Understand these key components of selling your company to maximize deal value.

Second in a three-part series on acquisition preparedness

In the article “Positioning Your Company For Sale” published in the July issue of PPB, one of my partners, Jeff Meyer, discussed a variety of key factors buyers look for in a company they want to acquire. A few of those factors included things like timely financial reporting, limiting customer and salesperson concentrations, having long-term contracts in place with customers, a policy and procedures manual, and having a business or operating plan.  Buyers find these factors attractive from an investment standpoint because they tend to lessen buyer risk and enhance the likelihood of future earnings.

So what happens now? You’ve worked hard to build your business and you’ve been disciplined in your approach to positioning it for sale. But how do you begin the process of actually selling it? How do you know who is likely to be interested and how long the process will take? Most important, how do you know what represents a “good deal” when selling your company?

By definition, a good deal implies some buyer pays you a lot of money for your business. While it is true that the financial reward of selling your company is important, there are other factors to consider as well. Think of it as a package deal with money being only one component. Others factors could include deal structure, payout structure, your role after the sale, involvement of family members who work in the business, what happens to employees, what happens to customers and the list goes on.

Planning for a good deal. Successfully selling your promotional products company requires thoughtfulness and planning. It’s a process that does not happen overnight. We tell clients to allow six months for the sale process. Some transactions take less time but many take longer depending on the company and any unique requirements of the seller. If the owner/seller is a key salesperson, their post-closing involvement could be three to five years, possibly longer; so plan accordingly.

Planning also includes determining what advisors will be required to accomplish the sale.  Sellers should consult their tax accountant for advice on the tax ramifications of selling.  It is always better to be proactive and understand the tax situation well in advance of the sale. Also, be prepared to engage an attorney to review purchase documentation.  Attorneys serve an important role in the process but keep in mind that their job is to give legal advice while yours, as seller, is to use that advice to make an informed business decision. Finally, someone acting as an intermediary can also be important to the process. Negotiating a transaction can be tense at times and it’s important to have someone who can wear the black hat so as to maintain a good relationship between the buyer and seller. This is especially true when the buyer and seller will be working closely together after the sale is complete.

Complete a Business Valuation. It is impossible to know if a buyer is offering you a good deal if you don’t know what your company is worth. Most people have an idea of what their homes are worth or even their cars, but many don’t have a clue on the value of their business. In many cases, the business may well be their most valuable asset. A business valuation is critical to the selling process. Anyone considering the sale of their business should have a valuation completed. Frankly, having a valuation performed, even if a sale is not imminent, is an important step for a business owner to take in order to understand what their company is worth.

Define Special Requirements. Once the valuation is complete and realistic value expectations have been set, it’s important for the seller to define any additional requirements he or she may have with respect to selling the business.

  • How long does the owner want to remain involved with the operation post-closing?

  • What are the requirements for continued employment of any family members involved in business?

  • Are there any requirements of the seller to keep all or certain employees employed for a specific length of time?

  • Is there a requirement to keep the business in its current location for a certain length of time or is relocation acceptable?

These issues and others like them should be brought to the buyer’s attention early in the sale process to avoid confusion and wasting time. That said, seller flexibility and compromise on issues such as these can be key to successfully closing a transaction in a timely fashion while maximizing deal value.

Deal Structure. Arguably, structure is as important to a transaction as overall deal value.   Sellers want a structure that calls for timely collection of deal proceeds with favorable tax treatment and an acceptable level of risk. Following are several components of deal structure you are likely to see in a sale transaction.

  1. Asset Purchase vs. Stock Purchase. Asset purchases are the norm for S corporations and LLCs, while stock deals are preferred by C corporations. Of the two, asset purchases are by far more common. Buyers and sellers alike enjoy certain tax benefits associated with the purchase of assets. Buyers will generally be able to deduct the cost of the acquisition over time, but the key for sellers is that any gain associated with the sale receives capital gains treatment instead of being taxed as ordinary income. This typically reduces the tax liability and increases value for the seller.

  1. Cash At Closing. There should be some element of cash at closing in virtually every transaction. The level depends on how risky the investment is to the buyer. Growth trends, profit trends, margin strength and concentration risks can all have an affect on how much the buyer is willing to pay in cash at closing. It’s not realistic for a seller to expect to receive all cash at closing but neither is it realistic for a buyer to think they don’t have to deliver some element of cash at closing.

  1. Earn-Outs. An earn-out or deferred compensation will likely be part of most deal structures. The earn-out is generally tied to gross margin performance and will therefore fluctuate as the margin increases or decreases. If the margin increases, so does the seller’s payout. The reverse is true if the margin declines. Earn-outs are generally viewed by buyers as a way to mitigate risk while incentivizing sellers to grow sales and maximize deal value. The duration of an earn-out can be as short as two years or as long as five years with most averaging three years.

  1. Promissory Notes. Although not common, our firm has been involved in transactions where promissory notes from the buyer were included as an element of deal structure. Notes are fixed in amount and typically replace the earn-out portion of the deal. They generally provide for some level of interest although usually at a nominal rate. Promissory notes limit a seller’s risk in times of declining sales and margins but they also limit any upside potential when times are good and sales are on the rise.

  1. The Balance Sheet Effect. A company’s balance sheet will undoubtedly have an impact on deal structure. Theoretically, if a seller keeps the accounts receivable, a buyer would expect to pay less for the business than if they were included in the deal. For that reason, it’s important for owners of the business to understand what value exists on the balance sheet. Cash and bank debt will almost always be retained by the seller regardless of how any remaining balance sheet items are treated.

Deal structure is an important element of any transaction. Careful consideration should be given to its components in an effort to maximize overall value while minimizing risk and adverse tax consequences.

Compensation or “Deal Money.” Most owners who sell their business will remain involved with the company for a period of time. In some cases, involvement will be limited to a short transition period, while in others, especially where the owner plays a key sales role, involvement could last for years into the future. In either case, salary or commissions paid for work performed for the buyer post-closing should not be confused with “deal money.” Salary and/or commissions are in addition to value received for selling the company. This is an important distinction for the seller to make in order to maximize value.

Nearing the End. One of the final stages of selling your business and completing the transaction involves the process of due diligence. Due diligence is nothing more than a period of time where the buyer and seller exchange information, some confidential and proprietary in nature, in an effort to learn more about each other. Due diligence goes both ways and it’s important for both parties to share. Buyers need knowledge about the seller to ensure a smooth and seamless transition of ownership, which diminishes the risk of a disruption to the revenue stream and enhances the likelihood of maximizing deal value for the seller. Likewise, the seller needs certain information about the buyer, including financial information, in order to formulate an opinion on the ability of the buyer to pay the obligations associated with the purchase.

Selling your promotional products company will probably be one of the most important transactions of your life, so be prepared and plan accordingly. Arm yourself with knowledge about the value of your company and think about what you want to realize from the sale. Consider retaining an experienced advisor to effectively manage what can be a complicated process. And remember, realistic expectations and flexibility are keys to maximizing value and “getting a good deal.”

Look for the third and final article in our acquisition preparedness series in the September issue of PPB magazine. 

John Schimmoller, CPA, is COO of Huntertown, Indiana-based Certified Marketing Consultants, Ltd., a PPAI business services member. He has been active in the promotional products industry for more than 27 years. He and his two partners serve companies exclusively in the promotional products industry with services including mergers and acquisitions, business valuations, strategic planning, business plans, marketing plans and general consulting.