Professional Advice Increases Value

by Charles V. Lemmon

Markets are like parachutes. They work best when they are open.

The Association of International Corporate Advisors (AICA’s) consensus survey of closings concludes that markets for mergers and acquisitions are both open and growing. Equity is plentiful, cash for debt is historically inexpensive, strategic buyers are acquiring market share, financial buyers are active, and individuals are buying their share of the American dream.

Within this market, we are amazed that many owners fail to take advance action to properly groom a company for its sale. Specific actions must be taken by owners to enhance the sales value of a business. Maximum value in any economy can be obtained provided owners have groomed a company with actions including:

1. Audited or reviewed financial statements, which will withstand the pressures of due-diligence. Buyers want to prove-up key matters not limited to gross revenues, gross margins, asset values, capitalization, bad debt, and excess owner’s salary.

Comprehensive audited financial statements cost extra time and money, but they increase a buyer’s confidence and accelerate negotiations. The relative low cost of an audit is always offset as businesses are sold on multiples of cash flow.

2. Decisive steps to improve business income and minimize expenses. The psychology of the current sales and profit trend is vitally important during the selling process. While maximizing operating profits an owner should also:

  • Analyze and document all products and services individually for their demand, competition, gross margins, and incremental contributions.
  • Evaluate and upgrade all production-related equipment for efficiency. Remember; however, that if capital expenditures are financed with debt, each dollar of debt repaid represents a dollar of equity in the seller’s pocket at closing. Institutional debt at the time of a sale should be avoided unless the seller can clearly justify the projected cash flows to directly result from the capital improvement. Even then, the seller may have to wait to receive the consideration relating to these improvements until the Company “proves-up” the increased cash flows.
  • Evaluate and upgrade all office equipment and computer software for efficiency and increased profitability even it the profits will not be recognized in the short run.
  • Justify and document employee costs within a specific industry.
  • Improve the overall appearance of the business’ physical plant.
  • Evaluate, justify, and document all ongoing service agreements and supply contracts.
  • Evaluate and adjust all owner-specific “Perks” and benefits. Unless the perks and benefits can be justified to improve business sales and margins, they should be completely dropped to promote simplicity in the buyer’s evaluation process.

3. Make the traditional definition of cash flow easy to calculate and prove. Among sophisticated buyers the traditional definition of adjusted cash flow is Earnings before Interest, Taxes, Depreciation and Amortization (“EBITDA”) plus excess owner’s compensation. AICA members can assist with the calculation and financial presentation of EBITDA plus discretionary add-backs.

While many companies regularly expense small equipment purchases and capital improvements, such policies prior to a sale depress earnings and are difficult to recast from “normalized earnings.” Sellers who want maximum value must maximize their earnings. Yes, the tax effect will be greater, but cash flow calculations for business value begin with “Earnings Before Taxes.”

4. Prepare reasonable proformas. Share your vision with the buyer as to how the business may grow. Businesses are valued on multiples of their cash flow. A clear appreciation of numerous revenue sources reduces perceived risk and enhances a buyer’s expected return on investment.

5. Attention to details. Properly organize a company’s records:

  • Bring all corporate minutes up to date,
  • Verify and update stock ownership records,
  • Obtain “Good Standing” and “No Tax Due” Certificates from each state in which the company pays taxes,
  • Update warrant, option, and other agreements relating to securities of the company, and related cancellation agreements,
  • Prepare a detailed organizational chart,
  • Renew important contracts,
  • Document proprietary procedures, methods, formulas and trade secrets,
  • Update written policies and procedure manuals including employee handbooks,
  • Verify and document compliance with regulatory and environmental laws,
  • Settle all pending or threatened litigation and claims including governmental administrative proceedings or inquiries (e.g. EEOC or OSHA),
  • Bring all fees and taxes current, and
  • Discuss union compliance with competent counsel.

6. Create a competent “Depth of Management Team.” All buyers, both strategic and financial, want competent management to remain. Document competency with resumes, awards, and accomplishments achieved by management.

7. List and document all business intangibles including:

  • Patents, copyrights, service marks, trade names and trademarks.
  • Name and Reputation recognized in the form of awards, articles, trade association recognition and etc.
  • Customer list (diversification and loyalty).
  • Depth of management/organization.
  • A company’s leadership within an industry.
  • Barriers to entry.
  • Competitive advantages.
  • Market conditions.

8. Anticipate buyer concerns. Smart sellers try to anticipate a buyer’s concerns and are prepared to overcome potential objections. AICA members can help you in a discussion process by relating the concerns of other buyers in similar circumstances – and how those concerns were overcome.

9. Give a buyer good reasons to buy. Stress the benefits of your company. Simultaneously, tell the buyer, “I want to sell” and “I will cooperate in a sale”. Active sellers create positive results.

Once a company has been groomed for its sale, the owner must plan for and fully consider his personal financial needs because they directly impact the probability of success. For your information, it is unrealistic to expect all cash at closing. All buyers reasonably request that the seller provide some financing in the form of a note, non-compete agreement, and/or management consulting agreement. If for no other reason, such deferred compensation serves as a protective indemnification relating to issues such as non-collectable accounts receivable, a future lawsuit resulting from events prior to the sale, unknown environmental problems resulting from events prior to the sale, and other normal and customary representations and warranties.
Smart sellers begin seeking an experienced advisor’s consultation three years in advance of a sale so they may be properly groomed for that important transaction.
The markets are always open for well-managed, profitable, and properly groomed companies. A seller’s best parachute is to follow the advice of an experienced advisor while anticipating what may be the largest financial transaction in a seller’s lifetime. Charles Lemmon is President of C.V. Lemmon & Co., Inc., a private M&A advisory firm in Dallas, Texas.

Charles Lemmon can be contacted by telephone @ (214) 207-9694 or by e-mail at cvlemmon@cvlemmon.com.