RSM Resources

For many reasons, now is a good time to sell a midsized, privatelyheld business. Prices are up, buyers are hungry, and financing isplentiful. However, experts say that lack of careful sale preparationwill prevent many business owners from maximizing the opportunity.

"Atthe end of 2005, there was about $200 billion in private equity capitalavailable for investing, not counting hedge funds and foreign buyers,which means there’s a lot of money chasing an inadequate supply ofquality companies," says Brian Boyle, a managing director with RSMEquiCo Capital Markets.

"When you factor in purchasing powergenerated by leverage, this total swells to $800 billion to $1trillion. Moreover, these figures are only for financial buyers and donot include industry or strategic buyers. But too many companies thatcould profit in this environment are hurting themselves because theydon’t take the time to create a realistic transition plan for a sale."

Aconfluence of factors has created the favorable deal climate. Forexample, the leading edge of baby boomers reached age 60 this year, andmany entrepreneurs in that generation are looking for new challenges.Some may sell a business to pursue personal interests, while others maywant to pursue new business ventures that better align with theirprofessional experience or goals.

While interest rates have beeninching upward, the cost of borrowing has not yet slowed the pace oftransactions involving midsized firms. In 2005, the InternationalNetwork of M&A Partners (IMAP) reported closing 220 deals worth$4.1 billion, a 14 percent increase from 2004. At the same time, deal"multiples" — the ratio of purchase price to revenue — were reported atbetween five and nine times EBITA (earnings before interest, taxes andamortization). Businesses with strong financials, stable management andattractive market niches often commanded price multiples above thatrange.

However, experts are quick to note that hot markets don’tlast forever. As more and more sellers crowd the midsized market, themost successful participants will be those who follow a cardinal ruleof home selling: "Stage for show, count more dough."

How can you best stage your company for prospective buyers? Consider the following tips.

Determine your timeline.Even in a strong seller’s market, finding an appropriate buyer andclosing a transaction may take up to a year. With that in mind, expertssuggest that business owners begin planning two to three years beforethe desired sale date.

"If a business owner is 74-1/2 andwants to have the company sold by age 75, it’s not a great idea tostart planning six months beforehand," Boyle says. "Very rarely doowners get a chance to just hand in their keys and walk away, so youreally need to allow at least a two-year window to plan a transitionout."

Establish a management succession plan. Businessowners should appoint a clear successor in the early planning phase.This can be either a strong inside player who has the talent to growthe business or an outside hire with a strong leadership track recordin comparable organizations. From there, identify, approach and giveincentives to key management and line employees. "Stay bonuses" canencourage employees to remain with the organization for a specifiedperiod up to and after a sale. If some key people opt to leave, theowner may need to adjust the sale timeline until the company has astable, strong base of talent in major functional roles such asfinance, marketing and operations. This step will smooth futurenegotiations with potential buyers, because they will value theperceived "bench strength" that remains after an owner’s exit.

Improve the bottom line.In essence, find ways to increase income, concentrate assets andminimize liabilities. For example, conduct a comprehensive review ofthe company’s cost structure and its use of assets to improveefficiency. Consider selling "noncore" or unproductive assets and usethe proceeds to pay off debt, which will ultimately increaseshareholder value.

When you are ready to sell, engage aninvestment banker, an accountant, or both, to "recast" the company’sfinancials; this will show how its performance would look if taxavoidance were not a priority. For example, you’ll probably want toremove the owner’s salary and perquisites and adjust family members’compensation to better reflect market rates. You should also recastextraordinary or nonrecurring items that might underestimate thecompany’s true earnings potential, as well as any large purchaseexpenses that could have been capitalized rather than expensed.

Sellingnoncore items such as real estate, disposing of unsalable or obsoleteinventory, and making judicious investments in capital improvementscould help concentrate assets.

"A lot of entrepreneurs don’tthink about the timing of key decisions, such as a major equipmentpurchase or a plant expansion," Boyle says. "For example, if you’re atfull capacity and don’t expand the plant, then you have no growthpotential to sell to a prospective buyer. If you make that investment —and allow enough time to absorb some of the capacity to get a return oninvestment — you’ll likely receive a growth multiple of five to ninetimes EBITDA. That should more than cover the cost of expansion."

Review any tax issues.Generally, the tax liability for any business transaction is governedby its legal status, and by whether the owner plans to sell the entireentity or simply its assets. For example, if an owner intends to sell a"C" corporation or a limited liability company (LLC) as a whole entity,that means all stock or membership interests in the transaction will betaxed at a long-term capital gains rate of 15 percent (assuming theinterests have been held for more than one year). On the other hand, ifonly the assets of those businesses are sold, the gain in some propertyclasses will be taxed at the higher ordinary-income rate.

Get an accurate valuation of the business.A sound valuation will include a review of tangible assets — such asplants or equipment — as well as intangible assets, which may includeenvironmental or economic forces that affect a company’s futureprospects. This step provides a business owner with a credible baselinefor establishing a reasonable asking price.

Expertssay prospective sellers should seek valuations based on a company’sinvestment value rather than fair-market value. That’s because theinvestment value calculation will consider any "special benefits" —synergies a buyer may receive, cost savings from procurement, overheadreductions, strategic alliances or strong brand awareness — to elevatethe company’s value above what a private-equity investor would look foras a rate of return on his investment.

To establish thosepossible benefits, look for valuation experts who can use a range oftools — including balance-sheet analysis, market comparisons withsimilar businesses and discounted cash flow — to arrive at anappropriate price.

Don’t go it alone. The sheer rangeof expertise required to handle the planning and execution of aprofitable sale makes it virtually impossible to handle withoutthird-party resources. Take the time to interview professional-servicefirms with expertise helping midsized companies in succession planning,tax, valuation, mergers and acquisitions, and investment banking. Bytaking this step to screen and choose a trusted guide, a businessseller can improve the prospects for receiving top dollar.