Cashing In — May 2016

This topic involves strategy.

Most entrepreneurs ultimately face the question of whether to sell their company and, if so, on what terms. While the entrepreneur makes the key decisions, an effective CFO is instrumental in providing relevant information and helping to guide the process.

When deciding to sell the business, the entrepreneur has multiple and varying objectives. Among the most common are optimizing the value of the business for a secure retirement, taking advantage of favorable industry conditions, capitalizing on favorable tax laws, marital dissolution, family members unwilling to succeed the entrepreneur, and finding a buyer to meet the owner’s expectations.

A team of trusted advisers is critical to the success of a transaction. Besides the CFO, who quarterbacks the process, important advisers include spouse and family members, partners and key employees, board members, a CPA firm, an attorney, a valuation specialist ,an investment banker (or business broker), and insurance professionals. A reasonable time horizon for the seller can often be 2 to 3 years as factors such as increasing profitability and optimizing operations are often necessary to obtain a favorable price.

It is essential that the seller, CFO ,and advisory team utilize due diligence to be proactive and optimize negotiating strength. The key elements of effective due diligence include:
• Developing an Exit Plan
• Assembling an advisory team
• Optimizing the value
• Understanding how a buyer will value the firm
• Review of tax and legal issues
• Preparation of an Offering Memorandum

Thorough consideration of the foregoing matters will help develop a reasonable valuation from which to begin negotiations. There are many ways companies are valued. We prefer a discounted cash flow methodology whereby the after tax operating profits are discounted to their present value using a discount rate that reflects the risks of the underlying business.

The result can be validated by common shorthand methods such as Price to Earnings ratio, Enterprise Value to EBITDA, and Price to book Value. In certain cases, a more appropriate means of valuation could be comparable transactions (i.e. social media companies), or the value of assets (financial companies). In our view, it is wise to utilize several methods, reconcile the results, and establish a reasonable range of value from which to begin negotiations. Once established, issues concerned with structure, terms, and closing must be handled.

In many small business sales, taxes are key consideration. This drives the structure of the transaction – specifically whether it is treated as an asset sale or a sale of stock. For small closely held corporations, asset transactions are the most common structure. Tax code considerations and legal liability issues favor asset transactions in most instances. Another relevant factor is whether the company is a C or an S corporation. Once these characteristics are understood, negotiations typically hinge of saving taxes.

Stock transactions are usually the result of the seller having disproportionate negotiating leverage. This enables the seller to insist that the buyer purchase the stock with all the negative aspects relating to the assumption of liabilities and the inability to adjust the basis of assets for depreciation recovery (in many but not all cases). The tax savings for the seller are generally so compelling that a good strategy is to position the business to be sold to optimize negotiating strength.

The terms of the transaction define the responsibilities for each party to the transaction. An important aspect of negotiating terms from the seller’s perspective is to consider the terms as a whole package, rather than focus on obtaining one or two favorable terms. Often, the buyer will insist on several contingent items that will provide a degree of additional security regarding post transaction risks. The seller should anticipate this and be in a position to negotiate aspects of contingencies that are not lopsided in favor of the buyer.

Once the price, timing, and terms of the sale are defined, the closing takes place. This is where the business legally changes hands. The CFO, as quarterback, must focus on moving the process forward, keep details as simple as practical, ensure that financing is in place, and control the preparation of transaction documents. Successful application of these tasks typically results in a smooth closing that is satisfactory to the seller and buyer.

Most entrepreneurs ultimately face the question of whether to sell their company and, if so, on what terms. While the entrepreneur makes the key decisions, an effective CFO is instrumental in providing relevant information and helping to guide the process.

Capitol CFO Solutions serves clients in Washington, D.C., Maryland ad Virginia. Please contact us for a free consultation.