Responding to an Unexpected Offer to Sell Your Company

Repeatedly we talk with private business owners confronted with an unexpected offer to sell their business… let’s call these “unsolicited offers”.  Many times, they haven’t really thought about a succession or exit plan nor have they prepared for a deal if they so desired.  Usually the owner of the company or one of their advisors (i.e. attorney or accountant) reaches-out to us for assistance.

Typical questions that we field in these discussions include –

  • How much is my business really worth?
  • Is the timing right to sell my company?
  • If I want to respond, what information should I share?
  • How do I control the competitive risks of engaging with them?
  • How do I know that what they are offering is the best deal for me?
  • Should I negotiate only with this potential buyer or should I try to bring other buyers to the table to create competition?
  • Who on my team should the buyer be talking with?

…. and the list goes on.

Many owners focus exclusively on valuation, missing the forest for the trees.   Evaluating an offer (unsolicited or otherwise) is about a combination of – – valuation AND deal structure AND timing!

Over the years, we have developed a streamlined process to help management, owners and their advisors sort through these and the other usual questions to determine a path forward.   One element of that process is to quickly assess the strategic relationship of that buyer relative to our client’s business and industry… and gauge the likely value they can achieve by owning our client’s company.  In other words, can the buyer likely realize significant value from our client’s company AND afford to pay at the upper-end of the valuation range?  This involves answering the question: “is there a compelling strategic reason for the buyer and our client to do a deal today”?  We evaluate this in connection with the recent historical and mid-term projected performance of the business.

From that last question, you see that we must first determine what is the market valuation range and have a defensible rationale for our numbers.   This involves looking at the value of the company from a number of perspectives.  To some degree, we are projecting what value our client’s company would command if we were to run a competitive process.

The next step involves understanding the deal structure that will work for the specific type of company being sold, thinking about both the business needs post-closing and the structure that will optimize the after-tax cash to the seller.  Deal structure is usually critical to how and when the seller is paid, and how much is retained after transaction costs and taxes.

Equally important to these financial and deal topics in a transaction, is the preparedness and maturity of the operating team… these are the folks that will be with the company after the closing.  So many businesses today are purchased (or NOT purchased) because of the quality and talent of the people.

I realize that I’ve just scratched the surface for this topic. My business partner, Buddy Howard, and I generated an easy to read primer called Value Levers: Increase the Value of Your Business From 3X to 7X. We wrote it for CEOs, CFOs, leaders and advisors of middle market businesses.  Though we live in Raleigh, North Carolina… the concepts we speak to are relevant to most privately held middle market companies regardless of location or industry. This short book should be of value as you think about exit strategies, succession planning and being prepared for an M&A transaction.

Know your EBITDA

If you are considering selling your North Carolina based business, a key metric you must understand is EBITDA – Earnings before Interest, Taxes Depreciation and Amortization. Buyers typically derive their initial value based on a multiple of the company’s EBITDA.

Ultimately, future cash flow determines value; and EBITDA is a proxy for that cash flow. When adjusted for owner related and one-off items, this measurement of the company’s earnings can gives buyers an indicator of what the company may look like in their hands. EBITDA is important to buyers as it enables them to evaluate a company’s level of profitability without giving consideration to the capital structure and factors like tax planning and financing activities. Business owners can increase EBITDA, and provide a truer picture of the company’s earnings, by adjusting for one-time non-recurring expenses such as capital projects that were expensed, professional fees, above market owner compensation, and broader items like non-recurring components of research and development.

The process of deriving an adjusted EBITDA is called normalization and results in a recast income statement (and sometimes a recast balance sheet). There are two steps to this process. The first is adjusting the financial statements to assure compliance to GAAP (General Accepted Accounting Principles) and the second is establishing a list of add-backs. There are nuances and differences between tax accrual accounting and GAAP reporting that can have a significant impact of value, in both directions. Typical areas of concern deal with revenue recognition and year-end accruals. Understanding the adjustments to comply with GAAP usually requires a CPA that has an audit background and understands public accounting reporting.

If you are considering selling your business or pursuing an acquisition, consider partnering with an M&A advisor or investment banker that can work closely with you to prepare the business for sale and optimize the value beforehand. Experienced intermediaries will have recast financial statements and understand what types of add-backs can make a significant defensible impact on EBITDA and conversely know when to avoid adjustments that may actually jeopardize your claims of true cash flow.

Adjustments, or add-backs, have to be defensible for a buyer to accept them and use them to establish a value. In most cases, interested buyers will ask for a copy of the recast worksheet so that they can analyze the add-backs and map them to a final adjusted EBITDA number. If the numbers don’t seem plausible, you, the seller, will lose credibility, which can negatively impact value. That said, the act of recasting or adjusting your EBITDA to represent the most realistic picture of profitability under a new owner should not be a creative exercise.

With a defensible, sound adjusted EBITDA in hand, the question becomes ‘how does the buyer apply the multiple’? One of the primary factors in determining the multiple is the industry or nature of the business. For example: pure distribution companies that don’t add significant value can trade as low as three times adjusted EBITDA depending on the size of the business, whereas value-added distributors can trade much higher. Technology companies fetch much higher multiples and can oftentimes trade on revenue multiples due to the potential for high growth and high profits.

Strategic buyers tend to pay higher multiples of EBITDA because the acquisition has some synergy with their existing business and can be accretive; meaning that it can increase their earning per share. In a similar vein, a private equity group with a platform company seeking to acquire your business as an add-on, the investment is strategic in nature and may command a greater multiple than a standalone financial investment.

To maximize value in a sale transaction and move the multiple to the higher end of the range, it is important to present the true value of the company to a potential buyer – financial or strategic. To do this, explaining the strategic positioning, core capabilities, market differentiation, strength of your team, and growth opportunity of the business in a clear and succinct manner is of utmost importance. The combination of a growing a business, solid financial performance, good business practices and appropriate risk mitigation is likely to garner the optimal value.

So, remember EBITDA – the acronym that just may be the key to you maximizing the value of your company.

Optimizing for M&A and Growth

Buddy and I recently wrote a chapter in the 14th volume of Advances in Mergers & Acquisitions, published last month.  The book (and chapter) are a bit academic, but there’s some good content and ideas that might be of value as you think about M&A.

We find that private, middle-market companies that choose to implement mergers, acquisitions or growth strategies in today’s environment often face challenges when engaging with the capital markets, particularly when bridging the valuation gap between market values and owner values[1]. The chapter we wrote applies traditional corporate finance theory to the real-world dynamics of private, middle-market companies and outlines practical steps to shrink the value gap and increase transaction readiness.

For private, middle-market companies – those companies with annual revenues from $5 million to $1 billion – value creation is principally based on long-term, expected future cash flow. In practice, the activities that lead to value creation are nearly the same when preparing for a financing, a wave of growth or an M&A transaction. Owners of private companies tend to manage the business to minimize taxes and maximize the current cash benefit to the shareholders. While this approach makes sense in the short-term, it often over-weights decisions and strategies for immediate impact at the expense of what outside investors or lenders would consider long-term value creation. Many times, improving the realizable value of a company means shifting its approach and stance from one that is reactive to one that is proactive. Taking a proactive stance means, among other things, a company will tackle tough issues and instill disciplines like those on which an institutional investor would insist. A useful question for management to ask in readying their company for change is “What would a private equity buyer do to improve my business?” The answer to that question will likely provide keen insights and areas of focus, and is what we hope to provide in this chapter.

Essential to increasing the value of a company is increasing the amount and certainty of its cash flow while reducing the risk of achieving that cash flow. Optimizing the business should result in both a shift in the market value of the company towards the upper-end of valuation benchmarks and increase its alternatives (more buyers, cheaper capital, etc.) when engaging with the capital markets. Our discussion here hinges on those value levers most critical to the optimization of private, middle-market companies from the perspective of those in the capital markets, including institutional investors, lenders and buyers.

Keep in mind that strategic decisions need to be thought of and developed by aligning the company’s long-term growth strategy with the right leadership team, with the appropriate entity and organizational structure supported by scalable systems, and capitalized by the proper funding sources. Management must also consider changes to a company relative to its stage and life cycle within its specific market.

Calculating the value of a stream of cash flow can be viewed in mathematical terms by this simplified formula[2].


According to this equation, we can increase value by increasing the absolute value of the cash flow, reducing the cost of capital or increasing the rate of growth of the cash flow (or any combination of the three). Reducing the cost of capital is, in part, directly related to the risk of achieving that cash flow. To frame the discussion and apply some basic corporate finance concepts, we will look at value creation and optimization of a private, middle-market company as an exercise with three distinct types of value levers: (i) pursuit of strategies that increase the return on invested capital, (ii) pursuit of strategies that reduce the risk of investment in the company, and (iii) pursuit of tactics and strategies that ease the transfer and reduce the company specific risk of transitioning a business to new owners (whether transferred in part or in whole).

Certain businesses don’t generate positive cash flow in the early phase of their lifecycle but do create significant inherent value. From a buyer or investor perspective, these companies may have captured (or are capturing) a significant customer base or developing a technology that will eventually lead to relatively large and material cash flows. These core concepts still apply.

[1] Owner value is the value of the business interest to the current owner, considering
the entire stream of value including both financial and personal considerations that
accrue to his/her total economic benefit. The risk implied by owners to this value
stream is usually less than what the market would otherwise impute, which exacerbates
the valuation gap.

[2]There are variations of this formula that account for fast growth businesses, and
for those with negative short-term cash flow and positive long-term cash flow.


Where Does the M&A Advisor Add Value?

We surveyed private company sellers after their deal was done to gain insight into what was important to them and to better understand the selling process through their eyes.  While we are located in the Research Triangle Park area of North Carolina, we leveraged our national network of contacts to gain broad perspective in a variety of industries and states.  Below are a few statistics that might help you as you think about selling your company (or helping your client in the process):

Number of survey participants 63
Years in which companies were sold 2010 – 2014
Industries represented 18

As you can see from the chart below, companies representing the lower-middle and middle market participated, with revenues ranging from a few million dollars to nearly $250 million.



So where did the advisors add value?  That’s the chart below, ranking the area of value-add by highest or most value to lessor.  As you can see, the highest ranked areas were about the credibility attributed to the seller based on the advisor’s credibility coupled with leading the process and having an understanding of the transaction to negotiate on the seller’s behalf.  On a combined basis, these should enable the seller to achieve value that they might not otherwise have realized on their own.  Contrasting the value of legal counsel in the negotiating process, a M&A advisor should be able to assist in structuring the economic elements of the transaction to optimize the deal for you.  Surprising to many sellers is that “finding or identifying the buyer” is not on the top of the list.  It is important, and there should be solid process for understanding the logical buyer groups and who the key players are in each; however, actually contacting and get to the buyers is much easier in today’s environment than you might expect.  What is not so easy, is getting through their filter as a viable acquisition target ….in our view, this is why credibility of the seller ranked higher.


Two additional areas of value add are worth noting.  First, preparation for the sale process is so critical and relates directly to credibility.  A key concept above all is elimination of surprises to the buyer.  Surprises Kill Deals!  It is better to spend the time, understand the issues and opportunities specific to your company, and proactively prepare and address them at the right time in the process.  The second and last area of value add in this post deals with communication and negotiations. Private equity and strategics are the two main groups of buyers.  In both cases, management needs to preserve and build their relationship with the buyer as the process gains traction.  Invariably there will be tough issues to be communicated and tackled.  The M&A advisor should be able to run interference for management on the difficult and contentious issues, allowing the seller to preserve their goodwill in the relationship. Having a third party push on these deal points also gives the seller a fallback if the advisor pushes too hard.  After all, you can always fire the deal team …you can’t fire yourself as the seller.  So what you say is hard to retract.

I realize that this is self-serving, but we found in the comments, consistent feedback from experienced sellers indicating that they use a third part to facilitate their transactions.

M&A Advisor vs. Investment Banker vs. Business Broker: What’s the Difference?

Hiring the right team is always important, and no different when considering the purchase or sale of a company.  For owners in lower middle market businesses, it can be confusing when deciding on what type of advisor you need or who will really serve your interest.  Here’s a quick note on understanding the differences between business brokers, M&A advisors and investment bankers.

Business brokers typically work with smaller companies that will likely sell to an individual buyer (vs. a corporate or institutional buyer).  The process they use is very similar to that of listing a house for sale …and the terms they use are about the same.   In concept, business brokers sell companies that are income replacement for the owner/operator; and valuation is typically based on “sellers discretionary earnings”  (cash flow to the owner/operator).   Information is collected about the business and the company is advertised for sale on websites and marketed with an asking price.  The typical transaction is the sale of the company’s assets using template or standard forms.

M&A advisors and investment bankers are similar in their offerings, though there are some differences. To some degree, M&A advisors bridge the market gap between transactions that are clearly led by investment bankers (those where the deal size is greater than $150 million) and those led by business brokers (typically less than $2 million).  Investment bankers typically offer a broader range of services and work with larger companies …services like fairness opinions, public offerings, etc…  and those that might require formal licensing as a broker-dealer.  In practice, most lower middle market transactions do not require the advisor to be licensed under the securities laws, thus you find that most are not; however, this is a grey area and subject to specific facts and interpretation that will hopefully be addressed by the SEC and congress in the months to come.   In general, investment bankers are purely transaction driven and have minimum fee expectations (which tend to create a floor in the size clients that they serve).

M&A advisors tend to be somewhat consultative and might work with clients in the strategy and planning phases as they consider their exit or liquidity alternatives.  Both M&A advisors and investment bankers run a process to sell a company that is proactive and usually focused on creating a competitive and timed environment for the seller with the goal of optimizing the value and reaching the seller’s objectives.   Unlike the passive process used by business brokers, the actively managed process of M&A advisors and investment bankers tend to add value …and should pay for itself, not being a cost to the seller …rather an investment with an expected return.  M&A advisors and investment bankers typically buy and sell companies to/for other companies or institutional investors e.g. private equity funds.   The transactions involved at this size and stage of the market tend to be somewhat complex and require a level of sophistication and understanding in corporate finance not found at the lower-end of the spectrum.

Acquisition Financing

In 2012 we published our book on mergers and acquisitions ….it is called “Middle Market M&A: Handbook of Investment Banking & Business Consulting“.  One of the topics we address is financing acquisitions and various ways to thinking about getting deals done.  In the middle market, funding strategic deals is often a mix of senior debt coupled with mezzanine and some type of seller financing (i.e. seller note or earn-out).   If your company, as the buyer, is a lower middle market business itself; a key to being credible in the negotiating process is having evidence of financing before you enter discussions.  This essentially means building an acquisition strategy and plan, then obtaining buy-in from lenders and investors before going to market.  An advantage of this approach is having the experience and support of your financing sources early-on and in due-diligence.  Overall this helps improve the likelihood of a successful transaction.

Good News for Middle-Market M&A

Private equity in small and mid-sized transactions may have started to turn upwards.  According to the research at Pitchbook private equity middle-market deals bottomed in the 3rd quarter of 2009 and began to increase in Q4 with $15 billion invested in about 238 transactions; over half of those deals were less than $50 million in value.   Interesting that while there were about half as many transactions in 2009 as compared to 2005, the value of those deals were about the same.

It appears that the equity required to get buyouts done on average for all buyouts  is just about on par with 2006 at a little above 40% …but those deals in the middle-market with values between $25 million and $250 million are taking on average nearly 59% equity with 12% supported by sub-debt and the balance senior debt (as reported by GF Data Resources in February).   They also reported that Q4 2009 enterprise values to EBITDA multiples for private equity deals increases slightly from Q3 to 5.2 from 5.1.

Anecdotically there is an increase in lower middle-market and middle-market deal activity this quarter …I see some enthusiasm and excitement hoping that the volume of activity holds, and that the deals can actually get closed.