The Ultimate Guide to Selling A Business v3€¦ · To Selling A Business A comprehensive guide for selling small to mid-sized businesses ($5MM - $100MM Revenue) Written By: Nick

The Ultimate Guide: To Selling A Business

A comprehensive guide for selling small to mid-sized businesses ($5MM - $100MM Revenue)

Written By: Nick Arellano CVA®, CFP®, CIMA® Managing Partner Your Legacy Partners, LLC.

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Table of Contents INTRODUCTION ................................................................................................................................................... 4

ABOUT US .................................................................................................................................................................... 5

SECTION 1: WHERE TO START WHEN SELLING A BUSINESS ................................................................................. 6

STEP 1: TAKE TIME TO DETERMINE YOUR PRIORITIES ............................................................................................................. 7 How to Start Selling a Business ............................................................................................................................. 7 Reason for Selling ................................................................................................................................................. 7 Your Role Post-Sale ............................................................................................................................................... 7 Other Considerations When Selling a Business ..................................................................................................... 8

STEP 2: ENGAGE PROFESSIONAL ADVISORS ....................................................................................................................... 12 Process of Hiring Advisors: .................................................................................................................................. 12 Who Can Help Sell My Business? ........................................................................................................................ 13 Who Will Sell My Business? ................................................................................................................................ 15

STEP 3: UNDERSTAND AND CONSIDER ALL OPTIONS FOR A SALE ............................................................................................ 20 Tax When Selling a Business ............................................................................................................................... 20 Types of Business Sale ........................................................................................................................................ 20 Who Can I Sell My Business To? .......................................................................................................................... 21

SECTION 2: PREPARING YOUR BUSINESS FOR SALE ........................................................................................... 29

STEP 4: PREPARE FINANCIALS ........................................................................................................................................ 30 Financial Statements Needed – at a Minimum ................................................................................................... 30 Other Financial Information Commonly Needed ................................................................................................ 31

STEP 5: GET A PROFESSIONAL BUSINESS VALUATION .......................................................................................................... 35 What Is My Business Worth? .............................................................................................................................. 35 Benefits of a Professional Valuation ................................................................................................................... 35 Approaches to Valuation .................................................................................................................................... 35 Factors That Impact Business Value ................................................................................................................... 40

STEP 6: FOCUS ON THE BUSINESS ................................................................................................................................... 42 Keep the Machine Running at Peak Performance .............................................................................................. 42 Improve Areas That Can Enhance Value to a Buyer ............................................................................................ 42 Key Areas to Examine ......................................................................................................................................... 44

SECTION 3: GOING TO MARKET ......................................................................................................................... 49

Timeline: 4-6 Months .......................................................................................................................................... 50 STEP 7: PREPARE MARKETING MATERIALS ....................................................................................................................... 51

Tell Your Story – What is Your Purpsose? ........................................................................................................... 51 Include an Overview of Your Business ................................................................................................................. 52 Products & Services: What Does Your Business Offer? ....................................................................................... 52 Highlight Your Strengths – and What Makes Your Business Unique .................................................................. 53 Who Are Your Customers? .................................................................................................................................. 53 Talk About Ownership & Key Players .................................................................................................................. 54 Historical & Projected Financials ........................................................................................................................ 55 Where Are Future Growth Opportunities? .......................................................................................................... 55

STEP 8: REACH OUT TO POTENTIAL BUYERS ....................................................................................................................... 57 Teaser ................................................................................................................................................................. 57 NDA – Non-Disclosure Agreement ...................................................................................................................... 58 Confidential Investment Memorandum (“CIM” or “Book”) ................................................................................ 58 Expect Plenty of Questions ................................................................................................................................. 59 Indication of Interest (“IOI”) ............................................................................................................................... 60 Data Room (& Potential In-Person Management Meetings) .............................................................................. 60

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Letter of Intent (“LOI”) ........................................................................................................................................ 61 STEP 9: EVALUATE OFFERS ............................................................................................................................................ 63

Key Items to Consider ......................................................................................................................................... 63 Example – Comparing Offers .............................................................................................................................. 65 Assess the Buyers ................................................................................................................................................ 66 Key Items to Keep in Mind Throughout the Process ........................................................................................... 67

SECTION 4: DILIGENCE & CLOSING .................................................................................................................... 68

STEP 10: DUE DILIGENCE .............................................................................................................................................. 69 What to Expect During the Diligence Period ....................................................................................................... 69 Timeline for Due Diligence .................................................................................................................................. 70 Major Diligence Tasks ......................................................................................................................................... 71 Due Diligence Checklist: ...................................................................................................................................... 73 Continue Evaluating the Buyer ........................................................................................................................... 73

STEP 11: NEGOTIATE AND DRAFT PURCHASE AGREEMENT .................................................................................................... 74 Negotiations Resulting From Diligence ............................................................................................................... 74 Importance of a Good Attorney .......................................................................................................................... 74 Drafting the Purchase Agreement ...................................................................................................................... 75 Key Sections in the Purchase Agreement ............................................................................................................ 75 Additional Information Commonly Included ....................................................................................................... 76

STEP 12: CLOSING & BEYOND ........................................................................................................................................ 77 Prior To Closing ................................................................................................................................................... 77 Closing ................................................................................................................................................................ 77 Post-Close ........................................................................................................................................................... 77

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Introduction

After years of hard work, you are now considering selling your business – but now what? The thought of selling your business has likely been on your mind for a while and you continually hear about the strong valuations that others are receiving for their businesses. This naturally leads many owners to be interested in selling their business, yet there are so many questions and so much uncertainty that ultimately delays the decision:

- When should I sell my business? - How to go about selling my business? - Options when selling a business? - If I’m selling my business how much is it worth? - How to increase my business valuation? - How to prepare my business for sale? - Who can help sell my business? - What is the tax when selling a business?

This guide was written to answer these questions and more so owners like you have the knowledge and comfort to move forward with selling your business. It will cover all of the key areas and provide some tools you can use at different stages. It likely won’t hit every question and consideration for every person, but it will address the most important areas with enough detail to ensure you get through the process effectively and ensure you achieve your goals with no regrets Although this guide provides tips on selling a business of all ages and sizes, it was written with the small to medium-sized, founder owned business in mind. These businesses typically have $5,000,000 - $100,000,000 of revenue and a history of profitability. They have been around for a number of years and proven their business model, but realize it may now be time to explore outside capital or sell the company. Established businesses of this size are typically not best served by simply listing their business on a website and hoping the right buyer, or buyers, happen to visit the site right at the time they are ready to accept multiple offers. Plus, I can tell you from first-hand experience as a buyer that, the majority of qualified buyers you want to sell to are not focused on finding businesses this way. As the owner, this is a major decision in your life. You have the most to gain or lose and you will likely only get one attempt at this. So, understanding the steps involved and the options you have when selling a business is crucial to ensuring you proceed with confidence and have no regrets. Whether you ultimately decide on a full sale or partial sale, now or at some point in the future, this guide was written to help you understand how to go about selling a business and what you should expect and consider at each stage.

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ABOUT US

As the founder and managing partner of Your Legacy Partners, a boutique investment bank specializing in M&A Advisory, business valuations and pre-sale consulting, I’ve spent almost two decades advising owners of small to mid-sized businesses. In 2006 we began assisting owners through the process to sell their business. Working with a variety of companies I have been continually impressed with how many great niche businesses there are who provide great value to their customers. This also motivated me to spend multiple years working on the buy-side to acquire small to mid-sized businesses. Working along-side prior operators and seasoned investors during this time provided first hand insight into what factors were really driving growth and what attributes prudent investors were willing to pay more for. Both sets of experiences showed how much money was being left on the table by owners, due to insufficient preparation and a suboptimal execution, which is what ultimately drove me to start our firm. I’ve seen large amounts of money left on the table from not approaching the process correctly, as well as great results from those who take the time to do it right. It’s this combination of experiences that allow Your Legacy Partners to bring an unparalleled perspective to our clients, above and beyond what many others can offer. The ability to add significant value to hard working business owners is what motivates us every day!

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Section 1:

Where to Start When Selling a Business

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STEP 1: TAKE TIME TO DETERMINE YOUR PRIORITIES

How to Start Selling a Business Selling your business is not easy. It will involve a lot of hard work, take a considerable amount of time and include opinions from a wide variety of people. Before you get too far down the path, you need to spend time thinking through what is really most important to YOU. What are the specific pieces that will ensure you find the right fit and have no regrets in the future? Taking time to think through the following decisions early on will help you keep perspective, and guide you as you move through the process to sell your business. Reason for Selling Make sure to document your true reason for selling.

• Is it because you have the opportunity to move on to something else and would no longer have time for this business?

• Do you wish to spend more time with your family and friends or just be out of the office with time for yourself?

• Have you been approached by a buyer, with an offer that will help you and your company make large strides it couldn’t achieve on its own?

• Is it primarily about realizing financial benefits that you’ve earned for getting the business to this point and want to be able to enjoy?

There is no answer that is right for everyone, but depending on your reason for selling, there may be large implications for what type of buyers you want to seek and what your role will be post-sale. Keeping these reasons in mind when evaluating buyers will help you keep perspective and make the best decision for you and your business. Your Role Post-Sale Some owners have a strong preference regarding their future role, or lack thereof, so now is the time to think about what your preferences are. Determine the perfect scenario, but also consider what you would and would not be willing to do if asked by a buyer.

Exiting the Business Post-Sale …transition period If your desire is to exit the business post sale, then you will want to be sure that the transaction you enter into is with a party and structure that allows you to leave the business in your desired time frame. This also means that either the buyer, someone else from your team, or someone the buyer brings in, will likely have to take over your role and duties. If someone needs to take over your role you will likely be asked to provide some level of training, or assist with transition, for a period of time sufficient for that person to get up to speed without having a negative impact on the business. In addition, if you have key

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responsibilities and relationships, a buyer may want to tie up a portion of the purchase price in some form of contingent payment to ensure the business can perform at a similar pace without you involved. Without that, the business may not be worth as much to a buyer. Remaining with the Business Post-Sale If your intention is to remain with the firm post-sale, whether that be in the same role or a different role, that needs to be communicated up front to buyers and factored into the discussions. Your role and compensation desires will not only impact the price, but also the type of buyer that may have interest in the business. In this scenario, you will need to think through how decisions will be made once a new buyer is involved in the business and discuss those thoughts with potential buyers. It is often hard for previous owners to transition out of the lead role after spending so much time leading day to day operations. We often see owners who remain involved in the business want to continue making key decisions but, if there is a new majority owner, they will want the ability to make those decisions. Are you ok with taking instruction from someone else? In addition, employees who are used to coming to you with issues, will now have a different leader buy may still have comfort coming to you with questions or for advice. Will you have the authority to give them direction, or will the new owner want those questions to come to him? This can be confusing and frustrating for employees. So thinking through these items will help prepare you for those conversations later when interviewing the buyers.

It is important you think through your role post-sale as well as any compensation you desire. You may have great value remaining with the business, and a strong desire to do so, but buyers will want to have these discussions up front to help determine their interest and structure the deal. Other Considerations When Selling a Business Over the years that I’ve been working with business owners, I find there are many motivations that influence the decision of who they sell to. Many of them have multiple motivations but prioritize them much differently. Here are some of the more common priorities that have surfaced. As you read through them, consider which, if any, may impact your decision enough to accept a lower price from a potential buyer. Then rank them in order of importance for you. This will be helpful for you to refer back to later in the process.

Rank Consideration Context Money The most obvious consideration is related to money. But it’s about more

than just highest price, it also whether or not you are willing to accept a portion of the purchase price in some form of contingent payment. Doing so may result in a higher total price, but may also delay, and potentially risk you ever, getting that portion of money. Some owners are adamant that they want 100% of the cash at closing. But they need to realize, for that to

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happen, it will likely result in a lower total price. (We discuss more on why this is the case in step 9 “Evaluating Offers”). We cover this topic in more detail in step 9 when we discuss evaluating offers and negotiating structure, but it’s important to start thinking about his now. The advisors you hire (in step 2) can play a major role in helping you understand what the current market is around structure and also what risks in your business may cause a potential buyer to ask for some sort of contingent payment. In addition, by thinking about this and surfacing potential risks early on, you may have time to address & improve them prior to negotiations with a buyer.

Employees A number of owners place strong importance on the future of their employees when selling a business. Particularly, they want to ensure they will remain employed in a good work environment under new ownership. These are the people who interact with customers, work behind the scenes and have helped shape the culture of the company. They are the people who have helped get you here. Sure, it's YOUR business but, I'd bet most of you didn't get to where you are all by yourself. There are a few, or many, others that made sacrifices along with you in order to get to this point and ensuring their future employment, happiness and success is often a big factor for many owners. Will you be ok if a buyer has some of its own employees, creating duplicate roles and resulting in them laying off some of your employees? What if the buyer’s plans include taking the business in a direction that will require less employees, maybe replacing a number of them with technology?

Culture Good or bad, every business has a culture that has been created over the years. Culture is an area I often see overlooked in companies of all sizes. But a good, strong culture can have a major impact on the business, including employee productivity and morale, both now and in the future. Some owners and leaders intentionally focused on creating a specific culture at their firm that they and others enjoy and also helps them attract and retain employees. For others it happens unintentionally and was strongly influenced by the example you set as the leader, and further developed by the types of people who were hired over the years. Culture could have been formed by your strong or weak work ethic, positive or negative attitude, open communication and social efforts, birthday and holiday celebrations, team building events, casual Fridays, or even as simple as noticeably having a smile on your face when walking through the office. Some firms have been recognized as a “Top Place to Work” because of the culture that’s been created. For owners that realize they have a strong and beneficial culture within their

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firm, I often see them have a strong desire to ensure that any new ownership will align with this culture, even potentially enhance it, so that it can remain a strength for the company in the future.

Customers / Clients

I’ve heard a number of owners talk about how important their clients are to them and how the future service they receive is vitally important to them. Some have shared how the business wouldn’t have even been able to make it through the first year without a few early customers who gave them a chance and put their trust in them early on. Others have shared the amount of time and effort they put into acquiring certain clients and the promises they made to them, or the amount of time and money that’s been invested into working successfully with certain clients over the years, and to sell to a buyer that neglects that investment would be a waste. Others simply value the loyalty that all of their clients have showed them over the years, often times that loyalty allowed them to grow and expand in ways it couldn’t have without them. To sell to a buyer that doesn’t place the same level of care in servicing those clients would be unacceptable to some owners.

Company Name

Some companies have been passed down for generations, or have other deep reasons why the name of the company is part of the legacy that is so important for them to ensure lives on. Often times the name represents more than just letters on the sign, it’s a name, a meaning, a brand, or image that has deep meaning to an owner. Different types of buyers may have different plans for the future of your business or even their own business that your company will become a part of, resulting in the company name dying completely. Others may value the name and want it to live on, whether they already have their own company or not. If the name has intrinsic value for you, it may be important for you to understand what the buyer’s intentions are for future use of the name.

Social Impact I continue to be impressed by the larger meaning that some owners communicate their business has for them based on the impact that it has on society or other people. Some owners had the knowledge and passion to create something with positive and meaningful impact for the greater good of humanity, or a specific portion of the population. To deviate from this purpose would eliminate the entire reason for starting the business. If you were to sell to a buyer who didn't share that same passion, or worse, didn't even want to continue pursuit of that original mission, it may never reach the level of impact that you desired which may leave you with major regret.

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Other Each owner likely has other reasons that are important to them. There are no wrong answers, just potential trade-offs you may have to make at the end of the process to ensure your priorities are satisfied. Add whatever other priorities that you may have as you sell your business.

Many of the considerations mentioned above, and many others not mentioned, may come from a buyer who is willing to pay a higher price, but may not accommodate your preferences. How much money is that worth to you? Or will that completely prevent you from moving forward with that buyer? There is no one right answer, but having thought about this ahead of time with a clear mind (not under stress of the process and intense negotiations) will help guide you through all of the external noise and stress when it comes times to evaluating offers and deciding how to move forward. I encourage you to take some time with this, discuss it with your spouse, family and friends. They can often times help put this in perspective because they know you well and can provide an unbiased opinion. It will also help ensure you have no regrets after all is said and done because you were well prepared. It may mean that you accepted a slightly lower overall price but will help ensure you are completely comfortable that you made the right decision for years down the road. Once you've taken the necessary time to think about the answers, write them down, and refer back to them throughout the process. It’s quite possible that you learn some things throughout the process which alter your opinion - and that's ok - but remember the thought you put into these answers and why you chose them.

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STEP 2: ENGAGE PROFESSIONAL ADVISORS

After you’ve taken time to think about your priorities when selling your business, it’s time to start aligning yourself with people who can add value during the process. There are a number of people who want to help you sell your business and get paid to do so. But who are the essential parties and what do they offer? First off, if you are a business with over $5,000,000 of revenue you are likely large enough and sophisticated enough to benefit from outside advisors instead of trying to do it all yourself. Engaging professional advisors at this early stage of the process can help prevent mistakes and provide valuable guidance as you move through this process. Secondly, the value and guidance you get from GOOD advisors will be well worth the investment. Quite often I see owners delay engaging advisors because of the time and money it takes, but I am confident that involving them early will save you time, money, stress and regrets later in the process. So, think of it more as an investment. Process of Hiring Advisors: It is important that you take the time to identify good advisors for your specific firm and situation. We recommend interviewing at least 3 professionals in each category before making a decision on who to hire. Even if you already work with an attorney or an accountant, it will be beneficial to hear perspective from others. At the worst, you invest a little time to ensure you made the best decision, and you may end up discovering someone who will be much more beneficial to you throughout the process. Seek out advisors that have specific experience working with both firms of your size and within your industry. Different size companies and different industries have unique attributes that some may not be as familiar with. Working with someone familiar with multiple aspects of your business can help ensure you consider all relevant factors and don’t overlook key areas.

Note: Although we suggest you engage advisors early in the process, this does not mean that you need to put them on the clock and rack up large costs too early. Actually, we would encourage you to not let them spend hours doing a lot of up-front work such as deep analysis that results in large costs, it’s too early for that.

Talking through their process, services, prices and timing up front will help you determine which advisors are likely the best fit for you. In addition, these interviewing discussions will likely provide you with valuable insight which should help you throughout the process.

Once engaged, good professional advisors should be able to help you understand key questions and guide you down the right path, but the majority of their services and costs can wait until buyers have been lined up.

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Who Can Help Sell My Business? The two most important advisors to engage in any business sale are an attorney and an accounting professional. Whether or not you involve an M&A advisor, business broker or investment bank is ultimately up to you, but we will discuss details of that decision in this chapter. Attorney Hiring a good attorney is essential for selling a business. When I worked as a buyer, I highly encouraged the seller to engage his own legal counsel as soon as possible, and often required it as a prerequisite to us proceeding further. This is because there are a variety of decisions, issues and documents that will come up throughout the process and, if the seller doesn’t have his own legal counsel, key items may get overlooked and the process may get delayed. Business attorneys often specialize in certain areas, but most can provide professional guidance in a number of relevant areas including:

Preparation

- Deciding on whether to do a stock sale or asset sale and what implications that may have for you now and in the future.

- Ensuring organizational documents are up to date and fill in any missing information. As a seller, you "represent" they are complete and up to date as part of the sale.

Initial Structure & Negotiations

- Reading through offers and legal documents presented from buyers to ensure appropriate language.

- Editing and approving language in the term sheet

- Depending on the attorney, some may be willing to help structure and negotiate some of the terms of the sale.

- Documenting the agreed upon terms of the sale.

- Inserting adequate protections when considering any form of seller financing.

Business Specific Items

- Dealing with intellectual property and the potential transfer of these items.

- Drafting, reviewing or approving employment agreements, non-compete agreements, promissory notes and customer contract details.

Closing & Beyond

- Editing and approving language in the purchase agreement

- Addressing the nature of representations and warranties (often referred to as "Reps and Warranties")

- Ensuring final documents get signed and the appropriate money gets exchanged on time

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When interviewing business attorneys be sure to understand which services they provide and how much experience they have performing them with businesses of your size and in your industry. Accountant Depending on the size of your firm, you may already have a sufficient accounting expert on staff. Either way you need to be sure the accounting professional you rely on has sufficient expertise to assist throughout the sale process. Some key areas that accountants serve in the sale process are:

Prepare clean and accurate financial statements

As we cover more in step 4, the sale process will require that you share detailed financial statements with various parties, including the valuation professional and potential buyers, throughout the process. Having professionally prepared financial statements, along with documented accounting systems and controls, also helps your company seem more professional and well run, which can enhance a buyer’s image and potentially impact offer price. Note: that many buyers and lenders will require “audited” or at least “reviewed” financial statements which will require the use of an outside accountant.

Prepare and validate other financial information requests

A variety of requests for financial information will come up during the process including during due diligence. These may include requests such as revenue recognition policies that need to be in compliance with GAAP, accounts receivable aging schedule, adjustments to “normalized” earnings, list of capital expenditures and details of working capital. A common request from a potential buyer is that revenue and profitability be broken down by customer, location, product and/or service. Ensuring these numbers are accurate can have a meaningful impact on final price.

Determine accurate purchase price allocation

This ensures the most effective tax treatment when selling a business. Purchase price allocation includes determining the value of tangible and intangible assets, including any write-ups, on the balance sheet. The difference between purchase price and the value of assets is allocated to goodwill. There may be different tax treatments resulting from your purchase price allocation, so ensuring this is correct can greatly impact the amount of money you walk away with.

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In addition, the calculations for purchase price can get complicated if the structure of your deal contains an earn-out or other similar forms of consideration.

Assist in preparing future financial projections

It’s often helpful and necessary to have an accounting professional able to assist the buyer and any lenders in their evaluation of the company. Since you likely have the most knowledge about your business and how it may perform in the future, buyers will often ask for projected financials. This may include various scenarios given certain different assumptions. There are many considerations that go into accurately projecting financial numbers and a good accountant can provide guidance to ensure you are accurately communicating expected performance.

Who Will Sell My Business? Some owners may decide to sell their business on their own and others will prefer to hire an expert. The right answer for you may likely depend on the size of your business and the time and expertise you have to prepare the information and handle all of the inquiries and negotiations. My opinion is likely biased, but I strongly believe a good M&A Advisor can add significant value above and beyond the cost of using one. Doing It Yourself If your business has fairly simple operations and revenue below $500,000 or so, you may consider selling it yourself. If you choose this option there are online resources that will allow you to post your business on their site for a fee and will forward interested parties to you. The cost of this service is around $150 per year and may offer other options for an additional cost. With this method, you are hoping that the right buyer comes to the site, at the right time (when your business is posted) and is open to working a fair and straight forward deal with you. You will be the person that puts together all of the marketing materials, and once you have the listing up and start getting interest from outside parties you will be the one that has to answer all the calls, respond to the emails, coordinate NDAs, send out them information and move any qualified buyers through the process. If you haven’t been through a sale before you will quickly learn that there are typically a lot of parties that claim to have initial interest, but either they don’t really have the money to buy it, or don’t have the genuine interest to actually move through the process and make an offer. These non-qualified and non-serious buyers will typically be the majority and end up getting you nowhere. And that is in addition to those who claim to have interest in order to get information on your business so they can use it to help themselves in one way or another. In my opinion, smaller businesses may choose to go to market themselves and get away with this, but for businesses over $5MM revenue there is enough money on the table, complexity in the business and sophistication among buyers that working with an M&A Advisor can provide a lot of value.

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Note: It’s extremely important to ensure the business continues to operate successfully during the sale process. If you are still involved in the operations of the business, any time you spend trying to handle the sale yourself is time taken away from the business.

Who Can Sell My Business for Me? What type of expert you hire will largely depend on the size and sophistication of your business. The types of parties that you may choose to work will fall into the category of Business Broker, M&A Advisor and Investment Bank. Types of Intermediaries

All of these parties will perform services to help you prepare and sell your business, but the difference is in the types of service you receive, the level of expertise they bring and the amount of money they charge you. The cost of selling your business can largely depend on what type of professional you hire and the level of sophistication they bring.

What Do Investment Banks Do? Investment banks tend to offer a broader range of services and are more involved in all stages of the process through various members of their team. Some of these services may include public offerings or services only applicable to public companies.

They will typically put together a longer and more detailed book, help manage the diligence process and be more involved with targeting and negotiating with buyers. Outreach is very proactive to qualified parties and the process is very organized and planned out. An investment bank often will use its resources to gather a pool of interested parties, then run an auction type format where buyers submit offers in an effort to create additional competition. As indicated earlier, not all offers are the same and the value offered can come in more forms than just total price, so knowing what is most important to you will help here.

Investment banks will often create a number of valuation model scenarios for you, indicating a range of possible valuations under different circumstances. Also, if any external financing is needed, the investment bank can handle raising or facilitating additional capital from other

Investment Banks

•Size: Over $50,000,000 of revenue.

•Typically focus on larger firms, public companies and more complicated transactions.

•Although some of the larger investment banks have minimums at $250,000,000 or more of revenue.

M&A Advisors

•Size: $5,000,000 -$100,000,000 of revenue.

•Typically focus on small to mid-size companies.

•These tend to be established companies with a history of profitability and are often times still founder owned.

Business Brokers

•Size: Under $5,000,000 of revenue.

•Typically focus on smaller companies.

•Common types of companies may include hair salons, franchises, gas stations, restaurants and convenience stores.

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sources. Due to these additional services and more complex structures, the regulatory bodies require investment banks to formally register with FINRA and carry certain licenses.

How Investment Banks Make Money Investment Banks typically have minimum fee requirements which is why they usually work with larger companies, more complicated transactions and public companies in order for their fee level to make sense.

It is common for an investment bank to charge a retainer, paid monthly or in a lump sum, at the beginning of the engagement and a success fee that is paid as a percentage of final price at closing. This larger fee is partially because they have to pay a lot more people who are involved in the transaction. In addition, the more sophisticated transactions require more tools, research, and data in order to complete the process.

The amount charged by investment banks will often depend on the complexity of the transaction, but even a smaller investment banking deal would likely be charged a $50,000 retainer plus 5% of the final sales price. The retainer also helps offset costs during the process and separate serious sellers from those just looking to see how much their firm may be worth.

What Do M&A Advisors Do? M&A advisors & IBs are similar in their offerings, though there are certainly some differences. M&A advisors bridge the gap between the smaller businesses that are sold by business brokers and medium to larger size businesses that are clearly led by large investment banks. Similar to investment banks, good M&A advisors maintain relationships with a variety of firms, who are actively seeking opportunities in the space. Rarely do M&A advisors simply place ads on a website. Their marketing process involves proactive, targeted outreach to multiple qualified buyers in order to generate competition and drive a higher price. M&A advisors can help you understand valuation and structure expectations within your industry in the current market environment. M&A advisors and investment bankers typically sell companies to other companies, or institutional investors like private equity funds and family offices. The transactions involved at this size and stage of the market tend to be somewhat complex and require a level of sophistication and understanding in corporate finance not commonly found with brokers serving smaller companies.

M&A advisors will commonly draft a comprehensive “book” or “CIM” (Confidential Investment Memorandum) that communicates information about the company to potential buyers. They are often actively involved throughout the due diligence process, and are knowledgeable and experienced enough to be heavily involved in price and structure negotiations.

Depending on the transaction structure, some lower middle market transactions do not require the advisor to be licensed under the securities laws. You will find that most M&A advisors are not licensed and are not required to be.

How Do M&A Advisors Get Paid?

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Although the typical fee charged by M&A advisors can align with either the investment banking model or the business broker model, we tend to see the success fees fall in the 3% -7% range with some charging a reasonable retainer ($3,000 - $10,000) to ensure the parties are serious sellers and will work towards a speedy close.

What Do Business Brokers Do? Business Brokers primarily sell smaller companies that are commonly income replacement for the owner. These types of businesses are often sold to an individual buyer and therefore are valued on a basis of Seller’s Discretionary Earnings (“SDE”) rather than using EBITDA. The level of marketing is typically simpler in nature and tends to involve more one-off negotiations with individual buyers. Business brokers may advertise to prospective buyers on your behalf but, compared to investment banks and M&A Advisors, this is minimal and relies more on incoming interest vs outgoing connections. Oftentimes, these efforts are more of a passive process where the broker lists their deals on a website and reactively respond to inquiries. If external financing is needed, the buyer is responsible for making his own arrangements.

What Are Typical Business Broker Fees? Business brokers typically function like Real Estate brokers and get paid only a success fee, so if you don’t complete a sale there is no charge. Because of this, they may be working with a number of businesses at the same time since they aren’t sure if or when any of them will actually sell. It’s common to see business brokers charge 8% - 10% of final sale price as a success fee. The reason this amount seems high as a percentage is because, due to the smaller size companies they work with, they need to charge a higher percentage in order to hit an absolute dollar amount that makes the effort worth their time.

For Example, if your business is sells for $400,000, then a broker would need 10% in order to make $40,000. And although $40,000 may seem like a lot of money, this amount often covers numerous months, or even years, of work along with various costs throughout the process. Other common pricing methods for business brokers includes the Lehman Formula, the Double Lehman, the Double Percentage Lehman (“Modern Lehman”) or some modified variation. The reason for the sliding scale is so the broker is ensured to get sufficient compensation for their efforts, but not to charge the highest percentage on the entire amount. The traditional Lehman Formula charges:

- 5% of the first $1,000,000, plus - 4% of the second $1,000,000, plus - 3% of the third $1,000,000, plus - 2% of the 4th $1,000,000, plus - 1% of the remaining amount over $4,000,000

The Double Lehman simply doubles the percentage at each interval:

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- 10%, 8%, 6%, 4% and 2% of any amount over $4,000,000

The common formula used today is the “Modern Lehman” which charges: - 10%, 9%, 8%, 7%, 6%, 5%, 4%, and 3% of any amount over $8,000,000.

The common criticism with the declining formulas is that it does not align incentives for the broker to push for a higher price, since they get less and less of each incremental increase. I have engaged with sellers who actually offered to increase the percentage for any portion above the targeted asking price, which seems to align incentives better. But there is no one right way to price and many of these fee schedules are negotiable.

Using an intermediary helps remove emotion and provide objectivity into the process. They allow you to focus on your business, to keep it running at a high level until final sale, the importance of which is discussed in chapter 6. They can help create marketing materials, handle communication with interested parties and help you understand which offers are fair given the current market environment. In addition, intermediaries can help protect the identity of the seller and ensure that all information is kept confidential at all times. Finally, even if they aren’t directly involved with negotiations, intermediaries can help create a level of competitiveness among buyers without impacting your relationship with any of the parties.

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STEP 3: UNDERSTAND AND CONSIDER ALL OPTIONS FOR A SALE

If you've followed the steps and engaged good advisors, they should be able to add considerable value for you in step 3. Now that you've thought about what’s most important to you, the advisors can help you understand all of the different options when selling a business and the impact they could have on achieving your goals. Different options will have a different impact on your tax bill, your role within the business, the future success of your company, and many other important considerations that you should understand to ensure your long-term satisfaction with the outcome. Although this is not meant to be an exhaustive discussion of all the options, we would like to highlight a few considerations and some of the impacts they could have. Tax When Selling a Business A common question that comes up early on is How is selling a business taxed? The answer depends on a number of factors including what type of sale you agree to. *Please note: we are not attorneys or tax advisors, this is not an attempt to provide legal advice, but rather some general information that should allow you to think about, and engage a tax advisor to help you determine, the impact on your specific situation. At a basic level, the amount of tax you will owe after selling your business depends on whether your gains are treated as capital gains or ordinary income. Going a bit deeper, when you agree to a final price with a buyer you will need to allocate the purchase price (as discussed in chapter 2) to tangible assets, intangible assets and goodwill. The results of this allocation will determine how much of the price is treated as capital gains vs. ordinary income (another reason hiring professional advisors is often worth the money). It is often the case that the better the tax situation is for the seller, the worse it is for the buyer & vice versa. This is why type of sale, and negotiation with buyer, is a very important part of any sale and you should be utilizing professional advisors to get advice on what’s best for your situation. Types of Business Sale When selling your business, you will need to determine whether the transaction will be structured as an Asset Sale or a Stock Sale. The implications of which will affect your tax bill and may likely also affect the total price you receive. Keep in mind that a buyer will often have a preference on this decision and it may often be opposite of your preference because of who is receiving the most benefit. This can be a major negotiation point and should be evaluated with knowledgeable professionals.

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Asset Sale In an asset sale, the buyer purchases individual assets of the company such as equipment, inventory, licenses, goodwill and customer lists. Asset purchases are usually cash free and debt free meaning that the cash (or a specified amount of cash) remains with the seller and the seller is still responsible for all of its outstanding debt obligations. A couple areas of negotiation in an asset sale is how much cash is considered “operating cash” vs “excess cash”, and what amount of working capital is needed to operate the business at a similar level. The operating cash often remains with the business and is included in the purchase price, while the excess cash remains with the seller. In addition, the buyer and seller should work together to determine the appropriate amount of working capital that should remain with the business.

Note: Even stock sales of LLCs are taxed as asset sales. Stock Sale In a stock sale, the buyer purchases the stock of the company. In this structure, the buyer obtains all of the assets (including cash, permits and company name) and all of the liabilities (including any past or future legal issues). Although a stock sale is more straight-forward, the tax consequences are quite different from an asset sale for both the buyer and the seller. Here the buyer does not receive the step-up in basis on the assets, which may result in them offering a lower overall price. In addition, with a stock sale the buyer could be inheriting unknown past liabilities and other negative issues that may surface in the future. Due to these facts, I have seen a number of buyers push for an asset sale, and potentially even offer a higher price for using that structure. 338(h)(10) Election Since a major difference between the Asset Sale and Stock Sale is the tax impact for both sides, Congress enacted Section 338 to allow taxpayers to treat certain qualified stock purchases as asset acquisitions for federal income tax purposes. This election typically comes into play when there is either a strong preference from the seller to pursue a stock sale and/or when the buyer would have difficulty completing an asset sale but still prefers the tax benefits from that structure. The 338(h)(10) election is only available for certain S corporations. There are also certain implications and procedures to follow when making the 338(h)(10) election, so it is important to talk with a qualified expert about the details of your specific situation. Who Can I Sell My Business To? When selling your business there are a variety of different buyer types and each has different advantages, disadvantages and considerations. Below is an overview of the most common buyer types that you may come across. If you took time to analyze your priorities in step 1, those results should help you determine what type of buyer(s) may be best for you in this step.

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Note: Although some types of firms may fall into a particular “category” we would caution you from assuming all firms in each category have similar goals. Each potential buyer is very different and has different time horizons, strengths and goals that should be thoroughly understood before making a determination as to fit.

Internal Buyers May include selling to your other partner(s), management, a key employee or all employees.

Selling to Management or Other Partner(s) Some firms have internal candidates, including management or other employees, who may have both the interest and the financial means to acquire the company.

Potential Advantage(s) When selling to management, an employee or other partners you often have a better understanding of who the buyer really is and may be more comfortable that there will be less disruption to the day to day operations because that person has already spent time working in the company.

Potential Disadvantage(s) With an internal sale there is often not enough funds readily available to fully buy you out leaving the seller to carry a significant seller note to be paid over time. Selling to one person, or not offering to others, could leave others feeling left out or less important and potentially cause some internal issues amongst remaining individuals.

Potential Considerations Are the right people already in the firm that could successfully run the business in the future and that have interest in acquiring it? Has there been any prior arrangements (funding a buy-sell agreement, etc.) which will help create the necessary funds to purchase the company. If not, it may be quite difficult for other individuals to come up with the necessary funds and therefore needing to rely on bank debt and seller financing.

Selling to an ESOP (Employee Stock Option Plan)

Selling to an ESOP basically means selling to your employees by using a qualified retirement plan that must invest primarily in the stock of your company. This happens by the company making cash contributions to the ESOP trust, which the trust then uses to purchase the owners shares.

As the seller you typically receive majority of your payments from a promissory note from the ESOP paid out over time. In addition, if the business can support debt it may be able to borrow some of the purchase price from a bank so that larger amounts of stock can be purchased at once.

Potential Advantage(s) The cash contributions from the company to the ESOP are typically tax deductible.

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If your business is a C corporation, reinvesting your gains from sale may be tax-deferred if reinvested into certain other securities. If those purchased securities are held until death then there may not be any capital gains tax due. If your business is a S corporation you may effectively never have to pay income tax if certain conditions are met. An ESOP is also a way for the firm to remain with the employees. This can often help ensure the culture, name and level of service continues without disruption.

Potential Disadvantage(s) The above-mentioned tax benefit may not apply if the company remains a S corporation. In addition, by using an ESOP the payments you receive will likely be gradual as the company can afford to pay down your promissory note. The business may alternatively choose to take on debt, which would require a steady cash flow and profitability, but I’ve seen a number of owners simply not want to put a large debt burden on the company. In addition, selling to an ESOP does not always result in as high of price as when selling to external parties. ESOPs, because of the tax advantages provided, are often subject to additional scrutiny and regulation.

Potential Considerations Does your business have strong management beyond yourself? There will need to be others that are able to profitably run the business in your absence in order to service the debt (for your promissory note and/or for bank debt). Are there enough other employees in your firm to make it work? It is fairly complicated to set up an ESOP for a company with less than 15-20 employees. How long do you wish to remain with the firm? Owners who choose an ESOP are typically a number of years from retirement and want to stay involved in the business for a while. The ESOP typically allows them to take some money off the table but usually requires them to wait a number of years before receiving the full amount. So, if you can’t, or don’t want to, wait for the majority of your money this option is probably not right for you.

Strategic Buyers Include outside companies that are currently operating their own business. This may be a direct competitor in your industry, a firm from a different industry or even a supplier to your company. The classification of strategic buyer refers to their focus on how your company (clients, assets, core competencies, technologies, etc.) may fit with their company and enhance their current operations.

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Selling to a Competitor Often times another firm within your industry will have the desire to acquire you and your customers. This may be to acquire your customers or simply to reduce competition.

Potential Advantage(s) They know the industry and have experience running a business like this and serving customers like yours. In addition, they may gain synergies from acquiring your firm which will allow them the ability to pay more than other buyers who wouldn't realize those same synergies.

Potential Disadvantage(s) The competitor may not have the same level of care for your company and/or employees, but may be more interested in obtaining your customers or gaining other benefits from your firm.

Potential Considerations Many deals don’t go thru for various reasons. If you start down the path with a competitor, and they don't move forward, are you comfortable with them now having detailed information about many aspects of your business.

Selling to Another (Non-Competing) Company Companies in other industries often have interest in expanding their offerings or moving into different areas and one good, quick way they can accomplish this is by acquiring a firm already established in those areas. In addition, suppliers and companies in related industries may be looking to vertically expand into different parts of the supply chain, or horizontally expand into new geographies or product/service lines.

Potential Advantage(s) These types of firms may also gain synergies or access to

different (complimentary) markets/products/services by acquiring a business that helps position them better. This may also give them the ability to pay a higher price for the business than some others.

Potential Disadvantage(s) Similar to a competitor, another existing company may not have as much interest in certain areas of your business, or in retaining all of your employees. Rather they are more interested in obtaining access to the markets/products/services that you offer.

Potential Considerations Similar to a competitor, if you start down the path with this type of firm, they may determine they’ve learned all they need to in order to move forward on their own - without buying you. In addition, the industry they currently operate in may be very different to yours and doesn't work for your customers. They may take the business in a direction that your employees are not prepared or trained for.

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Financial Buyers Include groups like private equity firms and family offices. The classification of financial buyer refers to the return they seek from eventually selling the business and the cash flows the firm generates in the meantime. Although this type of buyer often gets criticized as focusing more on returns, there are a number of very good firms with very intelligent and experienced operators that are motivated and incentivized to make great decisions for the firm that lead to long term value creation. Financial buyers can be a great option for founder led firms that are considering the first outside ownership. The experience, expertise and large amounts of capital they can bring to the firm can often times help it become more professionalized and take advantage of opportunities that went unaddressed by original management.

Private Equity (“PE”) Firms Is typically a group of individuals with experience owning, operating or at least investing in companies; who have raised money from other investors and maintain that pool of capital in a formal "fund". In return for their money, these investors are promised a return on their capital within a specified time period. To achieve this return, the private equity group evaluates business opportunities in which to invest the investors’ money, usually based on some predetermined criteria (industry, size, etc.) This is why PE typically has a shorter-term investment horizon (often 3-5 years) for each investment, and focuses on making as many value enhancing improvements as they can, because they need to generate a return for their investors within a specified period of time. Since the PE fund managers have the discretion to invest the dollars as they see fit, the investors typically take time to evaluate them to ensure they have the necessary skills to make decisions on their behalf. If the managers exceed their targeted return, they are typically able to share in a portion of the profits above that return, which is called the “carry”. Achieving strong performance in their current fund will also allow the managers an opportunity to raise an additional fund in the future.

Potential Advantage(s) Private equity firms typically have experience investing in and

operating similar companies and have the business knowledge to make a number of value-enhancing improvements. In addition, private equity funds need to invest their capital in order to get a return for their investors (they don’t generate returns until they invest the money). This means they are typically motivated to get the deal done, can move relatively

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quickly and are often willing to pay a full price. Finally, since these types of firms typically have access to a large pool of capital, they are willing to make necessary investments into the company in order to help it achieve sustainable growth.

Potential Disadvantage(s) The historic perception has been that some PE firms rely more on cost cutting and short-term revenue boosts to enhance value until they sell. This could include laying off people in the firm that they feel aren't needed, or changing the way key things are done within the business in order to drive revenue and enhance profitability. While there are some firms that engage in activities like this, most realize that is not a great way to generate sustainable value and they would quickly develop a reputation in the industry that would hurt them when competing for deals.

Potential Considerations Take time to understand their plan for the business and what changes, if any, they intend to make. Ask about what other businesses they have invested in, what approach they took to growing them, and how long they held them before selling.

Family Office A single-family office, as defined by Investopedia, is a business run by and for a single family. Its sole function is to centralize the management of a significant family fortune. Simply put, a family office maintains a staff of people who are responsible for investing the wealth of one or more ultra-high-net-worth families. Throughout history many wealth families such as the Rockefellers operated a family office structure. Today they continue to gain popularity as more families choose to keep management of their wealth in-house. Some of these family offices gained their wealth from starting, running and/or growing businesses - maybe similar to yours - so their background is in doing exactly this - so they invest their own money. Others may have been inherited their wealth or gained from some other non-related activity in which they will often hire an experienced person or team to make investment decisions for them.

Potential Advantage(s) Because family offices invest their own money, they typically have a longer-term investment horizon. (For example, I know some family offices that have held businesses and/or other investments for decades). This means they don’t need to generate returns in a specific time period in order to return capital to investors and can enable them to focus on value enhancing decisions that have a longer payoff period.

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Potential Disadvantage(s) As with all other types of investors, family offices can vary widely in the amount of expertise they bring and the plan they have for your business.

Potential Considerations Make sure you understand who would be involved in the day to day operations of the business, what their plan is for the business what their intended holding period is.

Other Buyer Options

Individual Buyer An individual buyer may be someone who’s previously worked in the industry, owned a company in the industry, or has no relevant industry experience. An individual buyer will usually be using his own capital for all, or a portion of, the purchase price and relying on either bank financing (if available) or seller financing for the remaining portion. This type of buyer is often acquiring the business as a source of income and will likely participate in day to day operations of the business.

Potential Advantage(s) This type of buyer has often committed a meaningful portion of his net worth in order to purchase the business or obtain financing. Some sellers like the entrepreneurial spirit that an individual buyer brings and feel they will be most committed to the long-term success of the company. This type of buyer may also be very willing to understand and continue your vision for the company.

Potential Disadvantage(s) An individual buyer may not have the funds to make as attractive of an offer as other potential buyers, requiring a larger amount of the purchase price be carried in a seller note. This type of buyer may also not have enough relevant experience in the industry, or even with leading companies in general, to be an effective leader for your company.

Potential Considerations Will the structure of the offer require you to stay on board for a longer-term transition period so they can learn the business? Does he/she have the same vision for the business and the skills to execute it? Knowing your employees and other management, will this person be able to effectively lead the company and gain the respect of others?

Selling to a Search Fund A search fund may be a category you have not heard of before, but the model has been around since 1984 and there have been a number of search fund acquisitions that have performed extremely well.

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A search fund is an investment vehicle through which an entrepreneur raises funds from investors in order to acquire a company in which they wish to take an active, day-to-day leadership role. These entrepreneurs are typically a MBA graduate from a top tier school, or other experienced operator/CEO, often with experience in the particular industry.

Potential Advantage(s) This type of buyer can bring benefits of both the private equity firm and the individual buyer.

The “searcher” commits an important period in his life to identifying and running a business that he feels he can add significant value to. He manages the day to day operations and is often very willing to understand your future vision for the firm.

In addition, the typical investors into search fund are highly experienced operators and investors, many of which have built, acquired or currently operate successful companies. Some of them will sit on a formal board and can help mentor the CEO. The search fund model often provides the seller more flexibility in structures, the opportunity to roll equity and the possibility of joining the board. The group is willing to pay a full and fair price for your business and is often willing to make necessary investments to help the firm succeed in multiple ways.

Potential Disadvantage(s) Some of the searchers may be younger and this may be their first experience as a CEO leading to a slight learning curve. While many owners appreciate and value a young, motivated, entrepreneur some owners prefer to sell to a group that has significant experience in the industry or a leader who has previously been a CEO.

Potential Considerations Understand who the CEO will be and their experience in the industry and in leadership roles. Understand who the investors are and who will make up the board. Often times these are highly successful individuals with a lot of value to offer the group.

Each of the parties listed above, and potentially others not mentioned, could be a good candidate to purchase your business. Each type of buyer likely has different reasons for the acquisition, things to offer your company and priorities after the purchase. Understanding some of the strengths and weaknesses of each type will help you prepare and ask better questions during the process to ensure you find the best fit for your business.

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Section 2:

Preparing Your Business For Sale

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STEP 4: PREPARE FINANCIALS

Once you've spent sufficient time prioritizing what's most important to you, engaged an advisory team and understand all of your options, it’s time to get started on preparing your business for sale. I often see the “valuation” step listed before preparing financials, but in order to complete a valuation you will need much of the same financial information. Preparing financial information often takes time, so it is listed as a separate step. I highly recommend working with an accounting professional during this step to ensure all of your financial documents are accurate, organized appropriately and align with GAAP principles. These may seem fairly simple and straight forward, but a small mistake in the financials will surface later in the process and it’s better to get them figured out so they don’t delay progress, or potentially alter the offer price, later on. In addition, organized and accurate financials make your business appear more professional, not only to buyers, but also to the valuation professional when determining how to value the business for sale. Some of the intangible value of a business can be showing you’ve maintained organized systems and accurate financials.

Financial Statements Needed – at a Minimum At the very least, when preparing a business for sale, you will need the following financial statements: 3 Years of Detailed Income Statements The Income Statement details the financial earnings performance over a period of time for the business. Although a summary of this information may be sufficient in early stages of the sale process, once engaged with a buyer they will want to see the full detail in order to get a more thorough understanding of business operations. Three years is usually the minimum amount of time needed to show the recent financial performance of the company. The Income Statement should start with a revenue line for each product and/or service you provide and these should be consistent for all prior years. If there was an addition or deletion of a line item over the years, this should be easily identified in the statements. Each expense should be listed in its own line and should be further categorized into Cost of Goods Sold (“COGS”) and Operating Expenses (“OpEx”). For some businesses, expenses can be further grouped into related sub categories. Most Recent Balance Sheet The most recent Balance Sheet reveals the financial status of a business at that point in time. It shows what the business owns (assets) and what it owes (liabilities), with the difference being the amount of equity that is in the business for the shareholders. At a minimum, the Balance Sheet should list:

• Current Assets • Fixed Assets • Other assets • Current Liabilities • Long-term Liabilities

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• Shareholder Equity The reason these two documents are so important is that they tell the story of how well your business has been doing to this point and what type of financial situation you are currently in. These two documents alone can tell a buyer a lot about your business to determine if they have serious interest or not.

Note: Although not required in every situation, it is best, and often requested, to have "audited" or at least "reviewed" financials. Engaging a good accounting professional can help prepare this information. In addition, both the recent income statement and balance sheet information is typically requested on a month by month basis. This makes it easier to assess during financial diligence.

Other Financial Information Commonly Needed 5+ Years of Income Statements It is most helpful to provide multiple years of income statement as the buyer will want to see how the business has performed over a longer period of time. Companies that have been able to sustain revenue and profits over multiple years and through various economic conditions will be more attractive and have more value to buyers. Most prudent buyers understand that some businesses have a correlation to the economy (or other specific factors) and your financials will reflect that correlation in its numbers. But if you tell them that your business is not tied to the economy, or the rest of your industry is only mildly correlated to certain factors, then the historical numbers for your company should back that up. 3-5 Years of Balance Sheets It is helpful to provide 5 years of balance sheets because the additional years of detail can help a buyer (and the valuation professional) understand how you've used debt and cash over the years to support and grow the business and how much capital has been invested to get the business to this point. Multiple years of Balance Sheets also helps a buyer calculate working capital needs and establish a working capital "peg" when it comes time for the closing. In addition, the balance sheet provides insight into how you are depreciating assets and how fast you are paying accounts due and collecting on accounts owed.

3-5 Years of Cash Flow Statements The Cash Flow Statement shows where a firm is generating cash and where it is spending cash. It also breaks down if that cash was generated from Operating Activities, Investing Activities or Financing Activities. The Cash Flow Statement can be helpful in providing additional insight into the business including what the Capital Expenditures have been and what they may be in the future.

Projected Financial Numbers Most buyers, lenders and valuation professionals will also want to see future projections that you have

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for your business. The value of any business is its ability to generate future cash flows and, since it’s likely that no one knows your business better than you, understanding how you see the top and bottom lines evolving in the future should provide good guidance of what future cash flows are likely to be.

Note: I would caution you to be very honest in order to generate as realistic projections as possible. These projections could be the basis for determining your earnout. You should have key assumptions and data to support your projections and be able to communicate what they key "drivers" are for your business. A good M&A Advisor should be able to help you understand, articulate and project these drivers effectively for external parties to understand.

Details of “Adjustments” Needed to Reach “Normalized” EBITDA A number of businesses have some expenses within their financials that are either non-business expenses or one-time/non-recurring expenses. These types of expenses should be adjusted, or “added back” so that one can assess what your “normalized” financials look like. This will also help when determining how to price your business for sale. Non-business expenses may include items such as: the owner listing his personal vehicle or personal vacations as an expense, or there may be a family member that is paid from the business but doesn’t really perform services to justify that compensation. Although these types of expenses are not supposed to be run through the business, we do see this quite often with small, privately owned companies. One-time/non-recurring expenses result from activities that fall outside a company’s normal activities and are not likely to recur in the future. This may include one-time costs for relocation, a bank or legal penalty, a consulting engagement or company training.

Once you have identified all of the necessary adjustments, you can determine normalized numbers. From there you can calculate normalized EBITDA which is the number buyers will want to understand.

As we will cover in more detail in the chapter on valuation, the best measure of value for a business is its ability to generate future cash flows. Many buyers use EBITDA as a measure of cash flows because it shows how much cash a company can generate before accounting for any non-cash expenses. EBITDA stands for Earnings Before Interest, Taxes, Depreciation and Amortization. The calculation to get from Net Earnings to EBITDA is as follows:

Net Income + Interest + Taxes + Depreciation + Amortization = EBITDA

Detailed List of Assets & Depreciation Detail If your business has assets, especially if they are used to generate revenue for the business, (machines, vehicles, equipment, etc.) you will want to prepare a list of those assets when selling a business. Buyers will want to see a description of each assets along with sufficient other detail such as that shown below:

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Accounts Receivable (“A/R”) and Accounts Payable (“A/P”) Aging Schedule If your business regularly has an Accounts Receivable balance then buyers will want to see an aging schedule broken down by customer. This A/R aging schedule will show which amounts from which customers are overdue and by how much. As a buyer, if I see large customers are consistently having higher amounts of money overdue this could present a major risk that I want to get an explanation on before moving forward. Often times it is simply an oversight and contact with the customer will result in payment of the overdue balance. In other cases, it wasn’t an oversight but a conversation with the customer can help you both create a workable solution to solve the problem in the future. But if its determined that customers are actually having difficulty paying on time, or at all, it may result in an adjustment to the purchase price or structure. If the buyer is obtaining bank financing as part of the transaction, the bank will release a smaller percentage, sometimes zero, based on A/R aged over 90 days. An example of a sufficient A/R aging schedule is shown below:

In addition, buyers will also want to ensure you have been able to stay current with your suppliers by understanding your Accounts Payable details over time. Paying to quickly can show less than optimal utilization of cash. But taking too long to pay can negatively impact relationships with those suppliers and having numerous overdue balances can imply cash flow issues.

Item # Year Make Type VIN Book ValueAccumulated Depreciation

Debt Outstanding

Net Book Value

Lender & Notes

1 1996 Kenworth Tractor 123456 $80,000 ($20,000) $0 $60,0002 2000 Peterbilt Tractor 234567 $90,000 ($25,000) $0 $65,0003 2003 Mack Tractor 345678 $100,000 ($30,000) $0 $70,0004 2005 Sun Trailor 456789 $15,000 ($15,000) $0 $0 Fully Depreciated5 2007 Pitt Trailor 567891 $20,000 ($20,000) $0 $0 Fully Depreciated6 2010 Fruehauf Trailor 678912 $25,000 ($15,000) $0 $10,0007 2012 Chevy Pickup 789123 $30,000 ($5,000) ($10,000) $15,0008 2014 Dodge Pickup 891234 $35,000 ($6,000) ($15,000) $14,0009 2015 Ford Van 912345 $25,000 ($4,000) ($10,000) $11,000

Customer Current 1 - 30 31 - 60 61 - 90 > 90 Total1 $48,134 $0 $16,722 $19,039 $17,416 $101,3112 $38,500 $4,000 $25,500 $0 $0 $68,0003 $49,784 $0 $18,292 $0 $0 $68,0764 $93,165 $28,620 $0 $0 $0 $121,7855 $73,960 $982 $0 $0 $12,485 $87,4276 $33,139 $715 $6,150 $0 $0 $40,0047 $39,525 $0 $300 $12,875 $0 $52,7008 $11,430 $4,873 $0 $0 $0 $16,3039 $25,860 $1,002 $542 $146 $0 $27,550

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Looking through your financials with a fine-toothed comb can take some time. Getting started with this early in the process will help you identify irregularities or mistakes and address them before they come up in diligence with a buyer. If instead, these are not discovered until diligence, they could lead to delays, confusion or even a decrease in price. Having a detailed and accurate understanding of your financials at this point in the process can also help you determine how to price your business for sale.

Note: A common request I hear from owners is that they want diligence to move quickly and close in as short of time as possible. What they often don’t fully understand is that the amount of time that diligence takes can be greatly extended or reduced based on how organized and accurate they are with many of these financial items.

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STEP 5: GET A PROFESSIONAL BUSINESS VALUATION

What Is My Business Worth? It’s a question that every owner has when selling a business. The total value you receive for your business may vary depending on economic factors, the premise and standard of value selected, and the valuation method applied. But the true value of any business is its ability generate future cash flows. If you want to value a company’s ability to generate future cash flows you need to understand a variety of factors. You can’t simply rely on multiples, you need to understand the business – the products and/or services it offers, its position within the industry, types of customers it has, its competitive advantages and more. Benefits of a Professional Valuation If you want to understand the value of your business in the current market environment, we highly recommend hiring a business valuation expert. No two businesses are exactly the same, and a valuation expert is an outside party who understands the entire valuation process and has the necessary experience to examine all areas of your business to determine its true value in today’s market. There are a number of credentials that can help you identify a certified valuation professional. I choose to hold the CVA (Certified Valuation Analyst) designation, but other valuation designations include:

• CBA (Certified Business Appraiser) • ABV (Accreditation in Business Valuation) • ASA (Accredited Senior Appraisal)

In addition to discussions with management to understand qualitative factors, a valuation expert will also perform research to fully understand competitive advantages the firm may have, current industry dynamics and the current economic environment in order to more accurately assess the current market value. Besides helping determine how to price your business for sale, a thorough valuation can also help identify key value drivers and areas that could be enhanced in order to increase business valuation. A good valuation can also serve as an operating dashboard to ensure you are meeting goals and enhancing business value in the future. Approaches to Valuation There are 3 different approaches to valuing a business, and multiple methods within each approach. We don’t need to cover all of the methods in detail here, but it’s important to provide a high-level overview of each approach so you know what to expect when selling your business.

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Asset Based Approach This approach calculates value by adding up all the assets of the firm and subtracting all of the liabilities as shown here:

This approach is good for estimating the value of a non-operating business – like a holding company, or a business that continues to generate losses. A “non-operating” business does not manage any assets or directly conduct any business whatsoever. As an example, the business may simply collect money and distribute it to the appropriate parties. Many use the asset approach to set a floor value when determining business valuation. Because if the price offered for a business is lower than the value of its assets minus liabilities ($1,000,000 in this example), then anyone could just buy the business, liquidate all the assets, payoff the debts and be left with more than they paid. So, for businesses that are able to operate profitably into the future, you will want to value the business as a going concern and the asset approach should not be relied upon.

Market Approach The idea behind the market approach is that the value of a business can be determined by reference to reasonably comparable guideline companies (“comps”) for which transaction values are known. This is where people use multiples when selling a business. Multiples are simply the result of dividing an actual selling price by a financial metric common to many firms. Although we can calculate them on a variety of numbers, the most commonly used multiples when selling a business are revenue multiples and cash flow multiples. One of the problems with using this approach for small to mid-sized private companies is that not all transactions report their data, which leaves us with an insufficient amount of information on which to make an assessment. Insufficient data often leads to inaccurate multiples. In addition, no two businesses are exactly the same, so relying on a multiple for one business does not imply that multiple is the right one to use for another business – even if those businesses are the same size, in the same industry or both. Even if you think your multiples are

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accurate, you need to understand if those apply to last year’s numbers, training 12-month numbers, annualized run rate numbers or other before you can accurately use them to determine price when selling your business. Here are a couple simplified examples to show how two businesses, even though they are the same size and operate in the same industry, may have different multiples. Let’s start with revenue multiples:

If we simply relied on a revenue multiple to value these companies, we may see that each company has the exact same revenue and operates in the same industry, therefore concluding that we could use the industry revenue multiple of 1.2x to determine valuation for each company. But what if one of the companies had some form of competitive advantage (lower cost to manufacture, more efficient workforce, higher brand image, etc.) that allowed them to obtain 30% profit margins. Meanwhile, the other company had a less trained workforce, older machines, and hadn’t yet developed a brand image, which resulted in them having only 15% profit margins. Clearly these two businesses should not be valued the same, which is why we can’t rely solely on revenue multiples. Now let’s look at cash flow multiples:

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Note: Many people use EBITDA (Earnings Before Interest, Taxes, Depreciation & Amortization) as a consistent measure of cash flow between different industries. So, in our examples we use EBITDA multiples.

For this example, we assume the two companies have the exact same revenue and profit margins (unlikely in reality). If we relied solely on the 5x industry EBITDA multiple for companies of this size, we would value both companies at $25,000,000. But what if one of the companies had only been growing at 1% per year for the past few years (or worse) and was expecting similar growth (or worse) in the future. Meanwhile the other company had been experiencing annual growth of 7.5% (or higher) and expected similar growth (or even better) in the future. In this example, we just laid out one factor – growth – when there could be many others. But you can see that a prudent buyer would not pay the same amount for each of these businesses, nor should he. If you feel your business is exactly like all of the other businesses in your industry, then multiples may be fine, but most businesses are unique in one or multiple ways. So, while multiples may be a great starting point for initial discussions, and may be used as a point of reference when comparing to other firms in the industry after you determine actual value, you should not rely solely on elementary math from a limited data set when you’re determining how to price your business for sale.

Note: Recently there has been a lot of focus on recurring revenue businesses, including some software businesses. Many of these businesses have very similar business models and are highly scalable (adding additional customers and revenue results in almost zero additional costs). Due to these facts, buyers have been simply relying more on multiples of recurring revenue to determine how to price their business for sale. Although still not 100% accurate, it has become more acceptable due to the business models and scalability of these companies. In our opinion, we will see this evolve in the near future to reflect differences in business models, operating costs and competitive advantages.

Income Approach The income approach, and in particular the Discounted Cash Flow Method (“DCF”), is the methodology we place the most weight on when determining how to value a business for sale. This is because the DCF measures the value of a firm’s ability to generate future cash flows. It does this by understanding the uniqueness of each company and capturing the economic dynamics of the business. Here’s an example of what a discounted cash flow valuation may look like:

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Here’s a brief overview of the steps involved in the DCF process and how it determines value: (There is a lot of detail within each of these steps, but that is beyond the scope of this guide) 1. Determine estimated future cash flows for the business 2. Determine a terminal value by assuming a terminal growth rate 3. Determine a discount rate to reflect the perceived level of risk to future cash flows 4. Discount the projected future cash flows, and terminal value, back to today then sum those

values. Step 1 includes a lot of work to understand why historical numbers were as shown, determine accurate adjustments to “normalize” the numbers and prudently estimate future projections as accurately as possible. There are a number of factors that impact this assessment and utilizing a professional with experience valuing a number of firms over various time frames can make a major difference.

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As you can see in the illustration, the projections build up using very detailed line by line analysis. For example, the company shown is expecting much stronger growth from some products and services than others. In addition, each expense line is determined based on different factors and/or tied to different numbers. Simply using one growth rate for all of these numbers would not be accurate. Steps 2 and 3 use a variety of economic data as well as industry and company specific data to determine both the terminal growth rate and the discount rate. Step 4 simply applies calculations to arrive at a valuation. A valuation expert will take the time to gain a thorough understanding of the business, through conversations with the owner and reviewing years of detailed financial information. They also use that info to understand key drivers, research industry dynamics and evaluate the current economic conditions in order to develop educated assumptions for the future One common criticism of the DCF valuation is that it relies on a lot of assumptions, and therefore the valuation is only as good as the underlying assumptions that were made. In addition, it is nearly impossible to predict what the actual numbers will be in the future. While these criticisms are correct in theory, there is a lot of expertise that goes into the process of making assumptions and projecting financials. This is why it is so important to use a valuation expert to perform a professional valuation of what your business is worth in the current market.

So, while the income approach doesn’t come without potential limitations, many agree that it is the best way to assess the unique factors of each company and it’s why we at Your Legacy Partners give this method the highest weighting when performing our valuations.

Factors That Impact Business Value While there are many factors that can impact the value of a business for sale, too many to discuss in detail here, below you will find an overview of a few of the more common categories for you to consider as you determine how to price our business for sale.

Revenue Types, quality, growth, recurring nature, predictability Profits Amount, margin, growth, consistency Customers Quantity, type, concentration, contract, churn Products & Services Quality, consistency, price, mix Employees Number, efficiency, tenure, turnover, compensation, management Competitive Advantages Economies of scale, operational processes, branding, technology, location Growth Historical, opportunities, projections, resources needed to execute Competition Number & size of competitors, barriers to entry, positioning, market share Technology Systems used, quality, innovation, patents Capital Expenditures Historical, projected, requirements to grow

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Having sat on the buying side of the table for numerous years, we at Your Legacy Partners have deep insight into what buyers look for and use that to help our clients who are selling a business get the highest price possible. We also have an article on “What Buyers Are Paying More For In Today’s Market” which can be found by clicking this link. The importance of understanding an accurate value of your business in today’s market will help you when evaluating offers later in the process to sell your business. Like many owners, this is possibly your most valuable asset. One that you've dedicated countless hours and multiple years of your life to. There are a variety of things you’ve done to make your business unique and you should settle for nothing less than a thorough and professional assessment of your company, in the current market, in order to determine how to price your business for sale.

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STEP 6: FOCUS ON THE BUSINESS

At this stage you've prepared your financials and have a professional valuation underway. These two steps will allow a good M&A advisor help you understand what areas of your business buyers will be most attracted to and which could use some improvement. Throughout the process of selling a business you want to make sure that sales and profits remain strong, or at least steady. But it’s also a time when you should be examining all areas of the business to ensure they are all operating as effectively as possible. These efforts will help ensure your business sells for maximum price. Once you “go to market” with your business (in the next step) your next 3-6 months will be busy engaging with potential buyers and responding to additional data requests. This is why we list this step just prior to going to market. Take this time to revisit each segment of the business to ensure it is functioning as it should and spend any time needed making necessary adjustments and improvements. Keep the Machine Running at Peak Performance Engaging in the process to sell your business will likely take a lot of your time and focus. Even if your business is perfect in every area, you need to spend time ensuring that it stays that way. Far too many times I’ve seen owners get caught up in the sale process and allow certain areas of the business to lose traction or even fall apart completely. As an example, we recently worked with an owner selling a business who was doing a great job organizing all of their data and being responsive to diligence requests because he wanted to ensure the process moved along as quickly as possible. Meanwhile, the extra focus that was put on these tasks resulted in them falling behind in their customer billings. This fact wasn’t noticed until the buyer was in diligence and had ordered a Quality of Earnings (Q of E) which showed that many of their largest clients had large amounts becoming more and more overdue. This is a major red flag to a buyer if the largest clients are becoming unable to pay or deciding not to pay. Luckily, in this situation the customers who were late had all been happy customers for years and a simple call to each of them to explain that they had missed sending out some of the invoices resulted in them all catching up over the next few weeks. We’ve seen other businesses fall behind in their sales process resulting in a lower number of new customers. This seemed to imply that maybe business was having trouble winning customers or that growth may be slowing. Others have allowed marketing efforts to slow, processes to derail or innovation to lag. While there are many other examples, each of these raise a flag for a potential buyer and may negatively impact how much your business is worth. Improve Areas That Can Enhance Value to a Buyer As much as we may think otherwise, most of our businesses have some areas that could be enhanced in the eyes of a buyer. So, during this stage of the process to sell your business, you should also be

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spending time determining which areas of your business are the lowest hanging fruit for improvement and which could increase business valuation the most. In addition to reviewing the professional valuation, a good M&A advisor or business consultant will be able to assess the business and help you identify which areas are most important, which just need a little work and which are larger projects. They can then help you prioritize those areas and put a plan in place to address them. Similar to a real estate agent suggesting a few light paint touchups, there may be some areas of the business which would require minimal effort to address and can be taken care of rather quickly. These should be addressed in order of priority. Others may be larger projects, like replacing all the carpet on the main level or even remodeling the kitchen, that will take more time. As we continuously preach, the process to selling a business should start many months or even years prior to when you actually want to go to market for exactly these reasons. If there are larger projects that could have serious impacts on value, the additional time spent to put them in motion and prove their success will be well worth the effort. But many of you are likely closer to going to market, or maybe even there now. If this is the case, then at least identifying the areas, considering the best solution and putting a plan in place to address them is still much better than ignoring it. These efforts can help a buyer understand that there is a plan for enhancing those areas. For example, maybe the valuation revealed that top line revenue hasn't been as strong as it should be. Examining the issue, you see that the sales team hasn't been as productive as it had in the past. Further investigation may reveal issues that stem from the sales manager which also impacted the rest of the team. This resulted in sales meetings not being held, prospects being lost in the pipeline and people not being held accountable for missing goals. It’s possible that this could be resolved by a simple discussion with the team and manager. But if you determine the best course of action may be to replace that sales manager with a leader who will have a more positive impact on the team, then taking action now may be beneficial. In this case, by identifying the issue, finding a stronger replacement and putting a plan in place to get back on track you may be able to honestly show that this dip in revenue was a one-time personnel issue that has now been addressed so that the future expectations are back to normal or even stronger. Another example could be that your product or service has been losing volume to other competitors. While your initial thought was to drop the price to gain back market share, this has resulted in lower profit margins. An assessment of the market and competitor’s products could give key insight to improve the pricing model for your product or service, which may include offering tiered pricing. Changes like this can impact key drivers to businesses projections and have a positive effect on the price you receive when selling your business. Identifying and improving what you can at this stage of the process to sell your business is similar to having an inspection done on your house before you sell it. Changes made, or at least started, before going to market could catch the interest of more buyers. It’s also important, and ideal, to show positive trends in the business which could have a major impact on both the speed to sale and final sales price.

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Key Areas to Examine The following are some key areas that you should examine at this stage of selling your business. Whether you feel your company is strong or weak in these areas, it’s worth it to examine them to ensure your business is showing at its best as buyers perform their diligence.

People The people who make up your company are a valuable asset to its success.

Right People in Right Roles When we consult with a company regarding its people, we often start by determining if they have the right people in the right roles. This process starts by identifying how the business is organized and what roles are accountable for the major functions within the company (finance, sales & marketing, operations, etc.). This is different than a simple organizational chart, which simply shows who reports to who, and focuses more on who is accountable for each of the major functions that drive the business.

Once you have that structure laid out you can then start to assess if you have the right people in each role to be accountable for that function. Defining the roles to be accountable for each function will guide your decisions for hiring, replacing and promoting those in that role.

Ensuring you have the right people in the right roles means that they fully understand what that role entails, have the desire to work in that role and have the skills and experience necessary to be successful there.

Now if you’ve started the process to sell your business early enough before you go to market, then this kind of analysis can be thoroughly analyzed and corrective measures can be taken to ensure you get the right pieces in place. But, if you are going to market soon, you may not have enough time to go too in depth here and you may not want to disrupt the organization to that degree. If this is the case, look for the most obvious mis-matches. Is there someone who should clearly be promoted, let go or simply moved to a more appropriate area? If so, these small, proactive improvements may help your company when buyers are assessing during diligence.

Employee Contracts Before selling your business, it is also important to ensure all of the employee contracts are up to date and any necessary non-compete agreements are in place. This is probably not something you want to wait until the last minute to do, as employees may start to get suspicious and potentially realize they have more bargaining power. When a buyer considers purchasing a business, he wants to know that the key people are happy, will remain with the firm and have compensation expectations that are in line with what is being communicated to the buyer. We’ve certainly seen situations where once the buyer acquires the company, they start getting approached by employees who say “I was promised a significant raise this year” or “I was told I would be promoted at a certain time”.

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We’ve also seen key people leave right after a sale only to start their own company or directly compete with the prior business. Buyers will understand who some of the key employees are and will view it as a major risk if an appropriate non-compete agreement is not in place. Having these documents updated prior to going to market will make your company look organized and help ensure the buyer that they will have the people they need to continue operating the business successfully.

Customers Your customers are the lifeblood of your business and when you engage in the process to sell your business, it’s essential to make sure all aspects relating to your customers are satisfactory. Even obtaining feedback from your customers, regarding what your company does well and what could potentially be improved, can provide valuable insight to help enhance value. Your customers are the ones who were sold on the value you provide and have been satisfied enough to remain with the company over time and help the business become what it is today.

Customer Concentration Customer concentration is a major factor in a buyer’s mind and can often impact price when selling a business and the structure of that offer. As a buyer, I am willing to pay a higher overall price and a larger portion up front for a business where no customer makes up more than 5% of revenue, than I am for a business where the top 3 customers make up 65% of the revenue. The latter business presents more risk to a buyer because if just one of those customers leaves, the business would experience a major decline in financial results.

If your business has a large amount of customer concentration, expect a buyer to tie a larger portion of the purchase price to the performance and/or retention of those customers over the next 2-3 years. If you are able to make efforts to diversify that concentrated revenue it will not only show that there is less risk in your business, but new customers will also show that you can grow outside of those large customers.

Customer Contracts When preparing your business for sale it is a great time to review customer contracts to make sure they are all signed, accurate and up to date, especially any larger clients as discussed above. We have numerous stories about buyers asking for copies of customer contracts during diligence only to find out that some have expired, were never signed or are still using an old version that doesn’t align with current practices. Even contracts that are correct may be coming up for renewal soon. Before going to market to sell your business it’s a great time circle back with those customers to ask how they are liking your product or service and potentially see if you can get them to renew now. If they are happy with your services, they may even be willing to renew new for a longer period of time, and the longer the customer contracts are the more that increases business valuation in the eyes of a buyer. In certain situations, it may even be worth it to offer customers a slight discount in order to entice them to sign a longer contact. A good consultant can help you weigh the value of extending a discount in return for signing a longer contract and its potential impact on valuation.

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Address Weak Customers Customers that are a hassle, not profitable, falling behind in payments, or other should be discussed amongst the team and determine the best course of action. It is quite often worth the time to reach out to these customers simply to understand how their business has been going and how they plan to engage with you moving forward. Some businesses are just small and won’t ever be able to become a larger client. But others may be deciding between you and your competitors, in which a simple call to understand how you can work better together may help sway that decision. We’ve also seen some customers holding back because they had a bad experience or aren’t quite getting everything they need from you. Again, a quick call to understand those issues could have a meaningful impact to the business moving forward. If you have customers who are behind in payments, now is a great time to reach out and address those issues. It may be that the delay was caused by something on your side, in which you can correct it and make sure it’s addressed for the future. Or it may have resulted from something on the client’s end. If this is the case, then taking time to understand that problem and determining a way to address it moving forward will bypass potential setbacks later in diligence and help the business show better to potential buyers.

Cement Strong Customers In addition, this is also a great time to cement strong customers. This is likely as simple as calling them to say thank you for your business, inviting them to an event or dinner or even showing up to their work to see how they are using your product or service. Internally, make sure these customers are receiving a high level of service from your team. Also, it will go a long way to ask these customers for their feedback and what else you could be doing to improve their satisfaction. These customers are already doing a large amount of business with you and see major value in what you do, so getting their feedback and ensuring their satisfaction can prevent major surprises, ensure revenue stays strong and even lead to more business or referrals.

Processes & Systems Have you taken the time yet to document the way everything in your business should be done? If not, and even if you have, this is a great time to walk through ALL of your processes to ensure they are operating in the best way possible. This effort can provide great insight to you, your employees and a potential buyer as to how things work and also help evaluate areas for improvement. When employees know what processes to follow and why, it can lead to a more efficient and effective workforce resulting in higher productivity and stronger financial results. If they all know the processes, take the time to ensure they are all executing them in the correct fashion and a timely manner. When we’ve worked with owners who examine these processes, we often find that some steps are being skipped. For those, you need to take the time to help staff understand the importance of each step and how best to follow the steps in order to improve results. We’ve also seen owners identify ways to improve efficiency within their processes which have a direct impact on the bottom line and the value they receive at closing.

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Finally, showing these processes to a potential buyer can help them better understand the business and identify ways in which they may be able to make improvements and enhance value in the future. Data Most businesses have specific KPIs (Key Performance Indicators) that they know they need to focus on in order to measure performance toward goals. In addition, there are often a number of metrics (or numbers) within each of these KPIs that allow them to track progress toward achieving those KPIs. When preparing to sell your business you should make sure you document all of the KPIs and underlying metrics that you track. You should also document the results of those findings for the past few years, if possible, to show how those numbers directly impacted financial results. This not only helps a potential buyer better understand the business, it also shows that the business is well run by a leader who knows what has to happen in order to maintain and grow. For example, we’ve seen some leaders manage the business through a score card. This often includes 5-15 high level numbers that the company needs to hit on a weekly basis. This also give the manager a heads up when things are beginning to fall off track and also provides some insight to predict future developments and numbers. It is much easier to quickly spot potential issues, or identify strengths, as they come up as opposed to reacting to financial numbers in a statement long after the fact. Positioning for the Future As you examine all of the areas listed above, you should also take this time to ensure the business is positioned to execute whatever growth opportunities you plan to communicate to potential buyers. To start, if you haven’t yet identified ways the business can grow in the future you should start there. As buyers examine businesses, they are very interested in what they could do with it in the future to drive additional growth and profits. Approach this process with this in mind: if someone came in with a bunch of capital and wanted to accelerate growth, what are the best ways they could utilize that investment to get the best results, given how you've positioned the firm. While many buyers will have some of their own ideas, no one knows the business, its strengths and opportunities as well as you do. So, for you to outline what you feel are the best opportunities to pursue, it not only helps them see those opportunities but it may also turn them on to new ideas that they had not yet considered. Those opportunities could potentially lead to a higher offer price when selling your business. Once you’ve outlined what opportunities the business has in the future, then take time to ensure the business is set up to accomplish those, or at least to get started down that path. For example, a firm we were recently talking with said that a major growth opportunity for a buyer was to start making acquisitions of other smaller firms in the industry. But when we looked into details of the company, they didn’t have nearly the people or operational structure to support the types of acquisitions they were talking about. This was certainly possible in the future, but it would require a decent amount of investment in to staffing, technology and other areas before they could even begin to start down this path. Another firm had built out pro forma financials stating that there was a huge opportunity to add new customers in a specific area. But when we looked further into their sales structure and history, we found

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they had not won a new customer in over 3 years, nor did they have the sales team in place to even pursue new customers as they had described.

Note: With the suggestions made above, you want to make sure any specific growth paths you choose are the best fit for the company before you decide to dedicate new resources to going down that path if you are about to go to market to sell your business.

For example, in your assessment you may decide that the business could grow by expanding into a new market with a new product. If you start committing a bunch of resources to that right before going to market, and a number of the buyers disagree with that assessment, then that may deter those buyers. Even buyers that agree, may choose to take the business in a different route resulting in these efforts being a waste of resources.

The opportunities available to a firm, and those that are best for it, are heavily dependent on how the company is positioned and what its competitive advantages are. Having a thorough understanding of these opportunities, and articulating to a buyer how they could evolve, may help the buyer see more potential and increase business valuation. You should also be able to communicate an estimate of what investment would be needed to pursue certain opportunities. You don’t need to know exact numbers for every scenario, but you should be able to give them high level guidance. For example, what capacity your current team has and who else would be needed in order to expand into a certain new area. Or approximate new pieces of equipment needed for a certain opportunity and an estimate of what each would cost. As a buyer, when I’m talking to a seller about their business, the more they can tell me about opportunities the business could pursue, and the more detail they understand about what it would take to do that, the better the business looks and the more excited I am about the opportunity. Often times increasing my willingness to offer a higher price.

Legal Last but not least, review any past or outstanding legal issues. Are they fully resolved? Is there a simple & cheap solution to get them resolved? Even if they are not resolvable, do your best to address them as much as possible right now. It’s better to address these issues and attempt to resolve them beforehand so they don’t need to be addressed during diligence. This could potentially delay the process and may signal risk to the buyer, potentially causing them to reduce price or walk away all together.

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Section 3:

Going to Market

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Timeline: 4-6 Months Before diving into steps 7-12, we find it helpful to provide an estimate for the amount of time it commonly takes to get to closing once you “go to market”. We consider the start date as the day you sign the engagement letter with your M&A Advisor, and the end date as the day of closing. This process typically takes 4-6 months. While this process can extend much beyond 6 months, depending on the company and parties involved, we rarely see it completed in 3 months or less. We discuss details of this timeline in chapter 7.

2-3 WeeksPrepare

Marketing Materials

4-6 WeeksReach out to

buyers & receive IOIs

3-5 WeeksData room & management

meetings

2-3 WeeksReceive LOIs

& make selection

5-10 WeeksDue diligence & purchase agreement

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STEP 7: PREPARE MARKETING MATERIALS

At this point you’ve thought through all of the considerations with your team of advisors, have a good idea about market value of your business in today’s market and have spent time working to ensure your business will show in the best light. You’re now ready to go to market! Before reaching out to potential buyers you, or your M&A Advisor, will need to put together the package of marketing materials to present to buyers so they can understand the opportunity. This package will contain multiple pieces of information and details about the business that will help buyers get a good enough understanding of the business to make an informed offer. This is another part of the process that a M&A Advisor has a lot of experience and should be able to add significant value. They have been through the business sale process many times and can tell you what information you need, let you know if the data provided will be sufficient, and help you get all of that information organized into a format that engages and excites buyers during their review. In addition, they have experience doing all of this without jeopardizing confidential information. A good M&A advisor can put these materials together in about 2 weeks, but there may be delays if he requests information that the seller does not have readily prepared. If you’ve decided that you will be taking the company to market by yourself, without an intermediary, then you will be responsible for putting this package together. Tell Your Story – What is Your Purpsose? The marketing materials are your opportunity to really “tell your story.” As discussed in the valuation section, each business is unique, and that uniqueness should be evident through these marketing materials.

• What makes your business different and better than competition? • How is the company positioned and how has that progressed over the years? • What types of opportunities exist for the company in the future?

This is an important piece of the process because these marketing materials help determine how many parties have serious interest in making an offer on your company. Even the look & presentation of this package can leave a strong, or weak, impression of your business that psychologically can alter a buyer’s opinion throughout the process. A strong set of marketing materials can spark serious interest from a neutral party and could also deter an interested buyer. It’s important to give the right level of detail, without sharing too much, and also to present the information in a way that is easy to understand.

2-3 Weeks

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Include an Overview of Your Business The marketing materials should include an overview of your business. This should be a summary of what the business does and how it got to this point. It may also include what geographies the business currently operates in. When putting together the business overview, make sure you start with a very simple, but detailed, explanation of what the company does. In order for the rest of the information to be meaningful and make sense, the buyer has to be very clear on what business(es) you are in. Once that is clearly communicated, you can get into more details. When did you start the business? What has enabled you to be successful over the years? It takes a lot of hard work and success to stay in business for a number of years and through various economic cycles so, if this is true about your business, make sure you highlight those details. What are the major events that have happened along the way which helped define the company and get you to where you are today? It may have been a prior sale or acquisition, the hiring of a great CEO, the opening of a new office, or the offering of a new product or service. Products & Services: What Does Your Business Offer? This section should go into detail on the different products and services the business offers. It should also help a buyer understand how those products and services position you within your industry. Although you don’t need to include every single product or service, you should cover all of the main ones in enough detail that a buyer can understand what they are and how they benefit customers. This detail often includes what differentiates your products and services from the competition, what types of customers you are currently targeting and who else they may be a fit for. Understanding a company’s positioning within their industry is an important piece to determining a future vision for the company. Who are your primary competitors? How do you win business over them? Are your products and services more focused on higher quality and higher price? Or do you offer an acceptable product or service at a lower price? Why did you choose to enter the markets that you did and the product/service mix that you did? How has that evolved over time and what impact has that had on performance? Why is this still the right positioning for your company? These factors come in part from your competitive advantages and will impact strategy moving forward. Helping a buyer understand these areas will give them a better idea of how they can grow your company in the future, often allowing them to offer a higher price.

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Highlight Your Strengths – and What Makes Your Business Unique The valuation should have helped you identify some areas of strength for you company, and in step 6 you took time to ensure these areas were continuing to operate effectively. In the marketing materials be sure clearly articulate what these strengths are and how they are helping the business maintain an advantage. There are likely numerous factors that helped you get started, maintain throughout the years and drive strong growth. These factors may include your experienced team, key supply chain dynamics or a strong brand image. Highlighting those factors will help demonstrate the additional value that your business offers and show why you are unique.

Competitive Advantage(s) A competitive advantage is what makes an entity's goods or services superior to all of a customer’s other choices. Competitive advantages allow an organization to outperform its competition often by allowing it to produce a good or service of equal value at a lower price or in a more desirable fashion. These conditions allow that business to generate more sales or superior margins compared to others in its industry.

A company’s competitive advantages depend on the benefit(s) their products and/or services offer, the target market for those products and services, and all of the possible competition for those products and services. It may include things such as economies of scale, know how, processes, quality and capital.

Discussing how your competitive advantages relate to your positioning and success can give a buyer a better understand of how they could use those to grow the business the future and help support a higher valuation.

Who Are Your Customers? In this section, the most important item that buyers seek to understand is customer concentration. Do you have one or more customers that make up the majority of your revenue? Providing some type of client breakdown, such as the example below, is beneficial in this section.

Additionally, buyers will want to understand the types of customers that you work with. Is it primarily large corporations or mostly small businesses? Maybe the majority of your customers are individuals or schools or government entities. Do you primarily serve customers in a particular industry like automotive or fitness? Are most of your customers located in a specific geography or are they all over the country or world?

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In this section, it is also helpful to highlight the average tenure of your customers and details of any customer contracts. If your company has been operating for many years and you’ve been able to retain a number of customers for a long time, this is the place to highlight those facts. The ability to maintain customers for a long period shows that they value your products or services and choose to do business with you over other options. In addition, if you have contracts with any or all of your customers consider providing an overview of those here. What is the length of those contracts? What type of notice is required to terminate the contract? If no action is taken by the customer, do they automatically renew or cancel? Does the contract state that if there is a change of ownership the contract is terminated and needs to be resigned? If the contracts vary widely between clients, consider preparing a redacted customer list showing the high-level terms of each contract for at least the largest few clients. An appropriate and helpful level of customer detail is shown in the chart below:

Note: You should not list customers by name. A redacted version, as shown above, is appropriate.

Talk About Ownership & Key Players Take time to discuss the key people involved in the company. Who are the owners and what percentage do each of them own? What are their current titles and how are they involved in the business today? What is their desired plan and role post-sale? Is that negotiable? Identify the managers of each major area within the business. What is their background and how long have they been with the company? If you, as the owner, currently hold a leadership role but will be exiting after the sale you will need to discuss which members of the management team have sufficient knowledge, experience and leadership skills to lead the company in your absence. Even if the buyer will

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be operating the company himself or brining in an outside CEO, they will want to know who the other top leaders are in the organization. Who are the other key people in the organization? What is their role and how long have they been with the company? Many companies will include a redacted list of employees, at some stage of the process, that includes title, compensation level and tenure with the company. Also, although it may not be necessary to list in the marketing materials, you should be prepared to discuss any anticipated staffing changes in the near future. Are you planning to layoff or promote anyone? Are there certain positions you intend to hire soon? These are important questions that a buyer will want to understand at some point in the process. Historical & Projected Financials One of the main things a buyer will be looking for in the marketing materials is financial information for the company. This includes both actual historical numbers and estimated projections for the future. As discussed further in step 8, different levels of financial information are appropriate at different steps in the outreach process. In the teaser, you may just include 1-3 years of historical revenue and EBITDA numbers. These should be the adjusted numbers that show normalized operating results. In the CIM, you will need to go into more detail and may include a summary of projected numbers. By the time you get to LOI buyers will want to see all detail of every historical financial statement and also understand what key assumptions you used to assemble the future projections. Where Are Future Growth Opportunities? One of the major things that can lead a buyer to increase their business valuation is helping them understand the growth opportunities that the company can pursue now or in the future. Too often I see companies miss the opportunity to effectively convey their growth opportunities and discuss how the company is currently positioned to purse those. Buyers acquire companies for a variety of reasons, but most of them are in one way or another related to the financial gains they can achieve by owning it. They want to understand all of the ways they can grow the business in order to achieve those gains, and there is likely no one better than you to help them understand those opportunities. It may be that certain opportunities would require additional capital, leadership or other resources in order to execute, but listing those may help the buyer envision the possibility. In addition, a buyer may have access to the capital or other resources to accomplish them sooner. Listing all of the growth opportunities, that are actually realistic, will be beneficial. Approach it as if you were presented this question: “If you had $10M to invest in your biz, what would you do & why?”

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In addition, you should be able to discuss how the company is currently positioned toward these opportunities now, or what may be needed in order to get started. What pieces are already in place, and what steps have you started on, that will enable the company to be successful pursuing those opportunities. Based on past experiences and efforts of the company, you may already be heading in the right direction, and articulating that to a buyer can positively impact his vision for the business. As a buyer, one of my favorite questions when talking to an owner is: “Tell me about how you've gotten to this point, how you're positioned today & why, and what your vision is for the future.” It’s purposely asked as a very open-ended question because where the owner goes when answering it will give you great insight into the company’s major events and strengths as well as what he feels is most important. The quality of his answer, level of detail he shares and his passion for the future of the business can provide a great perspective into how good this business really is and what it’s potential is for the future. The marketing materials are your opportunity to answer this question in detail. Taking the time to make sure these materials are as good as they can be will help you attract more buyers, likely leading to more offers and likely resulting in a higher total price. Take advantage of this opportunity! To learn more about what to highlight in these materials, check out our blog on “What buyers are paying more for in today’s market”

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STEP 8: REACH OUT TO POTENTIAL BUYERS

If you’ve decided not to engage a M&A Advisor and instead sell your business yourself, this step may be the toughest. Like most owners, you’ve spent the past few years focused on running your business and not maintaining relationships with active and qualified buyers. Therefore, those who choose to do-it-yourself often rely heavily on posting their business to one, or numerous, deal websites during this step and hope a number of qualified buyers happen to notice it. They also hope these buyers all surface in a short period of time in order to create competition, and hopefully one of them is the “right” buyer for you. If you’ve decided to hire a M&A Advisor – congratulations - they should be able to add extreme value to you in this step. Most M&A Advisors spend a lot of time networking with different groups and companies who are actively looking to acquire a business similar to yours. They spend considerable time maintaining relationships with these parties so that, when working with a client to sell a business, they can generate a lot of interest and present their client with options to identify the best fit. There are multiple steps involved in the outreach process that you should be familiar with: Teaser The first step in the outreach process is to prepare and send out a teaser. A teaser is a very short summary of high-level information about the business. This first piece of communication is typically sent to a large number of parties, covering a broad audience of potential buyers, in order to determine initial interest. Because of the large number of people who will receive the teaser it is generally rather short, containing only high-level information and does not include the name of the company or any information that could reveal the identity of the company for sale, in order to protect confidentiality. The teaser often contains information such as:

- Type of company - Industry or sub-industry - Last year's or Trailing 12-month (“T-12”) revenue - Last year’s or T-12 EBITDA - Region of the country it’s located in (if this wouldn't give away who the business is) - Any other high-level information necessary for parties to determine if they would like to

learn more. An example of what a teaser may look like: Cleaning Company

• 25-year history with many long-term clients • Specializes in schools and hospitals • Located in Southeast United States • T-12 Revenue $26.5MM ($19MM recurring via 3-year contracts) • T-12 EBITDA $5.2M • Top 10 clients < 35% of revenue

4-6 Weeks

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This level of "blind" information is enough for a potential buyer to determine if they have interest or not, yet does not give away any details that would allow someone to determine who the company is.

Note: Businesses of this size usually work with EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization) and not SDE (Seller’s Discretionary Earnings). Also, the teaser does not usually include an asking price. This is usually left off in order to see where initial bids come in later in the process.

NDA – Non-Disclosure Agreement From the information in the teaser, potential buyers will determine if they have serious interest in learning more about the business for sale. If so, the M&A Advisor will require them to sign and return a NDA (non-disclosure agreement). The main purpose of the NDA is to protect confidentiality of the business for sale. Since the next step will be obtaining more complete and detailed information about the company for sale, likely including the name, it is important to have this confidentiality agreement signed by all parties who will receive the “book”. By signing the NDA, the party agrees to keep all information confidential and only share it with those on their team who have a "need to know". They are also agreeing to discard all information provided to them at the point they disengage from the process. The NDA also prevents the parties from contacting any of the employees or customers of the company.

Note: During this step of the process you will typically receive a number of inquiries from parties that are either not serious buyers or unqualified to make the purchase. These parties will be a waste of your time and are most effectively handled by an M&A Advisor who will take the time to deal with them for you and has the experience to determine which are legitimate buyers and which are not. Your time is better spent focusing on your business to ensure it maintains its numbers and shows well to buyers.

Confidential Investment Memorandum (“CIM” or “Book”) Once interested parties have signed and returned the NDA they get access to the second round of information called the “CIM” (Confidential Investment Memorandum) or often called simply the “Book”. The CIM contains more detailed information about the company including a list of its locations, what specific products or services it offers and more detailed financials. The CIM usually contains the name of the company so buyers will know exactly which company they are evaluating. This is the first real insight into the actual details of the business. For those that expressed interest and signed the NDA, the CIM should give them enough information to determine if they want to further engage in the process by making a formal offer.

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Note: It is helpful for the CIM to have information presented in an organized fashion. You want to make it as easy as possible to understand key elements of the business and follow along with the book. Over my years in the business I have seen some great CIMs and some very bad ones. Regardless of if you were the one that actually assembled the book or not, it comes off as a reflection of your business. Just the simple layout of this piece, along with what information is included, can leave a buyer with a very positive or negative image of the company. A good M&A Advisor will have a lot of experience assembling this information for you in an effective way.

In chapter 7 we discussed key areas that should be addressed in the marketing materials. Examples of important areas covered in the CIM are:

- Background and overview of company - Reason(s) for selling & owner’s desired role, if any, post-sale - Products and services offered - Sales & Marketing - Customer overview - Organizational chart, including management and key employees (names are typically redacted

and just show titles) - Historical & projected financials

o Depending on the complexity of your business, the CIM may still not provide every necessary detail in your financials, but it should include most of the high-level numbers to give interested parties enough information to understand how the business has operated.

o This would typically include: § All lines of revenue, § At least one line for COGS, § At least one line for Operating Expenses, and § A line for profit

(although more detail is certainly welcomed and common) - Future growth opportunities - Ability or plan to achieve future projections

Note: As with the teaser, the CIM typically does not include any information about the asking price. Instead, the M&A Advisor will wait to receive initial bids via IOI so as to not restrict any bids over a stated asking price. At the same time, they wouldn’t want to list an asking price that is so high that it deters potentially interested parties from engaging in the process.

Expect Plenty of Questions At this stage of the outreach process, there are often a number of questions that buyers will have. Majority of questions should have been answered by the CIM, but there are usually some other requests or clarifications that need to be addressed. How well your CIM was put together will determine how much time you spend at this stage. A good M&A advisor can anticipate what information will be requested while also guiding you on the appropriate level to disclose at this stage.

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In response to the numerous questions, the M&A advisor will often create a FAQ (Frequently Asked Questions) sheet that can later be distributed to all remaining parties or added to the data room. If appropriate, they may also schedule calls with select interested parties and the seller in order to get more sufficient and accurate answers directly from the source. Yet other requests for information may be held off and provided in the data room to select parties.

Note: Your M&A advisor (or you) should continue to vet the interested parties during this stage. Good M&A Advisors will be able to tell who’s actually engaging with the materials sent. If they are asking good questions, requesting additional information and responding in a timely manner, there is likely genuine interest from that party.

On the flip side, if it takes them a couple weeks to respond to the information, and when they do there seems to be a lower level of engagement, they likely aren't as interested or serious as other parties and it should be determined if it is worth engaging with these parties further.

Indication of Interest (“IOI”) At this stage, many M&A Advisors will request IOIs from parties that have serious interest. An Indication of Interest (“IOI”) is a document prepared by the potential buyer, and submitted to the seller, which communicates a high-level overview of what their offer may look like based on the information they have already received.

Note: An IOI is non-binding and usually only includes a valuation range along with a high-level overview of what details may be included in a formal offer later in the process (via LOI).

The IOI serves 3 primary functions:

• First, it helps determine who has serious interest at this point by requiring them to take action. • Second, it helps the buyer understand which party’s offers are most attractive or even in-line

with expectations so they can determine which groups are the best fit to move forward with. • Third, it starts to give the seller and his advisor real-time feedback on how “the market” values

this business in the current environment and what type of structures are likely to be included in future offers received.

The IOI helps to further narrow down the number of parties that get access to the more detailed information in the data room and ensure those moving forward are in-line with valuation expectations and have the ability to close. Data Room (& Potential In-Person Management Meetings) Once the interested parties submit an IOI, the seller and his M&A advisor will review the indications and determine which parties to move forward with. Those selected parties will get access to the data room which contains a more complete list of information that will help the remaining parties determine if and how they will make their formal offer via LOI.

2-3 Weeks

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A data room is a vault, Dropbox folder or other organized electronic location that contains all the comprehensive pieces of information that the seller has prepared to share with potential buyers. Although the data room may not be 100% inclusive of every single item a buyer may desire, it does contain a large amount of very detailed information including, but not limited to:

- Detailed - line by line Income Statement and Balance Sheet - Detailed financial projections and assumptions used - Debt schedule - Detailed A/R & A/P aging schedule - Detailed list of assets including purchase price, current value, etc. - Details of any recent appraisals on the equipment - Redacted list of every customer - Examples of customer contracts - List and biographies of key management and other key employees - List of all employees, tenure, salary, etc. (typically with names redacted) - KPIs (Key Performance Indicators) tracked by the company

Depending on the business, there may still be some information that is not prepared or intentionally held out of the data room and will be made available once the company is under LOI with one company. The amount of information to present, and when, is a decision that should be discussed and made with your M&A advisor as it is really case by case. Letter of Intent (“LOI”) The final stage of the outreach process is the Letter of Intent (“LOI”). Once you’ve generated interest from as many groups as possible, narrowed down that list after IOIs and provided those remaining groups with sufficient information, it is now time for those remaining groups to submit formal offers via a LOI (Letter of Intent). From the date they get access to the data room, 2-3 weeks is usually sufficient for them to review the information, ask any additional questions and draft their offer. The LOI is a document that outlines the intent of two or more parties to engage in a prospective deal. It provides details regarding the proposed transaction price and structure, and communicates the parties’ intent to formalize this deal in a legally binding agreement in the future. The LOI serves as a very useful tool to ensure both parties are serious and willing to move forward with a transaction:

1. By signing the LOI, the seller is validating his intent to sell the business; 2. The buyer and seller agree upon a value for the business (or a basis upon which to value it) and

major terms which otherwise could become deal-breakers; 3. It is a valid trigger for both the searcher and seller to commit to invest considerably more time

and money in the third stage of evaluation; and 4. It usually contains a binding “no-shop” obligation on the seller to provide exclusivity in

negotiating a transaction only with the searcher for a specified period of time.

2-3 Weeks f

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The following are some key items that are commonly included in any LOI: • The price the buyer is willing to pay • The terms and structure of how they will pay • Whether it will be an asset or stock sale • List of key diligence areas • Exclusivity period requested • Details of seller’s role post sale, if any • Non-compete agreements

Although many of the provisions in the LOI are typically non-binding, it often contains some binding provisions such as the “no-shop” obligation which restricts the seller from soliciting or negotiating other offers during a defined period of time called the exclusivity period. The length of exclusivity period commonly requested in an LOI is approximately 60-90 days. Since exclusivity ends at the end of the diligence period (unless extended, which it often is) the buyer will usually ask for a little more time than he expects to be necessary in case there are some unexpected delays (which there usually are).

Note: Although we have seen some exclusivity periods as short as 30 days, this is not good practice as it’s highly unlikely that sufficient diligence can be completed in that amount of time (we discuss the diligence timeline in more detail in chapter 10). Anything over 90 days is typically viewed as not in line with the market but, in certain situations, may be appropriate given the level of diligence required or other circumstances that would prevent it from being completed sooner.

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STEP 9: EVALUATE OFFERS

Now that you’ve received a number of offers it’s important to be able to understand and accurately evaluate all of the offers. This is another area where a good M&A Advisor will be able to add significant value because they see a lot of deals, understand the different structures and can provide useful insight as to what structures should be acceptable given the stated risks in the business, the industry and the current market environment. No two offers are the same. Even in the slight chance that the total price and structure of the offer are identical, they still come from two different parties, with different backgrounds, who will have a large impact on the future of the business. Key Items to Consider Asset Sale vs. Stock Sale As noted in step 3, an offer can propose that the transaction be structured as either an asset sale or a stock sale. Each of these structures will have a different impact on your tax bill. In a C-corporation, since a stock sale is often more beneficial to the seller from a tax perspective, it may still be in your favor to accept a lower price in a stock sale over another offer with a higher price but structured as an asset sale. If you agree to go with an asset sale, maybe it makes sense to raise the total purchase price to account for tax differences between the two scenarios. Each transaction is different and is open to negotiation between buyer and seller. Either way, you should be consulting with your tax advisor to determine the specific impact on you before making a decision. Up Front Cash Typically, some amount of the offer price will be paid in up-front cash. This means that amount will be wired to your bank account on the day of closing. Although every seller would prefer 100% of the offer price be paid up front, it is not that common and you may get a higher total price if you accept some portion later. The reason you may get more by waiting for a portion, is that waiting transfers some risk from the buyer to the seller and, to compensate you for that transfer of risk, the buyer needs to offer more total money. Let’s take a look at a couple examples and how they transfer risk. Deferred Payments One way to accept a portion of money later is in the form of a deferred payment. An example of a deferred payment may be a portion of the purchase price that is held in escrow to cover reps and warranties. As mentioned earlier, reps and warranties are statements made by the seller in the purchase agreement to describe the current situation of the business. In order to allow the buyer time to verify that these statements are true, they may require a holdback of these funds for a certain period of time. A common amount of time for this holdback is typically 12-18 months after closing.

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This transfers some risk from the buyer to the seller because if it turns out that the seller did not do everything he agreed to do or the buyer later found certain statements to be untrue, the buyer now has a much easier path to recover those funds than if he had paid the entire amount to the seller up front. Contingent Payments Contingent payments are amounts held back from total purchase price in order to ensure that certain financial or other significant milestones are achieved by the business. The reasons for contingent payments may be tied to anything the buyer deems critically important such as continued revenue growth, maintaining profit margins or ensuring customer retention. The seller may project that the business will perform a certain way based on attributes of the company already in place. Although the seller wants the price to incorporate those attributes, the performance hasn’t played out yet and the buyer may have doubts that those things actually happen. If the desired performance happens, both sides agree that the price should be higher. A contingent payment is a way to mitigate the risk to the buyer while allowing the seller to benefit from what he is confident will happen. They do this by releasing a portion of the purchase price contingent on the company achieving those pre-determined targets.

Earn-out is common form of contingent payment that is used to help bridge a pricing gap due to different expectations of future performance. With an earn-out, the seller only receives a predetermined portion of the purchase price from the buyer when specific performance targets are met. Earn-outs are often based on 1-3 years of performance and are typically tied to revenue or earnings targets. This transfers risk from the buyer to the seller because if these targets are not hit that portion of the purchase price is never paid. Since the seller is now holding some risk of not receiving all of the money offered, then he may demand a slightly higher price for accepting that risk. But if he is confident those things will happen, then he should view that as a positive risk/reward tradeoff. Earn-outs may also be structured as uncapped. Since an earn-out could result in less money if the company underperforms, an uncapped earn-out would allow for additional money to be owed if the company outperforms those hurdles.

Note: Earn-outs are typically complex structures that could have a large impact on both the buyer and seller. If you think an earn-out structure may be appropriate for your transaction it is important to work with an experienced M&A Advisor and attorney to ensure it is structured fairly and worded correctly.

Seller Financing

Rolling Equity is one form of seller financing where the seller contributes or “rolls” a portion of their proceeds into the new deal and therefore will continue to be a minority owner. Rolling equity primarily comes into play for one of two reasons:

1. The buyer does not have enough cash, or equity, to contribute on his own and needs some additional cash in order to qualify for the debt capital he intends to use. This scenario is more common for smaller businesses that are selling to an individual buyer. Often times an

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individual buyer is using a SBA loan or other bank financing that is requiring a certain portion of equity be contributed to the deal.

If the buyer doesn’t have the sufficient amount of cash required, some lenders will allow the seller to roll a portion of his proceeds into the deal instead. The banks like this because it reduces some of their risk by having other capital in the deal. It also shows that the person most familiar with the business, the seller, is willing to risk some money because he is confident that the business will perform in the future. This may also ensure the seller sticks around long enough to ensure a smooth transition so that the new owner will be successful running the company.

2. The other common reason for a seller to roll equity is that they still believe strongly enough in the business that they wish to continue to participating in future upside. This is attractive to the seller because he cashes out a large portion of money today, but also gets to leave a little money in to continue growing so he can hopefully cash out a second time for a larger amount in the future. Sometimes this means that the seller is willing to remain in an active role with the company post sale. While this can sometimes be beneficial for future performance of the business, other buyers prefer that the seller completely exit after a specified transition period. This is because keeping the former owner involved could potentially lead to internal issues. These issues may stem from a desire to still control ongoing decision or from employees being biased or confused at who they should listen to in case of a disagreement.

Seller Note is another type of seller financing where the seller agrees to receive a portion of the purchase price in the form of a loan. The details and terms of a seller note vary with each transaction, but some require regular principal and interest payments while others rely on a lump sum payment, or payments, at the end of a stated period of time.

As is typical with most notes or loans, the seller note typically includes a specified interest rate that coincides with the risk being accepted and comparative lending rates available in the current market. Since the seller is still accepting additional risk by delaying payments, because the buyer may not ever make those payment, he may require that the total purchase price be higher if he has to hold a seller note.

Example – Comparing Offers Let’s look at an example to illustrate how 3 offers could differ in price and structure: For this example, let’s assume that the seller communicated the following numbers in his projections and wants to be paid like a business that is already positioned to achieve these results.

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Let’s also assume that in this industry, a business of this size growing at 2% per year would likely sell for approximately $42,000,000. But if that same company were growing at 10% per year, they could likely sell for closer to $48,000,000. Here are a couple offer structures that may be received for this business:

Offer 1: All Cash Offer 2: Cash & Seller Note Offer 3: Cash, Seller Note & Earn-out Total Price = $40,000,000 • Paid 100% Cash at closing

Total Price = $45,000,00 • $20,000,000 Cash at closing • $25,000,000 Seller note

- 5-year term @ 7% interest

Total Price = $50,000,000 • $15,000,000 Cash at closing • $25,000,000 Seller Note

- 5-year term @ 7% interest • $10,000,000 Earn-out

- Based on growth years 1& 2 - Every 1% growth over 3% = $1M - Up to total of $10M over 2 years

*To clarify the earn-out, if the company grew 10% the first year, the seller would receive (10-3 = $7M) paid in year 1 and could earn up to another $3M in year 2. Assess the Buyers During this step, you want to make sure you continue to evaluate the buyers in depth. This part of the process should be as much about you vetting the buyers as it is the buyers vetting you. The group making the offer, and their intentions with the business, is a key piece to evaluate and understand. Make sure you are comfortable with answers to the following questions:

- What is their background & experience? - What is their plan for the business and can you trust that guidance? - Do they have other businesses they’ve bought?

o If so, how did those work-out and did they utilize a similar strategy with them? o If not, why would this one be different?

- Who are the people that will be running the business day to day? o What are their backgrounds?

- How have they been interacting with each of the parties throughout the process? o You o Management o Other employees

You should also understand the estimated time it will take each group to complete diligence and what types of analysis they will use during that process. The less experience that a group has in your industry they longer it may take them to analyze the data and assess the risks. In addition, assess the types of data they will be requesting and the analysis they will be ordering. Do those seem to be in line with industry norms? And are they acceptable to you?

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Key Items to Keep in Mind Throughout the Process Remember What Was Most Important to You All of the work that you put in during step 1, in regards to deciding what was most important to you in a transaction and why, comes to great use when evaluating LOI offers. Take time to review the work you did during step 1 and keep that in mind during this step. It is very easy to get emotional and greedy when you see the amount of money on the table and lose sight of what was truly most important to you (that’s why we started with that step!). Taking time to review those thoughts will not only help you determine what questions you want to ask the buyers, but also ensure you make the best decision so you don’t have regrets later. More Than Just Price Most sellers only have one thing in their head as they look at offers – what is the total price they are offering. But there is a notable quote throughout the industry that says “You can pick the price if I can pick the structure …OR… you can pick the structure if I can pick the price.” This highlights the fact that just because an offer price is higher, doesn’t mean that it is the best offer. The structure, and additional details, of an offer can have a large impact on the overall attractiveness of that offer. Understanding these details, with someone who is familiar with them, is important to making an educated decision.

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Section 4:

Diligence & Closing

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STEP 10: DUE DILIGENCE

Once you've evaluated all of the buyers and LOIs, you will choose the offer you feel is the best fit (remembering all of the important factors you thought through in step 1), then sign their LOI and move into the due diligence period. Due diligence simply refers to the exclusivity period where the buyer performs research and analysis to confirm all material facts being provided before entering into a transaction. Similar to an inspection on a house you are about to buy, diligence is the buyer’s time to thoroughly examine all areas of the business to ensure he is comfortable enough to finalize a deal with you.

Note: An important point to remember is that you don’t want any surprises to surface during diligence. This includes financials, customers, operations, legal risks, etc. If you’ve followed the preparation discussed earlier in this guide, and been honest in your communications, you shouldn’t have any problems.

The costs of due diligence can vary widely depending on the size of the company being acquired, the scope of analysis sought, and the firm(s) hired to perform the work, if any. During diligence each side pays its own expenses including any outside parties or advisors it utilizes. Since the costs and amount of work can vary, the time it takes to complete diligence can also vary. What to Expect During the Diligence Period Once in diligence for a transaction, we often find that owners expect the diligence process to move very quickly so they can get to closing. Any why not? You’ve already supplied the buyer with a lot of information about your company, answered many of his questions and done a decent amount of negotiating. So why shouldn’t this just be a very quick process now? The answer is three-fold:

1. Buying a business is a major event for the buyer. A prudent buyer won’t want to rush through the process of verifying all the information that has been presented.

2. There are typically a number of costs involved in the diligence process, some more expensive than others, so buyers will wait until one assessment is completed before starting on the next.

3. We often find that the selling company needs time to prepare information for some of the requests made by the buyer or their diligence team. This often causes additional delays from the optimal timeline.

As a seller, the best thing you can do to ensure the diligence process moves as quickly as possible is be prepared. Knowing what is typically asked for, and preparing those ahead of time with sufficient and accurate detail, can help limit any delays from your end.

Here are some of the more common items examined during due diligence: • Financial Information • Structure & Operations • Physical Assets & Real Estate • Customer Information

• HR & Employee Information • Material Contracts • Technology & Intellectual Property • Taxes

6-12 Weeks

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• Insurance • Litigation

• Licenses, Permits & Compliance • Environmental Issues

Timeline for Due Diligence Here is an example of a few tasks commonly performed during diligence and the amount of time it takes to complete them:

*These tasks are discussed in more detail later in the chapter.

Note: Depending on the type of firm, some of these tasks may not apply. For example, a software company would not require an equipment appraisal, but instead may require an assessment of their technology.

Optimal Timing of Tasks If all of these tasks are scheduled, analyzed and completed in the most efficient timeline, then the process, in theory, could be completed in less than 6 weeks. In that scenario a buyer could start day 1 with the Quality of Earnings. Once that is started, he could immediately begin the equipment appraisals. Once appraisals are underway, he could perform the background checks. Since each of these tasks is likely performed by a different party it is possible to have them all working at the same time. Drafting of the purchase agreement is usually held until the rest of diligence is completed because if issues are discovered during other parts of diligence it would be costly to go back and adjust work that has already been completed and charged for. In addition, legal costs are usually the most expensive part of diligence and there is no reason to spend money for attorneys to draft the purchase agreement if there are issues that may still arise during diligence and need to be discussed. But in an optimal scenario, one could begin the legal work as the group is finishing up the Q of E report, as shown below:

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Realistic Timing of Tasks In reality, because buyers commonly utilize outside parties to perform expert analysis in these areas they come with a price. Because of those costs, many buyers want to be prudent with their spending by starting with the most important area(s) first to ensure they are in line, before moving on and paying for other assessments. In this situation, the tasks aren’t all done at the same time, but rather staged in succession, and may look more like this:

In addition to these activities performed by outside parties, the buyer would typically be performing additional diligence on a number of other areas in parallel. Unexpected Delays There are almost always a number of unexpected, and sometimes unnecessary, delays that come up during the process which prevent it from moving along at an optimal pace. Since “exclusivity” ends at the end of the stated due diligence period (unless extended), buyers typically request a diligence period that provides a little cushion due to the unexpected delays that may arise. Here are some of the unexpected delays that we have come across in our prior deals:

o It took the buyer time to evaluate outside parties who would perform the diligence assessments. This included discussing scope of the project and drafting the engagement letter.

o The outside parties being hired were already be involved in other engagements and couldn’t start on this one for a few days, or even weeks.

o Many of the projects involved traveling to the location(s) of the business to make on-site observations. Coordinating travel and schedules took time.

o The various parties involved including seller, buyer, hired parties and other employees have lives in which things came up. We’ve seen delays for vacations, illnesses, funerals, board meetings, other company projects, events for their children, etc. all which were an unexpected delay to the progress.

Major Diligence Tasks Quality of Earnings Time: 2-3 weeks assuming you have all of the information they request. If you need time to locate or generate the information requested, that could delay the process. Cost: $20,000 - $80,000 depending on the size and complexity of the business. Some transactions will only require a “limited scope” Q of E resulting in lower costs and completion times closer to 2 weeks.

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Others will require the full scope Q of E which can take 3 weeks or more and comes with additional costs. Typical range for many small to mid-sized businesses is $30,000 - $45,000. (Paid by buyer) If you are selling your business, a buyer will almost always require a Quality of Earnings (“Q of E”) be performed on the company prior to closing. The Q of E is an analysis performed by an accounting firm in order to validate the company’s financials. It not only verifies all of the financial information that the seller represented as accurate, it also ensures that information is presented in accordance with Generally Accepted Accounting Practice (“GAAP”) standards. This helps eliminate misunderstandings related to a company’s chosen accounting policies. One of the big focuses of the Q of E is to determine the true T-12 EBITDA to understand what cash flow the firm is generating. Since EBITDA is not normally identified in GAAP accounting practices, this often times has to be calculated separately from the information provided and ensure its accuracy. In addition, since many businesses are sold intra-year the financials often need to be adjusted from year end and year to date, to trailing 12-month numbers.

Equipment Appraisals Time: 1-3 weeks depending on the number of assets and the number of locations needed to visit in order to assess those assets.

Cost: $5,000 - $30,000 but many small to mid-sized businesses can have this done for $10,000 - $15,000. (Paid by buyer) Buyers will want to verify that the equipment (trucks, trailers, machines, large tools, etc.) they are buying is in good working condition and worth approximately what was represented to them on the asset list. Obviously, there are firms who don’t have or use many assets in their normal course of business and would not require this step. In addition, buyers are usually only interested in appraising larger items that are used in the normal course of business to generate revenue. Background Checks Time: ~1 week Cost: ~$1000 per person It is highly encouraged that buyers run background checks on the owners and potentially other key people in the organization before completing the purchase. While most of these rarely surface any issues, a buyer would want to know if, for example, the owner/seller has 2 recent charges of fraud or other major issues that may raise a flag or raise character issues resulting in the buyer not trusting or wanting to move forward with any transaction with that seller. Small charges are common and normally don’t have any impact on a buyer’s decision. Negotiate & Draft Final Purchase Agreement Time: 1 week – 4 weeks, although could be much longer if there are disagreements. Cost: Highly depends – on the cost of your lawyer and the number of changes required. But for SMBs this can range from $10,000 to well above $100,000. This is typically the most expensive part of diligence for most transactions. We discuss the purchase agreement in more detail in chapter 11.

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While these tasks don’t apply to every transaction, they are some of the most common analyses performed. Each situation will have its own set of required analyses depending on the buyer and the type of company. For example, we have been working with more technology related companies recently. These firms have very few assets so don’t require an equipment appraisal, but may instead require a technology assessment. This assessment evaluates the architecture and code of the software, examines the intellectual property and understands the people involved in maintaining that technology.

Due Diligence Checklist: A number of the information requests will be from the Quality of Earnings group, but there will likely be requests related to all areas of the business. While each business is different and will have requests specific to their business or industry, the following is a Due Diligence Checklist that contains additional detail on some of the more common items requested during due diligence. (Insert Diligence Checklist) Continue Evaluating the Buyer Finally, keep in mind that you should still be taking time to assess the fit and character of the buyer during the diligence process. This is your first real gauge actually working with them and your last opportunity to change your mind. Take note of how they are handling the process:

- Are they respectful? - Do they seem organized? - How are they talking to customers? - How are they treating employees they have dealt with? - Does it seem like they have a good handle on the business and vision for the future? - Are they following through on items previously communicated? - Do they backtrack on stuff they’ve promised or “sold” you on to get to this point? - If all of the diligence items have come in just as previously communicated, are they still trying to

re-negotiate the terms to be more favorable for them? At this point you can also start to see the character of all parties involved. It is something that may provide comfort to you or something that leaves you uneasy. Your gut instinct on these evaluations is often right. As painful as it may initially seem to dis-engage after this amount of time and effort, if it doesn’t feel right it may be better to walk away and find a new buyer than to settle for a buyer that will leave you with regret into the future. But most strong buyers are genuine and fair. They stick by points previously negotiated and also understand that there will likely be small findings in diligence that don’t necessarily require any adjustments to the offer. At this point you are ready to engage the legal team and focus on the final purchase agreement!

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STEP 11: NEGOTIATE AND DRAFT PURCHASE AGREEMENT

Now that you have completed diligence, you are ready to negotiate final terms and draft the purchase agreement. The purchase agreement is a formal legal document that describes all details for the sale of your business. This document can take many forms depending on the structure of the sale and will likely contain many pages with complex legal language. Understanding the purchase agreement, from a high level, is very important for the seller – not only because of price, but also because it explains exactly what’s included in (and excluded from) the purchase. It also describes how the agreed-upon payment will be paid and allocated among the different asset categories. Negotiations Resulting From Diligence Since you’ve already done some negotiating prior to the LOI, there may not be many items to discuss here. But coming out of diligence, it is fairly common for issues or discrepancies to surface that the buyer feels may impact the initial offer or structure communicated. While it is not good practice for a buyer to “re-trade” after diligence (meaning change the terms of the offer), if diligence reveals that the actual data is different than what was presented, then he is right to want to adjust the price or structure of the deal to reflect those findings. Since you pay attorneys by the hour, it is often cost effective for you to take time to negotiate any items you’re comfortable with prior to formally involving the attorney. If you are working with a good M&A Advisor, he will have sufficient expertise to help you with a number of these points. But I caution you to err on the side of more attorney involvement, they are usually worth the money you pay them and can add significant value that protects you in the long run. Importance of a Good Attorney At this stage, it is almost essential that both sides engage and utilize their own attorneys as the purchase agreement is a legally binding document. In addition, you will likely be racking up significant costs and will want to be sure the money you spend is used towards guidance specifically for you. As discussed in chapter 2, it is important to work with an attorney who is familiar with your industry and size of company. The purchase agreement can be very long and contain complex legal descriptions. The specific language of a particular point, or the exact term used, may drastically alter the implications to you once the transaction is completed. An attorney who has worked on a number of similar transactions within the industry can counsel you on, not only how different scenarios will impact you, but also what language is most appropriate for the specifics of this transaction.

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In addition, it is common to have multiple mark-ups from each side, with each requiring detailed negotiations. Therefore, each side will want their own legal expert to review language suggested by the other party. Drafting the Purchase Agreement The buyer’s attorney will typically draft the purchase agreement, but it is sometimes done in conjunction with the seller’s attorney. Once the first draft is completed, the seller will review in detail with his attorney and note any points they would like to discuss further or suggest changes to. Upon receiving back the marked-up document, the buyer and his legal counsel will determine if the suggested changes are acceptable or not. This back and forth between legal teams can take days, weeks or even months depending on the level of negotiating that occurs. The availability of all parties involved, the number of points to discuss and the willingness of each side to come to a fair compromise will determine this length. Key Sections in the Purchase Agreement

Description of the Parties

Provides the legal names of both buyer and seller. Be sure to confirm these match or represent the parties who sign the contract. This information often includes the physical addresses and phone number of the parties listed.

Description of the Sale

Identifies whether the transaction is a stock sale or asset sale. This section also provides a description of every asset, stock and item included in the sale and every one that is not included.

Purchase Price Explains the financial terms of the agreement, including purchase price and the method of payment. This includes any seller financing or contingent payments agreed to and the details of those arrangements.

Representations and Warranties

Communicates exactly what each side is attesting to, and relying on, as part of the transaction. This may include statements about the condition of assets, the types of services provided or the existence of any debt. The seller’s representations are often more extensive than the buyer’s since they are providing all details related to the business.

Covenants Contains a number of promises between the buyer and seller that detail what they will do prior to the sale closing, and after it closes. These may include statements related to normal operations of the business up until time of closing or an agreement to cooperate if issues should arise after closing.

Closing Conditions

Outlines the requirements in order for closing to occur. It states that if these requirements are not met the parties can walk away from the deal. Typically, this section also includes language around delivering funds at close or satisfactory completion of diligence.

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Miscellaneous Often called “boiler plate language” this section includes important information such as governing laws, validity of the agreement and how disputes will be resolved.

Signatures Legal documents require a signature from both parties involved in the transaction, acknowledging that they agree to the terms and conditions outlined in the document.

Additional Information Commonly Included In addition to the key sections the Purchase Agreement will also typically include information in the following areas:

• Closing date • Any liabilities being assumed by the buyer • Details of any price adjustments at closing based on actual business standing • Details of any transition assistance agreed to, and provided, by the buyer post close • Details related to employee contracts between the buyer and seller • If there was a broker involved with the transaction or not • Post-closing rights and obligations • Assumption of risk and liabilities

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STEP 12: CLOSING & BEYOND

Prior To Closing In the days leading up to the final closing you should be sure to communicate to any and all necessary parties. This may include:

- Contacting banks regarding business accounts - Cancelling insurances policies not being assumed by the buyer - Cancelling or transferring your lease, if appropriate - Notifying creditors to coordinate payoff amounts or future payments - Contacting vendors and other parties for which you will be transferring contracts - Reaching out to any other parties with a need to know.

In addition, you should coordinate with your accountant to ensure you file the appropriate tax forms for selling a business. Closing If all the other steps have been performed correctly and diligently, the closing (although a major day for both parties) is really a non-event. The events leading up to this point have been critical to the success of the transaction and now the closing is really just signing papers and ensuring the correct amounts are wired to the correct parties’ accounts. Similar to selling a house, now that you are no longer the owner you will need to turn over all information related to operating the business. This may include items such as keys, operating manuals, supplier and vendor lists, alarm codes, and computer passwords. In addition, you should provide the buyer with your contact information for any needed future communications. Post-Close It is typical that your obligations don’t completely stop after the closing. Post-closing commitments often include transferring customer relationships, explaining key management or market dynamics, and other proprietary information or trade secrets needed to operate the business optimally. If you agreed to provide any transition support you need to be sure you honor that commitment for the agreed up on time frame. The typical transition time is about 6 months but can vary depending on the complexity of the business and the experience of the buyer. Some businesses and buyers don’t require any transition assistance, while others may require a year or more. If you’ve agreed to accept any contingent payments such as an earn-out you’ll want to make sure you do what you can to help the business meet those hurdles. Sometimes there isn’t a lot an uninvolved owner

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can do from the outside, but to the extent you are allowed, you want to help ensure the business achieves the stated milestones in order to receive maximum payments. In addition, if you’ve agreed to any amount of seller note, even if no longer involved in the business, you will want to provide any assistance or oversight possible to ensure you continue to receive all of your payments. If you’ve agreed to non-compete and/or non-solicitation agreements, be careful that you abide by all of the language contained within those documents.

Non-Compete Agreement Is a contract stating that you will not enter into, or start, a similar profession in competition against your former company. This typically includes working for a competitor in the same market. The non-compete agreement can be important for a buyer to request of the seller since the seller knows the strengths and weaknesses of the company and could quite easily help another company take business from them. The duration of a non-compete can vary depending on the parties involved, but is commonly 2-3 years.

Non-Solicitation Agreement Is a contract stating that you agree not to solicit a company’s customers or employees after leaving the company. Since many small business owners had close relationships with many of the customers and employees, without this agreement the seller could theoretically take money for the business, then turn around and take the employees and customers that would allow the business to be successful in the future. The duration of this agreement varies by transaction but is commonly 1-3 years.

Documents

The Ultimate Guide to Selling A Business v3€¦ · To Selling A Business A comprehensive guide for selling small to mid-sized businesses ($5MM - $100MM Revenue) Written By: Nick