Understanding the Process of Selling A Business

Many small business owners reach a point in their career wherein they make the decision to reduce personal risk and maximize gains through the acquisition of their company. The process of selling one’s business involves a mix of strategically executed procedures which achieve the desired results without sacrificing confidentiality, risk management, mutually beneficial deal structure and optimum price.

In order to achieve effective results, business owners must (1) have a clear understanding of the metrics that govern their business, (2) realistic expectations of the marketplace and (3) a group of trusted advisors, comprised of accountants, attorneys and bankers, in place to provide guidance and structure to the acquisition process.

Steps To Prepare A Business For Acquisition

In order to maximize price and present an ideal picture of your business to the marketplace, key steps must be taken so that your business is properly developed and maintained. The financial and organizational structure of your company should be transparent to a buyer, so that he or she will be assured of the value and feel comfortable in assuming ownership.

Step1: Systematize and Document Your Business

The functions and procedures in your business should be concisely identified so that a buyer can clearly understand the chain of command and how results are achieved. Written agreements with vendors, customers and industry contacts can also bring substantial value to an acquisition. Documented agreements ensure that valuable relationships are concrete and will extend into the future. These assurances create confidence for the buyer and make the company more attractive in the marketplace.

Step 2: Maintain Organized Financial Data

Many business owners are heavily influenced by tax liability. The potential trap in focusing more attention on tax liability than profit performance is that it becomes difficult to prove the true profitability of the business to a buyer. Therefore, assuming greater tax liability in the short-term can result in increased value on the income statements. In addition, profit and loss reports should be generated and reviewed on a monthly basis, the company’s stock levels should be at full value and all capital expenditures should be clearly identified and booked on the balance sheets prior to an acquisition. [1]

Step 3: Maintain Accurate and Updated Corporate Documents

Due diligence is one of the most important elements of the sales process. Diligence items include corporate, legal and tax documents that define and validate the representations and warranties of a company. Business owners should be familiar with the issues and should attend to corporate maintenance on a quarterly basis.

Obstacles in Selling a Business

1) Achieving realistic price expectations. A business has value to a buyer because of its anticipated future earnings and a demonstrated successful track record.[2] Businesses that show consistent growth, positive adjusted earnings and EBITDA and reliable financial projections are able to command high industry multiples and premium prices.

2) Accurately adjusting the net owner earnings. In order to accurately determine value, the balance sheet and income statements should be re-cast and items such as depreciation, owner’s salary and interest expenses can add-back significant value. The re-cast earnings will reflect the actual owner compensation in order to determine market value.[3]

3) Understanding deal structure. Sellers should be educated about possible alternatives for structuring a deal, such as earn-outs, non-compete agreements and long-term employment contracts. These items can add substantial value when combined with the negotiated purchase price. In addition, sellers need to be aware of how business liabilities, such as excess inventory and existing lines of credit, are assumed by the buyer and how liabilities are integrated into the final asking price.

4) Maintaining Confidentiality. Confidentiality is crucial in ensuring that existing employees and clients do not become aware of a potential transaction. If the sales process is not managed and the transaction is disclosed at the wrong time, key employees and valuable customer relationships could be sacrificed, thereby jeopardizing gross revenue if the sale is not ultimately consummated. Savvy buyers will use this as a tool to lower value.

5) Securing qualified buyers. A buyer’s material ability to consummate a transaction must be verified at the start of the sales process so that time and resources are not expended on inappropriate candidates.

6) Maintaining profits and growth during the sales process. Once your business has been introduced to the marketplace, it is crucial to continue to develop and maintain growth until the transaction is fully executed. It is the performance and productivity of the business that holds value in the eyes of a buyer. Therefore, a business that begins to drop-off in the months prior to a sale will incur difficulty in obtaining optimum price and qualified buyers.

7) Preparing proper due diligence. A thorough die diligence manual should be prepared in advance of bringing a business to market. Inaccurate or incomplete diligence materials can destroy buyer confidence and cause a deal to collapse. A seller must be able to defend the representations and warranties they assert during the sales process.[4]

8) Seeking professional guidance and consultation. Sellers should realize that it is nearly impossible to efficiently manage a transaction without the assistance of accountants, lawyers and bankers. These trusted advisors should work in tandem to help sellers achieve the desired results while limiting personal exposure and liability.

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[1] “Selling Your Business For the Best Possible Price” Lloyd’s Business Brokers, http://www.lloydbus.com.au/bestprice.html, pages 2-3, 7/19/2005.

[2] “12 Fatal Mistakes You Can Make When Selling Your Business” Transworld, http://www.tworld.com/fatal.htm, page 2, 7/19/2005.

[3] http://www.tworld.com/fatal.htm, page 1

[4] http://www.tworld.com/fatal.htm, page 2

Pros and Cons of the SB 899

Last year in April 2004, Arnold Schwarzenegger enacted one of his most ambitious campaign mandates, the Senate Bill 899 (Poochigian). SB 899 is a detailed revision of the workers compensation process in California and will have substantial long and short-term effects.

The bill specifies 10 key provisions that are designed to structure and regulate the claims process to an even more stringent degree. However, the bill requires business owners to be more involved in employee claims or risk incurring substantial fines and litigation.

“Due to the tremendous complexities of SB 899, the application and interpretation of this legislation for the near future is uncertain…In fact, the only thing certain is that there will be substantial litigation, both at the Workers Compensation Appeals Board as well as in the civil courts.” Nick Roxborough of Roxborough, Pomerance & Nye LLP

Therefore, while the SB 899 has the potential to provide significant cost-reduction options, employers need to drive the process and remain involved in the handling of employee claims to benefit from these savings.

SB 899 Positives

The following key points are areas of the bill specifically designed to reduce claims costs.

1. Doctors are required to follow specific protocols in treatment, with an emphasis on less and more consistent treatment.

2. Attorneys for injured workers do not get to select doctors for treatment or evaluation of injuries, if the employer has a comprehensive medical network available for care of injured employees.

3. For employers with 50 employees or more, permanent disability awards are reduced by 15% if modified work or a return to work program is offered.

4. Temporary disability payments are limited to 2 years in most cases, down from 5 years previously.

5. Employees with minor injuries will receive a reduction in benefits.

6. Utilization review guidelines are strengthened, specifically defining what constitutes “medically necessary” treatment.

SB 899 Negatives

The following points could result in an increase in employer operational costs.

1. Employers must authorize medical treatment within one working day after a claim form is filed and could be responsible for up to $10,000 on a claim – even if the claim is later proven to be non-work related.

2. Disability awards are increased by 15% if modified work is not offered.

3. Employees with severe injuries will receive substantially higher benefits. Business owners will have to be additionally vigilant in their review and processing of claims cases. There are also several preparatory steps employers should be taking in order to stay current with the legal and regulatory issues affecting workers compensation.

1. Effective 1/1/2005, a medical provider network should be created and active.

2. Return-to-work programs and documentation should be consistent and up-to-date.

3. Review and update the ‘carve out’ portion of your Collective Bargaining Agreement.

4. Complete a self-assessment of your workers’ compensation program with your broker and claims administrator.

If a claim has already been filed, the following steps should be implemented:

1. Each claim should be addressed immediately and fully documented.

2. Each injured employee should submit an accident statement directly after the injury has occurred.

3. Network physicians should be alerted to any suspicious claims.

4. After the employee has been examined, diagnosed and approved to return to work, the employer should submit a written offer of return to work.

5. If an employee is granted temporary disability, the employer or claims administrator should stay in regular weekly contact with the employee. After review of both the potential positive and negative consequences of SB 899, do small business owners feel that SB 899 has created more or less cost-savings alternatives to the workers compensation process?

Value versus Risk

There are two components to each transaction: compensation and risk. While many investment bankers and business owners tend to focus almost solely on compensation, PLG Advisory Group gives equal consideration to the risk associated with each transaction.

There are three primary areas of risk:

(1) Known risks, for example the liabilities set forth on the company's balance sheet, or known regulatory risk;
(2) Unknown risks, for example, unanticipated employee or customer lawsuits; and
(3) Transactional risk, which is the risk that the transaction will be litigated, either prior to or after a closing.

How do small business owners view risk in a business transaction: is price or the reduction of risk the most important component of a M&A transaction?

Worker's Compensation Reform

Governor Schwarzenegger proposed yet another rate reduction to the Insurance Commissioner this month. This is another sign that soaring insurance rates are finally on the decrease, as this is the third rate reduction since the SB 899 was passed in April 2004. However, since California insurance rates vary from company to company, not all employers will feel the relief equally.

My question is, are small and mid-sized employers feeling the effects of this new legislation and the subsequent additional reductions?

Rising Health Care Costs in California

PLG Advisory Group is currently conducting a survey of small business owners and their employees to gain more insight on issues and concerns that are unique to the California business environment. According to the June 2005 survey published in the California Small-Business Conditions report, when asked to rank the state’s business environment – which includes government, bank, the media and community groups - the state’s score dropped 17 points from the previous quarter – making California the second-worst state in the country for small business.

We would like to begin our discussion with employer mandates and the expansion of health insurance coverage. The recent rise and fall of the SB2 bill provides an interesting case study by which to explore how and why the adoption and implementation of employer mandates are both contentious and subject to shifts in economic and political environments.

The goal of the SB2 was to expand health coverage to uninsured Californians by requiring employers with 20 or more employees to provide it or pay into a purchasing pool. The bill was initially signed into effect by Governor Gray Davis in 2003. While employer mandates have been incorporated into employment legislation in other states such as Oregon, Washington and Hawaii, these previous laws included subsidies for employers and low-income individuals, stronger regulation of insurance plans and other methods of cost containment.

The SB2 however, was narrow in scope and did not include specifications to control rising costs of the mandated coverage. Therefore, there were elements of the SB2 that would have been potentially detrimental for both workers and business owners. For example, under SB2 legislation, a family of four with an annual income of about $18,000 a year could be charged as much as $920 per year or $77 a month, plus substantial deductibles and co-pay fees. However, this same family of four would qualify for no-cost Medi-Cal – which would cost both them and the employer $0.

The lack of planning in terms of cost control for the SB2 made the bill unsustainable for employers and inherently controversial for the public. In addition, because of the political shift in California from Gov Davis to Schwarzenegger, there was not enough support for the bill after Davis left office.