There is nothing new about companies buying other companies. Acquisition has been going on since businesses first existed, and are recently quite popular within the TPA industry. As with any purchase, most of the buzz usually surrounds the price of the firm or the purchase multiple. When the dust settles, stories arise of how the two companies came together (or didn’t). There are a lot of moving parts when it comes to combining two firms, whether you are a seller or a buyer.
An acquisition from either perspective can be tricky business. Research shows that nearly 50% of all acquisitions fail for reasons that you would expect: valuation of the company acquired was too high, a cultural mismatch between the acquired and the acquirer (very common when a large business acquires a small business), or even a lack of understanding of what the true value drivers are of the acquired firm. Acquirers also have an advantage. They repeat this process with each business they purchase. However, most small business owners will only do it once, so getting it right can be difficult.
Though tax and legal issues can dominate the discussion of a sale, understanding your motivation for selling may be even more important. In 2007, I sold my TPA firm to a public company. I was not yet 50 years old and had dreams of being part of a larger, more powerful organization. I thought I was in a strategic transaction where I could become an active participant in a larger company. In reality, I was part of a financial rollup where the focus was to acquire companies to show scale and then resell. My motivation was strategic; theirs was financial. It was, for sure, a mismatch. So, how can small business owners navigate what will certainly be a difficult and emotional process?
First, identify your reason for selling. Many acquisitions are simply a result of an acquirer knocking on a buyer’s door. This is a definite advantage to the acquirer since the seller is a bit star struck by all the attention and the thought of a big check! So, if the knock came today, what would your motivation be to sell? Some common reasons are listed below:
- The owner has reached a point where they don’t feel that they are as energetic about their business (they’re drained!)
- Family related issues or illness
- An industry turn or revenue loss that overwhelms the owner
- Strong competition has emerged
- Desire to broaden product offering (a DC firm purchasing a DB firm)
- Achievement of well executed business plan
Second, find a buyer that matches your objectives. In addition to my own acquisition, I have had the opportunity to work with several companies who either sold or considered selling their firms. Different owners have different objectives and even different timelines. While all are looking for a great price, one may be seeking a quick exit while another could be looking to broaden their product offering and ensuring that their employees continue to have opportunity after the sale. Chances are that there is more than one motivator so prioritization before entering into discussions with a potential buyer is key. Being involved in the due diligence of a sale should not be taken lightly. It is a long, laborious process. Knowing what you want and doing your own due diligence on a buyer will save you and your staff time, stress and money.
Third, engage your tax and legal professionals. A sale will bring with it significant legal and accounting fees so understand that up front. The first number you will focus on is your price. The second will be the amount of tax that you will owe from the sale! It’s fine to use the accountant and/or attorney who you have dealt with for years, but be sure that they have expertise in mergers and acquisitions (not all do). Depending on your firm’s entity type, a stock sale or asset sale will have different tax and legal ramifications. Understand what type of sale and terms will be ideal for you!
Other areas to consider during acquisition:
- Is the acquirer adequately funded and do you know the source of their funding? If it is private equity or venture capital, ask about their timeframe for holding the acquisition(s) before it is up for sale. PE firms typically have a 3 to 7-year timeframe before flipping their investment (5.5 years in 2015). In my acquisition, we were for sale almost immediately. The constant due diligence from engaging with outside acquirers was exhausting.
- Who runs the show after the sale? The M&A people that are involved in the acquisition are not operations people. Who will be running the firm(s) after the sale? Check to see if the acquirer has staff members or has hired staff members that are from your industry. One recent client discovered that the acquirer they were in discussions with, though a large firm overall, had nearly no staff members allocated to the management of the acquired firms after the sale. Of the few being allocated, none had industry experience.
- Clean up your income statement and balance sheet. Many small businesses legally purchase items in their firms that will not remain corporate expenses after the sale. Cleaning up your income statement and balance sheet will not only help you maximize your sale price, but will also give you a realistic view of what your company is worth. Most sales in our industry occur in one of two ways: a multiple of recurring revenue or a multiple of EBITDA (earnings before interest, tax, depreciation and amortization).
- Track any services that are a work in progress or unrecognized revenue. Do you bill up front or in arrears? If you pre-bill, you could end up owing your acquirer the funds that you have collected for which you have not delivered services. However, the opposite is true as well. If you bill in arrears, or want to mitigate unrecognized revenue, be sure you can track and prove any work in progress that has yet to be billed.
- Lock in your key employees. Having been a member of a bank board during an acquisition, it is a very common practice to use “stay bonuses” to quell employee fears through a sale. Stay bonuses are paid at a stated period after the close and are memorialized as part of the deal. By financially incentivizing key employees, the owner can advance through the process without the fear of turnover in key positions. Employee turnover in a service-based business translates to a loss of clients and revenue, which erodes the ultimate sale price. So incentivizing key employees makes good financial sense.
Whether or not you are currently looking to entertain a sale of your company, it is always wise to go through the process of being sale-ready. You may find that your firm is not worth enough for you to consider a sale and the process may help you to set goals for growth so that a sale ultimately satisfies your financial targets.