Business owners who are looking to exit their business in the future can often do better longer-term planning to maximize value and increase the certainty of closing the sale.
Like most things in business, there is usually a short-term plan and a longer-term plan for a sale event, and its important to properly focus on both.
SHORT TERM:
If the exit is imminent, the steps to take to get ready for the sale are generally straightforward:
Draft a confidential investment memorandum (CIM) explaining the business and growth story
Build a forecast model
Prepare the data room
Identify potential Buyers and reach out to them through a structured process
Of the buyers who express interest, select the right Buyer(s) and move forward to structure and close the deal
LONGER TERM:
Most businesses can and should be doing much more to prepare before the sale process even starts.
The below areas can take multiple quarters (sometimes 1-2 years) but will make the sale process easier and lead to a better valuation upon exit.
1) CLEAN UP ADD-BACKS:
Most private businesses have various adjustments that the Sellers want to “addback” to show a normalized EBITDA to buyers.
Examples include non-recurring expenses, above-market compensation to the owner or certain employees, or personal costs running through the P&L.
Either side usually performs a Quality of Earnings (“QoE”) to tease out what these add-backs should be.
And the buyer makes some subjective assessments to include or exclude certain addbacks.
Reducing these addbacks earlier on makes the Seller’s books cleaner and reduces the need to negotiate this point, and can have a favorable impact on the Seller (see link here about why add-backs are so significant to valuation).
2) ADDRESS LEGAL ISSUES:
Legal or regulatory issues are usually a major cause of the Buyer’s uncertainty about the business.
To reduce risk, Buyers could ask for purchase price reductions, hold-backs, or indemnifications – all of which could reduce the Seller’s proceeds at or after the close.
And justifiably, Buyers almost always perceive this risk to be far bigger than the Sellers’ perception of it.
If the legal matters can be resolved with a relatively small settlement, having minimal litigation overhang helps the Seller.
3) INCREASE OR STEADY MARGINS:
This could involve increasing gross margins (i.e. reduce cost of sales) or increasing EBITDA margins (i.e. decreasing other operational expenses).
And execution might require finding different suppliers, increasing pricing, trimming head-count, implementing systems and technologies to increase operational efficiencies.
….which sometimes take years to implement.
Buyers generally start their valuation of the stand-alone business using the margins of the past 1-2 years as a baseline.
Again, justifiably, Buyers rarely take the Seller’s hockey-stick projections at face value, and Buyers discount both the projected revenue growth and margins.
Showing that the business has already been running at a certain EBITDA margin for at least a year or two shows the buyer that the business is already efficient.
And this implies the buyer would have to do less work to structurally improve the business. This reduces the Buyer’s uncertainty in the deal and increases the valuation for the Seller.
4) SHOW THAT THE BUSINESS CAN OPERATE INDEPENDENTLY WITHOUT THE LEGACY MANAGEMENT TEAM
One of the biggest fears Buyers have, especially when the Sellers are ready to retire, is the dependency on the Seller’s expertise.
Often, Buyers structure the deal to ensure that the Sellers are engaged in the business after the close – via earn-outs and employment agreements.
If the Seller can demonstrate that the management team that is staying behind is strong enough to lead, this increases the Buyers’ comfort.
This kind of succession planning can take 2-3 years to put in place, but is well-worth it to get a clean exit at a better valuation for the Seller.
The above list is not exhaustive and is by no means simple.
However, starting this planning process proactively 1-2 years before a sale can significantly improve both valuation and the chances of closing the deal.