How to Maximize Sale Value When Selling a Company

Key Actions to Undertake to Increase the Price of a Company

This article provides a brief overview covering what the author—a middle market investment banker—believes is the most worthwhile and impactful actions that anyone contemplating the sale of their business can take right now to set themselves up for success in a future transaction process. The author recommends that prospective sellers and their advisors focus on five critical steps, with the aim of having key points to negotiate the sale and commanding the highest selling price.

Steps to Raise the Price of a Company

Anyone seriously contemplating the sale of their business can take impactful actions immediately to set themselves up for success in a future transaction process. The most worthwhile actions require some time to plan and properly implement.

Because of this, we highly recommend getting organized early on and really making the most of this lead time. This step is valuable to both enhance your business’ marketability and arm yourself to defend its value during negotiation.

• Improve accounting—Poor accounting raises the risks of inaccuracies and, by extension, increases potential buyers’ difficulty in effectively determining price.
• Key man issues—Over-dependence on certain individuals increases the risk that the revenue or operational ability of the company will not continue.
• Customer concentration—Buyers discount the value of companies that are overly dependent on a small handful of customer accounts.
• Profit improvement—Sellers can achieve a much higher valuation from buyers if they are able to show a recent increase in earnings. We discuss some of the most reliable and impactful ways to make profits “pop” before a sale.
• Push back write-offs and expenses—Sellers should strive to make their financial numbers for the 12 months leading up to the sale as clear, straightforward, and unambiguous as possible.
• Quality of Earnings Report—Obtaining a trusted third party’s expert opinion on your business’ financial performance and accounting practices is no longer cost-prohibitive for sellers in the middle market and can pay for itself several times over.

Key Actions to Undertake to Increase the Price of a Company

The most worthwhile steps you can take to set yourself up for success require time to plan and properly implement.

The main reason why certain sell-side due diligence and performance improvement initiatives should be tackled before getting in contact with potential acquirors is that getting these things out of the way early on helps to significantly speed up the remainder of the process once buyers do become involved.

This means reducing the amount of time spent in negotiation and thereby minimizing the potential for breaking points which might compromise sale price, closing probability, or both.

The bottom line is that the longer you remain in discussion with buyers—especially if this time is spent addressing concerns that could have been anticipated and remedied before going to market—the more vulnerable you are to trading down.

Prevent Trading Down

This consideration becomes increasingly important in later stages of the process as leverage begins to shift away from the seller. Once the seller accepts an exclusive letter of intent, it becomes much harder for them to guard against reductions in price—particularly those levied in response to any issues which come to light in the final round of diligence.

This brief overview covers what I believe to be the most worthwhile and impactful actions that anyone seriously contemplating the sale of their business can take right now to set themselves up for success in a future transaction process.

Improve Accounting

Poor accounting raises the risks of inaccuracies and, by extension, increases potential buyers’ difficulty in effectively determining price.

The number one thing that I recommend to anyone looking to maximize the value of their company in an upcoming sale is to identify and fix any issues with their accounting.

Potential buyers will often begin their due diligence by diving straight into a target company’s books and attempting to identify any red flags that might cause problems for them down the line. Accordingly, it is extremely important to leave a good impression on this front by making sure that you have done everything by the book for the duration of the lookback period and are maintaining timely, accurate monthly closes; clear accounts receivables aging; accurate inventory reports; and well-structured budgets and forecasts.

If you do nothing else to prepare your company for sale, a full and comprehensive review of your accounting records and practices should not be omitted

This is even more important when dealing with financial buyers, who might know very little about your company or its industry but may nevertheless be interested in acquiring the business as a profit-generating engine for their portfolios. For these buyers in particular, an inability to get comfortable with your numbers and the methods used to generate them will quickly snuff out any interest that they might have had in the proposed transaction.

Buyers will use the state of your accounting as proxy measurement for everything from the company’s sophistication and professionalism to the accuracy reported of historical performance and attainability of future projections.

Thus, any issues in your accounting processes, either real or perceived, will breed an uncertainty that increases the difficulty of estimating your company’s value with any sense of confidence. This can result in lowball offers, as well as buyers dropping out of the process entirely, and is one of the leading reasons that we see deals in the lower middle market fall apart.

With all of this in mind, I cannot stress enough that even if you are in such a hurry to exit that you do nothing else to prepare your company for sale, a full and comprehensive review of your accounting records and practices should not be omitted under any circumstances. This process is essential to presenting the business in its best light; it creates the opportunity to recognize and correct any mistakes before they become an issue and is, by far, the most effective way to increase your chances of successfully closing around a favorable offer.

Key Man Issues

Over-dependence on certain individuals increases the risk that the revenue or operational ability of the company will not continue.

A key man risk is the industry term used to describe the degree to which a company’s performance is assumed to be dependent upon certain essential personnel who may be difficult or impossible to replace, depending on the circumstances surrounding their potential departure. And in the lower middle market, often, the biggest key man or woman in question is the outgoing owner.

In this segment of the marketplace more than any other, the owner is more likely to play an active and central role in day-to-day operations.

This concern will exist in the forefront of a buyer’s mind, regardless of whether you plan to leave the company immediately following the sale or intend to stay on in a management capacity for a few years.

In the former case, buyers will understandably be worried that the business may suffer immediately due to the sudden loss of your leadership and expertise.

However, in the latter instance, they may feel as though they cannot fully exercise their control to implement major changes without running the risk of losing your support and cooperation, which might have even more severe consequences for the company’s performance than your outright departure.

Of course, it is only natural for an owner to have a sense of pride in the company that they have built from the ground up or grown into what it is today, and there is nothing wrong with taking credit for this appropriately since in the lower middle market, often, the biggest key man or woman in question is the outgoing owner.

But we have found that it is important to place this section of the firm’s history squarely in the past and acknowledge that while, yes, the owner may be solely responsible for things like developing the company’s business model, establishing major customer and supplier relationships, and leading with distinction during prior times of uncertainty or distress, these volatile formative years are behind you and the business is now a well-compartmentalized machine that no longer relies so heavily on the unique balance of qualitative attributes present in its leader.

The best way to do this in a way that is convincing to buyers is for the owner to step down from their management position prior to beginning the sale process and, if in line with their post-sale desires, geographically relocate away from the business’ physical center of operations.

They should remain strategically active and perform whatever roles are necessary to prevent performance from suffering, but the goal should be to decrease operational involvement as much as possible and transfer this responsibility to a competent and suitable replacement whose lower age and increased financial dependence upon the position’s salary will make them appear less of a key man risk to private equity and other buyers.

To give an example, we recently had an engagement where our client was trying to sell a healthy company with $100 million in revenue, but the owner was perceived to be so essential to the function of the firm that we had difficulty getting traction with any serious buyers. Ultimately, we ended up advising that this client put the sale process on hold for a period of two years and use that time to step down, retire to someplace warm, and demonstrate that their business could be successfully run by a younger executive with a more traditional background.

After this had been done, we resumed the process and immediately received strong interest from several potential acquirors. From there, the sale moved quickly and smoothly to close, even securing an offer that exceeded the seller’s initial expectations. This really stands out in my mind as a powerful testament to the importance of addressing key man issues if you want to maximize the market value of your company.

Customer Concentration Issues

Buyers discount the value of companies that are overly dependent on a small handful of customer accounts.

Along with key man issues, customer concentration is another risk factor that we frequently encounter with our clients in the lower-middle market and strongly recommend proactively addressing before beginning a sales process. This is because buyers use concentration as a proxy measurement for revenue stability and will be deterred by companies that appear overly reliant upon their major customers.

The benchmark for significance when it comes to revenue or gross margin concentration can vary somewhat from industry to industry. But as a general rule, any single customer that is responsible for more than 20% of either metric will be a cause for concern among buyers who may worry about the company’s performance sensitivity to the sudden loss of that customer’s business.

This stigma and its negative impact on your firm’s marketability can be expected to increase with any additional degree of concentration beyond the 20% threshold and can grow into a near-insurmountable problem at and above 40%. In our experience, sellers with such severe customer concentration routinely receive steeply discounted valuations relative to comparable companies which do not exhibit the same issues. And moreover, they often struggle to find buyers even at this greatly reduced-price level.

For this reason, we recommend that you take any reasonable steps available to reduce concentration risk ahead of a sale and diversify your customer base. Additionally, if optimal diversification cannot be achieved, the next best thing you can do to mitigate revenue risk is to secure favorable, long-term supply contracts with your major customers which will demonstrate to buyers that these accounts are healthy and well-protected through the forecast period.

Profit Improvement

Sellers can achieve a much higher valuation from buyers if they are able to show a recent increase in earnings.

As a part of helping our clients prepare to go to market, we always try to find ways to make earnings “pop” in the months leading up to the sale and enhance trailing 12-month (TTM) EBITDA, which is the metric most likely to be considered when buyers are estimating the enterprise value of a business. Accordingly, along with taking steps to avoid valuation discounts and ensure that the factor by which your earnings are multiplied is as large as possible, it is just as important to maximize these earnings, themselves.

When considering which profit-improvement initiatives to pursue, we always try to focus on making changes that will continue to benefit the company even after the sale takes place. This gives buyers something to be excited about, especially if they can plot a clear trajectory and quantify the anticipated long-term benefit to future-earnings.

With this in mind, we typically recommend reducing unneeded overhead as a safe and relatively foolproof opening gambit to effect a direct increase in projected profits both leading up to and in the wake of a sale.

Another tactic we like to employ is raising prices. This can be a much tougher sell to our clients and predictably makes them very nervous at first. But the truth is that it almost always pays off in spades.

My experience has been that whenever I come in and say, “we have to increase the rates you are charging by 20% across the board,” the seller pushes back and tells me that they are going to lose all of their customers. But I can confidently say that in all the times I have done this, clients have only ever lost their most difficult and least profitable accounts. So, with that in mind, I really do believe that, underutilized as it is, price raising really can be one of the best ways to increase earnings and drive up the value of your business.

And while it is perfectly normal to feel some degree of anxiety about the potential for loss of business as a result, the fact is that if you cannot increase rates without customers leaving, then there is nothing truly special about what your company offers beyond sheer cost savings.

This is a precarious position to be in, all on its own, and buyers will tend to steer clear of acquiring businesses that they know compete on fickle terms of pricing, alone.

The final option that we typically explore with our clients on this front is cutting back on unprofitable lines of business. It is very common to see companies which have been built around a very successful core set of products or services choose to pursue growth through aggressively expanding their offerings, only to wind up losing money in some of these new areas.

However, by the very same token, being able to demonstrate strong customer retention through a recent, significant price increase can be a powerful indication to buyers of the value associated with your brand’s reputation and competitive position.

Sometimes, the true extent of the problem is not even known to management and ownership due to a lack of sufficiently detailed data available by segment. However, in many more cases, sellers are keenly aware of their company’s shortcomings in these areas but simply fall victim to the sunk cost fallacy and become reluctant to cut programs which may have begun as their passion projects and required substantial time and effort to get off the ground.

But no matter how painful it may be to do this, the reality is that any sentimentality you might have toward underperforming sections of your business will not be shared by buyers. So the question then becomes whether you are willing to make the cuts yourself and realize the resulting gains to sale price, or if you will instead elect to leave money on the table by selling a company that is less efficient and profitable than it could be.

Push Back Write-offs and Expenses

Sellers should strive to make their financial numbers for the 12 months leading up to the sale as clear, straightforward, and unambiguous as possible.

Another thing we urge sellers to do is to facilitate the presentation of clean, easy-to-defend numbers so that any profit improvements that they do achieve are not obfuscated by a series of unrelated compounding adjustments for the same period. In practice, this means that once you have committed to selling your business, you should fast-track any extraordinary or non-recurring expenses that you know will need to be incurred and recorded before the sale, so as to make sure that they age out of the all-important TTM window as quickly as possible.

A well-run sale process can take as little as four months to complete

This includes everything from payouts on legal settlements to significant inventory write-downs and receivables write-offs. All of these should be paid out and/or recorded immediately to increase the probability that once you are sitting down with a buyer to negotiate the final purchase agreement, you will not have to make the case for adjusting them out of the TTM EBITDA to arrive at a higher price because, by that time, they will no longer fall within the lookback period.

In our experience, a well-run sale process can take as little as four months to complete, so in order to achieve this result with a high degree of confidence, extraordinary and non-recurring expenses should be fully processed at least eight months before going to market.

Quality of Earnings Report

Obtaining a trusted third party’s expert opinion on your business’ financial performance and accounting practices is no longer cost-prohibitive for sellers in the middle market and can pay for itself several times over.

In any sale process, the burden of communicating and substantiating real earnings, both past and projected, rests squarely on the shoulders of the seller.

This goes beyond simply building the right narrative in support of reasonable adjustments and extends to the most granular details of the underlying accounting, itself. If buyers discover anything suspect about this accounting, they can very quickly lose interest in a deal and often become very difficult to re-engage once trust has been jeopardized in this way. For this reason, in many cases, we highly recommend that sellers commission a full quality of earnings report from a reputable third-party firm and review the results carefully before beginning a sales process.

Whereas these reports were once prohibitively expensive for our clients in the lower-middle market, increased competition in this space has reduced the average cost to a fraction of what it used to be, and we find that they now commonly pay for themselves several times over through the benefits they provide to sellers at nearly every stage of the sale process. From attracting a greater number of potential buyers, to minimizing the time and expense associated with satisfying diligence requests, to helping guard against trading down in the negotiation phase, a quality of earnings report is a wise investment and a powerful asset for just about any seller.

Some other steps that we recommend taking prior to sale:

• If you have any intellectual property, it will be taken much more seriously by buyers if you possess a trademark or patent on it. However, if you do not yet hold one by the time a sale process begins, just the mere act of applying for one can make a difference.
• You should resolve any open lawsuits prior to beginning a sale process. Buyers are known to display a tremendous aversion to legal costs and will often greatly exaggerate the risk involved, eventually resulting in a discounted valuation or loss of interest, entirely.
• Although this can be expensive for smaller companies, it is good to have fully audited financial statements rather than just a compilation report. One of the main reasons that an audit can be beneficial is that, in general, a public company cannot acquire you as a subsidiary unless you have been audited. Often, sellers in the lower middle market will mistakenly believe that they are too small to be a target of interest for publicly traded corporations and use this as justification for foregoing an audit. But the truth is that there is no minimum size for a synergistic add-on, and we have seen this fact borne out on multiple occasions with our own clients.
• Clean up any potential environmental issues. Nothing undermines a deal faster than damning revelations from Phase I and Phase II site assessments. I have had so many deals wither due to environmental issues. Get them out of the way early so that the results do not come as a surprise to either you or your buyers.
• Clean and update your facilities. At some point in the process, buyers are going to show up to take a tour, and they are going to form an impression based on what they see while they are on-site. Just having bright lights and a fresh coat of white paint on the walls can make a big difference in how things are perceived. On the other hand, if the facility appears dilapidated, dirty, cluttered, or otherwise in a state of general disrepair, buyers will hold you and your business in lower regard as a result.
• We recommend commissioning appraisals on real estate, as well as machinery and equipment. Sellers can put themselves in a much stronger negotiating position by being able to reference a recent and reputable third-party estimate of the value held by these assets and stand a much better chance of receiving their full value in a sale. In this sense, we have found that appraisals almost always pay for themselves, quite literally, in the long run.

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Tom Goldblatt is the Managing Partner of Ravinia Capital, LLC. Ravinia is a boutique investment bank for the middle market, that Mr. Goldblatt founded in 1998. Ravinia combines investment banking services with advisory services that include:

•  Sales of companies (healthy and distressed)
• Debt refinances
• Capital raises
• Assessments, option analysis, and action plans

Ravinia Capital, LLC can be contacted at info@raviniacapitalllc.com.

Mr. Goldblatt can be contacted at (312) 316-4641 or by e-mail to tgoldblatt@raviniacapitalllc.com.