October 16, 2019

Do’s and Don’ts When Selling Your Business

Consider this scenario: You’re an entrepreneur. You’ve spent the better part of your adult life building this “thing” that feels bigger to you than the product or service advertised on the box or website… something akin to a child if your child has the propensity to intermittently confound, exhilarate and betray you. Against the odds, you have built something valuable both to you and others but your real kids have their own lives and careers, and you’re tired. It’s time to sell. Where to from here?

As an independent, employee-owned money manager, we attract a lot of like-minded entrepreneur-clients like the one in this scenario – but, while we’re very happy to help them invest the funds once they are through this critical sale process, facilitating mergers and acquisitions (M&A) is not our business. So to learn more about what potential sellers can expect and how to prepare, we spoke with Axel Christiansen, Vice President at Renaissance M&A.

Renaissance is a boutique investment bank that grew out of an accounting practice founded by Mike McIsaac in 2008 after he recognized a client need for advisors on the sale of businesses under $50 million. Christiansen says many of their engagements today are in the $5 to $25 million range.

Why do entrepreneurs sell?

Christiansen says there are a variety of reasons a client may choose to sell. The first is a desire to cash out upon retirement, a trend that has gained steam in recent years as more baby boomers have hit 70. Another is that the entrepreneur may have outgrown the challenge of the current business, and is keen to move on to new challenges (with a few bucks in their pocket). The flip side of that – that the business has outgrown the founder – is an equally valid reason to sell. After all, fresh blood (and the skill sets, resources, and energy that can bring with it) is sometimes necessary for a business to get to the next level. A fourth motivator is the almighty dollar.

“There's a saying in the industry that you don't get to pick when you sell,” said Christiansen. “The market tells you when you sell.”

What he means is that to maximize your proceeds, you want to sell when it’s a seller’s market – ideally timing it for a cyclical high in your particular industry along with the important element of strong and competing investor demand for private businesses in general.

“[Private sales] are a very cyclical market. So when the factors are lining up… valuations are high, credit's cheap, there’s lots of private equity in the marketplace and just more buyers and sellers. That is a time when you really want to seriously consider transacting because you might not see that valuation again for another five, six, seven years… you know, the next up cycle.”

What are the current market conditions for private sales?

After 10 years of near-continuous economic and public market growth, coupled with historically low interest rates, times have seldom been better. Add to that big demand from what Christiansen calls “strategic buyers,” which include large public companies from both the US and Canada, competing for deals, and it lines up for some pretty rich valuations.

“The common theme today is this: there's lots of debt financing out there on very inexpensive and very favorable terms. There’s tons of private equity chasing transactions. And up until fairly recently, the baby boomer demographic hadn't really started moving in earnest, so there was a lack of supply of companies. So all of that has created a really strong sellers’ market. In the small to medium-sized space under $25 million… historically those were selling for 3-5x EBITDA, [the acronym for the cash flow proxy of earnings before interest, taxes, depreciation and amortization]. Now it's more like 4-7x and we're even seeing outliers at higher than 7x for attractive companies in the right circumstances, oftentimes being sold to strategic buyers for that highest value.”

Beyond price, sellers of small businesses are increasingly able to demand more “cash” deals, with fewer earn-out clauses. Some are also inking deals where they are able to retain a majority stake with the major buyer coming in for only a minority interest.

“It's really tough for bidders to be successful ... and I think out of necessity that's forced them to look at stuff that they historically didn't want to bother looking at,” Christiansen said.

Once the decision’s been made to sell, there are a number of key issues to navigate. Christiansen broke them down into the following:

Don’t Get Greedy: Like a good portfolio manager, the best businesses have the discipline to sell when times are still good. Don’t ride it over the top. Christiansen points to the building products industry as an example, saying that nowadays “there's a little bit of uncertainty in the marketplace, so it might have been ideal to sell a company like that a year and a half or two years ago as opposed to now.”

When it comes time to price your business, it’s also important to be reasonable in your assumptions around normalizing EBITDA. Both sides will naturally bring a more or less conservative approach, but being overly aggressive can degrade trust and derail a deal.

Another aspect of the sale that can be contentious is working capital: how much to leave in the business? The issue is that many businesses, in an abundance of caution, run with more working capital than is strictly necessary and so sellers (rightfully, in their view) want to pull some out at sale time. “Our recommendation is to run efficiently from a working capital perspective for at least a couple of years before you sell. Make sure you're collecting receivables in a timely manner, manage your inventory, take advantage of trade credit, etc. Because then you can say, ‘Hey, we've demonstrated we only need a million in working capital to operate and that's all we're leaving in.’”

Leave Some Upside: For a deal to be successful, you need to leave some upside for the purchaser. The result of trying to “squeeze every last drop out of the lemon,” said Christiansen, is that inked deals can later fail because buyers realize their haste to sign, and then get cold feet.

Manage Your Emotional Attachment: Selling a business built over a span of decades can be a painful, emotional process because it means ending something that’s come to constitute part of the entrepreneur’s self-identity. It can feel like a divorce. Recognizing that in advance and planning for it can help. One strategy is to focus on the next thing, Christiansen says. “The best way to deal with that is to not go into a black box… do some planning around what's coming next and ideally the entrepreneur is being drawn to something that's exciting in the next chapter as opposed to focusing on what’s being left behind.”

Think About How You Want to Get Paid Out: In addition to the dollar figure, you and the buyer will have to decide on how you’ll get paid. All cash deal, stock swap, or a mix? All paid now, or over time with “earn-outs” embedded that rely on you hitting certain performance benchmarks? What post-sale role will you assume, if any,  and minimum or maximum timeframe for your involvement after the handover? Non-competes? Clawbacks? What reps and warranties are being made and what happens if they’re inaccurate? Christiansen recommends putting thought into these in advance, so you know your comfort level and priorities when it’s time to negotiate. Having a tax accountant in the mix would also be a good idea.

Get Advice: While tempting, Christiansen strongly advises entrepreneurs against engaging in a sale process without a professional advisor. “A lot of times, we see entrepreneurs who are approached by a strategic competitor in their industry or a private equity firm who flatter them, saying, ‘Hey we've been watching you and are really impressed with what you're doing. We'd love to talk about buying your company,’” said Christiansen. “And so they engage in this sort of unilateral one-on-one discussion… but these groups are reaching out directly because they want to have these one-on-one negotiations where there is no competition, with nobody else at the table.”

In contrast, he says, a good M&A advisor can create a competitive landscape for the sale, drawing on dozens of potential buyers on whom they’ve done prior research. “Within that group, there's a high probability several players will have interest and we can then play them against each other. So now purchasers may pay more than they wanted to because of the competitive pressure that we're able to create.”

Exit This Way

In signing off, Christiansen mentioned Exit This Way, a half-day seminar series that Renaissance runs in which professionals from the full value chain of a business sale speak. Tax accountants, lawyers, investment bankers, entrepreneurs, money managers and more. If you’re in Vancouver on January 28, 2020, Leith Wheeler Portfolio Managers Cindy Huang and Michael Schaab will be leading a session on putting your money to work – after you’ve sold.

By Mike Wallberg, CFA MJ | Vice President, Marketing & Communications