Value is in the eye of the buyer, so sellers of middle-market companies should position their businesses as attractively as possible before they try to make a deal. Some owners run their companies as if an offer could arrive at any time. Other executives operate their companies as if they will never sell them and then wonder why the market undervalues their businesses.
“My advice is to begin planning 18 to 24 months in advance of marketing the company for sale,” says Michael Tuchman, partner at Levenfeld Pearlstein, LLC. “This gives owners time to assemble the team of professionals, begin strategic planning, and allow strategic decisions to mature and be reflected in two annual financial statement cycles.”
Smart Business spoke with Tuchman about how to effectively prepare middle-market companies for a sale.
Why is it important to strategically position your company for a sale?
Strategic positioning is all about refining the buyer’s perception of the value that the ownership and management have created. A recent transaction involved a financial services company that provided a broad range of services and had two niche areas. Working with the investment bankers, the company restructured itself to put the niche service areas front and center, including elevating management in these niche areas. Since competitors in the niche market segments had sold for higher multiples of earnings than diversified financial services companies, this company as whole was able to sell for a higher multiple of earnings.
What type of issues do middle-market companies need to consider?
Management retention, accounting and tax are among the most important issues. Regardless of the buyer’s intentions for management, the deal process requires that key management be fully on board. Many middle-market business owners believe they can sell without involving management and sometimes without even disclosing information about the sale to them. This is a mistake. The buyer’s perception of value is strongly influenced by the strength of the management. Management incentives in the form of appropriate forms of compensation and change of control protections help maximize the value proposition, assure stability through the deal process and give ownership something to fall back on if the deal does not close.
The integrity of financial data is also key. Sophisticated buyers want to know that they have reliable financial information. This is not about having audits as much as it is about elevating existing processes, including the establishment of controls, and addressing weaknesses in current systems. Seemingly immaterial weaknesses create serious question marks for buyers that can result in disproportionately high ‘dings’ to price.
Finally, inefficient tax structures can reduce the net value realized by ownership on a sale by half. Strategic positioning begins with understanding the tax consequences of a sale, deciding the best way to go to market in light of those tax consequences and discussing pricing in view of the different ways of closing the transaction. I have seen sellers set price expectations with reference to a tax-efficient stock sale, make a casual structural concession to the buyer to do an asset sale and not realize there was a significant difference, almost double, in tax liability.
What professionals play a key role in the process?
The professional team will, of course, include the client’s lawyers and accountants. Most important, however, is the involvement of a good investment banker with experience in the type and size of company being sold. The investment banker does much more than find a buyer. He positions the company for sale at maximum value. The financial services company, mentioned above, that highlighted its niche service offerings demonstrates how a good investment banker with access to marketplace information can optimally position a company. A good investment banker will also be an effective negotiator for the deal, filling the void between the ownership and legal counsel.
Sellers should look for legal counsel that fits their needs. A middle-market law firm that concentrates on middle-market mergers and acquisitions can offer the best knowledge and experience to a middle-market company looking to sell. The deal lawyer must know the regulatory environment in which the company operates and must have the resources to deal with ancillary issues, such as employment agreements, noncompetes, antitrust clearances, ERISA and benefits rules. Most of all, the deal lawyer must know how to talk to the other side in a way that keeps business issues first.
MICHAEL TUCHMAN is a partner at the Chicago law firm of Levenfeld Pearlstein, LLC. He is a transactional lawyer with extensive experience in negotiating company acquisitions, dispositions, recapitalizations and joint ventures. Tuchman is also a CPA and adjunct professor at John Marshall Law School in Chicago. Reach him at (312) 476-7550 or firstname.lastname@example.org.