At some point, every business owner thinks about selling. No matter what stage your business is at, it is never too early to start planning an exit strategy. Achieving a successfully sale requires careful preparation.
The latest sale I was involved in was an SME in Singapore that had been going for more than 10 years. This construction project management company had over 100 professionals in more than six countries. The lessons learned from this sale also apply to start ups and SMEs.
1. Factors to consider when thinking of selling
There are many reasons why you might want to sell your company and it might not be an easy decision. Some start-ups are built to sell, but many owners become attached to their business, customers and employees. Is your decision about money, retirement, a change of direction or family reasons? Whatever the reasons, talk with shareholders and family before making any decisions.
Consider how much is your business worth? How much do you want? Do you need to lower expectations or work harder for a few more years? Who will run the business while you go through the sales process? Realistically, expect to be distracted for three to nine months. What are you going to do next? Will you work for a buyer, set up another business, or sail off into the sunset?
2. Once you’ve decided to sell, prepare, prepare, prepare
Buyers want clarity and to avoid risks, so the better you prepare, the smoother and quicker the sales process will be and the better the valuation you should be able to achieve.
Begin by ensuring you have the right team to see you through. I was hired as CFO by shareholders who wanted to sell in three to five years’ time. In the end, we sold the business in three and a half years. We set targets and the sale went almost according to plan.
Consider who your buyers might be, and your valuation. The industry norm for valuation is a price/earnings multiple (P/E). For example, they might take an average of the past three years earnings and value the company at ten times those earnings (a P/E of ten). Alternatively, buyers might be interested in the management team, a specific IP, a client, a long-term contract, numbers of customers, number of subscribers, or even a geographical market you have entered. Normally, it’s a combination of factors.
Target factors improving your valuation and ditch those not paying off. Close or sell side projects. If the valuation metric is earnings, focus on maximizing earnings in three years’ time. If it is subscribers, focus on subscribers – it may seem obvious but often this is forgotten. Focus on the goal.
Identify any skeletons in the closet. Issues discovered during due diligence will raise flags and risks and could result in a buyer not purchasing the company, a reduced valuation, delayed payments or long warranties where the seller covers liabilities. The longer a business operates, the more issues emerge, such as tax, pending court cases, insurance claims, etc. If you can’t clear them, consider whether to disclose them to a potential buyer.
Focus on what the buyer wants, your objectives and metrics. If you are selling for a 10x multiple of earnings, anything that adds $1 to earnings is worth $10 when you sell. If you need good people to get there, get them early and give them time to pay off. If you can’t afford good people, look at giving them shares or options. If people or investments are not performing and affect valuation metrics, consider whether you need them.
Understand any shareholders agreement and any other agreements covering investments such as convertible notes and bank covenants to ensure approvals are sought and disclosures are made at appropriate times.
Prepare a due diligence pack and keep it up to date. Use a due diligence checklist to work through documentation needed for legal and accounting aspects for the past three years of business operations. Set up a virtual data room to store documents; this provides levels of access and audit trails. Get this ready early rather than rush through it during the sale. Even small businesses find accounts, taxes, lease and employment details build up and are hard to find. The pack also helps find problems and gives you time to address issues.
Seek advice about making your financials look better. Clean up your balance sheet as early as possible, don’t forget earnings (or whatever metric you are using to sell) and where possible, ensure earnings growth. At the very least, buyers want to see finances for the past three years. Be ready to explain them.
Select an internal team to review the sales process. Brief them about areas they will be expected to discuss with potential buyers and what areas they should not.
Depending on the size of the sale, create an external team which are on the larger end and may consist of consultants, lawyers, tax experts and other advisers. You’ll certainly need a lawyer, so factor fees into your calculations.
Prepare for the unexpected. Market downturns, personal issues, other business opportunities and unexpected problems when conducting negotiations and due diligence may test your patience, so try to keep a sense of humour! The process might not be easy for a small company particularly if facing a large purchaser with a lot more resources.
Consider ways to minimize tax implications for the company, yourself and other shareholders prior to the sale. Finally, set a sales process timeline and stick to it.
3. The sales process
Once you are ready to sell, it’s time to identify a buyer. If you have venture capital or external funding from a professional house, they will be able to assist. If not, you may have already thought of a suitable buyer, possibly trade, sale to a competitor, partner or private equity firm. Otherwise, prepare a target list of 10 or more buyers. Who benefits the most from purchasing your business? Ideally, get two or three potential buyers interested in order to have a negotiable position.
Prepare a “teaser: document of less than than 10 pages, summarising the business. Include details about products or services, organisational structure, headcount plus some clients and minor financial details. To get buyers interested, highlight your business’ value. For competitive reasons, you may not want to state who you are.
For initial contact with buyers, consider using a third party who understands your business to discuss the sale opportunity. This allows for plausible deniability that your company is for sale if you prefer the market not to know about it.
If you cannot identify a buyer, advertise in a trade magazine or online (i.e. Craigslist or AsiaXpat for smaller companies). Alternatively, hire a broker. It’s an expensive option for a smaller company, but useful if you have exhausted other possibilities. If you’ve prepared early on, you should not need this option.
After initial contact, list interested parties. Obtain a non-disclosure agreement (NDA) and be ready to answer questions regarding your business. What is provided at this stage depends on who the buyer is (i.e. provide less information to competitors than other buyers). I’ve seen a few cases where competitors have just come in and done some due diligence then walked away with the info – the NDA being really only as good as your ability to pay legal fees, so be careful.
Discuss absolute and non-negotiable terms you expect including whether you and management want to stay with the buyer’s company, whether they want you to stay, will there be an ‘earn-out’ period where you need to stay in order to reach certain targets, or for example if you want certain employees looked after.
Obtain indicative non-binding offers and explore further details, monetary and non-monetary. This should lead to a binding offer, subject to contract and due diligence, at which point choose the best offer to enter into an exclusivity period and move to due diligence.
If you sell to a large organisation, due diligence could take a while. In the case of the Singapore SME, the buyer raised more than 500 queries. Since we had a virtual data room, all details were readily available and the buyer never needed to come to our office which kept the sale quiet until the last day.
You need to decide who knows about the sale. Discussing it with a larger team or employees could get them excited about a buyer but it may also result in employees and clients leaving.
Examine every clause in the sales agreement; it’s all negotiable and don’t give anything away lightly. Look at delayed payments, how much is upfront, how much later, whether you receive cash or shares, earn outs – how much and for how long, key staff arrangements, non-compete clauses and warranties.
Build a good relationship with the buyer and their team and raise issues as soon as they happen. Buyers want a level of trust or they might back out. Be open and honest about issues, as the last thing you need is problems and for the sale to break down.
Valuations is a whole different subject. In theory, a company is worth the discounted present value of its future cash flow. This assumption is difficult for smaller businesses and depends on a large number of assumptions. So stick with your numbers and if a buyer wants you, they will find a way to justify it. For start-ups, valuation depends on management, vision, how much money is need and what people will pay. Ultimately, you are only worth what someone will pay.
Finally, you and your lawyer must check all sales and purchase agreements. Don’t underestimate the time this takes. In the case of the Singapore SME, more than 50 documents needed to be signed and delivered on the closing date. The business was successfully sold to a UK-listed company that was an excellent fit with our business in Asia. It took almost nine months, and lots of late nights, but it was worth it.
Rob Christie has worked in Asia for 25 years. He currently advises business owners wanting to restructure, grow or sell their businesses at CFO Counsel. Prior to this, he was head of finance for various companies with revenues between U.S. $10-$70million. Having grown up in a pub, he has also, as a sideline, started, bought or sold many F&B businesses.