The Confidentiality Agreement
When considering selling their companies, many owners become paranoid regarding the issue of confidentiality. They don’t want anyone to know the company is for sale, but at the same time, they want the highest price possible in the shortest period of time. This means, of course, that the company must be presented to quite a few prospects to accomplish this. A business cannot be sold in a vacuum.
The following are some of the questions that a seller should expect a confidentiality agreement to cover:
- What type of information can and can not be disclosed?
- Are the negotiations open or secret?
- What is the time frame for which the agreement is binding? The seller should seek a permanently binding agreement.
- What is the patent right protection in the event the buyer, for example, learns about inventions when checking out the operation?
- Which state’s laws will apply to the agreement if the other party is based in a different state? Where will disputes be heard?
- What recourse do you have if the agreement is breached?
Obviously, executing an agreement does not mean a violation can’t occur, but it does mean that all the parties understand the severity of a breach and the importance, in this case, of confidentiality.
While no one can guarantee confidentiality, professional intermediaries are experienced in dealing with this issue. They are in a position to understand the extreme importance of confidentiality in business transactions as well as the devastating results of a breach in confidentiality. A professional intermediary will require all legitimate prospects to execute a confidentiality agreement.
A confidentiality agreement is a legally binding contract, enforceable in a court of law. It establishes “common ground” between the seller, who wants the agreement to be extensive, and the buyer, who wants as few restrictions as possible. It allows the seller to share confidential information with a prospective buyer or a business broker for evaluative purposes only. This means that the buyer or broker promises not to share the information with third parties. If a confidentiality agreement is broken, the injured party can claim a breach of contract and seek damages.
© Copyright 2015 Business Brokerage Press, Inc.
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The Devil May Be in the Details
When the sale of a business falls apart, everyone involved in the transaction is disappointed – usually. Sometimes the reasons are insurmountable, and other times they are minuscule – even personal. Some intermediaries report a closure rate of 80 percent; others say it is even lower. Still other intermediaries claim to close 80 percent or higher. When asked how, this last group responded that they require a three-year exclusive engagement period to sell the company. The theory is that the longer an intermediary has to work on selling the company, the better the chance they will sell it. No one can argue with this theory. However, most sellers would find this unacceptable.
In many cases, prior to placing anything in a written document, the parties have to agree on price and some basic terms. However, once these important issues are agreed upon, the devil may be in the details. For example, the Reps and Warranties may kill the deal. Other areas such as employment contracts, non-compete agreements and the ensuing penalties for breach of any of these can quash the deal. Personality conflicts between the outside advisers, especially during the
due diligence process, can also prevent the deal from closing.
One expert in the deal-making (and closing) process has suggested that some of the following items can kill the deal even before it gets to the Letter of Intent stage:
- Buyers who lose patience and give up the acquisition search prematurely, maybe under a year’s time period.
- Buyers who are not highly focused on their target companies and who have not thought through the real reasons for doing a deal.
- Buyers who are not willing to “pay up” for a near perfect fit, failing to realize that such circumstances justify a premium price.
- Buyers who are not well financed or capable of accessing the necessary equity and debt to do the deal.
- Inexperienced buyers who are unwilling to lean heavily on their experienced advisers for proper advice.
- Sellers who have unrealistic expectations for the sale price.
- Sellers who have second thoughts about selling, commonly known as seller’s remorse and most frequently found in family businesses.
- Sellers who insist on all cash at closing and/or who are inflexible with other terms of the deal including stringent reps and warranties.
- Sellers who fail to give their professional intermediaries their undivided attention and cooperation.
- Sellers who allow their company’s performance in sales and earnings to deteriorate during the selling process.
Deals obviously fall apart for many other reasons. The reasons above cover just a few of the concerns that can often be prevented or dealt with prior to any documents being signed.
If the deal doesn’t look like it is going to work – it probably isn’t. It may be time to move on.
© Copyright 2015 Business Brokerage Press, Inc.
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Family Businesses
A recent study revealed that only about 28 percent of family businesses have developed a succession plan. Here are a few tips for family-owned businesses to ponder when considering
selling the business:
- You may have to consider a lower price if maintaining jobs for family members is important.
- Make sure that your legal and accounting representatives have “deal” experience. Too many times, the outside advisers have been with the business since the beginning and just are not “deal” savvy.
- Keep in mind that family members who stay with the buyer(s) will most likely have to answer to new management, an outside board of directors and/or outside investors.
- All family members involved either as employees and/or investors in the business must be in agreement regarding the sale of the company. They must also be in agreement about price and terms of the sale.
- Confidentiality in the sale of a family business is a must.
- Meetings should be held off-site and selling documentation kept off-site, if possible.
- Family owners should appoint one member who can speak for everyone. If family members have to be involved in all decision-making, delays are often created, causing many deals to fall apart.
Many experts in family-owned businesses suggest that a professional intermediary be engaged by the family to handle the sale. Intermediaries are aware of the critical time element and can help sellers locate experienced outside advisers. They can also move the sales process along as quickly as possible and assist in negotiations.
Keeping it in the Family
It’s hard to transfer a family business to a younger kin. Below are some statistics regarding family businesses.
- 30% of family businesses pass to a second generation.
- 10% of family businesses reach a third generation.
- 40% to 60% of owners want to keep firms in their family.
- 28% of family businesses have developed a succession plan.
- 80% to 95% of all businesses are family owned.
Source: Ted Clark, Northeastern University Center for Family Business
© Copyright 2015 Business Brokerage Press, Inc.
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The Power of Growth Rate: Differentiating Value in Similar Businesses
In the world of business, it’s not uncommon to come across two companies in nearly identical industries, each boasting similar EBITDA figures. However, their valuations can differ significantly. Let’s consider two hypothetical companies, both with an EBITDA of $6 million, yet one is valued at $30 million (5x EBITDA) while the other fetches a price tag of $42 million (7x EBITDA). The question that arises here is, why such a stark difference in their valuations?
The discrepancy in valuations might tempt one to turn to the typical factors, such as:
- The Market
- Management/Employees
- Uniqueness/Proprietary
- Systems/Controls
- Revenue Size
- Profitability
- Regional/Global Distribution
- Capital Equipment Requirements
- Intangibles (brand/patents/etc.)
While all these factors play a role in the valuation of a company, one key element sits at the end of the checklist that plays an oversized role: the Growth Rate. This value driver is paramount and often becomes the key consideration for prospective buyers when evaluating a business’s worth.
Let’s delve into our hypothetical scenario a bit deeper. The company valued at 7x EBITDA boasts a remarkable growth rate of 50 percent, while its counterpart, valued at 5x EBITDA, shows a modest growth rate of 12 percent. This difference in growth rate can be a game-changer, significantly impacting the valuation multiples.
However, to comprehend the real growth narrative, it’s crucial to address certain pertinent questions:
- Are the company’s growth projections credible?
- Where is the growth originating from?
- What products or services are driving the growth?
- Where and why are customers supporting the projected growth coming from?
- Are there long-term contracts in place?
- How reliable are these contracts or orders?
These questions help buyers and sellers alike to unravel the true story behind a company’s growth rate, allowing them to evaluate the potential for future expansion. It’s not just about the current growth rate but also the sustainability and quality of this growth.
For instance, growth propelled by a diverse customer base, innovative products, or services, and a strong market position can be more sustainable and thus more valuable. On the other hand, growth reliant on a few major contracts or a limited customer segment might entail more risk, potentially reducing the company’s valuation.
Moreover, the credibility of growth projections is also paramount. Buyers tend to prefer businesses with reliable, well-documented growth projections backed by robust strategic plans.
To conclude, while many factors contribute to a company’s value, the growth rate often holds the key to unlocking its true worth. It is not the sole determinant but often becomes a decisive factor differentiating two similar companies. Understanding this can enable businesses to plan better, optimize their growth strategies, and maximize their value in the marketplace. So remember, when it comes to business valuation, the growth rate often dictates the tale of the tape!
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What Are Buyers Looking for in a Company?
It has often been said that valuing companies is an art, not a science. When a buyer considers the purchase of a company, three main things are almost always considered when arriving at an offering price.
Quality of the Earnings
Some accountants and intermediaries are very aggressive when adding back, for example, what might be considered one-time or non-recurring expenses. A non-recurring expense could be:
- meeting some new governmental guidelines,
- paying for a major lawsuit, or
- adding a new roof on the factory.
The argument is made that a non-recurring expense is a one-time drain on the “real” earnings of the company. Unfortunately, a non-recurring expense is almost an oxymoron. Almost every business has a non-recurring expense every year. By adding back these one-time expenses, the accountant or business appraiser is not allowing for the extraordinary expense (or expenses) that come up almost every year. These add-backs can inflate the earnings, resulting in a failure to reflect the real earning power of the business.
Sustainability of Earnings
The new owner is concerned that the business will sustain the earnings after the acquisition. In other words, the acquirer doesn’t want to buy the business if it is at the height of its earning power; or if the last few years of earnings have reflected a one-time contract, etc. Will the business continue to grow at the same rate it has in the past?
Verification of Information
Is the information provided by the selling company accurate, timely, and is all of it being made available? A buyer wants to make sure that there are no skeletons in the closet. How about potential litigation, environmental issues, product returns or uncollectible receivables? The above areas, if handled professionally and communicated accurately, can greatly assist in creating a favorable impression. In addition, they may also lead to a higher price and a quicker closing.
© Copyright 2015 Business Brokerage Press, Inc.
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