Last Updated on Tuesday, 29 December 2009 11:06 Written by Mark Greenberg
Among the many difficult tasks a business owner and CEO may have faced throughout a career, few are likely to be as challenging as selling the company that he or she has labored long to build and probably not taken nearly enough time to admire.
Selling your company, as anyone who has done this will readily attest, is demanding personally, takes far longer than anyone would wish and is unfailingly complex both in financial and legal respects. Success takes a steady hand, knowledge of the process, in addition to an ability to anticipate the twists and turns a deal often will take. It also requires that you continue to run the company even as chaos threatens and rumors abound.
While we can't offer a sure-fire method to reduce the anxiety that usually attends the sale of a company, there are actions you can take to ensure a more predictable process, and to better guarantee that the offer you have agreed to and the consideration you receive at closing, are more than vaguely related.
In all likelihood, you may not know what your company is worth right now. Your CFO will be able to make educated guesses based on various valuation methodologies. But regardless of how adept these professionals may be, the result is often an inadequate proxy for what the market may likely yield.
Business values ebb and flow with the liquidity of capital markets, borrowing rates, and the flow of similar, identifiable deals, in addition to the fundamentals of the company being put up for sale.
Valuation rules-of-thumb can often be misleading in many transaction circumstances, and should not be relied on solely.
The most commonly used valuation benchmarks are market multiples---multiples of operating cash flow (EBITDA) or of revenue and even, though less common, of book value. Market multiple approaches to valuation using revenue or operating cash flow as variables can indeed be very misleading. While quick and handy approaches make for useful value approximations some of the time, they can fail to account for the particular financing environment appropriate to the buyer and suitable to the target company, and how that financing may in turn impact valuation.
Sellers regularly learn far too late in the game that there is a critical intersection between the ability to finance a deal and what market-multiple arithmetic might avow the company is worth. Real transaction values--- what companies ultimately sell for--- are not exclusively about EBITDA or revenue.
In other words, received value is also often about assets and collateral support. For buyers intending to use debt to finance a large portion of the deal---and that is many, if not most, buyers--- this is obviously a critical juncture. It's futile to argue that a company is worth so much, when qualified buyers cannot find a way to finance the deal. Additionally, targeted equity returns seldom can be achieved without concomitant debt financing, and often that debt financing can make up to 50% or higher of the total package.
So how do you prepare yourself? Have your company valued by disinterested professionals who know how to ask the right questions and have access to market data, and have a depth of transaction experience. It will be worth it. Remember that value, besides being driven by company and industry fundamentals, is also determined by capital markets liquidity and the mood and appetites of credit markets.
You're proud of what you've built, but unrealistic expectations about value have a way of showing up at inconvenient times. They also have a way of turning away qualified buyers at a time they're ready and willing.
There's no substitute for audited financial statements. But the auditor's unqualified opinion is often insufficient to insure that the value of your balance sheet will hold up fully through due diligence and survive the dreaded working capital (balance sheet) adjustment at closing.
Practiced buyers will eagerly review assets for impairment. They want to ensure that what they are buying will be accretive to earnings and cash flow; that it will generate for them the same, or better, business they are undertaking to acquire. The buyer's basis for determining asset value and impairment may not, however, always correlate fully with the GAAP standards under which your company has been operating.
Inventory, for example, is a prime and frequent target for overly exuberant revaluation tactics. Inventory might be revalued by the acquirer based on throughput calculations that reflect higher-turn segments of your inventory, but not all segments. Or it might be based on the buyer's inventory turn rates or industry averages or even more academic assumptions.
Nevertheless, you can be certain that inventory, once de-valued by the buyer, will not be viewed as "extra, bonus assets", but rather as impaired and thus potentially nettable from the purchase price at closing.
You can, of course, insist that your balance sheet is fine as is. You can, with some academic authority, argue that this is very same balance sheet that underwrote the company's revenue and earnings upon which the buyer developed his or her offer. But by then you are likely to be in due diligence with limited alternatives to completing another more favorable deal. (More about this later)
While these examples concern inventory assets, other asset categories such as plant capital, accounts receivable among others are as likely to be subject to revaluations based on buyer-imputed performance and investment return metrics.
There's no absolute safeguard here for a seller. But acting on conservative accounting decisions early will help. Taking write-offs systematically and ensuring that you are properly and conservatively reserved just makes good sense.
It's a continuing source of amazement that a well reserved balance sheet, supporting an exact same set of revenue and operating cash flows--- and consequently an identical valuation--- is far less likely to be the source of negative outcomes at closing for the seller when it comes time to settle up. It's apparently harder to argue that there are too few assets than it is to argue that there are underperforming assets. The irony is that if those "bonus assets" simply weren't there, it would likely never come up.
Self-auditing for these kinds of vulnerabilities prior to entering the market, and certainly well prior to due diligence, will create better odds that the offer price you accepted tracks closely to the closing settlement.
But isn't what we just discussed contradictory? Why would an enterprise-based valuation be subject to asset impairment and negative working capital adjustments? Didn't the balance sheet, as we just suggested, support the cash flow and revenue that the valuation process was based on?
Wouldn't the value difference, to the extent one wished to push the point, actually be attributable to good will, and thus not a potential depletion of value?
In some cases, valuation theory and real-world transaction mechanics actually do fit well together. For example, the best reason for a working capital adjustment is to establish a neutral balance sheet.
The company was valued on annual or trailing 12 month basis; therefore the balance sheet delivered at closing is appropriately adjusted, in many cases dollar for dollar, as a way to achieve a period-neutral outcome. For businesses with significant seasonality, making closing cash adjustments to achieve balance sheet neutrality makes perfect sense, and stands to favor both buyer and seller equally.
But does it make sense beyond achieving a neutral balance sheet. The answer is never completely. But it happens.
As most private market deals are considered "asset" acquisitions, where a buyer acquirers essentially all of the company's assets and, usually, the related trade liabilities, but does not assume legal liabilities other than those specifically transferred in the asset purchase agreement, liberties are often taken. For some aggressive acquirers, it can be a core methodology.
Do not accept an offer for your company without an exceptionally detailed, comprehensive letter of intent. It's almost always a bad sign when an acquirer isn't willing to be specific about transaction mechanics. All of the major issues should be settled, including key deal mechanics, before you go into due diligence.
While the letter of intent may only be legally binding with regard to confidentiality and may bind the seller to refrain from other-party negotiations for a specified period, it nevertheless does lend moral authority to the processes leading to closing. As a seller, you do not want to negotiate major issues in the middle of due diligence. It's usually a point when your bargaining leverage has diminished considerably