“The modest unassuming and subservient John D. Rockefeller, Jr. was overly burdened with his father’s obligations, but he surprised all as an astute bargainer. When the indomitable J.P. Morgan was seeking the Rockefeller’s Mesabi iron ore properties to complete his assemblage of what was to become U.S. Steel, it was Junior who went head-to-head with the financier. ‘Well, what’s your price?’ Morgan demanded, to which Junior coolly replied, ‘I think there must be some mistake. I did not come here to sell. I understand you wished to buy.’ Morgan ended up with the properties, but at a steep cost.”
Sellers’ Ten Mistakes
1. Selling your business is emotional and distracting. It is very important to retain professional advisors including an investment banker to do the “heavy lifting” when selling a business. Do not neglect running your business, otherwise sales and earnings will deteriorate and the potential buyers will back off. Move quickly with the help of your advisors.
2. Many sellers dream about their company’s worth based on their “sweat equity,” Wall Street comparisons, etc. The merger and acquisition marketplace is fairly efficient, although it is not formalized like the real estate industry in which all sales are public knowledge and all properties have assessed values. However, placing too high a price on the business can be a mistake. If the company does not sell in a reasonable period of time, the business becomes shop worn and tarnished. There is a greater risk of confidentiality becoming breached the longer the selling process. A higher price often requires the buyer to use greater leverage, thus possibly jeopardizing the debt payments and/or the sellers’ notes. For a variety of reasons, it is usually the best for the seller to arrive at a win/win arrangement with the buyer.
3. Maintaining confidentiality should be more than just having the buyer sign a Confidentiality Agreement. A premature breach of confidentiality can blow the deal. The seller should constantly remind the potential buyers of the confidentiality requirement and take all precautions accordingly such as having the relevant mail addressed to his or her home instead of the office.
4. The purported number one reason for owners of private companies selling is “burn-out.” The tendency is for the owner to work like a dog until he or she “hits the wall”…. then sell out immediately. Time out! Do not sell impulsively. Ideally the owner will plan ahead carefully: clean up the balance sheet, settle all litigation, solve environmental problems, and pay the extra money for audited financial statements one or two years in advance of selling. The latter could increase the company’s value by up to 20% more by generating “believable” financials.
5. Many sellers will not anticipate the requests of the buyers. Acquirers usually require bank financing and that means appraisals of the property and the machinery and equipment. Both of these items take time, so have it done before the seller goes to market. Other items to anticipate would be the total closing costs; e.g., intermediary, attorney, accountant, banker. On a $5 million transaction, that could cost $350,000 and up.
6. Negotiating with only one buyer at a time is frequently the choice of the seller principally because the seller finds it too confusing to negotiate with two or more potential buyers at one time. This is a big mistake, because the seller loses the leverage of competitive offers when only dealing with one buyer at a time.
7. Sellers usually want to retire after selling their business. According to Michael Selz, staff reporter of the Wall Street Journal, owners will receive considerably more money if they are willing to stick around after the deal. M&A Today reported this in an article in our January/February 1994 issue in which Selz cited a specific example of a seller receiving 20% more for his business, because, by staying aboard, it helped reduce the risk to the new owner.
8. Naturally, most sellers want all cash at closing but it is estimated that less than half of middle market transactions are structured that way. In many deals the structure is more important than the price, so if a seller is inflexible on structure, it can be a major obstacle and most likely a deal breaker.
9. Negotiating every item or almost every item is much less effective than keeping your powder dry for the more important issues. If a seller tries to win every point of contention, the buyer may just walk away from the deal. Most successful transactions are a win/win scenario for both parties.
10. Some sellers want to take their time throughout the selling process probably because they equate the length of time as being careful. Jack Kellogg, an experienced transaction attorney, states that deals which drag, don’t close. When the company is in play, move quickly for the close.
Ten Tips on Selling
1. The decision to sell is not irreversible, but it should be firm. In a family business, it is important that it is not just the majority owner and/or CEO, but that all the family members who have some ownership or who work in the business are brought into the selling process. Hopefully they are in concert with the decision to sell. For non-family private businesses, all stockholders should be apprised of the situation.
2. Decide up front who is going to be the ultimate manager of the selling process so there is no ambiguity later on. Decide whether it should be the majority owner, the CEO, the investment banker or some other logical person.
3. Set time frames on the selling process in order to have milestones; e.g., completion of selling memorandum, contact buyers, Letter of Intent, close, etc.
4. Partner with real professionals. Improper advice could cost you tenfold later on. In retaining an attorney, be sure he or she is a “transaction” attorney, not a trust attorney. Make sure the intermediary properly screens and qualifies potential buyers.
5. Communicate with your banker about what you are doing. Bankers not only hate surprises, but if they are surprised, may not be cooperative when you need them most.
6. Target buyers which would perceive your company to be the most valuable.
7. Openly recognize certain “on and off” balance sheet items such as customer pre-payments, work-in process billing, contract obligations, lease obligations, legal threats, etc.
8. Negotiate “stay agreements” with top management so they will not jump ship before the business is sold. Depending on the situation and the importance and number of people involved, a stay agreement could be equivalent to anywhere from two to six months salary.
9. Set up a complete file in one place of all relevant information the buyer and/or his due diligence team will ultimately request; e.g., contracts, distribution and purchase agreements, leases, licenses, intellectual property documents.
10. If a buyer indicates he or she will be submitting a Letter of Intent, tell them right up front what items you want to be included in the document: – Price and Terms – If asset purchase, what assets and liabilities are to be assumed – What contracts and warranties are to be assumed – Lease or purchase of real estate – Responsible for what employee contracts or severance agreements – Time schedule of due diligence and closing
Understand The Buyer’s Concerns
The buyer is usually aware that the founder, owner, and CEO is principally responsible for running the business. If the company has no depth of management or is perceived to be a
“one man band,” the price for the business will be discounted. It is not wise for the CEO to overly brag about himself or let the seller know he has not taken a vacation in three years and works twelve hour days.
The buyer is particularly concerned whether the earnings are really there or was last year a spike in earnings? Will the earnings continue? Is the seller justified in all those add-backs? Almost all businesses have “some” travel and entertainment (T&E) expenses.
As a seller, be prepared to answer these questions: – How do you grow the company? – What is the Company’s competitive advantage? – If you had a million dollar windfall in the Company’s checking account, what would you do with it?
Deal Breakers
You are ready to go to market to sell your business. WAIT! You should be aware of the eight prevalent deal breakers.
• An undisclosed material fact surfaces at the due diligence stage or just prior to closing such as the loss of some major accounts, a product recall and, of course, environmental problems.
• The seller, a C Corporation, figures out the amount of the double capital gains taxes in an “asset sale” and tries unsuccessfully at the last moment to convince the buyer to do a “stock sale” which would be a single capital gains tax.
• At the purchase and sale agreement stage, the buyer wants his note uncollateralized and wants a hefty escrow account or an overbearing list of “reps and warranties.”
• The chemistry between the buyer and seller was never really established, so when the deal runs into road blocks for a number of reasons including the egos of the advisors, there are no personal relationships to bridge the differences nor to get the deal back on track.
• The buyer is undercapitalized and just before closing, the buyer is unable to raise the necessary cash to do the deal.
• Seller’s remorse happens more often than one might expect. It is like a bride backing out of her wedding the day before. In this case, the seller realizes that his life’s work, the company, is too important and he or she cannot part with it.
• The deal lags and either buyer and seller loses patience and walks away from the deal.
• The seller loses control of the deal either to the buyer or to one of the advisors. The seller is not accustomed to the selling process and succumbs to the other players. Out of resentment, he or she picks up their marbles and goes home.
Conclusion
Like the story of John D. Rockefeller, Jr. in the beginning of this article, the seller should portray himself as one who does not have to sell. He should negotiate on his own turf for psychological reasons and realize that most successful transactions have a win/win attitude by both parties.
