Reflections

Earnouts are a way for the acquirer to manage risk

What is an earnout in an acquisition? This is a type of deal structure whereby the acquirer will place an overall valuation on the seller’s company and then determine how much will be paid in cash at time of transaction and how much will have to be “earned” by the seller over time through future performance of the business. Earnouts are very simple in concept, but are most often quite complex to negotiate, challenging and stressful to execute.

When placing a valuation on a business, an acquirer assesses the future benefit to them in owning the target company and equally they consider the risk in owning the company. Simply put, the greater the risk the acquirer sees, the more likely they are to require the seller to carry some or all of the perceived risk going forward and therefore accept less cash at transaction closing and move a small or large portion of the overall payout to the future achievement of performance targets.

Earnouts are of the greatest value to the acquirers as they place much of the future business performance risk on the seller. Therefore, as a seller you want to years in advance of attempting to sell, look for ways to reduce the risk that an acquirer might see in your business. Reduce the risk in areas such as too much customer concentration in your revenue and profit, single point of failures in your supply chain, risks within your organization and team and even risks associated with the language in customer or vendor contracts that you’ve signed. With the right prior planning, you can eliminate or reduce the need for an acquirer to require an earnout because they too often don’t like them as they know they are difficult to negotiate, difficult to administer and are often contentious during the periods of time the earnout is in effect.

Start your optimal exit event preparations today by asking where a future acquirer might see risk in your business. Prioritize these areas of potential risk to take steps to either eliminate or reduce each area. Taking these steps today could help you build overall company worth and help you get an acquisition deal structure that affords all the payout at time of close, not having to earn your reward while working for the acquirer of your company going forward.

Things to avoid when the times comes to exit

Talk with anyone directly involved with buying and selling small to mid-sized privately held businesses and you will hear real life situations where sellers had second thoughts about selling their company in the final weeks of the event happening. When this occurs, it adds stress and expense to the deal and can take what was supposed to be a wonderful, potentially life changing event, and turn it in to a nightmare…a nightmare that can be fully avoided with proper planning.

Here are some real-world situations that have given business owners second thoughts - ask yourself, could any of these happen to me?

• Just weeks before the transaction was to close, the reality set in for the seller that they had nothing to do starting the following week of the deal closing. Forty years of going to their business and suddenly no schedule, no meetings or trips on the calendar and stress set in. The seller was so mentally invested in the business that they didn’t think through their life post deal closing. The deal collapsed as the seller changed their mind about wanting to exit and led to a lawsuit by the acquirer to reclaim the expenses they incurred pursuing the transaction.
• A seller who realized too late that something as simple as how they would introduce themselves to new people they met in the future was now creating mental uncertainty. For years they introduced themselves with great pride as the owner of XYZ company as they met people at industry or social events and upon selling their business, were suddenly worried about how they would present themselves. This situation didn’t kill the deal but it did delay it and caused entirely unnecessary stress for all parties involved.
• The seller that certainly knew personal cash flow would be important but hadn’t really planned for this, including how they would be paying for healthcare coverage post transaction. So as the transaction closing date approached, the urgency of thinking and planning for this accelerated and although it didn’t kill the deal, it added an unnecessary layer of anxiety and stress for the seller and her family as they scrambled to figure things out.

Talk with any business broker or investment banker and they can share many stories like this. What they all have in common is that with proper exit preparation, you can avoid them. And know that although your lawyer and CPA will play a critical role in your business sale process, they are NOT the ones that will help you take a holistic exit preparation approach inclusive of the mental preparations.  Get holistic exit preparation guidance from those that have been down this path and can help you get your business and yourself mentally prepared for the event.

Ensure you have a minimum of 3 years of consistent financial reporting

A common mistake that privately held businesses make is they periodically make changes to their financial statements without giving thought as to what the change might mean when comparing financials to prior periods. The problem with this is when a potential acquirer comes in to do their due diligence, they (and you) will find it frustrating and time consuming to compare prior years given the inconsistencies that have occurred.

These inconsistencies might be in areas such as changing how you calculate your product or service gross margin, changes to your chart of accounts and where you report various expense items, what investments you capitalize and changes to your revenue recognition or inventory management policies. Changing any of these at the time may make sense but think about what it will mean to prior period comparisons, especially for the prior 3 years. What seems like a simple change may in fact lead to confusion and stress when you present your company to an acquirer.

Talk with your accounting partner (whether on staff or external) and discuss the year over year consistency in your financial reporting. If you need to make changes, try to make them backward compatible for consistency of reporting sake so that you have a minimum of 3 years consistent reporting of your numbers.  This basic step can help you and your acquirer eliminate unnecessary stress and time delays during due diligence and reduce the likelihood that they may try to lower their initial valuation and deal structure of their offer based on a degree of risk they are seeing in your financial reporting.

Don't assume rewarding your team means giving equity away

A common topic that we work through with our clients is how they might reward their key executives when company sale day arrives. They often assume they have to consider the complexity of providing these executives equity in the business and although this is a viable option, it’s not the only one.

At a very high level, here are the options you have for rewarding key members of your team should you desire doing so when you sell your business one day:

• Subjective award at time of exit – this option has you deciding upon exit what dollar amount you may wish to award key members of your team. You have the right as the owner of the business to subjectively award anyone you wish with a payout from the proceeds you will receive from the acquirer. The upside to this option is it’s purely subjective and is determined at time of exit. The downside is this option doesn’t give you an optimal vehicle for retaining and motivating these key people in the years prior as you prepare for a sale because they aren’t aware of your plans to make such a subjective award.
• Subjective award communicated prior to exit – this option simply takes the option above but has you conveying your plans to your key team members years in advance of selling so as to help excite and retain them in their roles. You convey to these team members of your plans to one day reward them at time of an exit but you remain vague as to how much. If your team members highly respect and trust you then they may be motivated by your subjective plans but in most cases, this option might not have the motivational impact as the team members might be skeptical due to the lack of clarity of your future subjective plans.
• Objective award communicated in a letter – this option has you providing select team members a basic letter, not legal in nature, but one that documents your thoughts to reward them at time of future exit. This letter would identify your plans to one day reward them with either a percentage of the deal proceeds you will be receiving or just a fixed lump sum. This letter doesn’t require lawyers to draw up and informally conveys your plans. This can work if your team greatly respects and trusts you to hold true to the non-binding letter you’ve provided.
• Objective award through a phantom equity plan – this option has you working with a lawyer to draw up a plan that imitates actual equity in your business but doesn’t require giving up actual legal ownership shares in your business. A plan of this type assigns phantom shares of stock, documents very clearly how the plan works for you and the participants and is a legally binding agreement that you would give to your key team members years in advance of your exit.
• Equity participation – this is the most extreme and complex option as it does have you issuing equity in your company to the team members. This option has the same motivation drivers as the phantom plan and shows the ultimate degree of commitment from you to your team but also comes with a greater degree of complexity and cost to set up.

There is no best answer as each company situation is unique in terms of how best to motivate, retain and reward the key members of your team and your personal relationship with them. Get guidance from exit planning advisors as firms like ours can help you determine what will be optimal for helping you achieve your future euphoric exit event. In addition, the option you select may have positive tax implications for you as the seller so making the right decision will not only motivate your key executives but can also provide you tax benefit at time of the exit.

Prepare your business to command the high end of market multiples being paid

Like trying to time when to buy and sell in the stock market, the same timing challenge applies to selling your business. The last few years we have experienced very high exit multiples being paid for all types of businesses. Now as economic and global uncertainty continues to grow, this is putting downward pressure on the exit multiples that strategic and financial buyers are willing to pay. This is because acquirers factor risk into their valuation and currently they are seeing growing risk in making acquisitions due to general market factors.

 What we tell our clients is that although you cannot control what the market is doing and how it’s impacting the range of exit multiples being paid in your industry, what you can impact is where your particular business will fall within the range when you want to exit.  As an example, let’s say the range of exit multiples in your industry had been running at 7x to 9x the last twelve months of company profitability and now with growing market uncertainty, acquirers are lowering the range to 5x to 7x. What your plan should be is to ensure you are prepared to present a business that warrants an acquirer paying you the high end of the range, even surpassing it, even though the range itself has decreased.

 You can command the upper range of the market multiples being paid by ensuring that you present a company with good year over year financial performance, strong visibility and prospects for future growth, a unique value proposition offered versus competition and an organization the acquirer will find attractive. Building a business like this takes time and doing so will ensure you are rewarded at time of exit with a premium to the market multiples being paid. Use time as a friend now to prepare your business for making you personally and professionally euphoric when your exit day occurs regardless of what’s happening with the market dynamics around you.

Knowing the answer can move you toward a euphoric exit event

It’s very common for owners of privately held businesses to be approached by a potential acquirer looking for the opportunity to have a private viewing of their business. When selling, there are two options. Run a public auction, by which you will introduce your company to as many potential acquirers as possible. Or you can run a private auction, which has you focused on only one potential acquirer. When is doing this in your best interest and when is it not? At a high level, here are the pros and cons:

Pros of running a private auction – know that normally the benefit here goes to the acquirer and not you as the seller. But there are a few reasons you might consider this approach:

• The distraction for you and your team could be less versus having to meet with multiple potential acquirers, giving them management presentations and facility tours
• You might have a special connection with the acquirer and see them as the best partner for your business going forward
• The acquirer may have placed a premium in their offer for the right to have a private viewing of your business and in some cases, even offering a break-up penalty should they ultimately decide to back away from the transaction

Cons of running a private auction:

• You lose the benefit from there being competition to acquire your company. With a sole acquirer, they don’t feel the pressure of having to sharpen their pencil as much in making an offer because they know they aren’t competing against others
• You won’t have anything to compare a single offer to, so of course you will naturally wonder whether it’s a great offer you are receiving
• You lose the leverage in the deal negotiations and process. The acquirer will know they are the only game in town and may take advantage of this by dragging out their due diligence and/or trying to change their initial offer valuation or deal structure. They will know you are invested in the exit and you don’t have other suitors standing by and may try to take advantage of this

Being euphoric from the future sale of your company will require knowing which of these two exit strategies is best in your situation. Get experienced input specific to your company and your personal situation to determine which will help you optimize what could be the most important event in your professional life.

Sale process can be delayed or derailed with poor preparation

Talk with any business broker/investment banker or even active acquirers of small to mid-sized private companies and they will share stories of deals they’ve worked on that went south in the final stages due to the seller not being mentally prepared to sell their business. Owners/CEOs think in terms of preparing their business for a successful sale to a third party, but too often they don’t give the needed thought to their mental preparation.

Here are some real-world examples of owners and CEOs that delayed or derailed getting their company sold to a third party:

• As the closing date for the transaction came within 30 days, the seller realized they would no longer have an office to go and realized they’d be home each day. They conceptually knew this months prior to the exit, but 30 days away the reality truly set in.
• An owner that realized that when they met new people, how proud they were to convey when discussing what they do for a living, that they own and run a business. Reality set in just 2 weeks prior to closing that they would no longer be able to say this and were now unsure of what they would tell people about what they do for a living.
• The owner that didn’t realize upon the successful transaction closing of selling their company, they would no longer have health insurance for their family. Great stress kicked in for the owner and spouse as they felt rushed in having to figure this out and it delayed the transaction closing.
• The company owner that hadn’t mentally prepared for losing a weekly paycheck once the company was sold. Hadn’t though this through as to where ongoing cash flow was going to come from.
• The seller that got close to the finish line to sell their company only to start thinking about how their employees might respond to the sale. They realized the particular acquirer might not invoke confidence in the employee base and needed to rethink the sale.

Stories like this could continue but the bottom line is this. Think as much about preparing your company, as yourself mentally, years in advance of attempting to sell your company. You can avoid the stress and financial cost that arises from delaying or derailing your final exit stages of working with an acquirer. Use time as a friend to prepare you business and yourself for the event of a lifetime. This exit event should be one that makes you and your family euphoric. Hope and dreams alone won’t get you there, but a sound, well executed plan can.

Identify which will best enable your future company exit event

Ask yourself this question – is the strategy I’m employing at my company enabling our operating effectiveness or is it enabling how we are truly going to be different in the market versus our competition?

Having a strategy of operating effectiveness means you are playing the game the way your competition does but are trying to do so better than they do. This differs from a strategy of your team working to position your company to be vastly different than your competitors, trying to change the rules of the game in your industry.

Let’s be clear, both of these strategies can build the value, or net worth, of your company. But, depending on your industry and depending on what type of future exit event you desire for your business (i.e. how much net payout you would like to receive for your company and in what time frame), one of these may be of greater value to you than the other.

It’s important that you determine which strategy your company needs to bridge to your long-term exit event desired outcomes. You don’t want to work hard for years only to find a focus on an operating effectiveness strategy didn’t get you to the euphoric exit event you desired because you needed to tackle a more differentiating and game changing strategy. And the opposite could apply in that you may not need to employ game changing strategies to achieve your desired end game and incur the associated risk and potential costs only to find that a strategy of operating effectiveness would have been more effective in your situation.

Don’t lose time in thinking this important topic through. Use time as a friend to consider which type of strategy will bridge you to your future euphoric exit event.

Selling your business one day - great questions to ask today

As we wrap the first 6 months of the year, every business owner and CEO should be asking themselves strategic questions to evaluate where their company is on their value, or company worth, building journey. Once you have your financials closed for the month of June, meet with your leadership team and discuss these important questions:

• Is our revenue performance the first 6 months of this year flat, accelerating or decelerating versus the last 6 months of 2021?
• As we continue to come out of the COVID market impact, is our value proposition (the value we bring to our customers) and our unique selling proposition (how we are unique versus competition), still relevant or do we need to make any adjustments?
• In looking at the trailing 12 months of revenue and profit performance, (July 2021 thru June 2022), what does this month over month trend look like for us? Are we flat, accelerating in performance or decelerating?
• Are each of our products/services performing as we targeted/desired or are some performing well while others are not meeting our targets? Don’t just look at your consolidated revenues and margins, look at them by product/service types.
• In looking at revenue by our top customers (either specific customers or by customer segments), how are they performing the first 6 months of 2022 versus the last 6 months of 2021?
• When we look at our customers in tiers (i.e. customer #1-100, 101 – 250, 251 to 500, etc), which tiers are growing and which ones might be declining versus prior year(s)? For the balance of this year, should we place more emphasis on one of our tiers versus another?
• What is our employee attrition YTD versus 2021? What is it by department? What is it by employees who have only been with us 1 year or less and those with us more than 1 year?

Good leaders ask good questions of themselves and their teams. Asking strategic questions, and using data to answer them, can help you as a leader facilitate great dialog with your team. Use this time of year to engage your team in a strategic dialog as doing so could help you build new worth in your business.

Knowing the difference can build your company exit valuation

The future acquirer of your business will want to be excited by the growth potential your company has going forward under their ownership. To build this excitement in a way that gets them to consider placing a premium value on your company, you will want to ensure you can exhibit an optimal sales model for pursuing and capturing your various types of revenue opportunities. These revenue opportunities are often comprised of squirrels and elephants.

The squirrels are smaller revenue opportunities for your business, the elephants being the larger ones. Ask yourself this question – is the selling effort and process that is needed in my industry to secure a squirrel order similar or different than that which is required to capture an elephant? If you’re fortunate to say they are the same, then you most likely just need one sales model. However, if you see there are differences, then you’ll want to build a sales model that shows your team knows the difference and approaches each effectively. The squirrels many times take shorter timeframe to close the deal and require no or less complex negotiations. The elephants on the other hand may take more time as their size brings new levels of complexity and more people involved in the customer decision process and the negotiating to close the deal may be much more challenging.

Now ask yourself this next question – is my sales team good at capturing both squirrels and elephants or are they better at one  versus the other? The skills needed are different for each and sometimes even the sales person compensation model needs to be different. You want a squirrel hunter focused and thinking about the best sales technique for a smaller deal but the elephant hunter, who also needs to be very focused, may need to apply a different sales technique. What some businesses find is that through the course of the day, it’s inefficient and less effective for some salespeople to move between squirrels and elephants and lose focus on one or the other. These companies often find benefit in having sales resources focused on one versus the other so they can perfect their selling technique for each.

If yours is a company that does sell to squirrels and elephants, talk with your leadership team about your sales model and your sales team to determine if each is optimized in how you approach your smaller versus larger revenue opportunities. Investing this time and identifying any opportunities for improvement could greatly help you build the future valuation of your business in the eyes of an acquirer.

Assess your company risk profile long before trying to sell

When the day comes that you desire to sell your business to a third party, a potential acquirer is going to assess the “risk” of buying your company. The lower the risk the higher the valuation they may place on your company and the opposite of course is true if they perceive higher risk. This risk assessment will include things like what is the likelihood of continued growth and profitability of your company going forward or what is the risk in any customer relationships  and/or contracts that you have.

Well in advance of starting the process to sell your business, sit with your board or your advisors and even key members of your leadership team and ask this question. Where might a future acquirer see risk in acquiring our company and how can we use time as our friend to address the area or areas where they might see risk and either eliminate or reduce the risk?

This basic but important question can help you identify steps you could take that will ultimately help increase the value, or worth, that an acquirer will place on your business. And equally important, it might greatly improve the deal structure that the acquirer might propose for acquiring your company. You want to avoid a deal structure that requires you to accept the risk of an earnout as acquirers generally introduce this concept when they want you to share the risk they see in your business going forward.

We help business owners use time as a friend in preparing their business for a future euphoric exit event. Part of this preparation is understanding what risk a future acquirer might perceive in the business and identify needed steps to reduce or eliminate that risk.

Assess your company risk profile long before trying to sell

When the day comes that you desire to sell your business to a third party, a potential acquirer is going to assess the “risk” of buying your company. The lower the risk the higher the valuation they may place on your company and the opposite of course is true if they perceive higher risk. This risk assessment will include things like what is the likelihood of continued growth and profitability of your company going forward or what is the risk in any customer relationships  and/or contracts that you have.

Well in advance of starting the process to sell your business, sit with your board or your advisors and even key members of your leadership team and ask this question. Where might a future acquirer see risk in acquiring our company and how can we use time as our friend to address the area or areas where they might see risk and either eliminate or reduce the risk?

This basic but important question can help you identify steps you could take that will ultimately help increase the value, or worth, that an acquirer will place on your business. And equally important, it might greatly improve the deal structure that the acquirer might propose for acquiring your company. You want to avoid a deal structure that requires you to accept the risk of an earnout as acquirers generally introduce this concept when they want you to share the risk they see in your business going forward.

We help business owners use time as a friend in preparing their business for a future euphoric exit event. Part of this preparation is understanding what risk a future acquirer might perceive in the business and identify needed steps to reduce or eliminate that risk.

Doing so can help you see how to build the value of your business prior to exiting

One of the steps we take early on in engaging with new clients is sharing with them samples of CIMs (Confidential Information Memorandum). This very simply step a year or more before trying to sell your company can help trigger fantastic ideas for generating greater value, or company worth, with your business.

A CIM is the document that will ultimately be developed that will articulate for potential acquirer’s what your business is all about and why it’s an exciting investment opportunity for them. We refer to the CIM as your silent salesperson as a potential acquirer will receive the CIM (after signing a confidentiality agreement) and they will go through it in detail to determine what interest they will have in acquiring your company and what valuation they may place on it. Certainly, your broker or banker who is representing you in the process will be talking with potential suitors and adding valuable color to the CIM, but the document itself has a very important job to do in exciting an acquirer.

Well in advance of having the CIM written about your company, review a few solid examples. Doing so will help you in thinking of ways that you’ll want to present your business one day. The types of data and information you will want to effectively portray in your CIM that will tell your compelling company story. In my years as an operating CEO, we periodically reviewed CIMs of businesses and invariably doing so gave us great ideas for how we should mold our own business so that it would shine one day when we developed our CIM.

Contact us and we can share great examples of CIMs (company names redacted) that have helped prior sellers get the euphoric exit outcomes they desired. Don’t reinvent the wheel in selling your business one day, learn from others that know how best to prepare you and your company for your euphoric exit event.

Clearly know which one you will be before attempting to exit

The first owner, or seller, is one that wants to sell their business, step aside and let the acquirer do with the business as they wish. The second type is one who wants to remain involved with all or some aspects of the business and does care what will be done with and to the business going forward under new ownership. Here is the key point…know very clearly which of these you will be and remain consistent in your thinking through the exit process.

Although this seems obvious, it’s not for many sellers. Their mindset when they begin the process of selling their company can evolve as the day approaches where they will no longer have control of their business. This evolving, new thinking can begin to slow down the exit process, bring unnecessary stress to you as the seller and create frustration for the acquirer as they begin to hear new thinking that is counter to what they first heard when the engagement process started.

Avoid this common, and very unnecessary issue, by ensuring you are asking yourself all the right questions early on in the exit process to ensure you will be mentally and emotionally prepared for the exit process. Get advice from those that know this process well to help ensure this issue doesn’t arise during your exit process.

Knowing this revenue number can help you greatly at time of company sale

When you go to sell your business one day, an acquirer is going to ask you what the growth outlook is for your business. You are certainly going to have an answer for them and you will want to be able to convey it in a way that gives them great confidence in your outlook. To give them this confidence, you’ll want to show them that you have a good revenue forecasting model/discipline in your business and it includes regularly identifying what your revenue “go get” is. When they see this type of discipline, they will be more confident in your revenue outlook for factoring into the valuation they will place on your business.

As part of your revenue forecasting, the Go Get revenue is that revenue which you still need to get in order to deliver on your full year revenue target. A way to think about it is:

• Take your Year-to-Date revenue (that which you’ve already invoiced for in the year)
• Add to this number your order backlog (Purchase Orders you have in hand but have not yet fulfilled on or invoiced for but you will be in this year)
• Add to these two numbers the value of new orders that you confidently believe you will secure as a result of current proposals in the hands of potential customers and proposals you are highly confident customers will be coming to you for yet this year. For the purpose of forecasting this year only, just include in this number the value of orders you believe will be fulfilled and invoiced in this year.
• Total these 3 numbers above
• Take this total and subtract it from your full year revenue budget or target that you set for the full year

The difference is your Go Get revenue. Meaning, you don’t yet have clear line of sight or very high probability awareness as to where this revenue amount is going to come from and yet you still need to find it to make your revenue target for the year. The smaller this go get number, the much more likely you are to deliver on your full year revenue. The higher this go get number is, the more aggressive selling steps your team may still need to take in order to deliver on your budget for the year. Discussing this number will help facilitate good strategic selling deployment with your team.

This basic concept can help you build a strong revenue forecasting discipline in your company. Building such a discipline will help you one day build the confidence of your future acquirer because they will see that you have a good internal revenue forecasting tool and discipline that bridges to how you then deploy your sales team to deliver on your revenue targets. This will encourage them that under their ownership of the company, this discipline is in place and will increase the likelihood that your team knows how to deliver on its revenue targets and this confidence will factor into the valuation they place on your company.

These will help you build your company valuation long term

In a presentation this week to the Consumer Technology Association, we shared the top questions that sellers of businesses wished someone had asked them years prior to selling their business. We want to share here these value creating questions for all to think about:

• Am I clear on what will make me euphoric at time of an exit event
• Can my business continue to flourish for an acquirer without me at the helm
• What will my company performance data convey to a potential acquirer
• Is any portion of our revenue highly predictable
• How sticky is our business with customers
• Can we prove a strong growth outlook for the acquirer to benefit from going forward
• What will my exit narrative be one day and will my financial results support it
• Can my company successfully undergo an acquirer’s due diligence
• Do I have seasoned deal partners helping me get to a euphoric exit event

You’ll want to think about all these questions well prior to your exit event. Don’t just hope for a future euphoric exit event, use time as a friend to plan for it. Give us a call and we can add color to any of these questions to help you think it through for your business. Call 949.874.0787.

Knowing the difference can help you sell your business for a premium one day

Too often business owners/CEOs confuse their team working hard with their team working smart. One is motion, the other is progress. And motion isn’t what will excite an acquirer one day to pay a premium for your business, but progress will.

Leadership teams that let the business manage them are what we refer to as playing whack-a-mole. Their day is comprised of playing defense, which is whacking at each problem or opportunity as it pops up, but not having enough time to play offense which is working on making things more strategic and better.

Effective leaders are those, that despite having to deal with daily challenges and opportunities that arise unexpectedly, still know the value of having a strategic plan that will guide them in knowing which areas of their company they need to focus on in order to make progress. And having a plan that you’re working too won’t eliminate days of whack-a-mole, but it will add more days of thinking and acting strategically which is where you’ll be building the value, or net worth, of your business.

Ask yourself, is my business managing me or am I managing it? And if it’s the former, think about stepping back and developing a more strategic pathway for your business. Doing so won’t eliminate whack-a-mole, but it will help reduce it and will give you the confidence that you’re building a business that will excite an acquirer to make you euphoric with the sale of your business one day.

In God we trust, all others bring data

Economist, Clive Humby, is noted for saying that “data is the new oil” within our businesses. And there is no more important time to have accurate and effective data than when you want to sell your business to a third party. Acquirer’s will have many questions when probing your business for potential acquisition, and the vast majority of their questions, they will want to have answered supported by your data.

Imagine yourself buying a company. You’ll ask many questions and the majority of the answers you will hear you won’t want to take on faith alone. You’ll ask to see data that backs up the claims the seller is making and for the answers they are providing to your questions. When selling your business, take time well before starting the exit process to ensure your internal data is available to support the due diligence by an acquirer. You will want to review your own data trends (financials, customer, vendor, operational and employee related data) to fully understand what it’s conveying about the strengths and even challenges within your company.

We help our clients leverage their data, their oil, to help optimize the exit plans for their business. Contact us and we’ll help you think through how to dig for the oil in your business.

Think about what company size means before selling your business

Size does matter when it pertains to selling a business. Technology companies are an argument against this common phrase but all others it does apply. What few private business owners realize is that acquirers very often reward sellers for building scale, scale of revenue and profits.

Both strategic and financial acquirers (i.e.: private equity) will often reference that they like their target acquisitions to be achieving a minimum level of profitability annually. The starting point for many is a minimum of $2.5M of EBITDA (Earnings Before Interest, Taxes, Depreciation, Amortization) and some even $5M or more. Below these amounts they may not your company having enough scale to invest their resources in to acquiring it. But as the EBITDA grows incrementally, acquirers will reward you for that scale so you want to think about achieving a minimum threshold before attempting to sell your business to get a premium valuation. As an example, if your EBITDA today is $1.5M, you should build a plan to get this to the first threshold of at least $2.5M. Doing so will increase the number of acquirer’s that will have interest in considering an acquisition of your business and it may get them to pay a slightly higher exit multiple than if you’re still doing $1.5M annually. And the same applies to building a plan to get your EBITDA to the annual $5M level. And if you today are doing $7M of EBITDA, build a plan that will get you to the next important threshold in the eyes of acquirer’s of $10M because this will move you in to an entirely different valuation category in their eyes.

Put on the glasses of your future acquirer when thinking about what level of scale you want to achieve with your business before attempting to sell it. Think about how they will view your business in relation to these EBITDA incremental thresholds of $2.5M, $5M, $10M then jumping to $20M. You will be rewarded by the acquirer for having greater scale and you’ll see this in the exit multiple they will be applying to the valuation of your company. As you do strategic thinking to develop your plan that will deliver a euphoric exit event one day for your business, have these important EBITDA thresholds in mind because it could be the difference between an unhappy exit outcome and a euphoric one.

Exit preparation includes having effective narrative around each

We share with new clients that a successfully run business today doesn’t necessarily mean an exit ready business tomorrow. The reason for this is many private business owners believe that if they have good revenue and profit the potential acquirers will line up outside their door. They may in fact line up with interest to acquire your company, but to open their checkbooks and pay you a premium for your company will take much more than just historical revenue and profits. There are several other areas you’ll need to be prepared to excite them to get them to pay a premium. In addition, here are 3 critical  questions the potential acquirer will ask and you’ll want to be well prepared with effective answers:

• Why are you selling now? They aren’t asking to be kind or to warm up the conversation. They are asking because they truly want to understand your motivation to ensure it doesn’t include things like you believe your company has reached its peak or you see a potential issue brewing within your industry or your company and you are concerned there could be challenging times ahead. They also want to ensure that you’ve fully thought through the idea of selling so they don’t waste their time applying their resources to the process only to have you change your mind.
• Why is your company unique versus competitive alternatives? Make sure you have positioned your business, well in advance of selling it, to be able to exhibit and articulate a unique position in the industry. Whether the uniqueness is in the product or service itself or the intellectual property you own or how you fulfill on providing your product or service to your customers, be prepared to articulate this clearly. Don’t assume the potential acquirer will know why your business is special.
• What is the future outlook for your business? Acquirer’s will want to know that under their ownership, your business will flourish in a way that enables their company. An acquirer isn’t going to pay you a premium for your historical performance as they will assume you’ve already rewarded yourself for that. But they will pay a premium for a business with a proven successful track record and good visibility to future positive performance. Ensure that years prior to attempting to sell, you build a good sales opportunity pipeline for your business. And build a discipline in using the pipeline to track opportunities you have visibility to, the associated potential revenues that might be attained and even win/loss rates as you've pursued the opportunities.

There are certainly many questions you’ll be asked by a future acquirer. These 3 are main staples so you’ll want to ensure you are well prepared to articulate effective answers. Doing so can be the difference between selling your company and selling your company and being euphoric with the outcome.