How to Prepare for a Transaction

By: Richard Harmon

“Always be ready to sell.” It’s a timeless business adage. Transactions require a mix of vision, timing, and most importantly, preparedness.

Consider this scenario:

In less than three years, your business has grown from a small consulting project to a services firm with hundreds of employees and Fortune 500 clients stretching across 30 states. Your limited partner, thrilled by the growth and profits, wants to sell his share. The market is peaking, and you realize there may never be a better time for a liquidity transaction. So you decide to join your partner and sell the entire business.

But a snap decision like this is only possible when a company has made the right preparations. I appreciate this better than most, because that was my company.

We had audited financials dating back to inception and extensive, organized operating documentation. As a result, our buyer closed quickly and leveraged that same information to hold a successful IPO shortly thereafter. For myself and my partner, the seamless transaction, coupled with our growth momentum, resulted in a significant exit.

This type of situation plays out constantly in businesses across America. Owners who get ahead of potential transactions, and lay the groundwork to sell well in advance, are often rewarded with timely exits and high valuations.

If you want to get ahead of the curve, here are nine things you can do to optimize the value of your business and prepare for an M&A or Employee Stock Ownership Plan (ESOP) transaction:

  1. Make sure your financial statements have integrity. Your financial statements are your scorecard. No one buys a business without a scorecard they trust. So, engage a CPA firm and have your financial statements audited or at least reviewed on an annual basis. Not having audited or reviewed financial statements will extend the due diligence process and undermine value.
  2. Normalize your EBITDA (earnings before interest, tax, depreciation and amortization). Most businesses have several expenses that wouldn’t continue if the owner sold or retired. Those items may include and owner’s salary, auto expenses, travel, insurance, donations, and family expenses. All can be added back to normalize EBITDA. Expenses for one-off initiatives can also be added back. For example, you may have incurred expenses related to a software transition or a move to a new facility. Documenting these add-backs can have a meaningful impact on your EBITDA and improve your sale price.
  3. Get a Quality of Earnings (QOE) Report. Prepared by your CPA firm, a QOE report assesses the accuracy and quality of past earnings and assets while evaluating the future sustainability of those earnings. It objectively documents the condition of your business and highlights potential areas of concern that would otherwise only be discovered during a buyer’s due diligence process. A QOE report also assesses one-time, non-recurring addbacks and/or expense reductions that affect your normalized EBITDA calculation. Buyers are increasingly asking for QOE reports. Having a QOE will give your buyer confidence and help expedite your transaction.
  4. Document all key relationships. This includes vendors, customers, employment agreements to retain essential staff, licensing agreements, leases, permits, intellectual property, insurance, incorporation documents, and the like. As they say – if something’s not documented, it doesn’t exist.
  5. Settle any legal suits. Frivolous or not, uncertainty surrounding legal action, especially of a material nature, will diminish value. Settling is often the best course.
  6. Be mindful of customer or vendor concentrations. The less dependent you are on any one supplier of customer, the more resilient your business and the higher multiple you will command.
  7. Be an owner, not an operator. If you are able to reduce operational dependence on you, you are more saleable, so make sure your team can function without you. The more dependency on the departing leader, the bigger the reduction in sales price.
  8. Don’t grow complacent. Optimization can drive valuation. New sales initiatives coupled with cost cutting measures are tools used by every business to maximize profit. The better you master this dance the more valuable your equity will become.
  9. Have your story ready. How did your business evolve? What sets your business apart? What makes your organization special? Telling a compelling story will inspire buyer interest and help command top dollar. Imbed your story in a financial memorandum that includes the history, the future and your financial information.

Ultimately, timing and momentum are essential. Maybe you have new products or services under development that are gaining traction in the marketplace. Or, your sales are rising and profits are increasing. Either way, the market can appreciate and value your company’s momentum. Businesses that are transaction-ready are best positioned to capitalize on momentum and secure a premium price.