BUYING OR SELLING A BUSINESS?
HERE'S HOW TO CREATE THE BEST DEAL (PART II)

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What should you focus on when buying or selling a business? In the last article, we identified six steps to success: Planning effectively, creating your transition team, establishing value, developing a compelling marketing program, successfully negotiating the deal, and completing a smooth transition. We discussed business planning and developing a transition team. Business planning helps set your course, respond to change, and build more value into your business. Developing your transition team helps you net more money, reduce personal time commitments and moderate stress.

In this article, we will highlight important valuation issues and survey important marketing program elements. Negotiation and transition will be addressed in a subsequent BP Report.

Valuation:

Valuation is important. You will gain a huge advantage during marketing and negotiation if you understand how buyers and sellers determine value.

A comprehensive valuation analysis prepared by a firm with transaction experience will highlight company strengths, weaknesses, opportunities and threats. It will provide you with national, regional and local economic and industry-specific data. You will learn about comparable companies and potential acquirers. Detailed financial analysis presents cash flows available to an acquirer and computes a range of values. You will learn how value is determined and which approaches are most applicable to the business.

You can use this information to establish a range of acceptable values, develop marketing and negotiation strategies, structure a deal to receive the highest cash flow and pay the least taxes, overcome buyer objections, limit possible deal killers, and expeditiously complete due diligence.

Valuation professionals apply up to four approaches. The premise for the market-based approach is that the value of a closely held company is comparable with publicly traded stock (or prices paid for entire private companies) after making adjustments for differences in size, profitability, product/service mix, management structure, geographic location, date of sale, opportunities, risk factors, etc. Common ratios used for comparison include price/sales, price/earnings, price/equity, price/assets, and price/cash flow.

The second valuation approach calculates the fair market value of tangible net assets. This approach is most useful for an asset intensive company, or when income is "low" relative to the value of net assets. Some examples include real estate development companies, heavy manufacturing, some contractors, and equipment rental stores. This approach is not useful for determining intangible goodwill value. However, when goodwill does exist, asset approaches establish a base level of value.

The third valuation approach is central to all investing. Business value is calculated as the present value of all future income or cash flows available to an investor, applying a rate of return the investor expects to receive based upon the riskiness of the investment. Historical, current and future cash flows are all used with this approach.

The fourth approach includes everything else you may hear about, the "rules of thumb." Many valuation professionals also refer to them as "rules of dumb." Rules of thumb do not take into account fundamental measures of value like customer relationships, management structure, asset value and condition, sales and earnings stability, cash flows to the investors, debt structure, and on and on. Rules of thumb can be useful as a reality check, but are not appropriate as fundamental measures of value.

Remember that the purpose for a transaction can have a huge impact on value. The range of values could start with a bottom-fishing "vulture" buyer, move through the financial buyer who desires a certain return on investment, and soar to the strategic buyer, competing with other buyers, who gains significant synergies from the combined entity. Valuation helps you identify the type of transaction anticipated and where to place the company in the value range.

Once the valuation process is complete, marketing begins in earnest.

Marketing:

The purpose of marketing is simple. Attract qualified buyers, create interest in the business, and motivate several buyers to make simultaneous offers.

Marketing usually begins with gaining an understanding of the business through the valuation process. This information is used to structure a program to identify, attract and screen high quality buyers.

Your chosen specialist in mergers and acquisitions develops a program to target prospective buyers in a concentrated manner to obtain the highest chance of multiple offers. Simultaneous offers often result in a higher price and better terms through a bidding process. The specific marketing program is based upon existing market conditions, the industry niche, sales trends, size and location compared to competitors, product quality and reputation, special competencies, general attractiveness, and so on.

Tools used to attract buyers frequently include a summary flyer and a compelling presentation package. The summary flyer is a teaser and does not include information that might disclose the company name. A compelling presentation package is prepared from valuation analysis, site visits, and discussions with management. It presents a complete picture of the business with an emphasis on the benefits of ownership. It is only given to qualified buyers who have signed confidentiality agreements. A "price" may be used with smaller businesses. With larger businesses, price is usually left up to the buyer because competition for the business, and buyer perceptions, may drive higher value than that identified by the seller.

Before learning the name of the business or meeting with management, all prospects should be screened for financial and managerial ability to acquire and run the business. This is where an intermediary, whether it is a broker, CPA, or attorney can really add value.

Confidentiality is of primary importance until the deal is closed. Those who pass the screening should sign confidentiality and non-disclosure agreements before learning the company name, talking to employees or seeing detailed information. Some companies have lost employees, customers, and business value when it becomes known that they are for sale.

The time from marketing to closing might take from six to nine months unless someone comes directly to you or you go directly to someone else to make a deal. Deals can take from a few months to a few years, especially in a soft market! As a general rule of thumb, expect three to six months to value, market, screen prospects and get letters of intent or offers, several weeks for negotiations, and several more weeks to line up financing, complete due diligence, and close the transaction.

In this recessionary economy values are down for closely held companies, just as they are for publicly traded companies. Now is the time to focus on planning, improving systems, and positioning your company for the economic rebound that I am sure is to come. Or, if you're an acquirer and believe in America's fundamental strengths, go buy a bargain. We experienced dips in World War II, Korea, and the Gulf War. The American economy rebounded strongly each time and will likely rebound from this war. Get your company ready to reap the benefits, and when the timing is right, make a deal!

In this BP Report, we have discussed the second two steps to successfully complete a profitable business transaction. Value the business to understand how value and deal structure work, and then undertake a focused marketing program. The final steps include negotiating a great deal and closing it with minimal bottlenecks. These topics will be covered in an upcoming issue of the BP Report. Please give Greg Porter, Bob Berntson, John Launceford or Allan Vander Hamm a call at (425) 454-7990 to discuss any of these topics.

Allan Vander Hamm, CPA, ABV
Director, Business Valuation &
Litigation Services Dept.