“26.2” – How Preparing Your Business for Sale is…

By John Herubin, Managing Director

As we enter into a new year, many will consider a number of resolutions (personal, physical, spiritual, professional) that are intended to improve that person’s life in 2023.  If you watch any amount of television you will notice that the preponderance of popular culture New Year resolutions are focused on weight loss and fitness.

As I witness this phenomena it occurred to me that committing to a fitness goal (say running and completing a full marathon in 2023 – 26.2 miles), can mimic the preparation of an owner and their business for a sale process.

Don’t be confused.  There are days I dread driving 26.2 miles and this is NOT one of my personal 2023 resolutions, although I do know a number of friends and colleagues that have undertaken and completed this daunting challenge.

Years ago I naively assumed that someone could jog five miles a day for a few months and show up at the starting line in Boston to give it their best shot.  Fast forward to today and I marvel at the number of training regimes, time required, and sophisticated fitness monitoring apps available to ensure that a person will successfully complete a marathon.  Similarly, in order for a business owner who is considering the sale of their business to achieve a successful outcome, a significant amount of “training” or preparation will ensure the best outcome to complete this “race”.

A well-run process to sell a business can often take 6-12 months (which can seem like a marathon even to a knowledgeable owner).  Speed/timing to completion is a critical element in achieving success.    The owner that has prepared for this journey will have the capacity to endure both the physical and mental stress that accompanies this process.  Just like in a marathon, you will be competing elbow-to-elbow with potential buyers, their advisors, and some instances with other business owners like you trying to sell their business.  Adequate “training” and preparation will help you separate from the pack and move ahead in the race.

There are aspects of marathon training that I see mirror certain key aspects for the preparation of a business sale:

  • Weight Training = Management Strength

Dedicated marathon runners know the value of whole-body muscular strength, in addition to lung capacity, to carry them through the punishing hills and tough weather conditions that exist in most races, as well as avoid injury.

Developing key employees to augment and diminish reliance entirely on the business owner’s involvement to successfully run the business will enhance the attractiveness and value of the enterprise.  This “bench strength” gained by delegating responsibilities will help distinguish the business and keep the process/race moving.

  • Distance Training = Preparing Detailed Financial Materials

Most runners will methodically build-up their distance capacity in the months prior to a marathon.  This steady activity will enable them to know that they will have enough energy and “gas in the tank” to complete the entire race.

Likewise, the business owner (in conjunction with his deal/race team – more on this later) must review their historical financial records and business reporting to demonstrate the growth and profitability of the business.  Going back several years and analyzing product/service/customer/vendor mix, profitability margins, and uncovering potential future growth opportunities, will entice potential buyers to see the staying power and continued endurance of the business model.  It also provides the owner an opportunity to enhance prior business practices and improve areas not previously a focus of the business.

  • Speed Training = Quality of Earnings (QoE) Assessment

Many distance runners will intersperse speed training in conjunction with their distance training to create balance and enable them to occasionally sprint when the marathon course or competition dictates.

This activity can be equated to an owner deciding to undertake the preparation of a Quality of Earnings report with a CPA just prior to beginning a sale process.  This exercise resembles an audit but is usually more focused in scope (i.e. confirming adjusted earnings, reconciling existing financials with GAAP accounting, aligning earnings for project-based businesses).  It can uncover areas where the buyer will encounter questions from potential buyers, and enable the business owner’s team to be better prepared to answer those questions and keep the process sprinting towards the finish line.

  • Nutrition = Assembling The Deal Team

The body is an incredibly complex engine and most experienced runners know that eating the proper foods/fuel leading up to and in preparation for a race is crucial to a peak performance.

This aspect reminds me of the business owner assembling the proper professionals to prepare for the sale process.  This includes a seasoned CPA to assist with financials and tax planning, an attorney that is primarily focused on merger and acquisition transactions, a financial advisor that can assist with pre and post-transaction wealth management, and a seasoned investment banker to guide the preparation, marketing, and negotiations of a sale process from beginning to end.  An owner that ignores this advice and tries to sell their business without this team in place is like a runner eating too much or too little of the proper food the days prior to the marathon, or not being properly hydrated. The guidance, like nutrition, provided by this team will sustain the owner through the inevitable rough parts of a process (“hitting the wall” in runners language). The pain may result in lost value in addition to painful cramps.

  • The Finish Line = Peaking At The Right Time

Marathon runners who have completed multiple races know that all the above steps in the correct sequence will result in a personal best time for most races.  The exhilaration of finishing a marathon (I’m told) is an emotional and physical high that is not experienced by many.

The “high” we are most familiar with is the immense satisfaction of one of our business owner clients that has prepared for the sale process as outlined above and achieved their “personal best” in value and or terms for their own wealth as well as that of their family, key employees, and community.  Hitting the finish line in our process doesn’t (normally) involve physically collapsing, but our clients know the happy results would not have been possible without the disciplined “training” we provide.

You are more likely to see a “0.0” sticker on the back window of one of my vehicles than the traditional “26.2” or “13.1” (although I do speed-walk a treadmill).  I greatly appreciate the preparation and dedication it takes to properly prepare and successfully compete in a marathon.

Our team is quite familiar with the “training” process that enables our business owner clients to run the race of a sale process that results in an outstanding outcome.

How Important to Selling Your Business is a Plan…

By John F. Herubin, Managing Director

In most instances, an investor or buyer is purchasing an asset in hopes that it will grow in value during their ownership. This is true for a home, crypto-currency, artwork, or classic car. If growth in value is anticipated to be significant, the buyer/investor is often inclined to pay a premium at purchase for the growth potential.

The same can be said for many buyers of closely-held lower middle market businesses. A well-articulated and visible path for growth can often lead to a premium price being paid to a seller of these businesses. The premium can be material if the buyer believes the growth will significantly increase the ultimate return on investment to their general and limited partners and financing sources.

We often discuss with owners we are advising prior to a sale to articulate for us the areas they see where growth might be achieved. From there we often collaborate and brainstorm about growth paths some owners don’t even consider given their singular focus on operating their business day-to-day. We refine and present these ideas where realistic as pathways for buyers to achieve growth and increase the future value of their investment in our clients.

Growth strategies that often resonate with buyers include:

1. Identifying specific acquisition targets – Many of our clients are aware of a number of smaller or same-size competitors that if acquired would increase both top-line revenue and ideally profitability. These acquisitions may also have some ancillary benefits such as adding a product line, acquiring new or larger key customer relationships, or increase in the seller’s geographic reach. Given the challenges most businesses have attracting and maintaining employees, adding a solid in-place work force from an acquisition can also create future value.

With the possibility of a recession or economic headwinds on the horizon, there will likely be some competitors and owners that will struggle financially during these times, and be more open to an acquisition at a reasonable purchase price in order to keep their business going or facilitate an exit. These circumstances certainly occurred during the 2008-2010 recession. There may also be acquisition targets that have not fully recovered from the Covid pandemic and the resulting obstacles (i.e. labor shortages, supply-chain issues, diminished business).

2. Investing In A New Facility Post-Sale – Oftentimes we advise manufacturing companies that are at capacity in their current facilities, to visualize what growth could ensue from buying an existing or building a new/additional facility. This strategy has been more challenging in recent times given the overheated real estate market. If a strong business case can be made for making the investment that will expand sales and profitability in the future, an astute and well-funded buyer will strongly consider this option when making a buying decision on an acquisition target. This decision will potentially expand a business’s geography to facilitate growth. We’ve seen this strategy work especially well for certain businesses such as those involved in distribution where long-term shipping costs can be prohibitive or stretched supply chains can be shortened and mitigated.

3. Purchasing New Equipment – A conundrum (big word for a guy from Youngstown, Ohio) many business owners confront when contemplating a sale is whether to invest in new machinery or equipment that they believe will help them increase revenue and profitability in advance of a sale. Depending on whether the business owner anticipates remaining active in the business post-sale, they often feel that the new owners will disproportionately benefit long-term from the investment they are making in the short-term. This situation is often analogized to the homeowner deciding whether to refinish a basement or bathroom prior to a sale in hopes that it enhances attractiveness/value and they will recoup their investment. Certain buyers with strategic vision can believe and support growth through this strategy and get creative with the seller for the timing of making this investment. The spectrum of strategies may include:

• outright paying for the equipment investment by the buyer
• some negotiated cost-sharing allocation between buyer and seller with a correlating adjustment in purchase price
• post-sale cost-sharing arrangement based on measurable future growth achieved by the equipment investment

4. International Expansion – Where appropriate it can be beneficial to look overseas to achieve growth. Any of the prior mentioned strategies can be applied to expanding beyond domestic markets. We’ve seen this strategy considered where a company has products that might have an untapped or underutilized exposure or potential demand or customers in other countries. Examples include equipment dealers that have not had the ability to access foreign-based dealers for their equipment. A sophisticated buyer (strategic or financial) can help a seller to implement this strategy with a seller that doesn’t have the resources or knowledge to pursue this path.

5. Acquire/Develop Existing or New Intellectual Property – This strategy is often considered where a business deals with a technically sophisticated process or product (think highly engineered aerospace parts, specialty chemical formulas, unique licensing or processes). We’ve seen sellers contemplate acquiring the engineering department and intellectual property portfolio of a specific company to facilitate growth from these types of assets.

An example where these tactics have been successful will help illustrate. We represented a seller who manufactured a precision metal product used in medical and health care environments. The EBITDA (adjusted profitability metric) for this business was hovering around $3MM. The valuation multiple for this business at this level of profitability was in the 4-6X EBITDA range when we began speaking. The owner was still interested in being involved with the business post-sale and had identified several acquisition targets that would expand their geography and diversify their product line and production capabilities.

Two of those acquisitions resulted in an increase in revenue and profitability and added a product in a previously untapped market. When the private equity owner sold the combined entities several years later, the EBITDA had grown to exceed $10MM. The secondary sale as a result of organic and acquisition growth resulted in an exit multiple of 8-10X EBITDA. Our client benefitted immensely from this exercise that occurred prior to initiating the sale process and was quite lucrative to the buyer and their investors.

Business owners are well-advised to explore and discuss with their investment banking professional before embarking on a sale process, the above and any additional growth areas that if marketed properly, can ultimately result in a greater sale value or desired terms.

© Copyrighted by John Herubin, Managing Director, EdgePoint Capital, merger & acquisition advisors. John can be reached at 216-342-5865 or at jherubin@edgepoint.com.