team improves the value of any company. Unfortunately, many middle-market businesses lack a management team that can run the business without the owner’s involvement. Without professional management, your business is unlikely to thrive without you. How long can your business survive once you’re gone? One year? One month? One week? 

Building a professional management team is a Herculean task requiring a new set of skills for most entrepreneurs. When you first started your business, you likely performed most of the key tasks yourself. Once you reach a certain point, however, you must build a team to replace you, and that primarily requires recruiting and management skills. You must learn how to find and hire good people and how to get results from those people. 

Determine what position or positions would add the most value to your company. What does your company need most? Do you need a CFO, COO, VP of Marketing, VP of Sales, VP of Human Resources, or should you bring in an external president? Spend time developing a formal management team. Not only will your business be easier to sell, your revenues and profits will likely increase as well.

As an entrepreneur, you must understand that the more indispensable you are to your business, the more difficult your business will be to sell – and the less your business is worth. Learning to become a successful captain isn’t easy. To be sure, if you just received a $20 million venture capital injection, you can afford the best talent available and motivate your team with stock options and other incentives. Such scenarios tend to attract strong, autonomous, driven talent. But if you own a small manufacturing company in Boise, Idaho, and you have no institutional investors, you must learn to make do with less.

Other than retirement, this is perhaps the number one reason entrepreneurs sell their companies – because their businesses are highly dependent on them, and they feel as if they can’t escape. They have no time to relax, can’t take vacations, and have a hard time letting go. It’s a Catch-22 – they want to sell because the business is so dependent on them – but they wouldn’t sell if the business weren’t dependent on them. What’s the solution? Either way, it’s to reduce your business’s dependency on you.

Many excellent books have been written that can help you transform your company into an established middle-market business, and I recommend the following:

• Scaling Up by Verne Harnish (Gazelles, Inc., 2014) 
• The New One Minute Manager by Ken Blanchard and Spencer Johnson (Harper Collins, 2016)
• Ready, Fire, Aim: Zero to $100 Million in No Time Flat by Michael Masterson (Michael Masterson, 2008)
• The Founder’s Dilemmas by Noam Wasserman (Princeton University Press, 2021)
• Work Rules! by Laszlo Bock (Hachette Book Group, 2015)
• Organizational Physics by Lex Sisney (Lulu.com, 2013)
• High Output Management by Andrew S. Grove (Vintage, 1995)
• Measure What Matters by John Doerr (Portfolio, 2018)

It’s important to understand the circumstances in which a strong team is necessary and under what conditions you can sell your business despite high concentrations of risk in your team. It’s also essential to prioritize the actions you can take and the degree to which buyers see value in those actions. Understanding the high-level picture will help you prioritize your actions and determine to what degree you should attempt to reduce the risk and whether expanding this effort is worth the lost opportunity cost to you. 

Your employees are one of the two most important assets of your business – the other being your customers.

Staff Concentration and Dependencies

Aside from customer concentration, concentration in key employees is perhaps the most common area of concern for buyers and is one of the most prevalent areas of risk in mid-sized businesses. The smaller the business, the more likely this will be a concern. 

How much staff concentration will buyers tolerate? The degree to which this is a concern depends on the two primary types of buyers and can be broken down as follows:

1. Financial Buyers: Most financial buyers only acquire businesses that have a management team in place that can continue to run the business post-closing. If your business is heavily dependent on you, and you aren’t willing to remain with the business after the sale, it’s unlikely you’ll be able to sell your business to a financial buyer. The primary exception will be financial buyers who are planning to hire a CEO to replace you or financial buyers who own a portfolio company in your industry and plan to integrate your company with their platform company. In these cases, they won’t be as dependent on your key employees.
2. Strategic Buyers and Direct Competitors: Selling to a strategic buyer or competitor is the simplest method for reducing the risk associated with staff concentration. But the degree to which this risk is mitigated depends on the extent to which the buyer will integrate your business and products with their own. If the buyer plans to operate your business as a stand-alone entity post-closing, a management team will need to be in place to run it for the buyer after the closing. On the other hand, a concentration in responsibilities is unlikely to be considered an issue if the buyer plans to fold your product or services into their existing product suite, close your facility, or eliminate duplicate functions such as accounting, HR, and legal.

Methods for Reducing Staff Concentration Risk

Reducing your staff concentration risk can be further broken down into the following strategies:

• Distribute Responsibilities: Evenly distribute responsibilities among your team, so your business isn’t dependent on any one individual – avoid high concentrations of duties in any one employee, including yourself.
• Distribute Authority: Evenly distribute decision-making authority within your firm. Make sure authority isn’t highly concentrated in any one person.
• Build an Independent Team: Build a management team capable of developing and executing their own strategy and goals with the authority to make their own decisions. 
• Implement a Retention Plan: Develop and implement a retention plan to retain your key employees after the closing. The retention plan can consist of a cash bonus or equity incentives, such as phantom equity. 
• Sign Agreements With Key People: Ensure you have signed employment contracts with your key people that include non-disclosure, non-compete, and non-solicitation clauses.
• Eliminate Personal Relationships: Reduce or eliminate personal relationships you have with customers and delegate relationship-building evenly across your staff. Handle this transition process with care so customer relationships with your company remain strong, while still removing yourself from the equation. 
• Build Trust Through Timely Disclosure: Reassure your team that the transition provides an opportunity for them due to a potential increase in benefits or salary. Reinforce the role and value of the retention bonus. 

New Employees

Avoid hiring new employees for roles that have a steep learning curve or for roles that don’t offer an immediate return, such as sales positions. Such hires can reduce your EBITDA, which will decrease the value of your business. If you’re going to fill a new position that has a steep learning curve or a C-level position you haven’t hired for before, be sure to do so well in advance of the sale to avoid a drain on cash flow in the years running up to a sale.

Employee Compensation

Ensure all employee compensation and benefits are at current market levels. This also goes for any family members working in the business. Employee compensation above or below current market levels can turn off potential buyers and will need to be normalized to market levels, which has the potential to reduce the value of your business. While a buyer can make this adjustment to your financial statements, the fact that compensation is not at current market levels will likely bring up other questions that likewise raise the buyer’s antennae.

Employee Manual

Prepare an employee manual or handbook. Employees are a vital asset of any business. An employee manual or handbook projects a positive image to buyers that your business is well-run. Such documents set clear expectations and boundaries with employees, improve the ability to manage operations, and facilitate a smooth transition. This reduces perceived risk for the buyer and enhances the attractiveness of your business in a buyer’s eyes.

Family

Replace or reduce the involvement of any family members who work in your business. If you believe family members won’t stay on after the sale, replace them before you put your company on the market. The fewer family members working in your business, the better. Buyers get nervous about buying a business in which a lot of family members are working because they must often be replaced, or they may team up to form a coup if they disagree with any decisions being made in the business. Either way, the presence of family members in a business is risky to any savvy buyer. 

If it’s impractical to phase them out of the business, you should formalize their roles and compensation and pay them a market-rate wage and benefits. This simplifies the process of replacing any family members for your business because the buyer will know how many hours they’ve worked and an approximate replacement salary. Again, the fewer the unknowns for the buyer, the better.

Regardless, you must realize that the more family members working in your business, the more risk a buyer will perceive. For example, if you have four to five family members working in your business, some buyers will discount the value of your company by up to 20% to 40%. At a $20 million valuation, this means you’ll put $4 to $8 million less in your pocket at the closing table. Unless you love your in-laws more than 100 pounds in hundred-dollar bills (assuming a $5 million discount – one million dollars weighs 22 pounds), I recommend you begin phasing them out. On the other hand, if you do love your family, then rewarding them with a golden parachute, or perhaps 20 pounds in hundred dollar bills each, may be the wisest and most thoughtful course of action. If you really want to have fun, try giving your entire family a $1 million bonus in single dollar bills, but rent a U-Haul first because the load will weigh in at a whopping 2,204 pounds.

Employment Agreements

Make sure your employment agreements address ownership of intellectual property, and the notice period required when resigning. It would also be wise to inform your corporate attorney about your plans and ask them to review your employment agreements to make sure there are no unresolved issues that need to be addressed. While your employment agreements terminate at the closing if your transaction is structured as an asset sale, there are still potential ramifications of a poorly worded employment agreement, so it’s best to consult with your attorney to make sure no such issues exist. 

Action Steps

• Management Team: Focus on building a strong management team with evenly distributed responsibilities.
• Staff Concentration: Implement the following strategies to reduce staff concentration:
  • Evenly distribute responsibilities and decision-making authority among your team, so your business isn’t dependent on you or any one individual.
  • Build a management team capable of developing and executing their own strategies and goals, with the authority to make their own decisions. Only hire experienced people with a demonstrated history of achieving results.
  • Develop and implement a retention plan to retain your key employees after the closing. 
  • Ensure you have signed employment and other major contracts with your key people to address issues of confidentiality, non-compete, and non-solicitation.
  • Reduce or eliminate any personal relationships you have with customers and delegate relationship-building evenly across your staff.
• New Hires: Avoid hiring new employees for roles with a steep learning curve or for roles that don’t offer an immediate return, such as sales positions.
• Employee Compensation: Ensure all employee compensation is at current market levels. 
• Employee Manual: Prepare an employee manual or handbook.
• Family: Replace or reduce the involvement of family members who won’t be staying with the business after the closing. Formalize the role of all family members and pay them a market-rate salary. 
• Tenure: Address any problems with employee turnover well before you begin the sales process.
• Agreements: Make sure your employment agreements address ownership of intellectual property and the notice period required when resigning. 

While legal issues generally aren’t an opportunity to create value, they do present an opportunity to reduce perceived risk for the buyer. When maximizing your business’s value, ask your attorney to identify any legal issues that need to be cleared up before you begin the sales process. In most cases, legal issues take time to resolve, so start this as early as possible. The following section outlines an overview of the most common legal issues.

UCC Search

Perform a Uniform Commercial Code (UCC) search to make sure there are no existing liens on your business before you go to market. Existing liens can lead to delayed closings, which can lead to a host of other problems. When selling your business, speed is key to ensure you maximize price. If you do have existing liens, clear them prior to putting your business on the market to ensure a smooth and uneventful closing.

Entity

Ensure your entity is up to date. Not doing so can delay the closing. I’ve been involved in transactions in which the seller’s entity was not up to date, and the closing was delayed by several weeks or more. Again, if the closing is delayed, this is an opportunity for the buyer to dig up additional problems or even change their mind about the transaction. This may also cause the buyer to doubt the accuracy of your recordkeeping, and they may dig deeper into issues they previously weren’t concerned with.

Intellectual Property

Document any intellectual property included in the sale and gather the necessary paperwork to assist with the transfer. This can consist of trade secrets, proprietary products or services, trademarks, patents, and any other registered and unregistered intellectual property. If your employees or other contractors assisted in creating the intellectual property, make sure you have signed invention assignment creation agreements on hand. Many issues regarding intellectual property can take a significant amount of time to clear up, so it’s best to resolve these issues as soon as possible before you begin the sales process.

Litigation

Resolve any pending litigation, other legal matters, or even threats of litigation before you put your business on the market. Even though you might offer to take full legal and financial responsibility for any negative consequences, many potential buyers will pull back, fearing the unknown – including how lawsuits and other disputes may affect the public image of your business. In short, if you can’t reach a settlement before you go to market, the salability of even a well-run, profitable business will be stalled, if not impossible to conclude. Alternatively, if the litigation is frivolous or for a small amount, obtain a letter of opinion from your attorney to present to potential buyers, and be prepared to hold back a portion of the purchase price in escrow.

Action Steps

• UCC Search: Perform a UCC search to identify any outstanding liens on your business. If any exist, clear them up prior to putting your business on the market.
• Entity: Ensure your entity is up to date.
• Intellectual Property: Document any intellectual property included in the sale and gather the necessary paperwork to assist with the transfer. Ensure you have invention assignment creation agreements with your employees.
• Litigation: Resolve any pending litigation or other legal matters – or even threats of litigation – as soon as possible before you put your business on the market. 

Customers are a key asset of any business. Buyers consider several aspects of your customer base and metrics when evaluating your business as an acquisition opportunity. These factors can either add a tremendous amount of value to your business or serve to destroy value. 

Customer Base

Consider how diversified your customer base is. Your customer base should consist of not just early adopters but also late adopters. For example, many software companies make fast progress initially as they sell to early adopters willing to take a risk on unproven software, but progress stalls once they’ve exhausted the supply of early adopters. Ideally, your business should have a balance of early adopters, the early majority, the late majority, and a handful of laggards. 

Of course, small innovative companies’ customer bases will consist primarily of early adopters and the early majority. But the more diverse your customer base, the better. Diversity in your customer base signals to the buyer that you’re obtaining strong traction with your customers and that you have a sound product fit.

If you have a business-to-business (B2B) company, seek to establish customer relationships with large, established companies. The more established your customers, the better. If there’s a strong product fit between your customer base and the buyer’s product line, it may be a prudent investment for the buyer to acquire your company solely for the value of your customer base, especially if time and lost opportunity costs are critical factors in your industry.

Customer Concentration

Customer concentration occurs when a small number of customers generate a significant percentage of your business’s revenues. Here are examples of how the amount of customer concentration is often expressed:

• The top customer generates 57% of the business’s total revenue.
• The top 3 customers generate 27% of the business’s total revenue.
• The top 5 customers generate 42% of the business’s total revenue.
• The top 10 customers generate 3% of the business’s total revenue.

The higher the customer concentration in your business, the more risk this presents to the buyer. On the other hand, the greater your customer diversity, the less risk a buyer will perceive. In extreme circumstances, I’ve encountered businesses that couldn’t be sold due to high levels of customer concentration. 

How much customer concentration will buyers tolerate?

Some buyers will tolerate customer concentration as high as 20% to 30%, but they may expect certain deal-protective measures in the purchase agreement, such as escrows or earnouts, or a reduction in the purchase price to offset the increased risk. If you have customer concentration above 30% to 50%, your business may be unsalable unless you’re willing to agree to a transaction structure that offers the buyer numerous protections in the event one of your customers leaves shortly after the closing. 

While the exact figure depends on the industry, customer concentration generally becomes a concern once a single customer generates more than 5% to 10% of your revenue. If the concentration level is below 5%, many buyers won’t question the relationships at all. If it’s between 5% to 10%, many buyers will begin to probe deeper and may start to consider measures designed to reduce the risk from customer concentration. If one customer generates more than 10% of your revenue, expect to agree to protective measures in the purchase agreement or be prepared to reduce the purchase price to offset this increased risk. 

Customers are a key asset of any business. Buyers consider several aspects of your customer base and metrics when evaluating your business as an acquisition opportunity.

Develop strategies for mitigating customer concentration risk before you go to market, if you can, such as asking your largest customers to sign long-term contracts in exchange for discounts. There are methods for mitigating this risk to the buyer that generally fall into one of two categories: 

1. Actions Before the Sale: These include asking the customer to sign a long-term agreement and “institutionalizing” the client – that is, reducing the personal relationships you have with any customers. 
2. Deal Structure Mechanisms: These include methods to assess the risk, such as customer surveys and interviews during due diligence, and mechanisms designed to reduce risk if a customer is lost, such as earnouts, holdbacks, or other contingent payments.

There are several specific methods for addressing customer concentration risk:

• Reduce Customer Concentration: This method only works in the long term and involves diversifying your customer base so that no single customer generates more than 10% of your revenue. If you’re selling your business in the next year or two, this likely won’t be practical. For example, if one customer generates 50% of your revenue, focus on obtaining new customers by diversifying your customer base to reduce your dependency on that one customer. This obviously isn’t possible in most cases for the short term, but many businesses can diversify their customer base over time.
• Mitigate Customer Concentration Risks: This method involves instituting measures designed to reduce the risk of customer concentration to the buyer without actually reducing customer concentration and includes the following:
  • Long-Term Contracts: Ask your key customers to sign long-term contracts. Offer incentives in exchange for signing a long-term contract, such as grandfathered pricing or other sweeteners, such as free support, discounts, or other add-ons.
  • Institutionalization: Institutionalize your relationships with your customers. In other words, reduce the level of your personal involvement with the customers. If you have a strong personal relationship with a customer, slowly transition the relationship to some of your key employees who will remain with the business after the closing. But before doing this, make sure you have also implemented a retention plan with your key employees to ensure the customer relationship transitions smoothly to a buyer. If there’s a risk that your key employees won’t stay after the closing, then such a strategy is unlikely to reduce risk for the buyer.
  • Deal Protective Measures: Deal protective measures include escrows, earnouts, holdbacks, and other forms of contingent payments. You can’t act on these items prior to a sale, but you can be mentally prepared to accept such protective measures, or you can include specific proposals in your information memorandum that are designed to reduce the buyer’s risk. By proposing specific mechanisms for reducing risk, the buyer will feel you understand the risk inherent in your business, and they’ll feel comfortable you’re prepared to ensure your business is a wise investment. In most cases, an escrow, or holdback, is more appropriate for addressing customer concentration risks than an earnout and involves a portion of the purchase price being held in escrow by a third party. The amount held in escrow would then be released over time according to a schedule, assuming the customer is retained.

Customer Contracts

Customers are a key asset to your business, and it’s wise to document these relationships. Ask your attorney to prepare an agreement between you and your customers, even if there isn’t a term to the agreement. This facilitates a smoother transition by reducing a buyer’s uncertainties regarding the value of your customer relationships. 

If you already have customer agreements in place, ask your attorney to review them to ensure they’re transferable upon a sale. In many cases, customer agreements aren’t transferable. One common solution is to structure the transaction as a stock sale, but many buyers are unwilling to do this due to the possibility of contingent or unknown liabilities. 

Unfortunately, many third-party contracts include a “change of control provision” that prevents the contract from being assigned in the event of a change in control of your business. While you could structure the transaction as a stock sale, doing so would often be characterized as a change of control as defined under such a provision and would therefore require approval by the third party. One method for skirting change of control provisions is a “reverse-triangular merger,” but this topic is beyond the scope of this chapter. If you do decide to switch your customers to contracts, be sure to include a clause addressing assignability.

The greater your customer diversity, the less risk a buyer will view in your business. 

Customer Acquisition

How healthy are your customer acquisition metrics? Can your marketing methods be automated and scaled, or has your business depended too much on your personal selling, networking, or marketing efforts? 

Start tracking your customer metrics in a dashboard and strive to create marketing methods that can be automated and scaled. Limit the amount of personal selling you do unless you’ll stay with your business after the closing. Track the metrics for each marketing strategy in your dashboard so you can establish projections based on assumptions that are backed up by your data. 

Customer Sales Pipeline

Document your sales pipeline in your CRM so the buyer can more easily project your revenue. Keep track of your pipeline, along with relevant metrics that will enable the buyer to project future sales. If your pipeline is strong before the closing, you’re in a much better position to negotiate a high purchase price than if your customer sales pipeline is weak or undocumented.

Customer Metrics

Maintain a centralized dashboard with key customer metrics and monitor your metrics on a regular basis. Watch your customer acquisition cost, customer retention, lifetime value, and other key metrics. Then develop weekly sprints with your deal team to improve these metrics over time. Track your metrics on a weekly or monthly basis in a spreadsheet so you can spot trends that can be used as the basis for the buyer’s strategy moving forward.

For example, if your customer acquisition cost lowers to $900 from $1,000, and your customer lifetime value increases to $5,500 from $4,000, you can use these improved metrics in your projections and base the value of your company on these newer metrics, as opposed to the historical metrics. 

Documenting the assumptions in your projections allows you and your investment banker to more easily defend your asking price. Your projections are built on your assumptions – so documenting and tracking your key metrics lays a solid foundation for your projections.

Close Relationships

Reduce any personal relationships you have with your customer base. Some customers may believe the only way they can do business with your company is by doing business with you. In their minds, their relationship may be with you, not your company. When you leave, their business may leave. Minimize any personal relationships you have with customers by transferring these relationships to your staff to reduce this impact during the transition. 

Action Steps

Here are tips for maximizing the value of your business when it comes to your customer base and metrics:

• Customer Base: Build a sales infrastructure and a team that gives you the capability to acquire larger customers. Build a diverse customer base consisting of a critical mass of customers at various adoption stages of your business.
• Customer Concentration: Minimize customer concentration. Institutionalize customers that generate a significant percentage of your overall revenue and reduce your personal involvement in these relationships.
• Contracts: Ensure customer contracts are assignable in the event of a sale. Develop incentives to convert customers to long-term contracts, such as grandfathered pricing or free add-on modules.
• Customer Database: Build a robust customer database that contains detailed information on your customers that allows a buyer to develop scalable, targeted campaigns.
• Customer Acquisition: Track your customer metrics in a centralized dashboard, then track metrics for each new marketing strategy to be used as the assumptions for your projections.
• Customer Sales Pipeline: Document your pipeline in your CRM so a buyer can easily project your revenue.
• Customer Metrics: Build a centralized dashboard to track your key metrics. Prepare a backlog of projects designed to improve and track the improvement of your metrics over time to serve as the foundation for your financial projections.
• Close Relationships: Reduce any close relationships you have with customers.

You should invest a substantial amount of time to ensure your operations are running as smoothly as possible, which minimizes risk for the buyer. Here are several suggestions for doing just that.

Systems

Standardize, document, and systemize the primary processes in your business. Establish internal controls, create systems, and produce a short operations manual for all key procedures. Developing systems involves streamlining, automating, and documenting your processes. By documenting your key processes, you increase the chances of selling your business. 

Here are the major benefits of building systems in your business:

• Attract valuable employees to your company with well-documented processes and clear job descriptions. 
• Streamline the management of your business with well-documented processes.
• Increase the value of your company by having systems already in place.
• Improve the chances of maximizing your price by having detailed processes.
• Enhance the scalability of your business by documenting your processes.
• Simplify the integration process for the buyer by building systems.

Suppliers

Consider your supplier base and determine if you need to diversify. Buyers don’t want a key supplier to hold them hostage, so consider ways to reduce your dependency on any single supplier. Ask yourself the following: 

• How are my relationships with my suppliers? 
• How long have I worked with them? 
• How much leverage do my suppliers have over me? 

If you’re at all dependent on any one supplier, create a strategy for diversifying your supplier chain. This will likely involve shopping for backup suppliers and having them ready to go at a moment’s notice.

Online Presence

If you own a business-to-consumer (B2C) business, check your online presence to make sure you don’t have any poor reviews. If you do, work to clean them up or push them lower in the search results. Poor online reviews can be a deal killer for many businesses, especially B2C businesses or those that rely on a strong online presence. If an online presence is important to your business, make sure your online image is as pristine as possible before you go to market.

Premises

You know what they say about curb appeal. I’ve had several deals die over the years because the buyer’s first impression wasn’t positive. Unfortunately, it’s difficult to change someone’s first impression. Don’t let this happen to you. Implement cosmetic enhancements to help increase your business’s value. Perform quick and easy improvements, such as cleaning up the physical space and improving online reviews. You may also consider hiring a commercial interior designer to do a light makeover of your business, but keep it simple and practical. A pretentious facility sends the wrong message to buyers. You want to convey a clean, trustworthy corporate image.

Real Estate

If you own the real estate your business occupies, ensure the real estate is owned by a separate legal entity (the “Real Estate Entity”) from your business (the “Business Entity”). Your Business Entity should pay the going market rate to your Real Estate Entity to rent the premises. This ensures your financials are representative and allows your business to be valued independently from the real estate. You should also have a draft lease prepared that’s based on current market conditions. Sign the lease and conduct business as if you were working with a third-party landlord. You should only run real-estate-related expenses through your business that the buyer would continue to pay. This will simplify the process of valuing your business because business valuations are performed independently of the value of the real property, and the rental rate and terms must be adjusted to current market rates.

If you’d like to lease your real estate to the buyer instead of selling it, retain a commercial real estate appraiser or broker to perform a comparables analysis to determine an appropriate rental amount and terms. Hold onto this documentation so you can provide it to buyers to substantiate the amount you’re asking.

Invest a substantial amount of time to ensure your operations are running as smoothly as possible, which minimizes risk for the buyer. 

The Lease

Informing your landlord early carries the benefit of allowing you to pre-negotiate the terms of the transfer, in some instances. Landlords are accustomed to businesses being bought and sold, so the news is unlikely to shock them. Your landlord may also potentially have a buyer in mind. 

But landlords can be opportunistic and difficult to predict. Buyers like options, so don’t sign or renew a long-term lease if you think a buyer may consider relocating your business. On the other hand, buyers also like stability, especially if your location is important. The best of both worlds is a lease that contains options to renew that are assignable. This gives both you and the buyer stability and flexibility. Still, there are downsides. Options to renew aren’t always assignable and don’t usually specify the amount of rent. 

Regardless, pre-negotiate an option to renew your existing lease if you can. If the location is vital to your business, the buyer will feel more comfortable if a long lease term is guaranteed in the form of an option to renew, even if the amount isn’t specified. Buyers are uncomfortable with verbal assurances, so be sure to get an option to renew in writing. You may consider talking to your landlord to obtain this option prior to selling your business, but make sure the option is assignable.

Finally, ensure the landlord is willing to renew your lease on favorable terms and that they won’t opportunistically ask for a higher rate. I recommend taking the assumptive close when you’re asking the landlord about the qualifications for a new tenant. You can say something to the effect of, “I assume the same terms I’m under now will apply.” If the terms were to change, your landlord will likely let you know. If there will be material changes to your lease terms, your M&A advisor should know this so they can indicate these terms in the confidential information memorandum (CIM) and not surprise the buyer with a change in lease terms later in the transaction.

Inventory

Your inventory is also a key asset of your business and will be examined by buyers during the sales process. The following are suggestions for ensuring there are no problems related to your inventory:

Purge Your Inventory

Liquidate any old, unusable, or unsalable inventory. You’re unlikely to get paid for it, so liquidate it now. Stale inventory includes obsolete, out-of-favor, or overpriced items that can deter buyers, so purge your inventory before you put your business on the market. Doing this also simplifies the inventory count at the closing and helps tidy up your facilities. 

Prepare an Inventory List

Compile a preliminary list of inventory that will be included in the sale. This helps eliminate last-minute surprises, such as underestimating the amount of inventory and, therefore, the value of the working capital that’s included in the purchase price.

Equipment

A similar rule to inventory applies to equipment. Here are my suggestions for addressing any potential issues related to your equipment. 

Prepare an Equipment List

Prepare a list of all hard assets included in the sale, including furniture, fixtures, equipment, leasehold improvements, vehicles, and any other hard assets that will be included in the purchase price. Keep the list in an easy-to-update format. There’s no need to include values for each piece of equipment. In fact, this can work against you because the buyer can dispute the individual values of each piece of equipment or argue that the purchase price should be allocated to the equipment based on your estimated values.

Perform an Inspection 

Hire a third party to perform a preliminary equipment inspection to ensure all equipment is in proper working order. Repair equipment that isn’t working properly or liquidate it if you no longer need it. This reduces any concerns a buyer may have regarding the condition of your business’s physical assets. Keep a copy of the equipment inspection report to show to potential buyers during the sale process.

Purge Your Equipment 

Liquidate or sell any equipment that’s inoperable, outdated, or that you don’t use in your business. Repair or replace broken equipment. Remove any assets from your premises that are excluded from the sale, such as the basketball you have on your desk that’s signed by Michael Jordan, or the Persian rug in your office that’s been in your family for generations. If the buyer sees them, they’ll assume these assets are included, so it’s best for the buyer to never see these assets in the first place.

Equipment Leases

Consider paying off any equipment leases, but do the math first. This is a financial decision requiring developing a financial model to determine if it makes sense to keep the leases and have the new buyer assume them or to pay off the leases at closing. Deciding to pay off your equipment leases before selling your business is primarily a mathematical decision with one unknown variable – the multiple. Here’s an example to illustrate the math behind the decision.

• Example:
  • EBITDA = $4 million
  • Multiple = 5.0
  • Business value = $20 million
  • Equipment lease payment = $50,000 per month
  • Paying off the lease will save the buyer $600,000 per year ($50,000 per month x 12 = $600,000 per year).
  • EBITDA will increase to $4.6 million from $4 million if the lease is paid off.
  • The value of the business will increase to $23 million if the lease is paid off.
  • The difference between the two business values is $3 million.
• Conclusion:
  • If the payoff is less than $3 million, it’s worth considering paying off the lease.
  • The example above assumes the multiple will be 5.0. If the multiple changes, so will the formula. 
  • Don’t pay off your equipment lease until closing. You don’t want to pay off the lease and then not sell your business. Instead, inform the buyer that you’ll pay off the lease out of the proceeds at the closing.
  • Consult your CPA to take the tax implications into consideration.

The bottom line is that if paying off your equipment leases will increase the value of your business by more than the current payoff of your leases, it makes sense to pay them off. The reverse is also true – it doesn’t make sense to pay off the lease if paying off your equipment leases will increase the value of your business by less than the current payoff amount.

Action Steps

• Systems: Standardize, document, and systemize the primary processes in your business. Develop internal controls and systems and draft a short operations manual for all key procedures.
• Suppliers: Diversify your supplier base if you’re dependent on any one supplier.
• Online Presence: Work to improve your online presence if you own a B2C business, especially if you have any negative reviews online.
• Branding: Prepare a list of any positive mentions of your company that you can present to the buyer.
• Premises: Perform quick and easy improvements, such as cleaning up the physical space or hiring an interior designer to do a low-cost makeover of your premises.
• Real Estate: If you own the real estate, ensure the real estate is owned by a legal entity separate from your business and pay the going market rate to the “Real Estate Entity” to rent the premises. 
• Lease: Don’t sign or renew a long-term lease if you think a buyer may want to relocate your business. Pre-negotiate an option to renew your existing lease. Contact the landlord early and ask about their financial and experience requirements for approving a new tenant and ensure the landlord is willing to renew your lease on the current terms.
• Inventory: Prepare an inventory list and liquidate any obsolete inventory.
• Equipment: Prepare an equipment list and remove any equipment you don’t use. Have the remaining equipment inspected to ensure it works properly. Finally, consider paying off equipment leases.

Most buyers will ask why you’re selling when you’re at a supposed inflection point in your business. Your answer will either strengthen or destroy your positioning. The solution is to prepare a short plan that outlines the growth potential of your business. Highlight the major ways you can grow your business and include a short, bulleted list for each growth opportunity. Ideally, you should begin executing your growth plan before putting your business on the market, so you can establish assumptions that can be used in your plan. Having real-world data to back up your assumptions will give you and your plan much more credibility. 

You should also prepare a set of simplified financial projections. Here are some guidelines to keep in mind when preparing your projections:

• Don’t lump all revenue streams together. Break revenue down by product and service type.
• Include three sets of assumptions – low, medium, and high. 
• Av0id so-called hockey stick business plans – scenarios that show steep increases following periods of flat performances. These will diminish your credibility. 
• Prepare your financial projections in a spreadsheet, so the buyer can play with the numbers to determine the impact of any potential changes in the variables and perform a sensitivity analysis. 
• Provide backup documentation for each key assumption. To do that, consider the following questions:
  • What’s the basis for forecasting each source of revenue? 
  • What’s the basis for forecasting costs? Are they based on a percentage of revenue, fixed costs subject to inflation, or something else? 
  • What are the assumptions behind capital expenditures over the coming years?

Action Steps

• Prepare a brief plan that outlines the potential growth opportunities in your business. Highlight the major ways a buyer can grow your business and include a short, bulleted list for each growth opportunity. Outline your assumptions and back them up with data.
• Prepare financial projections. Here’s how:
  • Separate revenue streams.
  • Include three sets of assumptions – low, medium, and high.
  • Document and provide backup documentation for each key assumption.

All business valuations are based on some measure of your business’s financial metrics. It’s wise to ensure your metrics are as healthy as possible before you begin the sale process. Doing so will make your business appear more attractive to potential buyers, no matter the buyer type.

Increase Profitability

The fastest way to improve the value of your business is to increase its EBITDA. Changes that don’t improve EBITDA have a less significant impact on your valuation than changes that immediately improve your EBITDA. One of the most effective methods for increasing profitability is to increase prices. One hundred percent of a price increase leads to an increase in EBITDA – minus direct costs, such as sales commissions. 

For example, suppose your business generates $10 million in revenue and $2 million in EBITDA and is valued at a 5.0 multiple, or $10 million. If you increase prices by 10%, your new EBITDA will be $3 million, and the value of your business will be $15 million ($3 million EBITDA x 5.0 = $15 million). In this case, a 10% price increase will result in a 50% ($5 million) increase in the value of your company. 

Test the elasticity of your pricing to determine the right pricing for your products and services. The entirety of a price increase falls to the bottom line, less any direct costs such as sales commissions, and an increase in profitability can dramatically improve the value of your business. 

Increase Revenue

Buyers look for businesses that have stable, upward trends. If revenue is increasing, buyers assume this trend will continue. If revenue is decreasing or inconsistent, buyers also assume the trend will continue and will view your business as risky. It’s best to sell your business when revenue is stable or growing. If your revenue is decreasing, create a plan and work to turn the trend around so you can reduce the perceived risk of your business to the buyer. If income is inconsistent, stabilize your revenue to ensure consistency from year to year. If you can’t turn the trend around, identify additional ways to increase sales and show these potential improvements to a buyer. At a minimum, you should prepare a plan and start implementing it. Progress on the plan will help inspire confidence in the buyer that the trend can be turned around.

Increase Recurring Revenue

If your business has recurring revenue, set up a dashboard to track metrics that impact recurring revenue, such as customer retention, customer churn, lifetime value (LTV), customer acquisition cost, months to recover customer acquisition cost, customer engagement, and leads by lifecycle. The majority of your key metrics will have an effect on your recurring revenue, either directly or indirectly, and tracking these metrics allows you to spot leaks in your funnel and plug them. Doing this also allows the buyer to understand how your business operates and the potential improvements they can make to increase the amount of recurring revenue.

Increase or Stabilize Margins

Buyers become concerned if gross margins have recently declined in your business. If this is the case, work to increase or stabilize them. Decreasing gross margins may indicate increased competition or an increase in your cost structure. If gross margins are decreasing, consider shifting revenue to a more profitable product line or develop a plan to stabilize them.

Capital Expenditures

Capital expenditures, or CapEx for short, are investments made in capital equipment and other fixed assets. Capital equipment is depreciated because it’s expected to have a useful life longer than 12 months. While depreciation is added back when calculating EBITDA, some buyers subtract a reserve for capital expenditures when valuing your business. A low CapEx makes your business more attractive to most buyers. Carefully track your capital expenditures for five years prior to a sale, and be as frugal as possible with any capital investments you make in your business. 

Reduce Expenses

Another effective method for increasing EBITDA is to reduce expenses. You should pinch every penny for two to three years prior to your planned exit to help maximize EBITDA. For every dollar in expenses you cut, not only will you save that dollar, but you’ll also receive a multiple of that total at the closing table based on the multiple you receive when you sell your business. 

If you cut expenses by $500,000 for two years before the sale and the sale process takes one year, for a total of three years, you’ll put an additional $3.5 million to $4 million in your pocket – $500,000 (year 1) + $500,000 (year 2) + $500,000 (year 3) + $2,000,000 to $2,500,000 (increased purchase price). 

Avoid making any large investments in your business, such as creating new products or services, or rolling out new sales or marketing campaigns that are high risk or that require significant up-front investments. These investments decrease profitability in the short term, which decreases the value of your business. If you do make a large investment, organize all expenses related to the investment under a separate chart or account so you can adjust these expenses in your financials when calculating EBITDA. Another option is to stick to low-risk strategies for increasing your profitability. 

As a general rule, you shouldn’t purchase new equipment or other hard assets when you’re in the process of selling your business unless it immediately increases your EBITDA. Why? Because you’re unlikely to recoup your investment. Buyers value businesses based on the EBITDA they generate. If the new equipment doesn’t increase your EBITDA, it likely won’t pay for itself. Most buyers in the middle market reduce their decision to a financial model, but these financial models don’t usually take into consideration the value of any new equipment in your business.

While the buyer may appreciate your investment in new equipment, they’re unlikely to assign enough value to it to justify your purchase. If the buyer is considering two similar businesses at the outset, the age and condition of the equipment will be one of dozens of factors they may take into consideration. Your business’s EBITDA will outshine most other factors, so make it your first priority. 

To illustrate this point, here’s a breakdown of the process of selling a business into two main steps: 

Step 1 – Attracting Buyers: This first step involves confidentially marketing your business for sale and responding to buyers who request additional information on your business. At the outset, buyers consider a limited amount of criteria when initially evaluating your business. At this stage, the main thing they look at is profitability. Few will consider the investments you’ve made in new equipment or other capital assets at this point in the transaction. In other words, investing in new equipment is unlikely to produce a higher response to your initial outreach. In this first step, those early criteria – your multiple, competitive advantage, and growth rate – are far more important to the buyer than your equipment or capital assets.

Step 2 – Convincing Buyers: After you’ve attracted a buyer and they’ve responded, you must now convince them to buy. The buyer will now consider a broader range of criteria once they’re inspecting your business more closely. This criteria may now include the current condition of your equipment. If a buyer doesn’t make it to this second step, your investment in new equipment is moot.

Most buyers’ main criteria is the cash flow, or EBITDA, your business generates. After all, buyers purchase businesses to make money, so their primary interest in buying a business is how much money a business makes. Anything you can do to increase EBITDA will have the greatest impact on the salability and value of your business. As a result, you should generally only buy new equipment if it immediately increases your EBITDA.

There are two scenarios in which an investment in equipment can increase your EBITDA:

1. Increases Your Revenue: If the equipment or investment immediately increases your revenue, it may be a wise investment. This won’t be true in most cases, so it’s usually best to delay purchasing new equipment.
2. Decreases Your Expenses: If the investment immediately reduces labor or other costs, it may be a wise investment. If the investment will increase the value of your business by more than the initial cost, the investment may be justified. To calculate how much the investment will increase the value of your business, simply multiply how much the equipment will reduce your labor costs by, then apply your multiple. For example, if the investment will reduce labor costs by $100,000 per year, and your multiple is 5.0, then the equipment will increase the value of your business by $500,000.

For example, let’s say you own a manufacturing plant and purchasing a new piece of equipment is estimated to improve productivity by 5%, which will reduce your payroll by $100,000 per year. Because of the new equipment, you may be able to receive an additional $500,000 for your business, assuming it sells for a 5.0 multiple ($100,000 increase in EBITDA x 5.0 = $500,000). Most buyers won’t be willing to pay you for 100% of the savings until they’re proven, so it’s best to assume you will only receive a portion of the credit for the savings. In this case, I wouldn’t recommend purchasing the piece of equipment unless it costs significantly less than $500,000 due to the risks involved in doing so. To find out, perform a calculation to see if the investment and the resulting increase in cash flow will have a positive ROI for you. 

If a new piece of equipment would simply be nice to have, or if it represents a new product or service line you could potentially pursue, I recommend holding off on the investment. Point out the opportunity to the buyer and let them decide if this is something they want to pursue and let them make the investment instead.

Reduce Working Capital

Most transactions in the middle market include working capital as a component of the purchase price. Working capital is calculated as accounts receivable, inventory, and prepaid expenses, minus accounts payable, short-term debt, and accrued expenses. 

Working capital is viewed by sophisticated investors as an asset that should be included in the purchase price. If you must keep a certain amount of working capital in your business, this is no different than any other piece of equipment, since the working capital must remain in your business as long as your business is operating. For example, if your business is valued at $5 million and it requires $500,000 in working capital to operate, most buyers will request that $500,000 in working capital be included in the purchase price. 

Which business would you rather buy?

• Business A: Asking $14.0 million + $1 million required in working capital. Total investment = $15 million. Generates $3 million in EBITDA. Effective multiple is 5.0 ($15 million / $3 million = 5.0). The return on investment is 20%.
• Business B: Asking $14.0 million + $4 million required in working capital. Generates $3 million in EBITDA. Effective multiple is 6.0 ($18 million / $3 million = 6.0). The return on investment is 16.6%.

All things being equal, nearly every buyer would rather purchase Business A because it generates a higher return on the investment due to its lower working capital requirement. Therefore, if you want to maximize your proceeds, minimize the amount of working capital required to operate your business. You can generally do this by keeping your accounts receivable and inventory levels as lean as possible. 

The two main components of working capital are as follows:

Component 1: Accounts Receivable

Because accounts receivable is included in the calculation of working capital, you can put more money in your pocket if you reduce your normal operating level of accounts receivable for at least 12 months prior to the closing. The primary method for reducing accounts receivable is to reduce the average number of days your accounts receivable are outstanding. 

Other tactics include: 

• Writing off any bad debts that are old and uncollectible.
• Invoicing customers in a timely manner.
• Giving discounts to customers who pay early.

Also, if you consistently have late-paying customers, consider developing new collection procedures.

You should also formalize the terms you offer to customers. Businesses that offer terms to their customers are less desirable to buyers than businesses that don’t. Why? Businesses that offer terms have a longer cash conversion cycle and need more cash to grow the business. The shorter the cash flow cycle, the more desirable the business is because less working capital is necessary to scale it. Businesses with a long cash flow cycle require more working capital, and sophisticated buyers include the amount of working capital required to operate the business when calculating their return on investment.

Component 2: Inventory

In addition to accounts receivable, inventory is also included in the purchase price for mid-sized companies. By reducing the normal operating level of inventory in your business, you also have the potential to increase your net proceeds. The primary method for reducing inventory is by increasing your inventory turnover rate and moving to a lean, just-in-time system.

Inventory amounts vary from business to business, and changes in the value of inventory that’s included in the purchase price can significantly impact your net proceeds. Buyers consider any investments they must make in inventory when calculating their potential returns. If you have surplus inventory, look for creative ways to reduce it without impacting revenue, if that’s possible. 

Which of the following two businesses would you rather buy?

• Business A: Asking $4 million + $100,000 in inventory. Generates $1 million in EBITDA. The effective multiple is 4.0. The return on investment is 24.39%.
• Business B: Asking $4 million + $2 million in inventory. Generates $1 million in EBITDA. The effective multiple is 6.0. The return on investment is 16.66%.

Clearly, Business A is a more attractive investment because it requires less inventory to operate, and therefore generates a higher return on the capital invested. If you can, reduce the level of operating inventory necessary to operate your business prior to the sale.

Because you must include working capital in the purchase price of your business, it makes sense to reduce it as much as possible prior to the sale. For every dollar you decrease your working capital before the sale, you’ll put an extra dollar in your pocket at closing time. But the changes you implement to reduce working capital must be sustainable in the long term.

The fastest way to improve the value of your business is to increase its profitability. 

Action Steps

• Increase Profitability: Focus on maximizing cash flow over other value drivers.
• Increase Revenue: Focus on stabilizing or increasing revenue at least three years before beginning the sales process. Revenue should be on an upward trend prior to the sale. Consider increasing pricing to maximize revenue, which is the easiest way to increase sales.
• Increase Recurring Revenue: Track your key metrics that affect recurring revenue and work to improve them over time.
• Improve Margins: Stabilize or increase gross margins before the sale if they have decreased recently.
• Cash Flow Cycle: Track your cash flow cycle and implement methods to reduce the total number of days of your cash flow cycle.
• Capital Expenditures: Track your capital expenditures for five years prior to the sale and limit any capital investments you make in your business.
• Decrease Expenses: Pinch every penny for two to three years before the sale to maximize EBITDA. Avoid incurring any discretionary expenses.
• Decrease Working Capital: Focus on reducing the working capital requirements of your business by lowering normal operating levels of accounts receivable and inventory.

The more easily a buyer can replicate what your business has to offer, the lower the price they’ll be willing to pay. If you create a business that’s difficult for the buyer to replicate, you’re more likely to receive top price. To do this, develop the aspects of your business that are difficult for buyers to reproduce, such as strong relationships with customers, trade secrets, proprietary processes, long-term customer contracts, and patents. Next, I’ll describe the main aspects of your business model that you can improve to enhance the desirability of your business and, therefore, its value.

Branding

You know how good your company is, but will your buyer? When selling your business, it’s essential to communicate to buyers what makes your business special. To do this, organize and have on hand any customer testimonials, credible customer lists, case studies, awards, or any other recognition your company has received, including any involvement your company has had in community programs. Having this information organized and easily accessible offers demonstrable proof from third parties that your value proposition is attractive to customers in the real world and helps convince buyers that your business represents a sound investment.

Competitive Edge

Buyers are in the market for a business with a competitive advantage that’s sustainable and difficult to replicate. For this reason, you should consider how your business is different from its competitors. If your business has low barriers to entry and is a “me too” product or service, the lack of a competitive advantage may turn many buyers off, especially if they feel they can easily replicate your business. Personal relationships aren’t a competitive advantage, while proprietary technology, as well as economies of scale and brand recognition, can be. A competitive advantage should be summarized in an objective statement and should be difficult for competitors to replicate. The stronger your competitive advantage, the more your business will be worth.

Scalability

Buyers also look for a business that’s scalable and has the potential to grow quickly. Financial buyers love a business that has infrastructure in place but whose full potential hasn’t been tapped. This scenario usually involves an owner who’s burned out or hasn’t built effective sales and marketing systems, but has operational systems in place that allow the business to quickly scale once sales and marketing are ramped up. 

If you want to sell your business for the maximum amount possible, focus on building a business that’s scalable. You do so by developing systems, processes, and documentation that can remain stable as your business experiences rapid growth. If you lack experience building scalable systems, consider consulting with an expert who’s familiar with the most commonly used systems and software in your industry. Alternatively, consider hiring a COO to help you build a management team and infrastructure that improves your business’s scalability. Doing this will dramatically improve the value of your business.

Product Concentration

Product concentration is the degree to which your business is dependent on a specific product or service. For example, if you own a manufacturing firm and 90% of your revenue is generated from manufacturing one product, your business is considered to have high product concentration. 

How much product concentration will buyers tolerate?

Generally speaking, high product concentration isn’t a concern for most buyers. Buyers are much less concerned with product concentration than they are with customer or staff concentration. 

When Product Concentration Is a Problem

Whereas customer concentration can be boiled down to a certain number that buyers may be willing to tolerate – let’s say more than 20%, for example – the degree to which buyers will tolerate product concentration varies depending on the business and industry. The risk of product concentration is considered on a collective basis and can’t be boiled down to a specific number. The buyer will assess the risk associated with product concentration based on the underlying risks of your product. What’s the typical lifespan of a product in your category? How susceptible is your product or service to obsolescence or innovative solutions? 

Product concentration is considered a risk in industries that have a high degree of innovation and new product development, or if your product is susceptible to technological obsolescence – in other words, if a new product is likely to outseat your existing product. 

I sell many businesses in which 100% of the revenue is generated from one product or service. In most cases, this isn’t considered an issue by the buyer. At the same time, I’ve encountered online businesses in which a single product generated over 50% of revenue and that one item was marketed solely through one channel, such as Amazon. In this case, high product concentration made the business unsalable. 

Mitigating Product Concentration Risk

Product concentration risk can be reduced if your buyer plans to integrate your product into a wider suite of their existing products. In most acquisitions, buyers often plan to add your product to their existing product line and distribution network, which can result in increased revenues. This enhances their existing customer relationships since they can offer a wider suite of products. It also simplifies operations for the end-user as they have fewer relationships to maintain. Additionally, this can serve as a vehicle for the buyer to establish new relationships by opening doors to new customers who have a need for your product. Collectively, a situation like this changes the buyer’s perspective from one of mitigating risk to one of capitalizing on opportunity. By focusing on opportunity, you take the buyer’s focus off risk. 

Regardless, every business is unique. It’s the big picture that buyers consider, not isolated risks. Product concentration isn’t always an issue. If you’re unsure, an experienced investment banker or M&A advisor can often determine if product concentration is likely to be perceived as a risk factor in your business by buyers. 

Distribution Channel Concentration

Distribution channel concentration is the degree to which your business is dependent on a specific distribution or marketing channel. For example, if you have a tech or online business and 90% of your revenue is generated from Facebook ads, your business is considered to have high distribution channel concentration. 

How Much Concentration Buyers Will Tolerate

Ideally, your sales and marketing methods should be diverse, and your business shouldn’t be dependent on any single channel. If you own the channel, all the better. Buyers are concerned with distribution channel concentration to the degree to which that distribution channel is considered unstable. 

About 10 years ago, I encountered a business owner whose business was shut down overnight because of an issue he had with PayPal and eBay. His business went from generating seven figures to grinding to a halt in less than 24 hours. He lost everything. His business was entirely dependent on eBay and PayPal. And due to a dispute, they shut down his account, effectively destroying his business and forcing him to lay off all his employees. His fate, and the fate of his business, were in the hands of a monolithic bureaucracy that couldn’t care less that he was now destitute. His disputes fell on deaf ears, and his situation remained bleak. Unfortunately, there was nothing I could do to help. 

These types of riches-to-rags situations are far from rare. I’ve encountered other business owners who lost everything overnight – in some cases, wealth that took decades to build was vaporized in an instant. 

Reducing Distribution Channel Risk

The best antidote to distribution channel concentration risks is to eliminate any dependencies your business has on third parties. If you’re dependent on Amazon, Facebook Ads, Google Maps, Yelp, or other marketing channels, strategize to see what you can do to eliminate these dependencies. A change in the ranking algorithm of one of these channels can have a disastrous effect on your business overnight if you’re dependent on them. In some cases, as an alternative, it may be possible to sell your company to a buyer who already has a diversified array of distribution channels. If they purchase your company, your business would then have access to these distribution channels after the closing, and the risk would be much lower as a result.

The Founder’s Role

To further exacerbate this risk, founders are often the technical experts or inventors and lack sales, marketing, or business development experience. If this describes you, work to develop exposure and credibility for your company in your industry – become a cited and published expert in order to cast a favorable light on your company. Build social media traction and industry or institutional thought leadership. Develop a wide variety of proven advertising tactics and materials to eliminate potential dependencies on marketing channels.

Sales Team Concentration

In addition to marketing channel diversity, you should build diversity across your sales team. Do you have any salespeople on your team who generate a majority of your revenue? If so, it’s possible this individual may intentionally jeopardize the sale and blackmail you for a large sum in exchange for their cooperation with the transition. Think this is unrealistic? I’ve witnessed this situation play out more times than I can count on both hands. Even if this doesn’t happen, buyers will view this as a major source of risk and downgrade their valuation as a result. To counter this, work to build a diverse sales team and implement retention bonuses with your key salespeople to ensure they’ll remain with the business after the sale.

If you create a business that’s difficult for a buyer to replicate, you’re guaranteed to increase the value of your company.

Action Steps

• Branding: Organize and have on hand any customer testimonials, credible customer lists, case studies, awards, or any other recognition your company has received.
• Competitive Edge: The stronger your competitive advantage, the more your business will be worth. Strategize what you can do to create and document a competitive advantage that’s difficult to replicate.
• Scalability: If you want to sell your business for the maximum amount possible, focus on building a business that’s scalable. Consult with an industry consultant or hire a COO if you lack expertise in building scalable systems.
• Product Concentration: Reduce your product concentration only if you suspect it will be an issue for buyers. Consult an experienced deal-maker if you’re unsure.
• Distribution Channel Concentration: Reduce your dependency on distribution channels if you believe any of your channels represent high risk for the buyer.

“Your task is not to foresee the future, but to enable it.” – Antoine de Saint-Exupéry, French Poet

Your business is likely one of your most valuable assets and can represent a considerable portion of your net worth. You may have spent decades building and growing your business, making countless sacrifices along the way. Investing time in preparing your company for sale is a wise investment to protect all that hard work. Getting your business ready for sale allows you the flexibility of being able to sell at any time and helps protect this valuable asset. This preparation also results in significantly more negotiating leverage throughout the transaction, which further serves to maximize the price you receive.

Unfortunately, there’s not one simple method for increasing the value of a business. Dozens, if not hundreds, of direct and indirect factors can affect your business’s value. In this chapter, I’ll examine some of these factors, as well as what actions you can take to maximize the value of your business. 

Despite the complexity involved in valuing a business, there are actually only two primary ways to increase its value:

1. Increase EBITDA: The first method is to increase your business’s earnings before interest, taxes, depreciation, and amortization (EBITDA). One of your primary focuses when looking to maximize the value of your business should be to improve its profitability, which can either be accomplished by reducing your expenses or increasing your revenue.
2. Increase the Multiple: The second method is by increasing your multiple. Multiples are based on two factors – risk and return. Your multiple is a reflection of the risk a buyer perceives in your company and the growth opportunities your business offers. To increase your multiple – and thereby your valuation – you can either take steps to reduce risks associated with your business or improve your business’s perceived growth potential.

Based on these two direct factors, the formula for valuing a business is simple: 

Profit (A) x Multiple (B) = Value of Business (C)

Example: $10 million EBITDA (A) x 8.0 Multiple (B) = $80 Million Valuation (C)

This generalized formula is at the heart of valuing any business. So to increase the value of your business (C), you can focus on increasing profitability (A) or increasing the multiple (B). Note that, as stated above, the multiple is based on the amount of risk and return within a business. The formula could then be restated as:

Profit (A) x Risk/Return (B) = Value of Business (C)

The advice in this chapter can therefore be categorized into the following topics:

1. Increase profit (i.e., EBITDA)
2. Increase your multiple, which can be done by
   1. Decreasing the perception of risk
   2. Increasing potential returns

Collection of Factors

Unfortunately, despite this clean separation of distinct categories that affect the value of your company, real businesses can’t be categorized into neat little buckets. I wish it were that simple, but it’s not. While I’d love to reduce this advice down to 8 or 10 simple value drivers all buyers look for, it isn’t that easy in the real world. Instead, from my 20 years of experience selling companies, I’ve distilled the factors that can affect the value of your business into the following categories:

• Business Strategy
• Financial Metrics
• Growth Opportunities
• Business Operations
• Customer Base
• Legal Factors
• People
• Shareholders

After reading this chapter, you’ll understand the most important factors that can impact your business’s value, which will allow you to focus on those considerations that will have the greatest impact on your business. At the end of each section is a short list of action steps you can take to maximize the value of your business. Roll up your sleeves and let’s get started.

There is no simple method or formula for increasing the value of any business. There are dozens, if not hundreds, of potential direct and indirect factors that can affect the value of your business.

How important are negotiating skills during the sales process? How can negotiating skills affect the ultimate price you may receive for your business?

Negotiating is a critical component of the sales process. While you don’t need to have expert negotiating skills to successfully sell your business, you do need to be involved in the process and on the lookout for some common mistakes in order to maximize your negotiating position. What you may lack in negotiating prowess can be compensated for with preparation and positioning. Let me lay out a strategy for doing just that.

Creating Options

The best way to maintain a position of strength during negotiations is to have multiple options on the table at all times. One way to create options is having multiple buyers interested in your business. Negotiating with as many qualified potential buyers as possible will drive up the price. Also, keep in mind that the better your business is performing, the stronger you’ll appear to buyers and the more likely you’ll be able to negotiate a favorable price. 

If you’ve got one or more buyers on the hook, remember this – more than half of all transactions collapse before making it to the closing table. The lesson? Don’t lose focus on running your business just because you think you may have landed a buyer. After all, if revenues slip during negotiations, you can expect the buyer to demand a lower price. But if you keep your nose to the grindstone and revenues increase, you can expect to maintain a strong negotiating position.

Surviving Due Diligence

Many business sales fall apart during due diligence when issues are discovered. If the buyer uncovers problems that weren’t disclosed, they can end up in a unique leverage position, and you’ll lose your negotiating posture and receive a lower purchase price as a result. Make no mistake – each item the buyer finds fault with during due diligence enables them to claw back at the purchase price, if they don’t abandon the transaction altogether. 

Avoiding Deal Fatigue

Sophisticated buyers are aware of the natural tendency of business owners to experience fatigue as the process wears on. They may take advantage of this by drawing out the process and nibbling at the purchase price or terms at the last minute. If you have other options available in case the buyer attempts to renegotiate the price, you’ll maintain your strong position. The more prepared you are, the more likely you will minimize the chance buyers will discover a material fact they can use against you during the due diligence process.

The Importance of Honesty

Any buyer who believes you may be less than forthcoming will either head for the hills or triple their level of scrutiny during due diligence. They may also request holdbacks or other forms of protection, which can reduce your net proceeds. If the buyer believes you are honest, they’ll perceive your business as less risky, and negotiations are likely to be smoother as a result.

Humility also goes a long way in a transaction and is a significant factor that can affect the value of your business. Price is inversely related to risk. The lower the risk, the higher the price. Who do you trust more – a pompous, arrogant blowhard or a humble individual? The more humility you show throughout the process, the less risk the buyer will perceive, and potentially the more valuable the buyer will view your company.

Being honest saves you time and can help increase the value of your business. Building trust through authenticity and proper disclosure can reduce the intensity of the buyer’s scrutiny during due diligence, reduce the possibility of re-trading, and make negotiations less contentious. Selling a business is a protracted endeavor. It’s nearly impossible to conceal material facts in perpetuity. Your odds are slim-to-none for concealing a material defect all the way to the closing table and even less so after the closing. A sophisticated buyer will perform excruciating due diligence and is likely to discover any material facts. If the buyer uncovers a fact you failed to disclose during due diligence, you’re doomed. I guarantee the terms of your transaction will change – and not in your favor. 

As a seller, your exposure can last years due to safeguards buyers include in the purchase agreement, such as reps and warranties. If the buyer discovers a material misstatement – even after the closing – they may seek damages pursuant to the reps and warranties you signed in the purchase agreement. Even worse, they may offset any payments due to you via a setoff.

Full transparency can reduce the buyer’s perception of risk, meaning they may be willing to pay more for your business. Honesty reduces a buyer’s perception of risk and as a result, increases the value of your business. 

The best way to maintain a position of strength during negotiations is to have options with multiple buyers interested in your business. 

Conclusion

Many 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 is perceived to have, the higher the possible value. For most businesses, focusing on reducing risk is more prudent than focusing on maximizing potential. This is because potential is usually limited by external factors, such as demographic information and industry structure, whereas reducing risk is less influenced by these external factors. Value also tends to be more adversely affected by risk than it is positively impacted by the potential for returns. So, generally speaking, you will benefit more from reducing risks than you will from creating the opportunity for returns.

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

Here’s a cheat-sheet listing 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
• Future outlook for your product category
• Overall demand for your product – discretionary, cyclical, and countercyclical
• Intellectual property rights
• Warranty obligations

Customers

• Mix and type of customer base, like Fortune 500 or mom-and-pop stores
• 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 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 economy
• 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

This list contains most of the factors that can impact the value of your business. However, there may be others depending on your product or service and industry.

How will the economy impact the value and sale of your business? Let’s take a look at two primary economic factors that can affect the level of interest in your company and the price you may receive – unemployment rates and interest rates.

Unemployment Rates

If the bottleneck in your business is finding talent, a low unemployment rate may negatively affect its value. In some economic cycles, the primary limitation for businesses is hiring skilled workers. In these cycles, many businesses can’t find experienced people at a reasonable cost, which could hamper expansion. If your business struggles with growth because it’s in a talent-driven industry, low unemployment will only make this more of a challenge when selling it.

Sophisticated buyers may also consider a high unemployment rate a warning sign. Unemployment rates are a lagging economic indicator. Most sophisticated investors view an increase in unemployment as a sign of a weak economy and will remain cautious – unless you own a recession-resistant business, such as healthcare or pets.

If your wages are high as a percentage of revenue, a decrease in unemployment rates will negatively affect the value of your business. Consistently low unemployment rates tend to lead to increasing wages over time. If this happens in your business, wages as a percentage of revenue will increase, resulting in decreased earnings and a decline in the value of your business.

If your business is payroll-heavy, a low unemployment rate will cause a dip in its value. This means a market with higher unemployment may be a good time to sell. For example, if you own a business with gross revenues of $50 million per year, EBITDA of $7 million per year, and your payroll is 30% of revenue ($15 million per year), a 10% increase in wages (to $16.5 million from $15 million) will cause a 21% decrease in your EBITDA ($7 million – $1.5 million from increased wages = $5.5 million EBITDA). 

Let’s assume you could receive a 7.0 multiple for your business if the unemployment rate is 8% and a 6.5 multiple if the unemployment rate decreases to 4%. Here’s how the change would impact the value of your business:

• Before: $7 million EBITDA x 7.0 multiple = $49 million value of business
• After: $5.5 million EBITDA x 6.5 multiple = $35.75 million value of business
• Result: a 27% decrease in the value of your business

Note: This level of impact would only be seen in businesses in which payroll constitutes a significantly high percentage of revenue. How high is high? The percentage varies drastically by industry. According to FreshBooks, an accounting software company, service-based businesses may spend as much as half of their gross revenue on labor costs. For most businesses, however, 15% to 30% is the norm.

High unemployment rates also weigh on the value of consumer businesses because they usually correlate to dampening consumer spending. If you have a business that caters to consumers, such as a high-end retail store, an increase in the unemployment rate will negatively affect the value of your business, especially if the trend is expected to worsen over time. For example, if you own a chain of jewelry stores, a high unemployment rate will serve as an indication that the economy isn’t doing well, especially if your products are discretionary. Weak consumer sentiment will only serve to make this situation worse. 

If your business is in a trendy or luxury industry that caters to consumers, a high unemployment rate will cause a dip in the value of your business. This means a market with lower unemployment may be an excellent time to sell.

There’s no general rule for how unemployment rates affect acquisition rates overall. Many factors and variables are at play, and these factors can also “stack” in certain industries. For example, you may have one positive factor in your business and one negative factor that cancel each other out. In other industries, a moderate change in the unemployment rate may have little impact. In still others, a significant change in the unemployment rate may signal doom for all but the best performers. As a result, it’s important to take all of these factors into consideration when you’re valuing your company.

Interest Rates

Interest rates can also impact the value of your business and overall acquisition activity. As interest rates rise, the value of businesses generally decreases. Why? There are two main reasons:

1. The Cost of Money Increases: Because most acquirers use debt when purchasing a company, an increase in interest rates increases their monthly payments on that debt and therefore decreases their cash flow. The value of the business must be lowered to compensate for the inflated cost of borrowing.
2. Compete with Higher Rates: When interest rates are high, other investment opportunities may become more attractive. Because of this, your business must perform better in order to compete.

Safeguarding your business through insurance, copyrights, and other legal methods will substantially increase its salability. Here are three examples of how these factors can affect value and risk in your business.

Insurance

Is your business sufficiently insured? If not, an amount will need to be deducted from cash flow based on the cost of carrying adequate insurance, which will reduce the value of your business.

Intellectual Property

If your business has valuable intellectual property, it will be more difficult for a buyer to replicate it, which improves its value. 

Pending Litigation

Pending litigation will negatively affect the value of your business. If you are facing litigation, most buyers will prefer to wait until the matter has been resolved before proceeding with the transaction. Even if the threat can be mitigated for buyers with an opinion letter from your attorney or by withholding a portion of the purchase price in escrow, pending litigation will nonetheless decrease the value of your business due to the increased perception of risk. 

Your business’s finances are one of the first things any buyer will examine. How does your company’s financial performance compare with its peers? The stronger your financial metrics are compared with others in your industry, the more your business is worth, provided your metrics are sustainable in the long term. It’s crucial your finances are in order if you want to maximize the value of your business. 

Revenue

If revenue from your business is trending higher, this enhances its value. Buyers generally assume that financial trends will continue in a business if all signs point in the same direction. As a result, revenue trends are of particular importance to buyers and can have a significant impact on your company’s value. If revenue growth is consistent for your business, this reduces the perceived risk for a buyer, which increases value. 

What are the growth prospects for your company? The higher the growth potential and prospects, the more your business will be worth. On the other hand, if the revenue from your business recently declined, buyers will consider this excessively risky. If revenue growth is inconsistent for your business, this increases the perceived risk for a buyer. Inconsistent revenue is viewed as risky by most buyers and will always result in a lower valuation.

Margins

Are gross profit margins holding steady, increasing, or decreasing? How do your gross margins compare to your industry’s benchmarks? Strong gross margins improve your business’s value, especially if your lower cost structure is sustainable and your margins are consistent from year to year. If gross margins are low for your business compared with others in your industry, this will decrease its marketability and, hence, its value.

Profitability

If your company generates a limited amount of EBITDA, your business will be difficult to sell. Buyers compare an investment in your business to alternatives. If the cash flow from your business is less than that of more attractive alternatives, there needs to be a significant upside to attract interest.

Consistent earnings in your business reduce its risk and improve both its marketability and value. If earnings from your business are inconsistent, most buyers will consider this risky, which will result in a lower valuation.

EBITDA is the starting point of nearly all negotiations for middle-market transactions. For most industries, EBITDA multiples are fairly predictable, and acquirers rarely stray from prevailing industry multiples. For example, if your company generates $3 million in EBITDA, most buyers will value your business at 4.0 to 7.0 times your EBITDA, or $12 million to $21 million. 

How does a buyer determine where in the range you fall? 

It’s simple – they consider all the factors other than EBITDA. In other words, nearly every buyer will initially establish a baseline value based on a multiple of your EBITDA, and then increase or decrease the price they’re willing to offer within that range based on all other factors. The higher your EBITDA, the higher the baseline value of your company. 

EBITDA is the starting point of nearly all negotiations for middle-market transactions.

Recurring Revenue

If your business generates recurring revenue, this improves scalability and reduces risk. Contractually recurring revenue is the number one value driver for many industries, such as software and tech. There’s a reason the so-called subscription economy is expected to reach $1.5 trillion by 2025, according to UBS Wealth Management, more than double the amount at the start of the decade. Recurring revenue is viewed as more valuable than income generated from new sales. Buyers are willing to pay significantly more for a business that generates recurring revenue as opposed to revenue generated from drumming up new customers.

Examples of companies with recurring revenue include:

• Netflix: Monthly subscription fee
• Spotify: Monthly subscription fee
• Apple: Recurring subscription fees for Apple Music, iCloud, and more
• Accounting Software: Subscription fees for QuickBooks, Xero, and others
• Web Hosting: Subscription fees for GoDaddy, Bluehost, and other services
• Microsoft: Recurring subscription fees for Office 365, and other programs

There’s a difference between recurring and repeat revenue. While it’s good to have repeat revenue, it’s an unpredictable form of income. Recurring revenue is predictable because it’s usually auto-debited from the user’s credit or debit card on a regular schedule, such as with cell phone bills, gym memberships, or various online services.

If your business doesn’t generate recurring revenue, this limits scalability and increases risk. Recurring revenue is more predictable and results in a higher customer lifetime value than non-recurring revenue. The higher the lifetime value, the more a company can afford to invest in acquiring customers, the more scalable the business is, and the higher its valuation.

Then there’s the matter of customer retention. If your business suffers from high attrition, which could be due to high customer churn, your business will have a difficult time scaling. Poor retention can be caused by a number of issues, from product features to the overall user experience. 

Recurring revenue is viewed as less risky by acquirers than forecasted revenue based on new product sales, which buyers heavily discount. If the revenue isn’t contracted, the owners may leave and take their relationships with them, or customers can leave during the transition phase due to the uncertainty an acquisition creates in the mind of the marketplace. As a result, contractually recurring revenue is the gold standard when buying and selling a business. It’s no coincidence that even sales of non-traditional subscription items such as vitamins and pet food have grown so much in recent years. 

Contracts ensure retention and offer the acquirer enough time to build trust with the customer post-closing. This means that businesses with contractually recurring revenue will sell at higher multiples than those with non-contracted revenue. A bird in the hand truly can be worth two in the bush.

Cash Flow Cycle

The cash flow cycle is the amount of time it takes to convert a sale to cash. Highly scalable companies have a short cash flow cycle and, therefore, a higher value. The shorter your cash flow cycle, the more scalable your business will be. For example, if your business offers no or minimal terms to customers, this shortens the cash flow cycle, thereby improving its scalability and reducing risk. If your cash flow cycle is long, a buyer must make a significant investment in working capital if they want to grow your business quickly. As a result, they often include a deduction for an increase in working capital, which decreases cash flow and, subsequently, the value of your business.

If your business offers significant terms to customers, this increases the cash flow cycle, which reduces scalability and increases risk. Has your business loosened terms to boost revenue in the short term? If so, this revenue will be discounted by buyers.

Likewise, if you carry significant inventory levels, sell customized products, or offer your customers terms, your sales cycle may be extended. A long cash flow cycle limits the scalability of your business and requires the buyer to make large working capital injections to fund future growth. Both factors drive down the value of your business.

Working Capital Requirements

If your business requires a lower-than-average amount of working capital, your company’s ROI and value will increase for the buyer. Nearly all buyers in the middle market make an offer that includes a set amount of working capital in the purchase price. Working capital is calculated as accounts receivable, inventory, and prepaid expenses, minus accounts payable, short-term debt, and accrued expenses. If your business needs a high amount of working capital, this must be factored into the purchase price, decreasing your net proceeds. 

Most buyers factor the amount of working capital required to operate the business into the total investment to calculate the multiple. 

For example, if cash flow from your business is $5 million per year and your business is valued at a 6.0 multiple, your business will be priced at $30 million ($5 million x 6.0 = $30 million). But if your business requires $5 million in working capital (total purchase price = $30 million + $5 million = $35 million), then your multiplier will be 7.0 ($35 million / $5 million = 7.0) if working capital is included in the calculation. 

If your business requires a lower-than-average amount of working capital, your company’s ROI and value will increase for the buyer. 

Capital Expenditures

Capital expenditures, or CapEx for short, are investments made in capital equipment and other fixed assets. Capital equipment is depreciated because it’s expected to have a useful life longer than 12 months. While depreciation is added back when calculating EBITDA, some buyers subtract a reserve for capital expenditures when valuing your business. A low CapEx makes your business more attractive to most buyers. Carefully track your capital expenditures for five years prior to a sale, and be as frugal as possible with any capital investments you make in your business. 

If your business requires lower-than-average CapEx, this is a positive attribute for buyers because it will require less capital to sustain or grow operations. Some buyers subtract a CapEx reserve from EBITDA before valuing a business. Low CapEx – a hallmark of any acquisition targeted by legendary investor Warren Buffett – makes your business more attractive to sophisticated buyers. High CapEx makes your business less attractive.

Quality of Financial Records

Take a close look at your financial records and consider the following questions:

• Are they accurate? 
• Do your tax returns match your financial statements? 
• Are your financial statements clearly presented? 
• Do you have strong accounting controls in place? 
• Is your business using the last in, first out (LIFO), or first in, first out (FIFO) accounting method, or some other form of inventory accounting? If so, how has this affected your earnings? 
• Have you properly recorded inventory, or have you under- or overstated inventory in an attempt to manipulate earnings?
• Are your financial statements prepared on a cash or accrual basis? If the latter, are the accruals being correctly done?

The stronger your financial statements, the less risk buyers will perceive, and the more they may be willing to pay for your business.

Do you have any family members working in your company? Are your key employees willing to stay after the sale? 

These and other people-related issues constitute another primary aspect of risk – and therefore value – during the sale of a business.

Ownership

If more than one owner is actively working in your company, a buyer will need to replace all owners unless the owners are willing to stay with the business long-term. This significantly increases risk for the buyer and will result in a lower purchase price. The advantage of having only one active owner in your business is that the buyer only needs to replace one person – the active owner. The fewer individuals the buyer must replace after the closing, the lower the risk is for the buyer. As a result, a higher purchase price can be justified.

Is your reason for selling your business non-urgent? Ideally, all owners should be healthy and otherwise not have a pressing need to bail. If the sale is urgent, and the buyer knows it, the value may decrease.

Are all owners receiving a salary? If you’re working 80 hours a week, it’s unlikely that one salaried manager could replace you. Because of that, a deduction must be made from EBITDA to replace you with two employees. Consequently, the value of your business will be less.

If your company isn’t heavily dependent on you, this reduces risk for the buyer and greatly improves the marketability and attractiveness of your business – and consequently its value. If your business is dependent on you, the buyer will consider this risky and be willing to pay a lower multiple than if it were not.

Family

Family members actively working in your business can pose a risk factor to the buyer because they will likely need to be replaced after the sale. The buyer may consider it excessively risky to attempt to replace these employees while also closing on the transaction. Having any non-working family members on your payroll also complicates due diligence and represents additional risk to the buyer, which will negatively impact the value of your company.

Management Team

How strong is your management team? Do they have a solid track record of achieving results? Do you have a trained and experienced management team in place? If so, the value of your business will be higher as more buyers are willing to make an acquisition with fewer people they need to replace post-closing. If your business has a strong management team, this increases the universe of potential buyers you can market your business to, thereby improving the odds of a successful sale. 

Key Employees

Is your business highly dependent on any employees? Businesses that aren’t highly dependent on key employees are far more attractive to both sophisticated and unsophisticated buyers because it reduces risk for the buyer. 

If any essential employees are unwilling to stay, a buyer will consider this risky. If some of your employees are difficult to replace, a buyer may consider the acquisition of your business too risky if they believe key employees may not be retained after the closing. Key employees may find out about the sale and threaten to leave, which could both kill the transaction and damage the value of your business.

Are non-solicitation or non-compete agreements in place with key employees? If so, this reduces risk for the buyer and increases the value of your business.

Compensation

Are wages above or below industry averages? If wages are lower than average, a buyer will need to increase compensation, which will decrease the cash flow of the business, and, subsequently, its value.

Tenure

What is your employee turnover rate, and how does it compare to industry benchmarks? If your employee tenure is longer than average, this reduces risk for the buyer and improves the attractiveness of your business. 

Be sure to compare your company’s turnover rate with businesses similar to yours. There can be a wide disparity in tenure among different sectors. In recent years, for example, the national average for total separations hovered around 20%, according to the U.S. Mercer Turnover Survey. While the retail and wholesale category exhibited the highest turnover at about 60%, most other industries were at or below 20%. Geography also makes a difference. Turnover tends to be the highest in the South and the lowest in the Northeast.

If the tenure of your employees is shorter than average in your industry, this increases risk for the buyer and reduces the attractiveness of your business. A shorter tenure, or high turnover, could signal problems with your corporate culture. If the buyer is concerned about the culture of your company, this can dramatically reduce the value of your business in the buyer’s eyes.

The fewer people the buyer must replace after the closing, the lower the risk is for the buyer. 

Operations are a broad category that can greatly affect valuations. The following is an examination of each component of your operations as it relates to value.

Systems

Do you employ strong systems and controls in your business? Are your business’s operations, policies, and processes thoroughly documented? Well-documented systems, processes, controls, and forecasts improve the manageability and scalability of your business and, thus, its value. 

Facilities

How modern are your operations? Buyers prefer facilities that are up to date and that don’t have deferred maintenance. Modern, up-to-date facilities are worth more than those that are not.

Do you own the real estate your business occupies or do you lease it? If you own the real estate, are you paying your business a market rate to rent the premises? If you own the real estate and your business is paying below-market rental rates, consider increasing the rent to market rates. This market-rate rent will more closely reflect the amount the buyer will need to pay if they buy your business. 

If you lease the real estate, is your rent above or below the market rate? If your lease is below the market rate, the value of your business may be higher than a comparable business with a lease at the current market rates. The reverse can also be said – a lease at above-market rates will negatively affect the value of your business.

If your business has a long-term lease, this also reduces risk for the buyer. If location is critical to the success of your business and you don’t have a long-term lease, not only will the value of your business be affected, but your business may prove to be unsalable. 

Relocation

Can your business be relocated to another geographic market? If so, this increases your marketing options, thereby increasing the probability of successfully selling your business for top dollar. If your business would be difficult to move to a new market and is located in a smaller geographical area, your options for successfully marketing your business are less than if it were located in a highly populated metropolitan area.

Equipment

Do you lease any equipment? If so, are the leases structured as capital or operating leases? Will the leases be paid at closing? Any drain on cash flow, such as an equipment lease, will lower the value of your business.

Is your equipment up to date? Is there any deferred maintenance? If a buyer must replace equipment because it’s out of date or if you have deferred maintenance, your business will be worth less than if the equipment is in tip-top shape.

Inventory

What are your minimum inventory requirements? If your business requires a large amount of inventory on hand to operate, this increases the working capital requirements for the buyer and potentially decreases your business’s value. 

If your business requires a lower-than-average amount of inventory, this increases the overall return on investment (ROI) for the buyer. If your business requires a higher amount of inventory than other businesses or industries, this must be factored into the purchase price. Many buyers factor the inventory into the total investment when calculating their multiple and projected returns. 

For example, if the cash flow from a business is $3 million per year and we have priced the business at a 5.0 multiple, the business will be priced at $15 million ($3 million x 5.0 = $15 million). But if there’s $3 million in inventory (total purchase price = $15 million + $3 million = $18 million), the multiplier will be 6.0 ($18 million / $3 million = 6.0) if inventory is included in the calculation.

I was once selling a party rental business that had $1 million in EBITDA and over $2 million in inventory. A business of this type and size might normally sell at a 3.5 multiple of EBITDA, or $3.5 million. But if we added inventory to the price, the business would be valued at $5.5 million, which would equal a 5.5 multiple. If the owners sold the business at $3.5 million, this would only net them $1.5 million after the value of the inventory. Unfortunately, this transaction didn’t make sense from either the buyer’s or the seller’s viewpoint due to the high amount of inventory necessary for the business to operate. As a result, the business didn’t sell.

Well-documented systems, processes, controls, and forecasts greatly improve the scalability of your business and, thus, its value. 

Once the closing has occurred, both you and the buyer will have a vested interest in working with one another to successfully complete the transition period. Both of you will also be contractually obligated to fulfill your post-closing covenants to the extent that such obligations exist. You are likely to be motivated to ensure the reps and warranties remain true after the closing. 

For example, you may have represented that the receivables are collectible. If that’s the case, you should assist the buyer in collecting the receivables after the closing, therefore incentivizing you to ensure the transition progresses as smoothly as possible. 

For you, the “real closing” has not occurred until the following has transpired:

• You have fulfilled your transition.
• Any post-closing adjustments have been made, such as working capital adjustments.
• You have received all your money due.
• The earnout periods have expired.
• You have satisfied the terms of employment and consulting agreements.
• The indemnification period has elapsed.

While you may have reason to rejoice at the closing, don’t get too caught up in the celebrations. You should not be ready to fully “let go” until all of the events above have occurred. 

There generally won’t be a defining moment, but one day you will wake up and realize you have finally completed all of your obligations. Congratulations! When that happens, the largest transaction of your life will be successfully behind you.

“An entrepreneur is someone who will work 24 hours a day for themselves to avoid working one hour a day for someone else.”

– Chris Guillebeau, American Author and Entrepreneur

Conclusion

The best problem a seller can have is struggling to find a new passion after selling their business. And hopefully, one day, you, too, will finally take up watercolors or get around to reading all those books that have been piling up. Until that point, though, until the first hints of boredom have snuck up on your afternoon, don’t assume the transaction is finished. Expect last-minute problems, expect fierce negotiations over the purchase agreement, and be aware that even then, problems with those reps and warranties could stymie your long walk into the sunset. 

Once again, understanding these mechanisms is your best defense against them. So, double and triple-check the wording of your reps and warranties, maintain a healthy relationship with the buyer, and do your best to be honest. And if you’re lucky, you too could find yourself bored, early into the afternoon.