You have likely seen a recent increase in unsolicited offers to buy your business. From Search Funds to Private Equity, there is a huge demand to buy lower middle market companies which will only increase as alternative investments during economic downturns attract much attention. If you’re interested in the process and want to learn more, this article is for you. Here are a handful of potholes and pitfalls to avoid.
First, be prepared. If you are contemplating an exit or have an offer in hand, sit down and write out answers to these questions
- Why do I want to sell?
- Will the sales price (after fees and taxes) get me to my financial goals?
- Is now the best time for me, my business, and other stakeholders?
- Do I want to get out of the business entirely or stay on and join a larger entity?
- Can I commit significant time to due diligence and negotiation?
- Do I understand the process?
Once you have these answers, please take a few days and don’t think about it. Then go back and again review the questions and your answers. If you come to the same conclusions, go to the next step of setting goals.
Defining your goals is essential to creating a successful exit strategy. Each exit is unique, but many failed exits share common mistakes. When owners don’t define their goals, there is no target upon which to focus. Consider two different owners, one wants to retire, and the other wants to be a part of a larger organization. Retaining equity in a transaction will likely not fit the retiring owner, while the other would welcome it. Know what you want from a transaction, then design the strategy. Otherwise, you may find yourself in the middle of a frustrating process.
Get your financials in order. You don’t need audited financials to exit successfully, but you must prove your firm’s past financial performance and profitability in due diligence. Because the tax code incentivizes owners to show reduced profitability, the actual free cash flow numbers often need explanation. This extensive investigative process nets out the owner’s discretionary spending and reclassifies other one-time expenses. These adjustments are called add-backs and are often misstated (both over and under). Buyers will negotiate these heavily, so review these with your intermediary and accountant, and be prepared to back up each add-back with evidence that they are non-recurring.
Is your Org Chart ready for a transaction? Buyers will want the following people to stay with the company post-transaction:
- The management or executive owners of client relationships
- The management or executive owners of employee relationships
- Management and employees who build or deliver the IT, service, or product
- Financial and accounting personnel necessary to invoice clients and prepare financial results
If any of these roles reside exclusively with the owner, the buyer will require a more extended transition period or a contra add-back to account for the replacement costs of these roles. A fully loaded org chart is a significant positive factor leading to successful exits and higher valuations.
Build out your transaction team. Aside from having an experienced M&A advisor, you’ll need an accountant to help you navigate tax planning and a deal attorney to help craft and negotiate the agreements. Doing this before you begin the transaction will ensure that the team understands your goals and delivers an exit that meets or beats your expectations through its pricing and terms. Don’t wait until you have a negotiated deal to bring on these experts, as what may seem like a terrific deal can quickly fall apart with legalese or negative tax implications.