Getting Out – and Making the Getting GoodBy Loretta Hall
Article Date: 02-01-2008
Copyright(C) 2008 Associated Equipment Distributors. All Rights Reserved.
You've spent your entire career building a successful company, and now it's time to develop an exit strategy that will be best for your employees, your family, and yourself. That's a whole new challenge.
Even before becoming president of the heavy construction equipment dealership he had worked for 44 years, Bob Austin wanted to sell the company. "We were a small fish in a large pond, and we had competitors with much greater resources than we had," he said. "We were very solvent, but to stay competitive we needed to align ourselves with a larger company with greater financial resources."
Selling the company turned out to be a four-year learning experience. If he had it to do over, it wouldn't take nearly that long. Every company is different and every ownership transfer is unique, but Austin's experience with the sale of North Carolina-based A.E. Finley and Associates raises a common set of key issues.
Ownership Transfer Options
The process depends heavily on whether the transaction will be external (sale to a third party) or internal (transfer to family members or employees). In Austin's case, the search for outside financial resources meant selling to a third party.
"A third party will want you to stay around for some period of time, usually at least a year, for some transitioning of clients and relationships," said Tony Perrone, a principal in FMI Investment Banking. "But it's a lot quicker than selling to family or employees."
However, the number of third parties with the resources to acquire construction equipment distributors is limited, despite increasing interest from financial investors and private equity groups over the past five to 10 years. Also, Perrone said, "If you have any major line, the manufacturers have say-so on who the new owner's going to be."
Most AED companies are owned by an individual or a family, and the most common ownership transfer is to family members. Although this seems like a natural choice, it should be considered carefully. David Kauppi, president of MidMarket Capital, says one important question is: "Do the kids have the competitive fire to be successful in this extremely competitive environment, or would I be better off liquidating the company and simply turning it into financial assets that would be more appropriate for them?" Furthermore, he says, a family transfer should be structured carefully to avoid substantial gift tax penalties.
Selling a company to its employees is the least common option chosen by AED firms. Kauppi says this is usually a method of rewarding loyal employees. However, employees often don't have the money needed to buy out a company and are generally reluctant to risk borrowing it. Instead, Kauppi suggests, "Sell your company for as much strategic value as you can to a bigger industry player and then have some sort of percentage bonus for the loyal employees based on years of service or whatever measure you feel is appropriate."
The Selling Process
"I had never sold a company before so I didn't really know how to do it," Austin said. His company's first step was to identify and approach a potential buyer. "They were interested, but we were too far apart in what we felt the company was worth," he added. Then Austin contacted AED for advice and ultimately worked with two M&A (mergers and acquisitions) firms recommended by the association.
"I was very impressed with both the M&A firms," Austin said, noting that their marketing strategies differed considerably. After the first firm was unable to find a buyer, he engaged the second firm. "In less than 30 days, they had three buyers that were interested in us, and the acquisition was completed 90 days later," he said.
Austin's experience is a common one, particularly the do-it-yourself beginning. Kauppi says the biggest mistake he sees an owner make is directly contacting an interested company suggested by a trusted advisor such as his accountant, banker or lawyer.
"I've seen construction equipment companies be for sale for five years and cycle through six potential buyers, and every negotiation has blown up," Kauppi said. Meanwhile, the company's value erodes because the owner is preoccupied with negotiations rather than running the business.
"The professional M&A people just had so much more experience," Austin said. "They helped me anticipate what would need to be done, and when we were in negotiations they told me what to be looking for and listening for, and how best to present our company."
Payment to an M&A firm typically consists of a lump sum up-front fee or a monthly fee until the sale is completed, plus a percentage of the transaction amount. "I'm not saying ours is normal," Kauppi said, "but for my size of the market (transaction values between $5 million and $25 million) it's generally $5,000 a month and then a success fee that's a sliding scale downward, for example, 8 percent of the first $2 million, 6 percent of the next $1 million, and 4 percent for anything above that." On average, the process takes about six months.
"A lot of people don't know what their businesses are worth, or they may have an idea that is way out of line with current market reality," said Perrone. Yet determining a fair and realistic valuation is crucial for an ownership transfer to occur and to benefit the exiting and acquiring owners.
Austin says that when setting an initial asking price for his company, "we looked at what our annual sales were and how solvent we were. The biggest difference was in what we thought that nebulous term "good will" was worth. We learned later, as we worked with professional M&A people, that in today's environment, at least in our industry, the good will number was not as valuable as we had thought. So we adjusted what we thought the company was worth and actually sold it for the asking price."
Experienced advisors can calculate a business valuation based on metrics such as recent sales of comparable companies and multiples of EBITDA (earnings before interest, taxes, depreciation and amortization) that are typical for a certain industry.
"I think it's a good idea to have some metrics, but if you take your company to only one buyer, his valuation is right," said Kauppi. "If I were selling my business, I would use that as a frame of reference, but what I would want to know is, (1.) Did my company get presented to the universe of viable buyers in a competitive bid situation, and (2.) Was that process completed properly. The key is you've got to give the market the ability to form their own opinion on your company's value."
One factor that significantly influences business valuation is whether the ownership transfer will be internal or external. "For an internal deal, usually the valuation is much more conservative because of the practicality of what the new owners can afford," Perrone said. "If you're going to take a long time to pay out the original owner from earnings, generally you're being conservative on what those future earnings are going to be, and the value up front is more conservative than it would be if you were going to sell to a third party."
Owners can do many things to make their company attractive to buyers and maximize the profitability of the sale. Here are some examples:
When to Begin
Offer an attractive organizational structure. "We were an ESOP [employee stock ownership plan] corporation," said Austin. "That became an obstacle in selling the company because buyers recognized that there were additional steps that had to be taken to close down an ESOP." In his case, it meant the difference between an asset purchase and a more attractive stock acquisition.
Demonstrate a broad base of long-time clients. "The biggest value detractor in a business is revenue concentration," Kauppi said; "that is, you've got a massive account that's 80 percent of your business."
Have a solid base of contractually recurring revenue. Kauppi suggests turning your time-and-materials repair business into a proactive, contractually recurring automatic tune-up and inspection service, and putting equipment on a rent-to-own basis with maintenance built in to the lease agreement.
Keep your company competitive. "You've got to be sensitive to your marketplace," Perrone said. "The marketplace has been changing in that there's more and more equipment being rented by the bulk of the clientele of most AED dealers. You might have to expand your rental fleet in order to be competitive."
Ensure that smooth operations will continue. "Prepare a deeper management team, and make sure that the intellectual property is dispersed throughout the organization," Kauppi said. "If some procedures are in your head or the heads of key people, make a handbook or procedure manual to document everything."
Identify and access hidden assets. One often-overlooked asset is business life insurance policies such as key person policies, buy-sell agreement policies, policies securing business loans, and policies funding employee benefit plans. Before or after selling your company, some policies may no longer be needed. Many owners and their advisors are unaware of an alternative to cashing out the policies. "A life settlement is nothing more than the sale of a business life insurance policy to an institutional investor for a cash payment that's greater than the policy's cash surrender value," said Rhona Sacks, president of Legal Life Settlements. "Institutional investors purchase these policies for an alternative investment not correlated to the stock market." Besides advising on when and whether a policy can or should be sold, she helps clients compare the options of cash surrender, borrowing against the policy, or selling it. "We have a proprietary analyzer wherein we're able to figure out whether or not an institutional investor may be interested in the policy. Each case is on its own individual merits; it's really about the health status of the insured, and usually that person has to be 65 or older," Sacks said.
"Planning an exit strategy is an extremely complex, multidisciplinary process, and an emotional one," Sacks noted. "Business owners put it off to the last minute because they're so busy trying to put out fires every day in their company and because they're so overwhelmed by the process." Yet, she added, "Exit planning should be done as soon as possible. It is only going to get more intense because of the number of people 65 and older who are going to be retiring in the next 10 years."
"We recommend," Perrone said, "if dealers are thinking of keeping the business with the family or employees, that the principal owner should start planning for continuity or transfer of ownership when they're in their 50s, because the internal transfers take some time. The other choice is to sell to a third party; then you can do it anytime. Obviously, the best time is when the business is doing well and the prospects for the business are also good, at least in the near term."
"Begin making initial plans for exiting from the business prior to the death of a president or the owner of a company," Austin advised. "As you begin to age a little, you need to be making initial plans and accumulating information and talking to your accountant and your attorney to better acquaint yourself with what is involved." n
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