After selling my logistics company in 2012 and my e-commerce company in early 2014, I've had some time to reflect in how differently each sold. My notes from both sales created the list of seven things every entrepreneur must cover well before selling your business.
First, I want to give you a short summary of the two sales I went through over the last few years. I elected to sell my logistics company myself and avoided private equity (PE) firms, investment bankers, and business brokers. Simply by posting my business online and getting the word out within my 20 year old transportation Rolodex, the best outcome was right down the hall as I ended up selling it to my terminal manager. The negotiations were clean and concise and lasted less than a week, only one business attorney was involved, papers were signed and the deal was done. From start to finish, the sale was complete in less than 90 days.
The second time around, I hired an investment banker, put months into a CIM (confidential information memorandum) document, worked on a list a mile long of potential buyers - from PE firms to fortune 500 companies, and did multiple dog & pony shows in front of interested buyers. In the end, we got a handful of non-binding bids that all ended in disappointment for various reasons. One year later, I sold out my shares to my minority business partner.
Each of these experiences produced a plethora of new found knowledge in an area I thought I knew pretty well through a few of my past experiences, books I've read, and colleagues I knew in the M&A arena. Let's just say I had no idea! I am grateful for both experiences, what I learned, and my desire to share them with other entrepreneurs.
With the startling number of start-ups sprouting up everyday, it is critical to have the end in mind. The "end" is an exit strategy under your terms and within the parameters you set that triggers the start of an exit. It is healthy to think through possible exits once your business is financially stable and has a strong operational foundation. The following are seven things you must get in order and optimally presented before putting your business up for sale. Knowing this simple outline will help you set up your company for securing the best multiple of EBITDA to all potential buyers that show interest in your business.
#1: Your Financial Statements must be in order from day one. As an entrepreneur, you do not want any holes in your historical financials. Get with your CPA or Controller and put together the following critical financial statements:
#2: Estimate the Value of Your Business Assets. It’s essential to list and price all physical assets of your business, including furnishings, fixtures, equipment and inventory. In my simple transaction, this was done down to every piece of furniture, computers, and office supplies. With the overwhelming approach in my e-commerce business, this was overlooked by both sides and became a mess a few months after we closed.
Tangible Assets – The worth of these items is important for buyers who require you to provide a complete asset list, including purchase prices and fair market values. The worth of these assets is also very important in determining whether or not you should liquidate these assets before the sale.
#3: Prepare Your Statement of Seller’s Discretionary Earnings. Work with your accountant or bookkeeper to "recast" or "stabilize" your business income statement into what’s interchangeably called a statement of owner’s cash flow or a statement of seller’s discretionary earnings (SDE). Public companies and middle market businesses are valued as a multiple of EBITDA - Earnings Before Interest, Taxes, Depreciation and Amortization. However, smaller businesses are valued as a multiple of Seller's Discretionary Earnings (SDE), which can be defined as EBITDA + Owner's Compensation AND owner perks (bonuses, company car, and other special perks the owner did for her or himself. Therefore, SDE is typically the net income (or net loss) on the company tax return + interest expense + depreciation expense + amortization expense + the current owner's salary + owner perks.
#4: Estimate the Earnings Multiple That’s Likely to Apply When Pricing Your Business. Most owners receive somewhere between one and four times the annual SDE of their business, with the multiple pegged to the attractiveness of the business being purchased. Go into this with defined expectations of what you are wanting to see regarding the SDE multiple.
#5: Do the Math to Arrive at an Early Estimate of Your Purchase Price. Based on how attractive your business appears in key areas that most affect its future success under new ownership, you can multiply your annual SDE by your estimated earnings multiplier to arrive at a preliminary estimation of your business purchase price.
#6: Price Check! After arriving at your estimated purchase price, conduct the following research: 1) Search every online businesses for sale marketplace to research similar listings and sales in your business category, market area, and price range.; 2) Gain insights into selling prices of comparable businesses.; 3) Work with your sales agent (investment banker, broker/consultant, or adviser) to see how your pricing lines up with the prices of comparable businesses that have sold over the last 24 months. Look for trends - both up and down.
#7: Research. Research. Research. You simply cannot do enough research before and during the process of getting your business ready to sell. Whoever you partner with the assist in the sale or you decide to put it on the market yourself, it is critical that you do your homework so none of the many wool blankets that are out there get pulled over your head! Good investment bankers will shoot straight but are very good at dampering your expectations, throwing out multiples that are sometimes in left field, and discounting parts of your business or intellectual property that might increase your multiple significantly. Research other business like yours and determine: who the buyers were and where they came from (industry, PE's, etc.), what multiple range over the last 24 months, and who else is for sale that might create a blind-side competition.
Looking back, my simple and somewhat naive approach with selling my logistics company ended up being the best approach in a lot of ways. From being much less stressful to hitting my target sale price. However, the second time around I learned a lot in a much bigger arena. Have fun through the process and stay engaged. It just might be a life changing event that opens many new doors to choose from! Good luck.
Scott E McGlon is the President of McGlon Properties, LLC and the author of many blog post on MP Blog. He has been a serial entrepreneur, investor, and president of many successful start-ups since 1998.
by: Scott E. McGlon
From company owners to inexperienced deal analysts, many confuse EBITDA with cash flow. Clearly understanding the distinction between the two is critical whether you are a start-up, angel investor, or an established business looking to expand via acquisition or other means.
When leveraged buy-outs (LBO) gained popular ground in the 80's and early 90's, EBITDA became the primary metric of choice to determine how much a company could potentially take on (the foundation of qualifying an LBO). Since then, EBITDA has gained even more prominence since it is one of the baselines used to get to a starting-point valuation as a multiple of EBITDA. The multiple used usually is determined by industry and based on the current M&A supply & demand of the company being evaluated. A key point is that the EBITDA metric is not uniformly defined under GAAP standards thus allowing many ways companies can calculate and, in some cases, manipulate EBITDA. This variance in how companies define EBITDA leads to inequalities and sometimes confusion regarding the true cash-generating abilities of a business. Depending on third-parties that look at EBITDA as one of their main metrics and the confidence level it creates, differences in EBITDA calculation usually lead to additional questions or more stringent due diligence.
The key take-away's to understanding EBITDA is the fact that it does not take into account the following:
If a company wants to grow, defend its market position, and remain viable & profitable, the monthly cash needed to finance the above obligations carries prominent importance. There are three main costs that are not usually found in company's stated EBITDA which lead to overstated cash flows. These are underestimating or accelerating depreciation, working capital adjustments to fuel growth, and week to week capital expenditures (capex).
Depreciation - The over or underestimation of capital expenses for asset-heavy companies such as the trucking industry (over 30 years industry experience) is one of the oldest tricks in the book and can grossly skew available cash flow. Adding back all depreciation for a company without leaving an allowance for capex will overestimate the available cash flow significantly. However, not adding back any depreciation can underestimate the cash flow. This is especially true if a company uses accelerated depreciation to reduce its tax burden. In most of these cases, the companies are profitable and carry little to no debt, Simply put, there have been a lot of cases over the years of companies manipulating depreciation schedules to inflate EBITDA. This is a true indication of a company that is not being true to their actual capex allowance needs.
Working Capital Adjustments - Most companies need to invest profits back into the company just to keep their growth objectives moving forward and to stay ahead of competition. EBITDA does not account for changes in working capital and the cash required to run the daily operating activities or the fluctuations associated with it. Ignoring working capital requirements assumes that a business gets paid before it sells its products or services - e-commerce companies for example. However, very few traditional companies operate this way. Most businesses provide a service and get paid in net 30 (industry average). Ideally, a business collects in advance for its services, pays off its due payables within terms or earlier, and uses its profits to reinvest into additional raw material inventory, products, or even staff.
Capital Expenditures (capex) - What assets or equipment is fundamentally required to operate? This is a critical question for understanding a company's capex month-to-month requirements. Certain industries like transportation, heavy/industrial manufacturing, and oil & gas all require heavy, ongoing investment in equipment just to operate. Most EBITDA calculations do not take into account capex. Line items within a chart of accounts balance sheet will show the significant investments in plant and equipment required to operate. EBITDA can get artificially inflated when companies capitalize operating expenses and allow them to be depreciated over time, thus decreasing operating expenses. The closer you can get to fully understanding true capex, the more you can rely on EBITDA as a dependable metric.
In closing, the EBITDA metric has received a bad reputation in recent years (post Internet bubble) but this should only be taken with entities using it in improper ways. Just as a steering wheel is great for navigating an automobile, the same method is ineffective in steering your horse! How you define EBITDA might be different than a featured company does. Bottom line, it shouldn't be used as the main metric in evaluating corporate profitability.
Like any other metric you use in evaluating a business, EBITDA is only a single indicator. Depending on the company's accounting methodology, EBITDA could be construed as vague, unclear, and/or a great metric to hide the true financial story. The people that make up the business, the processes they have to execute, the market share it has, and the products they sell are all key indicators that must be defined thoroughly when making a business decision on any company.
Scott E McGlon is the President of McGlon Properties, LLC and the author of many blog post on MP Blog. He has been a serial entrepreneur, investor, and president of many successful start-ups since 1998.
You are on track for a successful merger if you plan and execute with no excuses while keeping your ultimate pre-defined objectives in tact.
Part I: Planning
Begin Planning at least 100 days before deal completion -- the earlier you begin planning your merger, the higher the chance of success. In fact, starting to prepare for your integration before you even find your target company is critical. Advanced preparation allows you to excel in negotiations, but also let's you get prepared for any challenges that may arise. Trust me, there will be quite a few surprises throughout the process. If you do not have a plan for the target company, you are going to pay the wrong price and you are not going to be ready to handle the integration on multiple fronts. As a deal progresses, it is easy to focus all your efforts on completion and forget about the day after. Oftentimes, in the rush to do the deal, managers put off what they think could be easily done after closing. Ideally, you would start planning as soon as you decide to buy another company. Building a full integration plan around 100 days before you believe the deal will take place will define a lot of things - both positive and negative. To prevent a failed merger, it is important to begin planning early and comprehensively. Although such extensive planning may seem excessive, the benefits are extremely important. By having a strong plan established, you can communicate effectively right out of the gate. Many problems in deals originate from indecisiveness. Good planning and early planning leads to quick decision making, quick delivery and good communications.
Standardize a List of Items to Review During Due Diligence - To maximize your 100 days of planning, it is important to have a prepared list of items to review. For each merger, you should have a very thorough list of items to consider that you should expect to grow throughout the first 30 or so days of your plan. The list will serve as a database of questions and considerations that's sole purpose is to build a targeted list for each deal. This ever-expanding list acts as your insurance that every question, factor, or variable is or will be covered so be as thorough as you can right out of the gate. When determining merger criteria, you need to consider absolutely everything. If you were to start with a blank sheet of paper and invent a 2,000+ person company, you would need to consider every process and every situation to determine the best overall strategy.
Don’t Try to Salvage a Failed Deal - Walking away from a failed deal can be challenging and frustrating. Since most deals tend to take on a life of their own, all parties will have invested so much of their time, effort and career equity in the deal that they typically feel intense psychological pressure to shepherd it through to completion. Do not get yourself in a position where you start favoring information that supports the deal while ignoring information that was originally defined as breaking the deal. If it wasn't meant to be, accept it. Do not let the "pressure to close" drive a bad decision. Just getting a deal done has nothing to do with the ROI you set up to achieve originally Also, transaction urgency is institutionalized and magnified by a reward system that emphasizes deal completion over ROI. Finally, significant deal momentum can often take over an M&A process leading to management blinders around transaction risk or the cost of the deal, especially if multiple parties are still involved near the letter of intent (LOI) stage.
Don’t Forget Basic M&A Principles - Even without the pressure to close, many deal professionals deviate from traditional M&A best practices. Many organizations regularly and inadvertently deceive themselves into thinking they follow M&A best practices when in fact
they don’t. For example, managers often delude themselves around the extent of their
market knowledge, only to bump against deal-breaking information deep into the process at which point they are less likely to acknowledge it. This false-confidence in knowledge or ability can often lead involved parties to miss vital information in due diligence, have ineffective negotiations, and possibly pay the wrong price for an opportunity. Additionally, the people running the deal usually lack the expertise to plan and implement the messy work of post-transaction integration. This lack of attention will quickly derail the initiative and push out the time to value, especially when the post-transaction integration isn't part of the compensation for completing the deal. This myopic tendency can have both short-term and long-term consequences. The turnover in target companies is double the turnover experienced in non-merged companies in the ten years following a merger. M&A best practices and processes, although often cumbersome and detailed, exist for a reason. Companies may have a disciplined M&A approach (designed to reduce risk and streamline their efforts) but they will regularly ignore the process out of laziness, arrogance or difficulty of use. Finally, leaders will frequently over-estimate their firm’s capabilities and under-estimate competitive threats, resulting in a significant increase in deal risk and resources required. It might be worthwhile to critically re-examine your processes, instead of simply relying on past methods.
Expect Information to be Leaked - Although deals are traditionally conducted with an element of discretion and secrecy, it is extremely difficult to guarantee total confidentiality. It is rare that prospective deals stay under the radar for very long, particularly when low to mid-level managers become privy to the process.” As the number of people involved with the deal process grows, it becomes progressively more difficult to ensure confidentiality. Although some leaked details may seem harmless, “a confidentiality breach can have major consequences, including a rapid and unexpected rise in the target firm’s stock price, if they’re public,” explains Osak. Even for private companies, excessive sharing has its risks. Osak continued, “A confidentiality breach can also can incite a competitive response from industry peers or can provoke turnover in the target firm. While proprietary deals are rare to begin with, the fact that a deal is garnering significant interest can lead to ‘deal fever’ which makes an otherwise good deal less profitable.” Because of these risks, it is ill-advised to rely on confidentiality as a prerequisite for deal completion. If possible, anticipate the effects of leaked information and plan them into your acquisition process or negotiations.
Accept that Due Diligence Won’t Uncover Everything - Although thorough, proper planning can help prepare you to navigate a merger successfully, there will be inevitable, unplanned challenges to overcome. As you plan, there will be a whole slew of information that you can’t plan for because your due diligence only throws up a certain amount of information. Although you may have a full plan there will always be information to find out.
At a certain point, Davis believes it is better to accept certain unknowns and simply prepare for the unexpected. “It is better to wait until you’ve bought the company to discuss these issues. After the first few days or weeks, you will be much better equipped to answer these questions and issues,” says Davis. “In some cases, the target company may have already thought about the issues and you can adopt their strategies.”
Part II: Execution
Communicate - One of the most important qualities of a successful post-merger integration is open communication between the acquirer and the acquired. During the entire process, there will be many questions, concerns, and uncertainties on both sides. The more proactive you can be in addressing these various qualms, the smoother the integration will run. Danny A. Davis -- a UK-based merger integration specialist -- emphasized the importance of communication in a successful merger. He explained, “I always look at communications very early. These days, with e-mail systems, it is very simple to promote company-wide communication. Many companies do not do that.” Tom Nelson -- CFO of Racine Federated until they were recently acquired byBadger Meter -- echoed Davis’ sentiments. “Typically, communication is what makes [a merger] work. The best approach is to just get everyone on one page and communicate the best you can. Once the deal is done you want everyone to feel like they’re being treated fairly so that they jump into their job with both feet. If there is uncertainty after the close it can cause real issues in integration.”
Integrating Divisions One-by-One - As soon as your deal closes, it is important to begin integration efforts immediately. To make the process as thorough and as effective as possible, it is important to integrate the two companies on a division-by-division basis. As Davis explained, “It is important that you go through every function and every division - HR, Finance, IT, Sales, Marketing, Distribution, etc. It is vital to think about how to integrate each of those functions because each one pervades the whole organization. IT, for example, helps to manage the data and systems used by all the functions, in all the parts of business. To successfully integrate an entire company, you need to consider each of its pieces." Reviewing divisions piecemeal create new problems if any inter-division lines of communication are cut. “Since you have split out each function to integrate each of them, there is a possibility they may stop communicating with each other,” says Davis. “It is important to ensure that the functions of the divisions remain linked.” Disconnected and de-linked departments can cause serious problems in the long term -- especially as you lay the groundwork for further growth.
Address Conflicting HR Policies and Pay Structures - Combining two unique HR policies can be one of the most sensitive and challenging issues in a merger. If handled improperly -- whether in hiring policies, reporting, hierarchies, or employee benefits -- it can cause vital talent to leave and can crush company culture and morale. Nelson explained, “The real challenge is in the perks that some smaller companies offer to mid or senior level people that you’d prefer not match. Compensation patterns and compensation structures are some of the things to deal with early in the process. However, compensation is just one pain point for the staffs of merging companies. Deeper HR policies, like job reviews, can also create challenges. Nelson noted that “A lot of the policies have to do with supervision. If you can keep as much of the existing supervision as possible you’re better off. Look at HR patterns when you’re looking at the deal. During due diligence or near closing the skeletons start to come out of the closet. You’ll get a sense for the good managers and the ones you need a more hands on approach with. Then you have a meeting with those managers. You’re also sensitive to the fact that if they’re not getting on the bus you need to address that issue.”
Take Control of Finances - After spending so much time focused on financials and purchase price during negotiations, it can be tempting to postpone further financial planning until later in the integration process. However, to postpone would create serious risks. As Nelson explained, “Many times in smaller companies the CEOs or owners don’t do a lot of formal bookkeeping so there is a lot of legwork to get all the numbers and information.” If this informal bookkeeping persists unchecked for too long, cash may begin to disappear. According to Davis, “There are examples of employees at the purchased company, with access to the bank accounts, stealing money. Surprisingly, that still happens today. That is why it is important to get control of the bank accounts, get control of signatures on the bank accounts, and control the drip-feeding money.” This stolen money is particularly problematic because it could include some of your invested capital. “When you purchase a company, there is usually little money in their bank accounts. As a result, you often inject some money early on. Ensuring that money does not go missing is very important. Since the whole point of the deal is to increase profit, it would be a horrible waste to see money just disappear,” says Davis. “That is why finances need to be consolidated relatively quickly.”
Handle Politics - “There is always a lot of politics in a merger,” says Davis. While politics may
seem more of a nuisance than a real threat, ignoring them can yield new, more substantial problems. “For example, if you have two sales and marketing directors, you generally only need one. The consolidation will probably cause some politics, unrest, and issues.” Even more problematic, however, is if the political unrest drives competition and performance misrepresentation. Davis continued, “If you have two sales and marketing directors, you will need to consider the product range each director represents. If you keep only one product range after the merger, will you keep that director? If so, people may be incentivized to lie about future sales of products.” Suddenly, office politics can begin to impact your projections and your financials. "This falsification could lead you into a difficult situation for the next year. If everyone has lied about sales, you will probably predict an unreasonably large profit. Inappropriate estimates can mean mismanaged capital, inappropriate strategies, and even a profit warning (if you are a public company). As a result, some of the politics and ‘lies’ may cause a double set of problems -- issues with integration, products, and people, but also with financial predictions.
Build Identity through Under-branding - For the acquired company, a merger can mean the abrupt transition away from a culture, brand, and identity they have come to value. If dissolving of the identity occurs too quickly, employees can become dissatisfied, which may result in lower productivity and create territorial behavior. Nelson -- very cognizant of the risks of identity shifts -- helped integrate new companies and cultures through the process of ‘ under-branding’. “In this process, the target company’s name is kept in a premier position for a while (XYZ, a division of Racine Federated). This situation allows employees under the new management to retain a sense of identify from the past company,” says Nelson. “Then, over time -- maybe a year or so -- the two brands are more thoroughly merged. By then, the employees feel comfortable being part of the larger organization.” The results of under-branding speak for themselves. Nelson explained, “At Racine, we didn’t see much employee turnover. I think because of the under-branding, which usually lasted a year or so, most of the people are onboard by the time we fully integrated the companies. The people who leave right away are the ones who don’t want to change to the new hiring policies, HR reviews, new culture, etc.”
Remember that each M&A process is different so treat every step you go through with a clear lens. Yes, past experiences can help mold the next deal but keep focused on maximizing the results, good or bad, of every pre-defined step of the process.
MP, LLC credits blog post with the original author and links (if available).
Scott E McGlon is the President of McGlon Properties, LLC and the author of many blog posts on MP Blog. He has been a serial entrepreneur, entrepreneur-in-residence, investor, and president/CEO of many successful start-ups since 1998.
“Success is walking from failure to failure with no loss of enthusiasm." - Winston Churchill
"The few who actually
go out and take extraordinary initiatives are the envy of the majority who sit back and just observe."
“The LORD makes firm the steps of the one who delights in him; though he may stumble, he will not fall, for the LORD upholds him with his hand.” - Psalm 37:23-24
“Keep away from people who try to belittle your ambitions. Small people always do that, but the really great people make you feel that you, too, can become great.”
"It is more important in what you become than what you achieve. What are you going to become in pursuit of what you want?" - John Marsh, Marsh Collective
“Work harder on yourself than you do on your job" - Jim Rohn
"The secret to success is very simple: EVERYDAY if you do quality work, take initiative, act on innovative thoughts, and are assertive in your actions all backed by faith, the dividends will consistently flow your way." - SEM