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How to chart your course and pick your crew after you decide to sell your business.
Running your own business is often more than a full-time job. So-called business hours demand focus on product, people and customers, while the rest of the day — and often night — is devoted to strategy.
Years of careful planning and effort go into making a company a success. Creating something out of nothing and sustaining it demands courage, hard work, perseverance, personal sacrifice and financial risk. For most business owners, it is simply a labor of love.
Eventually, though, the moment comes when the owner must decide who the next owners of the business will be. Here, we focus on the most frequent choice — the outright sale to a third party.
Most owners are surprised by the sheer complexity of the sale process, and the vast divide between the skills required to build and run a business and those required to sell it. Our goal is to shine a light on the latter set of skills — the key questions, assembling the necessary deal team, and the steps required to sell your business at full value.
Thirty years into building his company, John Kelly created a new concept. Eighteen months of challenging work later, John’s company has a new client segment and a new product set. With sales contracts in place, revenue will likely rise by double digits over the next five years. With the expected growth in EBITDA (earnings before interest, taxes, depreciation and amortization), John expects the company’s value to jump significantly.
He is wondering what to do. The company will almost certainly outlast his career and probably his lifetime. Yet his outside investments, excluding IRAs, are still less than the company’s excess cash. Meanwhile, he’s about to celebrate the birth of his sixth grandchild, his 36th wedding anniversary and his 60th birthday.
While his professional goals are largely achieved, some personal goals remain. John and his wife, Mary, have discussed gifts to their kids and educational trusts for their grandchildren, as well as a substantial donation to the medical facility that cared for both of their kids and two of their grandkids. He knows it’s time to move ahead, but he’s not sure how.
Over the course of a breakfast meeting with his attorney, accountant and wealth management advisor, John begins to form a plan to sell his company. He realizes immediately that the involvement of these advisors will be critical before, during and after the transaction.
After the meeting, John and Mary sketched out their personal goals:
John meets again with his attorney, accountant and wealth management advisor to examine these goals and begin assembling the external team to work through the issues. John’s business lawyer refers him to a trust and estate lawyer and a transaction attorney. His wealth management advisor provides referrals to a business appraiser and merger and acquisition (M&A) advisor.
The Wealth Strategist
The wealth strategist focuses on the personal wealth management aspects of the transaction. “We are often the first to arrive and continue to serve the client long after the company’s sale,” says Michael Duffy, Strategic Wealth Advisory Group, Merrill Lynch Private Banking and Investment Group.
“We begin by talking at length about post-transaction objectives in terms of income, wealth transfer and philanthropy,” he says. “We also need a thorough understanding of an owner’s financial situation, including an analysis of health and other benefits received through the business.
“Once we understand the owner’s priorities and financial situation, we can explore solutions. An upcoming transaction, for example, presents an excellent opportunity for owners to shift assets off personal balance sheets while still keeping them within the family and potentially minimizing tax implications,” Duffy says. “If we’re involved early, we can explore a variety of vehicles that may enable owners to transfer some or all of the upside potential of the business out of their estate.”
Widely used strategies include the grantor-retained annuity trust (GRAT) and the sale of assets to an intentionally defective grantor trust (IDGT) in exchange for a note. “In their simplest forms, both transfer the upside potential of the asset, rather than the asset itself.”
Duffy also recommends developing an investment plan for the sale proceeds prior to the sale. A sound plan will factor in the owner’s return requirements and risk tolerance, and reflect an understanding of the owner’s financial life after a sale.
“It’s important to remember that tax-saving strategies evaporate as the sale approaches. Starting your wealth transfer, income tax and investment planning as early as possible can often save substantial amounts of money and maximize opportunities to create more wealth moving forward,” Duffy says.
David, a college student and immigrant, accepted a student internship for two summers at a car dealership in Chicago. The first summer he did manual labor; the second he did finance and sales. He found he had a passion for cars, and continued to work at dealerships for a major car company until, before he was 30, he partnered with the same major car company to start a dealership of his own.
David’s first business was successful enough for him to pay off his multimillion-dollar loans in 14 months. With continued success, he went on to buy and grow multiple dealerships over the next 10 years. Then, years later, someone from a large publicly traded holding company for dealerships offered to buy David’s entire portfolio. After some back and forth, the company offered a sum that David knew was too good to pass up.
But after the closing, David began to feel that he not only had given up his company and his employees but also, in a way, his identity — his entire adult life had been built inside the auto dealership world. His experience was fairly typical. Many entrepreneurs have a difficult time after the sale of a business, and David had a particularly rough time deciding on his next steps. Today, however, David is a different person from the young man he was back when he started his internship. He wants to find a business opportunity to start and grow with the same passion and success as he did with the dealerships. And now he has the time to find it.
The Business Appraiser
Another key early member of the deal team, business appraisers provide opinions of value on the enterprise, stock involved in pre-transaction gifting and management compensation, as well as intangible assets. Business appraisers, or valuation advisors, are involved in the sale process, but they are often engaged long before the sale gets under way. This often identifies value in intangible assets, intellectual property and goodwill for tax and financial reporting purposes.
There’s often a phase of the sale that incorporates the owner’s plan to transfer ownership interests to other parties who could benefit from the eventual sale. An owner may decide to gift or sell minority interests to children, or make a charitable gift. Those gifts have to be substantiated with an independent appraisal. If the seller has objectives in either of these areas, a valuation advisor is necessary.
Appraisers are also required whenever company equity is offered to management as part of compensation or when company shares are owned in an employee stock ownership plan (ESOP).
Appraisers can also identify value drivers for companies and industries, as well as potential buyer concerns in a consulting context, without issuing a formal appraisal.
The Transactional Attorney
Among other things, transactional attorneys guide on structure, obstacles and critical deal terms. They also ensure compliance with regulatory requirements and work through any deals with management incentives.
“It’s important to know that we do more than draft agreements,” says Stuart M. Cable, chair of the M&A group at the international law firm of Goodwin Procter. “We negotiate every term and condition other than price.
“We understand the prevailing market practices in both strategic and private equity transactions, so we can advise the seller and M&A advisor as to whether the proposed deal is better, on par or worse than market terms,” he says.
What advice would Cable give to our hypothetical business owner, John Kelly? “The first order of business is to assemble a collaborative team of experts in whom you have trust and confidence. The team should include an investment banker and an M&A attorney. You should anticipate a six-month process. You should consider carefully the motivation and incentives of your key employees. You should also commission an up-front legal due diligence review so that you identify and remediate any major legal impediments to value maximization before you are confronted with those issues by your buyer.”
Cable also highlights the importance of discussing with owners how they go to market, their interest in maintaining a role in the business, and how they are going to handle key people pre- and post-sale.
Does Cable have any final advice? “Trust your deal team,” he says. “This isn’t always easy, but the best results happen when the owner makes important strategic decisions but doesn’t dig in too deep on day-to-day tactical decisions.”
Doctor John Mahoney always planned to retire when he turned 65, but in order to make that happen, he needed to sell his orthodontics practice. However, even though his practice was top tier, buyers were sparse.
John’s two sons had built careers in other fields, so he couldn’t pass the business to them. The ambitious young orthodontist John had hired years earlier was also out — she was more interested in working as an employee, and could see that, if she took out the loans to buy the practice, she wouldn’t be able to retire at 65. And when John looked for younger orthodontists, he discovered that most carried student loans and didn’t have the wealth or credit history to make a suitable partner or a credible buyer.
Luckily, John had advisors who had experience selling businesses. They set him up with a business broker specializing in orthodontic practices, and the two began working about a year prior to the sale. The broker used the practice’s stellar reputation to find established and growing corporate buyers. John liked having a middleman market his practice, while also keeping his values in mind.
In the end, the broker found a buyer who suited John’s needs, and who made the process run smoothly. John even remained involved as a consultant. Now John’s practice is thriving, and he’s achieved his retirement goals.
The Merger and Acquisition (M&A) Advisor
While sell side M&A financial advisors take center stage as the sale approaches — assisting the client with its marketing efforts to a qualified universe of potential buyers — these critical members of the transaction team are active well before the sale process launches.
“Prior to launching any sale process, we discuss our client’s objectives in the context of market trends and industry dynamics to assist the client with their assessment of the optimal time to explore a sale,” says James Rourke, Managing Director in the Mergers & Acquisitions group at Bank of America Merrill Lynch. Rourke says, “Initial discussions with a client often center on determining how best to maximize value while minimizing disruption to the business and achieving an outcome that is consistent with the client’s vision for the legacy of the company post transition. These conversations may also include evaluating strategic alternatives other than a potential sale of the company. Knowing the client’s views on these and other topics well in advance of launching a sale process is often important in helping the client obtain a successful result.”
Once the client’s objectives are clear, the process can begin. “We work extensively with our clients’ management teams to facilitate interaction with potential buyers. Importantly, we help the client identify the appropriate parties to contact, with the goal of generating competitive tension along a structured, disciplined timeline that will deliver the highest valuation on the best terms. The decision to sell is very often the most substantial professional decision a client will make in their lifetime. Partnering with an experienced, trusted financial advisor early on can make all the difference in the pursuit of flawless execution once the decision to sell is made.”
Rick Eskin saw an opportunity to help the creative community. Although in high demand, creative professionals were some of the most disorganized people on the planet. Photographers, brand developers and graphic designers compelled people to take action, to buy things and to become passionate, but they needed a central place to connect and showcase their work.
Rick started a website where people could do just that. He built the business from the ground up, supported by a few hundred thousand dollars from fundraising. He raised additional funds based on a valuation, which allowed Rick to retain the talent he had and bring on new members.
During the process, Rick never considered an exit strategy. “Does an artist think about the price they will sell a painting for when they create their work?” he asks.
Soon, the team grew from 12 to 32 people and their users quadrupled in a single year. Then a buyer came knocking. A major supplier of creative software was looking to expand into the service business, and saw the business as a major stepping stone — one they aggressively pursued. Rick thought it was too early to be acquired, but the company kept raising the price, eventually offering $150 million.
Rick accepted the offer, but made sure that it wasn’t the end of the business. He worked with the software company to ensure that his vision continued, and that his staff, 12 of whom became millionaires in the deal, kept their jobs. Two years after the deal, the network continues to grow, and because Rick was clear on his goals, his team is still running the site.
The sale of a company is more like a marathon than a sprint. During the process, a successful transaction usually becomes clear. With a well-chosen deal team in place, chances are that the owner has been giving thought to the deployment of both the cash proceeds from the transaction and his or her own human capital.
In terms of reinvesting the proceeds, the wealth management team will have been positioning investments in advance of the sale and developing a post-sale investment plan.
The transition from being entirely invested in the company to having mostly liquid assets and an open calendar can be both exhilarating and challenging.
For most business owners, though, post-transaction life gets easier over time. Just as careful planning and a great deal team can streamline the transaction process, thinking through post-transaction life and anticipating potential challenges can make it even easier.
Case studies are intended to illustrate products and services available through Merrill Lynch Private & Banking Group. The case studies presented are based on actual experiences. You should not consider these as an endorsement of Merrill Lynch Private & Banking Group or as a testimonial about a client’s experiences with us. Case studies do not necessarily represent the experiences of other clients. Results may vary. The strategies discussed are not appropriate for every client and should be considered given a client’s objectives and based upon particular needs.