Brian D. Bornino

Brian: Companies are sometimes acquired for a premium price over-and-above the fair market value of the business on a stand-alone basis . These premiums typically reflect anticipated synergies and cash flow enhancements that a strategic buyer (oftentimes a competitor, customer, or vender) believes it could achieve. Examples of synergies include reduced materials costs, elimination of redundant overhead, or enhanced revenue through an expanded product line. These factors may result in a business that is worth $10 million on a standalone basis being acquired for $12 or $13 million, for example. These synergies are often buyer-specific, so it is difficult to predict what premium may be achievable without knowing the specific buyer.

Brian: Yes. Valuation is an inherently forward-looking exercise. While the company’s historical performance is an important indicator of future potential, a buyer is not buying your company’s historical cash flows; rather, all of a buyer’s return will be generated from future cash flows. As such, the value of any company is largely a function of the buyer’s and seller’s assessments of the present value of the company’s future cash flows. A common challenge is that buyers and sellers oftentimes cannot agree on a company’s potential, which is why transaction prices are often structured based on current or actual performance rather than future performance. Also, when there is considerable disagreement about the future of a business, an “earn-out” (i.e., additional purchase price that is only paid if certain future performance objectives are achieved) can often be structured to bridge the gap between the buyer and seller’s expectations.

While the company’s historical performance is an important indicator of future potential, a buyer is not buying your company’s historical cash flows; rather, all of a buyer’s return will be generated from future cash flows.

Brian: It is never too soon to being developing an exit strategy. Generally speaking, the more time you plan, the better result you will achieve. A good rule of thumb would to begin developing and planning for an exit strategy no less than 3 to 5 years prior to your desired exit. This will allow you ample time to prepare your business for sale and maximize the value of your company.

Brian: While there are hundreds of variations of various exit options, they can generally be condensed into 4 categories: (a) sale of the business to a strategic buyer, (b) sale of the business to a financial buyer (such as an investor or a private equity firm), (c) sale of the business to employees or key management, or (d) in the case of a family-owned business, sales, gifts, or transfers of the business to the next generation of family. Each option has pros and cons, and selecting the best option is almost always determined based on the goals and objectives of the current business owners.

Brian: Selling a business to your employees through an Employee Stock Ownership Plan (“ESOPs”) is an often-overlooked option that can provide tremendous advantages to the selling shareholder, the company, and its employees. ESOPs are permitted to pay up to fair market value, so the business owner will receive a fair price. The business owner will receive favorable capital gains tax treatment because the transaction is a stock sale rather than an asset sale, and there may be an opportunity to defer the capital gains tax if certain requirements are met. The company and employees benefit from numerous significant tax advantages, such as repaying the transaction debt with pre-tax dollars and possibly even becoming an income tax-free entity in the case of a 100% ESOP-owned S- corporation . Another very important advantage of ESOPs is their flexibility; business owners can choose to sell a portion of their ownership to an ESOP and create a gradual ownership transition plan that is often not feasible with other exit planning options. Plus, many business owners would rather sell their business to their employees who have helped build the business rather than a competitor.

Brian: ESOPs offer many advantages, but are highly specialized. It is important to discuss the pros and cons of ESOPs with advisors who are heavily involved with ESOPs, as most CPAs, attorneys, and financial planners only have a cursury understanding of ESOPs, which often leads them to dismiss an ESOP as “too complicated”. Ask your current advisors if they are aware of any ESOP experts in your city. Also, you can search the ESOP Association’s website for a list of experts. Most major cities only have a small handful of ESOP experts, so it is not uncommon to look outside your geography to find this specialized expertise.

Brian: The decision of whether to sell stock or assets can be an important one for both the selling shareholder and the acquiring company. From a seller’s perspective, there is almost always a preference to sell stock, primarily because of favorable capital gains tax treatment. However, an acquiror almost always will prefer to acquire assets, both for liability reasons as well as for tax reasons, as the buyer would prefer to be able to “step-up” the basis of acquired assets and benefit from higher levels of future depreciation tax write-offs. This is often a heavily negotiated issue in a transaction, and it is imperative to involve your tax advisor in this discussion.

Brian: This can be a difficult situation. Oftentimes when shareholders have different ideas about the timing of their exit from the business, it will be necessary to buy out the shareholders who wish to exit. All businesses with multiple shareholders should have a buy-sell agreement that dictates the process by which a shareholder may be bought out. The goal is typically to avoid conflict, ensure that the departing shareholder is treated fairly, and ensure the remaining shareholders can continue to operate the business. Determining a fair purchase price is often the most difficult part, and the best practice is for comapnies to obtain valuations of their business on a regular basis (i.e., perhaps annually or semi-annually) to establish a fair market value that all shareholders understand before a triggering event.

Brian: While many shareholders want to sell their business at its peak value, this is not the optimal time to sell. The optimal time to sell is when a business is on the upswing, and the outlook remains positive. Since value is forward-looking and an educated buyer will be in-tune with the competitive marketplace, it is important that your company’s business outlook is strong when you are attempting to sell a business. Waiting too long and trying to sell a company when growth or profitability are beginning to plateau or decline will typically result in a lower purchase price.

Determining a fair purchase price is often the most difficult part, and the best practice is for companies to obtain valuations of their business on a regular basis to establish a fair market value that all shareholders understand before a triggering event.

Brian: There are a number of action items when preparing your business for sale, and most of them involve “cleaning up” any issues that a potential acquirer might discover in their due diligence . It is always advantageous to find and correct issues before a potential buyer finds them, as these problems often result in a buyer delaying a transaction, reducing their offer price, or even withdrawing from the negotiations. To uncover these hidden issues, the best advice is to have a reputable CPA firm (i.e., one that a potential acquiror will have heard of) perform a review or audit of your financial statements for the past couple of years. Also, this CPA firm and a good law firm should perform “pre-deal due diligence”, which is intended to replicate the due diligence that a buyer will perform. This process often uncovers accounting, tax, and legal issues that should be corrrected before putting your business up for sale. This can be an in-depth and expensive process, but business owners should view this an an investment that will make their business more marketable and potentially fetch a higher price.

Brian: While there is no requirement to have your business valued before you sell it, it is often advisable to do so. The key benefits that a valuation from a high-quality valuation firm can provide include: (a) provide an understanding of how a buyer will look at your business, (b) provide an objective bassis for reviewing offers, (c) understand industry dynamics, such as what “multiples” are typically paid by buyers in your industry, and (d) understand whether the value of your company is sufficient to meet your needs, which can affect your decision of whether or when to sell your business.

Brian: Business valuation is grown to become a highly specialized niche within the finance field. While historically professionals such as business brokers, financial planners, or CPAs offered valuation services in addition to their core services, the industry has evolved and valuation expertise is now largely concentrated among professionals who have dedicated their entire career to valuation services. There are national, regional, and local boutique practices that offer valuation valuation services. Also, many larger CPA firms and investment banks have dedicated valuation practices. As such, it is not advisable to have your CPA or financial planner value your business, unless these firms have active and reputable divisions that focus exclusively on business valuation.

Brian: As mentioned above, business valuation is highly specialized, so it is critical to select a valuation firm that has a high degree of valuation experience. Oftentimes, your CPA, attorney, or financial planner will be able to recommend a valuation firm to you, as they may have had other clients who needed a valuation in the past, so that is a good place to start. Also, you might ask other business owners you know for recommendations. It will be important to interview potential valuation firms before hiring them, and cost should not be the key factor, as better valuation firms are often more expensive. Good interview questions to ask include (a) what percentage of your time is dedicated to business valuation (100% is the only correct answer), (b) how many valuations have you completed during your career (you are looking for hundreds or more), (c) how many valuation professionals are on your team, (d) can you provide references of clients in a similar industry that you have valued, and (e) can you provide references from other attorneys, CPAs, or advisors who you have worked with in the past. Conducting a thorough search and interview process will typically result in you discovering who the most qualified valuation practices are.

… business valuation is highly specialized, so it is critical to select a valuation firm that has a high degree of valuation experience.

Brian: Many business owners make the mistake of thinking they can sell their business without the help of an investment banker or business broker. While these intermediaries often command a high fee (oftentimes 2 to 5% of a transaction price), good investment bankers are worth the investment and will pay for themselves by (a) correctly positioning the company for sale and presenting the company’s advantages in a comprehensive offering memorandum, (b) conducting an in-depth search process to identify as many likely buyers as possible, (c) helping create an “auction process” whereby buyers are competitively bidding for your business, (d) running a professional and smooth managed sale process, and (e) ultimately achieving a higher sales price than could typically be achieved by business owners on their own. Various studies have shown that on average, businesses that are sold through investment bankers will fetch higher prices, with an average difference around 20%.

Brian: The most important piece of advice is to prepare. A big part of that is to surround yourself with experienced advisors who can help you and your company prepare to sell. Buying, selling, or valuing your business may be a once-in-a-lifetime event, so selecting appropriate advisors (even if they are more expensive), is almost always a great investment. When buying or selling a business, you will want an attorney and CPA with plenty of experience with business transactions. It is also advisable to use an intermediary, such as an investment banker or a business broker, to help you position the company for sale, search for buyers, and negotiate the best deal. Lastly, if you wish to have your business appraised prior to a sale, be sure to select the best valuation firm you can find.