Preparing for a Liquidity Event: Increase Value by Being Prepared

There are many reasons why owners of small businesses decide to pursue a liquidity event, some of which include health and/or age of the owners, timing in the business cycle or life cycle of the company, the personal desires of the sellers, general economic indicators, trends in capital markets, tax issues and other factors.

The right fit culturally leads to sustainability which leads to increased value. The key for business owners pursing this type of opportunity is to maximize the value of the company they have worked so diligently to build.

There are two types of buyers: Internal and external. The internal buyers consist mostly of relatives and employees. The external buyers consist of institutional and unrelated strategic buyers. Regardless of the type of buyer and their level of sophistication, sellers need to look at their businesses through the lens of a sophisticated buyer. When a determination is made that a liquidity event is on the horizon, whether it be 2, 5 or 10 years away, it is imperative to run the business to protect and increase value. Keep in mind that a discount of earnings will always be greater by the buyer than the seller. The quality of earnings will be generally be analyzed over a trailing 12- or 24-month period.

There are many considerations in preparing a business for sale, which include, but are not limited to, the following:

1. Operate under the no surprises rule. Think like a buyer of your business and proactively address any potential concerns.
2. Perform. Do not miss projections.
3. Growth equals value. Prepare a detailed quantitative and qualitative story substantiating growth and projections.
4. Be organized. Get ready early for due diligence and have your house of data in order for review.
5. Be prepared to do battle. Some items will be always be subject to scrutiny, such as growth potential, quality of financial performance, market opportunity, and regulatory risks.

One of the key ingredients to success is to contact professionals early in the process. This can make a difference in the outcome. Having audited financial statements is typically a key element in preparing for a sale. The engagement of qualified professionals should be done early in the process to assist in increasing value. Hiring a business intermediary with experience can help to both organize the company and help identify areas that may detract from value. Attorneys need to be retained to help prepare and negotiate letters of intent and purchase and sale agreements, solidify contracts, assist with buy/sell agreements and review communications with the prospective buyer.

There are four key areas where buyer due diligence takes place: business, financial, legal and other. The business category includes management, markets, customers, growth plans, sale and marketing, products, technology and operations. Financial consists of accounting, tax, financial systems, and internal controls. Legal involves a comprehensive legal review, including outstanding and potential litigation, intellectual property, and contracts and records. The other category is comprised of everything else, including human resources, insurance and environmental considerations. Paying careful consideration to each of these categories and being prepared for due diligence in these areas can pay big dividends.

Even the most well-prepared sellers have struggles, though. There are many things that can go wrong. Here are a few to consider:

• Key employees refuse to sign a required non-compete or non-solicitation agreement. This can be particularly problematic if those key employees are instrumental in customer relationships or growth.
• Deal fatigue. Sometime one or both parties just get tired of negotiating.
• Key customers won’t sign consent. This takes personal discussion and sometimes takes creativity to work around.
• Time. The deal takes so long that funding dissipates or another offer becomes more promising to the buyer or seller.
• Price. Sometimes the terms of earn-outs or representations and warranties are onerous on the seller.
• Contingencies can’t be agreed upon. If there are some nebulous items that exist and their future is indeterminate, they could become a sticking point.
• Potential relocation. This may be a deal breaker if the employees are critical to the growth of the business and they do not favor relocation.

The sale of a business is a very personal matter and there are many options and choices to be made along the way. The volume of data required in the due diligence process can be overwhelming. Being prepared is the key to managing the process and assuring the highest value for business owners and stakeholders. Beginning the process with the end in mind, which means engaging professionals, being prepared, having flexibility, and solving deterrents along the way is the key to a successful liquidity event.