Who Is Today’s Buyer?

/in /by

It has always been the American Dream to be independent and in control of one’s own destiny. Owning your own business is the best way to meet that goal.  Many people dream about owning their own business, but when it gets right down to it, they just can’t make that leap of faith that is necessary to actually own one’s own business.  Business brokers know from their experience that out of fifteen or so people who inquire about buying a business, only one will become an owner of a business.

Today’s buyer is most likely from the corporate world and well-educated, but not experienced in the business-buying process.  These buyers are very number-conscious and detail-oriented.  They require supporting documents for almost everything and will either use outside advisors or will do the verification themselves, but verify they will.  A person who is realistic and understands that he or she can’t buy a business with a profit of millions for $10 down is probably serious.  They must be able to make decisions and not depend on outside parties to do it for them.  They must also have the financial resources available, have an open mind, and understand that owning one’s own business means being the proverbial chief cook and bottle washer.

Today’s buyers are usually what might be termed “event” driven.  This means that the desire to own their own business is coupled with a need or reason.  Maybe they have been downsized out of a job, they don’t want to be transferred, they travel too much, they see no future in their current position, etc.  Many people have the desire, but not the reason.  Most people don’t have the courage to quit a job and the paycheck to venture out on their own.

There are the perennial lookers.  Those people who dream about owning their own business, are constantly looking, but will never leave the job to fulfill the dream.  In fact, perspective business buyers who have been looking for over six months would probably fit into this category.

Business brokers spend a lot of time interviewing buyers.  Here are just a few of the questions they will ask. The answers they receive will determine whether or not the prospective buyer is serious and qualified.

  • Why is the person considering buying a business?
  • Has the person ever owned their own business?
  • How long has the person been looking?
  • Is the person currently employed?
  • What kind of business is the person looking for?
  • Is he or she flexible in the kind of business?
  • What are the most important considerations?
  • How much money is available?
  • What is the person’s timeframe?
  • Does the person’s experience match the type of business under consideration?
  • Who else is involved in the purchase decision?
  • Is the person’s spouse positive about owning a business?

There are other questions and considerations, but those cited above reveal the depth of a buyer interview.  Business brokers want to work only with buyers who are serious about purchasing a business.  They don’t want to show a business to anyone who is not qualified, which is simply a waste of their time and the seller’s time.

Why Deals Fall Apart — Loss of Momentum

/in /by

Deals fall apart for many reasons – some reasonable, others unreasonable.

For example:

• The seller doesn’t have all his financials up to date.
• The seller doesn’t have his legal/environmental/administrative affairs up to date.
• The buyer can’t come up with the necessary financing.
• The well known “surprise” surfaces causing the deal to fall apart.

The list could go on and on and this subject has been covered many times. However, there are more hidden reasons that threaten to end a deal usually half to three-quarters of the way to closing. These hidden reasons silently lead to a lack of or loss of momentum.

This essentially means a lack of forward progress. No one notices at first. Even the advisors who are busy doing the necessary due diligence and paperwork don’t notice the waning or missing momentum.  Even though a slow-down in momentum may not be noticeable at first, an experienced business intermediary will catch it.

Let’s say a buyer can’t get through to the seller.  The buyer leaves repeated messages, but the calls are not returned.  (The reverse can also happen, but for our example we’ll assume the seller is unresponsive.) The buyer then calls the intermediary.  The intermediary assures the buyer that he or she will call the seller and have him or her get in touch.  The intermediary calls the seller and receives the same response. Calls are not returned.  Even if calls are returned the seller may fail to provide documents, financial information, etc.

To the experienced intermediary the “red flag” goes up. Something is wrong. If not resolved immediately, the deal will lose its momentum and things can fall apart quite rapidly. What is this hidden element that causes a loss of momentum? It is generally not price or anything concrete.

It often boils down to an emotional issue. The buyer or seller gets what we call “cold feet.” Often it is the seller who has decided that he really doesn’t want to sell and doesn’t know what to do.  It may also be that the buyer has discovered something that is quite concerning and doesn’t know how to handle it. Maybe the chemistry between buyer and seller is just not there for one or the other of them. Whatever the reason, the reluctant party just tries to ignore the proceedings and lack of momentum occurs.

The sooner this loss of momentum is addressed, the better the chance for the deal to continue to closing. Because the root of the problem is often an emotional issue, it has to be faced directly. An advisor, the intermediary or someone close to the person should immediately make a personal visit. Another suggestion is to get the buyer and seller together for lunch or dinner, preferably the latter. Regardless of how it happens, the loss of momentum should be addressed if the sale has any chance of closing.

How’s Your Corporate Social Responsibility (CSR)?

/in /by

Your first question may be, “Just what is Corporate Social Responsibility (CSR)?” We see CSR demonstrated in a variety of ways in areas such as:

THE COMMUNITY:
o Contributing to local community programs through financial support and personal involvement

THE ENVIRONMENT:
o Using packaging and containers that are environmentally-friendly
o Recycling
o Using low-emission and high mileage vehicles where possible
o Seeking more efficient manufacturing processes, etc.

THE MARKETPLACE:
o Utilizing responsible advertising, public relations and business conduct
o Exercising fair treatment of suppliers/vendors, contractors and shareholder

THE WORKPLACE:
o Implementing fair and equitable treatment of employees
o Upholding workplace safety, equal opportunity employment and labor standards

Actions such as these not only uphold today’s business standards, but they also pave the way for future generations. In years past, many of these elements were considered almost anti-business and some had to be enforced by governmental regulation.

Successful companies such as Tom’s of Maine (producer of natural personal care products) and Newman’s Own have practically been built on CSR. More and more companies – public and private – are following the elements of CSR. Google is a desired workplace because of the way they treat their employees: great benefits, great food in the employee cafeteria, exercise equipment – you name it, Google provides it.

Recognizing CSR in today’s business climate not only increases shareholder/investor interest, but also increases value. Socially-conscious companies are considered sound investments.  They attract buyer interest and acquire higher selling prices when it comes time to sell. After all, most buyers want to find a business with the following attributes:

• Good relations with the local community
• Products and/or services that are meeting the current trends in the marketplace and are positioned to meet future trends
• Positive relations with employees and low-turn-over
• Excellent customer loyalty
• Good relationships with suppliers and vendors
• No “skeletons” in the company closet

In addition, good environmental practices reduce costs, create efficiencies and provide excellent public relations. Good employee relations make for happy workers, which translates to higher productivity and lower absenteeism. Good relationships with customers and suppliers eliminate, or greatly reduce, the possibility of legal entanglements.

All in all, Corporate Social Responsibility not only creates additional value and helps in creating a higher selling price when that time comes – it is also very good business for now and in the future.

Personal Goodwill: Who Owns It?

/in /by

Personal Goodwill has always been a fascinating subject, impacting the sale of many small to medium-sized businesses – and possibly even larger companies. How is personal goodwill developed? An individual starts a business and, during the process, builds one or more of the following:

• A positive personal reputation
• A personal relationship with many of the largest customers and/or suppliers
• Company products, publications, etc., as the sole author, designer, or inventor

The creation of personal goodwill occurs far beyond just customers and suppliers. Over the years, personal goodwill has been established through relationships with tax advisors, doctors, dentists, attorneys, and other personal service providers.  While these relationships are wonderful benefits, they are, unfortunately, non-transferable. There is an old saying:  In businesses built around personal goodwill, the goodwill goes home at night.

It can be difficult to sell a business, regardless of size, where personal goodwill plays an integral role in the business’ success. The larger the business, the less likely that one person holds the key to its profitability. In small to medium-sized businesses, personal goodwill can be a crucial ingredient.  A buyer certainly has to consider it when considering whether to buy such a business.

In the case of the sale of a medical, accounting, or legal practice, existing clients/patients may visit a new owner of the same practice; they are used to coming to that location, they have an immediate problem, or they have some other practical reason for staying with the same practice. However, if existing clients or patients don’t like the new owner, or they don’t feel that their needs were handled the way the old owner cared for them, they may look for a new provider. The new owner might be as competent as, or more competent than, his predecessor, but chemistry, or the lack of it, can supersede competency in the eyes of a customer.

Businesses centered on the goodwill of the owner can certainly be sold, but usually the buyer will want some protection in case business is lost with the departure of the seller. One simple method requires the seller to stay for a sufficient period after the sale to allow him or her to work with the new owner and slowly transfer the goodwill. No doubt, some goodwill will be lost, but that expectation should be built into the price.

Another approach uses some form of “earnout.” At the end of the year, the lost business that can be attributed to the goodwill of the seller is tallied.  A percentage is then subtracted from monies owed to the seller, or funds from the down payment are placed in escrow, and adjustments are made from that source.

In some cases, the sale of goodwill may offer some favorable tax benefits for the seller. If the seller of the business is also the owner of the personal goodwill, the sale can essentially be two taxable events. The tax courts have ruled that the business doesn’t own the goodwill, the owner of the business does. The seller thus sells the business and then also sells his or her personal goodwill. The seller’s tax professional will be able to give further advice on this matter.

Ownership Transition — Survey Results

/in /by

Mass Mutual Life Insurance Company provided the following survey results based on family-owned businesses. Although the survey was conducted several years ago, the results are still quite revealing, and still applicable.

• Four out of five companies are still controlled by the founders.
• 30% of family-owned companies will change leadership within the next five years.
• 55% of companies fail to conduct regular valuations of the company.
• 55% of CEOs who are 61 or older have not chosen a successor.
• 13% of CEOs will never retire.
• 90% of businesses will continue as family owned.
• 85% of successor CEOs will be a family member.
• 20% of family owners have not completed any estate planning.
• 55% of family owners do not have a formal company valuation for estate tax estimates.
• 60% of businesses do not have a written strategic plan.
• 48% of companies rely on life insurance to cover estate taxes.

The above survey indicates that many family businesses are not optimizing their opportunities. Their insular approach to succession, leadership, planning, etc., indicates their vulnerability for the long term. These vulnerabilities suggest that many business owners should work with professional advisors to resolve these issues. A professional intermediary is an essential member of this advisor group.

An Update on Earnouts

/in /by

New accounting rules may require that acquirers and acquiring companies report earnout agreements as liabilities.

Joel Johnson, president of Orchard Partners Inc., in his article, “Earnouts,” published by Valuation Strategies, states: “In a given year, 2% – 3% of announced mergers and acquisition agreements involve earnouts.  These figures probably understate their prevalence.  Earnouts tend to be a characteristic of smaller deals; and in many small deals, terms are not announced.  Earnouts are rare when public companies are acquired and more common when ownership is concentrated among a few shareholders.”

This would mean, if implemented, that earnout agreements must have a value placed on them for accounting purposes. As Joel Johnson points out, “The higher the earnout, the greater the liability.”

Why the Earnout?

Johnson further states that earnouts are used for various reasons:

1. to bridge the pricing gap between the seller who places a heavy emphasis on the company’s projections, and the buyer who places most of the company’s value on its present and past performance.
2. to tie the acquisition payout to future performance.
3. to create a form of seller financing in that some of the buyer’s purchase price is delayed into the future. 4. to establish a form of escrow account in that the money is paid on condition of meeting certain thresholds.
5. to act as a type of employment agreement in that the CEO has to stick around in order to collect.

Remember: It Is Not Always the Price

/in /by

The following are situations where the price was not the deciding issue in the successful sell of a business. The ultimate buyer may be the only one who really understands the situation. A business intermediary really understands the issues and can lead the buyer and seller to a successful resolution.

• One seller had 60 shareholders who needed to walk away from the deal.  The losing buyer wanted all selling shareholders to be accountable for the “reps and warranties.”  The winning buyer waived the reps and warranties at closing.

• A seller’s management team wanted some future upside in the deal.  The losing buyer offered all cash and normal compensation.  The winning buyer offered 80% cash, 20% stock plus 3-year earnout on revenues — including acquisitions.

• Time was of the essence.  The losing buyer needed 30 day due diligence and negotiations plus a 60-day window to close the deal.  The winning buyer offered to close within 40 days of the Letter of Intent and agreed to have limited due diligence.

The Three Ways to Negotiate

/in /by

Basically, there are three major negotiation methods.

1. Take it or leave it. A buyer makes an offer or a seller makes a counter-offer – both sides can let the “chips fall where they may.”

2. Split the difference. The buyer and seller, one or the other, or both, decide to split the difference between what the buyer is willing to offer and what the seller is willing to accept. A real oversimplification, but often used.

3. This for that. Both buyer and seller have to find out what is important to each.  So many of these important areas are non-monetary and involve personal things such as allowing the owner’s son to continue employment with the firm.  The buyer may want to move the business.

There is an old adage that advises, “Never negotiate your own deal!”

The first thing both sides have to decide on is who will represent them.  Will they have their attorney, their intermediary or will they go it alone?  Intermediaries are a good choice for a seller.  They have done it before, are good advocates for their side and they understand the company and the seller.

How do the parties get together in a win-win negotiation?  The first step is for both sides to work with their advisors to settle on the price and deal structure positions.  Both sides should be able to present their side of these issues.  Which is more important – price or terms, or non-monetary items?

Information is vital to a buyer.  Buyers should keep in mind that the seller knows more about the business than he or she does.  Both buyer and seller need to anticipate what is important to the other and keep that in mind when discussing the deal.  Buyer and seller should do due diligence on each other. Both buyer and seller must be able to walk away from a deal that is just not going to work.

Bob Woolf, the famous sports agent said in his book, Friendly Persuasion: My Life as a Negotiator, “I never think of negotiating against anyone.  I work with people to come to an agreement.  Deals are put together.”

Due Diligence — Do It Now!

/in /by

Due diligence is generally considered an activity that takes place as part of the selling process. It might be wise to take a look at the business from a buyer’s perspective in performing due diligence as part of an annual review of the business.  Performing due diligence does two things: (1) It provides a valuable assessment of the business by company management, and (2) It offers the company an accurate profile of itself, just in case the decision is made to sell, or an acquirer suddenly appears at the door.

This process, when performed by a serious acquirer, is generally broken down into five basic areas:

• Marketing due diligence
• Financial due diligence
• Legal due diligence
• Environmental due diligence
• Management/Employee due diligence

Marketing Issues
It has been said that many company officers/CEOs have never taken a look at the broad picture of their industry; in other words, they know their customers, but not their industry.  For example, here are just a few questions concerning the market that due diligence will help answer:

• What is the size of the market?
• Who are the industry leaders?
• Does the product or service have a life cycle?
• Who are the customers/clients, and what is the relationship?
• What’s the downside and the upside of the product/service?  What is the risk and potential?

Financial Issues
Two important questions have to be answered before getting down to the basics of the financials: (1) Do the numbers really work? and (2) Are the seller’s claims supported by the figures?  If the answer to both is yes, the following should be carefully reviewed:

• The accounts receivables
• The accounts payable
• The inventory

Legal Issues
Are contracts and agreements current? Are products patented, if necessary?  How about copyrights and trademarks?  What is the current status of any litigation?  Are there any possible law suits on the horizon? What would an astute attorney representing a buyer want to see and would it be acceptable?

Environmental Issues
Not too long ago this area would have been a non-issue.  Not any more!   Current governmental guidelines can levy responsibility regarding environmental issues that existed prior to the current occupancy or ownership of the real estate.  Possible acquirers – and lenders – are really “gun-shy” about these types of problems.

Management/Employee Issues
What employment agreements are in force?  What family members are on the payroll? Who are the key people?  In other words, who does what, why, and how much are they paid?

Operational Issues
The company should have a clear program covering how their products are handled from raw material to “out the door.” Service companies should also have a program covering how services are delivered from initial customer contact through delivery of the services.

The question is, do you give your company a “physical” now, or do you wait until someone else does it for you – with a lot riding on the line?

The Offering Memorandum

/in /by

A solid, factual and compelling offering memorandum maximizes the chances of not only selling a business, but obtaining the highest possible price.  An offering memorandum is also referred to as the selling memorandum, a confidential descriptive memorandum, or simply as “the book.” The memorandum, regardless of the terminology used, must be as factual as possible, but the Executive Summary portion of it allows for a bit of “selling the sizzle.”  Most potential buyers want to know the basics of the company and of the deal right at the beginning.  What is the proposed transaction and what are some of the company highlights?  The executive summary should also contain an outline of the ownership and management structure, a description of the business, some financial highlights, a quick review of the company’s products and/or services, its markets, reason for sale and any other major items of importance.

The executive summary, then, is a quick synopsis of the items covered in the offering memorandum that should entice a prospective buyer to study the offering memorandum itself.  Here are some critical elements of the offering memorandum:

• Executive Summary
• The Company
• History of the Company
• The Markets
• The Products
• Distribution
• Customers and/or Clients
• The Competition
• Management
• Real Estate
• Financials
• Growth Strategies
• Competitive Advantages
• Conclusion
• Exhibits

“The offering memorandum should not only be a compelling document in order to capture the reader’s attention, but it should be so thorough that one should expect the potential acquirer to submit a fairly tight price range for his or her initial offer.  In short, the best offering memorandums are complete but not too long, easy to read, believably professional and show that the company has an opportunity for growth.”
    Source: The Best of the M&A Today Newsletter