The Dismal D’s of Buy-Sell Agreements

/in , , /by Al Statz

Well-written Buy-Sell Agreements (BSA’s) enable orderly share transfers upon the occurrence of certain events during the life of a business. Buy-Sell Agreements also prevent litigation that can quickly create a lose-lose situation for business owners. This article presents a list of 27 trigger events and common issues to be addressed in Buy-Sell Agreements. And, just for fun, each item on the list begins with “D”.

Buy-sell issues are unpleasant to think about; which is why owners often put off addressing them and why we call them Dismal D’s. However, it’s only good business to put a plan in place that protects company and shareholder interests when these events occur.  And they will occur.

Buy-Sell Agreement Dismal D List

  1. Departure (quits or leaves)
  2. Disinterest (mentally but not physically leaves)
  3. Discharge (fired)
  4. Divorce
  5. Death
  6. Disagreement
  7. Deadlock (major disagreement)
  8. Disability
  9. Distress (within the business)
  10. Default (personal bankruptcy)
  11. Disqualification (licensing, regulatory, etc.)
  12. Disclose (confidentiality)
  13. Donation (donate or gift stock)
  14. Do not compete
  15. Dual entities (e.g. holding and operating)
  16. Dilution
  17. Drag-along rights
  18. Distribution policy
  19. Dividends and Distributions after a trigger
  20. Dispute resolution
  21. Death benefits (life insurance)
  22. Down payment and debt (buyout financing)
  23. Determination of value (fixed price, formula, or independent valuation)
  24. Defining elements of any valuation engagement
  25. Discounts (for minority interests)
  26. Different discounts (depending on trigger type)
  27. Dueling appraisers

Items #1-14 are common trigger events. Items #15-27 are common issues to be negotiated and addressed in the BSA. Items #22-27 are nearest and dearest to our hearts as business valuation experts. Arguably, valuation is the most important (and argued over) aspect of buy-sell transactions.

The above list is essentially a checklist for consideration by shareholders when creating or reevaluating a Buy-Sell Agreement. Owners should work with their partners, corporate attorney, CPA and business appraiser to understand and address all of these issues.  “Daunting D List” may be a better description!

Not only is it critical to have a BSA (yes, many businesses don’t have one), but it’s also vital that the BSA be kept up to date. Owners come and go. Shareholders’ personal, family and financial circumstances change over time. Likewise, businesses are not static and economic and industry conditions, services offered, customers, management depth competition are in a constant state of flux – all key factors in business valuation.

Click here for more information on how Exit Strategies’ helps with buy-sell agreements.

Business valuation plays a central role in buy-sell transactions and buy-sell agreements. Contact one of Exit Strategies’ senior advisors with any questions or for a no obligation, no cost and confidential consultation.

Exit Planning: A New Year’s Resolution

/in , , /by Al Statz
“Expect the best, plan for the worst, and prepare to be surprised.” – Dennis Waitley
This is the time of year when many of us decide that we need to change things or accomplish new things, and we set goals at the beginning of the New Year. Quit smoking; lose weight; make more money? How about taking a look at your business this year and begin to prepare it for your exit, which will ultimately arrive whether you’re ready or not.  Surveys have shown 75% of business owners have done little or no exit planning. Owners that do plan ahead are more likely to attract buyers and obtain a higher selling price. Here are some key steps to take this year:
1. Clean up financial records.
  • End commingling of expenses, assets & liabilities. This may result in increased tax liability, but will more than pay for itself by returning a higher sale price. Example: suppose you wanted to sell your businesses in 3 years. If the market multiple of EBITDA (Earnings Before Interest, Taxes Depreciation & Amortization) is 4, for every extra $1 of EBITDA you show on the bottom line, you receive an extra $4 in the selling price.
  • Declare all sales revenue.
  • Sensible, consistent, GAAP financial statements (from the buyer’s CPA prospective).
  • Normalize each of your financial statements. Make notes below each of your year-end statements regarding expenses that are non-recurring in nature, or one-time expenses that are not normal in your business operation.
  • Control expenses: if you have a corporation, take a look at your salary, perquisites and benefits. Decide what it would cost if you had to replace your services with someone else. A business broker/appraiser would make this adjustment to arrive at a modified level of earnings that is commensurate with market rates of compensation. If you have more than one owner working in the business, adjust the salary, perquisites and benefits for each of the owners.
  • If you personally own the building that houses your operation and the corporation or LLC pays rent to you, check to see that the rent is at a market rate. Differences between market rent and actual rent being paid will adjust EBITDA.
  • Pay all of your taxes on time; sales, personal property, payroll, etc.
  • Maintain sensible, accurate management reports.
2. Systems, policies and practices.
  • A well-documented operation pays off by adding intangible value from a buyer perspective.
  • Develop or update systems – and have detailed documentation for all processes your business performs.
  • Measure, report and act on key performance indicators
  • Develop or update employee manuals, policies and job descriptions  for each employee.
3. Personal Goodwill.
Depending upon the type of business and your role in it, take a hard look at your involvement with customers. If most of them do business with the organization because of personal relationships with you, begin to transfer these relationships to someone else or a new hire in your organization. From a value perspective, goodwill that is attached to you is more difficult to transfer to a buyer than goodwill attached to the enterprise.
4. Customer Concentration.
Take a look at your top 10 customers and the percentage of revenues and gross profits that each customer generates. A high concentration of business with a small number of customers will have a negative effect on value. One way to correct high concentration levels is to increase the size of the customer base.
For advice on exiting your company feel free to contact Bob Altieri at 916-905-5706 or boba@exitstrategiesgroup.com. 

February Seminars: Maximize the Value of Your Business

/in , , /by Al Statz
Now in its 9th year, Exit Strategies’ Maximizing the Value of Your Business seminar delivers essential and practical information to business owners who would like to sell for top dollar in the next 1-5 years.  It is not too early to plan the successful exit you deserve!
In this fast-paced workshop, business owners learn …
  • The elements of an effective exit strategy
  • Types of buyers and what they value
  • Business valuation nuts and bolts
  • How to increase valuable and marketability
  • M&A selling process steps and timeframes
  • Current market conditions
  • Deal structures and tax implications
  • The secret to cashing out
  • What a professional M&A broker brings to the table
  • Answers to your questions and concerns
This seminar is complimentary to owners of $1-30 million revenue businesses
 
Dates: Petaluma – Tuesday, February 10, 2015
Roseville – Tuesday, February 24, 2015
Time: 4:00 to 6:30 pm
Presented by: Exit Strategies senior-level advisors and a guest speaker
Register:
Petaluma:  707-778-2040, info@exitstrategiesgroup.com
Roseville:  916-800-2716, info@exitstrategiesgroup.com
Space is limited. For privacy, we allow just one owner (or set of partners) per business type. When we confirm your registration we will provide the location address. Schedule conflict? Contact us to be notified of future dates.
“Amazing amount of information that I can use immediately. You made a complex topic clear and easy to grasp.”  -KM
“Everything that you said would happen when we sold our business happened, and we were prepared. Thank you.” –TB
Because you only sell your business once!

– See more at: https://web.archive.org/web/20150212225951/https://www.exitstrategiesgroup.com/blog.html#sthash.IDVsikiL.dpuf

Your December Checklist for a 2015 Business Sale

/in , /by Don Ross
Thinking of selling in 2015? Here are ten actions you can take this month to achieve a higher price in the New Year. 
  1. Finish 2014 strong.  Buyers and their lenders will want to see your last full fiscal year profits on an uptick. Ship and invoice everything you should this month. Resist artificially pushing income into next year to reduce your tax bill.  Don’t go nuts prepaying expenses like monthly service contracts, retainers or rent.  Review the functional health of fixed assets.  They should be in good working order – after all you’re still in business – but refrain from replacing good with new this December.
  2. Sell off non performing assets. Assets that aren’t being used productively in a business reduce its return on assets. And, it can be hard to convince buyers that such assets aren’t necessary. If they aren’t necessary, dispose of them now and get them off of your balance sheet. Also, you’ll generate extra cash now that you probably wouldn’t get in a sale of the business.
  3. Assess inventory levels.  If your inventory turns are below industry norms, convert excess or slow moving inventory to cash. Write off any dead inventory that may be lingering on the books.  Why? Simply put, buyers buy cash flow, not inventory.  A one-time inventory write off is relatively easy to explain, and you won’t get paid for it in a sale. Also, Now is the time to take a physical inventory count (rather than estimate), and adjust your books accordingly.
  4. Have your CPA review the financials.  For those of you who haven’t prioritized accounting in the past, now’s the time! Are year-end CPA-provided expenses such as depreciation reflected in the income statement?  Are all “suspense” accounts eliminated and properly attributed to the right accounts?  Are divestitures of fixed assets removed from the balance sheet?  Are the financials verifiable against federal tax returns? Are capital leases correctly accounted for? Does the balance sheet make sense? Will your accounting make sense to a buyer’s accountant in due diligence?  Why is this important? As business brokers, over and over we see good buyers and lenders turned off by shoddy accounting.
  5. Pay as much as you can in taxes this year.  No, this is not a typo! Why? “Lifestyle entrepreneurs” who hide profits and pull everything they can out of their business often find it difficult to sell that business for a good price.  Entrepreneurs who pay the tax can usually sell the business at a multiple of earnings that well exceeds the additional taxes they shelled out. Explain to your CPA that you are selling in 2015; they should understand.
  6. Prepare the tax returns early.  Close the books and turn them over to your CPA as soon as possible after year end. Why? Business acquisition lenders need to see tax returns, and we can get an early jump on having your business preapproved for financing if the 2014 tax return is prepared.
  7. “Tend the Herd”.  If your business has customers under contract, find ways to extend those contracts.  If your customer portfolio is limited and you have one or two major clients that comprise a large share of your business, aggressively pursue new clients for better diversification.  The same is true with vendors.  Why? This reduces risk for buyers (and you), and business value is inversely proportional to risk.
  8. Update your business plan.  Why is this important if you’re selling? Buyers prefer to see business-as-usual while a business is for sale — especially buyers who are willing to pay top dollar. Businesses with a clear and compelling growth plan sell for more money.
  9. Assemble your transition team.  Consistent success in business sales requires A) an organized process, and B) expertise that few business owners have.  Assemble a team that includes at minimum a competent business/M&A broker, wealth manager, business transaction attorney and accountant. Pay for their advice and let them collaborate. You receive more in the end when you use the best advisors from the very beginning.
  10. Plan for your future.  Beyond the business sale, there is your next adventure to ponder.  Look forward to it. Find time during December to plan for it – with your transition team, so that you can enjoy it when the time comes.
Successful entrepreneurs plan their exit and sell from a position of strength, on their terms and time frame. For more information on any of the above points, or to sell your Northern California business, contact Don Ross at 707-778-0210.

Your Buy-Sell Agreement – Keep It Current Before It Costs You Money and Grief!

/in , , /by Exit Strategies

Buy-Sell agreements (BSA’s) are an essential, and often overlooked, element in allowing shareholders to realize the value of their investment in a privately held company. The BSA’s purpose is to a) provide a market for ownership interests, b) establish the price and terms for these interests, c) specify a buy-sell process that is orderly and reasonable, and d) specify financing should a “trigger” event occur. There are several reasons this contract among owners can fail. Let’s briefly examine a few reasons why this can occur and it will become obvious why this document needs to “live and breathe” outside the confines of the corporate archives.

A BSA that is written upon entity formation, even if well-articulated, becomes less relevant as time marches on.  This happens for myriad reasons ranging from changes in business conditions and value, or changes in an owners personal situation or objectives. Language in BSA’s is often not sufficiently precise and leaves too much room for interpretation that can result in shareholder disputes and costly litigation that dilutes value for all shareholders.

There are three types of BSA’s: fixed price; formula pricing; and valuation process. Business valuation is a function of economic conditions and business fundamentals. Of the three BSA types, only the valuation process is flexible enough to fully accommodate the range of changes that can occur in a business. Fixed price and formula driven valuations may be less expensive to execute, but they are simplistic and can omit key value determinants that ultimately can prove very costly.

There are a wide range of trigger events where an owner may quit, be fired, retire, die, be disabled, or get divorced to name only a few. Each trigger event can alter the personal objectives of one or more owners, impact the business, and may have both control and valuation implications for all concerned parties.

Template-driven BSA’s frequently either omit, or do not make a clear distinction on the standard of value to be used in calculating value. For example, the difference between using an investment value standard or a fair market value standard can be very large. If the standard is not clear in the BSA, a buyer would naturally assume the lower price implied in the fair market value standard, while a seller would assume the higher price found in the investment value. Hence, if the BSA does not clearly address this issue, conflict and costly litigation is a likely outcome. Similarly, the level of value also has valuation implications that create potential for conflict if not clearly addressed in the BSA, because the difference between a controlling interest and a minority interests can be substantial.

As is now readily apparent, a well-defined and current BSA is important to accurately allocate value and keep the peace! Key elements of the BSA should seem reasonable to all owners BEFORE a trigger event (before the parties know if they will be a buyer or a seller), when it is easier to reach consensus. AFTER a trigger event this becomes difficult since there is an inherent conflict between a buyer and a seller.

Business valuation plays a central role in Buy-Sell Agreements. For more information about Exit Strategies’ BSA-related services contact one of our senior business appraisers.

Don’t be a Victim of Seller’s Remorse

/in , /by Jim Leonhard
More business owners than you’d think second-guess themselves within a year of selling the business.  In my experience as an M&A advisor and business valuation expert, the main reason for the failure of business exits is the seller’s lack of planning on how and when to exit.  Too many owners never plan and simply wait until something happens that essentially forces them to sell, such as health issues, marital stresses, poor business conditions, or when “burnout” becomes unbearable. This is usually the worst time to sell — and the results are usually disappointing.
If you are approaching retirement, start proactively planning for it well ahead of time (3-5 years) while things are going well and while you have time to make and reap the benefits of course corrections.  Have the business professionally valued when you start to plan.  This will give you a sound basis for knowing what your business is worth, and understanding its strengths and weaknesses from strategic and financial investor perspectives.  If the value of the company is equal to or greater than you need or want, you can take steps to keep it that way and protect against contingencies.  If the value is less than you need or want, you have time to construct and implement a plan to increase value and reduce investor risk.
Your plan can then ensure that you exit on your time frame, maximize value regardless of the situation, minimize taxes, and reach your personal goals.
For more information about preparing to sell and exiting your business successfully, please contact Jim Leonhard at 916-800-2716 or jhleonhard@exitstrategiesgroup.com. 

Ingredients of a Successful Business Sale

/in , /by Al Statz
Going to market when you and your business are ready to sell and market conditions are right provides the best opportunity to maximize results. Let’s look at how these three ingredients combine:
  1. You, the Owner
  2. The Business itself
  3. The Market
Having these ingredients come together at the same time requires planning. You can prepare personally and you can prepare your company for sale.  You can’t control the market, but you can choose market timing. So, basically, it’s up to you to prepare yourself and your business so that you can initiate the sale process when market conditions are favorable.

Are you and your business prepared to sell?   

In complex business deals, we achieve more in the end when we use great advisors from the very beginning. Most business transition teams include an experienced M&A broker, valuation expert(s), an accountant with a strong tax background, a business transaction attorney, and a financial planner. Depending on the nature of the business and the type of transaction, other specialists may be needed. An experienced M&A broker can help you form a great ensemble.
Some of the questions that a transition team can help you answer include:
  • What is the company’s probable selling price in today’s market?
  • Are value drivers and detractors clearly identified?
  • How do marketability, goodwill transferability, due diligence survivability, and deal finance-ability measure up?
  • Who are the most likely buyers and what deal terms are you likely to see?
  • Is cash flow being optimized at this time?
  • Does management have good visibility and a clear runway?
  • Are you on top of major industry and market trends?
  • Will net sale proceeds be sufficient to support your (family’s) desired life style?
  • How will your proceeds be reinvested?
  • Are you ready for life after business? What are your personal plans?
  • Are you prepared to assist in a smooth ownership transition?
  • What steps can be taken now to minimize taxes and reduce risk at deal time?
  • Is the management team sufficiently committed to the future success of the company?
  • Are key employee incentives in place to support a sale?
  • Are leases and contracts assignable and attractive to a buyer?
  • Is intellectual property properly titled, protected and transferable?
  • Are all books and records in good order?

Plan ahead, or plan for less

There are so many potential obstacles to a successful sale that planning is a must.  Unless you have substantial training in this area and deal experience, its hard to see the obstacles, let alone overcome them.  A transition team will more than pay for itself as its insights and  recommendations help remove obstacles and add value, sometimes substantially, while you focus on running the business at peak performance and maintaining strong relationships with key stakeholders during the sale process.
 
If you have questions about preparing to for a business sale or forming a transition team, call Al Statz at 707-781-8580 or email Al to arrange a confidential consultation.

Is your company an add-on candidate?

/in , /by Al Statz
Most business acquisitions by private equity firms have been “add-on” deals lately.
In private equity jargon, a large company acquisition is usually a platform acquisition, and a smaller company acquistion is most often an add-on  (or “bolt-on”, or “tuck-in”) acquisition. Add-on acquisitions are complementary to and synergistic with an existing platform company held by a private equity firm. Platform acquisitions dominate the headlines and represent most of the dollar volume, but add-ons now represent the majority of deals.
The trend toward a higher percentage of smaller private equity transactions is continuing this year, as private equity groups have shifted their attention to add-on opportunities. This upward trend in add-ons is occurring across all industries and regions of the U.S. according to Pitchbook, a private equity and venture capital market research firm. Pitchbook focuses on the higher end of the middle market (over $50M transactions), however we’re seeing increased interest in add-ons at the very low end (transactions under $10M) as well.  Click here for a copy of the Pitchbook Q4 2014 U.S. Private Equity Breakdown report.
According to Pitchbook, high valuations are at least partially responsible for the continuing increase in add-ons, which generallydon’t attract as much competition on the buy-side as large platform deals.
This is great news for company owners looking to sell. If you are considering selling a $5M+ revenue business, chances are good that one or more private equity firms would be interested in adding your business on to one of their platform companies. If you are looking to divest all or part of a company, now is the time to learn what it takes to properly position your company for a successful exit.
Understanding what sophisticated investors are looking for is key to ensuring that you don’t leave money on the table when you sell your business. For a discussion about whether your company is a candidate for selling to a private equity backed company, or to explore how you can develop your company into an acquisition target for this type of investor, Email or call Al Statz, 707-778-2040, in total confidence.

Please don’t tell me liquidation is my best exit option!

/in , /by Jim Leonhard
While the typical premise of value in valuing an operating business for a sale/acquisition or exit planning is as a going concern, occasionally, facts and circumstances indicate that an owner would be better off liquidating his or her business.  Unfortunately, this often comes as a shock to an owner who has spent years working in and building a business with the expectation that it can be sold for enough to provide a significant nest egg for retirement.
When and why is liquidation the best course of action?
Fundamentally, liquidation is the best option for an owner-operator when the assets can be sold off or liquidated in an orderly fashion for more money than a rational, well informed buyer would likely pay for the company as an operating business. This is usually the result of the business, as structured, not being profitable enough to pay a new working owner adequate compensation for their labor and yield a reasonable return on their investment (down payment, working capital injection, and closing costs). It can also be the result of exceptionally high risk inherent in the business.
The failure of a business to afford a fair wage to the working owner is an immediate red flag.  Why is the owner willing to be under compensated?  In theory, he or she would be better off liquidating the business and working for someone else.
Sometimes a lack of profitability manifests itself as the business paying no rent or below-market rent on a facility that the business owner or his family owns.  If the business were suddenly burdened with a market rent, as would be the case for a new business owner, the business becomes much less profitable or unprofitable. The owner might be better off liquidating the business and renting the real property to another company.
An example of exceptional business risk is the inability to secure a long-term lease for a location-dependent business.  This problem is particularly acute for retail businesses whose sales can suffer dramatically from relocation, or a business with a very high investment in tenant improvements or equipment installation, such as car washes and food processing businesses.
We frequently uncover these issues and many others in our business valuation and M&A brokerage work, particularly with mature family-owned businesses. Fortunately, with sound business/exit planning, orderly liquidation can often be avoided.
For more information about preparing to sell and exiting your California-based business successfully, please contact Jim Leonhard at 916-800-2716 or jhleonhard@exitstrategiesgroup.com. 

Be Prepared!

/in , /by Don Ross
“Be Prepared” is the Boy Scout Motto that has served young individuals and their character development in over two hundred countries since 1907. It can also be an effective mantra for a business owner who will engage in marketing and selling a business.  A well prepared business owner plays a vital role on the transaction team and helps ensure maximum value to the shareholders and a smooth transition of ownership.
Critical components of “Be Prepared” for a business owner are the following:
● Sustain.  Continue to operate the business effectively.  Having made the commitment to sell, don’t allow your mind and spirit to “go on vacation”.  Maintain business as usual and meet or exceed your sales/profit projections.  Buyers want to invest in businesses that are running smoothly.
● Demote.  This may seem counter-intuitive to “Be Prepared”; however, it is important that you develop a management team that can operate efficiently in your absence.  The more replaceable you become in the daily affairs of the business, the more you eliminate buyer risk.
● Disclose.  Total transparency empowers the prospective buyer to make informed decisions, eliminates suspicion, and obviates potential “landmines” during negotiation and due diligence.
● Diversify. “One trick ponies” are difficult to market and sell.  You don’t want to be indispensable to the future success of the business, nor do you want to be overly reliant upon one or two customers or suppliers.  Buyers will perceive less risk when they see a well-diversified portfolio of customers and suppliers.
● Coordinate.  Your transaction team can include a business broker, accountant, attorney and escrow officer.  Work closely with them.  Make yourself available and responsive to their requests.
● Update. Current monthly financials and any significant changes in the business must be updated and forwarded to your business broker.  Remember that during marketing and negotiations, your business continues to be dynamic:  it can’t stop.  Buyers attribute greater value to a business that can provide timely, accurate reports.
● Improve and Maintain. A freshly detailed and serviced car is generally easier to market and sell.  Examine the physical attributes of your business.  Put a “fresh coat of paint” on the business: repair and replace furniture, fixtures and equipment that are integral to the business and remove those items that are inoperative or unproductive.
● Organize.  Among the intangible assets of your business that bring added value and goodwill are your company’s records.  Employment records, supplier lists, customer lists, procedural documentation, handbooks, contracts, licenses and permits, et al, should be organized and updated.  It is reasonable for a buyer to expect company records to be current, accurate and complete before the change of ownership.
To paraphrase a popular quote, “An ounce of preparation is worth a pound of cure”.  You don’t climb a mountain by starting at the top . . . you prepare, plan and perform and hopefully enjoy the trek along the way.
 
Don Ross is a business broker with Exit Strategies. He can be reached at donross@exitstrategiesgroup.com or 707-778-0210.