A merger or acquisition (M&A) often is the key component of a successful business exit strategy or liquidity event, allowing a business owner to either reap the benefits of decades of hard work or simply take some chip off the table while continuing to work on the business for a predetermined period before retirement.
However, selling a privately held, mid-market or lower-mid-market business is a complex and time-consuming process that requires extensive preparation long before such an event materializes.
Typically, the longer the business owner prepares for the sale, for example, over three- to five-year period, the higher the valuation of the business.
An early preparation also allows business owners to implement incremental improvements over a longer period. This will help avoid the pressure of making changes as an afterthought when the owner is compelled to sell because of unforeseen circumstances, such as illness or business decline.
The pressure to sell because of these circumstances leaves no room for a business owner to make meaningful changes that will drive the valuation of the company higher.
The Pre-sale Preparation Process
The two- to three-year period prior to putting a business on the market is a critical time during which owners should take concrete steps to increase the value of the business. A few strategies business owners can implement to accomplish this should include a combination of the following:
1. Establish a professional management team with a strong financial background.
This typically includes a controller, CFO, or director of finance, depending on the size of the business. Potential acquirers will gain confidence that a sophisticated management capable of positively influencing the financial drivers of the business is at their disposal.
2. Make the owner redundant to minimize the possibility that his or her departure adversely impacts the company.
All our discussions with potential buyers invariably involve a question on whether the business can run smoothly if the owner leaves the company for a prolonged period. To do so, an owner should start the process by delegating many high-level tasks and responsibilities to managers so they are prepared to take over immediately upon the owner’s departure.
3. Implement enterprise-wide operational procedures, systems, and methodologies.
This can be achieved by adapting an IT system that automates manual processes, such as a work flow tracking system.
4. Establish key performance indicators (KPIs) for all managers and employees in every department without exception.
For a metalworking company, a few KPIs that can be implemented for its production department includes customer responsiveness (on-time delivery), quality (number of rejected parts), efficiency (hourly throughput), and inventory management (inventory turns per month). KPIs that produce predictable results should be adopted. Companies with robust KPIs perform better than those without them.
5. Focus on improving value drivers, which mostly revolve around the financial elements of the business.
A marginal increase in each value driver can have a significant positive impact on what is commonly referred to in M&A as EBITDA (earnings before interest, income tax, depreciation, and amortization). This is a proxy for cash flow and is widely used as the base number, multiplied by an industry multiple (EBITDA of $1 million x 4).
For example, if sales increase by 5 per cent, gross margin improves by 2 per cent, and operating expenses are reduced by 5 per cent, the aggregate impact on EBITDA could translate into several million dollars in additional value, depending on the size of the business.
6. Produce realistic sales forecasts that are supported by hard data.
A sales pipeline that is based on the number of outstanding proposals or signed contracts is a good indicator that the forecast is achievable.
7. Strengthen the balance sheet by divesting redundant and non-operating assets.
The owner needs to manage capital expenditures effectively by having a keen foresight on what equipment to purchase based on which contracts or purchase orders will materialize.
8. Produce reliable and accurate financial statements in a timely manner.
Statements should be reviewed or audited by a reputable accounting firm. Audited financial statements minimize the scrutiny during the due diligence process.
9. Reduce customer concentrations so the business is not economically dependent on one company or industry, or a handful of large customers for revenue and profits.
10. Articulate a long-term vision for the business after the owner departs to help new owners envision the landscape once they take over.
In addition, at least one to two years before contemplating a sale, an owner should begin assembling a team of M&A experts, which should include an M&A adviser, legal counsel, and tax accountant.