Navigating your sale

Running your own business is often more than a full-time job. So-called business hours demand focus on product, people and customers, while the rest of the day—and often night—is devoted to strategy.

Years of careful planning and effort go into making a company a success. Creating something out of nothing and sustaining it demands courage, hard work, perseverance, personal sacrifice and financial risk. For most business owners, it is simply a labor of love.

Eventually, though, the moment comes when the owner must decide who the next owners of the business will be. Here, we focus on the most frequent choice—the outright sale to a third party.

Most owners are surprised by the sheer complexity of the sale process, and the vast divide between the skills required to build and run a business and those required to sell it. Our goal is to shine a light on the latter set of skills — the key questions, assembling the necessary deal team, and the steps required to sell your business at full value.

First steps: A case study

Thirty years into building his company, John Kelly created a new concept. Eighteen months of challenging work later, John’s company has a new client segment and a new product set. With sales contracts in place, revenue will likely rise by double digits over the next five years. With the expected growth in EBITDA (earnings before interest, taxes, depreciation and amortization), John expects the company’s value to jump significantly.

He is wondering what to do. The company will almost certainly outlast his career and probably his lifetime. Yet his outside investments, excluding IRAs, are still less than the company’s excess cash. Meanwhile, he’s about to celebrate the birth of his sixth grandchild, his 36th wedding anniversary and his 60th birthday.

While his professional goals are largely achieved, some personal goals remain. John and his wife, Mary, have discussed gifts to their kids and educational trusts for their grandchildren, as well as a substantial donation to the medical facility that cared for both of their kids and two of their grandkids. He knows it’s time to move ahead, but he’s not sure how.

Over the course of a breakfast meeting with his attorney, accountant and wealth management advisor, John begins to form a plan to sell his company. He realizes immediately that the involvement of these advisors will be critical before, during and after the transaction.

Many factors require John’s consideration:

• What type of scrutiny will there be? John will need to prepare historical and projected financial statements including an income statement, cash flow statement and balance sheet. Historical numbers will be audited. And potential buyers will check for obsolete inventory or aged receivables.
• Who is on the transaction team? John will have to focus on his trusted inner circle, creating a core internal group of his management team that can maintain confidentiality. He should consider incentives to keep this team focused on both the day to day and a successful sale.
• What’s my personal financial plan? John needs to build a personal balance sheet, outline financial goals, learn how to transfer wealth efficiently and prepare his kids to handle their new wealth.
• Is it a sale to a strategic or financial buyer? Since John’s children aren’t interested in going into the business, he needs to consider a third party, whether to retain a stake for himself, and the type of buyer. This last item may impact whether John is asked to stay on with—or leave—the company.
• What’s my role in the company post sale? Will the buyer insist on a noncompete agreement? Would John still be able to run research and development while shedding the rest? Could a consulting agreement or earn-out defer some income and capital gains taxes?

After the meeting, John and Mary sketched out their personal goals:

• Give their kids gifts of $1 million each.
• Give approximately 10% of the sale price as a gift to the Memorial Hospital NICU.
• Spend 25% of each year traveling.

John meets again with his attorney, accountant and wealth management advisor to examine these goals and begin assembling the external team to work through the issues. John’s business lawyer refers him to a trust and estate attorney and a transactional, or mergers and acquisitions (M&A) lawyer. His wealth management advisor provides referrals to a business appraiser and investment banker.

Your deal team

The financial advisor

Financial advisors focus on the personal financial aspects of the transaction. They are often the first to arrive and continue to serve the client long after the company’s sale.

Financial advisors begin by talking at length about post-transaction objectives in terms of income, gift and estate, and philanthropy. They also need a thorough understanding of an owner’s financial situation, including an analysis of health and other benefits received through the business.

For many business owners, financial assets and income are tied to their business. Financial advisors are instrumental in working with owners so they can maintain their desired lifestyle once they no longer have access to business income. 

Once the owner’s priorities and financial situation are understood, solutions can be explored. A future sale may present an excellent opportunity for owners to shift assets off personal balance sheets, for example, by making gifts in trust, while still keeping them within the family and potentially minimizing tax implications. If advisors are involved early, they can explore a variety of strategies that may enable owners to transfer some or all of the upside potential of the business out of their estate.

Widely used strategies include the grantor-retained annuity trust (GRAT) and the sale of assets to an intentionally defective grantor trust (IDGT) in exchange for a note. In their simplest forms, both transfer the upside potential of the asset, rather than the asset itself.

Developing an investment plan for the sale proceeds prior to the sale is also recommended. A sound plan will factor in the owner’s return requirements and risk tolerance, and reflect an understanding of the owner’s financial life after a sale.

It’s important for business owners to realize that tax-saving strategies begin to evaporate as the sale approaches. Considering wealth transfer, income tax and investment strategies as early as possible can often save substantial amounts of money and maximize opportunities to create more wealth.

The business appraiser

Another key early member of the deal team, business appraisers provide opinions of value on the enterprise, stock involved in pretransaction gifting and management compensation, as well as intangible assets. Business appraisers, or valuation advisors, are involved in the sale process, but they are often engaged long before the sale gets under way. This often identifies value in intangible assets, intellectual property and goodwill for tax and financial reporting purposes.

There’s often a phase of the sale that incorporates the owner’s plan to transfer ownership interests to others who could benefit from the eventual sale. An owner may decide to gift or sell minority interests to children, or make a charitable gift. Those gifts have to be substantiated with an independent appraisal and a valuation advisor is necessary.

Appraisers are also required whenever company equity is offered to management as part of compensation or when company shares are owned in an employee stock ownership plan (ESOP).

Appraisers can also identify value drivers for companies and industries, as well as potential buyer concerns in a consulting context, without issuing a formal appraisal.

The transactional attorney

Among other things, transactional attorneys guide on structuring, obstacles and critical deal terms. They also ensure compliance with regulatory requirements and work through any deals with management incentives.

“It’s important to know that we do more than draft agreements,” says Stuart M. Cable, chair of the M&A group at the international law firm of Goodwin Procter. “We negotiate every term and condition other than price

“We understand the prevailing market practices in both strategic and private equity transactions, so we can advise the seller and M&A advisor as to whether the proposed deal is better, on par or worse than market terms,” he says.

What advice would Cable give to our hypothetical business owner, John Kelly? “The first order of business is to assemble a collaborative team of experts in whom you have trust and confidence. The team should include an investment banker and an M&A attorney. You should anticipate a six-month process. You should consider carefully the motivation and incentives of your key employees. You should also commission an up-front legal diligence review so that you identify and remediate any major legal impediments to value maximization before you are confronted with those issues by your buyer.”

A similar upfront audit of the company's financial statements, conducted by the business accountant, will also identify, and help in resolving, any bookkeeping or tax matters ahead of negotiations. This practice also helps to shed light on the tax consequences of different sale structures. 

Cable also highlights the importance of discussing with owners how they go to market, their interest in maintaining a role in the business, and how they are going to handle key people pre- and post-sale.

Does Cable have any final advice? “Trust your deal team,” he says. “This isn’t always easy, but the best results happen when the owner makes important strategic decisions but doesn’t dig in too deep on day-to-day tactical decisions.”

The merger and acquisition (M&A) advisor

While sell side M&A financial advisors take center stage as the sale approaches—assisting the client with its marketing efforts to a qualified universe of potential buyers —these critical members of the transaction team are active well before the sale process launches.

“Prior to launching any sale process, we discuss our client’s objectives in the context of market trends and industry dynamics to assist the client with their assessment of the optimal time to explore a sale,” says James Rourke, Managing Director in the Mergers & Acquisitions group at BofA Merrill Lynch. Rourke says, “Initial discussions with a client often center on determining how best to maximize value while minimizing disruption to the business and achieving an outcome that is consistent with the client’s vision for the legacy of the company post transition. These conversations may also include evaluating strategic alternatives other than a potential sale of the company. Knowing the client’s views on these and other topics well in advance of launching a sale process is often important in helping the client obtain a successful result.”

Once the client’s objectives are clear, the process can begin. “We work extensively with our clients’ management teams to facilitate interaction with potential buyers. Importantly, we help the client identify the appropriate parties to contact, with the goal of generating competitive tension along a structured, disciplined timeline that will deliver the highest valuation on the best terms. The decision to sell is very often the most substantial professional decision a client will make in their lifetime. Partnering with an experienced, trusted financial advisor early on can make all the difference in the pursuit of flawless execution once the decision to sell is made.”

After the deal closes

The sale of a company is more like a marathon than a sprint. During the process, a successful transaction usually becomes clear. With a well-chosen deal team in place, chances are that the owner has been giving thought to the deployment of both the cash proceeds from the transaction and his or her own human capital.

In terms of reinvesting the proceeds, the wealth management team will have been positioning investments in advance of the sale and developing a post-sale investment plan.

The transition from being entirely invested in the company to having mostly liquid assets and an open calendar can be both exhilarating and challenging.

For most business owners, though, post-transaction life gets easier over time. Just as careful planning and a great deal team can streamline the transaction process, thinking through post-transaction life and anticipating potential challenges can make it even easier.