M&A: How To Make For Your Exit

Felix Yiu built Apricot Designs into a multibillion-dollar company over 32 years and then sold the maker of pharmaceutical liquid-handling equipment to SPT Labtech in January. It was a strategic sale within the industry, and the 65-year-old Yiu is staying on only for a year as a consultant.

“At my age, there are things I would like to do that I consider more meaningful and interesting,” says the Covina, California-based entrepreneur. “Now that I have a little bit of capital, one thing is to give opportunities to entrepreneurs or small businesses who really want to do things.”

Many more mid-market business owners will exit their companies this year. The M&A market is robust—even frothy—driven by the strong economy, low interest rates, ample cash available to acquirers, fears that the Biden administration will boost tax rates, the reluctance of millennials to take on the family business, and a certain “Covid exhaustion among business owners that’s accelerating plans to sell,” says Alan Scharfstein, president of The DAK Group, a middle-market investment bank.

But while the golden ring may loom closer than ever, grasping it in this environment requires a founder’s strategic thinking, due diligence, stamina and good life planning.

Strategic transaction consultant Marshall Rowe says the exit decision requires a framework he calls “the three clocks.” One gauges the level of performance and liquidity in an industry prospect for its continued success and the availability of buyers. The second “clock,” says the founder of Harvest Capital Management, which is now part of the Colony Group, tells how well the company itself is positioned.

The third is the “personal and family clock” about whether it’s time to sell an entity that has “provided financial security and probably a sense of identity in the community,” Rowe says. “It’s a very significant emotional decision. And more than likely, if a deal is going to fall apart at the eleventh hour, it’s for that third reason.”

Chief Executive reached out to a host of CEOs, advisors, bankers and other experts for some quick, savvy suggestions on selling into this magic moment for deals. Here’s some of what they shared.

Preparing the Sale 

Owners often must do “counter-entrepreneurial work” to make their company sellable, says Patrick Ungashick, CEO of financial advisory firm Persium. For instance, they “must develop successor talent and leadership that isn’t in the day-to-day focus of even very successful enterprises” because the founder is used to addressing customer-relations, troubleshooting and problem-solving challenges himself. And then “use golden handcuffs to create that incentive for the non-owner leaders to stay with the work for the long term.” 

Carrie Kerpen sold her New York-based marketing agency, Likeable Media, to 10Pearls this year but only after “productizing our offerings.” Services companies should “create packages that can be sold over and over again by salespeople, versus making everything on a custom basis—so you can scale and take ‘you’ out of the business. It should be able to run without you, though you’re an asset.” 

EBITDA is usually buyers’ focus—and remains so these days—so nurturing it must be sellers’ focus. “It’s easy to make the mistake of focusing on growing the top-line revenue because your ego gets built on that: how many employees you have, and at a trade show you’re comparing sticks,” says Stephen King, CEO of GrowthForce advisors. 

So, grow the top line as expressed in gross profits and gross profit percentage, he urges. “Are you pricing your jobs right to make sure your gross profit is covering overhead and generating the net profit you need to get the valuation you want? And increase the bottom line by replacing lower-margin businesses with higher-margin clients and services.” 

Ideally, a rule of thumb is to be plotting a sale at least three to five years out. “Once you learn more about your company, the changes you have to make that will increase value aren’t flip-the-switch kind of changes,” says Shawn Regan, CEO of Rhythmlink, a medical-device maker in Columbia, South Carolina, that he sold in 2018. “There will be things structurally, culturally and process-wise that will take some time to change.”

John Jungk began gifting shares in Old World Spices & Seasonings to offspring in 2009; the next year, the owner of the Overland Park, Kansas-based outfit began assessing his company in preparation for his retirement; three years later, Jungk developed an advisory board; then he recruited a board member to update the accounting system. He finally sold to Chicago-based Shore Capital Partners last year.

Ungashick advises owners to use a pre-sale countdown to focus on cash and working capital “years before you’re planning on selling. You want to get that number down low because every dollar of surplus cash you leave in the business is a dollar you might not see in the sale.”

He also urges owners to “eliminate customer or supplier concentrations because they create significant risk.” Ideally, no single customer on an annual recurring basis accounts for more than 10 percent of the annual revenue or profits.

Chris Kampitsis says that “often, owners don’t consider the tax ramifications or don’t consider how their month-to-month lifestyle costs might change if the company is no longer part of their lives, such as deductions for auto leases. They have to bring all those expenses back to the personal side,” explains the advisor at Barnum Financial Group.

In any event, it pays to always be ready for sale. “Owners often don’t plan their exit or think about selling until a catastrophic event hits: partner disputes, divorce, pandemic or a death,” says Michelle Seiler Tucker, author of Exit Rich: The 6 P Method to Sell Your Business for Huge Profit. “The worst time to sell your business is when it is trending down and you’re at risk.”

In the Homestretch 

Before Howard Lind sold Cicoil, his Los Angeles-based specialty-wire maker to TPC, a strategic buyer, last year for more than $50 million, he projected that earnings hadn’t yet peaked. TPC could see there was more value to come. 

“Selling in the middle of a growth path is the best thing to do versus trying to time a peak or something,” Lind says. “That’s difficult to do. And buyers want a company that has a lot of growth in it.” Also, he advises, “Be more optimistic in the out years—but make sure you kill the numbers” in the here and now.

“You have to have everything bulletproof. You can’t have things not lined up correctly, because buyers will just shoot holes in it. And that’ll slow down the process and ultimately hurt the sale and hurt your valuation.”

In the effort, Lind says, he spent nearly $200,000 to hire a contract CPA who specializes in preparing a company for sale. Then this person stayed with the company after the deal closed “because, as questions come in, you need someone who can respond quickly.”

The current moment also brings new issues that sellers only a couple years ago didn’t need to consider. For one thing, digital transformation, often accelerated by Covid, may be determinative these days. 

“If a company has resisted the adoption of technology in its business processes, and it’s in a business where tech is starting to have more of an impact, the owner has a few questions to answer,” says Ted Gavin, founding partner of Gavin/Solmonese advisers. “Do they want to invest before a transaction or sell without investing? You’ll pay for the work to be done whether you do it or a buyer does it.”

Similarly, companies are facing an unprecedented labor squeeze. “It’s a problem now,” Gavin concedes, “but it actually could be a huge opportunity later. If a company can run well with a small staff and that’s the bottleneck to greater production, rather than business demand, when the [labor] cycle changes and you can bring in more workers, it’s all upside for the company. Sellers should be conscious of that because you don’t want to lose out on potential value in the sale.”

Other potential deal killers to think about include environmental issues and a company’s treatment of gig workers in the face of stricter regulations. “Every deal has them, but they can be controlled if you plan for them and control the narrative around them,” Scharfstein says. 

Selling Your Buyer

The sheer volume of dollars chasing opportunity today can be a siren song for owners. But be sure your goals—not theirs—determine the buyer you choose. “What do you want to be doing the day after you close?” says Mitch Woolery, an M&A lawyer for the Kutak Rock firm. “Sitting on a beach—or do you want to be an integral part of the company? You can go with a particular type of buyer because you want a particular role post-closing.”

Shawn Regan talked with potential strategic buyers of Rhythmlink “in case there was some ungodly valuation that would be hard to say no to. But we were concerned about the company, the employees and the culture and wanted to keep things going.”

So, in 2018, Regan sold to New Heritage Capital, a Boston-based PE group that touted its approach as a “private IPO.” And sure enough: New Heritage bought a big minority stake in the company while letting Regan and his partner maintain control of the board, helping Rhythmlink grow organically and through acquisitions. Sales have risen to more than $30 million from about $25 millon at the time of the sale.

Sellers can leave some money on the table in the expectation that the company’s continued growth will make the stake more valuable in the future. Jungk, for instance, structured his sale so that his two daughters and his president would keep a combined total of 22 percent. “They’ll have another dip in the bucket because this investment group will hold on to the company for about five or six years,” he says. 

And while Lind “had to roll over a significant chunk” of his ownership with TPC, “I’m fairly happy with that,” he says. “I don’t have my house or my personal guarantee on it. So it’s a nice, nice investment in a nice, nice future.” 

Another possibility: Consider an ESOP. By selling to an employee stock-ownership plan, you “control how rapidly turnover occurs,” notes King.

Plus, sale to an ESOP is “very advantageous right now, with deferred income and a bunch of ways to capture the tax advantage today and push the bill out to the future,” says Robert DePalo Jr. of National Financial Network. “There’s also speculation that there could be lots of changes coming in Biden’s final tax bill.”

If you do stay with the company you’ve just sold, be ready for a big change—one that’s a struggle for many former owners. “You have to be able to collaborate with people, to take advice and to understand your role in the organization—and that you did sell,” says Fred D’Alessandro, who sold a majority stake in his Kenilworth, New Jersey-based broadcast-services business, Diversified Systems, to Tailwind Capital, then remained as CEO. “A lot of CEOs can’t handle this because they’re not calling the shots now in every case. It’s a big change.”

Keep in mind that exiting your company isn’t the only option for achieving your goals. Rajiv Khaneja, for instance, enjoyed the company he started up, ActivBoard, an online-forum outfit in Seattle, “and being part of it,” he says. “But I didn’t enjoy being essential or having obligations. I didn’t need the capital or immediate liquidity to do something else. So I ended up putting a general manager around the company and was able to move on without having to vend it, and continue to make profits on it.”