Ripe For Selling?
Bill Karol had high hopes when he put his Nivel Parts & Manufacturing up for sale last summer. But even he had no idea just how sought-after his distributor of parts for golf carts would turn out to be. Twenty-three potential buyers responded to the selling memorandum prepared by Karol's investment bankers. It's easy to understand their enthusiasm. The Jacksonville (Fla.) company has little competition. Since purchasing Nivel in 1998 for $7.5 million, Karol had expanded its warehousing capabilities and its inventory. The 30-employee company had shown earnings growth of at least 10% in each of the previous five years. By the time Karol put it up for sale, Nivel had $17 million in revenues and gross margins of 50%.
On the next-to-last day of bidding, Karol was looking at several solid offers, the highest at $28 million. Then, at the last minute, New York buyout firm Sentinel Capital Partners showed up with a bid of $30.5 million. There was a catch, of course: Unless a deal was struck that night, "the offer would vanish like Cinderella at midnight," says Karol.
IT WAS A NAIL-BITER. Serious talks got under way at about 6 p.m. Eventually, Sentinel would decide its growth projections for Nivel were too aggressive and begin cutting its price. Still, by midnight, Karol and Sentinel had reached a verbal agreement. Karol had a letter of intent in hand a few days later. "It's nice to be popular," he says with a laugh.
In the end, Karol got $28.7 million for Nivel. That's 6.8 times Nivel's earnings before interest, taxes, depreciation, and amortization, or EBITDA. And it's a great price: Multiples on deals valued at less than $50 million averaged 5.5 times trailing EBITDA in 2003, according to Standard & Poor's. Beatrice Mitchell, a principal at New York investment bank Sperry Mitchell -- and Karol's banker -- says that multiple has continued to rise through the beginning of 2004. High-quality companies, she says, are going for as much as six to eight times EBITDA.
Sure, it's a seller's market. But the economic environment is not the only consideration when deciding whether -- and when -- to sell a business. Your goals for your company and yourself loom large. Entrepreneurs like Karol will sell one company only to buy another. Other owners may be inching toward retirement. Trends in a particular industry also play a role.
If you decide you are ready to sell, be aware that the road to a deal can be rocky. Even for old hands, the process of selling a company is complex, stressful, and time-consuming. "I've done more than 200 deals in my life, and I still haven't done an easy one," says James B. Freedman, managing director of Los Angeles investment bank Barrington Associates.
Still, a solid understanding of how deals typically work, plus a few smart moves before you put up the for-sale sign, will help you fetch the best price and keep your deal on track. You'll need to make sure your financials show your company in the best possible light, have a strong management team in place, and understand your options regarding deal structure and payment. No matter how hot the market, says Andrew Sherman, capital partner at Washington (D.C.) attorneys McDermott Will & Emery, "preparation and having the right advisory team are critical."
Several economic and market factors have converged to drive up the pace of buying -- and the prices. Private equity firms, which account for about 60% of buyouts of small and midsize companies, spent $89 billion on such acquisitions last year, according to Buyouts newsletter. That's more than double the 2002 outlay, and almost four times 2001's $23 billion. And many buyout firms are still sitting on capital, waiting for the market to ripen. Buyouts pegged uninvested capital at $90 billion in 2003. Much of that capital was raised from institutional investors in the late 1990s. Unless it's put to work in the next two or three years, buyout firms face the prospect of having to give the money back.
At the same time, a rebounding economy means many small companies are looking more attractive. Revenues and earnings are perking up. Strategic buyers -- those looking for geographic diversification, product-line growth, or new customers -- are also worrying less about flatlining sales. Instead, they can focus on expanding their businesses, often by buying other companies.
Lenders are pitching in, too. Low interest rates are prompting banks to lend more, allowing buyers to bid higher or use more cash in a deal. In 2001, lenders were willing to finance deals at about 3.5 times cash flow. That multiple was up to 4.1 in 2003, according to S&P. "Now is a very, very good time to sell," says Mitchell. "The market is extremely active, and there's a tremendous amount of interest in small companies."
BUT CHERYL LONDON HAD mixed feelings when a buyer came calling last March for her Chicago-based Illinois School of Health Careers, a for-profit vocational school she co-founded with Karen Genender in 1990. Enrollment had exploded by about 25% in each of the last three years as frustrated job hunters returned to school to get training in new fields. London was eager to build on that success. Yet she also knew that her industry was consolidating and that large institutions were snatching up smaller schools like hers.
Four months later, London sold her school to ForeFront Education in Barrington, Ill. Although a nondisclosure agreement prevents her from divulging the sale price, she says: "I knew my business was doing better than it had ever done before. That's when you get your best dollar."
Many business owners, like London, aren't actually running their companies to get top dollar. Instead of maximizing revenue and earnings, they're plowing money back into the business. But since earnings and revenues are two numbers buyers look at, anyone contemplating a sale should run the company with an eye to these figures for at least a year.
Even if your business is doing well, it may not look that way on paper. Your accountant should prepare at least one year's audited financial statements with a sale in mind. If the business has been managed to minimize taxes -- say, by providing its owners with generous compensation and plenty of perks -- your accountant can recast the financials to reflect the elimination of those costs. On paper, this will boost your company's cash flow and earnings.
Building a strong management team is also crucial, as a buyer will naturally worry about who will manage a company after it's sold, says Freedman. You'll need a strong second-in-command, chief financial officer, and head of sales and marketing. And you might need to give your team some incentive to stay on after the sale. Before selling Nivel, Karol explained to his management team that the company needed the financial resources of a buyout firm to keep growing. As part of the deal Karol negotiated with Sentinel, Nivel's management got a slice of the company.
Above all, keep your eye on the ball. The most common reason deals collapse? Owners and managers get distracted by the selling process, allowing revenues and earnings to stumble. "You should run the company like it's not going to sell," says Rick Kohr, president of Columbia (Md.) investment bank Evergreen Capital.
ENTREPRENEURS ARE NOTORIOUS for trying to do it all, but when it comes to selling a business, that can be a big mistake.
Karol discovered that the hard way. Two years ago he decided to sell an automotive specialty chemicals business himself. He contacted two potential buyers and signed a letter of intent with the larger of the two. That company went on to cut back on every promise it had made to Karol during the negotiation phase. Karol wound up selling the business to the second bidder for 25% less than the first company had offered. "Get help," he says. "You'll have to pay a fee, and that's painful, but it's money well spent."
Such help generally consists of three types of professionals: an investment banker, an attorney, and an accountant. The investment bankers reel in buyers and manage the sale. They send out a package of information on your company, set deadlines for bids, and negotiate the deal. And they'll probably get you a better price than you could manage on your own. Unsolicited offers run about 20% less than bids clients get by putting their companies up for auction, says David Kauppi, president of Mid Market Capital, a Hinsdale (Ill.) mergers-and-acquisitions firm.
A good broker also will keep a second and, ideally, third buyer in the loop in case a deal goes south. "People who are inexperienced in this business always assume the top bidder will do the deal. We assume they won't. We always have backups," says Freedman.
An attorney helps negotiate the final purchase and sale agreement after a letter of intent has been signed. You might not want to use your regular attorney for this, and indeed, experts caution against doing so. An attorney that has an ongoing relationship with the company may have a vested interest in seeing the deal fail, in order not to lose a client. What's more, negotiations often grow contentious, so finding an attorney with extensive dealmaking experience is crucial.
BEYOND PUTTING YOUR finances in order, your accountant can also figure out the most advantageous structure and terms for your sale. The terms of the deal, and whether stock or assets are sold, can have large tax implications. "To the extent you can predict the tax impact of a sale up front, that's a huge help," says John Muskus, a partner at Grill & Partners, a tax and accounting firm in Fairfield, Conn. "You can negotiate with a lot more knowledge."
Then, of course, comes the minor matter of getting paid. Most sellers love the instant gratification that comes from an all-cash deal, but there may be good reason to consider alternative payments. Used properly, they can help entrepreneurs lessen their tax hit. In some cases an alternative payment arrangement can even result in a premium being paid for the company.
One alternative to cash is a note, or promise to pay. They're typically paid in installments over five to seven years, and you pay taxes only as you receive money. The drawback? If the buyer mismanages the company or its own finances, you may not get paid in full. It's essential, therefore, to do a thorough investigation of a buyer's credit history before agreeing to accept notes.
So-called earn-outs can help you get a price that reflects the earning potential of the business -- especially if the buyer is less optimistic than you about the company's future. With an earn-out, you'll get additional payments after the official sale -- but only if the business hits certain targets. Buyers like earn-outs because they can deduct the payments as ongoing business expenses. For you, the payments are ordinary income. Of course, if the company misses its numbers, you can say goodbye to those extra payments.
Richard Oppenheimer chose a blend of cash, notes, and a consulting agreement when he sold Holbrook (N.Y.)-based Jentronics, a $2.2 million manufacturer of electronics, in 2002. Oppenheimer got 75% of his price in cash and 25% in a one-year note and agreed to stay on as a consultant for a year. He says he had an offer for twice as much as he eventually received, but 70% of the purchase price would have been paid out over 10 years in a note. He says he has no regrets: "I can sleep at night, not wondering if I'll get paid next month," he says. "I had too many nights like that when I was working."
Perhaps the greatest risk, however, is sitting out a healthy market. There's no guarantee that these favorable conditions will last. Kauppi has this advice: "If you have the opportunity to take chips off the table now, do it." Whatever your plans, a successful sale could be the smartest business move you've ever made.
By Virginia Munger Kahn