Most entrepreneurs dream of someday selling their company. There are several steps they should be taking well in advance to ensure a profitable exit. Procopio Partner Bill Eigner identified 8 key steps business owners should take during a webinar hosted by the PBO Advisory Group.
Below are some highlights from Bill’s remarks.
There are a lot of things that a business owner should do to plan for a successful exit. It’s easy for most people to remember three steps. I’ll start with three, but also offer some extras.
1. Adjust your ownership stake
It’s important to own less of the business when you sell than you have now. That can include working with your advisors for your estate planning, such as setting up a trust for your family.
Here’s a really dirty little secret. If you’re selling your business to a big company, they are going to tell you, “Fran, you own 50% of the company now. Well, now you’re really owning 25%. We’re going to have you revest in half of your stock over the next three years, and we can terminate you for any reason during that time. And Fran’s going to say, “I’m not going to put up with that.” But that’s what she says at the beginning. Then she sees a big number and says, “Okay, we’ll do it.” If you have already taken some of Fran’s stock off the table, then less of it is at risk.
Now, obviously we negotiate for better terms than what they’re first offering. Still, it’s important to give them a smaller target to aim at. They’ll put their arm around you and say, “Fran, you can ask around. We’ve never terminated anyone.” But if you look around you’ll find they have, and usually after two years instead of three. They’ll maybe make a deal with you, but you’ll get less than you expected.
So, if you’re in the process of getting ready for a sale, do your estate planning. Maybe set up a trust with your wife’s name or family’s name or just some geographical name and figure that some second-year associate at a law firm who’s preparing the term sheet or letter of intent will may spare you the hit that you’d otherwise take. You’re therefore already playing with house money.
2. Consider your future salary
Most CEOs and business owners don’t think of their salary as important. They imagine their distributions and other money they’ll receive. When they control a business, they continue to essentially get what they want, or at least what the business can pay. Once you sell the business, the buyer may want you to stay, but you are working for them at that point and yet you’ve never negotiated yourself an employment agreement. You need to have an employment agreement in place, basically you with yourself that will be more favorable. You could have a severance provision, at least for one year. You can include fringe benefits, such as having a car from the business. Now the buyer may not agree to those terms, but it’s a place to start.
Clients taking this step have thanked me afterward and said, “Oh my God, you saved me hundreds of thousands of dollars by ensuring I get paid.” Otherwise the buyer will say, “Here’s our standard agreement. Here’s our standard package.” You’re not sure what you’re going to get when the deal closes. This protects you going forward.
3. Secure documents in a data room
The third thing you should do is get your documents into a data room. There isn’t a high close rate for exits; only about 30- 40% of the time you’ll close. You may have to keep providing documents to new buyers. If you have that material sealedd into a data room, you can easily review it and ensure you’re complying with all the due diligence and be prepared for any gaps.
And now the extras:
4. Have an audit
If you have the luxury to do so, you should have an audit conducted. When you are selling your business, in your letter of intent and in the other documents, there will be references to GAAP, which means generally accepted accounting principles. Most private businesses aren’t GAAP compliant. With an audit, you can at least understand where you’re not GAAP compliant. You can be prepared, because you’re basically speaking French and the buyer is speaking English. They’re referring to numbers that differ from yours, and when you close you may owe them money. The audit also helps you reassure the buying company’s staff, because the person who recommends buying your company is at severe risk. She could lose her job if the deal doesn’t go well. If your company is audited, then she can say, “Hey, they were audited. It’s not my fault that their numbers weren’t right.” It helps you earn credibility with the buyer.
5. Consider vesting options
Give a lot of thought to your stock option plan. What happens in the event of a change of control when the company gets sold? Will there be an acceleration of vesting? If you’re the recipient of the options, then you want that. On the other hand, if you’re the owner of the business, you want to protect your employees, but you don’t want them to get all their cash at closing. In that case someone has to give them more money to stay on, and it usually comes out of your pocket. That’s why you sometimes will have double-trigger provisions in the options whereby, with an employee, there needs to be a change of control and they need to be terminated without a reason or for a bad reason within a year. It protects the employee, but also protects the owner from having to further subsidize the deal.
6. Ensure you have the right Board of Advisors
It’s also important to take advantage of your Board of Advisors. They can be really helpful in raising money, giving you credibility, introducing you to customers, and helping you recruit talent. They can also advise you on lines of business that you should pursue to increase your valuation. Now during the operation and growth of your business, try to be nimble. You want to be able to change out your Boards of Advisors members in a way that meets your current needs.
If you want to sell your business, the ideal advisor would be someone who sold her company to the potential acquirer of yours. She has credibility with the buyer, and can discuss the seller in a way that they’ll feel more secure doing the deal. Most importantly, it gives you credibility with a buyer, a halo effect. What you’re trying to do is put yourself on Mount Rushmore with the best presidents we’ve had. You want the best people in your field with you. Business owners who have had a big exit and who enjoy good credibility with their buyers are ideal.
7. Connect with investment bankers and other professionals early
Start thinking about your exit well in advance. You don’t want to start looking for an investment banker two months before you want to sell. It’s better to make contact two years out and say, “Please take a look at where we are and let us know where we need to be. What part of our business will be most lucrative in two years? Where should we invest?” It doesn’t mean you have an obligation to retain that person, but it’s smart to start educating yourself early.
What business owners have to understand is that they are often one-time players up against a professional team. They’re like the Boston Shamrocks or the Washington Generals having to play the Harlem Globetrotters. Or it’s Bambi versus Godzilla. It’s easy to look silly. You need professionals involved because the buyers have very smart, extremely well-educated people who will say, “Let’s just talk person to person. We don’t need the lawyers involved.” These people are often lawyers themselves. They’ve been through this before. They know certain business owners have a particular number in mind and they’ll offer a letter of intent with that number. What happens, though, is that with a quality of earnings report and other due diligence, by the time the payment comes to you it’s gone through a funnel and can be greatly diminished. Involving professionals early helps you scale your business as you’re going forward and realizing more when you sell it.
8. Do your homework on buyers
This is when a seller has to have their BS detector at full force. It’s important to qualify your buyers as you compare offers. It’s like selling your house. What if somebody said, “I want to buy your house, but it’s subject to financing and I have the right to assign it to somebody else.” That’s not yet a real sale. You need to qualify your buyers and not waste time with ones that aren’t qualified. With some private equity, they’re basically borrowing the money or they’re going to their investors deal by deal. What sometimes happens is you’ll get a letter of intent with certain terms, you finalize that, then the financier of the deal says, “Oh, wait a minute, I need these additional points.” Now you’re renegotiating and getting less favorable terms because by then you’ve been worn down.
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