Investors Point to Exit Strategies for Startups*

Based on an interview of George M. Shea, Partner and IT Team Leader, and Manan K. Shah, Managing Partner, FOCUS Investment Banking LLC

You’ve scaled and done all the hard work. Should you prepare your startup for exit? How do you know if your business is ready for a sale or acquisition? As a CEO, it’s important to have your affairs in order before putting it up to the highest bidder. From financial to operational preparation, it’s important to take your time and not take the first offer on the table.

FOCUS Investment Banking‘s George M. Shea and Manan K. Shah share invaluable advice with Hypepotamus about picking the right exit strategy for your company — from knowing the right time and making your company more attractive to managing your employees through the sale and avoiding common mistakes.

How do you know when your business is ready for a sale?

There are several ways to know. Perhaps the business has reached an inflection point, meaning there is a significant incremental investment required to continue the growth of the company into the future. Second, business is at a level where it can comfortably generate the value the sellers are looking for or maybe the owners are planning to retire.

Another sign could be when business is in a sector where there is considerable growth and new competitors are emerging every day. In such scenarios, it would be beneficial to partner with a larger firm with more resources and reach to the market to take advantage of the opportunity.

What steps can be taken inside the business to make it more attractive?

FINANCIAL PREPARATION:

  • Ensure their valuation expectations are in line with market comparable.
  • There is a favorable backdrop/momentum for financial performance. When the business is performing well and future is looking strong, that’s when the buyers are going to be attracted to the business.
  • Audited Financials – not always necessary but would be nice to have if companies can get them ready.
  • Be ready to present necessary level of financial details.
  • Tax Planning – to ensure they get the maximum tax benefits from the sale proceeds.

OPERATIONAL PREPARATION:

  • Streamline the working capital. Reduce unnecessary expenses or speculative investment activity, ensure timely billings and collections.
  • Documentation for key business processes.
  • If the business is contracts driven, make sure that key customer contracts are extended or renewed for a longer term and are not going to expire shortly after the transaction.

How do you get multiple offers from different buyers and leverage those offers against each other?

This is an area where the investment banker is most helpful. The good ones will always produce multiple, competitive offers for quality companies. The key is aggressively going after a broad market of obvious and not-so-obvious buyers; often the best offer comes from an “outlier” who is not directly in the company’s business, but is under a mandate to do so.

Highest value deals come from buyers for whom the target is not just a want-to-have, but have-to-have. Not uncommon for the successful buyer to raise its bid two or more times.

As a CEO, what things do you need to keep in mind when preparing your company for an exit strategy?

This is a difficult problem for companies. Most CEOs limit buyer discussions to top management, and do not inform employees of a potential sale until just before closing. An acquisition will always bring significant change.

Employees will be most receptive to a buyer with similar culture and a willingness to retain staff, and not terminate people to cut costs. Brand retention is always an important issue, and most buyers will be sensitive to this. This is an area that needs to be agreed upon before closing.

When thinking in money terms, what factors should CEOs pay attention to when thinking of selling their business? 

  1. Capital gains treatment vs. ordinary income — transaction should be structured to maximize the former.
  2. Stock sale vs. asset sale — the need to understand the consequences of each.
  3. Contingent consideration as a part of the deal (stock, earnout, seller note) — how open is management to this?
  4. Post-closing management compensation, including incentives, should be discussed early on.
  5. Maximizing EBITDA (earnings before interest, taxes, depreciation, and amortization)

What are some mistakes you’ve seen companies commit prior to considering a sale or offer?

One big one is overvaluing the company. Companies should get a clear sense of market value from both the public market and private company sales of similar firms before starting the process. Another is taking the first unsolicited offer that comes along before thoroughly exploring the market. Once a letter of intent is signed with an exclusivity provision, the seller does not have a backup if the buyer reduces the price during due diligence.

Do you have any other advice for entrepreneurs?

Ideally, potential sellers should start preparing their firms for sale long before going to market. This means having their financials, corporate infrastructure, and management team in place, minimizing any customer concentration, using marketing tools to establish themselves as thought leaders, and understanding their competition well enough to clearly articulate their key differentiators.

*This article appeared November 29, 2016 in Hypepotamus--Atlanta for Startups by Startups