For most business owners, there will come a time when they must decide whether they want to sell their company. If the answer is yes, a significant portion of their financial and professional future will suddenly hinge on an undertaking they’ll be doing for the very first time. And let’s be honest, there are few things in life we get right the first time.
Years ago, when our business first started to attract potential suitors, I sought out the advice and experience of several experienced business owners in our industry who had already navigated the process successfully. Not only did I gain a realistic sense of what our company, Acceleration Partners, might be worth in the eyes of a buyer or investor, but I learned how to put myself and my business in the best position for a good outcome.
A few years later, we ended up finding the right partner and making a deal. Since late 2020, I’ve sat on the opposite side of the mergers and acquisitions (M&A) process. I’ve evaluated over 75 businesses as a buyer, as we continue to build out our platform with our partner.
All too often, I’ve run into people who remind me of myself a few years back. These sellers are approaching what could be the most important transaction of their life without the right support team, materials, or expectations, and as a result, they are unlikely to get across the finish line.
With the wisdom of hindsight and now having now been involved in selling two businesses and buying three, here are the six pieces of advice I would give to potential sellers who want to get the best deal they can with the right buyer.
Rely on Experts With Transactional Experience
You would never try climbing Mount Everest without an experienced guide. Similarly, the worst thing a founder can do is try to navigate the M&A marketplace without expert assistance. Specifically, you’ll likely need accountants, lawyers, and a transaction adviser who understands the M&A process, can help prepare you for the sale process, and can manage negotiations with buyers. The most common forms of transaction advisers are investment bankers for larger deals ($50M or more) and M&A brokers or advisers for smaller deals.
While some businesses really are too small to afford a traditional investment banker — for example companies worth less than $50M in valuation — oftentimes the seller is just hoping to save money by doing things themselves. In my experience, the vast majority of businesses taking this DIY approach either didn’t sell at all or sold after an undesirably long timeline for a lower-than-expected price.
Quality bankers, brokers and transaction advisers know how to effectively navigate the M&A process. Aside from the accounting and legalese, an M&A transaction process is frankly a lot like dating. There’s a certain order of operations that helps everyone feel comfortable with the progression of the relationship and the sharing of information. Momentum and competition are really important factors in getting a deal done. You’ll sell faster and get better offers, if buyers know other buyers are interested.
Understand the Buyer’s Mindset
Conversely, buyers might take advantage when your deal process loses momentum. If you tell a potential buyer there is substantial interest in your business and then you don’t have any offers or progress when they check in later, they might sense you are getting fatigued or that interest is not as strong as expected. A good banker or broker avoids this issue by creating a competitive process with specific deadlines and leading negotiations, so you don’t have to negotiate directly with a buyer.
Experts also protect sellers by keeping buyers honest. Many prospective buyers try to quickly move sellers to sign a Letter of Intent (LOI) just to eliminate competition, knowing that they can renegotiate or “retrade” at a more favorable price before closing. Experienced bankers and brokers know this game well and help sellers keep the buying process competitive. They’ll often move forward with multiple parties and multiple bidders up until a deal is closed. Almost everyone I have spoken with got a meaningful premium for their business running an expert-led, competitive process compared to the offers they got before enlisting a banker. It’s just better to lean on people who know the game.
Choose Your Team of Experts Wisely
One last note on experts: don’t assume the lawyers, accountants or advisers in your network today are the ones you need to go through the M&A process. Your family lawyer is probably not the right person to represent you in a sale nor is your solo practitioner accountant uncle. I’ve even had a founder tell me that they did not need an M&A adviser, because their partner worked in investments/finance. This founder spent over a year trying to sell their business in a very strong market, with several failed transactions.
To get the best deal, you need the right team of experts. Treat it like a hiring decision that you absolutely cannot afford to get wrong — proceed with caution and rigor.
Understand the Market for Your Industry, Size, and Business model
Most sellers are not very objective when valuing their own business; everyone thinks their baby is beautiful. Sellers tend to believe they are more differentiated from their industry competitors than they really are and therefore should command a premium on the market. And while it only takes one irrational bidder to overpay, markets tend to be efficient, and a seller should get a clear sense of what the market has actually paid for similar companies in their industry.
When selling your business, remember the potential buyer is often a larger, more established company within your vertical or a private equity firm who has studied your industry’s M&A market and understands how you measure up to other acquisitions in your field. To attract these buyers, you have to know what constitutes value in your industry and understand how your company’s size and pricing model look to scrutinizing eyes.
Key Factors to Consider
While no two businesses are the same, a business’ value outside the world of hyper growth, venture-backed tech business generally depends on a few core factors:
- Level of Profit
- Growth Rate
- Business Model
Many founders and owners mistakenly compare their selling prices to companies that appear similar to theirs, but they aren’t always very comparable on those four core factors.
For example, almost all professional services businesses are valued based on their level of profitability. They typically don’t have proprietary assets or intellectual property and earn money from their people, who walk out the door each day and aren’t guaranteed to return.
An acquirer most often values a services business as a multiple of the company’s EBITDA, or Earnings Before Interest, Taxes, Depreciation and Amortization, from the past 12 months. In valuation shorthand, this is referred to as TTM EBITDA, or trailing-twelve-months EBITDA. This is a proxy for the annual cash flow a business generates before debt service.
Businesses with higher levels of TTM EBITDA get higher multiples (for example, 10X EBITDA versus 5X EBITDA), especially as EBITDA surpasses the $5/$10/$20 million thresholds. Companies that pass these round numbered thresholds are viewed as more established and sustainable, and therefore acquirers consider them safer bets.
Considerations for SaaS Companies
In addition, a company that sells a software-as-a-service, or SaaS, solution will command a higher multiple than a typical services business, even if it’s selling within the same vertical. SaaS businesses often have recurring revenue from customers, on multi-year contracts that renew automatically, which assures more reliable revenue as compared to one-time or project-based revenue. SaaS sellers also don’t need to worry about their proprietary technology walking out the door during the next Great Resignation.
You can probably guess where this is going: if the owner of a services firm enters the M&A market believing they will be valued the same way as their friend who owns a SaaS business, they are in for a rude awakening.
Once you objectively identify the closest industry comparisons — something an experienced banker or broker can easily help you do — you then need to anchor your expectations around other deals that have actually closed, by looking under the hood of those deals. Too many founders and owners get caught up in the headline value of deals in their industry without knowing all the details.
Knowing What to Expect
Just as your social media feed will only show you the best five percent of others’ lives, the rumors and tall tales you hear about M&A pricing are often greatly exaggerated. In some cases, people simply embellish the truth; in other instances, the devil is in the details.
For example, there is a big difference between a company that sells for $10 million in cash and one that sells for the same $10 million price tag but with only $5 million in cash up front and a five-year earn out. In the latter case, only the initial $5M is guaranteed and the other $5M is paid out if milestones are hit. Very often that earnout requires the founder or leadership team to stay onboard for those five years to achieve the full $10M. That extra $5M is effectively being paid out of the business’s future earnings, and because of inflation, it’s worth less in the future than it would be in an immediate payout. Most founders I know would prefer a lower “headline” number for their freedom and more money guaranteed.
Understanding the Proposal Details
Also, don’t assume that an offer or LOI someone in your LinkedIn network got for their business represents accurate market value. Harvard Business Review found that between 60 and 80 percent of proposed acquisitions fail to close. As mentioned earlier, many acquirers make a practice of using LOI’s to get a business under agreement with an explicit plan to “retrade” the seller before close or change material conditions of the deal after a long and exhausting due diligence process.
I can’t stress this enough: tune out everything but market-clearing prices — the realized value of the deals that have actually closed in your industry or in industries similar to yours, with an awareness of the business model, the size of the company and the deal terms. Otherwise, your expectations won’t match reality.
Clean-up Your Books
Many business owners, especially those who have co-mingled their personal and professional finances for years fail to understand or appreciate how a potential buyer will interpret their financial picture and bookkeeping. Your definition of profit is likely differ from a buyer’s. A potential buyer wants to see financials that adhere to generally accepted accounting principles (GAAP) and what’s known as Adjusted EBIT, which gives a more accurate financial picture of the business for a new owner.
Some of these adjustments benefit the seller, such as when there are vacations, non-working family on payroll, and other expenses that are run through the business for tax purposes and will not continue after a transaction. These are “add backs” to Adjusted EBIT that increase profit.
Just as often, however, sellers fail to account for “subtractions,” which are unaccounted for expenses that will reduce the go-forward profit of the business. For example, a founder might show a business with $500,000 in annual EBIT to potential acquirers or investors, only for the buyers to discover that the founder takes a paltry $50,000 salary and generates most of their income from profit distribution.
Things to Consider
If the founder’s role has a market salary of $200,000 and they, or their replacement, will need or want to earn that same level of income when the deal is closed, then the new owners will have to add that extra $150,000 to costs going forward, which is a subtraction from profit. Instead of the $500,000 annual profit the company shows on its income statement today, the adjusted profit is $350,000. If the buyer made its offer by valuing the business at 5X EBITDA, or $2.5 million, this necessary change would lower the deal value to $1.75 million.
In other instances, the seller may be showing a profit on a cash-accounting basis, when buyers want to see accrual-accounting, which presents a far more accurate financial picture without any distortion of timing. For example, the seller may have counted a large customer deposit toward their revenue and profit for the quarter when the deposit was paid, when the actual services and correlating expenses will be delivered over many months or years in the future.
These nuances are a great example of why it’s important to work with an experienced M&A adviser and/or accountant who can help you put your best foot forward before sharing your financials with a buyer. Cleaning up your finances is not an overnight process, which means you should think about hiring these experts far in advance of going to market. First impressions matter a lot and a business with poorly organized financials that misrepresent the company’s value will almost always lead to problems and mismatched expectations down the road.
Do Your Own Due Diligence
Warren Buffett once said, “you cannot make a good deal with a bad person.” I would argue the inverse may be true too: you cannot make a bad deal with the right person. The buyer is the most important factor to consider before selling. Be sure to research any potential buyer accordingly.
First, it’s crucial to find out whether the buyer actually closes deals. Familiarize yourself with the acquisitions they’ve made and find out if they’re serious about doing business with you or if they’re just casting a wide net and stringing you along or making you a good offer that they’ll just retrade later.
Second, if you are going to be staying with the company or if you have any future earnings tied to the long-term performance of the firm, learn as much about the buyer as they will learn about you. Get acquainted with their leadership team and understand their culture to see if they’re a good partner. If they’ve bought other businesses, ask to talk to the leaders of those companies to get a sense of how they’ve handled acquisitions in the past.
While you might think money is the most important factor in a deal, that viewpoint can change quickly. I know plenty of people who got lucrative earnouts from selling their businesses but ended up begging to be let out of those earnouts after less than a year of misery under their partner’s leadership.
Be Prepared For the Grind
The process of both selling and running your business simultaneously is a grind that will wear on you both mentally and physically. Let’s say you are one of the lucky ones who finds a good buyer, agrees on a price, and signs an LOI. Congratulations on getting this far. Your reward is now months of grueling due diligence to get to the finish line.
Due diligence will involve endless calls and meetings explaining and validating every tiny facet of your business, for several hours a day, often for months with bankers, buyers, accountants and lawyers. It means pulling together data you didn’t know you’d ever need and often locating documentation for any contract, deal, or employee in your company’s history
I’m not a hyperbolic person, so you can trust me when I say that due diligence is the most exhausting thing I have ever experienced. The first time I went through the process, I needed six months to recover mentally and physically. And our process was amicable.
Plus, in those months where you and your leadership team are overwhelmed by due diligence, you need to ensure your business is still running at peak performance while you and the rest of your leadership team are focused elsewhere. If your sales or profit begin to slip, buyers may get cold feet and decide to pull out of the deal.
Once again, if I somehow haven’t made this clear enough: this is why I really don’t recommend trying to sell your business yourself. Get a banker or transaction adviser who knows the M&A world and can run point. You should also have a lawyer and accountant who have done it before. You may even want to consider bringing in a consultant or project manager to help you stay organized during due diligence. They will help to ensure you have time to keep your business running at a high level.
Selling a business doesn’t take as long as building one. However, it can feel like the same amount of work compressed into weeks or months. If you surround yourself with the right team and go into the process with the right expectation and data, you’ll be much more likely to get across on the finish line and on your way to a well-deserved vacation.
Featured Image Credit: Photo by Yan Krukau; Pexels; Thank you.