Exit Planning and Succession III - The External Sale
A business owner looking to sell their company has two options: an external sale, in which an outside buyer purchases the business; or an internal sale, in which management or family purchase the business. Most contracting companies pursue an internal sale through management buyout or gifting to family. Why? It is difficult for outside buyers to predict consistent profits with the cyclical nature of the construction industry.
A company owner might consider a sale to an external source because of a lack of a successor, health issues or an urgency to exit. Attractive companies will have a strong cash flow and management team.
Selling to an outside buyer can be an uphill battle. A study by the U.S. Chamber of Commerce revealed that fewer than 20 percent of companies that go to market actually sell. The statistic is closer to 10 percent for contracting companies.
Businesses opting for an external sale can improve their odds of success through early preparation and assistance from a mergers and acquisitions consultant. This article explores the top 10 key considerations to selling to an external buyer.
1 - Complete a business valuation
Prior to a sale, a business owner must have an accredited business appraiser perform a valuation of the company. The owner needs a realistic understanding of the value of the business, as well as of the tax ramifications of the transaction for setting realistic expectations to achieve post-exit financial goals.
2 - Start early
An owner should start the sales preparation process by meeting with an exit planner or mergers and acquisition adviser a year before he or she is ready to sell. This time will give an owner the opportunity to properly align all the moving parts in the sale process—especially the due diligence process—with minimal adjustments by the buyer.
The advisers will also assist the owner with a marketing book that can act as a commercial for the business, outlining strengths (primarily) and weaknesses.
3 - Use a team
An owner should not deal with potential outside buyers by themselves. For many, transitioning a business is an emotional process. A great deal of time and frustration can be controlled by relying on an exit planner or an M&A adviser in attracting and qualifying buyers. Seller representation is critical to assist with this negotiation for the best possible price and terms and to suppress emotions.
4 - Plan for succession
Most owners leave with the sale of the company. An owner needs to replace themselves with a strong management team. Remember, what the buyer wants in a business is not the equipment, the facility or the products. The buyer wants the cash flow, and a solid management team will be instrumental in helping transfer that cash flow to the buyer with reduced risk.
5 - Change the C-Corp to an S-Corp
An owner should consider electing to change from a C corporation (C-Corp), to an S corporation (S-Corp). C-Corp and S-Corp are two distinct business classifications that affect how a business is taxed. A C-Corp is taxed separately from its owners, while an S-Corp is generally not taxed separately. There are distinct disadvantages of being a C-Corp. One of them is the double tax ation inherent in the C-Corp structure, and another is the built-in gain tax that stays with a corporation for 10 years. The built-in gain tax essentially eliminates the capital gain tax treatment for an S-Corp company that was previously a C-Corp. Early planning will help an owner avoid this pitfall.
6 - Recast earnings
Private owners need to organize their books and recast their financials to reflect normalized earnings by adding back discretionary expenses. There are many expenses that are currently being run through the business that will no longer be used by the acquiring company. This can include such items as salaries/bonuses paid to family members, business vehicles, memberships, travel and entertainment. If possible, these expenses should be eliminated from the financials altogether, because these adjustments are usually a point of contention with the buyer as they are often difficult to prove.
7 - Sell the opportunity
Yes, a company’s financial strength and future cash flow are central in the valuation and pricing of your company. But, what are the highly profitable aspects of a business that will differentiate the company from the competition? An owner must be able to tell a story in the marketing position that is clear and measurable, and that defines the company’s competitive advantage.
8 - Clean up any distractions
A buyer’s due diligence process will examine a lot more than just a company’s financials. It will include key contracts, supplier agreements, legal agreements, insurance policies, company health and pension plans, human resource policies, corporate records/minutes, etc. A business owner should clean up files, paperwork, processes, and any other distractions, and should disclose everything that could cause a surprise and kill the deal. It is critical to be transparent, even if it kills the deal.
9 - Prepare to negotiate terms
Every deal is different, but these common items are negotiable and will determine the price:
- Will the owner keep some of the assets in the deal, like a car or truck?
- Will the owner be paid in a lump sum or installment payments?
- How large of a down payment will the owner require and what will be the length of the installment payments?
- Is the owner flexible on selling the assets or equity?
- Is the owner willing to work for the buyer after the closing as a consultant or manager?
- Is the owner willing to sign a non-compete agreement and the limits of restrictions?
- Is the owner willing to finance the balance of the transaction?
- Is the owner willing to earn the balance of the sale price?
The devil is in the details. While an owner may think they are getting a good deal, the details of the transaction will be critical in determining how much they actually receive.
10 - Continue to drive the business
Throughout the selling process, an owner needs to continue driving the business and let the M&A professionals drive the sales process and manage the buyer. The buyer does not want to see shrinking margins or a loss in sales during the diligence process. It is best for an owner to stay at arm’s length from the buyer during due diligence and brought into the critical negotiations period at the end of the process.