I have always found the process of selling a business to be the most challenging but fun and rewarding projects that a CFO can experience. Divestiture work can be laborious, tedious and not to mention a little unnerving as your future job prospects are always unknown. Correspondingly, a sale process allows a CFO to use all skills imaginable from strategic thinking, financial modeling/analytics, communication and a dash of competitiveness goes a long way. Thus far, I have been the finance executive for the sale of several mid-size Clinical Research Organizations (MDS Pharma Services, Omnicare Clinical Research and Theorem Clinical Research). I enjoy the process so much that I currently provide outsourced divestiture assistance through my consulting practice (Pivotal Financial Consulting, LLC).
The objective of this blog is to identify the missteps owners of small to mid-size organizations commonly make when selling their businesses.
Misstep #1: Not Treating a Sale as a STRATEGY
Selling a business is quite possibly the most important strategic move one will ever make. Let’s take a look at how BusinessDictionary.com defines both a strategy and an exit.
Strategy: “A method or plan chosen to bring about a desired future, such as achievement of a goal or solution to a problem”.
Exit: “Point at which an investor sells his or her stake in a firm to realize gains (or losses). Generally, and exit is a move planned at the time of investment decision and may also be included in the firm’s overall plan.”
Selling a business is a strategy and requires appropriate planning and investments to successfully execute. The decision to sell a business is psychologically a big step. Owners realize that they may cash out with a great deal of money and move on to the next phase of their lives. However, a sale is quite often looked at as a forgone conclusion and the appropriate investments are not made.
Within the clinical research industry, many businesses that decide to expand geographically or add therapeutic expertise don’t think twice about making staff and infrastructure investments to execute their desired strategy. Investing in a sale process seems expensive because it is a short-term goal without long-term benefits. Unfortunately, a failed process can result in:
1) A delay in the execution of your exit strategy (potentially years)
2) Selling for less value
No sale process is guaranteed but investing and planning for your exit strategy can make a successful exit more likely. Which leads us to misstep #2…
Misstep #2 - Not Hiring Advisors to Assist
Full disclosure that this part of the blog will be a little self-serving, but based on my experience this is the area where many businesses fail to appropriately invest. The key advisors that I believe should be in place are a qualified middle market investment banker, a CFO experienced with selling businesses, and legal and tax advisors.
What value does a middle market investment banker provide? According to CFO.com, the top 5 services provided by middle market investment bankers are:
Managing the M&A process & strategy - By maintaining a competitive process with multiple bidders, investment bankers can maximize shareholder value through a disciplined process.
Structuring the transaction - With good structure, buyers can limit their potential risks while sellers can often get preferential tax treatment or gain significant upside beyond the consideration paid at closing.
Educating and coaching the owner - Many owners have can use a sounding board as they have never experience a sales process. An experience banker can provide a balance perspective.
Negotiating the transaction - By allowing the investment banker to lead the negotiations, sellers can maintain a positive working relationship with the new owner.
Enabling management to focus on running the company - By communicating with buyers and consolidating all of their diligence requests, a banker can shield management from many of the distractions inherent in a sales process.
Investment bank advisory/transaction fees can be hard to nail down as each firm can have a different pricing model (there is not database of typical fees). Additionally, fees can vary based upon deal complexity and size. The Double Lehman Formula ("DLF") is a well known formula that can be used to estimate the cost. The DLM Formula goes like this:
1) 10% fee on the 1st $1,000,000 of enterprise value
2) 8% fee on the 2nd $1,000,000 of enterprise value
3) 6% fee on the 3rd $1,0000,000 of enterprise value
4) 4% fee on the 4th $1,000,000 of enterprise value
5) 2% fee on all value above $4,000,000 of enterprise value
Below is an analysis of fees using the DLF for a variety of enterprise values:
Another fee sanity check comes from a report completed by Michael B. McDonald, Assistant Finance Professor at Fairfield University. Mr. McDonald surveyed 85 business owners who sold their businesses for between $10 million and $250 million during the period from 2011 to 2016.
Larger deals have higher dollar deal fees but lower fees as a % of total enterprise value.
Outsourced CFO for Divestiture Preparation and Assistance
Here is the self-serving portion I mentioned as I provide outsourced divestiture preparation and assistance services. Quite often, small to mid-size companies either can’t afford or don’t have a need for a full time experienced CFO. Additionally, many experienced CFO’s look for opportunities at larger companies or private equity backed businesses as compensation can be greater. All of this has created a skills gap that becomes acute when small and mid-size organizations enter a sales process.
Deloitte published a survey based report that explains how CFOs can maximize both EBITDA and the sales multiple:
Providing strong underlying management information and key process indicators (KPIs) – Sophisticated buyers will expect sophisticated financial information. A+ CFOs will identify and present the key drivers of the business so that acquirers can quickly understand and gain confidence in the numbers. Detailed and accurate financial statements, forecasts, operating metrics, analysis requests, etc… will build credibility with the buyer.
Creation of the growth story for future investors – Experienced CFOs understand that buyers want to understand both how the business achieved past growth and the plans for future growth. Weaving into a coherent story organic growth, acquisitions, one-time events and the use internal and external data to support how the company plans to grow will be key to excite buyers.
Advance planning for the exit process to allow for a smooth process – A sale process can take up to over a year. Answering questions from multiple interested buyers, numerous calls and presentations all the while trying to complete your day job can result in diligence errors and a slip in company performance. CFOs with divestiture experience understand what to expect and can put together a plan to effectively manage the internal process.
Expect the costs to be roughly 2%-3% of the transaction value – slightly lower on a % basis for larger deals and higher for smaller transactions (it takes just as much time to execute a small deal as a large deal). The fee is split into two pieces – a monthly fee for completing all the work required to sell the business and a transaction success fee. Pulling together all of the diligence documents, building financial models, learning the ins and outs of the business takes time but pays off when the business transacts.
Legal and Tax Advisors
Lastly, legal and tax advisors are necessary as a lengthy and detailed Sales and Purchase Agreement (SP&A) will need top be negotiated and executed. A lawyer with transactions experience can help communicate and negotiate key clauses to insure the seller is protected. A tax advisor can assist with structuring a tax favorable arrangement for the seller.
One last point - good advisors can increase the likelihood of getting a deal closed as the best possible value. Key word being good - make sure you do reference checks and get solid referrals. Poor performing advisors can be detrimental to getting a deal completed and could result in a lower sale price. Pick the partners that you feel will add the most value.
Misstep #3 - Thinking Like a Seller Instead of a Buyer
I didn't write Misstep #3 backwards - I feel all sellers should think like a buyer. TheMidmarketPage.com has an informative article about thinking like a buyer when selling your business. 5 Common areas where buyers focus include:
Financial records - I think we've discussed this area enough - financial records will get a lot of scrutiny
Customer base and suppliers - Recurring revenue and customer diversification is important
Management team - A strong management team can do much to increase a business’s value from the buyer’s perspective.
Products or services - Are the products or services differentiated? What is the businesses's value proposition?
Flaws of the business - Every business has warts, understanding, mitigating and having logical explanations or solutions for them is critical.
Remember, buyers complete due diligence to reduce their risk of overpaying for an asset. Taking the buyer's perspective into consideration likely improve your planning process and increase the likelihood of a deal.
Misstep #4 - Being Unprepared for Diligence
Forbes.com lists being unprepared for due diligence as a common deal killer. Here is a summary of due diligence requests I received while at Theorem Clinical Research.
I'm pretty sure I had several "adult" beverages during that sales process. Keep in mind that doesn’t include all the meetings, phone calls, verbal questions and follow on analysis that were requested. Needless to say that selling a business is time consuming – its doubtful you will be able to handle diligence requests and continue your day job without adequate preparation. A pre-populated data room can reduce the overall time of getting a deal done. Buyers will be able to more efficiently complete their diligence instead of waiting for you to fulfill their requests. Keep in mind - the longer a process takes, the more chance for bad things to happen (cue my blog on cancellations).
Misstep #5 - Having Unrealistic Valuation Expectations
Pepperdine University's most recent "Private Capital Markets Report" states that from the data they collected that the biggest reason for deals not closing is a valuation gap on sales price. Forbes.com provides great advice: "Use objective, comparable market-based metrics along with your company’s profitability, growth, risk factors and opportunities to test your valuation." Leverage your advisors to help get realistic valuation ranges. Nothing will aggravate a buyer more than spending time and money on diligence, making a fair offer when compared to industry comparisons only to find out the seller has unrealistic value expectations (I am living through this now with the local housing market as we are finding the previous housing bubble has created unrealistic expectations). This doesn’t mean that through negotiations you can’t hold out for a larger offer – negotiating is part of the process. However, if industry comps show your business should be worth $50M and you are expecting $75M, word will get around and your buyer pool could quickly vanish.
Misstep #6 - Marketing Your Company as What You Want it to Be Not What it is
I previously wrote a blog discussing how acquirers of CROs would be wise to spend ample time performing diligence on backlog. Don’t try to position your business as something that it isn’t. A perfect example would be a CRO that is running a couple medical device trials marketing itself as a medical device CRO. You run the risk of turning off buyers looking for a pure play medical device CRO and alienating buyers that aren’t looking for medical device capabilities. The underlying data needs to support your positioning of the business, otherwise the diligence won’t hold up. Buyers could walk away thinking your aren’t sure of your business strategy or even disingenuous about your business. Don’t overthink the issue – position your business for what it is.
Misstep #7 - Not Acknowledging the Competition
A common mistake is thinking that everyone will be lining up to buy your business because its special and now available. The reality is that both financial (private equity) and strategic buyers may look at 50-100 deals before acquiring one (possibly more). INC magazine discusses how in 2009, Riverside Company (a large international private equity firm), saw the sales book for 4,228 companies, visited 347 of the companies, singed a letter of intent with 63 companies and actually acquired 15 of the businesses. Basically, they ended up acquiring .3% of all the businesses presented to them that were available for sale. When I was CFO at Theorem Clinical Research, I would receive 2-3 unsolicited emails a month for CROs up for sale.
Remember acquirers want to buy the best business at a price that balances their upside and risk. Sellers can be founder, private equity or publicly owned. Here is an example of matching up to the competition: I have never met a private equity owned business that didn’t have a CFO and an investment bank assist them with the sale of a business. Standing out among the competition isn’t easy, so I recommend doing everything possible (within reason) to make your business a desirable acquisition candidate.
Misstep #8 - Getting Distracted
Hopefully, you are getting the picture that selling a business is challenging. Getting distracted by this process and letting normal operations slip would not be wise. The last thing you want is for something bad happen that could have been avoided with a little focus. How does an owner keep from getting distracted? Learning to delegate, adding and utilizing key advisors and focusing on what’s important. You won’t be able to do everything yourself as you won’t have all the answers anyway. Many companies have the CFO manage the diligence process and run interference. Put processes in place that allow you to focus on the most important drivers of the business (a good strategy to have even without a sales process).
Misstep #9 - Counting the Money Before a Deal is Done
Kenny Rogers had the best advice here:
"You never count your money
When you're sittin' at the table
There'll be time enough for countin'
When the dealin's done
I have seen this happen before and it isn’t pretty. Former owners that prematurely think a deal is done and then begin to relax and lose focus. Next thing you know the deal is off and you are back to square one. and retirement is off for the foreseeable future. You wouldn't slow down half way through a mile race, so don’t ease up until the deal is signed and closed. Stay focused on the business, due diligence and executing your sales strategy until you cross the finish line.
Acquisitions are a critical component of our business environment. We like to read about the latest rumor or acquisition expected to occur. The clinical research industry has been consolidating for years. Keep in mind that its commonplace for deals to fall apart - due to confidential reasons, we just don't hear about most of the failed deals. Congratulations if you put yourself in the position to sell a successful business - I would advise that you make the appropriate investments and plan accordingly to execute a successful exit strategy as well.
Jason Monteleone is President at Pivotal Financial Consulting, LLC. A Strategic Financial Consulting Firm serving the Clinical Research Industry. Jason can be reached at firstname.lastname@example.org. Follow me on Twitter @JMPivotal.