For business owners that have successfully navigated through COVID thus far and a tumultuous 2020, 2021 may be an ideal time to sell.
With fewer quality businesses available for sale and Private Equity groups sitting on over a Trillion Dollars in capital to be put to work, there is a massive amount of capital seeking a home. However, the M&A process can be quite complicated and fraught with risk, as only an estimated 20-30% of companies brought to market actually sell.
It is essential that business owners be fully prepared, realistic and committed to the process. If you are thinking about selling your business in 2021, these are the four key questions to ask yourself that will maximize the likelihood of a successful transaction.
Am I psychologically ready to sell?
This is the #1 essential question business owners need to be able to answer. We often meet business owners that have owned their businesses for 20+ years and think of them as their children. Heck, they may even like their businesses more than their spouses and kids!
Often business owners dedicate so much time to these businesses at the expense of their families, personal lives or hobbies, that they wouldn’t know what to do with their time if they were to sell! Further, the cash flows generated by these businesses often fund living expenses for the entire family and, as a result, the owner can’t afford to sell.
While a business owner may be attracted to the romantic notion of retiring on a beach and transitioning to the next phase of his or her life, in actuality, they are often not psychologically ready. That’s OK, but before we take a business to market, we always ask owners, “why sell?” and “why sell now?”
Without a compelling reason, the odds for a successful outcome are highly diminished.
Will I be committed to the process and continuing to run the business?
Even under ideal situations with well-funded buyers acquiring a thriving business, M&A deals take time, typically 9-12 months. We ask that owners commit to dedicating a year to the process and to keep running the business optimally throughout.
Unlike real estate, where the values don’t change dramatically month-to-month, business valuations fluctuate based on a wide variety of conditions. For example, if a company loses a key customer during the week before closing, the buyer will likely demand a price reduction. To preserve the maximum selling price, it’s essential that the business continues to perform at historic levels.
I have an 82% close rate on my M&A transactions. What happened to the other 18%? These were deals in which the business owners became complacent when we were on market and performance tanked to the point that buyers decreased or withdrew offers.
One thing will be guaranteed in this process: the deal will invoke a roller coaster of emotions.
It’s imperative that the business owner have the right team of advisors around him or her. This team typically includes the company CFO, CPA, corporate attorney, wealth manager and an M&A Advisor, who will quarterback this process so that the owners can continue to run the business.
The owner has to be committed to running the business and utilizing a “deal team.”
Is the business financially and operationally stable?
As I’ve highlighted in a previous post, buyers typically acquire businesses based on expected future cash flows, and apply industry multiples to determine valuation. Businesses that sell the quickest and at the highest multiples tend to have increasing revenue and profits for at least the past three years.
If financial performance is declining, buyers will assume the worst and make low-ball offers for what they assume is a distressed business, requiring them to invest significant time and resources to turn the business around.
If the business has been underinvested in (e.g. machinery is at end of useful life), buyers will reduce their investment by a multiple of this amount they estimated they will need to spend to run the business efficiently. For example, if a company needs to spend $500,000 to repair old machinery and the buyer is willing to pay 5x cash flow for this business, the buyer would likely reduce their offer by at least $2.5M.
If the business has been underinvested in (e.g. lack of IT systems or utilizing equipment at the end of its useful life), buyers will reduce offers by a multiple of the incremental capital required post-closing.
If a business owner expects maximum sales price, it is imperative they can demonstrate stable to increasing profits. Doing this will expand the buyer pool and create competition among buyers, improving price and terms.
Can I keep an open mind relative to value, terms and the potential buyer pool?
It’s essential that the owner maintain flexibility and reasonable expectations throughout the process. Prior to going to market, we create an “Opinion of Value” that provides our professional assessment of the realistic selling price range and terms in the current market. We analyze comparable transactions in the same industry for similarly-sized companies and anticipate risks the buyer will likely perceive (e.g. customer concentration, personal dependency on seller, etc.).
We always provide an expected valuation range and seek to justify the high end of the range, but if the business is realistically worth $5M and the seller insists it’s worth $10M, we will politely step away, as we are unlikely to have a successful outcome.
All business owners desire 100% cash at closing, and we strive for this. However, we advise sellers that expecting 10-25% of the total consideration in a seller note or rollover equity has many positive benefits, including increasing the buyer pool (by demonstrating confidence in the health and future of the business), getting a “second bite of the apple” (chance for a large secondary exit on a Private Equity buyer’s potential subsequential sale), as well as potential tax savings by taking some proceeds over multiple years.
When a business owner demands all cash, this perspective will likely deter buyers and become an impediment to an optimal sale process.
Selling a business is hard work! Before embarking on an M&A process, the business owner must:
- Be psychologically ready to transition out of the business and not compete with the buyer
- Be committed to the process, running the business optimally throughout the process, and working with advisors that share a common view of success
- Demonstrate that the business is stable and performing well financially and operationally
- Remain open-minded in terms of deal structure, potential buyer pool and terms
If you have any questions about your readiness to sell, please reach out to me for a confidential discussion. I’d love to learn more about your business and provide my perspective.
Kevin Berson is an M&A Advisor with Kinected Consulting, based in Los Angeles. He specializes in helping business owners maximize outcomes in selling their businesses. He is also the founder of Kinected, a Management Consulting firm that advises companies with strategic planning, exits planning and merger and acquisition diligence. Kevin can be reached at firstname.lastname@example.org.