Mergers and Acquisitions For Dummies (14 page)

2. Make sure inventory is all saleable.

If you have obsolete or slow-moving inventory, talk to your accountant about how best to write off this inventory. Writing off inventory decreases the company's earnings, so you want to get this step out of the way before you go through a sale process. If you write off any inventory prior to a sale process, you should be able to discuss the rationale you used for those write-offs as well as the steps you've taken to prevent future build-ups of excess or obsolete inventory.

You put yourself in a precarious position as Seller if, during the due diligence phase, Buyer discovers a boatload of obsolete inventory that isn't reflected on the valuation. In this scenario, Buyer will likely attempt to
renegotiate
(that is, argue for a different deal, probably with a lower price) because earnings are now effectively lower in light of the inventory the company needs to write off.

If you want more information about the wonderful world of accounting, check out
Accounting For Dummies,
4th Edition, by John A. Tracy, CPA (Wiley). Or you can talk to your accountant.

Pay off debt

Another hurdle in selling a company is taking care of your long-term debt. Many Sellers either “conveniently” forget about the debt or hope/assume that Buyer will simply assume the debt no questions asked. Here's a little bit of expert advice: That ain't gonna work! The long-term debt of the business is Seller's obligation.

Don't despair if your business has unattractive long-term debt; you have some options: Retire that debt now, make a plan to retire that debt before closing, or retire that debt at closing. Although Buyer can assume the long-term debt of an acquired company, Buyer will probably simply deduct the amount of debt from the proceeds of the sale. For all practical purposes, if Buyer assumes the debt, Seller is retiring that debt at closing.

If you're worried that your company's long-term debt may block a sale, here's a tip for negotiating with the lending source. Call the lender, explain that a deal to sell the company is on the table but may be in jeopardy because of the company's debt load. Ask whether the lender would accept a percentage of the amount owed (60, 70, 80, or whatever) within a certain time period (such as 45 days) and then consider the debt paid in full if you meet those new terms. Tell the lender that if you fail to meet the terms of this new agreement, your deal reverts to the original 100 percent. The lender, if it accepts the deal, gets the benefit of getting part of its money repaid right away (or in the near future), and if that immediate repayment doesn't materialize, the lender hasn't lost anything. It's an offer some lenders won't be able to refuse. If the lender agrees to this gambit, be sure to memorialize the agreement in writing.

Address legal issues

A wise business owner settles any outstanding lawsuits before a sale and is prepared to talk about those lawsuits and their outcomes. Planning to gloss over or omit mention of lawsuits, or simply expecting Buyer to uncover a lawsuit (or criminal investigation) by itself, isn't smart. These actions indicate that you're negotiating in bad faith, which means you've just kneecapped your credibility. Ideally, you want to be able to honestly say, “We are not aware of any pending lawsuits or investigations.”

The other major legal issue for many deals is the legal organization of the company. In other words, is it an LLC or a corporation (and if it's a corporation, is it an S-corporation or a C-corporation?). These distinctions are important because they affect the taxation of the business.

An LLC and an S-corporation allow for a single layer of taxation, which means the government taxes a sale of assets once, most likely at the prevailing capital gains rate.

The Seller of a C-corporation, on the other hand, gets hit with two layers of taxation. First, she pays on the proceeds of the sale at the corporation level, and then when the remainder of those proceeds is distributed to the shareholders, the shareholders also pay tax, most likely at the capital gains rate. This double-whammy means the shareholders of a C-corporation many be looking at receiving less than 50 percent of the gross proceeds. Ouch.

Sellers should speak with their tax advisors prior to pursuing a business sale and set a plan well in advance of the decision to sell. Depending on the company's legal organization, converting to a different legal entity may make sense tax-wise. But starting early enough is key: When converting from a C-corporation to an S-corporation, you may need a full decade before the full benefit accrues. And don't forget to talk to a wealth manager before the decision to go through a sale process. An able advisor can provide you with a structure for a deal that minimizes your tax burden. Don't wait until after the deal closes to talk with a wealth advisor, or you may be unhappily surprised.

Trim staff and cut dead weight

If you want to maximize the company's valuation, you need to maximize the company's profits. One way is to reduce and eliminate wasteful expenditures, and because the largest expense of most businesses is personnel, you may have to make some difficult decisions.

Please don't read this suggestion as a license to be capricious or cruel. Don't start firing staffers simply for the sake of cutting positions. Make a determination of what personnel you need to run the business and simply execute on that decision.

Don't be afraid to be tough. No one likes to let people go; it's difficult. But if certain employees aren't pulling their weight or aren't performing up to expectations, you need to lay them off. If an otherwise-good employee is in a low/no value position, either move that employee into a productive role or bite the bullet and let him go.

If some staffers are on the edge, give them a chance to improve. Set realistic goals and give them the tools to succeed. My experience has been people respond to this challenge in one of two ways: Either they step up and improve their performance to a tolerable level or they quit. Either option is a suitable outcome.

Increase sales

The other side — and happy side — of the “improve profits” coin is higher revenue. The profitability of your company improves when revenues increase and expenses stay the same. It's simple math, of course, but you can't follow the road to higher revenues until you push your salespeople and perhaps provide a different (that is, more lucrative) commission plan.

Don't settle for short-term fixes that will likely go away when the new owner takes over. That's why permanent plans, as opposed to a one-time, short-term stimulus plan, pay better dividends over time. Set the stage for long-term success. A savvy Buyer sees a short-term gimmick for what it's worth and argues for a lower transaction price.

Quantify owner's expenses and other add backs

Most business owners and executives are familiar with the term
generally accepted accounting principles,
or GAAP. Closely held businesses often utilize a different version, colloquially called FAAP, or
family accepted accounting principles.
Owners of closely held businesses often run personal expenses, such as car, country and other clubs, travel, cellphone, meals, and any other expense that isn't really a business-related expense, through the company. If you're one of those owners, talk with your accountant about how best to quantify and present those expenses.

These owner expenses are add backs to the all important EBITDA calculation. Providing these
add backs
, or a “roadmap of value” as I like to call it, helps provide Buyer with the ability to see the true value in the business and helps improve his willingness to pay for that value.

Although this section shows an owner or executive how to treat owner expenses prior to a sale, I don't actually advocate running personal expenses through a business. If the business is audited by the IRS, those expenses may be disallowed and the owners may face penalties.