Last week we went through the five growth stages of a small to medium sized business and the strategies that make it easier to move through them while increasing performance and reducing fragility as you go. If you’ve not read it yet, you can catch up here. In it I mentioned that you could exit your business in four out of the five stages and capture value. In this blog I’m going to take you through the exit process. We have a digital product launching in the New Year too, so if after reading this blog, you’re wishing there was more detail, fear not, the Exit Pack is on the way.
Okay so why would you want to sell and get out? You started the business; you chose this adventure and you’ve experienced amazing highs and lows over the years. It’s part of you. Well, age and energy are always factors. You might want to do something else with your time and there’s always the possibility that you’re not in love with it anymore. And then there’s the money. If I look back across almost three hundred M&A transactions that I’ve worked on in my career, I can’t find many examples of a business owner who started a business with the singular goal of selling it to become financially independent. Indeed, it’s often a surprise to discover what your business could be worth and that knowledge can be a powerful incentive to act.
However, as soon as you start thinking about the money, you feel a pull on your heart strings. You think about this group of people that you’ve hired, wired, and inspired over many years. You can’t let the team down. And the clients. Many are close and some are friends. What’s going to happen to them when you’re not there to protect them? How do you realise the value of the business, without destroying it in the process?
These thoughts often lead to the exploration of a management buyout or some other form of internal deal. But hang on, we’re going to wander off the path and there’s no map. Start talking to the team about them buying the business and your committed. If it doesn’t work, the senior people may not see a future for themselves and now they know you want to sell. You can read more about this challenge here, but it’s avoidable. There are seven main stages to the sale process. Let’s get into it.
Stage one – Preparation
The first stage is about planning, acquiring knowledge and lining up the right team. Most business owners skip this stage and head straight off to get a coffee with a prospective buyer. Just find out what your worth. Can’t hurt. You never know. But it can hurt. The person across from you can tell you whatever they like and the numbers their banding about are pitched at a level that will draw you into a deal. We call this the escalator of commitment. A quick coffee leads to you providing them with data, then several lunches, more meetings, supper, meet the spouse and finally an offer. Trouble is, you won’t know whether it’s any good or not. You also don’t know whether you will receive that offer once the process is complete. You might not receive it after several years either. Time to back track.
The first thing we want is a map. An outline of the process and a timeline. The latter is a guess and the duration is more important than the dates at this stage. I wrote this blog with the project plan I use, up on the screen for reference. So you can either build your own plan as you read through this blog or wait a few weeks and use the template that will be in the Exit Pack.
With an outline of the project in place, you need to get ready personally. For this you’ll need a mirror and a spreadsheet. Do some personal planning to uncover your current perspective on life and your incentive to exit. Do you really want to sell and if so, why? How much money do you need net of taxes and expenses? How much do you want? You might think it’s pointless to think about these numbers, without an idea of the value of the business but you’d be wrong. At this stage we are just preparing and you might not sell the business for several years. Knowing your number helps you determine the optimum time to sell. You might need a few more years of profits before selling.
Now we turn to the business. When Kingmakers sells a business, we produce a Confidential Information Memorandum (CIM). It’s a document that summarises what’s for sale, why and what the benefit might be for the buyer. It summarises financial statements and forecasts, some of which you will have and some you will need to create. It’s not that difficult but templates will be in the Exit Pack if you want a shortcut.
As you construct your CIM, you are going to want to get an idea of value. The more you know about how the buyer will approach the valuation process, the better equipped you will be when it’s time to negotiate. There are many ways to value businesses and I’m going to do a deep dive on this next week, so watch out for that. The most important thing you should keep in mind is that the capital you receive in a sale is like an advance on the cash the buyer expects to generate from your business in the future, once it’s inside their business. To make that advance, they need to have a high level of certainty about the likelihood of forecast cashflows materialising. Anyway, more on that next week.
The process of developing the CIM, will help you see your business from a different perspective, that of a buyer. This point of view is invaluable and will help you in critical moments as you navigate your way through the deal. It will also help you to identify things that need fixing or improvements that might increase value.
We round up the preparation stage by building your deal team. You will need a lawyer. You’re also likely to need specialist tax advice so it’s worth checking whether your accountant is comfortable providing it. And then there’s representation. Buyer’s pay brokers because they go and find sellers. You want someone on your side, representing you and guiding you safely through the process. If a buyer doesn’t need to pay a broker, they’ll have a little more in their kitty and a skilled negotiator can get them to add that to your price, which covers their fee.
Stage two – Search
If you have a desire to explore an internal transaction, this is the time to do so. The message should be carefully crafted and parameters need to be placed around the process, to help everyone focus. The team are likely to need some help, so be ready to guide but know where the conflict-of-interest line is and direct them to outside assistance as required. One of the biggest challenges they’re likely to face is raising the finance. It’s rare to find anyone in a service business that understands capital structures and funding, so give them time to get up to speed. If you’re not going to sell internally, you need to find a third-party buyer.
Everyone knows who the buyers are right? Well, not necessarily. Finding the right fit is essential, so knowing how to assess fit is an important skill. You want to build a list of buyers who have the capital, acquisition strategy and deal team in place and the right mix of symmetry and asymmetry that allows you to maximise price, without creating too much turbulence for the team or your clients. Ideally, you’d find all this out before making any contact, which is what our clients get when they access our database. There are several other ways to find this information out but be warned, if you don’t know the right questions to ask, it can be a rather pointless exercise. Not to mention, time consuming.
Ideally, you will have around a dozen names on your list. Each one gets an initial approach and provided the timing is right and they’re interested, you cover off confidentiality and then fire out the CIM. This usually goes to maybe half a dozen firms. You’ll then meet with these firms and provide some supporting data to compliment the CIM. Through the structuring process (see next section), you usually get down to three firms. There’s always a bit of competitive tension involved and the result should be a good fit and a strong price.
Stage three – Structure
If you’re selling externally, you probably have multiple interested firms at this stage. Each will outline their typical terms, so you can do your own calculations and figure out what’s on offer. This is all standard practice. To optimise the deal, you need to go a bit further. You want to understand the deal terms, and how each factor might alter the overall deal. Like a graphic equaliser. Move the slide controls around and you get a different tune. From shares or trade and assets, the headline price, the ratio of initial to deferred consideration, the payment terms for the latter, your salary through the earnout period, warranties and indemnities, the list goes on. All have an impact on the overall and each buyer will have a different perspective on value, risk, and reward.
Structuring will require meetings, data, and careful negotiation. At the end of this stage, you should have a signed Heads of Terms (HOT). This is a document that sets out the key aspects of the deal you’ve agreed, with the business you’ve selected as your buyer. A good HOT makes the lawyers jobs easier, as it provides the main commercial terms and signposts areas that require more work before completion can happen. This document is only legally binding in terms of confidentiality and exclusivity. The latter generally lasts for a sensible period and gives the buyer the confidence they need to commit the necessary resources to conclude the transaction (ie spend more money).
Stage four – Due Diligence
If you’ve prepared the business in advance, then you’ve probably extracted financial data and cross-checked it with client data, undertaken a compliance check, reviewed HR files, checked all your commercial arrangements, lease or licenses for property and all the contracts that support your proposition. If this is the case, due diligence is likely to be a straightforward process. If not, it’s likely to be stressful. Keep in mind, all the buyer is attempting to do is find physical evidence to verify the claims you’ve made, whether verbally or in the CIM. That’s it. They’re not trying to catch you out, although it might feel like that. If you’re doing an internal deal, the team should still be undertaking their due diligence and funding may depend on it.
In terms of process, most buyers undertake financial due diligence first. If the numbers don’t stack up, it’s best to know that early on. The tricky thing here, is that some of your financial information is in your accounts and bookkeeping software and the rest is in your back-office system and spreadsheets. What throws most sellers is that they’ve never pulled combinations of data from various sources and tried to read across them. It’s possible to do this in preparation and you’ve guessed it, there will be a comprehensive due diligence checklist and guidance on how to undertake this exercise, in the Exit Pack.
Regulatory compliance will likely be next and you can expect any revenue generated from transactions towards the spicy end of the risk spectrum to be checked. This may be the first time the buyer is looking at your files, so it’s important that they’re in order. You won’t know exactly what they’re going to look at, but it’s possible to take an educated guess.
The buyer will have various due diligence reports completed by the third parties assisting them. These reports probably won’t be available to you. If there’s an issue it will need to be resolved in negotiation with the buyer and this might include warranties, indemnities, or changes to the more important terms, like price or even switching from share purchase to trade and assets. If any of this happens, it’s important to keep in mind that this is a process and you are only ever deciding to move to the next step in the process. You will have identified red lines before you started, so you will know when you need to make a critical decision.
Stage five – Legals
The buyer probably won’t start the legal process until due diligence is complete. This is just cost management. No point in paying lawyers if something comes up in due diligence and the process needs to stop. Expect legals to include an acquisition agreement and (as required) a lease or license and maybe employment contracts where key individuals are staying on. It’s the buyer’s responsibility to produce first drafts and your lawyers’ job to explain them to you and propose amendments to strengthen your position and help you manage risk.
It’s very important to manage lawyers and help them, help you through the process. Lawyers love the law and left alone; they can get carried away. Clear instructions and regular all-hands meetings to tick off issues are advisable. And keep in mind that the lead representative of the buyer’s business, doesn’t always know what his own lawyers are doing and vice versa. Keeping everyone on the same page is very important.
There may be times throughout this process when you feel the buyer is being unreasonable. It’s very important to stay calm and work to understand what’s being requested and what risk the buyer is trying to manage by making the request. A spirit of collaborative problem-solving is invaluable as you work through the legals and reach agreement.
If you require third party permissions to conclude your deal, you might exchange contracts once the legals are agreed and wait for your permissions before completing the deal. No money changes hands until completion, so keep that champagne on ice a while longer.
Stage six – Completion
If everything else has been done well, Completion should be straightforward. You sign final versions of the legal documents electronically, prior to the day and on the day itself, you try very hard to stay busy while you wait for the call from your lawyers. You are likely to be exhausted at this point and you will know that there is much to do in the coming weeks and months. Once you’ve logged in to your bank and seen the balance, you can go home and relax. Before I worked on deals, I thought deal day would be all champagne and crazy parties. Once you’ve worked on a few, you realise everyone is exhausted and just wants to stop thinking about the deal for a few hours.
Stage seven – Post-completion
If you didn’t tell the team on completion day, you will be doing this in the days that follow. Think this through carefully and make sure you read what you’ve drafted and try to see it through their eyes. Your client communications will have been agreed in the legal process and they will go out straight after completion too, along with provider notifications and any press, if you and the buyer like that sort of thing. Being available for initial client rection is critical. Delaying the big holiday for a few months is sensible.
If you’ve sold the shares of your business, you will probably be focussed on making sure the completion accounts are done as soon as possible. The distributable cash in the business at completion won’t come to you until they are sorted.
As far as your situation is concerned, you should have mapped out what work you need to do in the weeks and months after completion. Get into your new routine as soon as possible and make sure there’s time to enjoy some of that freedom.
Summary
If you’ve read this far, you might be feeling slightly overwhelmed. After all, a business is just one or more people solving a challenge for one or more people and creating an exchange of consideration in the process. However, a company is a distinct legal entity. It is both a risk management device (incorporation offering a degree of legal separation from the individuals owning and working within it) and a time saving device (all interested parties contract with the company instead of each other). In many ways it’s like a wheel. The legal entity is the hub, to which spokes are attached. These spokes are legal contracts covering everything from client engagement to employment and all other suppliers. Think of the rim as the interests of all stakeholders.
The company buying yours, needs to understand your business, the potential rewards and the risks associated with them. This is a technical exercise, but it’s also a very human one. Over the years I’ve witnessed the entire gambit of human emotions: anger, disappointment, disillusionment, ambivalence, despair, and frustration. On the positive end of the spectrum, I’ve also witnessed understanding, compassion, empathy and at times, real loving kindness. Not from lawyers though obviously.
The sale of your business is likely to be the most significant financial transaction of your life. It’s the financial validation of all your hard work and perseverance over the years. To succeed, you need to know what good looks like, plan all the way to the end and then try to follow the process, while controlling your emotions. I wish you luck.
Did I mention the Exit Pack.