Before you sell Featured

8:00pm EDT August 26, 2008

If you are a privately held, middle-market company with $10 million to $100 million in annual sales and you are ready to sell but are concerned about the current economic climate, rest assured that this is still an acceptable time to move forward.

“Generally speaking, 2007 was a strong year for M&A in terms of the number of transactions and valuations, or ‘multiples’ — the amount of money buyers were willing to spend for a business,” says Michael J. Meaney, member of the business department and co-chair of the business transactions practice group at McDonald Hopkins LLC. “In 2008, the market is experiencing a drop-off in the number of transactions, and valuations are decreasing a bit as a result of the so-called credit crunch; however, based on historical values, they are still rather strong.”

Smart Business spoke to Meaney to gain some insight for those seeking to sell their middle-market companies in the near future.

What are some of the trends occurring in the M&A market for medium-sized businesses?

Tighter lending standards have reduced the amount of money banks might be willing to offer. As a result, buyers have to come up with more equity. This is not necessarily a problem because there is still a great deal of private equity capital available. However, when a greater percentage of a buying price has to be taken in equity, it means a lower return for the buyer, who, in turn, will not be as willing to pay as high a price. There are some positives, however. First, there is plenty of private equity capital just waiting to be invested. Second, the exchange rate for the dollar makes American companies attractive to foreign investors at this time.

What characteristics should owners look for in potential buyers for their businesses?

You want to find the buyer willing to pay the highest price, but there are other factors to consider. First, make sure the buyer is financially able to close. Second, make sure the buyer has enough additional money to fund the future growth of the business. Third, make sure this person will treat your employees and customers right. Fourth, make sure you have good chemistry — you will need it to get through the transaction process and after the sale. Often, a seller continues to be involved in the business as an executive or a minority shareholder, so you want someone you can trust and get along with.

What about hiring an investment banker to help sell the business?

There are several avenues to market your business for sale. One traditional way is through an investment banker. The Cleveland area is fortunate to have very well-qualified firms that operate in the middle market. An investment banker manages the process similar to a broker. He conducts a confidential auction process to identify the best possible buyers (private equity firms or strategic buyers in similar businesses), then requires them to sign a confidentiality agreement and provides them with information on the business. The potential buyers can then investigate the business and submit a bid. The investment banker and owner select the best bidder, who is not necessarily the highest bidder. After selecting the best bidder, the seller’s attorney negotiates the purchase agreement. The advantage is that the seller can be highly confident that he or she got the best possible price for the business, and that all interested parties had an opportunity to bid. The downside is that this process can be time-consuming. You must be willing to have discussions with multiple bidders and deal with numerous requests for information.

What about dealing directly with a private equity fund?

Northeast Ohio is also fortunate to have a number of high-quality private equity firms that are eager to buy middle market businesses. The owner may choose to approach such a buyer directly and engage in a one-onone discussion. The buyer investigates the company and then they negotiate. Some owners prefer this method because they don’t want an extended process. They might not get the highest price, but will still come close. Private equity firms realize that they need to be in a fair range and give a fairly strong bid. This route may be viewed as more confidential, as the seller is dealing only with one company. There is less risk of a private equity firm exploiting your confidential information, since it is usually not in your industry.

There are other advantages. A private equity firm is more likely to leave your business largely intact, since it has no other operations to consolidate with. Also, since an equity firm does not already have operational management in place, it will be more likely to allow and even encourage the seller to have a continuing role in the business post-closing.

How can a seller minimize liability to the buyer after the sale?

The seller’s attorney should carefully negotiate the purchase agreement, placing limitations on the buyer’s ability to make claims, including a time deadline and a maximum dollar amount. The attorney should negotiate deductibles to ensure that the buyer cannot bother the seller with minor claims. Also, the buyer may require the seller to put funds in escrow in case there are any future claims, so the seller’s attorney should minimize the amount required as well as how long the money must be held.

MICHAEL J. MEANEY is a member of the business department and co-chair of the business transactions practice group at McDonald Hopkins LLC. Reach him at (216) 348-5411 or mmeaney@mcdonaldhopkins.com.