By Russ Robb, author of Selling Middle Market Businesses: A Guide Book for Intermediaries.

Most small business owners are not familiar with the dynamics of selling a company, because they have never done so before. There are numerous potential “deal breakers.” Avoiding the following ten mistakes should mitigate the possibility of an aborted transaction.

1. Don’t Neglect Running Your Business

A major reason small companies with sales under $20 million become derailed during the selling process of the business is the owner becomes so consumed with the pending transaction, that he neglects the day to day operation of the business. During the selling process, which can take six to twelve months from beginning to end, the CEO/owner typically takes his eye off the ball. Since the CEO/owner is the key facet to all aspects of the business, his lack of attention to the business invariably affects sales, costs and profits. Then the potential buyer becomes extremely concerned when the business flattens out or falls off. Before long the potential buyer gets cold feet when the business turns south and the deal craters.

Solution: For most (CEOs/owners) selling their company is one of the most dramatic and important phases in the company’s history. This is no time to be overly cost conscious. At this point the CEO/owner should retain, within reason, the best intermediary, transaction lawyer and other advisors to take the pressure off him so he can devote the necessary time to run the business.

2. Placing Too High a Price on the Business

Obviously many owners want to maximize the selling price on the company which has often been their life’s work, or in fact, the life’s work of their multi-generation family. The problem with an irrational and indiscriminate pricing of the owner’s business is that the mergers and acquisition market is too sophisticated to fool professional acquirers. As a result, the business usually does not sell at the inflated price, and if the owner finally does receive an offer at a more reasonable figure, the process ends up taking twice as long as normal, thus increasing the risk of the information prematurely leaking out… which often blows the deal.

Solution: By retaining an expert intermediary and/or corporate valuation appraiser, you should be able to arrive at a price which is fully justifiable and defensible. Perhaps you might add an additional ten percent on top of their professional opinion for negotiating purposes, but if you set too high a price you could easily just be spinning your wheels. To be on the safe side, you might receive two opinions: one from your intermediary and one from your appraiser. If you set too high a price, you may end up with an undesirable buyer who fails to meet his purchase price payments and/or destroys the company from the seller’s corporate culture.

3. Breaching the Confidentiality of the Impending Sale

In many situations, when the selling process encompasses too many buyers over too long a time with too loose a system of transferring information, confidentiality is breached. It happens, perhaps more frequently than not. The results can change the course of the transaction and in some cases, the deal is called off by the owner out of frustration and disgust.

Solution: Using intermediaries in a transaction certainly helps reduce a confidentiality breach but limiting the number of potential buyers and shortening the period of time to complete the closure process also helps. A thorough clandestine approach to the selling process is paramount. Creating a believable story to tell senior management such as the pursuit of a joint venture or strategic alliance is recommended.

4. Not Preparing for Sale Far Enough in Advance

Most small business owners decide to sell their business somewhat impulsively. The major reason for selling is boredom and burn-out, and much further down the survey list of reasons is proper retirement age or lack of successor heirs. Unless the owner takes several years of preparation, chances are the business will not be in pristine condition to sell.

Solution: Having audited financial statements for several years in advance of the company being sold is worth all the extra money, and then some, compared to an accountant’s compilations and reviews. Buyers are suspicious of statements that are not audited… as they should be! Buying out minority stockholders, cleaning up the balance sheet, settling outstanding law suits and sprucing up the factory housekeeping are all important. If the business is a “one-man-band,” then building management infrastructure will give the company value and credibility.

5. Not Anticipating the Buyer’s Request

A buyer usually has to obtain bank financing to complete the transaction. Therefore, he needs appraisals on the property, machinery and equipment, as well as other assets. If the owner is selling real estate then an environmental study is necessary. If a seller has been properly advised, he will realize that closing costs will amount to 5-7% of the purchase price; i.e., $250,000-$350,000 for a $5 million transaction. These costs are well worth the expense, because the seller is more apt to receive a higher price if he can provide the buyer with all the necessary information to do a deal.

Solution: The owner should have appraisals completed before he tries to sell the business, but if the appraisals are more than two years old, they may have to be updated.

6. Only Negotiate With One Potential Buyer

Leverage comes in various ways. Historically, sellers are able to ratchet the price up when there is more than one buyer in the running. Businessmen are like athletes that become caught up with the excitement of the competition.

Solution: Amongst other things, the role of the seller’s intermediary is to create a competitive situation with buyers either informally or by use of an auction. The seller needs to have a third party (intermediary) to orchestrate this process.

7. Seller Wants to Retire After Business is Sold

It is a natural feeling for the burnt-out owner to take his cash and run. However, buyers are very concerned with the integration process after the sale is completed, and whether the customer and vendor relationships are going to be easily transferable.

Solution: If the CEO/owner were to become the chairman for one year after the company is sold, the chances are that the buyer would feel a lot more secure that the all-important integration would be smoother and the various relationships would be successfully transferable.

8. Inflexibility in Structuring the Transaction

Many deals crater because the owner wants all cash at closing, will not accept any contingent payments or will not accept an asset transaction.

Solution: A strong team of advisors who are experienced in successfully completing transactions will be able to determine the net after tax difference between various offers, or the present value equivalent, or the risk/reward factor of contingent non-secured payments.

9. Negotiate Every Item

Being boss of one’s own company for the past ten to twenty years will accustom one to having his own way… just about all the time. The potential buyer probably will have the same experience of getting his own way.

Solution: Decide ahead of the negotiation what are the very important items and which ones are not critical. In the ensuing negotiating process, the owner will have a better chance to “horse trade” knowing the negotiating and non-negotiating items.

10. Too Much Time Allocated for Selling Process

Owners are often told that it will take six to twelve months to sell a company from the very beginning to the very end. For the up-front phase, when the seller must strategize, set a range of values, and identify potential buyers, etc., it is all right to take one’s time. It is also acceptable for the buyer to take two or three months to close the deal after the Letter of Intent is signed by both parties. What is not acceptable is the phase during which the company is “put in play”, (the time between identifying buyers, visiting the plant and negotiating,) to take more than three months. Otherwise, if the deal drags it is unlikely to close. The pressure on the owner becomes emotionally exhausting and he tires of the process quickly.

Solution: Again, the seller needs to have a professional orchestrate the process to keep the potential buyers on a time schedule, and move the bids along so the momentum is not lost. The merger and acquisition advisor or intermediary plays the role of coach, and the player (seller) either wins or loses the game depending on how well those two work together.

Current Food Trends

• Take-out and delivery
• Small plates/Tapas/Meze
• Locally grown produce/organic
• Specialty alcohol drinks, i.e. martinis
• Flavored/Enhanced water
• Fast Food – wraps/pitas/salads
• Consumer Demands for healthy options
• Green movement eco-commitment
• Ordering options – online, cell phone
• Ethnic cuisines and food flavor.

Source: NRA Forecast 2008

Unit Level Economics

Target Operating Expenses:

• Sales                            100%
• Cost of Goods                        32%
• Payroll Cost                32%

• Other Expenses           20%
• Rent                            6%
• Cash Flow                   10%

Buying a Restaurant

Documents to be requested

• Copy of the Lease
• Tax Returns for 3 years
• Financial Statements for 3 years
• Complete Equipment List
• Latest Health Inspector’s Report

Source: Charles Perkins, The Boston Restaurant Group, Inc., Boxford MA

“The country’s largest listing site, bizbuysell.com, has 50,000 businesses for sale — up from 43,000 this time last year, said Michael K. Handelsman, the site’s general manager.  The number of businesses being sold also rose, to 1,795 listings that closed in the first quarter of this year, a 66 percent increase from 1,081 sales in the same quarter of 2007.

“But both listing sites and brokers around the country say that sellers have become more flexible about price.  In a survey by the International Business Brokers Association of its 2,000 members, nearly 73 percent predicted that 2008 would be a buyer’s market.  The survey was released in January.

 “One reason is that a crucial small business financing tool, home equity lines of credit, has been drying up as house values fall.  Traditionally, small businesses have had a hard time obtaining commercial credit, and that is worsened in rough economic times, several brokers said.”

Source: “A Time of Slipping Revenue and Limited Options” by Elizabeth Olson, The New York Times, May 27, 2008

The following article is an excerpt from a new book just published by Business Brokerage Press titled Selling Middle Market Businesses: Guide Book for Intermediaries by Russell Robb.

The representations and warranties in the Purchase and Sale Agreement take effect the date of signing. According to Stanley Foster Reed, author of The Art of M&A—A Merger Acquisition Buyout Guide: “These conditions are intended to disclose all material legal, and many material financial, aspects of the business to the buyer. The seller also gives assurances that the transaction itself will not have adverse effects upon the property to be conveyed. The buyer should be aware that lenders providing acquisition financing will require the buyer to make extensive representations and warranties about the target as a condition to funding.”

Exhibits are an integral part of the representations and warranties. Examples used by Stanley Reed are as follows:

No undisclosed liabilities of the target company except as set forth on Exhibit A.
No litigation that might have an adverse effect on the target except as set forth on Exhibit B.

Representations and warranties are very important in the sale of a company. According to Reed, “A buyer or seller will be able to back out of the agreement if it discovers that the representations or warranties of the other party are untrue to any material extent.” The words “no material adverse change” or “not material to the transaction” are the key phrases. In fact, the seller may insist on inserting the word “material” when referring to liabilities or litigation. While “material” can be construed as ambiguous, the arties can set a dollar threshold that defines it in particular circumstances.

The Important Elements

In representations and warranties, the important issues to focus on are financial statements, litigation, undisclosed liabilities, and taxes. Regarding the latter, for example, if the sale of the company involves a stock transaction, the following representations and warranties would be appropriate:

• Seller has filed all required tax returns.
• Seller has paid all the taxes due.
• Adequate tax reserves are reflected in the balance sheet.

An explanation of the basket provision is also used to protect the seller by indemnifying him for damages only up to a certain amount. Furthermore, there is usually a cutoff date by which the buyer can seek claims from the seller; three years is the outside limit.

One way to facilitate the buyer’s claims is to allow him or her to offset these amounts from the note due to the owner. Another method is to set up an escrow account equivalent to 5 to 10 percent of the purchase price.

The Purchase and Sale Agreement defines the parameters of both the purchaser’s and seller’s representations and warranties. The heaviest negotiating near the closing date usually involves the representations and warranties as well as the indemnifications. Also, the representations and warranties normally account for the largest part of the Purchase and Sale Agreement. The investigation follows the execution of the Purchase and Sale Agreement and is obviously before the closing. If an adverse material fact surfaces after the closing, then the owner will have to compensate the purchaser based on a breach of representation.

The Key “Reps and Warranties”

The following seller’s representations and warranties are the most important:

Financial statements. A closing audit is imperative to verify the authenticity of all the items, particularly inventory, receivables, and payables. Then a post-closing adjustment is factored into the final floating payoff at closing.

Assets. The buyer wants to be sure he is gaining full title to the assets, particularly as it pertains to items such as intellectual property and patents. Also, the buyer wants assurances that the machinery and equipment are in good working order.

Taxes. Not only is it critical to verify any tax liability if it is a stock purchase but in the case of an asset purchase, the owner wants to be sure there are no liens on assets due to failure to pay taxes.

Employee relations. Employee contracts and employee benefits are important even if it is an asset sale because if a new owner takes away knowingly or unknowingly an employee’s privilege, then he or she will walk into a hornet’s nest.

Environmental. Many transactions in today’s merger and acquisition business are being negated because of environmental liabilities. Just because the buyer leases the premises instead of buying the property does not mean that as a tenant the owner would not be held responsible in part for the contamination caused before your arrival.

Pending and potential litigation. This becomes a bigger issue with a consumer product company just by existing in our litigious society. The seller will want to place a time period or cap on his or her total responsibility. Usually, the buyer ends up sharing some of the risk for previously made products.

Authorization. To sell the company from stockholders, directors, or third parties such as the bank the owner will require authorization. He will be expected to ensure to the buyer that: all liabilities are represented; all contracts are disclosed; all wages, taxes, and insurance are current; and all bonus plans are disclosed.

While most of the burden for representations and warranties is on the seller, the buyer may be required to warrant that the acquisition does not violate their loan agreements or, if stock is to be used, that it is properly authorized. Obviously, if the transaction is a stock sale in which the buyer assumes all the assets and all the liabilities, the representations and warranties are more lengthy and complex. Often the buyer is only willing to undertake a stock transaction based on the tightness and thoroughness of the representations and warranties.

For the seller, the important issue is which representations and warranties survive the closing and which ones cease. Those that customarily cease at closing include warranties on equipment and guarantees on licenses. Those that often survive the closing include matters of litigation.

Conclusion

The following advice of Nelson Gifford is an apt way to end this chapter. As former CEO of the Dennison Manufacturing Company, Gifford was involved in more than thirty-five transactions. He says that from the buyer’s point of view, “the critical aspect of negotiations is what is stated in the representations and warranties such that the document reflects the following:

Everything you know, you told us.
Everything you told us is true.
Everything you didn’t know, you should have known.”

“I was talking to a PEG (Private Equity Group) in Florida and he said the exodus of Main Street Brokers to the Middle Market is over whelming.” Russ Robb

Mark Your Calendar! Spring Conference — June 1-7, 2008 Denver, CO

www.ibba.org

• Maintains confidentiality
• Knows and gathers pertinent information
• Recasts financials
• Has valuation knowledge
• Understands goodwill value (70%-90% of total value)
• Maximizes the value of the company
• Provides an overview of tax consequences to the parties
• Has relationships with professional experts
• Clarifies what is being sold:
  • Identifies, describes the historical
  • Identifies, sells the future
• Has market knowledge and understanding
• Possesses multi-pronged marketing strategies
• Has database of prospects
• Has understanding of various financing options
• Has contacts with appropriate specialists
• Is affiliated with other competent professionals in the Business Broker community
• Possesses negotiating skills and understanding of emotional issues of the parties
• Acts as the buffer between parties, thereby allowing seller time to make reasonable decisions
• Has the ability to better control the issues
• Coordinates and facilitates sell-side and buy-side activities with associated specialists and advisors such as:
  • Landlords
  • CPA’s, accountants
  • Tax attorney(s)
  • Transaction attorney(s)
  • Insurance carriers, agents
  • Lenders
  • Escrow processers, officers
• Permits the seller to maintain focus on running their business
• Is not emotionally tied to the business; able to maintain objectivity in process and transaction

“Cinema operators are increasingly taking steps to entice adults out of their living rooms and back to the theaters.  Some have waiters to deliver food to seats (though others offer the fancy food only at concession stands) and valets to park cars and dust off snow.

“Although eating dinner at the movies is not new – some small independent theaters have long served pub food and beer – a number of large companies are merging high-end restaurants, bars and lounges with their cineplexes.  There are now 300 cinema restaurants nationwide out of roughly 5,900 movie theaters, with more than 38,000 screens; dozens more are planned.” Source: The New York Times, February 2008

We realize that we may be beating a dead horse, as they say, or you may think we have nothing else to write about.  Our hope is that you might take us seriously this time.  

In a recent survey (February 2008), conducted by the listing web site Businesses For Sale (www.businessesforsale.com), 62 percent of the business brokers responding stated that it took them nine months or more from listing to sale. Only 28 percent reported that it took six months or less from listing to sale. 

Nine months, or longer, to sell a business – that’s hard to believe! Our last survey, conducted in 2006, stated that the average time between listing and sale was 7.9 months. At this rate, it won’t be long before it takes a year, or probably longer, to sell a business. Our survey also reported that the average listing period was 10.7 months. It seems to us that the way these time periods are increasing, listing periods are going to have to be at least a year or more. In fact, it wouldn’t surprise us if not too long from now, business brokers will have to take lifetime listings. We haven’t quite figured out whether it will be the seller’s life or the broker’s. 

As we have repeated many times, when we first got in the business, we took 30-day listings. (At that time, a long listing period was 45 days.)  Listing periods then became 60 days, then 90, then 120.  Now, listing periods are pushing a year.  

What can be done to speed up the time between listing and sale? First, constantly remind yourself of the business broker’s motto: “Time is of the Essence!”  Too much time is often spent getting the business ready to go to market. Gathering the necessary paperwork, preparing a business profile and checking the seller’s price against your price does take time, but how much? A big part of the problem, as we see it, is that once you have a six-month to a one-year listing, time loses its importance. It would be interesting to see how fast a business goes to market if some regulation popped up that said all listings must be no longer than 90 days.  

A new listing should be introduced immediately in an office; it just should be marked that it is not a complete file yet. The broker should also put the listing on the various web sites right away.  That will make the listing associate get the job done. As listing associates, we wanted to get our listings into play as soon as possible. 

Here are a few other tips: 

·      If you’re in an office with other associates, give them a copy of the new listing right away. You can tell them that you’re working on gathering the back-up materials, but you wanted to give the listing to them in case they might have a buyer looking for a similar business.

·      Gather the back-up information as quickly as possible. The seller has to understand that you can’t really go to market until you have it.

·      Ask the seller if they’ve ever been asked whether the business might be for sale. Many times the seller has had inquiries from interested people.

·     Ask the seller for information about trade associations. Check with these associations, as many offer listing services on their web site or in their publications.

·      Your office should have a monthly bulletin mailed or emailed to buyers informing them of new listings, price changes, etc. Make sure your listing is included.

·      Make sure your listing appears on all the internet sites your office subscribes to.

·      Stay in constant contact with the seller. New information – such as increased sales, new customers, or anything else that might be of interest to a potential buyer – should be communicated to the seller as well as to your associates. Update the ads on the internet sites. Push for a price reduction, lower down payment, etc. 

Quite frankly, the increased time from listing to sale that is taking place so quickly is one more big reason for co-brokering. A seller is usually most anxious to sell right after offering it for sale. One way to speed up the activity is for business brokers to have to tell the owner of a small business, who has a pressing need to sell, that it is going to take nine months or more to sell it. We think the owner might look at other options, talk to another business brokerage firm or, most likely, try to do it himself.   

Remember, time is of the essence!