Most advisors are not transaction intermediaries (investment bankers or business brokers) nor are we transaction attorneys, but all of us have worked with owners who have turned to us with questions about (or a desire to) selling to a third party. As financial planners, investment advisors, CPAs or attorneys whose expertise is not in M&A, how we answer those questions has direct bearing on how successful that type of transaction will be.
There is much we can do for both our clients and their companies to ensure a successful sale—if we undertake that work before the sale process begins. Essentially, your job is to help owners define the destination and to find the “smoking gun” (or guns!) that can lower the purchase price or kill the deal completely. These guns (or “deal killers”) can lurk in the owner’s psyche or in the company. Let’s look as both.
The sale process is not a cakewalk. It demands time and attention from owners at time when their companies are under a buyer’s intense scrutiny. Your first job is to help the owner articulate and set his or her goals, quantify existing resources, project net sale proceeds and address any gap between what an owner has and what an owner wants before diving into the M&A market.
It also falls to you to educate owners about the likely length and twists and turns of the sale process (including due diligence), and the need to follow the lead of advisors who have dealt with buyers in the past and know how they behave. You will be involved in choosing the transaction intermediaries and can help owners determine which one best fits their personalities and goals.
Preparing The Company
You, or another advisor, must make certain that the business is squeaky clean and ready for sale. This pre-sale housecleaning includes reviewing and tidying up every document and issue that a buyer will examine. The issues that kill deals are generally issues that could have been eliminated with careful pre-sale planning. Consequently, the most cost- and time-efficient way to avoid Deal Killers is to prepare both owner and company. In future articles we will examine the most common Deal Killers and how to de-fang them during pre-sale planning, but today let’s look only at your role in helping an owner to establish goals and understand the process in a case study I call:
How a business can sell for $19M . . . and its owner walk away empty-handed
James Padgett called Ace Exit Planner, Shirley Locke, as a favor to a golf buddy. James was thrilled with the $19M offer he’d received for his company, but was concerned by his friend’s off-hand comment that sale proceeds aren’t always what they seem. He brought the Letter of Intent (LOI) from the buyer to this lunch meeting and explained that he’d personally hired an investment banker who had negotiated the sale of his business for $19 million. Clearly, James was excited: first to be exiting and second to exchange ownership in a company for millions of dollars.
“The terms of the buyer’s offer are attractive,” James explained. “The sale price is $19 million—80 percent cash and 20 percent (about $4 million) in an earn-out. The buyer didn’t want to pay that much but that’s a fair price for a company with an EBITDA of $3.5 million!”
Shirley nodded and asked one question, “Mr. Padgett, how much cash do you need to net from the sale of your business to achieve your financial goals?” Already using Locke’s nickname, Padgett replied, “Shirl’ I expect about $15 million—which I’ll get—after paying capital gains taxes of 20 percent.”
Shirl’ picked up the buyer’s LOI which indeed offered to purchase James C corporation for $19M: the assets, not the stock, of that corporation. Locke explained to Padgett that a purchase of assets (almost entirely in the form of good will or depreciated property) meant that James’s corporation would first pay combined federal and state taxes of about 40 percent of the sale price (or $8 million). That tax bill would shrink the proceeds (still in the corporation) to $11 million. James would then receive $11 million (as a dividend) and pay capital gains tax of 20 percent (or about $2 million). The net proceeds to James contracted again to $9 million.
James was not pleased but still anxious to sell. “Just a minute, James,” continued Locke. “I estimate that the fees you’ll pay to your investment banker, law firm and audit firm will total about $1 million. Your company will also have to pay off its $4 million bank loan from the after-tax proceeds.”
James did the math. Those additional deductions left him about $4 million—barely more than one year’s worth of EBITDA. But Shirl’ wasn’t quite finished. “Don't forget that the 20% earn out ($3.8 million) means you’ll receive little or no cash at closing.”
James had written two numbers on his napkin as Locke talked:
Sale price: $19 million
Cash in my pocket: $ 0
How could Padgett have gone this far in the process of selling his business? After all, he had a CPA firm, a business attorney, a financial and insurance advisor, a CFO and management team. He’d already spent tens of thousands of dollars during the sale process.
How? James had consulted not one of his advisors and not one of them one had ever thought to ask James if he was, at age 63, beginning to contemplate someday leaving his business.
The moral of this story and recommendation to the thoughtful, proactive advisors who read these articles is simple: Ask!
Questions like these lead to discussion and discovery. Had an experienced advisor asked James (and the thousands of owners like him) these questions, James would not have proceeded into a sale blindly. He would have engaged in pre-sale planning.