To garner an optimum price for the sale of a company:
- Conduct due diligence as a buyer would.
- Address all findings openly and fix what can be fixed.
- Aim for complete transparency.
- Discern the best buyer candidates.
- Come clean on the past and be clear on the future.
- Organize a compelling narrative why you’re selling.
- And remember for a deal to work, both parties must come away happy.
There comes a time in many organizations’ existence to cash out—to sell the business or a division within it. Collecting a premium price demands more than simply announcing, “For Sale,” and hoping for the best. Big dollars can be lost at the negotiating table if the organization isn’t prepped and buffed to a tantalizing shine.
Too often, a company’s board and CEO decide to sell a company on a Monday and then send out word by the end of the week. There isn’t remotely enough time to do any sort of adequate preparations, which explains why investment banks, law firms and others counseling M&A dealmakers advise taking at least a year before even thinking about putting the business on the block.
With this in mind, Chief Executive reached out to the M&A advisors to CEOs who have sold off a company or two and asked, “If you have one year to prep a company for sale, what are the smartest things you can do to reap a bonanza?” The collected answers indicate that prepping a company for sale takes planning, sensitive communications and gut-wrenching honesty about the organization’s plusses and minuses to bring home the bacon. “Before a company undertakes a sale, it needs to put the mirror up to itself,” says Michael Butler, CEO of Cascadia Capital, a Seattle-based investment bank. “There’s nothing that scares a buyer more during the due diligence than when they find the books, records and management structure a mess. If you don’t have every loose end tied up neatly, buyers will walk or kill you on the price.”
Leave No Stone Unturned
To prevent these dire scenarios, sales-minded companies must walk in the shoes of prospective buyers, doing the due diligence into their own operations that others will do to them. A good starting point in this process is to assess who the likely acquirers will be for the entity. “You want to understand which buyers will value your company at a premium—for example, a buyer entering a new market via the acquisition of your company may arrive at a higher value for it than a company trying to achieve scale,” says Bob Zagotta, executive vice president of Chicago-based Project Leadership Associates, a management consulting firm. “Sometimes the obvious candidates might not be the best ones.”
A good example is an acquirer likely to relocate the business, which might compel key people to leave the company pre-acquisition, squeezing the purchase price. Butler instead advises seeking an acquirer “that shares your values, goals and culture to better streamline the integration process, and to keep the buyer’s post-acquisitions costs in check.”
Once potential acquirers have been pinpointed, the seller’s due diligence commences with a painstaking analysis of the financial statements—income statement, balance sheet, cash flow and tax returns going back at least six years, M&A advisors recommend. “If your house isn’t in order, you’ve now bought time to clean up the mess,” says Heidi Carpenter, a business transactional attorney and shareholder in the Minneapolis-based law firm, Fafinski Mark & Johnson. “If you had a couple bad years, you can formulate an explanation why this occurred and how it was anomaly that has since been fixed.”
In her experience representing diverse companies in M&A transactions, Carpenter says a seller’s inadequate, misleading or inferior financial statements will weaken the deal price. “I’ve seen substantial funds put into escrow or large cash payments being made at the closing because the value of the entity was reduced by inaccurate financial data or an unseen tax or environmental liability that came to light,” she says.
Others have seen the same thing. “CEOs think they understand their companies’ numbers at a very high level, but in my experience they understand a lot less than they think they do,” maintains Andrea Belz, president of Los Angeles-based Belz Consulting Group and author of The McGraw-Hill 36-Hour Course on Product Development. As companies grow larger, “it becomes difficult to know exactly how each division is doing in terms of sales and costs—basic cash flow and profit and loss stuff,” Belz explains. “The numbers may add up at the top very nicely, but if a buyer perceives part of the organization to be in trouble, it now has leverage at the bargaining table.”
To gain the upper hand thus requires leaving no stone unturned. “A buyer will be looking into a lot of information that the seller may not have assembled but should, such as profitability by customer, by product, by division, by geography, by distribution channel, and so on,” says William Spizman, managing director of the national transaction advisory group in the Chicago office of RMS McGladrey, the fifth largest accounting firm in the U.S. “We’ve worked with sellers that did not have the systems or processes in-house to get their hands on this information easily. It puts a big strain on the business, but is worth it in the long run.”
Think of this due diligence as an honest self-appraisal, “warts and all,” says Chuck Richards, CEO of Chairman’s View, a Boston-based consulting firm that assists private companies to improve their enterprise value. Richards advocates a self-assessment process in which various market and operational drivers like recurring revenue, product differentiation and customer satisfaction are scored in red, yellow or green zones (See Graph). A green zone score indicates the company can capture “nearly all potential value” from the market or operational driver, with red indicating it can capture “little to no value.” “By being transparent about your organization, you’re now in a position to see it as the buyer will see it,” Richards says. “Better yet, you now have time make changes or to prepare your explanations.”
Indeed, the goal is to reduce the risk of surprises at closing. “You want to be sure your financial statements are solid, that when you present your company a year from now that there are no hiccups—nothing to cause a valuation discount,” says Rick Kline, a partner at Goodwin Procter, a Menlo Park, California-based law firm specializing in private equity M&A deals. “If there are problems like a tax or environmental liability, intellectual property litigation or eyebrow-raising financial statement questions, you need to get these resolved or show a clear path toward their resolution.”
The Truth, and Nothing But It
The alternative is to sweep problems under the rug, crossing fingers that the buyer won’t find them. Chances are they will, however. “The more you disclose, the better,” says Scott Avila, managing partner in the New York-based management consulting firm, CRG Partners Group. Avila equates selling a company with selling a house: If the furnace isn’t working properly, fix it; if the water heater is old get a new one. “You want to show that you have a culture of finding problems and addressing them, not avoiding them,” he says. “You need to speak to the fears of the buyer.”
Others agree. “First impressions happen only once,” says David Epstein, chairman and CEO of C3/Customer Contact Channels, a Fort Lauderdale-based BPO (business process outsourcing) provider. “You want to show a culture of transparency. It begins with taking off your own blinders and accepting the truth about your condition.”
Seeing straight is more than myopically perusing the financial statements. It also means evaluating the risks associated with a sale, such as the likelihood of key executives rushing for the exits. The morale of those who stick around also may suffer, leading to motivational problems and productivity declines. “You need … maximum alignment among senior executives as to the strategic merits of the sale and individual financial opportunities,” says Tom Saporito, chairman and CEO of RHR International, a Chicago-based leadership consultancy. “These people will be critical to the success of the company going forward. You want to lock them in with compensation schemes that have `change of control’ agreements providing substantial bonuses and benefits if they lose their jobs.”
When business owners or senior executives plan to leave post-acquisition, succession management is critical. Carpenter recalls working on a transaction where the CEO and president planned to depart at closing, and they were the only parties to own the client and vendor relationships. “It created big problems,” she says, declining to name the company. “The solution in such cases is to ensure that other key executives start having dinners with clients and external parties well in advance of a sale to built trust going forward.”
Once a seller completes its own due diligence by pretending it’s the buyer, it can now begin to shape a narrative of why the company is such a great deal. While the clean and transparent financial statements show how successful the business has been, the narrative dramatizes the better stuff ahead—a compelling business plan that shows a clear path to profitability, much as a company would execute to seek financing from a bank. “The company needs to look appealing to you before it will look attractive to a prospective buyer,” says Belz.
Every narrative needs a beginning, and in this case it should open with why the business is being sold in the first place. “You want to produce a convincing story of why you’re selling, and have it make obvious logical sense,” says Avila. “Maybe the business doesn’t fit the parent company’s strategic rationale anymore, or the seller is going in a different direction. Maybe it no longer has the energy to put into a division it now sees as non-core, or it needs to generate capital to grow. The key thing is to explain your rationale so the buyer doesn’t get the sense it’s a ‘pig in a poke.’”
In developing the narrative, also beware of red herrings—an obvious diversion away from items of importance. Rather than spruce up a tax liability, for example, simply settle the issue. When postulating on the company’s future, back up assertions with examples from the past. “If you’ve got some new product launches in the early stages, show how past product launches were supported—that’s a good proxy,” McPhee advises. “If you haven’t done anything like this before, the buyer will give you zero credit for it. If you say you’re going to win customer XYZ, show where you are in this relationship right now—no meetings with them, zero credit. If you say your products have application in an adjacent market, produce the research you’ve done or your consultants have prepared. Put meat on the bones.”
One final piece of advice about prepping a company for sale comes from Butler: “Be honest with yourself about your desired acquisition outcomes from the beginning.” He elaborates, “The sellers that think they can score a big win at the table typically are the ones that haven’t done their own due diligence. Only after lifting the lid can you assure a price that is fair, reasonable and right for both sides.”
Telling the Tale
In 2008, just as the recession was taking hold and credit was tightening, a potential buyer stepped forward to acquire private equity-backed Penn Foster Education, a provider of online job-training and accredited career-education programs serving 223,000 students. And then the roof caved in. Credit availability vanished and with it the prospective acquirer’s appetite.
“Looking back, it bought us some time to think how best to position the company for sale—to tell our story,” says Stuart Udell, Penn Foster CEO at the time and currently the CEO of Catapult Learning, a provider of academic intervention programs.
Buying time turned out to be in Penn Foster’s best interests. In December 2009, the company was sold to Princeton Review for $170 million in cash, giving its owners, The Wicks Group, a 106 percent internal rate of return and nearly a seven times return on capital. What did the trick? Aside from the fact that Penn Foster’s underlying business was appetizing, the icing on the cake turned out to be the story Udell told. “We organized a clear and compelling narrative of where we’ve been, where we are today and where we were going,” he explains.
Chalk up his authorial skills to a professor he had at Columbia Business School in the 1980s. “He talked about how to dress up a company for sale, and it stuck with me,” Udell explains.
Like staging a house for sale, the chief executive did the same for Penn Foster. “We were located in a 50-year old building that was built in the factory age—here we were a cutting edge online education provider, but we didn’t look it,” he says. “So we did things like hanging college flags along the driveway coming in and put student testimonials on the walls. We changed the old carpeting in the hallways and even blacked the parking lot. And since the company was 120 years old, we went on eBay and bought some old bookcases and put diplomas and trophies from the early 1900s in them in the lobby. These were small things that didn’t cost a lot, but they helped make a difference.”
The company also mulled its likely buyers from a strategic standpoint. “We made lists, and while we eventually ran a full auction process we got ahead of it, setting up meetings with eight likely prospects to engage their interest,” Udell says. “This got word of mouth spreading, which created some competitive buzz. And it all worked out spectacularly.”
So spectacularly that Udell is now sprucing up Catapult Learning, another private equity-backed company (jointly owned by JMI Equity and the Carlisle Group) for sale. “We’ve definitely got something here of value,” he says.