As I worked with hundreds of businesses as they look at preparing their firms for sale, I developed the acronym FEISTY. To succeed you want your firm to be:
- Financially stable
- Easy to understand
- Industry in favor
- Size is good
- Timing is right
- You can leave the business without blowing it up
Easy to understand
I was talking to a firm one day about selling and they should have been a very good prospect: nearly $5 million in EBITDA, strong growth, a solid revenue forecast going forward, in an industry that was highly in favor. Then I looked at their financial statements: a disaster! On a monthly or quarterly basis, there was unbelievable volatility. Some months there were no expenses. Some months no income. Profit varied wildly from one quarter to the next. I knew that in its current state, the firm was literally unsellable. No institutional buyer would dig further after seeing all that volatility.
What was the problem? Not the underlying business, but the accounting. The firm had a business model where it incurred expenses under a contract and only later received revenue. And its financial statements were produced on a cash basis, rather than an accrual basis. The accounting method was completely unsuited for presenting that type of business. But it was a problem in presentation, not the underlying business itself. When the financials were restated on an accrual basis, buyers could see the business as it truly was, and we had plenty of interest.
So the second step to helping buyers feel safe is to make your company easy to understand. What are some of the tasks here?
Have your financials prepared on an accrual rather than cash basis. See above.
Have your financials audited. There are plenty of institutional buyers that will not look at firms with unaudited financials, or will insist on an audit as a condition of close. You make your company more attractive, and you shorten the selling cycle, if you get this done ahead of time.
Consider a quality of earnings report (“Q of E”). The purpose of a Q of E is to learn about the quality and source of a business’s earnings. While a Q of E is usually performed by a third party hired by a buyer, it’s also common for a business owner to have someone run a Q of E on their business to have a more detailed understanding of their business’s earnings and help the sale of their business run smoother.
During a Q of E, the accounting firm will try to figure out two main things:
- Is a business making as much money as the seller claims it is? (Amount)
- What are the primary sources responsible for the business’s earnings? (Source)
Prepare a monthly management report. A monthly management reports contain actual financial and operational metrics compared to forecast metrics (KPIs). These allow management to quickly see if business is on track, and if not where the variance is taking place. A company that routinely produces these is easier to understand than one that does not, and the fact that these reports are prepared gives institutional investors confidence in the management of the firm.
Structure and populate a virtual data room (“VDR”). Nothing says, “I’m ready to sell” like a well laid out data room. Over 80% of the questions that you’ll be asked during a buyer’s due diligence are well known before the sales process begins. Working with your banker and lawyer you can anticipate the questions, provide written answers and documents to support the answers, and post these online in a secure VDR. When the flood of questions start to come in from buyers, they can simply be answered by sending a link. More than anything else you can do, a well-stocked VDR shortens the selling cycle, keeps the maximum number of buyers interested, and demonstrates you’re ready to do business.
After making your company easy to understand, you want to see if your industry is in favor. We’ll pick that up next week.