How to sell and get maximum value

July 1, 2004
YOU'VE decided to sell all or part of your business. Now what do you do? Determine a get-out number, assemble support material, find a buyer, and complete

YOU'VE decided to sell all or part of your business. Now what do you do? Determine a get-out number, assemble support material, find a buyer, and complete the sale?

That's the process used by 80% of the privately owned businesses in the United States. But according to Gregory Harter, mergers and acquisitions advisor for RSM EquiCo, an investment banking firm whose single focus is representing sellers, nearly 80% of those businesses leave up to 80% of the deal on the table.

“There are three parties to every deal: buyer, seller, Internal Revenue Service,” he said. “The IRS takes a piece of the action. And some of the work that is done to leave money on the table is left by the buyer because he sold the business for a lower price than he should have.”

Harter said this is the professional process:

  • Determine the market value. “For those of you who own privately held businesses, what's a share of your stock worth? Whatever an outside buyer wants to pay — which you don't know. Privately held stock doesn't enjoy the luxury of the marketplace every day. So you generally don't know your company's market value. Once you determine it, you can decide whether to sell.”

  • Make a decision. “If you're 55 and you want to exit at 60, the time to plan is not 59 years and 11 months. The time to decide what you're going to do is when you're between 55 and 58.”

  • Develop a credible pro forma — a believable future income stream. “A premium buyer is not interested in your present or your past — it's your future. I can look at your tax returns, income statements, and balance sheets and find out everything I need to know about where you have been and where you are. Premium buyers — buyers who are seriously interested — want to know where you're going. That's absolutely critical.”

  • Find premium buyers. “You want buyers — not one, but several. You essentially want to have a limited auction. Don't you want a bunch of buyers beating each other up to buy? That's part of the strategy for succession planning.”

  • Sell at the right price. “What you do in selling your business is not nearly as important as when you sell. Timing is everything.”

Minimize taxes

Harter said the seller's financial history reflects negatively on value, deals with the past, expresses suppressed earnings, may reflect negative growth or an off year, and could fail to include dynamic values.

“Don't you want to minimize the taxes you pay?” he asked. “What we're talking about is tax avoidance — not tax evasion. The difference between those two words is about 10 years (in prison). You want to pay the absolute minimum fair share of taxes. Your financial history may reflect negative growth — an off year. The buyer has to see that, and will. But you also want to show the buyer the future.”

Harter said that sellers of privately owned businesses, in doing succession planning, look at buyers who are familiar with the industry, competitors, or employees — people they've been doing business with all their lives. But to maximize the value of the business, the most likely buyer won't be a competitor, partner, or group of employees.

“If you sell your business to a key group of employees — say five of them buy you out — how are they going to pay you? Future earnings, right?” he asked. “So your being paid in the future is totally dependent on the ability of your business, under their tutelage, of generating earnings and profits. Partners are typically no different. They typically don't have the capital to be able to afford to buy your business outright at market value.

“A competitor typically is trying to add to market share by buying your business and expanding and doing the things the competitor and you were doing before. There are no strategic or opportunistic factors.

“A buyer who buys your business and has nothing to do with you may say, ‘I want you to continue to run your business as robustly as you have. And by the way, the reason I bought is I'm going to use your customer base as an additional channel of distribution for my company's products and services’ — a completely different use than you may have thought. We have a phrase: In a strategic and opportunistic situation, a buyer rarely buys what the seller thinks he's selling. You know when you find out? After the deal's done. You got $10 million for your business and the buyer put it on the books at $25 million.”

Harter said that for the average seller, it's basically a single event. He may do it once or twice in his life. But a premium buyer does it thousands of times. For example, GE has bought 1,885 companies in the past 20 years.


He said the timing will be set for you, not by you, and the price is established by a believable future. Harter said there is no bad time for a large public company to buy from a private seller.

“The ordinary income tax rate is the lowest in 40 years — 35% — and the long-term capital gains tax rate is the lowest since 1966 — 15%,” he said. “You think that's a motivation for privately owned sellers? Absolutely, because they can get a deal where they either pay capital gains tax or if they take stock, they defer it until they pay taxes. In the last five years, there were more privately owned sellers in the US than there were in the 15 years before that. What does that say? What happened to the stock market in 2000 and 2001? It went into the dumper. There's no better time to do a deal between a large public buyer and a small private seller.”

Harter gave the example of a public company that closed a $21 million purchase for 100% cash and cash equivalents in the first quarter of 2001, motivated by the distribution channel and potential of the future.

“The buyer paid it without almost any risk — 100% cash and equivalents,” he said. “The seller had the market edge, and that's what the buyer wanted.”

He said the mechanics of value are misunderstood.

“Here's what many sellers do: They take their tax return and say, ‘But going forward, this is what I will earn,’” he said. “What's wrong with that? The buyer is going to say, ‘What kind of miracle happened?’ You have to provide continuity between the past and the present and the future, and the only way to do that is to re-state your balance sheet, income statement, and cash flow for the past five years so that you look like a wholly owned subsidiary of a public company.

“That's called recasting, and it's done to provide continuity and education for a buyer so he can see what you did in the past. Hypothetically, I've got to go back and re-state those things. And most of them have the effect of raising your earnings impact. Don't you want the buyer to see that? Of course.”

He said the key items for recasting the past five years are owner compensation and expenses (professional manager, competitive compensation), staffing levels (industry standards), phantom expenses, extraordinary items (performance under ordinary circumstances), and EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization).

“It simply means we're going to take your lifestyle out of your business,” he said. “When you do recasting, any professional will look at what your compensation is now and if you're taking more money out of the business than it's generating in profit. There's nothing illegal about it. But I'm going to go back for the last five years and give you a hypothetical payment. If you paid yourself $750,000 a year, a competitive manager in a public company would be paid $300,000. When I remove $450,000 in expense from your income statement, what did I just do to earnings? I raised them. That's what you want to show the buyer.

“When you sell your business, you can continue to pay yourself $750,000 a year. You're going to do it out of the $15 million you get. In a buyers' environment, they'll say, ‘Look, these people aren't going to stay in the company.’ It won't be at the expense of the buyer. We'll take out all the phantom expenses and extraordinary items and end up with EBITDA. If you're going to sell your business, I would not suggest you do this yourself. Get professional help. Recasting deals with complicated things.”

Pro forma

He said the five-year pro forma says, “I'm going to grow this business, Mr Buyer, but I'm showing you how you can grow it based on your resources, not mine.”

“This pro forma has to educate possible buyers: ‘Mr Buyer, here's what you can do with this business in the next five years.’ That's more important than what you as a seller could do in the next five years.

“Ratios are critical to the buyer. Your hot button is return on equity. But if you're talking to a buyer in the service industry, their hot button is return on assets. You have to simply recalculate your believable future income stream. You've got to speak the language of the buyer.”

He said the typical private seller's universe includes economic factors (roll-ups, key customers/major suppliers, competitors, and employees).

“These buyers are economic,” he said. “They say, ‘Your net book value is $8 million. That's what I'll pay you, and I get all your employees and customer base and supply base as a bonus.’”

The professional seller's universe includes strategic factors (off-shore public and private companies, US public companies, and private investment groups).

“A strategic buyer doesn't look at your net book value,” he said. “He looks to the future and pays a multiple of your net book value. A strategic buyer is someone who technically pays at least double your book value.”

Public buy

He said a large public company can take a patented product and sell it all over the world, but that company has no tolerance to do what you did — start it up — nor does it have a tolerance for the people or the culture. He cited a quote from GE vice chairman Edward E Hood: “Building new businesses from scratch is just too difficult for us to manage.”

Harter said the buyer does not have to be in that business: 26% of companies are purchased by a buyer who has nothing to do with that industry. And yet a lot of sellers look in their own industry for people they've been doing business with for decades or even centuries.

He said the stock market is not the driver of the privately held mergers-and-acquisitions market, as demonstrated by these facts: private companies fared far better than their public counterparts in 2002, and the number of acquisitions was the third-best ever.

He said European buyers buy in North America because it is a more affluent consumer market: US personal income was $9 trillion, compared to $6 trillion in the UK, Germany, France, and Italy combined.

He said international buyers are predominantly strategic buyers, meaning negotiations and value tend to be driven by pro formas. He said that's primarily because as of 2001, companies were not allowed to make tax-free stock swaps and not put it on their books.

“Now, the buyer must record it as a purchase,” he said. “Before, I could write off the goodwill over 40 years. In Europe, the Internal Accounting Standards Board will do the same thing. European companies can now do tax-free stock swaps without goodwill.”

Harter said the seller typically will leave 80% of the company's value on the table with any of the following: limiting the prospect universe; economic value (what is) vs market value (could be); pro forma created for existing resources vs the new owner's resources; missing the timing window (do you sell when you or the market is ready?); unrealistic levels of expectation (too low or too high); inadequate preparation for hurdles; attempting to negotiate the deal at the table; or failure to anticipate the deal structure.

Harter's conclusion is taken from British philosopher and sociologist Herbert Spencer: “The great aim of education is not knowledge but action.”

About the Author

Rick Weber | Associate Editor

Rick Weber has been an associate editor for Trailer/Body Builders since February 2000. A national award-winning sportswriter, he covered the Miami Dolphins for the Fort Myers News-Press following service with publications in California and Australia. He is a graduate of Penn State University.