Imagine someone calls and says, “We may be interested in buying your business.” What do you do? You might have been thinking about the possibility of selling, and may have even put out some feelers, on a confidential basis, to a few contacts. Or, you may not be thinking of selling, so an inquiry like that would really take you by surprise. In this article, we discuss how to evaluate a buyout offer, whether you have been thinking of selling or find yourself fielding a completely unsolicited inquiry.
Buyers are looking
Do not be surprised if you get an inquiry “out of the blue”. Professional buyers with dedicated development teams are actively seeking companies to buy. This can be particularly noticeable when interest rates are low and the economy is growing, but even in times of slow growth, there is capital that needs to be put to work. Private equity funds have the cash to invest, and other companies see acquisitions as a way to achieve growth fairly quickly. Independent business brokers and “finders” are always trying to make deals happen.
Buyers often find they are not able to deploy their capital fast enough, as there are frequently fewer quality opportunities than there are quality companies for sale. If your business has a track record of decent growth, positive cash flow, and a solid customer base, you may be on the receiving end of multiple solicitations. That sounds good (and it is), but it can be overwhelming. Know that you do not have to respond right away – in fact, it may be better to step back and consider your next steps carefully.
So, you have one or more potential buyers. Now, what do you do? First, decide whether you are interested in selling. Is now a good time for you? Unless the economy is in a deep recession, M&A deals will get done, but are you emotionally ready to sell? Are the financial records for your business in good shape? If not, you would be at a great disadvantage – getting a strong offer depends on giving buyers a clear picture of your company.
If you are interested and your financials are in order, assume you are not ready to have a conversation unless you have been through this process before. Do not call the buyer or his/her representative to say, “let’s talk!” unless you are confident you know how to have an initial conversation to gather information without saying too much. That is probably harder than you think. Even legitimate buyers who are entirely above-board will fish for information that can give them an advantage. Professional buyers have a strategy map. They potentially know more than you do about other companies in your industry that might be for sale – assume you are outmatched.
Having said that, if you are interested in selling it may make sense to have an “exploratory” call to gather intelligence about recent M&A transactions in your industry, and to gather information about the buyer. Develop a list of questions that are important to you; then decide if the answers to the questions are reasonable. Your list might include the following:
- Why my company? What do you know about us?
- How many deals have you done?
- How do you approach valuations?
- What are some of your disqualifiers for an acquisition candidate?
- What are the steps in your process and how long is each step?
This takes some self-awareness – if you have a tendency to say too much (and owners do enjoy talking about their companies), you may want to have an advisor with you in the room with you, someone who can tell you whether you should or should not answer certain questions.
Financial vs. Strategic Buyer
If you are interested in selling, should you have a preference for a strategic buyer versus a financial buyer? After all, money is money; you may be indifferent as to whether you sell to Firm A or Firm B. Note that while private equity firms are financial buyers, they can be seen as quasi-strategic. They tend to specialize in certain industries and can help to realize economies of scale for their portfolio companies PE firms may not offer as many synergies as a strategic buyer could, but it may make sense in your situation.
If your business is still in an early stage, a strategic buyer that can help you grow the business and gain market share maybe your best alternative. As the founder, your age may also be a factor —a fairly young entrepreneur may be a part of the reason the buyer is interested, and you could potentially become part of the combined entity’s senior management team.
What about multiples?
As the owner, you are interested in how much you could get by selling the company, but there is no easy formula for that. Although people talk about valuations in terms of “multiples” (e.g., ABC Co. sold for X times EBITDA or Y times revenues), a buyer assigns a value to a company based on the free cash flow that the business will generate going forward. Using EBITDA as a proxy for cash flow, a buyer comes up with a value, which can then be translated into a multiple. Newer companies are often valued as a multiple of revenues, with assumptions and forecasts about the growth of the business baked into revenue projections.
Should you stay or should you go?
Should you seek an earn-out as part of the sale? If so, over what period of time? Although earn-outs are quite common, the best advice is to be sure you are content with the money you will get at closing. You cannot count on what you might receive through an earn-out – they are complex to structure and monitor, and are prone to litigation. Furthermore, an earn-out provision means you cannot walk away if something goes wrong (buyers often want the seller to stay for that very reason).
Follow the M&A rules
Evaluating offers to buy your business sounds exciting but it can quickly turn into a nightmare. Entrepreneurs are usually visionaries, are not necessarily rule-followers, and are not eager to jump into the accounting statements, financial projections, and legal terms that M&A deals require. There are rules to follow, and coloring outside of the lines may not work to the entrepreneur’s advantage.
If a buyer asks you to sign a Letter of Intent (LOI) early in the process, you should decline unless you are sure this is the right time to sell and the right deal for you. Signing an LOI likely precludes you from talking to other potential buyers for a certain period of time, and buyers may choose to litigate if you sign and then use their offer to solicit others. If a buyer suggests the offer will expire unless you sign an LOI, that is a red flag.
We strongly urge every business owner to follow these seven rules if a buyer contacts you about selling your company:1. Know what constitutes an offer.
An offer is only “real” if it is binding, and no offer is truly binding until you have your cash in hand. There is a continuum of offer types, ranging from a non-binding expression of interest to a binding LOI to a signed, funded agreement.
2. Make sure the buyer is legitimate.
How do you do that? Call your corporate lawyer, CPA, or an M&A/financial expert who has access to Pitchbook and/or Capital IQ and/or Crunchbase to see what other deals the buyer has done. Do research online. A PE firm that has been in business for a decade and has a track record is probably legit.
3. Do not agree to pay anybody anything or share any information with anyone to get your business sold until you get some professional advice.
Some business brokers or ”finders” are not entirely scrupulous. They contact entrepreneurs, saying they have a buyer and ask for money and or a signed letter. We strongly recommend seeking legal advice before responding in any way.
4. Make sure you are prepared to engage in a serious conversation.
If the buyer is serious, legitimate, and motivated, have your ducks in a row. Make sure your financial records are in good shape and develop honest answers to questions about your market, your customers, your profitability, and your team that a buyer might ask. Deals can fall apart even after an LOI is signed if the seller is not sufficiently prepared, or has unrealistic expectations.
5. Get your business attorney involved right away.
Do not agree to anything, even verbally, without a lawyer’s input. Remember, there are rules to follow!
6. Have some idea of what your company is worth.
What would constitute a reasonable value (and deal terms) for a company like yours? Research recent transactions in your industry involving companies of a similar size to yours.
7. Work with an M&A expert.
You need a financial expert with M&A know-how to help you navigate through the process, point out the pros and cons of various offers, and negotiate deal terms. Use your professional network, a personal financial advisor, or CPA to get a recommendation. This should be a good “fit” for you, as you will work closely with this advisor through what can be an emotionally charged time.
Selling your business can be the culmination of years of hard work, and can open the door to a new and rewarding chapter in your life. However, the process does not always go smoothly and regrets are tough to live with. Make sure you have the right team of financial and legal experts to guide you to a successful sale.
What Should Be Included in a Business Buyout Offer
As mentioned earlier, no deal is complete until the seller receives cash in the bank. Following are several of the key items in a letter of intent:
- Aggregate Purchase Price. The price of a company is usually expressed on a “cash and debt-free basis.”
- Assumptions the buyer is making about the company to support the purchase price.
- Whether the transaction will be a purchase of stock or assets.
- The form of the consideration to be paid to the seller, which may include cash, stock, notes, and assumed liabilities.
- A list of any escrows and holdbacks at closing. This will also state the purpose of the escrow (items such as indemnity and net working capital) and the length of the escrow period.
- Whether there will be any performance earnout and, if so, the targets and time periods associated with the earnout.
- Potentially a discussion of the key indemnity provisions that the buyer will expect from the buyer (see your lawyer!)
- Who in the management team will be offered employment agreements and incentives. This should also include an amount of base salary for key executives and whether they will be expected to sign non-competition agreements.
- An assumption as to the amount of net working capital to be delivered by the seller to the buyer at closing.
- The anticipated timing to get to closing, usually 45-90 days.
- The exclusivity period, which is the period of time that the seller may not talk to any other potential buyers except the one that signed the letter of intent.
- A description of the conduct of the business prior to the closing of the transaction and the conditions to be met prior to closing.
This outline is greatly simplified, but it illustrates the importance of engaging experienced advisors and consulting experienced counsel when evaluating a business buyout offer (a legal document).
Free Bid Matrix Download
Thinking about selling your business? G-Squared Partners has deep experience and a specialty in guiding small- to mid-sized businesses through the M&A process. You need a systematic way to analyze and compare two or more offers, side-by-side, across various elements.
G-Squared Partners created a Bid Matrix to help you to do that – it points out key issues you need to consider when examining any offer.