Family businesses are critical to both the US and World economies. In fact, in the US alone, there are approximately 5.5 million family owned and controlled businesses. While much of the world’s wealth is a byproduct of family-owned businesses, the fact is that most are not actually prepared to sell in a way that will profit the owners for their life’s work.
Many owners of family businesses care deeply about the legacy that they built and want it to remain in their family or with someone that will continue it with the same mission, vision, and values on which it operates. This is often difficult as the owners lack an established succession plan or exit strategy.
Studies show that about one-third of family owners never even plan to retire. As a result, they have no succession or exit plan in place. In some cases, the business is forced to form a strategy by default when the business owner becomes burned out, disabled or worse, passes away. This is clearly not the best path when it comes to maximizing profits.
Pros and Cons of Conveying Your Business to Family Members
According to Businessweek.com, the average lifespan of a family-owned business is 24 years. About 40% of family-owned businesses are successfully passed down to a second-generation with only about 13% passed down to a third generation.  With the fourth generation and beyond, the survival rate is 3% or less. Regardless of whether a family business owner intends to convey their business to a third party or have it remain in the family, it is important to maintain confidentiality and have the proper documentation in place for a successful transition.
There are disadvantages that need to be considered if you plan to sell your business to a family member. One key disadvantage is that a family business owner will typically receive less value for their business than engaging the sale with an independent third party. Selling to an independent third party can often force a family business owner to also paradoxically agree to a lower value in an effort to negotiate the retention of jobs and incomes for the family members they wish to remain with the business after the sale. It is important to prepare the remaining family members that they will have to accept the fact that they now answer to new ownership and management with the business.
Handling Multiple Owners and/or Decision Makers
If there are multiple owners and/or decision makers in the family-owned business and the business is being sold to a third party, it is important to appoint one family member to represent the negotiations. Having multiple decision makers at this critical step in the process of conveying the business to a third-party owner can lead to numerous issues and headaches for both the buyer and seller. Many times, multiple decision makers cause failure in the ability to transition the business to third-party ownership, as the parties involved have competing priorities with the sale of the business that prevents satisfying everyone involved in the process. Keep in mind that all family members must be in consensus with the price, terms and sale of the business or it will never happen. This fact can be true even if the family members involved are just employees or active/passive investors in the business. Disagreements among family members often derail the possibility of a deal happening.
Obtaining Outside Assistance
To increase your probability of success with conveying a family-owned business to future generations or new independent ownership, having a third-party guide you through the process who is not emotionally involved like the various family members involved, can be critical in making the deal happen. That’s why a variety of professionals including business brokers, M&A advisors, lawyers, and accountants should be brought in to help.
This article highlights just a few of the myriad of issues and process involved in conveying your business to new ownership once you decide it is time to retire or move on to a new venture. If you are just beginning or actively considering transitioning your business to new ownership, please do not hesitate to reach out to us for advice and assistance.
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All too often a business owner decides to sell, only to learn a number of harsh realities. For example, oftentimes a business owner discovers that their lack of financial data represents a major problem. The simple fact is that prospective buyers will dive in and scrutinize every aspect of EBITDA (Earnings Before Interest, Taxes, Depreciation & Amortization) when looking at their perceived value of your business. This will most likely take place through what is called a Quality of Earnings Analysis Report (Q of E). General Accepted Accounting Principles serves as the key basis and language for financial reporting (known as GAAP Accounting). GAAP Accounting and Reports often represent a marked departure for how many companies handle their general and day-to-day accounting. The end result of all this can be a substantial shift in EBITDA as compared to what the actual number really is.
Potential buyers will ultimately receive numerous documents that outline the financial and operational health of your business during what is called the due diligence process in acquiring a business. This means that you, as a business owner, must be ready to invest a good deal of time in the process of disclosing as much accurate information as you can, in support and defense of the true and accurate EBITDA of your business. In short, preparing your business to be sold is no small affair when it comes to making sure that information is fully disclosed and in defense of the actual quality of financial and operational health to ensure the highest and best acquisition price.
EBITDA is one of the most common ways to value a business based on multiples of that number. When engaging your business for acquisition in the open market, you should expect that any buyer or potential investor will perform a review of your income statement for adjustments in order to arrive at an adjusted EBITDA that makes sense for THEM.
You need to be ready and fight back as to what the true Adjusted or Normalized EBITDA is, that serves as the basis for a purchase price of your business creating a value used with a multiple to negotiate a final price and terms that make sense for both parties. Miss out on the correct EBITDA for your business by $100,000 on a 3 multiple and you just gave up $300,000 in acquisition cost of your business – as an example.
There are three common EBITDA adjustments:
- First, items related to conversion based on a GAAP Accounting basis; this number can have a considerable range.
- Second, one-time events such as legal expenses, PPP loan forgiveness, insurance settlements, unusual expenses associated with issues/growth of the business can greatly factor into an adjusted EBITDA amount.
- Third, certain personal expenses a business owner takes that would typically not be part of the future cash flow of your business is another potential impact on EBITDA.
It is important not to ignore balance sheets when it comes to representing the financial health and aspects of your business as well. Smaller businesses typically focus strictly on profit, and this factor can result in balance sheets not being reviewed as often as they should be. A balance sheet needs to be recast in a way that the potential buyer truly understands the assets and liabilities that convey in a sale. It is better to recast the balance sheet upfront to what truly conveys with the business as the end result can be items popping up during due diligence causing hiccups in deal making and negotiations.
As an example – many times we see that business owners may park large amounts of cash in their business and on their balance sheets – over and above what is normally necessary. The minute a potential buyer sees a $1,000,000 cash position on a business when a $60,000 working capital position is needed, they are going to want that $940,000 cash to convey with the business. That’s fine if they are willing to pay $940,000 more for the business but not if they want the sale price of the business on a “cash free, debt fee” basis when the business conveys to stay the same with a reasonable sale price.
The same is true with liabilities. If you intend to convey the business without debt – if $500,000 in liabilities is relieved from the business, the value and burden of debt on the business logically increases by an adjusted amount in cash flow that is not needed by the business moving forward. This mathematically (and logically) increases the value of the business based on the cash flow used against the multiple used for valuation. Relieve $100,000 debt service to the business against a 3 multiple for the value equates to an additional $300,000 in value and price that the business should sell.
There are three key points that business owners should keep in mind when they are planning on selling their business:
- Make sure that managers and key employees are able to step in and run the business during the transition period.
- Review your financials, and get ready for GAAP reporting requirements during due diligence with a potential acquisition.
- Consider having a Quality of Earnings analysis performed with your business before going to market so you truly understand the financial health with your business.
As this article underscores, selling a business is a process with numerous moving parts. Well organized and solid financials – defensible EBITDA and operational health, represents to buyers and investors a sound and well-run business with an owner that is professional and realistic in their expectations.
Bottom line? Even if you believe it will be years before you place your business on the market, it is never too early to begin preparing.
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A lot of training and experience goes into good valuations. A variety of complex factors are involved. Plus, there are certainly some subjective elements. That means that one professional’s valuation may be different from the next. Let’s take a look at some of the factors involved when it comes to achieving an accurate valuation.
Determining the value of IP or other intangible assets can be difficult. If the business in question has trademarks, copyrights and patents, it can be far more challenging to properly assign a value.
Products and Services
As it turns out, businesses that only offer one product or service are far more difficult to analyze. If a company has a lot of product diversity, a professional will typically assess a higher value. The same is true for companies that have only one or two key customers. Lack of customer diversity can bring down overall values.
If a company is partially or completely employee owned, it can lower its marketability. Many company owners do not realize that employee stock ownership plans (ESOP) can change its overall value.
Life-Cycles and Supply Chains
In some cases, a business is nearing obsolescence due to advancements that have taken place. We often see this in technology companies. It should come as no surprise that if a business is near the end of its life cycle, this will raise potential issues during the valuation process. On a similar note, could the business be susceptible to supply disruptions? If a business is assessed as vulnerable in that area, it could also lower an overall valuation amount.
Accuracy of Data Received
Of course, the person handling the valuation must rely on the accuracy of the factual information they receive. If the numbers are off, the valuation simply cannot be as accurate.
These are just a few examples of the list of issues that can impact a valuation. If you’re trying to get an idea of what your business may be worth or if you ‘re wondering what factors might impact your valuation, reach out to our team. We’d be happy to discuss this in greater detail.
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When sellers get ready to put their businesses on the market, they often wonder what buyers are really looking for in an effort to make their businesses as attractive as possible. The answer to this question can seem mysterious when you are on the other side of the bargaining table. So, what are buyers typically thinking about when they make the decision about whether or not to purchase a business? It should come as no surprise that much of this is tied into earnings and stability.
Guarantees of No Surprises
Earnings that are sustainable are very attractive to buyers. After all, it allows them to know what to expect. Buyers can then factor in if they can advance the business in a way in which it would grow faster than the current pace. If not, they at least would have the confidence to know that the business will proceed at the same rate. Of course, no buyer would want to acquire a business only to find that it only had high earnings temporarily due to a one-time contract.
Accuracy of Information
Along the same line of avoiding surprises, buyers will want to verify the information they receive about a business. Anything involving past, present, or future legal issues will be scrutinized along with other issues, such as pending product returns. The due diligence process is when you can expect the buyer to really dig into the details of your business. You can expect that he or she will often do so with the assistance of an attorney and accountant.
Oftentimes, accountants or appraisers add back one-time expenses or non-recurring expenses. Buyers will want to look at the earnings and have proof of expenses that are non-recurring, such as fees for a lawsuit or heavy repairs to a building. Since this process inflates earnings, it can make it difficult for buyers to understand the actual earning potential of a business. Otherwise, those expenses would obviously throw off the true earning potential of the business.
These are just a few of the critical considerations made by business buyers when looking at a potential acquisition. There are numerous other considerations that a buyer will make and it is important to be prepared to address those questions and potential concerns a buyer may have up front, or they will quickly lose interest and move on to other potential acquisition opportunities. Put yourself in the shoes of a potential buyer and think about the kinds of assurances you would want before buying a business.
Working with a Business Broker or M&A Advisor can be tremendously beneficial in this regard. These professionals have worked with many buyers in the past, and therefore easily see things from a buyer’s point of view. They will not only be able to help you get prepared up front when buyers begin looking at your business, but easily identify and point out areas of concern that a potential buyer may have in order to keep the journey to closing on track.
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When it comes time to sell your business and sign on the dotted line, you only have one opportunity to get it right. In many cases, business owners have made critical mistakes while attempting to sell their business. This kind of scenario can often occur when an owner trusts a friend or relative to help navigate the process. In some cases, business owners have even been known to try to broker their deals on their own. Let’s take a look at some common errors that have occurred during the process when experienced professionals were not brought in to assist.
Not Prioritizing Confidentiality
We cannot understate the importance of confidentiality. When business owners try to go it alone, they often share valuable information with the wrong people, such as competitors. Or accidentally alert employees, suppliers and customers that the business is up for sale. When confidentiality is breached, unexpected and unfortunate consequences can result, such as employees looking for new work or customers switching over to work with different businesses. If any of these scenarios occur, it can devalue the business or even interfere with a sale going through properly.
Mistakes in Financial Information
If the party assisting you to sell your business lacks experience, he or she may accidentally omit preparing critical paperwork. Additionally, if the financial records are not properly audited, it could negatively impact the numbers. This could lead to lower offers and less interest from prospective buyers.
Failing to Involve Key Parties
Another error that could be caused by inexperience is neglecting to bring key parties into the deal. For example, when a business owner is guided by a layperson or trying to handle everything on his or her own, important people, such as the CFO, might accidentally not be brought into the due diligence process. While an error like this one might not necessarily kill the deal, it could lead to delays and complications.
The bottom line is that when it comes to a large transaction like selling your business, it is time to rely upon trustworthy professionals. There is a long list of protocols and steps that lead to a deal going smoothly. Experienced business brokers and M&A advisors will make sure that all the best practices are followed and that you come out ahead in the end.
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Many business owners don’t understand the concept of goodwill or how to calculate it. When a buyer is willing to pay a premium price for a business, far more than the company’s assets would typically dictate, that is considered goodwill. Any company can benefit from understanding how goodwill is cultivated and increasing it within their operations.
What is Goodwill?
Goodwill can be as simple as your company having an exceptional reputation and a very loyal base of customers. Often highly sought-after technology can be a part of goodwill. In other cases, goodwill can be in the form of IP or desirable domain names. However, as you can imagine, it is difficult to put a specific price on these kinds of benefits.
When a business involving goodwill is sold, it can be very challenging to determine a fair amount for a business, since subjective values are involved. In some cases, it can even be overvalued by the buyer. Your Business Broker or M&A Advisor will take goodwill into account when determining a fair and reasonable company’s valuation.
The Case of Personal Goodwill
In some cases, a company’s goodwill is personal. This is often due to a professional building personal goodwill with customers or clients. Oftentimes this is a relationship built over a period of time. In these cases, the goodwill is not necessarily transferable. The business is associated with a person who is often the founder of the company. You will typically see this kind of situation with dental and doctor’s practices and law offices.
So how does personal goodwill impact the sale of the business? When you sell it might be natural that the buyer will want protection in case the business faces a downturn when the current management departs.
What can work for the buyers and sellers is for the business owner to agree to stay onboard for a designated period of time. This can help ease the transition to the new business owner. In other cases, the buyer and seller arrange an “earn out.” Any lost business is factored at the end of the year, and then this percentage is subtracted from the amount owed to the seller. In some cases, funds are placed in escrow and adjustments are made depending on the performance of the business.
If you are buying or selling a business that involves personal goodwill, your situation may be different from that of the majority of businesses. However, a Business Broker or M&A Advisor can guide you through the process and ensure that all parties are satisfied.
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You may have heard the advice, “the best time to prepare to sell is when you start your business.” While this statement is far from realistic for most business owners and may even sound humorous, it does contain a certain amount of wisdom. When it comes to getting the best outcomes selling your business, preparation cannot be undervalued.
No matter where you are in the journey of running your business, we encourage you to prepare as much as you can. With that in mind, let’s take a look at some considerations and decisions that you’ll need to make when you do get ready to sell. It’s never too early to begin pondering the answers to these questions.
If you are involved in the day-to-day running of your business, logic would dictate that you’re quite busy and don’t have time to dedicate a lot of time towards the process of selling your business. The good news is that is one area where a Business Broker or M&A Advisor will make all of the difference.
Brokerage professionals will perform a variety of tasks from start to finish, including negotiating and interacting with prospective buyers on your behalf. These professionals will be able to work on many things independently and, if it is your preference, they can notify you only about the most relevant details of the transaction. On the other hand, you may want to be very involved in the process of selling. If that is the case, let your brokerage professional know.
Regardless of how involved you are with the business and the sales process, you will want to ensure that things stay as consistent as possible when you are in the sales phase. The reason for this is that buyers will want to see consistency. Any change in operations or revenue earned could turn out to be a red flag for a buyer.
Another item that is worth thinking about ahead of time is confidentiality. Professional Business Brokers and M&A Advisors will put utmost importance on confidentiality. When confidentiality isn’t taken seriously, leaks are very common. These could quickly interfere with the sale, whether it is due to a client/staff looking elsewhere or competitors taking advantage of the situation. Your brokerage professional will advise you of the policies and precautions that work best when it comes to preventing leaks and only revealing details about your business to prospective buyers who have been carefully vetted.
If you have partners in your business, it makes sense to bring up the discussion of a future sale well in advance. This will allow you to get on the same page about your plans for how things will be handled when the time comes. In the case that the date of the sale ends up being before you expect it to be, it will be very helpful to have already addressed these issues.
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Everyone knows that good employees are important for a thriving business. That’s why there has been so much emphasis on keeping employees happy. When your employees are feeling not only satisfied, but also valued, they will be more likely to keep your clients satisfied too. Your business will be more likely to thrive and grow. Of course, this works in the opposite direction as well. When your staff is frustrated and angry, their actions can drive away your customers and clients. If you are looking to sell your business for maximum revenues, it is a good idea to also maximize employee satisfaction levels.
Research from Oxford University found a link between happiness and productivity. According to their study, workers are 13% more productive when they are happy. It goes without saying that employees will be more likely to feel satisfied when they feel that their salary and benefits are fair for the work they do. If they are resentful about the compensation they are receiving for their work, this will ultimately impact their performance.
When you think about some of the most successful companies, you realize that many of them invest substantially in supporting their employees to cultivate higher levels of employee satisfaction. For example, Google is well-known for offering a wide range of perks ranging from parental leave and paid time off to free lunches and fitness facilities.
When it is feasible for employees to work remotely, many employers are finding that it makes sense to offer them this possibility. Not only will it help staff members to manage childcare, but also it can end lengthy and stressful commutes to work that could result in stress and anxiety.
Research in the journal Frontiers in Psychology showed helpful interventions that are proven to increase employee happiness levels. These included training in resiliency, mindfulness, and cognitive-behavioral techniques.
When you exhibit good leadership and act as a positive role model, your employees will likely follow suit. Employees should be acknowledged and rewarded for a job well done. In some cases, this may be a financial bonus, but in other cases it could simply be patting that employee on the back. Cultivating a positive company culture will prove to boost overall morale. This will increase success for your entire company.
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Are you selling a business that involves a lease? If so, this will be a factor that has significance to a buyer when you go to complete your deal. If your business relies heavily on its location and you don’t own property, then you’ll find the lease will be quite an important consideration for your buyer. By the same token, if you’re buying a business that involves a lease, you’ll want to carefully examine this document and consider how it might impact you and your business. Let’s take a look at some important clauses and terms you’ll want to be looking for.
What are the terms for transfer of the lease? This is something you’ll want to know before signing on the dotted line if you think you’ll be selling at some point in the near future.
How long is your lease? If your buyer can confirm that there are many more years on your lease, he or she will find that to be an advantage.
In the case of a business owner with a new endeavor, a shorter lease may actually be an advantage. That way the owner can get out of the lease if the business is not successful.
If you’re planning on a lease in a shopping center, it’s essential to get in writing that the center will not accept other tenants that do what your business does. Otherwise, you’ll be constantly faced with competing with a similar business.
It’s also important to look for clauses that address what happens in the case of an adverse event. For example, if the property was destroyed by a fire, who will pay in the interim?
There are other practical considerations to consider in leases that many business owners tend to overlook. For example, how are real estate taxes covered? Will you be charged a fee to cover maintenance of the property and, if so, what is it? Is someone in particular responsible for necessary repairs and who will pay for those?
It goes without saying that you’ll also want to check out clauses impacting rent changes. Otherwise, you may face unexpected rent increases that negatively impact your business.
If you are a new business owner, a landlord may ask you to personally guarantee the rent. This would be quite a different lease from one that accepts a well-established corporation as a tenant.
As you can see, there is much more involved in a lease than just the amount of the rent. Be sure to read your lease carefully and ask questions. A Business Broker or M&A Advisor can assist you with lease terms when you are buying a business.
If you’re selling your business, at some point you’ll likely be presented with a term sheet. As the name suggests, this document will include the “terms” of the deal including the basic economic terms and conditions of a prospective acquisition. It is a list of conditions to be met if the sale successfully takes place, yet it is not legally binding.
What is the Difference Between a Term Sheet and the LOI?
Both a term sheet and letter of intent (LOI) will include stipulations and lists for a buyer and seller to agree upon. The major difference is that the term sheet doesn’t require a signature, while the letter of intent does. In many cases, buyers are hesitant to sign before the due diligence stage. In this situation, you may find that the term sheet will precede the LOI.
How Lengthy are Term Sheets?
There is no standard model or form to a term sheet. Therefore, it may be as short as one page, or it could even be five or more pages. But no matter how many pages it may be, it should explain what is being purchased and a stated price. In some cases, the information in a basic term sheet will lead to a formal letter of intent.
What Components Should be Included?
In addition to the price and terms, a term sheet can include other considerations relating to the purchase of the business. For example, it can include employment agreements or non-compete clauses. They can also include conditions to be met upon closing. Often the term sheet will detail plans for the buyer to conduct due diligence and gain additional information. You can expect to find everything from warranties and lists of what is included in the sale to exclusivity clauses within term sheets.
One aspect of the term sheet that should not be overlooked is the method of payment. Typically, the payment sections are far more complex than just “cash at close.” Instead, they will describe a combination of elements including cash at closing, but also other forms of payments. In some situations, they will include details regarding a loan from the seller.
The term sheet is quite beneficial as it can expedite the sales process and prevent serious misunderstandings. As a result, this non-legally binding document can initiate a smooth beginning to a successful deal.
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