Business successions are generally accomplished in one of three ways: transition to next-generation family members, sale to key management or employees, or sale to an outside party.
There are many considerations, both financial and nonfinancial, when deciding on a transfer of ownership. But when maximizing the net proceeds from the sale is a priority and ensuring that the majority of the proceeds are up-front cash, a sale to
an outside party is the most viable option.
Buyers that already operate in the same or similar industry will be attractive. Their motivations may include eliminating a direct competitor, expanding operational capacity, acquiring new customer
relationships, adding new talent, or eliminating certain costs and enjoying additional economies of scale. These factors can drive the purchase price to a level that an internal buyer cannot afford.
Even if considering a transfer
of ownership to family members or key employees to maintain their employment, it may still be helpful to evaluate the valuation differential between an internal and strategic buyer. Some strategic buyers can provide good employment opportunities to
family members and key employees without their having to repay the acquisition debt or personal guarantees.
What Interests Strategic Buyers
It is important to recognize the attributes that buyers would be most interested in and then document efforts to improve those metrics. To capitalize on this, the succession planning process should begin early to allow time to demonstrate a multiyear
record of accomplishment.
The business model, size, industry, service and product offerings, history of performance, depth of management, annual revenues, and level of profitability will determine the types of external buyers that are viable
candidates. Interested parties may include the following:
- Businesses looking to incorporate certain elements of the target business into its existing operating structure and eliminate a large portion of standalone costs (personnel, occupancy, administrative). They may have surplus capacity that an acquisition
of customer relationships will solve.
- Businesses looking to expand geographically, increase their customer base, add new service/product offerings, obtain a trained workforce, or increase capacity. These buyers would likely retain a portion of the target’s cost structure but eliminate
executive and administrative costs.
- Businesses in an adjacent industry looking to incorporate intellectual property that can be used in its own industry, or a vertical integration to consolidate the supply chain. These deals sound great in theory, but they are more challenging to culminate.
Questions to Ask
In assessing how attractive a business may be to an external buyer, consider the following questions.
What has our financial performance been over the past five years?
Look at the trends and how they compare to benchmark
data. In assessing profitability, earnings should be adjusted to reflect owner compensation and related-party rents at estimated fair market value. In addition, nonrecurring revenue or expenses should be removed, and personal expenses eliminated.
Do we know our gross margin by product line and service offering?
To generate profitable growth, understanding which areas produce higher margins helps align new business development and investments. Gross margins
should reflect materials as well as direct labor and overhead.
Which business relationships are most important?
Many businesses have certain customer or vendor relationships that are critical to their success.
High customer concentration can spur rapid growth, but being overly dependent on one relationship is a risk. Some strategic acquirers can look past a strong, transferable relationship with a key customer if, in their organization, it would not be
Have we been able to attract, develop, and retain a quality workforce?
The sustainability and success of a business often depends on its employees. A well-trained, high-functioning workforce can be an
attractive intangible asset.
Do we have confidence in the quality of our numbers?
The previous questions all contain some degree of measurability. Make sure the data are tracked and they paint an accurate picture.
When developing an exit strategy that entails an external buyer, it can be helpful to obtain objective feedback in the following areas:
- Preliminary assessment of the business’s value
- Opportunities to improve the financial performance prior to sale
- Financial projections based on targeted strategic buyer
- Current data on industry valuation multiples and benchmark data
- An understanding of the personal financial situation and whether a sale can accomplish the objectives
With early planning, an understanding of buyer motivations, and objective professional guidance, a strategic sale can be an attractive succession option that provides financial benefits for owners and their families.
John S. Stoner, CPA, CVA, is a partner in the business consulting services group of RKL LLP in Lancaster. He can be reached at email@example.com.