[Originally Published in the Spring 2017 issue of Artisan Spirit]
In the course of advising entrepreneurs, Hooch and otherwise, I regularly receive this objection when offering suggestions about how to maximize the value of a business. This conversation springs from my belief — odd as it may seem — that one guiding principle for decision-making in a for-profit venture should be the question of what course of action is most likely to increase the value of the enterprise in the eyes of a potential acquirer. And, naturally, the potential of such an acquirer can offend the proud owner of a business who expects to run it throughout her career and then pass it along as a legacy to her progeny.
But of course it rarely actually works that way. The vast number of businesses that survive (i.e., businesses that do not simply fold) do not find their way into the hands of their founders’ heirs. They are more commonly sold to a third party. And even if they did end up in the hands of the entrepreneur’s kids, using the critical eye of an independent acquirer as a test for decisions offers the owner a lens through which to evaluate capital expenditures, expansion plans, personnel decisions and any number of other critical items. So, if we assume as true the notion that an acquirer’s perspective is useful for approaching the management of your business, then perhaps we can also agree that one of the better things you can do as you proceed down the path of entrepreneurship is to be continuously working to prepare your business for sale.
With that in mind, how do you prepare for such a transaction? Building on prior discussions in the fall and winter issues of Artisan Spirit, below I explore a number of concrete ways to build value in preparation for a potential sale, whether that sale is actually on the horizon or simply being used as a hypothetical exercise to aid in decision-making to build enterprise value.
First Things First: What Is Your Business? Several years ago, my wife and I had occasion to put our family’s home on the market. We dutifully engaged a realtor, who earnestly told us that our small house would “show better” and be more attractive to potential buyers if it looked larger — and the best way to make it appear more spacious was to reduce the number of things inside. The realtor wanted to stage the house and said she needed to remove some of our belongings and rearrange the furniture. She was being kind when she described the needed steps in this way. In fact, what she intended to do was to remove substantially all of my belongings from the space — leaving my wife’s things — and rearrange accordingly.
At first I was hurt by this. After all, removing my things was a reflection on me, wasn’t it? Was I, in some way, an embarrassment to the household? Well, perhaps. But perhaps not, as well. After all, maybe that chair in the living room (that fit my posterior so perfectly) was just a little bit bedraggled. What’s more, what if our target buyer wasn’t a business lawyer with a penchant for playing the banjo? What if by force of my personality, likes and dislikes, hobbies and foibles, I was a potential impediment to my own goal: the maximization of the value of our home in a sale?
To be sure, selling your business is in many respects different than selling your home. But in this respect it is not; the buyer’s potential use of the asset is more important than your own when it comes to determining what the buyer will pay. While I might highly value a place to sit in a comfortable chair surrounded by banjos, a buyer is just as likely (or more likely) to value a reading nook or watching television in that same space. Similarly, while you may value an experimental program in which you are doing interesting and exciting things with unusual yeast strains as you work to perfect a signature sweet potato based gin, a potential buyer may prefer that you devote that time, energy and resource to the development of something a bit more mainstream.
The key here is not to view a buyer’s views as indictment of your own, or as a dismissal of your aspirations, but rather to understand that achieving the maximum value for your business is most likely going to be obtained from pursuing a business strategy that is consistent with what the greatest number of potential buyers will want. Make no mistake, in taking this approach you may lessen the likelihood of finding that one potential buyer who is willing to pay a significant premium for your company because of your quirky gin. But you significantly increase the chances that you will find multiple potential buyers who may be interested in acquiring your business. And just as I hoped to find multiple buyers for my home, your chances of maximizing the value of your enterprise are greatly increased if you’ve got multiple offers.
With that in mind, what is your business? What are the key products that you are bringing to market today and that you expect to bring to market in the future? How do these products fill a market void? How are they compelling to the consumer? You must be able to answer these questions for yourself succinctly and without hesitation, in order to be able to convince a buyer to write a big check. And to answer them in such a fashion may require you to take a hard and fresh look at the business and its initiatives, and pare back those initiatives accordingly. In short, you may need to hide the banjos.
Next Up: Doing the Maintenance. Truth be told, there is quite a bit of drudgery involved in running a small distillery. From polishing copper stills to filling bottles and affixing labels, there is often not much time left at the end of the day to actually enjoy the product of your labors. But unfortunately the care and maintenance of a spirits business doesn’t stop there. To achieve the best potential outcome of the sale of your business you need to be doing more than the day-to-day physical tasks associated with the operation — you also need to spend some time focusing on legal maintenance.
A list of all the specific to-do items of legal maintenance for a business preparing for sale is beyond the scope of this piece, and in any event will be different for the specific business being sold. But as a starting point, consider the following:
- Corporate Records. Is the business up to date in terms of meetings of its Board of Directors and Shareholders (or similar governing bodies)? Do the records of the business contain minutes of their meetings (or written consents in lieu of meetings)? Is the Company’s ledger of shareholders (or members if the business is a limited liability company) up to date? By paying close attention to these items and being able to demonstrate attention to detail to a potential acquirer, you reduce the likelihood that your buyer will reduce the potential value placed on the business because of concern that corporate formalities haven’t been followed.
- Intellectual Property. Regardless of the specific nature of your spirits business, you almost certainly have some form of intellectual property. That property could be as simple as the recipe for your spirits (possibly a trade secret), as complicated as your patent application for a new form of dephlegmator, or anywhere in between (e.g., trademarks for your logos and copyrights for your written materials). In each of these cases, you need to consider the appropriate level of protection to seek for the underlying intellectual property, the jurisdictions in which you want to obtain that protection, and how far you are willing to go (i.e., how much you are willing to spend) to maintain it. Make no mistake, with some types of intellectual property (particularly trademarks), you must police the actions of others (i.e., prevent them from infringing on your rights) if you want to keep your rights. That can be an expensive proposition, but if you want to achieve the best value for your business in a sale (and you believe your brand and goodwill are a significant portion of the enterprise’s worth) then it is likely money well-spent.
- Contractual Matters. As part of your preparation for potential sale, you need to review and evaluate the contractual position of the business. A potential buyer will do this in its consideration of the transaction, so you are well advised to undertake your review well before starting a potential transaction process in order to have time and opportunity to address any potential concerns. For a spirits business, contractual concerns most commonly center around distribution agreements. A particularly onerous distribution agreement can, in some cases, make a buyer reconsider making an offer. And even if the buyer doesn’t walk away, the buyer may be expected to offer less for a business if the acquisition will mean that it finds itself saddled with a distribution agreement it doesn’t want, such as one containing a draconian buyout clause.
In addition to reviewing distribution agreements, however, spirits companies should also look at several other forms of agreements that are not unique to the spirits industry. Those include leases for any real property; employment contracts for key employees; intellectual property licenses to which the business is a party (either in-bound or out-bound); employee incentive arrangements (e.g., stock option plans); and any other contractual arrangement that is likely to have a change in control provision which may be triggered by the potential transaction. In reviewing these items, take particular care to understand whether the contract will require the consent of the other party in the context of a potential sale, or whether a potential sale will result in a loss of your rights under the agreement, and try to address these concerns before beginning discussions with buyers.
- Financial Matters. All too often, privately held businesses (large and small) are embarrassed when the time comes for them to share their financial statements with a potential acquirer. The problem isn’t so much that the financial statements make them look bad or that they look too good, but rather that they simply don’t always reflect the results of the business if it were to be run by a neutral party. The business may be paying for personal expenses of the founders, or it may be accounting for costs of the business in a manner more related to tax positioning than an effort to cause the financials to accurately depict the business’ operations. Certainly, accounting and tax rules can differ, but for a buyer to properly evaluate the results of an operation it really needs to have transparency and an understanding of how the business has been run. For most buyers of any meaningful size, this means they want to see a target’s financial statements to be prepared in accordance with generally accepted accounting principals (GAAP). Note that the GAAP financials of a target don’t necessarily need to be audited — depending on the size of the operation that may be an unnecessary expense — but they should be reviewed by an outside accountant if the intent is to give a buyer comfort that the financial statements are reliable.
Third Act: Try to Have an Out-of-Body Experience. This one is tricky. Much like the realtor’s effort to stage my home, the savvy seller (or potential seller) will want to conduct a thought experiment and put herself in the position of an acquirer. With that perspective, she should consider two questions. First, what problem is the potential acquirer trying to solve in its own business by making an acquisition? If the seller can identify something that the buyer (or better yet, a class of buyers) needs, then the seller can use that information to position itself as a solution to the buyer(s) problem(s). Make no mistake, this is a difficult task. But the seller that achieves this feat will be rewarded by having significant leverage in negotiations with the potential buyer.
Second, what problems will the potential acquirer find in the seller’s business and strategy? In some businesses, these problems consist of customer or supplier concentrations (e.g., a substantial majority of the seller’s products are sold to a single customer — or the seller is troublingly dependent upon a particular supplier in order to make and sell its products). In other businesses, these problems consist of internal difficulties (e.g., a fractious shareholder, former partner or disgruntled former employee). Your buyer will not want to purchase a problem — and so may discount the value of your business significantly if these or similar problems present. The clever entrepreneur will scour her business for these pitfalls and address them before approaching buyers.
Final Efforts. Unless you are a serial entrepreneur, you may only sell a business once. And when you do, it can be a very stressful time. To navigate these waters, it helps to surround yourself with people who have done this before. For that reason, the wise entrepreneur will begin assembling his transaction team well before a potential sale. That team will include the usual professional suspects (e.g., accountant and attorney) but may also include a few supporting characters who can play very useful roles.
First among these supporting characters is an entrepreneurial mentor. If you have successfully brought your business to a point where someone might want to buy it, chances are pretty good that you’ve found a mentor or two along the way. This is not the time to abandon those relationships. Rather, the support of a friend who has sold a business (or several) in the past can be extremely helpful. This person can act as a sounding board for you as you evaluate potential deals and post-closing arrangements, and can be a valuable support when you believe that the business may not survive the attempt to sell it and the accompanying distraction of the sale process.
Second, consider the benefit that can be found by bringing in your own personal financial advisor or estate planner. If this is your first sale, you may have a significant amount of your personal net worth tied up in the business. Selling the company can be a key to unlocking that value, but it is wise to have your personal house in order before you turn that key.
The last thing you want is to sell your business for a fantastic price only to find that because of the way you held the business (or your interest in it) you owe more tax on the transaction than might have been necessary. Getting your financial advisor involved early can help avoid this result. And of course you also don’t want to sell your business, obtaining a large amount of cash and then find that you spend it too quickly. Your financial advisor can help you avoid this as well.
Not every business is identical, and consequently not every transaction faces the same particular challenges. But by being prepared early, assembling the right team, keeping up with the necessary maintenance and putting yourself in the position of a potential acquirer, you can anticipate the majority of the problems that may impede or change the value of your potential transaction. Of course, you may never wish to sell. In fact, you probably don’t. But just in case you ever do, consider these tips. And I’ll let you in on a little secret — doing these things will also help your business flourish regardless of whether you sell. Not a bad outcome.
Brian – thanks for the column. Thoroughly good advice.
I hope you are compiling these columns with an eye to publishing them in a book. Particularly the ones bearing on selling a business. That act is so personal and, almost, intimate that it is hard to be objective about it.
Keep up the good work.
Thank you, Ed.