By: Mark Gaeto – Managing Partner, Conrad Olenik – Associate
Running a business is tough enough but selling one is equally challenging. Throughout our 16 years of advising companies, we’ve seen plenty of issues that need particular scrutiny before owners can sell a firm or raise capital or transition it to the next generation. Here we’ll present the 5 key issues owners need to examine before exiting a business or raising capital.
1. Accounting Best Practices
Many private companies seem to see accounting as a necessary evil rather than as the core system that measures performance and drives decisions and strategy. As a result, we find that many firms have inadequate accounting detail, accounting controls or reporting systems. The firm’s accountant is often not at a sufficiently senior level, and outside auditors may not be well suited to the firm’s type of industry. Buyers or investors generally want information—and lots of it—before they buy or invest in a business. A selling company’s failure to produce the right information sought by potential buyers, and in a timely manner, is a recipe for a low valuation and suboptimal deal terms. Even worse, poor accounting practices will alert the buyer to potential risk and could even kill a deal.
Our advice is to engage a CPA firm with experience in your industry, in particular one with an operator’s view of the business. You should also use GAAP (Generally Accepted Accounting Principles) accounting and have a formal revenue recognition policy. Your accounting needs to align with how you (should) run the business. For example, if you are a SaaS software company with recurring revenues, your accounting structure needs to be bound by industry metrics and best practices. You need to be capturing the right data at the right level of detail. That data needs to be uniformly understood and accepted. It must serve as a reliable foundation for action across your firm. It has to drive decisions around pricing, customer contracts, cost management, investments, incentives, compensation, metrics, etc. Therefore, your controller or VP of finance’s key role is ensuring that such data—and the knowledge that it creates within an organization—is gathered, accurate, interpreted, managed, properly presented to management, and put into action so you can drive the business forward and make smart decisions. Having a more sophisticated accounting foundation and better performance reporting goes a long way toward helping owners scale the business and provides a high level of comfort to buyers or investors. Note that just because you have the newest accounting software doesn’t mean you have the right accounting system and controls.
So invest in an experienced controller or VP of finance and a good accounting firm, one that can go beyond tax planning and that has experience in your industry.
2. Legal Compliance and Risk Management
Similar to accounting, your legal system needs to be complete across the enterprise. Agreements need to be squarely in place, well written and revisited from time to time. From a corporate and tax perspective, make sure you have the right legal structure. Agreements between partners need to be very well thought out. Plan for the worst when drawing up or refreshing these documents. Next, protect your intellectual property from patents to rights of ownership, rights of intellectual property, assignments of invention, and non-compete and non-disclosure agreements. These agreements have to be in place for any orderly investment in, or sale of, the company. Customer contracts need to clearly state your firm’s and your customers’ obligations and enforce your revenue and margin model. Contract consistency from client to client is very key. Customer contracts will dictate your revenue recognition policy. Employee offers, agreements, handbooks, etc., all must be in order. If you’re selling overseas, make sure you have the proper export controls.
All agreements and contracts have to be signed, digitized and stored in a secure and accessible place. Client contracts, too, must be signed and organized appropriately and, ideally, referenced throughout your bookkeeping according to that contract ID.
Your insurance coverage also needs to be reviewed and updated. We find that many private companies have not purchased all of the insurance required to help manage their risks.
Talk to your legal and insurance advisors and make sure they have experience in your industry.
3. Operational Resilience
When selling a firm or raising capital, investors or buyers want to gain clarity about how the business is run, and understand how mature or reliable the organizational and operational structure of the company is. They want to see process, order and structure because, along with capital, these are some of the essential ingredients to scaling a firm—growing it! A well-organized firm also points to the management and leadership capabilities of the CEO.
What investors and buyers look for are a documented vision, strategies, initiatives tied to assignments and measures. They hope the CEO is organized enough to set the vision, create strategy, drive initiatives, measure effort and hold people accountable. They hope to find performance measures and reporting, by department, to ensure that everyone is kept on track. Your sales department should be measured by leads, opportunities, closed deals, revenue production, net new deals, average deal sizes and even margins. revenue and margin by customer, sales rep, region, product, etc. are super important. Your collections department should be monitored by days sales outstanding (DSO) with the aim of getting that as low as possible and thus boosting cash flow. Your procurement team should be noted for their days payable outstanding (DPO) and how promptly they’re paying the bills. Your R&D team should track their time and expenses to know exactly how much is being spent on various efforts. A solid controller should be able to slice and dice data and give you what you need to measure operations.
Operations and related performance measures should be tied to your accounting system. It’s important to understand revenue drivers, various costs (breaking down COGS vs SG&A expenses is crucial) so you can manage your margins and contract with customers, and measure or rate them in an optimized manner. These suggestions will help drive operational excellence. In other words, they will allow you to drill even further down into margins, and determine the current and ideal unit economics of your business. For an example on how this is considered within cloud and SaaS companies, please reference our earlier post, “Up in the Air: Key Value Drivers for Sellers in the Cloud and SaaS Markets” https://www.falconllc.com/up-in-the-air-key-value-drivers-for-sellers-in-the-cloud-and-saas-markets/ .
Operating partners, management consulting companies, CPA firms, and investment bankers can provide valuable insight to improve operations, as can an advisory board, especially one with savvy industry veterans.
4. Personal Transition Planning
Selling a business is complicated and laden with many emotional issues. The owners are selling their means of livelihood and the configuration of their financial portfolio. There is much to think about and plan for.
Studies reflect that, post deal, sellers wish they would have done things differently. According to SEI Investments, a leading wealth and asset management firm, a study performed by the Exit Institute (which is representative of other studies) over 75% of family-owned-business sellers were dissatisfied post transaction. Only 25% felt like they accomplished their objectives. So why were there so many dissatisfied? Leading wealth management firms found that:
“…the satisfied 25% evaluated the sales of their businesses through a very different lens than the dissatisfied 75%. Instead of a “best execution” or “best transaction” lens, they saw everything through a “transition lens”. The transition lens still enabled them to place tremendous importance on the transfer of the business (as it should) —- but instead of a myopic view on just the sale; the 25% had a broader view — a view from which other, important priorities emerged and could be dealt with — like lifestyle concerns, family impact and, just as importantly, what to do next.”
Note that 88% believed they got the right financial deal. But the dissatisfaction came from what we’ll call softer post-deal issues relating to partners, family, and the question of what to do with their lives going forward. So take some time and do your homework. Many wealth management firms have excellent tools that walk owners through tough decisions, both from business and personal perspectives. The takeaway here is that satisfied sellers simply put in more thought and do better planning.
5. Uncertain Wealth Goals
Selling a private business must be best thought of as an ongoing planning process that begins well before a deal is completed. For a business owner, there is much to grapple with. Most owners focus on getting to some magic number and an all-cash deal. However, she or he may find that other options can offer acceptable and even superior results. We strongly advise owners to consult tax and wealth advisors to work out both personal and financial issues. As mentioned in the previous section, most wealth management companies have modeling capabilities and can quantify how the sale of a firm can meet an owner’s financial and personal objectives. Rigorous scenario analysis is critical to understanding the impact that uncertain future earnings, valuations, and tax rates can have on different deal structures that owners are considering. Unfortunately, many owners don’t work closely enough with the right types of wealth managers or estate attorneys, or do enough around tax planning, and this is the cause of most of the post-deal dissatisfaction they may experience. It’s really important that owners get ahead of this months, if not years, before any transaction of any sort. Firms such as SEI and Alliance Bernstein have wealth forecasting tools that help owners understand what is enough to meet spending, retirement and wealth preservation plans.
To reiterate what we said in the beginning, selling your business is complicated and complex. However, the process can be optimized in such a way as to maximize wealth, post-deal satisfaction and overall business outcomes. We often say that your growth plan is your exit plan, so even if you’re not in a position to consider an exit or outside investment, you should still be thinking about the next 3 to 5 years and have a plan that lays out actionable next steps. Achieving success will require that owners reconnect to markets, get the accounting right in order to understand what drives the business and profits, realign their organizations, and reposition attitudes for any identified opportunities, whether they be growth, succession or exit.. These are the imperatives of today’s fast-paced and hyper-competitive markets. These are the steps we must take to truly differentiate ourselves and deliver enduring growth and owner satisfaction.
Mark Gaeto is a managing director with Falcon Capital Partners, a leading mergers and acquisitions firm, where he directs their commercial technology practice.
Conrad Olenik is an associate with Falcon Capital Partners and began his career with JPMorgan Chase.
Mark can be reached at 610-989-8903 or firstname.lastname@example.org Jackim, R. and P. Christman, “The $10 Trillion Opportunity.” The Exit Institute, 2005.