In this installment of our “M&A Essentials” series — offering a fundamental understanding of the concepts, issues and processes every business owner should be familiar with when considering and conducting the sale of a business — we talk about key areas to address when preparing a company for sale.
Business owners looking to sell often go to an advisor saying something along the lines of “I want to get out …” or “I received an offer to sell …” The timeframe generally is something like “… next year” or worse yet — “I have xx days to respond.”
Selling a business is not like deciding where to travel for a summer vacation. Sure, one could probably benefit from referencing a checklist beforehand under either scenario, but selling a business is a process that should begin years before it happens, not in a period that could be measured in days. Below are three critical questions to help business owners begin the journey of selling the business.
1. Do you have an attorney?
Don’t look for just any attorney, but specifically an attorney who:
- Specializes in the area of business transactions or mergers and acquisitions;
- Serves privately held clients;
- Has represented companies of a similar size to your own;
- Ideally, works with businesses that operate in similar industries; and
- Works well with a team of other key service providers.
>> Read “M&A Essentials: Understanding Purchase Price”
The attorney is often the quarterback of your team, and it does little good to have a quarterback calling plays from one package when players in the other skill positions (e.g., accountant, tax advisor, investment banker, valuation analyst and wealth-management advisor) will run routes from another package.
2. Is Your Financial House in ‘Good Order’?
One of the first things a potential buyer will ask for as part of the due diligence process is to review the past three to five years of tax returns and financial statements. The instantaneous response to this question, and to those below, tells an advisory team how well, or not, the financial house is in order and what corrective actions (if any) may be necessary.
- Does the business have quality, internally prepared financial information (e.g., QuickBooks), or compiled, reviewed or audited financial statements? Although the near-term, upfront cost of a financial statement audit (for companies that do not have audited financial statements) may seem daunting, the long-term benefits of a more efficient, less-protracted due diligence process could trump the cost. Has your company filed all the necessary federal, state and local tax returns? In addition to federal and local filings, sometimes state filings are overlooked, particularly as a business grows over the years and individual state tax laws continue to change. This can serve as a great source of pain during a deal. Be aware of all of the company’s tax obligations and work with experienced tax advisors to become compliant before a buyer comes calling.
- Consider a sell-side QofE (Quality of Earnings) report prepared by a known accounting firm. A growing trend within the M&A world is having a sell-side QofE done prior to going to market. This helps potential buyers get the information they need and can be less disruptive to your business operations during the process.
The bottom line is be prepared, compliant, and know what a potential buyer may ask for and be ready to hand it over before the information is requested formally.
3. Has the Business Undergone a Valuation?
In the same way that a house, vehicle, jewelry or artwork can be appraised (or valued), a business can be appraised. There are many benefits. An accredited, qualified business valuation analyst will:
Provide, as of a given date, the value of the business — either as a single number or as a range of numbers.
Request certain types of information and ask specific questions that a potential buyer likely will, so treat this process as a dry run of the due diligence phase during a sale. For instance, a buyer or valuation analyst may request that owners:
Provide the five most recent years of financial statements and tax returns.
Provide any sets of budgets, forecasts and/or projections prepared as of a current date AND over the past five years.
Explain whether any non-recurring revenue/expenses exist as of a current date and/or are forecasted for future years.
Identify any contingent liabilities that may not be discernible within the financial statements.
Provide details of any related-party transactions.
Tell if there are any favorable terms with specific suppliers that may be affected in the event of a key person’s departure.
Identify any recurring business with specific customers that may be affected in the event of a key person’s departure.
Identify if there have been any prior transactions involving company stock and the details surrounding such transactions.
Help owners identify the drivers that increase, and the risks that decrease, the value of a business. Armed with this information well before contemplating a sale, an owner can devote more time to boosting value to the company and eliminating, or at least mitigating, risks that lower value.
>> Read “M&A Essentials: Elements of Value — Enhancers and Detractors”
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One other important note. There are many different types of valuations a business can conduct. However, a business valuation analyst who puts the owner’s needs ahead of his or her own would likely advise that, at this early stage in the process, an owner seek and obtain what’s known as a calculation of value.
In a calculation engagement, the owner and the valuation analyst agree on the specific valuation approaches and methodologies the analyst will use as well as the extent of valuation procedures he or she will perform. A calculation engagement does not include all of the procedures required for a valuation engagement.
Often, the output of a calculation engagement will take the form of an oral report with a set of supporting schedules and, depending upon the owner’s wishes, a brief written report. Contrast this with the output of a valuation engagement, which takes the form of a detailed written report with a set of supporting schedules. If an owner simply wants a general idea of the value of the business at this early stage of the sale preparation process, then a full valuation engagement and written report is generally not necessary.
Of course, these three areas can only help a business owner begin the process of preparing to sell. There are many other factors that should be addressed, such as leadership and succession planning, cultural issues and financial planning issues to name a few. Good advisors can help you navigate the process and ask the right questions at each phase along the way.
Please contact Jim Lisy at email@example.com or Josh Lefcowitz at firstname.lastname@example.org for further discussion.
Cohen & Company is not rendering legal, accounting or other professional advice. Information contained in this post is considered accurate as of the date of publishing. Any action taken based on information in this blog should be taken only after a detailed review of the specific facts, circumstances and current law.