Below are some of the mistakes/missteps we have seen made by private business owners in the sale of their business and/or raising capital. But, before we tell you the problems, we will give you a recommendation to hopefully avoid potential mistakes.
Recommendation: We recommend that you have at least a one-hour meeting with the following individuals as you prepare for a sale/capital raise.
- Investment banker,
- Transaction attorney,
- Transaction-related accountant/C.P.A.,
- Tax professional attorney and/or C.P.A.
- Estate Planning specialists
- Wealth Management advisors
In most cases, these professionals would be pleased to meet with you, at no cost, to “put you on the right road” to a superior result when you are ready to sell/raise capital.
- Preparation-Failing to prepare years in advance for an exit strategy/capital raise. We recommend that owners begin this preparation up to ten (10) years in advance since some issues can take that long to correct. An example of this type of mistake is failing to make an S Corporation election five (5) years in advance thus potentially resulting in significant structuring issues, double-taxation and/or additional “built-in” gains tax. Another example would be having significant customer/supplier concentrations which can take many years to diversify away from prior to a sale.
- Timing- Waiting to sell/raise capital until the company “tops out”/ matures or worse, waiting until sales and profits start to decline. The conundrum of selling a business/raising capital is that the best time to sell/raise capital is oftentimes when the business is doing well, has few problems and market conditions are good. However, many business owners fail to start the sale/raising capital process (which can take 6-12 months) early enough so that sales/profits continue to grow through the sale/capital raise process and for years to come. Selling/raising capital when things are going well is difficult. At such time, an owner usually feels so good about the business. But, that is potentially the time to maximize the sale multiple/capital raising proceeds and terms. Private business owners, many being “serial optimists”, think the “next year will be even better” and “I will get an even higher price later”. Then, an unforeseen calamity sometimes hits that may significantly devalue the business such as: major recessions, loss of a major customer/supplier/sales rep or key manager, industrial accidents, unforeseen litigation, personal health issues; among many others. Also, leaving some growth for the buyer helps to drive multiple and price and buyers see a way for them to profit. Unfortunately, such events may significantly reduce selling price/capital raised or make a transaction difficult.
Also, business owners should start the process in time to make sure they are exited when they want to exit. For example, for some businesses, the likely buyer may be a private equity firm. Private equity firms, in a platform investment, usually may only buy 50%-80% of the business initially and they require the owner/manager to stay on with the business anywhere from three (3) to seven (7) years to help them grow the business at which point the business is sold, re-capped or taken public to achieve the final exit. Therefore, if you are 55 years old and want to be “completely out” by the time you are 60 years old, then you need to start a transaction when you are 54 years old (one year to complete the transaction plus five years of employment running the business). These partial sale/re-capitalizations are often a good fit for a private business owner that is not ready to retire. They allow the private company owner/manager to “take some chips off the table” to secure your retirement but still be part of the business and potentially get a “second bite at the apple” when the company is totally exited 3-7 years later.
- Accounting Issues-Many private companies have not invested enough in their financial, accounting or reporting systems including the mistake of not having a professional accountant on staff and qualified outside auditors. Buyers generally want information and lots of it before they buy or invest in a business. A selling company’s failure to be able to produce the right information sought by potential buyers and in a timely manner can be a deal killer.
Additionally, most buyers want at least one year, and perhaps several years of audited statements. However, audits can be expensive. One potential less costly solution is to have your outside auditor perform year-end procedures work EACH YEAR-including Accounts Receivable/Payables cut-offs, inventory test counts etc. This work is typically far less costly than an audit but allows the outside accountant to upgrade a “Review” to an “Audit” at any time, usually at the time of sale/capital raise. Another option is to perform a pre-deal quality of earnings by a qualified accounting firm.
- Financial Numbers- Private owners often make “rosy” projections to “get the highest price”. First, in many sales/capital raises, the seller/owner will need to stay with the business for some years to come and will have to “live with those projections”. Therefore, being too aggressive can lead to problems down the road. Projections should be the “Most Likely Case”-somewhere between your “Best Case” and “Worst Case”.
As mentioned above, failing to sell/raise capital when your sales/profit trend line is on a continual upswing and some growth remains for the buyer can be a significant mistake. One “hiccup” breaks the trend line and can scare buyers/investors and may lower the price (at best) and can result in no ability to sell/raise capital at that time (or worse). Many owners have experienced this issue firsthand by not selling/raising capital during the “boom” years of 2004-2007 timeframe and now have significantly lower numbers and now need to re-establish the company’s trend line, a multi-year process that can delay a sales/exit at the time you want to exit.
- During the sale process, it is extremely important not to miss your numbers. Missing your numbers is a primary cause of lowering prices (at best) and killing deals (at worst). It also creates a credibility issue between you and the buyer/investor if you will be staying with the business for some time after the transaction.
- Ordinary Course-Just before or during a sale process, some business owners will:
Accelerate accounts receivable collections, take extraordinary dividends out of the company, slow down paying vendors/suppliers, slow down inventory purchases or fail to make normal or critical capital expenditures etc.. Most buyers are very sophisticated. They will usually uncover such issues in due diligence, and it not only negatively affects the price and ability to complete the deal, but also, the all-important ingredient of trust and credibility. Run your business as you normally would.
- Starting a Process without Professional Help-As previously mentioned, many strategic buyers/competitors and private equity firms are extremely aggressive about “cold-calling” private companies and trying to gain access to financial information and establish a relationship or “make an offer” to cut off any competition and an investment banking process that will invite competition and higher prices. Sometimes, a seller/owner will say or do something that he/she is unaware has just reduced the value of their business or their options for inviting more buyer/investor competition to the process. Sometimes, we are called in to help but it is sometimes too late to fix the problems already made by the owner/seller.