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You've spent a lifetime building your business.
How much time have you spent building an exit strategy?
Business owners should start planning an exit strategy three years before they actually intend to sell, according to Alan Crossley, a partner at Osprey Capital Partners.
“There are a lot of tax advantages you can take, but they have to be in place two years before you actually execute the transaction,” he said. “A lot of guys say, ‘Well, I'll just move my assets into this other company.’ The tax man says, ‘No, you can't do that right before you sell to avoid capital gains.’ But if you do it two years in advance, they are pretty good about saying it wasn't strictly done for tax purposes.”
Crossley said 69% of all family-owned businesses do not survive into the second generation, 87% are not viable into the third generation, and 96% are not operating into the fourth generation and beyond.
Inadequate estate planning and failure to properly prepare and provide for the transition to the next generation, coupled with a lack of funds to pay estate taxes, were among the three leading causes for failure of family-owned businesses, according to a 2001 University of Connecticut survey of 800 family-owned businesses.
The reasons to sell a business:
- Time to retire
Owners want to liquidate and relax.
- Moving on in life
Owners want greater stability, the industry has changed, or they have health issues.
- Monetize their life's work
Owners want to realize the value of sweat equity.
- Greater management horsepower
They want to bring in new partners.
- Succession issues
No family members are viable for the business.
- Raise money for expansion
Owners want to sell part of the company or become a public company.
“Those are very complex and expensive to do. You have to spend time with regulatory bodies. People are always amazed at how much time it means.”
Who do you sell your company to?
“If you want to sell or give your company to your children or child, it's best-suited to owners who want to step back from the business and retain the family business. The risk is that the children of owners may not have the skills or aptitude to run the business.”
- Management (MBO).
“You generally get the lowest purchase price. It's a vendor take-back on financing or a partner with private equity. It provides the least amount of change to the business in terms of identity, employees, etc. Are they up to the challenge of running the company without you? It's best suited to owners who have a solid management team and want limited involvement in the business. The risk is that your money is still tied up in the business. Incumbent management continues to lean on you for direction.”
“It provides the greatest value/price because they can afford to. It involves competitors and complementary product lines. If you're a bicycle manufacturer, you buy a chain company to save money.
“Strategic is the fastest and involves the most change. The downside is that you and the management team are most likely removed from company because they want to instill their systems and culture. As long as you're there, you're the culture. If your goal is to cash out and leave, this is the way to go. If your goal is to stick around, it's probably not a great plan.”
- Private equity fund/institutions.
“They are looking for financial return, so they pay generally four to six times the trailing EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization). They're looking to make a 25% minimum return on their investment. High value is placed on consistently growing earnings with significant growth potential. They look at growth as further acquisitions. There's a significant due-diligence process. They're looking for ownership control through equity. It's a very hands-off operational management approach. They need the management/owner to stay. They're very bright people and will learn the industry, but in terms of what's happening from day to day, they're not into that.
“The time line is three to five years. They buy a business, ramp it up, and sell it. In some cases, they put some lipstick on it and see who bites. This is best suited to owners who want to monetize corporate value and continue working for up to five years.”
- Public markets.
“They're priced according to other publicly traded companies. There's public scrutiny of all financials and major events going forward. You're now a public company, so the public sees it. You fall under tremendous scrutiny. The biggest issue is, there are 4000 companies listed on the stock exchange. You have to have a story as to why people should give you the money as opposed to the other 3999. You're competing for capital with some pretty big players and pretty safe investments.
“Value is placed on solid historical financial performance with potential significant growth opportunities. It's best suited to owners who are planning for significant expansion. The risk is that it's a costly process that might not achieve the goal.”
He gave the common business valuation methods:
- Multiple of EBITDA.
“It's the most common method of valuation used. Over 90% of businesses are evaluated on earnings stream. It's based on trailing cash flow, maybe some future.”
- Asset-based valuation.
“Some companies just get sold for assets. If you've got an underperforming business and you've got $10 million worth of assets and the business is only generating $1.5 million, that's a pretty crummy return, so sell the assets along with the business.”
- ROI-driven return.
“Return on Investment is not commonly used to value businesses by the acquirer but important to the vendor. What do you want to make on your future earnings? A 15% return is approximately five years of projected earnings.”
“As the seller, you will focus on the highest valuation of the three,” he said. “What's not included in your business' value: All sweat equity you put into building your business; and the emotional ties and sleepless nights you've had with your business.
“The real trick to sell your business and get what you want out of it is the process you follow. Make sure you hire a financial advisor. It's going to cost you money. It doesn't have to be a $100 million or $200 million deal (for an advisor to be worth it). It takes the emotion out of the thing and gives you a lot more credibility.”
Crossley gave the keys to success for a controlled auction:
Clear objectives and criteria.
“What are you prepared to accept? Some people don't understand what they're trying to get out of it. Are you going to take cash, stock? Sell a part of the company? Want the employees to stick around?”
“It's having objective criteria, knowing what you're doing. When this thing starts, it happens very quickly. You want momentum to be on your side. Companies are not necessarily looking to buy your company — they're looking to get into your market. If you're into discussions and go into a hiatus, they find another company, or somebody finds out they want to buy and calls them up.”
Control of the process.
“Whoever controls this process always comes out the winner. That's the guy who has got his ducks in a row.”
“Stay focused on closing. There are a lot of deals, surprisingly to me, that don't actually get closed. They get 90% of the way through.”
Potential sale criteria:
“What are you selling? Some people want the whole company, while others want a piece.”
Form of consideration.
“Cash, shares, vender take-back.”
Asset versus share acquisition.
“Companies will try to buy your assets. They really don't want to buy your shares. Asset sales are cleaner for the buyer.”
Availability of funds from purchaser.
Conditions to closing.
“Due diligence, financing, securities commission approval.”
Purchaser's acquisition history.
“There are a lot of companies out there who want to look and not buy. Some guys come in and low-ball you and drag it on and on. You want to stay away from those deals.”
Timing to close.
“Other acquisitions, other corporate activities.”
He said that for a controlled auction, Osprey Capital will manage all aspects of the process, including:
Preparation of appropriate financial and comparable analysis to determine a value range for the company.
Preparation of appropriate marketing materials and documents.
Assistance in the development of criteria to evaluate bids.
Identify, qualify, and contact potential purchasers to determine their level of interest.
Coordinate dissemination of information, meetings with management and shareholders, and due diligence activities.
Assist company in negotiations with the purchasers and their advisors.
Work with legal counsel to document and close the transaction.