Early preparation helps maximize valuation in an M&A sale process

With over 40 years of combined experience as M&A advisers, we’ve advised many owners on selling their privately held businesses. Some businesses are highly sought-after, attracting the attention of multiple highly motivated bidders. The owners of these businesses typically begin planning for a sale well in advance and, with the help of an experienced M&A advisor, can position their companies in the best possible light.

Other businesses struggle to draw significant interest or do not achieve the owner’s desired valuation. In some cases, these businesses have solid underlying fundamentals, yet are unable to achieve an optimal result due to a lack of thoughtful preparation.

Completing successful M&A transactions has additional challenges in today’s post-COVID deal environment. Economic uncertainty and elevated interest rates have cooled the overall market. Many buyers, however, are eager to put money to work. Corporates have record cash levels on their balance sheets, and private equity firms must invest their committed capital to achieve desired fund returns. Given the market uncertainty, these buyers want to invest in the highest-quality businesses. The best-prepared and marketed companies are achieving very strong outcomes.

Below are some ways business owners can prepare for a future sale:

Diversify customers and suppliers: In the eyes of a buyer, one of the biggest risks to a business is an overdependence on a single or limited number of customers. A current owner may have a long, deep relationship with an important customer. Still, a buyer will rightly consider whether that customer’s loyalty will be as strong under new ownership. Similarly, a buyer will view dependence on a single supplier as a potential risk to future production. Buyers will consider these risks in their valuation, so business owners should attempt to diversify customers and suppliers as much as possible before a sale.

Vet historical financials: Buyers will want to ensure the seller’s historical financials are trustworthy and will conduct financial due diligence, typically with their own accounting advisor. Business owners should consider having their annual financials audited by a credible accounting firm before a sale process — this will streamline due diligence and provide credibility to the numbers. At the appropriate time, sellers should also consider retaining an established accounting firm to perform a Quality of Earning (QOE) analysis. This analysis will identify and adjust out any non-recurring items in the numbers, likely increasing profitability and further bolstering credibility.

Create budgets and projections: Owners should institute an annual budgeting process to create a detailed budget for each new year. Buyers will draw comfort from comparing past performance relative to budget. Good performance versus budget will lend credibility to the current owner and management team. In addition, companies should produce medium-term projections (i.e., three to five years) based on a detailed buildup of business drivers, including trackable key performance indicators (KPIs). Buyers will use these projections to help value the business so a thoughtful and logical buildup will help drive buyer confidence.

Focus on profitability: Businesses in most sectors will be valued based on their “normalized” profitability. EBITDA, or earnings before interest, taxes, depreciation, and amortization, is a commonly used profitability metric. Therefore, owners who may have previously run the business to minimize taxes should focus on maximizing profitability before a sale. This could include cutting unnecessary costs and making sure any personal expenses are removed from the business.

Identify long-term growth areas: Understandably, many owners planning a sale are focused solely on near-term growth to maximize the company’s financials at the time of the sale. Buyers, however, will want to know the business will continue to grow after their purchase. A smart seller will set up the company for continued growth (through new product lines, geographic expansion, a pipeline of acquisition targets, etc.) and help the buyer formulate their own growth plan. The more a buyer believes in the future growth of the business, the more it can pay for the business now.

Set up a robust and flexible management structure: Buyers of a privately owned company will want to ensure a strong management team is in place to drive the business post-acquisition. A standalone private equity buyer typically wants a full management team, including a CEO, going forward. A strategic buyer, which may fold the acquired business into its larger operations, may not require a full management team. If the current business owner would like to exit the business upon sale, it is important that the business operations and customer relationships do not appear too dependent on the owner and that a strong group of managers is eager to remain with the company.

Selling a privately owned business can be complicated, and not all sales have a successful outcome. Business owners should begin planning for an eventual exit well in advance, regardless of the market environment. The more prepared a company is for a sale process, the better result it will achieve.