1338 HARDING PLACE • SUITE 200 BANISTER FINANCIAL, INC. CHARLOTTE, NORTH CAROLINA 28204 Business Valuation Specialists PHONE: 704-334-4932 FAX: 704-334-5770 www.businessvalue.com Contact: George B. Hawkins, ASA, CFA, President FAIR VALUETM Reprinted from the Summer 1999 Issue PREPARING A COMPANY FOR SALE­ OBTAINING THE BEST PRICE from the company, but will have to assist in the By Banister Financial, Inc. Staff transition. This assistance usually takes the form of a multi-year employment agreement and a non-compete agreement preventing the seller from starting up a new Introduction. Preparing a company for sale business in the area or joining a local competitor. An cannot be effectively done overnight. Whatever the owner might find it difficult no longer being the “top reasons for contem plating the sale of a pri vately held dog” and watching his company being managed in a busines s, such as we alth diversififica tion or t he lack direction he doesn’t agree with. The business press is of famil y m embers to en ter or ca rry on the bu sine ss , full of examples where former CEO’s have been unable owners shou ld m ake pr ep arations sev e ra l yea rs i n to function as the “number-two” man after a merger or advance. This articl e cove rs ten t opi cs a seller n eeds acquisition (such as with NationsBank and Bank of to consider when preparing his company for sale. A America). thorough business valuation report can help in the In summary, the seller must fully consider sale of a business as it addresses all of the items whether he has the ability to sell the company, is willing di scussed in t h is ar ticle a s we ll a s prov id es an to work with the new owners during a transition period unb iase d est im at e of va lu e. and is truly willing to exit the business by signing a non­ compete agreement. Clearly, companies are sold Assume for the sake of simplicity that there is without the current owner staying on, but buyers and one 100% controlling interest shareholder that has the sellers recognize the need of a transition arrangement to ability to sell the entire company. Shareholder justify any “goodwill” or premium in the purchase price. agreements, employee stock options and supplier The following ten items should be considered by agreements may hinder or prevent the sale of a company. current management as steps in evaluating their How much stock the owner will sell is obviously a major company and preparing it for sale: control issue. A recent example of the power of control Quality of financial statements. Privately held is the failed negotiations between George Shinn and companies operate in fundamentally different ways from Michael Jordan for the latter to purchase a 50% interest public companies. Private companies often seek to in the Charlotte Hornets. Jordan allegedly wanted minimize taxable income whereas public companies control over both business and player issues with only seek to maximize earnings. Private companies often 50% ownership and Shinn was speculated in the press to have shareholder perquisites buried in their financial be unwilling to give up control of the business end. statements such as country club dues, personal travel Working for a New Master- Not Always Easy and entertainment, personal educational expenses, etc. for the Seller. The current owner must also evaluate Whether or not these expenses are truly business-related whether he can work for the new owner. The current is not the issue. The key is that discretionary or non- owner in all likelihood will not be able to walk away operating expenses decrease earnings and therefore © Copyright 2003, Banister Financial, Inc. All Rights Reserved. 1 of 3 PREPARING A COMPANY (continued) value. Eliminating these expenses from the income strong internal accounting controls (IAC). Strong IAC statement several years in advance of a contemplated is not the norm in small businesses as employees often sale will allow the company’s true earnings capacity to wear many hats and have broader responsibilities than in be seen, which is fundamentally related to value. If the larger companies. Segregation of duties is often not owner doesn’t wish to stop running such expenses possible. Appointing one or more outside directors can through the company, at least be able to easily determine strengthen a small company’s IAC as can engaging your the total amount of such perquisites and where they are CPA firm to express an opinion on your IAC system. located on the income statement. This will allow the Develop the next level of management. Strong, buyer to consider the effect of these expenses on effective management is often the most critical factor in earnings. Bear in mind, however, that buyers are a business’ success. A company with a deep inherently suspicious of “add backs” and may or may management team is likely a more desirable purchase not choose or follow-through to add them back in setting candidate than a company with high key person risks. the price they plan to pay. The far better course is to get Given sufficient lead time, current management can rid of these costs years ahead. establish a training program for junior executives that Removal of non-operating assets such as boats, will eventually reduce reliance on a key person. airplanes and marketable securities from the balance Development of an organizational chart and formally sheet can improve a company’s financial condition. defining job responsibilities can also be helpful in These items usually are retained by the buyer and developing an efficient management team. represent non-operating assets that distort the company’s Evaluate shareholder involvement. A major profitability and efficiency. Pay off shareholder loans consideration in valuing small companies is shareholder and advances, and loans to and from related parties if at compensation and involvement in daily operations. For all possible. Ideally, the balance sheet should contain example, an honest evaluation of the need for both a only operating assets and liabilities. shareholder CEO and a non-shareholder general The SEC requires two years of audited financial manager may result in the conclusion that only one statements prior to the issue date for small companies position is necessary. Compensation to non-employed offering stock to the public. Whereas the cost of audited spouses or children in lieu of dividends should stop so financial statements may not be feasible for small that the true earnings of the company are reported. A businesses, “upgrading” compiled financial statements sound basis for shareholder compensation based upon to reviewed financial statements may provide the market data is a good step toward improving the quality potential investor greater assurance that the financial of a company’s earnings. The owner-officer should be statements are not materially misstated. Those able to estimate how much salary and benefits he would companies that only prepare financial statements for have to pay an unrelated executive to replace himself. income tax returns should seriously consider paying for Estimate acquisition synergies. Company A will compiled financial statements with footnotes and a pay more for Company B if A’s management thinks that supplemental schedule detailing operating expenses and the value of the new company (A+B) exceeds the sum of cost of goods sold, if necessary. Financial statements A’s and B’s individual values. Synergy can be created are usually prepared for two purposes in the United by increasing revenues, decreasing costs, decreasing States, financial reporting and income taxes. Each taxes or decreasing capital requirements. The seller can method uses different standards, with income-tax basis help increase the value of his company by identifying statements based upon tax legislation. Financial ways the prospective buyer can realize synergies, such reporting statements are prepared in accordance with as maximizing production capacity, eliminating Generally Accepted Accounting Principles (GAAP), overhead or utilizing tax loss carry forwards. which provides a better measure of economic earnings Identify likely buyers. A seller can help and value. maximize the sales price of the company by identifying Improve internal control. One objective in the most likely buyers in the industry and determining preparing a company for sale is to assure the buyer that the key factors the buyer looks for in a purchase the transactions reported in the financial statements can candidate. A good way to do this is to read the annual be relied upon as accurate and that corporate assets are 10-K reports of the major players in the industry. These reasonably safeguarded against unauthorized use or reports often state the desirable characteristics of disposition. Financial statements audited by an company acquisition candidates such as location, target independent CPA helps generate such reliance as does market and growth rates. 2 of 3 PREPARING A COMPANY (continued) Define corporate strategy. A strong mission Conclusion. What do all of the above factors statement can help a buyer determine whether there is a have in common? They are all covered in a good strategic fit between the seller and buyer. Is the valuation report! A valuation report is certainly needed company a low-cost provider or is it following a prior to the sale of a company. The owner is clearly the differentiation (niche) strategy where it can realize expert in the company, not the valuation professional, higher prices for its product or service? Does it target a but the valuation consultant is an expert at analyzing the certain customer group? Articulating a corporate industry and the company’s performance relative to its strategy may give the buyer some assurance that peers.