Selling a company is a long and complex process. Preparing for a sales process takes at least 12 months, and then the actual process itself can take another 12 months. If you think of selling your business as something similar to a very long multi-year enterprise sales cycle, you’ll begin to realise that a business sales process is like any other sale process in that it can be broken down into its core component stages and elements.
This article provides an overview of the key stages of an M&A sale process, whether it’s for a lower middle market company, a large public company, or anything in between.
Stage 1: Defining Potential Options and Exit Strategies
When considering the sale of a business, there are potetnially a wide variety of transaction options. These options must be understood and evaluated by the CEO, owner, and/or board. Understanding these options and the decisions they lead are the most strategic decisions a company will ever make when it comes to realising value. Leveraged buyout, strategic M&A sale, minority recapitalization, ESOP, etc — these are all fancy investment banker terms but they essentially boil down to various methods by which a company sells itself or part of itself or to whom it sells. Buyers break down at a high level into two categories: financial buyers and strategic buyers. They both have their pros and cons. Neither one is better by nature, it’s highly situational. A good M&A banker will work with the business owner to understand the selling requirements, the range of valuation expectations, and strategic goals. This also includes defining: exit strategy alternatives; thinking through the most appropriate types of acquirers; timing of sale; tax consequences and owner’s desire for future involvement with the company (or lack thereof).
Stage 2: Determing a Valuation Range For The Company
Determing a reasonable valuation range is a critical step in the process. If the banker thinks they can achieve a valuation range that isn’t acceptable to the owner, the process should stop right there. Too many deals get derailed by sellers and buyers having completely different expectations about business value. While it’s the job of the banker to close that gap with negotation prowess and transactional expertise, immense gaps can’t be bridged no matter how skilled you are. Valuation technique ranges from the highly academic and analytical methods of discounted cash flow and dividend discount models (DCF and DDM) to the more pragmatic comparable company valuation methodologies. Unfortunately, none of them is a replacement for the actual process of engaging with high quality and highly relevant buyers. Analysis and number-crunching is necessary but not sufficient, and will only take you so far. In the end, the price is determined in the market by the buyers and the quality of your engagement with them.
Stage 3: Pre-Marketing Value Enhancement
Often, Advisory firms will review a company’s strategic and financial condition and have suggestions for how the company, over a 6-12 month period, can make some changes to make it more desirable. These should not be massive changes in strategy because those take too long and are risky, but should be valuable changes to management team or business strategy that make the business more attractive in a reasonably short period. Sometimes a trigger-happy CEO just wants to sell the company, but the best thing to do is make some changes and adjustments first before going to market. Again, working with a knowledable banker or informed board members that have relevant industry experience and business strategy context can be very valuable.
Stage 4: Information Gathering, Data Collection, and Presentation
Spending the time to properly aggregate, interpret, and present a company’s financial and business history and future projections is a crucial element of the sale process. This requires trust between a business owner and his M&A Advisor because at this point, the kimono is being opened. The engagement letter should reflect the confidentiality that an investment bank commits to before they have access to such sensitive information. Business owners typically prepare their financial statements for tax purposes, not for business sale purposes. Using tax statements for business sale presentation is a major mistake, as it usually obscures the earnings capability of a business. Taking the time properly present a company’s earnings power can have a big impact on how the buyers view the opportunity. Of course, the seller can go too far here and lose credibility, which is also a big mistake in the other direction. However, making sure that the appropriate financial adjustments are made is an important step and takes time and analysis by the CPA and the M&A team.
Stage 5: Marketing Materials Preparation
When potential acquirers evaluate a company, they expect the records and facts to be properly organised and documented. Disorganized or poorly collated material on a business delays the process, looks sloppy, and therefore hurts the seller tremendously. It’s another area where many sellers are pennywise and poundfoolish and pay a terrible price for trying to save money in the wrong place. Well-packaged and presented business summaries increases a buyer’s confidence and comfort level and increase the likelihood of a successful sale. A business owner spends years establishing name recognition, market niche, vendor relationships, operation & production systems, management, personnel, distribution channels, customer loyalty and numerous other intangibles. This is a story that needs to be properly told to educate potential buyers.
Stage 6: Buyer Research and Buyer Outreach Strategy
While large multi-billion dollar companies often have only a handful of relevant and sufficiently capitalised potential acquirers, lower middle market companies (this generally refers to businesses whose value ranges generally between $10M and $250M) often have an enormous number of potential buyers. Some of these potential buyers are known to the business owner, some might be known by the Advisor, but no one’s rolodex is usually broad enough to know every potential buyer. This means that the banker and the business owner must have tools and resources to research and access the largest and most qualified data set of relevant buyers. Databases and tools of of varying qualities exist out there, but there is no silver bullet. This research process should be exhaustive, not rushed. The banker should review competitors, customers, strategic buyers, private equity firms with relevant expertise, and other sources of highly suitable capital and partnership. This is one of the most time-intensive elements of the process but it often determines the overall success of the sale process. If you don’t approach the best buyers, how can you get the best outcome?
Stage 7: Qualification of Potential Buyers
Many potential buyers that express interest in a business will not be qualified to purchase the company. These companies are referred to as tire-kickers. A good banker will know the right questions and have enough market intelligence and expertise to smoke these buyers out and pre-qualify the right potential acquirers before the tire-kickers impact the CEO or management team’s time and attention. This isn’t a particularly complex or time-intensive step, but if it isn’t done, the CEO will waste a lot of time and effort speaking with unqualified buyers and increasing the confidentiality risk of the entire process.
Stage 8: Negotiation Process
There are many schools of thought on how to run the neotiation and buyer engagement process. Some Advisory firms suggest a negotiated process with only one highly targeted buyer. This strategy has tremendously high risk but can be extremely expedient if it works out. In general, Sellers are more likely to achieve a stronger outcome when negotiating with multiple qualified buyers, rather than just one or a handful. This can of course be taken too far as well, where every buyer feels like they are part of a huge auction process, in which case they walk away for fear of over-paying. Competition in a sale process does typically drive up purchase price and quicken the pace and accountability of buyers, but it should be handled carefully, respectully and professionally.
Stage 9: Transaction Structure
The sale of a business has many financial and professional considerations for the management team / owner. The purchase price is only one component of the overall result. Other decisions and considerations include: stock sale versus asset sale; earnout; terms and interest rate on financing; liabilities assumed by the acquirer; employment contracts; non-compete agreements; current assets retained by the seller; stock ownership and equity options pacakges; relocation; employee preservation versus redundancy layoffs, etc.
Stage 10: IOIs, LOIs, and Purchase Agreements and Closing
Typically, buyers express interest in a company at three stages through three documents: the IOI, LOI and Purchase Agreement. The IOI is non-binding and provides the proposed terms, valuation and structure for a transaction. The owner wil review this with their banker and make a determination as to whether or not to invite the buyer to learn more about the company and become more serious. LOIs (letters of intent) are a more serious signal of interest by the buyer; once they are jointly executed, the seller is typically under exclusivity with that buyer, such that they are not able to meet with other buyers during a stated period of time. Meanwhile, that buyer is beginning to conduct heavy due diligence on the business with the intent of acquiring it. During the exclusivity period, the buyer must move quickly to determine if they want to proceed. If so, the purchase agreement must be drafted to define all the details of the transaction: legal, financial, representations, warranties, etc. The purchase agreement is the definitive document outlining the terms of the sale.
Stage 11: Post-Closing Issues & Business Transition
The transition period typically involves a period of cooperation during which time the seller will assist the acquirer in transition. There are instances in which the seller is specifically not interested in doing this, however a lack of willingness to ease the transition typically lead to a lower valuation and in plenty of cases can derail the deal process entirely. Sellers should proceed with extreme caution if they elect to have no post-closing commitment. Post-closing commitments often include transferring customer relationships, explaining key management or market dynamics, and other proprietary information and trade secrets needed to operate the business optimally.