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Pitfalls to avoid when selling your business

Updated: Jan 23, 2023

Why short-term attempts to optimise exit value can be a mistake

Let’s face it we all do it! It is only natural, that when you sell your car, you get out the touch-up paint to hide the scratches, get a wash and hot wax, spray the tires black and get a car freshener to make it smell new – or at least smell of fresh pine trees!

Some sellers believe this is the maximum preparation required to dress the car up for the all-important visit to the second-hand car showroom. The more informed seller will perform a full service, ensure the car tires have sufficient tread, that the brake pads are fully functional and that the slipping gears or clanking suspension are fixed. Indeed, the canny seller might even be tempted to tie up the bouncing exhaust pipe with wire, safe in the knowledge that it will pass the cursory inspection of the enthusiastic salesman eager to exchange it for a brand new (and expensive) car. There is a spectrum of seller types: the first group asks themselves why they should invest any money, time and resources in a car which they are going to get no future use of; the second group focus on getting the best return for their old vehicle.

Any temptation to be in the first group of sellers asking why you should invest any money, time and resources in a business you are going to sell, is frankly a mistake, it can seriously impact the valuation which you achieve for the business you wish to sell.

The reasons for this are two-fold

Firstly, the value of the business to a buyer is based purely on its enduring value and cash generation, and unlike a car salesman is unconnected to any premium made on up-selling you a newer model. What this means is that any defects in the asset which may impact the performance or lead to unexpected cash outflows or consequential losses will be viewed as a serious deal risk by the buyer, with resultant chips in the valuation.

Secondly, the inspection of the business, far from being performed by an enthusiastic salesman keen to close a deal, will be performed by a team of professional due diligence advisors led by an M&A director whose very future relies on identifying any negative factors to allow them to be considered in the deal price. These advisors have a “sixth sense” at locating any defects that have been superficially camouflaged. This is not just a tribute to the intellect of M&A advisors it’s just simply that they have experienced it all before. They know where the skeletons are buried!

It is a mistake to be in that first group of sellers who take quick and superficial action; it is a mistake to believe that problems can be hidden rather than resolved; it is a mistake to think that you can sell a business in a similar way to selling a car.

Here are a couple of superficial solutions and common mistakes are commonly uncovered by due diligence, which demonstrate the point.

Superficial Solutions and Mistake #1

Cease or reduce capital expenditure.

A seller may believe he can defer any expenditure to repair a faulty piece of equipment or delay the much-needed new equipment needed to remain his competitive edge. While such investment would likely benefit the future business and therefore the buyer – it is not a sound business reason to delay the deployment of necessary capital purely due to an impending sale. The buyer is acquiring the business as a “going concern”, and as such it is expected that there will be continual funding of capital expenditure. Failure to do so will not only drive the buyer to consider whether the business is under-capitalised but will also trigger suspicion that there are other areas where the seller is trying to preserve cash within the business to maximise his valuation, inviting a greater intensity of diligence.

Superficial Solutions and Mistake #2

Ban on recruitment

A seller similarly may consider banning recruitment on the grounds that this would incur short-term costs which will not deliver an immediate return. Such an assumption ignores the fact that most recruitment is necessary to increase capacity to take advantage of market opportunities or to replace or upgrade staff – all of which are critical for the business as a going concern. Buyers are particularly attentive to levels of staff before a sale, to ensure that the business has the staff complement and skills to deliver the business plan are often the very basis of the valuation. Identifying deficiencies in the very human assets necessary to deliver the plan will throw doubt on the seller’s commitment to the strategy and will deliver a devastating blow to any seller’s equity story – with a consequent impact on the valuation

Even though potential buyers react badly to superficial solutions, some sellers are concerned that proper solutions will reduce the cash funds that a buyer will take as part of the consideration.

There are however three key reasons why this should not be a short-term focus of the seller:

  • The business is only sold when the contract is signed. It is not uncommon for a badly run process to last for 12 months or be delayed due to external events (Covid19) or buyer funding or performance issues. Given this risk on timing, any delay necessary capital expenditure or human resource planning can prove costly to the business in a competitive market and could lead to an impact in short-term results, at exactly the time that management is trying to present business growth. Indeed, the sale process might even fall through, leaving the business in a worse trading or competitive position with which to start re-engaging with another potential buyer.

  • It is often the case that some of the consideration for the business may be by way of an earn-out arrangement on the future business performance, and therefore any defect in investment that impacts trading could have a major impact on the ultimate consideration received.

  • An experienced advisor such as Red Swan will be able to identify where such investments in capital and resources are benefiting the buyer at the seller’s expense and be able to negotiate a deal structure that seeks to compensate the seller for any loss. Such negotiations however must be entered into with credibility that the seller is continuing to invest in the business as a going concern, and not trying to starve the business of its very lifeblood to optimize their exit cash.

At Red-Swan Partners our team has extensive experience from growing and selling their own businesses, being TIC corporate’s M&A executives, as well as working with a wide range of TIC business owners to support them in the development of their own exit strategy. This wealth of relevant market experience allows us to work with business owners to develop the most appropriate plan well in advance of an exit, to ensure that the seller's actions do not conflict with obtaining a premium value for your business.

And to help prevent mistakes from being made.

By Talal Yousef

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