Consulting

Planning for the sale of a business is an ongoing process and those companies who start planning early on, well before the search for a buyer begins, will likely realize a higher purchase price. Planning should focus on identifying those areas in a business where there are opportunities to increase earnings and/or reduce risk, the two factors that directly impact purchase price.

Well before a business owner or investor begins the search for a target, they need to establish the parameters that will drive their search. This involves understanding the types of targets and synergies that will lead to post-transaction operational and financial success. Once a target is identified, management needs to fully understand the potential financial and operational benefits, as well as the risks associated with the proposed acquisition.

Accounting and financial reporting is the backbone for measuring a business’s profitability and financial strength. However, as many businesses grow, their accounting and financial reporting typically lag behind. This may result in management’s inability to provide prospective investors with the financial information they need to properly assess a company’s earnings and financial position. This can result in the buyer offering a reduced purchase price and/or a deal stalling or even possibly failing. For these reasons, it is advised that business owners invest in their accounting departments just as they would in marketing, operations, or I-T.

A QofE is a key financial tool used by investors as part of their due diligence to evaluate the accuracy of a target company’s historical earnings and the “quality” and sustainability of the target’s earnings into the future. A QofE provides prospective investors with the critical financial information that they need to value a target, as well as mitigate any potential issues that may arise as the transaction moves through due diligence.

Once potential targets are identified, financial modeling is the tool used to assess and understand what an entity will look like post-transaction. Financial modeling can take the form of forward-looking forecasts, pro forma financial statements, and pro forma key performance indicators (“KPI’s”). If the transaction is a merger, a financial model should be created to project the earnings, cash flow, and balance sheet of the combined entity.

Capital structure has a direct impact on a company’s earnings, cash flows, and cost of capital, as well as a company’s valuation. With this in mind and recognizing that many transactions are essentially highly leveraged re-capitalizations, it is important to project the post-transaction balance sheet and capital structure. This will help both the buyer and seller understand what the post-transaction debt/equity structure will look like and its impact on earnings and cash flow.

While sellers focus on maximizing purchase price, it is important for sellers to evaluate a potential buyer’s financial condition. This is especially true if the transaction is a merger where the post-transaction structure will be a combined entity. Recognizing that the future value of the combined entity will likely be impacted by the buyer’s pre-transaction financial position and overall financial health, the seller should consider performing its own due diligence on the buyer. This will help to avoid any post-closing “surprises”.

Once a target is identified, choosing the right structure (stock purchase, asset sale/purchase, or merger) for the transaction is a critical first step. Once the structure is agreed to by both buyer and seller, the focus then turns to assessing and negotiating key deal terms. This includes, but is not limited to, addressing post-closing net working capital requirements, milestones and/or other triggers for earnouts, and indemnity escrow holdback provisions.

Financial due diligence is a process that investigates and verifies the financial aspects of a potential investment. Buyers rely on due diligence reports to assess the quality and accuracy of a seller’s financial information and to evaluate to what extent such information can be relied upon to project future earnings. The confidence that a buyer has in the financial information provided will likely have a direct impact on the final negotiated purchase price.

It is important to consider how a deal will be structured to achieve the most beneficial tax result possible. How a transaction is structured can impact the purchase price, effective tax rates, and future write-offs.

Both the buyer and seller will have to negotiate how the purchase price for the business will be allocated amongst the assets sold. The final agreed-upon purchase price allocation will have direct tax implications for both the buyer and seller. In addition, IRS regulations require that both buyer and seller disclose the mutually agreed upon purchase price allocation in their respective tax returns.

Purchase agreements generally include terms that provide for post-closing purchase price adjustments that can either increase or decrease the negotiated purchase price. These can include net working capital adjustments, closing balance sheet adjustments, as well as purchase price adjustments associated with earnouts. While purchase agreements will detail the specific provisions and required calculations to be made, disputes are not uncommon. To avoid post-closing disputes, both buyer and seller should dedicate the time and resources necessary before a purchase agreement is executed to “fine tune” estimates.

Companies often look to divest non-core or under-performing business units so they can focus their efforts on other growth opportunities. When considering a divestiture, management will need to develop a clear picture of what the company will look like post-transaction. This is accomplished by creating pro forma stand-alone cost and profitability models. Similarly, when presenting the business unit to a prospective buyer, pro forma financial statements will also need to be prepared that clearly depict the stand-alone profitability and cost structure of the business unit being sold.

A management buyout involves the management team of a company combining resources to acquire all or part of the company they manage. This is an alternative structure that may be the best option for a business owner who may not want to sell to an outside buyer or simply wants to reward management for their years of dedicated service to the business. One form of management buy-out is an employee stock ownership plan, commonly referred to as an ESOP. In the right situations, an ESOP can be a viable option for a business owner.