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6 Dangerous Myths to Avoid When Selling Your Family Business

Sept. 1, 2007
For many owners, the sale of their company is the largest, most complex transaction of their careers. Because of its magnitude and impact on their future,

For many owners, the sale of their company is the largest, most complex transaction of their careers. Because of its magnitude and impact on their future, it's also one of the most stressful. Sellers will often find solace and security if they have the right acquisition advisor to guide them during this process. It can be especially helpful for sellers if the advisory firm is headed by an advisor who is also an entrepreneur and business owner, because they can personally relate to the intensity and depth of emotions other owners face when they sell a family business.

Many acquisitions in the electrical wholesaling industry are middle-market transactions valued between $2 million to $250 million. Unfortunately for business owners in the electrical market, very little information exists specific to deals of this size that can help a potential selling owner know what's involved in the sale process. That's why many prospective sellers have potentially harmful misconceptions about the sale process. During my many years in acquisitions, I have talked to thousands of middle-market owners who believe in six common but erroneous myths. This article will help debunk these myths and give business owners a better grasp of the realities involved in selling their businesses.

  1. A VALUATION IS BASICALLY A NUMBERS-CRUNCHING PROCESS. Nothing could be further from the truth. A properly conducted valuation involves the complete investigation of a company's business foundation. It includes defining the company's future opportunities and the major risks. The following factors must be evaluated during this process, because they become a prime determinant of the multiple to apply to the company's expected future earnings:

    • The strength of the company's marketing program, including the diversity and control of its customer base.

    • For distribution or service businesses, the demographics of its trading area, the quality of its product and service lines, the attractiveness of its locations and the ability to run its operation on a cost-effective basis.

    • For manufacturing companies, the ability to produce a high-quality, low-cost product, and the caliber and productivity of its research and development function.

    • The quality of the management team and the presence of a reasonably-paid, well-motivated work force.

  2. OWNERS USUALLY CAN'T INCREASE THE PURCHASE PRICE BY TIMING THE SALE. Wrong again. Sellers can plan and time the sale to maximize the transaction price. As part of the planning process, all factors defined in the first question are evaluated and suggestions are made to strengthen the business foundation. The solidifying of the business foundation will increase the transaction price. In addition, the planning of the sale will enable a company to be prepared to go to market at the appropriate time to generate the maximum price. It also helps owners respond intelligently to the unsolicited interest of a prospective acquirer.

  3. THE DEAL IS FUNDAMENTALLY COMPLETED WHEN A PRELIMINARY PRICE IS ESTABLISHED AT THE LETTER OF INTENT (LOI). In fact, the execution of an LOI is merely the start of the negotiating process. Unless you have a sophisticated, experienced advisory firm that can control the deal, it's not unusual for an acquirer to demand a price reduction between the LOI and the closing. You must make sure an acquirer knows that will never be productive. The negotiation of the Definitive Purchase Agreement (DPA) is a difficult, confrontational and time-consuming process. The DPA includes all the critical representations, warranties and indemnifications of potentially equal financial importance to the deal price itself. If they are not negotiated to provide the seller maximum protection, it can give the acquirer a post-closing opportunity to recover a considerable portion of a seller's deal proceeds.

  4. OWNERS SHOULD ONLY SELL THEIR COMPANY WHEN THEY ARE AT OR NEAR THE END OF THEIR BUSINESS CAREERS. This isn't true for most business owners. Many of them don't understand many of the benefits that can arise from a sale. Owners of closely-held corporations usually have a vast majority of their personal wealth concentrated in the business. In and of itself, this is poor financial planning, but it's a typical by-product of owning a closely held corporation. By selling all or part of the company, owners can reduce their concentration of wealth in the business. In addition, it puts their estate in more liquid condition. I have advised many younger owners recently in the sale of their business who selected this strategy. They also wanted to enjoy the finer points of life for a few years, while still in prime health. After their covenant-not-to-compete expires, which could occur after a five-year period, they can get back in business. However, they will commit only a small portion of their sale proceeds to the new business endeavor. This will assure that they have lifetime financial security. They will be refreshed and might be eager to pursue a new business endeavor. From a personal standpoint, this is a very attractive alternative for many owners.

    Where owners merely want to reduce their concentration of wealth in the business but still want to run the company, a recapitalization with a private-equity firm might be the answer. In this type of situation, a selling owner can get approximately 90 percent of the deal value while still retaining a 30 percent interest in the recapitalized company. As most private-equity firms strongly prefer management to stay, selling owners should be able to continue to run their businesses in basically an unfettered manner. The only thing likely to change is that the owner will now report to a board of directors. However, the owner will still determine the company's strategic course.

    If an owner wants to pursue this alternative, they must find the right private-equity firm. Only a few private-equity firms are price-aggressive and pay a price comparable to a strategic acquirer. Some of these firms might have companies in their portfolio that fit strategically with the seller. This should enable them to pay a price comparable to a strategic acquirer. An experienced advisory firm will know if a recapitalization makes sense for the owner. They also should know which private-equity firms historically pay a strong price.

  5. SELLERS WILL PROBABLY HAVE TO ACCEPT NOTES AS PART OF THEIR TRANSACTION PROCEEDS. Many unsophisticated people, or advisory firms not overly concerned about maximizing their client's interests, believe acquirers will always want a seller to take back a significant portion of the purchase price in notes. They rationalize that an acquirer needs this as protection against legitimate hidden problems that might be uncovered after the business is sold, and because growth-oriented companies must use all available leverage to fund future expansion. This is nonsense. When owners sell their companies, they have the right to receive their proceeds in cash, except for the equity portion retained in a recapitalization.

  6. SELLERS DON'T NEED TO EMPLOY SPECIAL LEGAL COUNSEL TO HANDLE THEIR TRANSACTIONS. This depends on the sophistication of the seller's present law firm. If it's a large firm that has specialists in the critical areas of environmental law, human resources, intellectual property, corporate finance and certain other areas, it might be appropriate to retain the current counsel for the transaction. However, if the seller utilizes a smaller law firm of fundamentally generalist attorneys, they should employ new counsel with specialists in the numerous functional areas to advise them in the transaction.

If the seller employs a sophisticated advisory firm that will direct the deal negotiations, it's often advisable to allow the advisory firm to bring in a large, experienced law firm with whom they are familiar. This will ensure a blending of compatible negotiating styles with people familiar with each other's negotiating style and skills. This will be a significant asset to the seller during negotiations.

If business owners don't believe any of these myths, they should be able to sell their companies at an aggressive premium price with only limited, if any, exposure to post-closing issues.

George Spilka is president of George Spilka and Associates, Allison Park, Pa. The firm specializes in mergers and acquisitions. The author's Web address is Reach him at (412) 486-8189 or by e-mail at [email protected].

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