Business Appraisers, before beginning an assignment, like to know the purpose of the appraisal. Usually the assignment demands “bullet proof” documentation: comparables, EBITDA multiples, projections, discount rates, etc.  Unfortunately, in situations where the purpose of the valuation is to establish a selling price, the business appraiser really doesn’t understand the business elements – or, since these business elements don’t figure into the numbers, they are largely ignored. However, they do have value; in some cases, significant value to a buyer.

Valuing these business elements requires that computers, adding machines and calculators be put aside. The business should be looked at from three key business elements: the Market, the Operations, and Post-Acquisition. These elements are certainly subjective, but also critically important to a prospective buyer.  A buyer’s opinion of the business elements can drive the actual offering price significantly higher—or lower. In fact, the business elements such as Fundamentals and Value Drivers can impact price as much as the Financials.

Here are some important questions to consider:

Market:   
Are there significant competitive threats?
Is there a large market potential?
Does the company have a reasonable market position?
Are there broad-based distribution channels?
Is there a wide customer base?
What’s the company’s competitive advantage?

Operations:
Are there significant alternative technologies?
Is sound management to remain?
Is there product/service diversity?
Are there multiple suppliers?

Many business owners feel that what prospective acquirers are looking for are quality and depth of management, market share, profitability, etc. Brian Tracy, in his book, The 100 Absolutely Unbreakable Laws of Business Success, states that the key ingredient is “a company-wide focus on marketing, sales and revenue generation. The most important energies of the most talented people in the company must be centered on the customer. The failures to focus single-mindedly on sales are the number one causes of business failures, which are triggered by a drop-off in sales.”

Tracy goes on to point out that company owners and/or presidents should observe industry trends, pay attention to what the competition is doing that works, and learn from them.  Find out what is successful and what isn’t in your industry – trends are vital. It is important to understand that established and mature companies are generally just trying to protect their market share, while start-up companies are really attempting to gain or establish market share.

Tracy estimates that 80 percent of new businesses close down within the first two years, and 100 either fall off or join the top 500 companies in the U.S. because they are acquired, merged or broken-up, and even a few actually fold – Enron being a good example.

Tracy also mentions that problem solving, decision making and team (not individual) collaboration are key factors.  However, as he points out, the best companies have the best people.

There once was a family-owned bakery that had sales in the millions. The bakery sold bread to restaurants, supermarkets and some retail outlets. The founder gave each of his 5 children 20 percent ownership of the business.  The kids really didn’t want to work in the business, so they turned the operation and management over to 2 members of the third generation.  For some years the business had been operating on a break-even basis, and sales were not increasing.

The founder’s children decided that they wanted to sell the business since they were close to retirement age. A professional business intermediary was retained to do this.  He contacted as many of the larger bakeries as possible, hoping to find a suitable acquirer, but there was very little interest. The intermediary continued his search, willing to do the hard work required to find a good buyer. He finally found a successful businessman who offered a price equal to 50 percent of sales – a generous offer.

The intermediary presented the offer to the five children – all equal partners.  Little did he know that he had walked into the proverbial hornet’s nest. A huge family argument ensued, and finally the intermediary was asked to leave the room so that the siblings could decide what to do.

The offer was turned down flat. There was no counter-proposal or even any negotiation on price, terms or conditions. The offer was dead. The intermediary had worked on trying to find the right buyer, figured he had – all to no avail, six months wasted.

It turns out that the major obstacle was thrown up by those two members of the third generation who had been operating the business. They feared that they might lose their jobs even though the prospective buyer assured the sellers that he would retain them.  Were they being unreasonable? The reality is that the operators were “family” – related in one way or another to the five owners, and blood is usually thicker than water.

Flash forward some 20 years.  The bakery is still in business with very little growth and still operating on a breakeven basis.  The five owners are now in their 70s, they have never received anything for their equity, and there is very little hope that they ever will.

The above is a true story.  It shows how a family can own a business and not be prepared or in agreement when it comes time to sell it. Although the bakery is still in business, it is barely hanging on. The story is sad as well as true. The proposed deal could have satisfied all of the owners’ goals and made their retirement years a lot more comfortable.

Family-owned businesses make up a lot of the non-public companies in the U.S., and according to industry reports, many of them will be up for sale in the near future.  In situations where the family owned business is owned by more than one person, it is crucial that a meeting be held with all of the family owners prior to electing to sell, unless a strong buy-sell agreement has already been agreed to.  This agreement should establish, among other things, specific guidelines about what happens if one family member wants out of the business.

At this meeting, the company attorney and accountant should be in attendance along with a business intermediary.  The reason to include the intermediary at this early stage is that he or she knows what the pitfalls are, what buyer concerns will be, and what should be done prior to going to market.

One of the major problems when there is more than one owner is communications. For example, one owner who is active in the business decides that he needs a new, expensive car and that the company should pay for it. This is the kind of issue a decision-forming meeting should bring to light and address. Strict guidelines should also be in writing concerning salaries, benefits, etc.  When one family member wants to cash out or another one spends a lot of money furnishing their office – it is too late to have an agreement drawn up to cover these possible roadblocks. The time is now!

This is just a partial list: Church’s Chicken, Uno Chicago Grill, Charlie Brown’s, Domino’s Pizza, Burger King, Cinnabon, Sizzler.  The first response would be that they are all in the food business, and that’s correct.  Now name the second thing that they all have in common?  Give up?  Well, they (and many others) have been purchased by private equity firms.  And, apparently, this is just the beginning.  The huge Dunkin Donuts chain is being sought after by two or three private equity firms.

Why the interest in restaurants from groups that most people associate with high tech?  Many firms got burned during the dot com and high tech meltdown.  Now these same private equity firms are looking at businesses that are stable, with more predictable earnings, and that are also very familiar businesses, time-tested and still have a lot of growth ahead.

One industry expert said in Nation’s Restaurant News, “What’s really driving this is the success of these deals, the numbers that the private equity companies are getting when they sell…”  For example, he noted, “Restaurant Associates bought Charlie Brown in 1975 for $3 million and sold it to Castle Harlan seven years later for $50 million.  Castle Harlan got almost three times that price – an appreciation of $90 million with the sale to Trimaran.”

If private equity and similar firms are now buying restaurants, what businesses are next?  If you are the owner of a small growing company or chain of businesses – is a private equity firm in your future?  A professional intermediary may be able to answer that question for you and if you are considering selling – they can also help.

When one sells their house, the best deal is usually the highest price.  When one decides to sell their business, there may be other factors to consider.  Many buyers are similar to the “overlooked” buyer described below, serious and qualified; and most sales of businesses are win-win transactions.  However, there are a few exceptions, and sellers should consider them carefully, balancing their prerequisites to the goals of the buyer.

Selling to a Competitor – Many company owners think this is the best way to go.  They read about the mega-mergers such as Bank of America and Fleet bank, or the pending deals such as Federated and the May Company Department Stores, and U.S. Air and American West.  Consolidation may play a major role in large public companies; this is not the case in middle market companies.

Many owners of middle market firms look at these mega-deals and think it might work for them.  However, upon further consideration, they realize that by disclosing a lot of confidential information to a competitor, their business could suffer irreparable damage if the deal would fall apart – and many do.

Selling to a Strategic Acquirer – This may bring the highest price, but there are several reasons why this may not be in the company’s best interest.  Many owners have worked with key employees for years and would not like to see them replaced. The strategic owner might not only replace members of management, but might also move the company to another part of the country.

Selling to a Financial Buyer – This buyer may not be willing to pay the seller’s price and is usually buying a company with intentions of selling it at a profit in three to five years.  This leaves the company and its employees in limbo waiting for a new owner to take over.

Other Buyers – The employees may decide to buy the company (ESOP).  However, this usually means a long-term payout for the owner. An individual buyer may come along such as a Warren Buffett, but what are the chances?  A key member or members of management might decide to purchase the company, but generally they won’t pay the price.  If a sale is not consummated, the key management member(s) will most likely leave.

The “Overlooked” Buyer – There are many individuals who want to own their own company.  They might be former executives of major companies who want to do something on their own. Some buyers have access to large amounts of investment capital. There are many qualified individual buyers in the market place. Russ Robb, the editor of a leading M& A newsletter, M&A Today, has written a book, Buying Your Own Business, for those individuals interested in buying their own company. This book has sold over 20,000 copies, which indicates the large number of people who are interested in buying a company.

There Is No Magic Answer – Selling a company comes with no guarantees.   When Badger Meter Company, a public company headquartered in Milwaukee, acquired Data Industrial Corporation based in Mattapoisett, Massachusetts, this appeared to be a marriage made in heaven.  Their respective product lines fit like a glove, their corporate cultures seemed compatible, and sales expansion by cross-selling was evident.

This strategic acquisition would have been fine except for one change.  The parent company moved Data Industrial’s operation to Kansas, and every employee’s job was terminated.  However, one should not construe that all acquisitions by strategic or competitive acquirers end up in a similar fate.  Furthermore, for price considerations, the seller can draft restrictions in the Purchase & Sale agreement to prevent the transfer of the business, at least for a specified time period.

Certainly selling to the overlooked type buyer doesn’t guarantee all of the seller’s concerns, but knowing the interests of some of the various buyer types can help insure that the goals of both buyer and seller are met.  Sellers should determine their goals prior to attempting to sell their business.  A consultation with a professional intermediary is a good start to this process.

Does your business have an orphan product or service that is doing okay, but doesn’t seem to fit into your core business?  Many companies, private equity groups and even some individual buyers are seeking product lines to augment existing ones, or even to build a business around.  Here are just a few of the reasons why a company might want to divest itself of a product line or even a particular service:

• It may not be a good fit for the parent company, thus diffusing efforts that could be placed into the core business.
• Because it is an orphan, it is a distraction.
• It man be a break-even side business that with a full-time effort could be profitable, but resources are better devoted to the core business or service.
• The money received could be used to expand the core business or fund some improvements that are not currently budgeted.

Certainly, there can be some disadvantages in allowing the adoption of an orphan – on both sides.  There is the all-important people issue.  Some valuable employees may be attached to the product line – and may go with the sale or decide to leave and move on.  This can negatively impact both sides of the transaction.  It can also have a negative impact on the selling company’s employees when the selling or purchasing company releases employees. There are cultural issues to consider.  The product may be a more important part of the selling company than management thought.  It may have played a role in selling other products or services.  The distribution channels may play a role in other product lines.  It is important for management to consider whether the orphan is really an orphan before selling it off.

On the plus-side for the acquiring company, the addition of the product line may be a perfect fit for their existing distribution chain.  The brand name acquired may provide name recognition to some existing products.  The new product line may be able to be manufactured with only a minimum increase in employees and plant capacity.

The purchasing company may have a difficult time establishing a price.  It may seem easy to look at the sales and the cost of sales, but the cost of sales may not include an allocation for rent, and for support services such as legal, accounting, corporate oversight, etc. Some part of the product may be manufactured on equipment used for other products, warehousing may be shared, and parts used in other products.  Many acquisitions are sold with a form of licensing agreement so the selling company receives a royalty or license fee representing a small portion of the sales of the acquired product line.

Company management is prone to think of only selling the entire business, a division or subsidiary of the company, when a sale of a product line may be an excellent solution.  The decision to sell a product line or service may solve a host of problems and perhaps even eliminate the need for sale of the entire business.  As Fortune magazine has written, “Companies once obsessed with cutting costs are now urgently trying to boost sales – with new products, new services and new markets.  The surest – and ultimately cheapest – way to increase your total sales is to persuade your existing customers to buy more products.”

Every company has weaknesses; the trick is to fix them.  There is a saying that the test of a good company president or CEO is what happens to the company when he or she leaves.  Some companies–on paper–may look the same, but one company may be much more valuable due to weaknesses in the other company.  Not all problems or weaknesses can be resolved or fixed, but most can be mitigated.  Fixing or lessening company weaknesses can not only significantly improve the value, but also increase the chances of finding the right buyer.  Here are some common weaknesses that concern some buyers, causing them to look elsewhere for an acquisition.

“The One Man Band”

Many small companies were founded by the current president, and he has made all of the major decisions.  Since he has not developed a succession plan, there is no one in place to take over if he gets hit by the proverbial truck.  He is the typical one man band; and, as a result, the company is not an attractive target for acquisition.

Declining Industry

Companies that are in a declining market have to be smart enough to recognize the situation and make changes accordingly.  A real-life example of a “smart” company is one that made ties, and, realizing the decline in this apparel item, switched over to making personalized polo shirts.  A company can still make ties but has to have the foresight – and ability – to move into new product areas.

Customer Concentration

This is a major concern of most buyers.  It is not unusual for the one man band to focus on what made the company successful – one or two major customers.  He has built the relationships over the years.  These relationships are seldom transferable.  Finding new customers may take time and money, but the effort is absolutely necessary should the owner eventually decide to sell.

The One Product

Many one man band run companies were based, and still are, on either the manufacture and sale of one product or the creation and development of a single service.  Henry Ford made a wonderful car – the Model A – but that’s all he made.  General Motors decided that many people would like something different and were willing to pay for it.  Fortunately, for Ford, he caught on quickly, but almost went out of business with the thinking that one model fits everyone.

Aging Workforce/Decaying Culture

Young people are not entering the trades, leaving many jobs such as tool and die positions filled with “old hands” who will soon be retiring.  Technology may be able to replace them, but that decision has to made and implemented.  No one wants a business that will have idle machines with no one trained to operate them.

There are many other areas that could be considered company weaknesses.  If there is a Board of Directors or an Advisory Board, perhaps they can help the one man band create a succession plan and just as importantly – a successor.  Certainly the time to act on all of this is before the decision to sell is made.    Whether current ownership plans on staying the course or eventually selling the company, the good news is that resolving company weaknesses is a win-win situation.

If you are considering selling your company in the next year or so, the time to start is now.  Planning ahead can significantly add to the eventual selling price.  A visit with a professional business intermediary is the first step.

In the proverbial “perfect world,” business owners would plan three to five years ahead to sell their companies.  But, as one industry expert has suggested, business owners very seldom plan to sell; rather, selling is “event driven.”  Partner disputes, divorce, burn-out, health, and new competition are examples of events that can force the sale of a business.

Sellers often find, after they have decided to sell, that the unexpected happens and they are “blindsided” and caught off-guard.  Here are a few of the unexpected events that can occur.

The Substantial Time Commitment

Sellers find that the time necessary to comply with the requests of not only the intermediary, but also the potential buyers can take valuable time away from the actual running of the business.  The information necessary to compile the offering memorandum takes time to collect.  Many sellers are unaware of the amount of their time necessary to gather all the documents and information required for the offering memorandum, nor of its importance to the selling process.

There is also the time necessary to meet and visit with prospective buyers.  An intermediary will play an important role in screening prospects and separating the “prospects from the suspects.”

Handling the Confidentiality Issue

Owners of many companies are also the founders and creators of them.  They can have difficulty in delegating and tend to want to make all of the decisions themselves.  When it comes time to sell, they want to be involved in everything, thus, again, taking time away from running the business.  Members of the management team, like the sales manager, have a lot of the information necessary not only for the memorandum, but also on competitive issues, possible acquirers, etc.  The owner has to allow his or her managers to be part of the selling process.  This is easier said than done.

Forgetting the Others

Many mid-sized, privately held companies also have minority stockholders or family members who have an interest in the business.  The managing owner may be the majority stockholder; but in today’s business world, minority stockholders have strong rights.  The owner has to deal with these people, first in getting an agreement to sell, then convincing them about the price and terms.  A “fairness opinion” can help resolve some of the pricing issues.  Minority stockholders and family interests have to be dealt with and not overlooked or pushed to the end of the deal.  When this happens, many times it is the end of the deal, literally speaking.

The Price is the Price is the Price

All sellers have a price in mind when it comes time to sell their companies. Most businesses go to market with a fairly aggressive price structure.  When an offer(s) is presented, it is generally, sometimes significantly, lower than the seller anticipated.  They are never prepared for this event – they are blindsided, and obviously not very happy.  They turn the deal down without even looking past the price.  Here is where an intermediary comes in, by helping structure the deal so it can work for both sides.

Not Having Their Own Way

Business owners are used to calling the shots.  When an offer is presented, they, in some cases, think that they can call all of the shots.  They have to understand that selling their company is a “give and take.”  They can stand firm on the issues most important to them, but they have to give on others.  Also, some owners want their attorneys to make all of the decisions, both legal and business.  Unfortunately, some attorneys usurp this decision.  Owners must make the business decisions.

Confidentiality Leaked

There is always the small possibility that the word will leak out that the business is for sale.  It may just be a rumor that gets started or it may be worse – the confidentiality is exposed.  Sellers must have a contingency plan in case this happens.  A simple explanation that growth capital is being considered or expansion is being explored may quell the rumor.

“Keeping Your Eye on the Ball”

With all that is involved in marketing a business for sale, the owner must still run the business – now, more than ever.  Buyers will be kept up-to-date on the progress of the business, despite the fact that it is for sale.

Who best understands my business?

When interviewing intermediaries to represent the sale of your firm, it is important that you discuss your decision process for selecting one. Without this discussion, an intermediary can’t respond to a prospective seller’s concerns.

Are there any potential buyers?

When dealing with intermediaries, it always helps to reveal any possible buyer, an individual or a company, that has shown an interest in the business for sale. Regardless of how far in the past the interest was expressed, all possible buyers should be contacted now that your company is available for acquisition. People who have inquired about your company are certainly top prospects.

Lack of communication?

It is critical that communication between the seller, or his or her designee, and the intermediary involved in the sale, be handled promptly.  Calls should be taken by both sides.  If either side is busy or out of the office, the call should be returned as quickly as possible.

Does the offering memorandum have cooperation from both sides?

This document must be as complete as possible, and some of the important sections require careful input from the seller.  For example: an analysis of the competition; the company’s competitive advantages – and shortcomings; how the company can be grown and such issues as pending lawsuits and environmental, if any.

Where are the financials?

It may be easy for a seller to provide last year’s financials, but that’s just a beginning.  Five years, plus current interim statements and at least one year’s projections are necessary.  In addition, the current statement should be audited; although this usually presents a problem for smaller firms — better to do it now than later.

Are the attorneys dealmakers?

In most cases,  transaction attorneys from reputable firms do an excellent job.  However, occasionally, an attorney for one side or the other becomes a dealbreaker instead of a dealmaker.  A sign of this is when an attorney attempts to  take over the transaction at an early stage.  Sellers, and buyers, have to take note of this and inform their attorney that they want the deal to work – or change to a counsel who is a “teamplayer.”

 

Intermediaries are responsible for handling what is usually the biggest asset the owner has – and they are proud of what they do.  Intermediaries realize that the sale of a business can create the financial security so important to a business owner.  Even when a company is in trouble, the intermediary is committed to selling it, since by doing so, jobs will be saved – and the business salvaged.

Since one often hears the term “fair value” or “fair market value,” it would be easy to assume that “fairness opinion” means the same thing.  A fairness opinion may be based to some degree on fair market value, but there the similarities end.  Assume that you are president of a family business and the other members are not active in the business, but are stockholders; or you are president of a privately held company that has several investors/stockholders.  The decision is made to sell the company; and you as president are charged with that responsibility.  A buyer is found; the deal is set; it is ready to close — and, then, one of the minority stockholders comes out of the woodwork and claims the price is too low.  Or, worse, the deal closes, then the minority stockholder decides to sue the president, which is you, claiming the selling price was too low.  A fairness opinion may avoid this or protect you, the president, from any litigation.

A fairness opinion is a letter, usually only two to four pages, containing the factors or items considered, and a conclusion on the fairness of the selling price along with the usual caveats or limitations. These limitations usually cite that all the information on which the letter is based has been provided by others, the actual assets of the business have not been valued, and that the expert relied on information furnished by management.

This letter can be prepared by an expert in business valuation such, as a business appraiser or business intermediary.  The content of the fairness opinion letter is limited to establishing a fair price based on the opinion of the expert.  It does not provide any comment or opinion on the deal itself or how it is structured; nor does it contain any recommendations on whether the deal should be accepted or rejected.

Fairness opinions are often used in the sale of public companies by the board of directors.  It helps support the fact that the board is protecting the interests of the stockholders, at least as far as the selling price is concerned. In privately held companies, the fairness opinion will serve the same purpose if there are minority shareholders or family members who may elect to challenge the price the company is being sold for.