Chapter 1

By and large, business owners are a schizophrenic group.  When starting their companies, they put everything they own on the line.  Typically they pour into their companies every dime of their personal funds, pledge their family homes, and borrow from family members and banks fully confident in their ability to pay off those loans. Even though they risk financial destruction (and often divorce) in doing so, they readily accept overwhelming odds as part of the package.
When it comes to selling their companies, however, owners have little stomach for risk.  Having devoted heart, soul and nearly every waking moment to nurturing their companies, few are confident about or eager to cash in their chips and walk away.

OBSTACLES TO SELLING A BUSINESS: REAL AND IMAGINES
In my career as an investment banker, I meet successful business owners every day who are, at some level, thinking about how they will jump off the locomotives that their businesses have become.  But they hesitate.  Some for good reason: their companies are simply unprepared for sale.  Typically, “unprepared” means that without the owner’s involvement, the company’s continued profitability is uncertain, at best.  These owners have failed to install the systems and management teams that enable a successor owner to operate the company successfully.

So let’s set aside the group of owners that justifiably hesitates to sell because they have not done the planning necessary to create saleable companies and focus on another group.

In this group, we find owners who have saleable companies but believe that they cannot sell their companies today (or anytime soon) because the economy is too uncertain, buyers have fled the marketplace, and/or that the buyers who remain are bottom feeders willing only to pay bargain-basement prices. 

Let’s, for the moment, assume that all three of these boogeymen—the uncertain economy, The Ghosts of Buyers Past and bottom feeders—are real and are crouched and ready to pounce on owners naive enough to put their companies on the market.  How then to account for the sales that do happen—even in a tough economy?  Further, how do we explain the fact that some companies are not only selling at healthy prices, but are selling at what I call, “Outrageous Prices?”

I define an outrageous price as one that is at least two times the EBITDA multiple of an average company in its industry.  While less common than during the heyday of the M&A market, even today there are real buyers paying outrageous prices for ordinary companies. Why and how does that happen? These questions fascinate me and I share in this book some of the answers I’ve discovered.

  Please don’t misunderstand me:  I applaud owners of saleable companies who are hesitant to enter the marketplace, to a point.  I agree that owners do well to think twice about selling their companies, but not because of the current state of the economy or the presence of bottom feeders.  Bottom feeders are all-season creatures and the economy has always been and will always be cyclical.

I believe owners should think carefully before putting their companies on the market because without careful preparation a hefty percentage of companies put on the market will never sell.  According to an Ernst & Young press release, “M&A conversion rates are at their lowest point for a decade.  For transactions announced in the last nine months, only 60% by volume and 42% by value went on to complete in the same period.”  (Reference:  Global announced M&A deals rise in Q4 2012, but conversation rates continues to decline, London, 20 December 2012.

www.ey.com/GL/en/Newsroom/News-releases/Global-announced-M-And-A-deals-rise-in-Q4-2012)
  It is worth noting that the average deal value in the report (during the fourth quarter of 2012) was $231M.  The presence of very large transactions in the marketplace overstates the success rate for smaller companies.  Bigger deals enjoy better odds of closing because there are usually several buyers vying to make the purchase and often, the deals are worked out before ever going on the market.  In fact, there is as assumption that the big deals will close.

That's not the assumption in smaller deals.  While transactions of any size can fail to close for a number of reasons (many of which we will discuss later in Chapter Three), several of the primary reasons deals in the mid-market fail include:

• Sellers expect too high a price.
• If significant change in the selling company occurs, rarely is it able to quickly regain its balance.
• Buyers in this marketplace are harder to find.
• Family dynamics (common in this segment of the market) can work against a successful closing.

Large sellers have an army of analysts (and usually minute-to-minute stock prices) to set sale prices so they rarely go into a transaction with unrealistic sale-price expectations.  On the other hand, owners of mid-market companies must rely on a competent and experienced investment banker to align their expectations of value with that of the marketplace.

In addition, mid- and lower-middle-market companies are more vulnerable to significant internal changes than are large companies. In a mid-market company, the death of a CEO is a certain deathblow to a sale transaction.  In contrast, large companies have succession plans in place and a stable of talent that reassure buyers who react with a yawn or a simple adjustment to the payment of the purchase price.

As implied earlier, large companies generally enter the marketplace with several buyers waiting at the negotiating table or eager to pull up a chair.  Not so for mid- and lower-middle-market companies. I devote an entire chapter of this book to how to locate, interest and eventually sell mid-market companies to qualified buyers. (Chapter Five.)

Finally, there are a number of family-owned businesses in the middle market. Without planning, family dynamics can torpedo a deal before we even have a chance to pull up the gangway.  Even with careful planning, delicate relationships in family-owned businesses must be handled with extreme care if a deal is to close.

When one considers that the conversion rate for middle-market and lower-middle-market deals likely falls well short of 60 percent, the reluctance of owners in these marketplaces to sell makes sense.  Sellers have a great deal to lose if they put their companies on the market and fail to close the deal. Losses can include:

• Customers, employees and vendors.
• Fees paid to advisors
• The cost of the owner’s inattention to running the company
• The owner’s personal disillusionment

In my mind, this list is far scarier—and deadly—than the boogeymen that keep most potential sellers awake at night.

Loss of Customers, Employees and/or Vendors
In an effort to gauge sale-ability and price, some owners decide to tell “just a few people” that the company is for sale or attempt to negotiate with an interested buyer without representation.  In the first case, owners have no control over who learns about the contemplated sale.  Employees, customers, vendors and bankers all nurture and plug into various grapevines and all will likely react less-than-favorably to rumors of a sale.

Let’s assume that employees, vendors, lenders and customers don’t abandon your ship when they hear your company is for sale.  At a minimum, this juicy information will make them pause to locate the nearest exits. Competitors will do everything they can to exploit the uncertainty rumor of a sale creates to lead your customers and employees to their own greener pastures.

To owners who are tempted to go it alone or doubt the damage competitors can inflict, I relate the story of one owner  (let’s call him Fred) who called me after having been approached by a competitor about a possible sale.  Fred had allowed the competitor (now acting as a potential buyer) to meet with his employees and customers.  Within days of these meetings, the competitor/buyer began to hire Fred’s best employees and to steal his best customers.  When Fred confronted his “buyer,” it coolly informed Fred that it was no longer interested in pursuing the transaction.  Too late, Fred realized that this competitor had never had a genuine interest in pursuing a purchase.

Loss of Advisor Fees
More cautious owners will spend thousands of dollars to hire an investment banker to take their companies to market.  Some bring in their attorneys to perform pre-sale due diligence and most ask their accountants to straighten out and audit their financial records. During the several months that it may take an investment banker to discover that there’s no suitable buyer interested in purchasing the company, the owner has paid that investment banker a hefty upfront fee and monthly retainers.  That’s as good a reason as any to pause before leaping into the market.

Cost of Owner’s Lack of Focus
  Harder to calculate, but no less damaging is the price companies pay as their owners spend more time (and energy) thinking about and working on a sale than they do on maintaining the company’s profitability.  The Proactive Sale Strategy takes about 18 months to execute, and the timeframe for a well-structured, well-planned sale (from the date the owner hires an investment banker to closing) is between eight and 12 months.   If those timeframes are longer than you expected, consider that the sale process for owners who enter the sale process armed only with the hope that the right buyer will appear can last years, assuming the transaction closes at all.

Owner Disillusionment
It is not uncommon for owners to retain an investment banker after they have either attempted—unsuccessfully—to negotiate a transaction themselves or have used an inexperienced advisor. Remember Fred’s story?  After the last phone call with his competitor both Fred and his remaining employees were completely demoralized.  Fred’s loss of faith in the sale process convinced him that he was stuck in his company forever.  This loss of faith and subsequent belief that one can never sell makes it especially difficult for owners to rebuild their management teams and to regain momentum.

An owner’s loss of faith in the sale process is similar to the loss of faith in the justice system that an innocent person might experience after having been convicted due to incompetent legal advice.  In either case, the wronged person must re-group and use exactly the system he now distrusts, to regain what he is due (his freedom or a reasonable purchase price).

In the face of these real risks—and the perpetual presence of bottom feeders and a cyclically uncertain economy—what can owners who want or need to sell within the next year do to not only close the deal, but close it at the best possible price?  I’m so glad you asked.

WHAT NOW?
I’ve spent the last 20-plus years of my career immersed in bringing together sellers and buyers.  During the market’s heyday, the high tide raised all (or nearly all) boats yet, two nearly identical companies, might sell for two radically different multiples.  In the heat of battle I could do no more than resolve to think about this observation at a future date. I’ve taken that time over the past several years.
In the cool objectivity of hindsight, I’ve reviewed the deals in which buyers paid at least twice the EBITDA multiple of an average company in its industry.  I tested the possibility that a company that sold for twice the multiple of similar companies did so because the company was inherently outrageous: it had discovered a cure for cancer or the eat-all-you-want diet pill.  That proved untrue.  Most of these “outrageous” companies were quite ordinary and generally their owners did not realize that what they were doing differently could be very valuable to certain buyers.

I then looked at the buyers who paid these outrageous prices; maybe they were outrageously naive.  Since most of them are and were major corporations with legions of expert negotiators working on their behalf, that hypothesis did not hold water.

Then what was it?
After reviewing the details of numerous transactions in the middle market, I discovered what makes one company sell at twice the price of a similar company.  I’ve tested my hypothesis and can now describe a two-part a process that we can use not only to reduce the risk of not closing (in difficult markets when sellers far outnumber buyers) but also to secure the best possible—and sometimes even outrageous—sale price.

THE PROACTIVE SALE STRATEGY
I’ve named the rigorous process I use to position a company to sell to a well-financed buyer at the best possible price The Proactive Sale Strategy (PSS).  Prospective sellers engage in this process before putting their companies on the market.  The PSS reduces the seller’s risk of not closing by putting energy, resources and effort—in advance of any sale—into:

•  Understanding the seller’s asset;
• Identifying and remediating any issues that could prevent a sale;
• Uncovering (and often enhancing) the company’s competitive advantage; and
• Identifying prospective buyers.

In its concentration on the buyer’s needs, and in other ways that we’ll discuss later, the PSS is different from every other sale process out there.
  Let’s look at each step of the Proactive Sale Strategy briefly, then in more detail in the following chapters.

Step One:  Assessing Sale Readiness
Entering into any endeavor before one is ready can, and usually does, end in disaster.  Consider the hiker who ventures into the wilderness without adequate supplies or equipment or the student who sits down to a final exam without having opened a book. Not as common a nightmare, perhaps, but one with disastrous financial consequences is the owner who enters the M&A marketplace without careful preparation. 

For that reason, our first step in the PSS is to ask an owner to answer a multitude of questions designed to assess how prepared the company—and the owner—is for sale.  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.
We need to know what expectations owners have about their exits and then ask if various constituency groups within the company (such as other owners, key managers, etc.) share those expectations.  We take a quick snapshot of the advisors an owner is already using, before diving into all of a company’s systems with an eye to understanding and how transferable, scalable and reproducible they are.
We then look at a company’s environment:  its competitors, possible buyers, and current acquisition activity in its industry.  Finally, we take a second look at the Company’s systems to determine which one(s) might make the company different from its competitors and thus valuable to a buyer.

Step Two:  Presale Due Diligence
In this Step, we dissect all of the information we collected and analyzed in Step One.  The owner’s answers to our Sale Readiness questions guide us as we put the company under a microscope to see if it can withstand the scrutiny of a buyer’s due diligence.  Buyers pry open every dark closet and turn every stone before taking a seat at the closing table.  For that reason, owners must not only reveal to us every skeleton in every closet, we must remove those skeletons or minimize their potential negative impact upon the buyer.  Preparing for due diligence before the sale process begins saves time during the sale process, and thus reduces the risk of a failure to close.

Step Three:  Identify the Competitive Advantage
Again in Step Three, we turn to the preliminary information about the company that we collected in Step One.  As you know a competitive advantage is the product a company makes or service it offers either better or more cheaply than its competitors—over time.  In the context of the Proactive Sale Strategy, however, we are looking for an existing, or potential fit between the seller’s competitive advantage and the buyer’s need.  Better yet—and absolutely critical to getting an Outrageous Price for a company—we are searching for a way that the seller’s company: (1) can (or could, if given time and preparation) meet a buyer’s immediate need, or (2) could pose an imminent threat to a buyer.

Step Four:  Identify the Buyers
At this point in the process we focus our attention on potential buyers in the marketplace. Our goal is to identify which companies in the M&A marketplace can use their significantly greater resources (such as access to capital, more efficient processes, deeper or wider distribution channels, or massive sales force) to make more money from a company than can its current owner.  Identifying the potential buyer, or possibly buyers, takes a huge amount of research, but pays equally huge dividends as it significantly reduces a seller’s risk of not closing.
Once we have identified the buyer(s) that could benefit most from acquiring a company, we will gather competitive intelligence about these buyers.  We look for information about:

• Past acquisitions;
• Prices paid;
• Changes in strategic acquisition plans;
• Problems they may be encountering in their industries,
• Changes in their industry position or reputation,
• Personnel changes; and
• Changes in their regulatory environment.

We’ll use that information about a buyer’s preferences and behavior (if we engage in the Outrageous Price Process) to map a strategy to make that buyer aware of the value in the acquisition.  We’ll talk about ways to inject awareness of the seller’s company into the consciousness of the selected buyers in Chapter Seven.

Once we have determined how to catch the buyer’s eye, we can actively, yet anonymously, engage the prospective buyer.  When an investment banker engages a potential buyer, it contacts representatives of each prospective buyer on a seller’s behalf without revealing the selling company’s identity.  Owners simply cannot maintain their confidentiality when representing themselves.

As the relationship between the transaction intermediary and potential buyer grows, we learn more specific details about what a buyer typically pays for companies in the seller’s industry, who its negotiators are, what attributes it looks for, and what problems it commonly encounters.  We use this information so that when the seller announces its intent to sell, it does so with all its ducks in a row.

The Proactive Sale Strategy reduces a seller’s risk of failing to close the deal, but it also increases the seller’s chances for getting the sale price he or she wants—even in a tough M&A market.  It does so by carefully preparing the seller’s company, aligning the seller’s assets to the buyer’s needs, and understanding and acting upon the buyer’s priorities and preferences.
Let’s look at each step in more detail beginning with Step One:  Assessing Sale Readiness.