Selling a Private Company
A decision to exit a privately held business is more nuanced than a corporate divestiture or another type of business combination. Even when the reasons to sell a business may be clear and compelling, the private owner may struggle to depersonalize what otherwise would be an objective, even straight-forward, economic decision.
This is understandable as private owners may have spent their lifetimes building their businesses through good times and bad. They may have struggled against larger competitors, capricious economic cycles, financial crises, and countless other challenges. Despite that, they have been smart enough and tenacious enough to survive and prosper no matter what. Starting and building a business that lasts is an extraordinary achievement. So, an owner should ask why should I sell? He or she may be thinking along the following lines: I have created the business and love what I am doing. The business needs me to continue growing. And, for that matter, I need it too in ways that I may not be able to fully describe to someone else.
Some owners can never see the path through the conflicts created by an exit. Even when they are well past a customary retirement age, or in ill health, some will leave the decision to sell a business to their heirs or successors. There are no absolute answers for the “right thing” to do in such cases. It comes down to a personal choice.
Nonetheless, for owners that have been able to depersonalize their business, the question remains: How can I determine when is the right time to sell my business and how should I prepare? Fortunately, there are proven steps an owner can follow in deciding on what to do.
Before deciding to sell, a business owner must first have a clear-eyed view of the current and future state of the business. This requires financial statements presenting the growth and profitability of the business in accurate terms. Ideally, a seller will have the past three to five years of performance presented in both reported and normalized formats. Financial statements should be reviewed or audited by independent, external accountants because potential buyers (and their bankers) will rely on these financial statements. Additionally, a business owner should have the company’s accountant and tax advisors streamline, eliminate/correct, and reformat as needed line-items in profit-and-loss statements and balance sheets which may confuse potential buyers or lead to questions about the quality of the company’s earnings. Things like family members ghosting on the company payroll or personal investments (for example, vacation homes on the balance sheet) will need to be addressed in preparing a company for sale.
Buyers pay premiums for future earnings rather than past performance. Before selling, a business owner must develop an attractive but realistic business plan laying out the next several years of financial performance (top-line growth and bottom-line profitability) in reasonable detail. Sometimes, however, sellers present a plan with extraordinary performance relative to their historical results. This situation is the “hockey stick” growth curve, which buyers view with reasonable skepticism in valuing a company. So, a seller should disclose the key assumptions and other bases for the extraordinary growth underpinning forecasted financial performance. They should also indicate who will do what and when to realize these plans.
Buyers will usually want to change some things once they assume control. Still, for the seller, a negotiating position particularly regarding business valuation is strengthened if a credible plan is in place for navigating towards a competitive and profitable future. Even if a deal falls apart, the business plan is a roadmap for creating value and helping to ensure the success of a future transaction.
Regardless of whether the buyer is a strategic firm or a financial investor, an owner must consider the management risk for the buyer in the event of a sale. Ideally, an owner should initiate a deliberate management succession process at least two to three years before launching a sale process. This can be an emotional issue for some owners as no one can manage your business as well as you can.
Nonetheless, the purpose is to transfer knowledge and day-to-day responsibilities to senior managers who will continue with the new owners after closing. If the buyer is not confident in the management team, they typically require the owner to remain for a year or longer with the company as an employee or a consultant after the sale. Accordingly, an owner must commit to transferring essential knowledge and transitioning important relationships with employees, customers, suppliers, and other stakeholders.
Of course, this requires hiring and developing the right team of senior managers and having a thoughtful plan for handing over the reins with milestones and a timeline. Not only does this step prepare the owner for a smooth exit but building in succession will help to ensure the company’s business continuity and financial performance post-sale. The latter point bears emphasis, especially as an earn-out provision may be included in the purchase offer for a seller to capture the goodwill embedded in the business.
Preparing for a sale also requires a business owner to embrace an objective view of what his or her company may be worth to a buyer. This view is perhaps the single most important factor affecting the success of a sale process. Buyers and sellers usually differ in their perspectives about what a company is worth.
That’s normal and is in fact the reason for negotiating a transaction only with committed and qualified buyers. At a minimum, a successful outcome requires both buyer and seller to have over-lapping perspectives on the value of a company. The differences can then be discussed and addressed during due diligence and final negotiations. On the other hand, if there is no common ground between a seller’s expectations and the buyer’s valuation, a potential transaction will fail before a formal process of confirmatory diligence can begin.
Private owners should consider reliable benchmarks in shaping expectations regarding the worth of their businesses. Public and proprietary data sources can be helpful for understanding recent trading multiples and pricing for comparable transactions in the seller’s industry sector. This type of information can be useful for assessing a reasonable range of values for a business in the current market environment. Such ranges in the simplest form are stated as some multiple of cash income or pre-tax earnings, free cash flow, or net income. Earnings multiples try to capture the full gamut of valuation factors, including the cost of capital requirements, growth expectations, taxation, and various business, management, and financial risk factors.
Notably, all other factors being equal, buyer expectations for high and sustainable growth in revenue and operating income tend to support high valuation multiples regardless of industry sector or size of the company. These buyer expectations are reinforced when an owner can point to a history of such outstanding financial performance rather than simply a plan forecasting such performance.
A business owner may not want to sell whatever the potential offer. But, for those owners contemplating the possibility of an exit, careful preparation is clearly key to a successful transaction.
