Chapter 2

Take your mark, get set, go.  How many childhood games start with these words?  While selling your company in a tough market at the best possible price is not a game for children, for the uninitiated, or for the weak of heart, it is a game.  It is game with multiple players, identifiable winners and losers, and a fluid set of rules.  But just because you have played other games (like running a successful company) with ease, expertise and finesse, that doesn’t necessarily mean you are prepared to play the game of selling your company for the best possible price.

I compare an owner’s entry into the transaction arena to experiences we’ve all had at some point growing up.  Remember being the new kid in a new classroom in a new school?  Or the time when the big kids asked you to join a neighborhood pickup game?  You’d been in a classroom for years or played the game hundreds of times, and up to this moment, you knew every player, every rule, every nuance and every exception. In fact, until that day you were likely the one making most of the rules.

But in this new situation you are uncertain.  You don’t know the rules or the players.  Which kid plays rough? Which kid wilts under pressure? Who are the smart kids, the thugs, and the brown-nosers?  What are the consequences for picking the wrong group, checking the wrong player or being a hot dog?  You watch, you listen, and you tentatively play according to the “old” rules.  Maybe things go well for a while until you break a rule you didn’t know existed.  Consequences are swift and vary in severity.
Remember feeling something between uneasy and scared or choosing between flight or fight?  That choice or feeling in the pit of your stomach is not one you want to experience when you sell your company.  Those feelings don’t always contribute to being and playing your best. When selling your company, you want to feel the way you did when one of the other kids explained the spoken and unspoken rules, helped you navigate the personalities, avoid obstacles and ultimately fed you the shot for the win.

When I represent owners, I try to be that kid—the one who helps the new kid understand enough about what’s going on not only to survive, but to win.  I call the process I use to help new kids, or owners, win this high-stakes game the Proactive Sale Strategy.  This strategy not only maximizes the owner’s chance of finishing the game, it also maximizes the owner’s chances of closing for the best possible—and even outrageous—price.

In Step One of this process, we begin with a valuation and comprehensive check up of both the seller and the seller’s company.  Before entering the game, we want to understand exactly what the owner brings to the starting line.

I divide Step One into two parts: Market Valuation and the Sale Readiness Assessment.   The purpose of the valuation is fairly straightforward:  we gather the information necessary to predict the average price a buyer would pay for a company in this industry, it its current condition and at this moment in the M&A cycle. Using a Sale Readiness Assessment we determine how prepared the company and owner are for a sale.

In most cases, we work to complete the valuation while the owner completes our Sale Readiness Assessment.

MARKET VALUATION

If you are like the hundreds of owners of companies in the middle market that I’ve met or represented over the last 25 years, you are successful, creative, driven and believe that you have a pretty good idea of the value of your company.  With all due respect for your business acumen, I suggest that you do not.
Before you assume that I have insulted you and toss this book without reading another page, let me assure you that not knowing the value of your company does not mean that you are out-of-touch with your industry or the inner workings of your company. Rarely is anyone as attuned to all of a company’s strengths and weaknesses as is its owner.

There are a number of reasons, however, why owners do not, and I submit, should not, know the value of their companies. The first is that as valuations are traditionally performed, the purpose for the valuation significantly influences the resulting valuation or enterprise value.  Second, commonly used assumptions that underlie valuations of privately-held companies (and that’s how most lower- to middle-mid market companies are owned) are inexact, at best. Third, privately held companies exist in a world devoid of empirical data. And finally, the input owners or sellers receive from potential buyers, input I refer to as “buyer speak,” is carefully designed to cloud and to deflate an owner’s idea of value.  (We’ll talk more about buyer speak in Chapter Five.)

Let’s look at each of the flaws inherent in the valuation process in more detail.

Flaw #1:  What’s The Purpose of the Valuation?
If you’ve had a professional (accountant, business appraiser, investment banker) place a value on your company, you know that one of the first questions you are asked is:  What is the purpose of the valuation?

Before we discuss how your answer affects the resulting valuation, let’s pause to examine the question:  Why do you want to know the value of your company?  The very fact that you are asked to declare—up front—why you want the valuation performed indicates that your answer has a direct bearing on the process’s outcome.  Could that mean that professionally established valuations may not be the objective be-alls and end-alls that many assume them to be?

In pointing out that the motive for a valuation influences its result, I am not questioning the professionalism or skills of those who perform valuations nor the validity of the reasons owners wish to have values put on their companies.  Indeed, owners have legitimate reasons for valuations, but understand that a valuation appropriate for one purpose is not appropriate for all.

Owners require valuation information when they create and update buy/sell agreements or estate plans.  The accountants or business appraisers who perform the valuations want to be aware of the owner’s motives so that they can create valuation formulas that treat fairly both the departing and remaining shareholders.  In the case of a valuation performed for estate planning purposes, the valuation expert will place the lowest defensible value on the company so that the owner’s heirs will pay no more taxes than required.

Many owners want to know the value of their companies as part of creating their Exit Plans from their companies.  To this end, they seek to determine if a sale, today or at a chosen time in the future, will provide them with financial freedom.   Most owners include “Achieve Financial Freedom” somewhere on their lists of “Reasons I Own My Own Company.”  While some owners go into business with that priority at the top of their lists, others place more emphasis on it as they age, as their priorities change or as market conditions change.  For example, when the Merger &Acquisition market is paying top dollar, owners who may not have considered selling will decide that they can’t afford not to sell.  Or, when economic conditions become more challenging, some owners will simply tire of fighting tooth and nail for smaller margins.

We’ll talk more in a moment about how valuations for sale purposes may not be as solid as we often assume them to be, but let’s first complete our discussion about the problems inherent in any valuation.

Flaw #2:  Faulty Assumptions
In addition to a valuation number being dependent on the reasons why the valuation is conducted, valuations typically rely on wildly imprecise assumptions.  The two biggest offenders are rules of thumb and multiples.  Valuation specialists examine and analyze a company’s financial statements, but they then factor in a generalization or rule of thumb to arrive at a enterprise value.  For example, they may observe that in a particular industry, buyers “historically pay one times sales.”  Historically, that rule of thumb may or may not be true, but due to the lack of reliable data in this marketplace of privately held companies, we just don’t know.

The second weakness inherent in any valuation made to predict a purchase price is the multiple.  Simply put, a multiple is the rate of return that a buyer expects on its investment.  So, if buyers traditionally pay “a 5 multiple” this means that the buyer expects a 20 percent annual return on its investment. On its face, that’s a fairly straightforward statement until we consider that twenty percent of the purchase price doesn’t factor in the post-closing benefits the buyer will experience from its expansion plans (made possible by its acquisition of the seller), the synergies between the two companies, or the expertise of the new management team.

Flaw #3:  Lack of Empirical Data
It would be great if we could look at a past transaction and agree on exactly what the “multiple” meant in that particular situation.  But, we can’t.  We’re operating in the privately held market where information about sale transactions is difficult to find even with professional assistance.  And that absence of reliable data is the third major flaw in the valuation process.

If you own a company worth between $10 million and $200 million, you occupy a spot in the no-man’s land known as the “lower middle market” where, according to the U.S. Census Bureau’s latest numbers (2007) there are 803,356 firms.  Hoover’s (a Dun & Bradstreet company) calculates that there are 1,068,848 companies with listed revenue between $5 million and $200 million.  Business owners in this market lack the accurate information about the value of their companies that is available to owners at both ends of the value spectrum.

Sellers of these middle-market companies are in no rush to share information about the sales of their companies.  There is no advantage to them in disclosing the details about these transactions.  The same is true of their public company buyers.  When public companies buy middle-market companies, the purchase prices are often too small to rise to the level of materiality so the buyers never need report them.

At one end of the value spectrum are large publicly traded companies.  Every time one share of their stock changes hands, the market establishes a precise—albeit temporary—value for that company.  At the other end of the spectrum, the market places a definite value on small items.   For example, on-line auctions put a value on everything from stylish, powder blue leisure suits from the 1970s to collections of lawn trolls.

Privately held companies not only lack the exact values assigned to public companies, but are too valuable and complex for any on-line auction.  For that reason, the method of predicting a sale price is similar to that of diagnosing a condition like Alzheimer’s disease.

When called upon to make a diagnosis, medical doctors rely on observations about changes in the patient’s personality, memory, judgment, abstract thinking, or ability to perform familiar tasks.  While physicians do use blood tests and various types of brain scans, they do so to rule out other potential causes of dementia.  The only way to achieve 100 percent accuracy in the Alzheimer’s diagnosis is to perform a post-mortem examination of the patient’s brain.

The investment banker faces similar obstacles in predicting a sale price.  Investment bankers can carefully analyze a company’s financial statements and make educated assumptions about the health of the M&A market, the future performance of the company and the willingness of buyers to assume risk.  Their estimates of a sale price, however, cannot be 100 percent certain until the transaction is completed.  If we could only see the future or read the mind of the buyer (or buyers) in the marketplace, owners would know exactly what buyers are willing to pay and thus know with certainty the true value of their companies.

VALUATION PROCESS
So let’s review:  valuations of middle market, privately-held companies are: 1) significantly affected by the purpose for the valuation, 2) usually based on faulty assumptions, and 3) performed in a vacuum of reliable data.   At this point, many owners justifiably wonder exactly why they need a valuation and are convinced that their money would be better spent on lottery tickets.

Well, if we return to our analogy that selling a company is somewhat like a game, players (in this case owners) must have the best possible understanding of the asset they bring to the starting line.  Failure to do so significantly increases the risk they they’ll not make it to the finish line, i.e. the transaction will fail, or they’ll lose by failing to get the best possible price for the company.

As you recall, the two primary purposes of the Proactive Sale Strategy are to: 1) reduce the seller’s risk of a failure to close, and 2) achieve the best possible sale price.  One way we improve the seller’s chances of success on both fronts is to match the seller’s asset to a buyer’s need.  But if we don’t understand the value of the seller’s asset, how can we make that match, much less get the best possible sale price? We can’t.

But just because we reject valuation formulas based on questionable rules of thumb and hearsay doesn’t mean that it is impossible to design a valuation process that combines rigorous analysis with the expertise and intuition of the professional performing the valuation.  Below I describe the valuation process that we use in the Proactive Sale Strategy.

Analysis of the Financial Statements.
We begin our valuation process with a review of a company’s most recent Profit and Loss Statements and Balance Sheets.  Ideally, we will review both reports for each of the last three years so we can spot trends and anomalies and confirm that any change to the balance sheet flows through to the Profit and Loss Statement.

We start with an assumption that a company’s financial reports are accurate.  That assumption is easiest to make if an owner provides us with audited financial statements.  If audited, we know that: 1) a Certified Public Accountant has created these statements; and 2) he or she agrees with the methods the company used to prepare the documents; and 3) the audit is accurate and complete.

One step below audited financials (in terms of credibility) is the unaudited financial statement. Here there are two levels:  reviewed and compiled. When a CPA reviews a company’s statements, she checks certain items (such as Accounts Receivable and the methods for recording inventory) according to a pre-determined routine.  These routine checks are both less stringent than ones used in an audit, and do not include a review for accuracy of every number that the company provides. The CPA may, however make one or more assurances about the reliability of the data.

In compiled statements, the CPA accepts all of the company-provided data and puts it into a standardized format designed to tell the story of the company’s financial performance In compiled statements, the CPA expresses no opinion and makes no assurances about the accuracy of the data the company provides.

With financials in hand, we can begin the process of adjusting the numbers to reflect what each would be if the company were owned by someone else.  For example, if the selling owner has taken a $2 million bonus, thus reducing the company’s profit to $0, we ask what salary could we pay a similarly skilled person to do the owner’s job?  If that salary is $250,000, we add back $1,750,000 to the company’s adjusted EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization).
We find these add backs primarily in three areas:  owner perks, one-time events and typical trouble spots. Let’s start with the most glamorous area:  owner perks.  In this category we find country club dues, tickets to sporting events or theater subscriptions and slope-side or beachfront condos.  We see higher-than-possibly-justifiable salaries and the purchase and maintenance of vehicles of all kinds:  boats, racecars, RVs, and airplanes.

Often we discover that owners have had their businesses perform expensive services (such as building a home, remodeling a basement, landscaping a yard) at the business’s expense. Again, if a replacement owner could be hired and satisfied to work without these high-dollar trimmings, we add back their costs.
One-time events are typically not so glamorous because they include natural and manmade disasters. On the natural side we find casualty events such as fire or flood.  On the manmade side litigation is the most common event that can skew a company’s numbers.  Of course, if a company is consistently involved in litigation, then we would not add back litigation-related costs.

Finally, we get to our most common, yet hardest-to-define area:  trouble spots.  These spots are usually industry-related.  For example, if a company maintains a significant inventory, we know that this is the easiest place for an owner to massage the numbers.  Here’s how one owner’s massaged the numbers in a short-sighted attempt to reduce his tax liability.

Vince Diamond owned a successful plumbing parts company in Detroit, Michigan.  For years, Vince had understated his inventory in an effort to reduce his profits, thus reducing his tax liability.  Vince provided the doctored numbers to his accountant who, year after year used them to prepare the company’s tax returns.

At Vince’s 50th birthday party, his youngest son (whom Vince had always hoped would take over the business) announced his plan to attend medical school.  Vince’s employees had neither the money nor the will to take over the company so Vince decided to investigate the option of selling to a third party.

During Vince’s first meeting with a business broker, the broker questioned Vince’s stated inventory of $250,000.  “How can you possibly support annual sales of $2.5 million with an inventory this small?”  Vince then admitted how, unbeknownst to his accountant, he had cleverly “saved hundreds of thousands” in taxes over the years by understating his inventory.
“Well,” his broker said, “now you face a difficult choice.  We can correct your inventory numbers so that your EBITDA will support a $10 million sale price.”  “Great! Let’s do it!” Vince replied.  “If we do,” the broker cautioned, “the IRS can, and probably will, charge you with tax fraud.”

Once Vince had absorbed and rejected that idea he asked, “What happens if I let the numbers stand?”  The broker replied, “In that case, I have good news and bad news.  The good news is:  you don’t go to jail.  The bad news is that without correcting the numbers, your company’s EBITDA is too low to support a $10 million sale price.  In fact, no buyer will risk buying a company with unsupportable numbers.”

Dejected, Vince left the broker’s office.  He ran the company for eight more years until he had enough money in the bank to support himself in his retirement.  At the end of those eight years, Vince liquidated what assets he could and closed the doors.

Another trouble spot appears in companies that use assets whose depreciation schedules exceed the assets’ useful life.  For example, if a company has significant investments in technology (computers, software and peripherals) we look carefully at the validity of its depreciation schedule.  For example, if a company purchases 50 new lap top computers for its sales staff, those laptops are assumed to have a useful life of five years and are therefore depreciated over five years. Let’s assume that in Year Four, the owner of this company decides to sell.  We often discover that in Year Three the company replaced those 50 laptops with newer technology, yet they remain on the company’s balance sheet.  We must deduct the un-depreciated amount (on assets the company no longer possesses) from the EBITDA so the company’s profitability is not inflated.

We also often find issues to resolve concerning the ownership of real estate.  One occurs when the company owns real estate inside the corporation.  In this situation, companies usually do not pay rent so we must show what rent would cost the company if it was owned outside the company. For sale purposes, we value the real estate separately from the company because the cash flow multiple for real estate exceeds the multiple for business cash flow.

The second issue occurs when real estate is owned by one or more of the company’s principals and rented to the company.  There is often a discrepancy between prevailing market rates and that paid by the principals. Some owners will charge less than market rates while others charge more.  In either case, we adjust EBITDA to reflect the difference between the rate the company pays and market rates.
Normalizing the Financial Statements
Once we have adjusted the numbers to best reflect what the company is worth, we can normalize the financial statements.  Normalize means comparing the selling company to others in the same industry and of similar size.  We want to know if the selling company uses the same methodologies in preparing its financial statements as do others in its industry. For example, let’s assume two companies show the same amount for the cost of goods sold.  If one company includes some direct labor components when it computes the cost of goods and its industry competitor does not, the financial reports will tell two different stories.  

The final step in the analytical half of our valuation process is to collect (using a number of proprietary data bases) information about recent sales in the industry.  This process parallels the one a realtor uses to develop a list of comparative properties before setting an asking price.  While we may not be able to uncover exact purchase prices for privately held companies, we can discover what buyers are active in the marketplace, how active they are, and what types of acquisitions they make.  If we discover that buyers have abandoned a particular market, we can make the appropriate adjustment to our valuation.

Intuition/Judgment.
In this second half of our valuation process, we draw upon experience, training and intuition to probe any anomalies we find in the company-provided data, the owner-provided information or in the information regarding sales in the industry.  We ask questions about any discrepancies between what the data indicate and what owners tell us.

One item that requires a judgment call is a variation on the one-time event anomaly mentioned earlier.  For example, a company may encounter a spike in the cost of fuel or in one of its primary input commodities.  If the price of that input has returned to normal levels and we do not foresee another spike, we re-cast the company’s numbers as if the spike had never occurred.  We do that so a future owner has a better appreciation of this company’s normal performance.  If, on the other hand, we believe that the price increase or fluctuation is likely to reoccur, we would not treat it as an add-back because fluctuations of this kind are part of this company’s ordinary business activity.

             Analysis + Intuition = Valuation Process
The combination of keen analysis and intuition based on years of experience yields our opinion of a company’s current and possible range of value.  “Current” relates to existing acquisition activity in the marketplace and availability of credit.  Our estimates of “possible” covers a range, but do not include the amount that the best possible buyer might be induced to pay under the best possible conditions (a/k/a the Outrageous Price). Although the very purpose of the Proactive Sale Strategy and Outrageous Price Process is to find that best possible buyer and prepare that buyer to pay the highest possible price, at this point, we do not include the Outrageous Price in our range of value. 

In contrast to a formal valuation report, our opinion of value is not a written report so if owners are at all pleasantly or unpleasantly surprised with our opinion, we encourage them to secure a formal valuation report.  Doing so is critical if there are minority owners involved who may, at some point, wish to question the majority owner’s decision to agree to a purchase price. 

We provide an opinion of a range of value to the owner before we enter into an engagement because designating the range of value puts owners at a crossroads. Knowing what they now know about current possible value, are they willing to sell for an amount within that range?  As they consider that range, they must think about the probability of securing a price within the stated range.  For example, we may be able to expect, with near certainty that a buyer willing to pay $4 million will appear.  The prospects for a sale are far fewer, however, at the $10 million end of the range.  

SALE READINESS ASSESSMENT

As we analyze data pertinent to valuation, we begin the process of determining how ready an owner and her company is for sale.  We conduct a full exam of the selling company, much like the executive physical exams performed on high-level business executives at major medical centers.  Over the course of a day or two, doctors take measurements, palpate, observe, listen and evaluate all of the executive’s systems including:  hematological (blood chemistry and counts) respiratory (chest x-ray) digestive, excretory, reproductive, cardiovascular, and neurological.  Doctors may also examine eyes, teeth, skin, diet, nutrition, and stress levels.

When we examine a company, the process is similar.  While our “patient” is the company, we ask the owner to assume the role of its spokesperson and to answer each question to the best of his/her knowledge.  Usually, those answers are based on the owner’s intuition.

The investment banker’s primary role in this Assessment is to ask the right questions, listen carefully to an owner’s answers and draw upon experience, intuition and training to begin to draw conclusions. 
We probe several important areas including:  Owner’s Exit Goals, Exit Strategy Awareness, Family Considerations, Advisors, Company Systems, Competitors, Potential Buyers, Industry Acquisition Activity and Competitive Advantage.  Appendix A is the Sale Readiness Assessment that my firm uses.  Let’s look at each Assessment area in more detail.

Exit Goals
At the outset of this process, we want to know what the owner expects from a sale. We ask owners to define their “ideal” sale in terms of price, timing, role after closing, role of employees after closing, feelings about possible reorganization of the company and optimal personal tax ramifications.
It is often a cat-and-mouse moment when I ask owners to name both their ideal and realistic sale prices.  Owners don’t know me well at this point, and they suspect that there’s an advantage in having me name these prices first.  Their suspicion that there’s more to this question than meets the eye is correct, but by declaring their prices first they do not put themselves at a disadvantage.  My only (and up-to-now) hidden agenda is to use an owner’s answer to gauge his or her understanding of his company, industry and marketplace.  In reality, owners lose no advantage in revealing their price targets because in the end—and at every point along the way to closing—the owner (not his or her investment banker) retains the power to accept or reject a buyer’s offer.

While we probe an owner’s gross price expectation, we also want to know what form of payment he or she deems acceptable.  Is she is willing to accept a promissory note, stock of the buyer’s company, royalties, earn outs or other non-cash arrangements? The answer guides future negotiations with a buyer.
During the Assessment we ask if there’s a party (or parties) that an owner is unwilling to consider as a potential buyer.  Several years ago I met with a seller who, during one of our first meetings, presented me with a list of companies he thought might be interested in buying his company.  Noticeably absent from this list was his company’s largest competitor.  When asked about this omission, this seller told me he didn’t trust the competitor and would not permit me to approach, much less negotiate with, this competitor.  Whether this seller’s feelings were well founded or not (and we later learned they were not) his veto had a profound affect on my estimate of the “average” sale price for this company.  In one blow, the seller eliminated the buyer best able to pay the highest price.

We also spend time exploring the owner’s role after the sale.  Would she consider remaining as an employee? If so, for how long? At what rate of compensation? Or would she prefer a consulting arrangement?  Would the seller prefer to work for a strategic buyer (probably a competitor) or for group that remains at arms length (Private Equity Group)?   If required to sign a covenant not to compete, what terms does the seller deem acceptable and unacceptable?

Exit Strategy Awareness
We turn then to an owner’s constituency groups.  These may include other owners, a spouse, family members, a Board of Directors, senior management, and key employees.   The critical question for each group is:  Are these persons aware of the owner’s ideal sale plan, and if so, do they share the same vision?

An owner’s answers to these questions give me insight into the amount of exit planning the owner has done and the culture of the organization.  It is optimal (but not necessary) for owners to start planning their departures at least five years in advance of their exits.  As part of the exit planning process, owners define their visions of the company’s future and communicate those visions and plans to their constituency groups so that everyone works toward the same goal.

In my experience, however, few owners devote the time and effort necessary to create comprehensive exit plans and fewer still share those exit plans with their employees.  While the benefits of creating an exit plan are many, most owners (and most of their advisors) have no idea how beneficial exit plans are in both the short term and long run.

Every exit plan is founded on a particular owner’s goals, one of which is usually to reap as much cash as possible at exit. To accomplish this goal, a comprehensive exit plan includes specific actions to promote and to protect business value.  Promoting value typically involves owners installing various incentive programs that both motivate key employees to increase the value of their companies and remain with the company—even after owners depart.

One technique that owners use to achieve this two-faceted goal is a Stay Bonus Plan.  It is so important that we’ll digress from our discussion of sale readiness for just a moment to describe it.

The Stay Bonus Plan
An effective Stay Bonus Plan accomplishes three tasks:  1) it gives the key managers a reason to stay with the company after the owner’s exit; 2) it is structured so that it increases the value of the company, and 3) it includes a penalty (usually in the form of a covenant not to compete) that prevents key managers from taking customers, vendors or trade secrets with them should they leave before or after the sale.

Owners who rely on their belief in their employees’ good will rather than on written Stay Bonus Plans often find themselves held hostage by those same good and loyal employees.

One owner was a week away from the sale of his company for $10 million when (at this very late stage of the game) the buyer met with each of the key managers to reassure them that they’d be retained by the new owners at their existing compensation levels. At its meeting with this owner’s top salesperson, the buyer was lavish in its praise of her performance and indicated how important her continued success was to the company’s future success.  When the buyer then asked her to sign a covenant not to compete before the closing date, the salesperson asked for a short break and headed straight for the owner’s office.  She proceeded to remind him that she’d help build the company to its current value during her tenure, and ever-so-generously consented to patiently wait until the closing date “to collect her $1 million bonus.”

This owner paid the ransom because he knew that if this salesperson servicing his top four clients left the company, the buyer would likely scrap the deal.  If the buyer did subsequently come to the closing table, it would reduce its purchase offer by far more than $1 million.

In another transaction, I was orchestrating the sale of a division of a publicly held company.  We were conducting a competitive auction (see Chapter Ten) and were introducing each of four possible buyers to the division CEO.  At the meeting with the first buyer, the CEO was rude.  I thought perhaps she was having an off day until she repeated the same behavior with the second buyer.

Before meeting our third buyer, she and I sat down so I could ask about her behavior.  To my surprise, she informed me that she didn’t like those prospective buyers and that it was critical that she like the people she’d be working for.  She patiently explained to me that, “If I pick the wrong buyer, I might be fired.” I left that meeting, contacted her supervisors and this CEO’s premonition was fulfilled sooner than she expected:  she was fired that afternoon.

In firing her, the parent company excised a thorn from its side, but that surgery cost it a third of its sale price.  It found itself selling a division with a brand new CEO and quickly learned that no buyer was willing to pay a premium for an untested manager.

As a result of these and many other all-too-similar experiences, I strongly recommend that owners engage in exit planning and implement Stay Bonus Plans with anyone who has a significant impact on their company’s performance. When considering which employees should qualify for Stay Bonuses, include anyone who has leverage against the company, and remember that among that group might be the janitor whose cousin is your biggest customer.

Family Business Considerations
In the course of my work, I meet with owners of family businesses who have decided to at least investigate, and often pursue, a sale to a third party.  These owners arrive at their decisions for various reasons, the two most common of which are: 1) their children are unable or unwilling to succeed them; or 2) the next generation simply cannot match the price that a third party will pay for the company.
It is not uncommon for children to be unwilling or unable to step into ownership positions.  Typically, the company that children are being asked to run is significantly larger and more complex than the one their fathers or mothers ran at their age.  In addition, few hard-charging entrepreneurs are also skilled trainers of a second generation.      Rarely have I met an owner whose son or daughter shares his or her unique drive or talents.  That’s not surprising when you consider that the two generations are often raised in completely different environments.  The parent entrepreneur likely had few parent-provided opportunities while Junior has likely had many.  Junior has watched Mom or Dad devote everything to the company and justifiably believes that, “There must be an easier way to make a living.”

The “kids don’t have the money to pay for the company” roadblock is very common.  While it is possible for family members to be able to match the price of a third party buyer, it can only occur when the departing owner takes action years in advance of the transfer.  Yes, years.  It takes years to put in place the mechanisms that transfer ownership and management responsibilities in a way that ensures both the ongoing success of the company and the departing owner’s post-business financial security.
If an owner decides that the time has come to exit and has not done the exit planning necessary to leave the company to children, that owner correctly views the sale to a third party as his or her best route to financial security.

Unfortunately, few owners verbalize to family members their evolution in thought from a transfer to children to a sale to third party.  Many owners talk for years about how their children will succeed them only to realize that a family transfer cannot meet all of their goals.

My job is to help owners understand how family members will react when they change horses mid-stream.  Spouses, ex-spouses, and children (both those active in the business and not active) will have strong opinions about a sale to a third party.  Some owners have written succession plans, but decide instead to sell to third parties.  Other owners have off-handedly quipped to a son or daughter-in-law that “One day, all this will be yours.”  To the owner, that comment means nothing more than, “Work hard and I’ll give you a chance to buy into the company.”  The listener more likely heard something about inheriting the company.

Family expectations, relationships and communications are loaded with emotion.  Family members can and often do oppose and derail sales to third parties.  That’s why it is so critical—before entering the marketplace—for owners to think carefully about all of the interested parties involved and to work proactively to manage their expectations.

Company Advisors
In this part of our Sale Readiness Assessment, we want to know about a company’s relationships with its lender(s) and advisors.  Primarily we want to know how strong the relationship is with the lender(s) and how experienced other advisors are in third-party transactions.

When an owner describes his relationship with his bank as “poor” (usually peppering our conversation with word like:  demanding, unresponsive, and unrealistic), we probe further.  Often, but not always, we discover that a poor relationship between an owner and a banker is the result of the banker’s lack of trust in company-provided numbers, or a company’s history of sporadic or late payments.
In terms of advisors, we are most interested in (and hope to influence) an owner’s choice of transaction attorney because that attorney is so critical to the success of the process.  Usually, owners have longtime relationships with a local law firm.  They’ve used that firm to set up the corporate entity, draw up shareholder or buy/sell agreements, and perhaps write employment agreements or benefit program arrangements. What those attorneys may not do often or at all, is participate in the type of sale process described in this book:  one in which every actor’s role is carefully scripted to yield the best possible, or Outrageous Price.

As I catalogue my experiences in securing the Outrageous Price, I notice that in almost every case, I had the opportunity to refer the sellers to a short, carefully compiled list of attorneys who were not only the best at what we asked them to do (pre-sale legal due diligence and creating documents that protect the seller), but who could play well with others.  In the cases where I did not handpick the attorney, the sellers picked attorneys who were excellent technicians, but had no desire to run the deal process.
Achieving the best possible price or Outrageous Price requires teamwork.  If an attorney adopts a know-it-all attitude, fails to ask questions, or doesn’t realize that his/her role is just one in an ensemble performance, he or she is an impediment to the seller’s goal.  In fact, a difficult or belligerent attorney is more damaging to the process than is an incompetent one.

As you’ll see in later chapters, pursuing the Outrageous Price is much like playing a high-stakes poker game.  Players carefully watch each other for tells.  The more experienced the players, the more subtle the tells and the more skill and sensitivity it takes to detect them.  The last thing a player needs is distraction from the cocktail waitress or a spectator.  In the pursuit of the Outrageous Price, the investment banker (your proxy at the table) doesn’t know what cards the buyer will play so must devote his or her full attention to the game.  If an attorney distracts rather than supports your investment banker, you will walk away from the table with fewer chips.

The Company
In this largest section of the Sale Readiness Assessment, we attempt to learn as much as we can about the company’s pricing, costs, employees, marketing plans, technology, business model, industry, customers, and last, but certainly not least, systems. The information we gather in this part of our Assessment forms the basis for our Pre-Sale Due Diligence in Step Two and Competitive Advantage Analysis in Step Three.
But our questions in this Step are unlike those we ask when performing Pre-Sale Due Diligence in Step Two.  For example, in this Step when we ask an owner about his employees we ask, “Do you know why your employees work for you?”  “Do you know how happy they are working for you? and “Do your employees affect your customers’ purchase decisions?”  By contrast, when we conduct pre-sale due diligence in Step Three, we ask for names of employees, tenure with the company, resumes of key managers, employment contracts, and EEOC policies and infractions.
In short, the Sale Readiness Assessment complements the due diligence process in that the latter is document-heavy and requires right-brain analysis while the former is softer and more intuitive.  The Sale Readiness Assessment not only helps us to determine if the owner is ready to sell, it provides the basis for the additional intelligent and targeted questioning necessary in the Outrageous Price Process.

Competitors
In this fifth area of our Sale Readiness Assessment, we seek the owner’s insights into his company’s competitors: who they are, whether the company has ever exploited a competitor’s weakness, and if, in the owner’s opinion, there is a competitor who might be a buyer.  We also want to know if the owner knows why potential customers choose to buy from a competitor rather than from the owner’s company.  Finally, we want to know if the owner is aware of, and/or measures her company against applicable industry standards.

Potential Buyers
Building on what we uncover about competitors, we ask the owner to list competitors, vendors, or others outside of the company who might benefit from buying the company.  If we anticipate that the buyer will be an industry player (as we often do in the Outrageous Price Process), owners generally are able to provide me a very good list of possible buyers.  On the other hand, if the company lacks the competitive advantage that we can leverage to cause a buyer tremendous gain or pain, your investment banker should do considerable research to create a comprehensive list of potential buyers. In either case, we want to know if the owner has any contacts in these organizations or is linked in any way to them.

Current Acquisition Activity
While any competent investment banker can gather data about acquisition activity in any industry, we want the owner to share with us his expertise and knowledge about any industry-specific valuation issues.  We ask the owner if she is familiar with any of the details of recent acquisitions such as:  why buyers are making purchases, what form of payment they use (cash/note/equity), how much they are paying and what size acquisition they prefer. This is the type of information we’ll collect from potential buyers as we prepare those buyers later in the Outrageous Price Process.

Competitive Advantage
Finally, we turn to questions related to a company’s competitive advantage.  We want owners’ opinions about why customers buy from their companies rather than from their competitors.  We ask owners if they have thought about developing a competitive advantage and for their ideas about how they could better position their companies to appeal to buyers.

This section of the Sale Readiness Assessment is the one that owners most often return unanswered, but answered or unanswered, these questions provide the springboard for our discussion of competitive advantage in Step Three.  If you are already scrambling (mentally, of course) to describe your company’s competitive advantage, let me assure you that few owners can articulate exactly what it is that makes their customers choose their companies over their competitors.  We’ll talk more about how to uncover and to exploit a competitive advantage in Chapters Four and Six.

As you can see, the purpose of assessing sale readiness is to obtain a fairly detailed overview of the company and to determine a likely sale price before entering the game (or going to market).  With that information in hand, owners can decide to pursue a sale, or return to their companies armed with information about how much they need to grow value and specific ideas about how to do so.
For a complete list of questions contained in the Sale Readiness Assessment, please see Appendix A