Every business owner eventually considers changing their ownership stake or selling their business entirely. The owner might transfer their equity to heirs, sell the business to management through a leveraged buyout, or sell to the employees. The owner may also consider selling the business outright to a third party, such as a private equity firm, a family office, or a strategic buyer.
All these choices are complicated and require careful thought. To choose the best option, the owner must thoroughly analyze the Company, clearly understand their own specific goals and objectives, and then outline and compare strategic options to create a plan of action.
When assessing their options, particularly in selling the Company, business owners should keep in mind the Five Ps of an ownership transition.
- Preparation
- People
- Positioning
- Process
- Patience
Carefully evaluating and addressing the five Ps can improve the business valuation and ultimately the final sales price.
Each of the five Ps will be explored in further detail below.
1. Preparation
When selling a company, it’s crucial to minimize deal risks and anticipate potential issues. This involves thinking like a buyer, addressing all their concerns, and gathering the necessary information to openly disclose and mitigate any possible business problems. Proper preparation greatly reduces the chance of unexpected problems during the sale.
A good first step is to work with your financial advisor to develop a comprehensive data room that includes all relevant documents and supporting materials needed for due diligence. This involves organizing financial records and all supporting financial documentation.
It is also important to gather all relevant legal documents, including the Company’s legal contracts, stock records, corporate minutes, and other essential records.
Starting early and gathering this information helps the seller identify gaps in their due diligence materials and address issues quickly. Doing this before contacting buyers allows for careful and systematic management of the information, which can be vital in reducing the stresses caused by a live deal.
Before a transaction, the seller should carefully review the Company’s facilities’ housekeeping and perform routine maintenance, such as fixing leaks, repairing peeling paint, and addressing similar physical issues. Improving the appearance of the Company’s plant and equipment through simple maintenance can leave a more positive impression on potential buyers.
Additionally, if the seller operates in an industry with potential environmental concerns, it’s important to review these issues and be ready to answer questions. Any environmental initiative must be disclosed; therefore, consulting an environmental expert and legal counsel is advised before starting any related remediation activities. The goal is to identify possible problems and address or mitigate them before beginning the process.
Another important part of preparation involves reviewing working capital items such as accounts receivable, inventory, and accrued liabilities. The goal is to eliminate outdated and obsolete inventory, write off and resolve problematic accounts receivable, and ensure all vacation accruals and other short-term liabilities are accurately recorded. Proper preparation is essential for keeping these items up to date. For more information on working capital, see Working Capital Adjustments, another Prairie Article.
Finally, we recommend that a seller obtain a sell-side quality of earnings (“Q of E”) from a reputable Q of E provider. The Q of E is a deal-focused accounting review that provides the seller with additional insight into its financial information, ensuring that its books and records are thoroughly examined and prepared for due diligence in the sale. Although a Q of E fee increases the costs of preparing for the sale, it can significantly enhance the sale value and save many times the fee paid.
The purpose of preparation is to prevent surprises during the Company’s sale. A bit of preparation can significantly improve the sales process and help reach this goal. If a seller takes these simple steps to prepare, there will be fewer issues during the sale and fewer surprises that could derail the deal.
2. People
The difference between exceptional and average corporate performance often hinges on a capable management team. Additionally, few acquirers are willing to buy a business without a strong team to operate it. Therefore, the management team is seen not only as a valuable “asset” but also as a vital part of the Company’s future value creation.
Additionally, when a business owner-operator decides to sell, they often want to retire, which can create a gap in the team. Therefore, having a management transition plan is crucial for owner-operators planning to sell and retire.
All business owners should regularly assess their management teams and create succession plans for key leadership roles. Each critical C-suite position should have a designated successor to the current leader. Additionally, if retirements are anticipated due to the transaction, a backup executive should be included in the Company’s descriptive materials to show how the team will look after the sale.
Even if a strategic acquirer, who might not need a full management team, seems like a likely buyer, it’s still essential to have a complete team. Having a full management team makes the Company more appealing to a wider range of potential buyers, encouraging more competition during the sale process.
3. Positioning
Selling a company is like any other sale; the seller must showcase its most attractive qualities to appeal to the buyer. Creating desire or solving a problem is what a strong sales process does when marketing a product or service. The same approach should be used in an M&A sale. The seller should highlight the Company’s appealing features and show how the business fits with a potential buyer, thereby building long-term value. Highlighting the Company’s unique features and demonstrating how the business aligns with the buyer is called a positioning strategy.
To prepare for a company sale, the seller’s deal team should begin creating a summary of the Company’s key features to attract buyers. A Confidential Information Presentation (“CIP”) is prepared to disclose all relevant details to potential buyers. The CIP includes sections describing the Company, its operations, a summary of the customer base and market sector, background on its facilities and major assets, and a summary of its financial information. This information aims to inform the reader about the characteristics of the Company being sold. It provides a detailed overview of the facts and presents the information for the buyer’s analysis and evaluation.
Since most of the CIP content is primarily descriptive, it’s important to include a section that highlights the seller’s perspective on how the Company should be viewed by buyers and how the seller perceives the investment thesis for the business. This positioning information is included in a section titled “Key Investment Considerations,” where the Company description is expanded to help the seller effectively position the Company for potential buyers.
While potential buyers will likely have their own views on how the business fits with their company, the seller can guide the analysis by emphasizing key investment factors for the buyer. Often, by highlighting the potential benefits of an acquisition, the seller can make buyers more aware of competing bidders and how the deal might align with their rivals’ businesses. There is nothing like a bit of competition to sharpen a buyer’s focus on the prize.
4. Process
Even with a well-designed CIP and a solid positioning strategy, an M&A deal benefits from price competition or discovery through a competitive sale process. Price discovery occurs during an auction, where numerous knowledgeable buyers compete for an asset, thereby setting a market-determining price through their bids. A robust M&A process uses competition to create urgency, set deadlines for participants, and secure the highest valuation.
Conversely, sellers are sometimes approached by an unsolicited buyer with an initial “offer” they consider more than acceptable. Often, over the following weeks or months, the buyer tries to keep the seller engaged and gradually lowers the original offer. The buyer keeps an advantage in negotiations by counting on the seller’s tendency to stay committed after investing time and legal resources, even as circumstances change. Without competition, these unsolicited buyer situations rarely benefit sellers. There is no process-driven price discovery, and buyers making unsolicited approaches are often more informed about the Company’s market value than the seller. These buyers use this knowledge to secure a better deal for themselves.
That’s why understanding that a competitive M&A process shifts negotiation power toward the seller is crucial. Conducting a competitive process with a well-prepared CIP demonstrates to all buyers that the seller is ready, committed to closing, and intends to market the Company through a competitive process. Moreover, this process facilitates a price discovery mechanism, as multiple buyers are contacted and submit valuation estimates, establishing a market value range.
In a well-managed M&A process, the seller creates a system that effectively targets a carefully chosen group of strategic and financial buyers, encouraging them to compete for the Company. During a structured process, the seller’s advisors systematically contact buyers and set deadlines to keep the process disciplined. After providing a reasonable amount of time with the CIP and other information, along with one or more Q&A sessions, the advisor sets a deadline for Indications of Interest (“IOI”). This deadline is communicated through a letter of instruction, signaling to buyers that a competitive situation exists. Once all IOIs are received, the seller’s team selects several of these buyers and invites them to a meeting with the Company and management, usually at the Company’s facility. These are called Management Meetings. Afterward, invited buyers gain access to a data room with additional information, conduct further analysis, and have another chance to ask questions. After a reasonable period, the seller’s advisor sets a deadline for a Letter of Intent (“LOI”) via an LOI instruction letter. Again, issuing letters and setting a deadline fosters a sense of competition. From these LOIs, the seller’s advisory team chooses a winning bidder but will likely still pit the finalists against each other in a final pre-LOI negotiation.
A well-executed M&A process is essential for encouraging competition among buyers, helping the seller secure the best price and terms. It also serves as a safeguard if the leading buyer attempts to change their LOI after being selected. A strong process keeps interested buyers engaged throughout the entire deal. In a smoothly managed M&A process, the top buyer understands that if they try to renegotiate or “retrade” the deal, the next-best buyers are ready to step in and take over. More details on M&A processes are available in The Value of an M&A Process, another article from Prairie.
5. Patience
In a well-managed M&A process, it is vital for a seller to act swiftly in the market and maintain momentum until closing. However, even with quick action, patience remains essential throughout every stage of the process.
Ensure you allocate enough time to carefully complete each step. When selling a company, the seller should carefully interview and choose the right deal team members. The seller should thoughtfully analyze and evaluate different strategic options. The team needs to spend time gathering all necessary information to prepare the CIP and fill the data room. If issues arise with the management team, the seller should dedicate time to improving it. If the accounting system has problems, the facility needs a new roof, or other issues come up, the seller should address these before starting the process. While acting quickly in an M&A deal is important, patience and careful attention to each task are equally essential. Be patient but purposeful; approaching buyers should only happen once the deal is ready for the market.
If issues are not addressed, sellers sometimes believe the buyer might overlook these problems and still purchase the Company. While that could happen, the sale is likely to occur at a valuation much lower than it should be. The buyer will consider the costs and time required to address the issues and may likely reduce the Company’s valuation for assuming the responsibility of implementing those changes. It’s better for the seller to be patient and handle the issues themselves than to lose value and let the buyer do the repairs.
Additionally, as a deal approaches completion, negotiations over the purchase agreement can become lengthy and frustrating. A bit of patience can go a long way in successfully negotiating and finalizing the legal documentation of a deal.
Be patient yet intentional. The proverb “haste makes waste” is especially relevant at every stage of an M&A transaction.
Conclusions
Being aware of and considering the Five Ps of M&A is essential when selling a company. Although much of this article is common sense, these tips can significantly impact the success of an M&A deal. The Five Ps can be the difference between success and failure. Most importantly, the Five Ps can lay the groundwork for a Sixth P, a higher purchase price.
Terry Bressler is a Managing Director at Prairie Capital Advisors, Inc. He can be contacted at 312.348.1323 or by email, tbressler@prairiecap.com.
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