You have spent blood, sweat, tears (not to mention time, money and sleepless nights) in building your business and now you are looking to cash out. How can you maximize the value of your business in the eyes of a buyer?

  1. Preparation.
    • Make sure you understand the current market conditions in the industry and who are the active buyers.  What are the buyers looking for?
    • Consider tax planning opportunities – a business sale might be a good opportunity to plan for transfers of wealth to the next generation or for making a tax advantaged gift to a charity. These planning opportunities need considerable lead time – start discussion with your advisors well before the business goes to market.
    • Select your transaction team. Selling a business is not something you have likely done before so you will need appropriate advisors including an accountant, lawyer, and transaction intermediary (business broker or investment banker). Your lawyer in particular must be experienced in M & A work – your regular business lawyer probably won’t do.
    • Prepare yourself mentally and emotionally.  Even with the best advisors, selling a business is a lot of work and stress for the business owner.  Make sure you understand the sale process and exactly what will be expected of you and the Company employees.
    • Prepare to tell your Company’s story. Presentation material should include all of the necessary facts and figures, but also describe what makes your Company tick. Emphasize your industry contacts and relationships. Work with your advisors to decide what should be disclosed – it’s usually better to disclose bad news up front rather than let the buyer discover it later in the process.
    • Get ready for due diligence – make sure your books are clean and all the legal arrangements surrounding your Company – leases, contracts, corporate records are in good order. Consider what intellectual property can be disclosed to a potential qualified buyer and what cannot.
  2. Understand Valuation
    • There are many ways to value a business and many buyers who do a lot of acquisitions have their own proprietary formula to determine whether a target company is a good fit.  However there are certain basic methods that you need to be familiar with:
      1. Multiple of EBITDA (Earnings Before Interest, Tax, Depreciation & Amortization). Businesses are sold based on cash flow, not accounting income.  EBITDA is one way to estimate cash flow generated by the business without considering interest bearing debt (or leverage).  Since a debt free company consists of assets + working capital liabilities, this valuation method yields an asset sale value.
      2. Discounted Cash Flow. This method consists of estimating future annual cash flows (on either a debt-free or debt-included basis), selecting a discount rate, and calculating the present value of the future cash flows. If we only estimate next year’s cash flow, we can apply a Capitalization rate (Discount rate adjusted for future expected growth in cash flow) to that one year’s earnings which results in an estimate of value.
      3. Frequently, buyers will “check “their value estimates by doing a financing analysis on the Company based on the estimated value.  By determining how much cash flow is left after financing costs, a return on investment (ROI) can be calculated. Buyers generally have a benchmark ROI for their capital investment.
  3. Understand Deal Structure
    • Buyers usually don’t pay 100% cash at closing.
      1. A deal might contain an “earn-out” in which a portion of the sales price is contingent on future company performance.
      2. An offer might include a “target working capital” – the deal price might be based on the assumption of a certain amount of working capital at closing.  The exact working capital at closing usually can’t be known at closing; therefore a portion of the sales price is held in escrow until a few weeks after the sale when the exact purchase price can be calculated to reflect the actual working capital.
    • A deal can be an “asset sale” or a “stock sale”; the asset sale might or might not include Company liabilities. Asset and stock sales can have very different tax implications which will have an effect on the purchase price.
  4. Understand the Fine Print in the Purchase / Sale Definitive Agreement – Post-Closing Risk
    • The Letter of Intent (LOI) is framed as a non-binding framework for the deal prior to the buyer’s due diligence. The LOI is stated as “if everything the buyer believes about the target company turns out to be true, s/he will pay X amount for the Company”.  The LOI will spell out the key terms of the deal.  If during due diligence, the buyer discovers facts inconsistent with its prior understanding, it will want to negotiate the price down. As a general rule the better and more specific the LOI, the greater the chances that the deal will close.
    • The Definitive Agreement is a binding legal contract that will include all of the representations, warranties, covenants, indemnifications, closing conditions, etc. of both the buyer and seller.
    • As the deal moves from a Letter of Intent to a Definitive Agreement all of the above mentioned representations, warranties, etc. will be negotiated. (Here is where a good deal lawyer is worth a lot.) Typical representations include that the financial statements are accurate, there are no undisclosed liabilities, A/R and inventories are properly stated, seller has good title to all property and no material items are omitted.  All of these provisions will have importance in allocating financial risk between the buyer and seller for events that occur post-closing.
    • The definitive agreement will also specify the scope of post-closing legal liability – e.g. a cap on liability of 20% of the purchase price might be agreed to.
    • These legal issues should not frighten you unduly, but they should encourage you to have a good deal lawyer on your side.