ARTICLE LIBRARY
THINGS TO REMEMBER WHEN SELLING OR MERGING YOUR COMPANY
Generating the highest price for your company requires a systematic approach to the selling process. Thorough preparation can ensure fair terms and a favorable price.
This involves preparing your company for sale, writing a descriptive memorandum that attracts acquires from the world, attracting a number of acquirors to compete among themselves, negotiating a letter of intent, providing the necessary information for the successful acquirors due diligence process, negotiating the purchase agreement and closing the transaction. Each step in the process requires many judgments and considerations, while you need to remain focused on running your company.
Selling or merging your company is a complex process. In the following pages, Houlihan Smith & Company, which has been representing companies in the sale process for more than 10 years, provides the things to remember when considering one of the most important decisions you will ever make.
Please contact Andy Smith at 312-499-5910 for more information to discuss your opportunity and to learn more about the M&A process.
- GENERATING THE HIGHEST PRICE
- VALUATION BENCHMARKS
- WHEN TO SELL
- WHY SELL
- GETTING READY
- 18 STEPS IN THE PROCESS
- INVOLVING ATTORNEYS
- INVOLVING ACCOUNTANTS
- ITEMS TO PROVIDE THE ACQUIROR
- ITEMS THE ACQUIROR MUST PROVIDE YOU
- SPECIAL SITUATIONS
- DIFFERENT TYPES OF OFFERS
1. GENERATING THE HIGHEST PRICE
Competition Among Acquirors
Attracting several acquirors and creating competition among them will result in the highest possible price. Some acquirors may not like it – but it works.
Acquirors Are Worldwide
Think internationally. The number of acquirors worldwide that are interested in buying companies has expanded dramatically over the past decade.
Using An Investment Banker
An experienced professional can develop and execute a program that will produce a higher price and typically will return several times the associated cost.
Systematic Approach
Exploring and developing all the options is likely to produce a higher price and better results than having discussions with a few competitors or the schoolmates of your professional friends.
Patience, Patience, Patience
Price negotiations can take a long time. A constant focus on running the company well and not appearing too hungry will create a stronger negotiating position.
Leaving Money On The Table
Not selecting the highest price is sometimes a sound decision, provided the process has produced several viable proposals.
Other Industries
Consider acquirors in other industries. Surprisingly, the record shows higher prices typically are paid by acquirors outside the seller’s own industry.
Walking Away
If a transaction does not feel right on all levels, be prepared to walk away.
Future Earnings
All companies being sold are offering, and all acquirors are looking to buy, an expected stream of future earnings. Different perceptions of value arise from the certainty, manageability and growth rate of that expected stream.
Price/Earnings (OR P/E) Ratio
Public-traded acquirors typically will view the price of an acquisition in terms of price relative to after-tax earnings because the public markets value companies in that way. For example, in a tax-free exchange, the public company can immediately report additional earnings that will affect the acquiror’s market capitalization.
The “POP”
Larger public companies acquiring smaller private companies look for a “pop.” This is the positive effect on their earnings per share when they acquire a company for a P/E ratio that is less than their own P/E ratio.
EBIT Multiple
Private companies or investment groups acquiring private companies usually view the valuation in terms of a multiple of EBIT (earnings before interest and taxes) or its variations, such as EBITDA (earnings before interest, taxes, depreciation and amortization).
Price/Sales or Price/Customer Ratio
Certain industries have developed rules of thumb to judge company value (e.g., an acquirer of a cable TV property will ask, “What is the price per subscriber?”)
Comparable Transactions
Every industry has a history of completed acquisitions from which comparable transactions can be selected for evaluations. Using comparable transactions requires judgment and expertise.
Formal Valuation
Sometimes, before beginning a program to sell or merge a company, it is desirable to prepare a formal valuation using an independent third party. The objective conclusions provided by this analysis can be helpful in making the decision to sell or defending the asking price and is often worth much more than the associated cost.
Gut Feel
You as the CEO/owner know more about your company that anyone. Your instincts are valuable in assessing what the company may be worth.
When The Future Looks Good
A CEO/owner whose business has never been better is well-positioned for a successful sales transaction.
When A Unique Opportunity Arises
Certain acquirors may be looking for a particular company to serve as a platform for a series of additional acquisitions.
When CEO/owners were asked in several surveys, “Give the most important reason why you sold or merged your company” the most common answers were:
Burnout
More than half of the CEO/owners polled indicated their reason for selling was because they were tired of the continued demands of their business.
Expansion Capital
The next most often cited reason for selling was the need for increased working capital, manufacturing capacity and other resources.
Liquidity And Estate Planning
Many CEO/owners of privately-held companies wanted to realize the value that had built up over the years and distribute it according to estate plans.
Age And Health Considerations
Another reason prompting merger and sale transactions was the reality of advancing age or declining health.
Other Opportunities
Other CEO/owners sold in order to spend more time with a different business, traveling, hobbies or charity work.
Reduction Of Risk
CEO/owners also cited uncertainty about taxes, the company’s industry or the economy. They wanted to reduce their risk by investing the sale proceeds in a diversified portfolio of assets.
Financial Statements The acquiror must become confident about the company’s historical financial results. Audited statements are preferable. Reviewed or compiled statements may require external verification.
Reconstruct Profits Private companies look to minimize income taxes by reducing profits. Adding back certain expensed items increases the earnings level to which a multiple can be applied. Acquirors are accustomed to working with these adjustments.
Stay Focused On Running The Company It is important to drive the business forward as though there will not be a sale or merger. Any improvements or gains in sales and earnings will increase the attractiveness of the company.
The process of selling a company can take between six and twelve months. Most, if not all, of the following 18 steps will be required to complete the sale.
Prepare A Confidential Memorandum
A confidential memorandum must be prepared describing the company’s history, products/services, markets, competition, management, facilities and future prospects.
Select Potential Acquirors
Approach acquirors from the growing number of distinct buying groups. These groups include strategic corporate acquirors, non-obvious acquirors from other industries, foreign firms and investment groups. Deciding which are best to approach is time-consuming but important.
Approach Selected Acquirors
Initially, acquirors are contacted without revealing the name of the company or its specific location.
Qualify Interested Acquirors
Interested acquirors are evaluated based on their fit and ability to complete the acquisition.
Provide Descriptive Selling Materials
The strongest and most serious candidates are provided with the confidential memorandum and pertinent supplemental information.
Follow-Up
A personal follow-up must be made with each potential acquiror that receives a copy of the memorandum.
Meet Principals
Each interested acquiror will want to meet with the CEO/owner and review the company’s operations.
Receive Offers
Each serious acquiror will make an offer. The first offer is rarely the best offer.
Stimulate Bidding
Competition among acquirors is required to produce different options, different structures and the highest price.
Select The Best Offer
Evaluate offers based on price, forms of consideration, terms and conditions, and the impact on owners, managers, employees, customers and overall company operations.
Negotiate The Letter Of Intent
Most letters of intent are nonbinding and outline the terms under which the parties plan to consummate the transaction. Most of the terms of the letter will be repeated in the final purchase and sale documents.
Minimize The Exclusive Period
Usually, one term that is binding in the letter of intent is the exclusive period for the acquirer to review the company. This period should be kept to a reasonable minimum.
Conduct Due Diligence
Due diligence is conducted by both sides. The CEO/owner should ask any questions and request any information needed to become comfortable with the acquirer.
Advise Key Managers
To minimize uncertainty within the company, it is usually – but not always – best to tell key managers about the proposed sale at the time a letter of intent is signed, and inform all employees shortly before closing.
Prepare Closing Documentation
It is important that corporate counsel has merger and acquisition experience. Otherwise, the compay should obtain the assistance of special counsel.
Specialists
Sale or merger transactions involve many complex issues often requiring the advice of legal experts in tax matters, patents, real estate, environmental laws, ERISA, OSHA, and many others.
Representations And Warrantees
Counsel will work to limit the representations and warranties made by the company and shareholders to minimize those liabilities that extend beyond closing.
Hart-Scott-Rodino
Counsel will work to determine that the proposed transaction does not violate the Hart-Scott-Rodino legislation, which addresses market-share concentrations that limit competition.
Foreign Acquirors
Foreign ownership limitations apply in certain areas, such as the communications industry, and require examination by special counsel.
Environmental Issues
In recent years, there has been an increased focus on environmental concerns. Often, an environmental report will be necessary, requiring time, special counsel, extra costs and patience.
Tax Opinions
It may be advisable to request a formal tax opinion on the expected treatment of certain aspects of the transaction.
Up Front Work
Remember, the more legal work done early in the process, the quicker the sale will close.
Historical Financial Information
The company’s C.P.A. or public accounting firm will need to provide historical financial information in the initial stages of the process so that the confidential memorandum can be accurately prepared.
Reconstrucetd Income Statement
The accountant should assist in examining the income statement for items that will be nonrecurring under new ownership.
Projected Financial Statements
The accountant should assist management in providing the acquiror with projected financial statements showing the current assessment of future results for the next one to three years.
Upfront Work
As with legal work, the more accounting completed up front, the quicker the sale will close.
Tax Aspects
The accountant will need to review all the tax aspects of the transaction and complete tax compliance matters.
9. ITEMS TO PROVIDE THE ACQUIROR
These items relate to the acquiror with whom the company has executed a letter of intent.
Full And Prompt Disclosure
The acquirer will incur significant costs confirming information about the company. The process will be accelerated with prompt response to inquiries and full disclosure.
Information Now Revealed
Certain confidential information that was previously withheld, such as the company’s customer list and tax returns, may now be disclosed.
Financial Items
Additional financial items likely to be requested interim financial statements, sales backlogs, accounts receivable aging, recent bank statements, current accounts payable, inventory breakdown, descriptions of all liabilities, depreciation schedules, and plant, property and equipment appraisals.
Non-Financial Items
Additional non-financial items likely to be requested include significant contracts, patents, trademarks, insurance policies, product warranty history, organization chart, shareholder list, environmental audits, corporate policies and employee benefits.
Warts And All
Every company has deficiencies. Some can be fixed and some cannot. Just be open about them.
10. ITEMS THE ACQUIROR MUST PROVIDE YOU
Publicly-Held Acquirors
Publicly-held companies make detailed disclosures through required annual reports, 10Ks, 10Qs and proxy statements. Read every word of these long, and often boring, documents, including the footnotes to the financial statements.
Checklist For Publicly-Held Acquirors
Create a list of questions that covers the following areas: stock price volatility, float, concentration of ownership, pending litigation, accounting methods, internal reporting requirements, and future plans.
Privately-Held Acquirors
Because privately-held companies are not required to make public disclosures even more questions need to be asked.
Prior Acquisitions
Be sure to personally speak with CEO/Owners of companies that the acquirer has previously purchased and ask what, if anything, they would have done differently.
Checklist for Privately-Held Acquirors
Create a list of questions that cover the following areas: ownership, capitalization, liabilities, contingent liabilities, management, competition, pending litigation, accounting methods, internal reporting requirements and future plans.
Partial Sale
In certain situations, the CEO/Owner may wish to realize some liquidity but still participate in the continued strong growth of the company. These objectives may be achieved through a partial sale.
Management Buyout
A sale to existing management may be an option to consider. One advantage of this type of sale is management’s familiarity with the business, resulting in comfort for lenders and equity participants financing the transaction.
Joint Venture
A joint venture or strategic alliance can be a valuable preliminary step to a complete sale or merger. The companies get to know each other well and the value of the selling company can be improved.
Employee Stock Option Plan
Sale of stock to an employee stock option plan (ESOP) is a tax beneficial method of selling to the company’s employees. It can be staged over a period of years, allowing the CEO/Owner to transition out of the company.
Stock Sale vs. Asset Sale
All sale transactions are either a sale of the company’s stock or a sale of the company’s assets. A substantial majority of acquirors prefer to purchase assets in order to avoid possible unknown liabilities.
All Cash Offer
An all cash offer provides maximum liquidity at closing. Typically, all cash offers are lower and have escrow provisions for post-closing adjustments, such as the collection of receivables.
All Stock Offer
Trading the company’s stock for the acquirors stock may qualify as a tax free exchange. The tax advantages may be offset by the downside risk of holding stock, especially if the stock received is restricted.
Earn-Outs
Earn-outs, properly structured, can substantially increase the total consideration received in the transaction, particularly for rapidly growing industries.
Other Forms Of Consideration
Frequently, the value received in a sale can be increased by accepting other forms of consideration, which include notes, non-compete payments, consulting payments, liabilities assumed and royalties.