Are you about to sell your company?

Date: 5 September 2011

Are you about to sell your company?

Will the buyer agree to pay a premium for a refurbished office space, brand name or ongoing (but not yet commercialized) R&D activities? Well, don’t count on it, especially not in the market of privately owned companies.

Rule number one: The perceptions of value always differ between a seller and buyer. And this is not only to the seller’s disadvantage. A proper M&A process should always start with drawing a clear picture of the market and the real reasons anyone would like to buy the particular target company.

There are three important forces that always precede a successful deal between a buyer and seller i.e. general market demand, making the company sellable, and conducting a proper M&A process:

MARKET DEMAND – The industrial and overall economic climate must in itself facilitate the strategic or financial buyer to seek acquisitions.

There is always a rationale behind increased demand of acquisitions. As in any market there must be a buyer for any particular item that is for sale, if not, you will not receive the asking price. There are no exceptions for this rule. You can’t lure a buyer to the table unless there is either industrial rationale or economic sense to go through the expensive and exhausting process of buying a company. So begin by asking yourself: What possible rational reasons are there to acquire my company in this market, at this time and at my asking price? And who is that?

Example: Currently there is a strong surge for technical engineers in Sweden which increases the demand to acquire consulting businesses. Also staffing companies are taking the opportunity to move up the value chain to earn higher margins on engineers.

What to do: Always keep a close watch on the movements in your own value chain and the margins earned at different levels. Try to read the patterns and learn about deals in your segment. Keep an eye on, and maybe even contact with, 2-3 potential buyers. Make sure you understand where they are going strategically and what their needs are or will be.

IS YOUR COMPANY SELLABLE? – Have you any idea what aspects of your company drives value and destroys value?

Predictable cash flows

You may think that this is all subjective and differs between buyers. Well, not really, because from experience every buyer will accept certain value drivers while disregard (or at least diminish) others. For example: There may be fantastic synergies between the buyer and seller and the buyer may accept to pay a premium because of this but he/she will normally never admit this. It is much easier to achieve a higher price based on earnings (cash flow) than synergies.

Example: The most important value driver is forecasted cash flow to equity. Period. And the best determinant for a buyer is a stable history and contracts to prove the future forecasts.

What to do:  Make yourself understand the concept of cash flow and how the way you run the company impacts short term and long term flow of cash. This analysis may require outside help and should be conducted regularly so that the cash flow is optimized, both short and long term. There may be significant opportunities for improvement in terms of future profit margins, capital investments, working capital etc.

Other important factors are making sure the company is not dependent on the owner (establish a functional executive management), transforming knowledge into processes and making sure that the company has not neglected to invest in the sales generation. There are a lot more but that would need the range of a book.

CONDUCT A PROPER M&A PROCESS – Make sure you spend time and effort on a focussed sales process

All privately held companies that are acquired face a certain discount in relation to stocks traded over a stock market. This is because a buyer must invest 6-12 months activity in a private acquisition, pay advisor fees and above all: there is no possibility to reverse the transaction should something not turn out right. The discount is widely debated but is normally from 10% up to 50-60% depending on different factors. The true job of the M&A advisor/business broker is to lead a process that is accessible (easy to enter and access early information), transparent (no hidden skeletons in the closet), competitive auction (time all buyers to make decisions at the same day). The desirable effect is a reduced discount applied to the transaction in the bidding process and no price reductions after due diligence and post-auction negotiations.

Example:  Sometimes buyers ask me what price they need to indicate in the auction in order to enter an exclusivity (no-shop) agreement. Why would they do that? Well, simply because they are confident that they will find discrepancies from the information they have received and the due diligence findings. By the time other bidders are gone they will dictate the process and final pricing of the company.

What to do:  Make sure the sell side controls the process. Never sign letter of intents unless pricing structure, major parts of the agreement etc have been resolved. Never, never hide anything material from a buyer before signing any terms of agreement. They will find out anyway and make it affect the price and warranties. Make sure to keep the timeline tight so that the competitive bidders are ready to step in.

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