Seven Rules of Turning Your Company into Cash

Nov. 19, 2003
Selling a middle market company isnt easy business. Because of the individuality and complexity of each company and deal, it is helpful to know the seven rules for a successful sale of a company.

Selling a privately held middle market company is an art, not a science. Middle market deals are defined as deals with transaction prices from $2 million to $250 million. Even experienced professionals realize there are few sources of empirical data to use in pricing a middle market deal. The available information is usually sparse and superficial, therefore of limited utility in determining a transaction price.

In addition, the procedures to sell or value a middle market company, the valuation multiple to apply, the appropriate transaction structure, and the likely events that will occur after a closing are substantially different for middle market deals than for the more publicized, major public deals.

Due to the individuality and complexity of middle market deals and lack of meaningful information on the subject, it is essential for a seller to know these seven critical rules of a successful sale of a company.


Obtain a Principally All-Cash Deal

In an acquisition, as in business, maximizing price and minimizing risk are the goals. There is no better way to accomplish the latter than by doing a principally all-cash deal. Generally, when an acquirer wants the seller to accept notes, there are two reasons:

  • There is either a lack of bank or institutional financing available to the acquirer, or it is available at an interest rate much higher than they are willing to give the seller.
  • Notes can be an easy conduit for an acquirer to collect for alleged seller breaches of representations and warranties. This could necessitate a seller pursuing litigation to collect on the notes.

    More than 92 percent of the deals we have closed during the past 15 years have been for cash. No deal has been transacted when the cash component of consideration was less than 87 percent of total consideration.

    Similarly, the firm’s leaders do not consider a deal with a contingent price factor unless the contingency portion is in excess of the expected transaction price. There is no way to protect the seller’s ability to meet the contingency goals without unreasonably restricting the actions of the acquirer after the deal.


    Retain a Competent Acquisition Advisory Firm

    A seller requires an advisory firm to guide and direct them through the entire process. This includes planning the sale, the valuation, the development of an enticing Offering Circular, the search for a synergistic acquirer, and the conduct and control of all negotiations leading to a closing. The advisory firm should use a personalized, tailored approach encompassing a review of all aspects of the seller’s business foundation and niche. Such review transcends a mere analysis of the financial statements, which only represents a fraction of the review. The advisory firm should be committed to closing a sale only after an aggressive premium price has been obtained. They should have a reputation that the seller’s best interest is the only factor that dictates an acceptable deal. The advisor needs a thorough understanding of the economic implications of the legal issues likely to arise in negotiating the Definitive Purchase Agreement, as they should control all negotiations with the attorneys working under their guidance. In a middle market deal, it is usually preferable to use an advisory firm with entrepreneurial flair, as they often have a similar background and psychological make-up to the selling owner. They will understand the feelings the seller will be dealing with during the acquisition process.

    Consequently, they can provide the emotional support most sellers find beneficial at this time. As the negotiations leading to the closing are the most critical phase of an acquisition, the seller wants a strong-willed, articulate and persuasive negotiator for an advisor. These skills, approach, and characteristics are necessary for a seller to obtain a premium price.


    Define your Expected Transaction Price Before Going to Market

    Acquirers try to steal the company, which is how the capitalist system works. Unfortunately, the acquirer is usually larger with greater resources and is more knowledgeable about acquisitions.

    However, sophisticated, hard-working sellers can level the playing field. Prior to going to market, the seller should require the advisory firm to make a comprehensive evaluation of the company’s business foundation. Major future opportunities and risks should be determined, evaluated, and quantified. When this process is completed, the seller and his advisory firm should understand that the potential of the company’s future earnings is greater than an acquirer’s.

    The determinant of a company’s value will be its expected future earnings/EBITDA and the risk of achieving those earnings/EBITDA. Short-term future earnings potential and long-term growth factors impact this value. The stability of the business foundation will influence the multiple applied to the company’s earnings/EBITDA. Depending on synergistic benefits, internal corporate needs, and differing perceptions of valuation factors, most prospective acquirers see a company’s value differently, but within ± 10-15 percent of an average market price range.

    Be aggressive in pricing expectations. Demand a realistic premium price. Remember, only one buyer gets the company. The objective is for one acquirer to pay a premium price. Once the pricing expectations are set, be confident and firm; most acquirers will try to convince you of the exorbitance of the pricing position.


    Demand Minimal Exposure to Post-Closing Issues and Liabilities from Definitive Purchase Agreement

    Large acquirers are used to shifting deal risks to the seller. This is the norm, and it is sometimes injurious to economic health. After a company is sold, the owner has no upside. Correspondingly, there should be no downside risk for occurrences realized after the deal closes. To assure a more equitable sharing of deal risk between seller and buyer, a seller should want the majority of the representations and warranties to be limited to the seller’s knowledge. A few reps and warranties require a higher standard of seller guarantee. However, for these reps and warranties, the seller is aware usually of problems prior to the deal closing, therefore risk of the unknown is limited. But, the general rule is the majority of reps and warranties should be limited to seller’s knowledge. An acquirer will strongly contest this position; however, a seller should not relent, unless the deal price compensates them for the added risk.


    Negotiations Tend to Be Adversarial — Accept It

    Negotiations are a test of wills, a battle for control. By its nature, negotiations are confrontational. A seller needs to accept that. In most corporate sales, the seller is usually much smaller and less knowledgeable about acquisitions than the buyer. Correspondingly, buyers are used to deals being priced how they want. If an acquirer is forced to pay a price in excess of the target price, it requires difficult and adversarial negotiations before an acquirer acquiesces. If negotiations go smoothly and amicably, the acquirer is likely obtaining the right price. Rarely does this represent a premium price to the seller. Therefore, accept the confrontational nature of negotiations; this is essential if a seller is to get a good deal.

    Patience Is a Virtue

    For a seller to be successful, patience, not to be confused with lethargy, must be demonstrated throughout the process. It represents the seasoned market response when a slow pace works to a seller’s advantage. If a seller has thoroughly evaluated all factors surrounding the sale, being patient should be easy. Patience is a by-product of the confidence in the validity of one’s position. A patient seller usually produces anxiety in an acquirer. As an acquirer should never be aware of the full dynamics of the overall sale process, a patient seller is interpreted usually to have attractive alternatives. This tends to make for more flexible negotiations.


    Divulge Proprietary Information only at the Appropriate Time

    As a general rule, do not consider customers, competitors, or suppliers as a potential acquirer. If there are unique or compelling circumstances mandating those prospects to be pursued, they must be approached more cautiously than a typical acquirer. When this type of prospect is solicited, it is advisable to strengthen the Confidentiality Agreement in the following ways:

    • Limit the acquirer’s right to solicit the employees and/or customers of the selling company in the future.
    • Limit the detailed information provided the acquirer at the initial stage of the process.
    • Require more detailed financial and business information about the acquirer at the initial stage than normal.

    Regardless of the acquirer, it is prudent to restrict the divulging of proprietary information to the latter stages of negotiations. This usually includes:

    • Information pertinent to sales levels or pricing specifics for individual customers or products
    • Purchase or production costs for specific products or customers
    • Specific pricing strategy by product, volume or other pertinent factor
    • Specific future operating courses of action

    Divulge this information after the seller signed a Letter Of Intent with a prospective acquirer. At that time, the parties begin to negotiate a Definitive Purchase Agreement, and the acquirer commences a due diligence process. At this point, sensitive information will be given to the acquirer, especially if a seller is to obtain minimal exposure in the rep, warranty, and indemnification areas. However, in certain high-risk situations, when the Letter of Intent is signed, a seller might expand the Confidentiality Agreement to prohibit the acquirer from hiring any key employees or soliciting key customers for a 12 to 18 month period if the deal does not close.

    Following these seven rules helps a seller obtain a premium price with favorable terms in the Definitive Purchase Agreement. And, although the rules can be a substitution for hard work, knowledge, determination, and patience, they can enhance the chances of a successful deal. The sale of a company usually culminates an owner’s career or, in many cases, the end result of the efforts of many generations of a family at the company. It can be the legacy of decades of effort. The seller who follows these rules can be responsible for the crowning touch on a successful career.

    George Spilka is president of George Spilka and Associates in Pittsburgh.