Merrimack-Group

Sale Prep tip 5-Develop a succession plan

Private equity buyers are increasingly active in the M&A market, and they typically prefer to invest in companies where the owner is several years away from retirement age, willing to retain some equity and stay involved with the business.

For owners close to retirement age, we recommend grooming a successor to take over day-to-day management, and taking long vacations to demonstrate that the business can still prosper without them.

We have seen some savvy sellers establish residency in a low-tax state (usually Florida), partly to demonstrate detachment from the business, and partly to eliminate state taxes on the sale. Strategic buyers typically prefer to have their existing team manage the business, so a 3 – 12 month consulting role is usually fine.

Sale Prep Tip 4: Clean up your contracts.

We find that many clients need to scramble to chase down contracts when it is time to set up a data room, which can obviously delay the sale process, disrupt the business and arouse suspicion. Setting up a centralized filing system a year or so in advance is a smart investment. It’s also a good idea to create a spreadsheet to keep track of when each contract expires so it can be renewed as appropriate. Obviously, it is also important to make sure that all contracts are dated and are signed by both parties.
Clients tend to focus on the more financially important contracts (typically with customers, suppliers and landlords), but often overlook contracts for miscellaneous items such as postage machines, forklift trucks, janitorial services, software subscriptions etc. Most buyers will agree to exclude smaller contracts from the scope of due diligence (which can be defined as those contemplating transactions less than $50k per year, for example).

If you have been doing business on handshake agreements, now is a good time to document the more economically significant business arrangements.
As you negotiate new contracts, we recommend paying attention to the assignment provisions. Ideally, your contracts should be assignable without the consent of the counterparty, and the counterparty should not have the option to terminate the agreement in the event of a change in control. Onerous assignment provisions usually aren’t dealbreakers, but they can prolong the sale process.
We publish tips for business owners planning a sale to ensure a smoother process, more offers, and ultimately a higher valuation.

Sale Prep Tip 3: Strengthen your point of differentiation in the market.

Buyers generally prefer companies with a well-defined point of differentiation. It could be superior products, faster lead times, outstanding support – anything that customers appreciate.

“Me-too” companies that try to be all things to all people typically don’t attract as much investor enthusiasm.
Most companies have a well-polished elevator pitch for customers, and sometimes that also works well for investors, but for this audience we recommend considering an elevator pitch that emphasizes the financial performance, such as “we serve the upper end of the market that is willing to pay a premium for quality and service”, or “our strategy is to outsource operations so we can expand rapidly with minimal capex”.

We publish tips for business owners planning a sale to ensure a smoother process, more offers, and ultimately a higher valuation.

Sale Prep Tip 2: Clear up any legal Issues

It is not unusual for large companies to have at least one active or threatened legal dispute at any given time, so it is generally not feasible to wait for a window when there are no legal issues to launch a sale process.A deal can still get done, provided the financial exposure is not material relative to the value of the company and/or the seller agrees to pick up the tab.
For smaller companies, however, buyers get nervous if there is any outstanding litigation. Even if the amounts involved are relatively modest, buyers will assume the worst-case scenario for valuation and indemnification purposes. We strongly recommend settling any legal issues before launching a sale process.
We also recommend consulting legal counsel to proactively identify other legal issues that can derail or delay a transaction, such as:
1. Missing corporate records
2. Significant contracts (particularly customer contracts and facility leases) that require the counterparty’s consent to assignment in the event of a change in control
3. Missing contracts with employees, such as patent assignment agreements
4. Handshake agreements with shareholders and employees contemplating a successful sale of the business
5. Onerous early termination penalties for financing or facility leases.

We publish tips for business owners planning a sale to ensure a smoother process, more offers, and ultimately a higher valuation.

Sale Prep Tip 1: Invest in audited financial statements

The cost of audited financial statements is typically minuscule relative to the value of a marketable company. We strongly recommend audited financial statements for sellers with more than $3m EBITDA, and smaller companies that should at least have reviewed financial statements for the last two years. Buyers have a strong preference for companies with audited financial statements for several reasons:
1. It reduces the time and expense they need to incur in due diligence
2. It is easier and faster to line up other capital providers (especially lenders)
3. It demonstrates that the seller is serious about getting a deal done.

We publish tips for business owners planning a sale to ensure a smoother process, more offers, and ultimately a higher valuation.

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