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7 Myths about Selling a Private Company

July 25, 2017 by Douglas Group

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Business owners take risks every day of their working lives.  They guarantee debt.  They dig into their personal pockets to finance growth.  They put heart and soul and twelve-hour days into growing and nourishing their companies.  The object of this all-absorbing quest is the creation of value.  The ultimate reward comes on the day when they can cash in that hard-earned value. For some there is huge wealth at the end of that rainbow.  Others seem to fade quietly into the sunset. 

The selling of a business entails a strange blend of art, science, and psychology.  The perfect result is the American dream – hard work, courage, and innovation pay off with glittering wealth and glory.  However, it’s incredibly easy for even the most astute business owner to fumble or miss what may be a one-time chance at the ultimate reward.  Why?  What runs amiss?  There are several common misconceptions that are at the top of the mistake list.

Myth #1 – I know the best buyers

Business owners assume that they know who the most likely buyers are for their companies, based on who has inquired about purchase, or who is hot in the rumor mill.  Experience has taught us that owners do not know.  It’s a constantly changing market, and the most aggressive buyer is usually not the obvious.  In nine out of ten cases, the highest priced proposal we receive is not one that either we, or our client, would have predicted at the outset.

To achieve the best premium in pricing, smart sellers do the homework.  Think beyond the simple direct competitor who calls periodically to inquire.  Consider a wide range of possible strategic fits. Research transaction histories and evolving strategies for players in the marketplace.  It’s often the off-center, new entry to your market who will be willing to pay the top premium for your organization and your reputation.

Myth #2 – The quick and easy sale

Business owners are afraid of “shopping” their companies.  They are uncomfortable making an overt approach to prospective buyers who they do not know and trust personally.  They don’t want many people to know they are considering sale, because they fear the potential impact of rumors.  If customers and key people become aware of the possibility of sale, they may feel insecure about their future, and may begin considering alternatives.  Unfortunately, the most common owner reaction to this fear is the inclination to talk only with a handful of buyers.  This lack of competition allows buyers to set lower prices and command tougher terms.

Competitive pressure pays big dividends.  Trying to sell your company without talking to alternative prospective buyers is like winking at a pretty girl in the dark.  It won’t result in anything actually happening.

Myth #3 – The quiet conversation

The fortunate buyer who is lucky enough to call at the right time often gets a very open discussion of the owner’s willingness to consider possible sale.  The owner responds because he thinks that as long as only a few buyers know about the opportunity, confidentiality will be controlled.  However, it is often during these earliest stages of conversation that damage is done.  The inexperienced seller doesn’t feel that he needs a signed nondisclosure agreement until he begins to share financial documents.  The excited would-be buyer finishes his conversation with the seller, and may walk back into a sales meeting thirty minutes later, with an excited announcement, “Guess who we are talking with about possible acquisition!”  From there it’s a short hop to customers and employees.

The prudent seller obtains a signed nondisclosure agreement from prospective buyers immediately, before any serious conversation about possible sale.  Broadcast information or rampant rumors about the potential for sale can only harm competitive desirability, and can create serious operational problems.

Myth #4 – Value rules of thumb

Every industry has commonly known rules of thumb for pricing of businesses.  Sellers hear that companies in their niche are selling for some standard multiple of pre-tax earnings, and they quickly accept that as gospel for the pricing of their business.  However, the application of these rules of thumb can be vastly divergent between one buyer and the next.  For example, let’s say the industry rule of thumb pricing is 6-8 times pre-tax earnings.  Buyer number one may pay 8 times earnings for the gross assets of the corporation – leaving the seller to pay off all liabilities of the corporation.  Suddenly the 8 times earnings offer looks more like 3-4 times earnings, on a net basis.  Buyer number two may offer 6 times earnings for stock – taking all assets and liabilities as part of the deal.  Sellers need to be wary of rule of thumb valuation mechanisms.

Value is what competitive buyers will pay in a moving market place.  The true market value can be estimated in advance of sale, but only with diligent study of the market place and careful analysis of the individual company circumstances.  Also – every seller needs to know that “rule of thumb” pricing goes out the window very quickly, when competitive velocity takes over.

Myth #5 – Price Desired X 125% = Asking Price

Business owners considering sale will very quickly meet with the question of “asking price”.  Buyers want to know what pricing the owner has in mind.  Professional investment bankers rarely preset pricing.  They let the buyer set the price point by competitive bid.  Buyers do not like to go first in setting the amounts, and, naturally, they put great pressure on the seller to say what he would accept for the business.  Most novice sellers succumb to that pressure, and throw away the potential for top premiums.  Others try to build in enormous leeway by asking for such preposterous amounts that buyers quickly back away, assuming the seller is ridiculous in his expectations and would be impossible to deal with.

Top pricing is most commonly achieved by letting the buyer set the level.  In two out of three cases, most offers will fall within a fairly predictable range.  In some cases, however, there will be just a few offers far higher than the pack.  The “premium” buyers are found.

Myth #6 – If they don’t ask, I don’t need to tell them

Viable buyers control substantial amounts of cash, and make critical decisions for their investor groups. They are likely to be very bright people. They will ferret out the business risks and ask the right questions, eventually.  To achieve top pricing sellers need to be absolutely frank and forthright in all discussions with prospective buyers.  If a seller discloses weaknesses up front and intelligently, the buyer may well perceive the problem as an opportunity.  “If the company is doing this well now, in spite of the problem in their sales staffing, just think how much better performance will be after we correct that problem.”  Additionally, the trust level resulting from such honesty makes the remainder of the negotiation infinitely easier, and enhances the relationship post-sale.

Consummated deals with truly premium pricing virtually always grow from an underpinning of fundamental integrity.

Myth #7 – We have a “deal”

Buyers can be very fast in giving the seller a letter of intent to sign.  Sellers accept, and believe they have a “deal”.  However, a great many of these deals never get to closing – or if they do, it’s at a severely reduced price.  The classic letter of intent binds no one except the seller.  The buyer invariably has the right to drop out, if his due diligence is unsatisfactory, at his sole discretion.  The seller, in the meantime, is asked to commit to an exclusive selling process, by agreeing that he won’t talk further with other alternative buyers.  Bad deal.  If competitors are chased away, the buyer now has tremendous negotiating power to reduce price or strike tougher terms.  The seller is forced to choose between accepting the changes, or incurring the time, cost, and the risks of starting the entire process over again.

The solution?  Don’t accept a letter of intent until the buyer has truly committed to the deal.  Consider a substantial deposit.  Work cooperatively with the would-be buyer to find some way to allow him to answer his critical questions and concerns in advance of entering into an exclusive relationship.

Wise sellers do well to study the buy/sell process, and to learn what they may expect as they work forward toward sale.  To reap the rewards of building a great business takes a few extra steps, beyond just the building of a performing business. The right handling of the exit process can triple or quadruple the end reward for the hard-working entrepreneurial owner – and it’s well worth the work and effort to maximize that end reward.

 

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  • Home
  • About Us
    ▼
    • Our History & Values
    • The Douglas Group Team
    • Industries We Serve
    • Our Past Performance
  • Business Sales
    ▼
    • Business Sale Services
    • Business Sale Process
    • Business Value Assessment
  • Acquisitions
    ▼
    • Business Acquisition Services
    • Business Acquisition Profile
  • Newsletter
  • Ripe Book
  • Articles & News
  • Contact Us